What are Non-convertible debentures (NCDs): Meaning, Types and How they work?

The Indian stock market is a complete solution for investing in a number of securities and making wealth by investing in the stock market over a period of time. In the stock market you can earn a return on your investment such as equity, And if you want to invest in low risky instruments then you can invest in debt instruments which offer a safer investment compared to equity or other volatile instruments.

To highlight a less riskier investment and earn constant gain you can invest in debentures.

What are debentures?

Debentures are unsecured bonds. Unsecured bonds are those that have no specific collateral or security tied to them. In case the issuer company fails in paying the interest or principal to bond holders, when they become due, the bond holders will have to make claims against the general assets of the company, in order to get their money back. There will be no specific assets that will be automatically put to sale to pay back the bond holders, the amount that is still owed to them. Debentures are usually issued for a long term, say for a period of more than 5 years. Debentures can be issued by companies as well as governments and their agencies.

Besides debentures or unsecured bonds, there are secured bonds too. Secured bonds are those that have a collateral or security tied to them. So if the company whose debentures you have bought defaults on the interest or principal that is due to you, the secured asset or collateral will be sold to pay that interest or principal. The security is usually some asset of the issuer company.

What are Non-convertible debentures (NCDs)?

Non-convertible debentures (NCDs) are those that cannot be converted into the equity of the issuing company. Debentures can be convertible too. Convertible debentures can be converted into the equity or shares of the company, after some time, usually at the option of the bond holder. The conversion ratio is specified at the time of selling of convertible debentures. Conversion ratio is the number of shares of the company that will be issued to the bondholder for every unit of the bond or NCD that the bondholder owns.

Types of non-convertible debentures

Non-convertible debentures can be registered NCDs or bearer NCDs. In registered NCDs, only the person in whose name, the debenture is registered will have the right to receive the interest and principal payments. In the case of a bearer NCD, anybody who is in the possession of the NCD will have the right to receive the interest and principal payments on the NCD.

NCDs can also be classified as redeemable or irredeemable. Redeemable debentures have a specific date of maturity. On the date of maturity all the principal is paid back to the debenture holders. Irredeemable NCDs are perpetual in nature. This means that interest on them is paid forever but there is no maturity date, on which the principal amount will be paid back.

Key features of NCDs

Key features of NCDs are:

• They are non-convertible in nature. They cannot be converted into the equity or shares of the company at a later date.
• They are usually issued for a long term.
• They are unsecured. They are not secured by any specific collateral or security.
• NCDs are debt that the issuing entity owes to those who have bought the NCDs. The issuer therefore has the legal obligation to pay back the interest and principal to the NCD holders, when they become due. If the issuer fails in doing so, then it will be rendered bankrupt. Its assets can then be sold to pay the amount due to NCD holders.

Key benefits of NCDs:

• Interest income can be earned through investment in NCDs.
• NCDs issued by companies that have investment grade credit ratings are quite secure in nature. They have low or negligible credit risk. Credit risk is the risk of the issuer company not being able to pay back the interests or principal on the NCDs, when they become due.
• Credit risk is high in case of NCDs issued by companies with low credit ratings. To compensate for this higher credit risk, these NCDs pay a higher interest rate.
• Some types of NCDs, like those issued by governments, may have some tax benefits too.

How does investment in NCDs work?

Most NCDs are now issued in demat form. Demat means dematerialized or electronic form. So you need to have a demat account with a broker such as IIFL Securities in order to buy NCDs when they are first issued by the issuing company or entity. The application process is almost similar as that for stocks or other securities. Your application is supported by blocked amount (ASBA). This amount is released from your account and paid to the issuer company when the NCDs are allotted to you.

Each NCD has a face value. The face value is the principal amount that the issuer owes to you. An NCD can be issued by the issuer at a price more than the face value, equal to the face value or less than the face value. Usually, the price at which an NCD is issued by the issuer company is equal to the face value. The face value of one NCD is usually Rs 1000. There is also the coupon rate that will be paid on the NCD. This coupon rate is the periodic interest rate that the issuer entity will pay to those who invest in the NCD.

You can also trade in NCDs that are listed in secondary markets, such as the various stock exchanges. This trading can be done through your trading account with IIFL Securities.

Conclusion

NCDs are unsecured debt securities. Investment in them could offer good diversification to those who also invest in equities. NCDs of investment grade issuers are also a secure form of investment.