Debentures are long term financial instruments that companies issue to raise more money from investors. It is generally not backed by any collateral and thus highly depends on the creditworthiness and reputation of the issuer.
Because of this reason, debentures are mainly issued by large companies to raise funds at a fixed rate of interest without any security.
There are various types of debentures. One such category is convertible debentures and nonconvertible debentures.
Convertible debentures are those debentures which give an option to the holder to get it converted either in a share of the issuing company after a specified period of time.
On the other hand, NCD meaning is that debentures do not provide any such option to the holder at the time of maturity.
What are Non-Convertible Debentures?
Non-convertible debentures are fixed income instruments for specific terms and interest rates.
Big companies issue them to raise funds without giving any option of conversion to equity.
The interest rates offered on NCD debentures is more or less fixed. On maturity, the investor will get back the principal amount along with interest. Since NCDs are not backed by collateral but just the creditworthiness of the issuer, ratings given by credit rating agencies become important. Such ratings help investors to understand the history of the issuer’s creditworthiness and what it may look like in the future.
Types of Non-Convertible Debentures: Secured and Unsecured
There are two types of non-convertible debentures:
Secured NCDs: Secured NCDs are those NCDs that are backed by the issuer company’s assets.
Unsecured NCDs: When the NCDs are based only on the creditworthiness of the issuer and not backed by assets, they are called unsecured NCDs.
Features Of Non-Convertible Debentures
Companies provide non-convertible debentures through open market public issues, which the interested investors can buy with a specified period.
2. Tradable Securities
Non-Convertible Debentures are traded in the stock market.
3. Credit Rating
Non-convertible debentures are not backed by any collateral, thus only companies with good credit rating can issue debentures. Even the NCD debentures are regularly rated by the credit rating agencies.
The interest rates are mostly fixed. The interest rate has an inverse relationship with the creditworthiness of the company. A high credit rated nonconvertible debenture will have lesser interest rates.
5. Return Rates
Every non-convertible debenture can earn returns in two ways – growth based and interest-based or cumulative opportunities. Secured NCDs may offer higher interest rates than unsecured NCDs. This is because the secured non-convertible debentures are secured by the company’s assets. They are considered to be relatively less risky.
How to purchase NCDs?
The issuing company begins the public issue of its NCD for a specified period. NCDs are listed on the stock exchange after that as specified by the company. After it gets listed on the stock exchange, one can invest in NCDs through registered brokers or any other medium through which the stock exchange can be accessed.
Factors To Consider Before Investing In Non-Convertible Debentures.
Non-convertible debentures are mostly backed by the creditworthiness and debt servicing capability of a company. Hence it can be said that they are highly affected by the nature of business and its money management capability. These instruments are vulnerable to business risks and threats. This is because if the company borrows more than it can pay back, its credit rating will go down.
Here is a brief summary of some factors you should consider when buying NCDs
1. Credit Rating Of The Issuer
Credit rating tells about the ability to raise funds from internal or external sources and its sustainability.
As non-convertible debentures do not give any option, it highly depends on the repayment capability of the issuer. Thus, it’s recommended to choose those companies with an AA credit rating or more.
2. Debt Level
Some scrutiny of financial statements of the issuer is also required before investing in any non-convertible debentures. The assets quality of the company, debt-equity ratio, etc should be considered.
3. Capital Adequacy Ratio
Capital Adequacy Ratio (CAR) gauges the company capital and sees whether the company has sufficient funds to survive potential losses.
4. Provisions For Non-Performing Assets
Keep a track if the company is regularly being able to apportion provisions for its non-performing assets. This will also depend upon if the company is able to churn enough profits.
5. Interest Coverage Ratio
This ratio shows the number of times the interest is covered by the earnings of the company. It determines how comfortably a company can settle its interest obligations. Thus, a higher interest coverage ratio may act as a plus point.
Organizations tend to raise funds through non-convertible debentures mostly to fulfil a specific business purpose. So, consider knowing more about the purpose of raising funds, where and how these funds will be used.
Just the interest rates alone does not decide the actual return an investor may get from the investment into non-convertible debentures. Running a check on the company’s health is also important; to check if the company will be able to honour the NCD payments to investors on maturity.