Non convertible debenture| NCD
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Know About NCD’s

A company can raise money for the purpose of carrying on its business by either issuing shares and/or taking loans and resorting to borrowings. The companies may use different ways to raise loans like they may take a loan from a bank, financial institutions, raise money from abroad, or raise money from the public. The loan can be taken as a deposit repayable within a fixed time period, at a fixed/floating rate of interest payable on maturity or fixed periodical intervals.

When they take a loan from the public other than deposits by issuing instruments of debt against the company, the certificate is usually called a debenture or a bond. Debenture includes debenture stocks, bonds or any other instruments of a company evidencing a debt, whether constituting a charge on the assets of a company or not as defined in section 230) of the Companies Act, 2013 Basically, the debenture is represented by a document or certificate signed by the authorized officers of a company, acknowledging money lent and guaranteeing repayment, with interest and with or without security on the assets of the company, for due performance of its obligation. The debenture is a debt instrument and is the commonest method of raising loan capital at a lower cost than a Bank borrowing, as part of project financing or for any other purposes.

The types of Debentures classified by its characteristics may be as under:

  • Unsecured Debentures also known as Naked Debentures
  • Secured Debentures
  • Redeemable Debentures
  • Perpetual Debentures
  • Bearer Debentures
  • Registered Debentures

Some companies allow such debt to be converted to claims in the form of shares. The conversion may be in full or a part of the debenture . Depending on the convertibility, the Debentures may be classified as Fully Convertible Debentures (FCD), Partly Convertible Debentures (PCD) and Non Convertible Debentures (NCD).The conversions into shares may take place between 18 months to 36 months.www.rbi.org.in

What is a Non-Convertible Debenture (NCD)?

A non-convertible debenture (NCD) is an instrument of debt executed by the company, acknowledging its obligation to repay the sum along with interest at a specified rate of interest. NCD is one of the methods of raising the loan capital of the company in contrast to equity capital or resources raised through borrowings. An NCD is thus, like a certificate of loan or a loan bond, evidencing the fact that the company is liable to pay a specified amount with interest and although the money raised by the NCD becomes a part of the company's capital structure, it does not become share capital.

Issue of all types of debentures, whether convertible or non-convertible, involves compliance with the substantive and procedural aspects of law. Documentation is equally important. The benefit of raising loan capital lies in the fact that it does not disturb the equity structure of the company and consequently the existing management. However, the success of a private or public debenture issue depends, to a large extent, on the goodwill and rapport built up by the company with the investing public. An important aspect is the protection of interest of debenture holders. Companies achieve this protection by the appointment of an independent Debenture Trustee, in regard to the public issue, as the number of debenture holders is considerably large. A separate fund known as Debenture Redemption Reserve is created and this is a statutory obligation intended to provide liquid resource, built out of profits of a company, for redemption of debentures.

You can buy and sell NCDs from secondary market. It is traded like shares. If the market interest rate is higher than the coupon rate of debentures, then the value of debentures fall, as people prefer to invest in bank deposits rather than in debentures. On the other hand, if the interest rate is lower than the coupon rate of debentures, than people will opt for debentures with higher interest rates, thereby, raising its value. However, there is no active market for NCDs on the wholesale debt market segment of the stock exchanges and their liquidity is low. You might not be able to find a buyer for your NCDs if their trade volumes on bourses are insignificant

The Debt Market –Structure

In order to understand the entirety of the debt market we will look at it through a framework based on its main participants.These participants are as follows:

  • Instruments - the instruments are the certificates issued in tradable form.
  • Issuers - are entities, which issue these instruments and are primarily corporates or the Government.
  • Investors - are entities, which invest in these instruments or trade in these instruments.
  • Regulators - The Debt regulators are RBI, SEBI and DCA.

In this section a schematic presentation is attempted on the micro-structure of Indian corporate debt market so that the issues are placed in a proper perspective.

The Figure given below presents a bird’s eye view of the Indian debt market structure.

Apart from the list of investors given in the figure the industry also has a number of other investors such as Mutual Funds, Private Trusts, Religious Trusts and Charitable Organisations having large investible corpus, Housing Finance Companies, NBFCs and, RNBFCs.

Appointment and Duties of Debenture Trustees

In terms of Section 71 (5) of the companies Act, it has been made mandatory for any company making a public/rights issue of debentures to appoint one or more debenture trustees before issuing the prospectus and to obtain their consent which shall be mentioned in the offer document. The Debenture Trustees shall not:

  • Beneficially hold shares in a company.
  • Be beneficially entitled to monies, which are to be paid by the company to the debenture trustees.
  • Enter into any guarantee in respect of principal debt secured by the debentures or interest thereon.

This section also lists the functions that shall be performed by the Trustees. These include:

  • Protecting the interests of the debenture holders by addressing their grievances.
  • Ensuring that the assets of the company issuing debentures are sufficient to discharge the principal amount.
  • To ensure that the offer document does not contain any clause which is inconsistent with the terms of the debentures or the Trust Deed
  • To ensure that the company does not commit any breach of the provisions of the Trust Deed.
  • To take reasonable steps as may be necessary to undertake remedy in the event of breach of any covenant in the Trust Deed.
  • To convene a meeting of the debenture holders as and when required.

If the debenture trustees are of the opinion that the assets of the company are insufficient to discharge the principal amount, they shall file a petition before the Central Government and the latter may after hearing the parties pass such orders as is necessary in the interests of the debenture holders. As per the SEBI (Debenture Trustees) Regulations, 1993, (hereinafter referred to as the 'Regulations') a Debenture Trustee can be a scheduled bank, an insurance company, a body corporate or a public financial institution.

Regulations on NCDs

SEBI regulation covers guidelines for issue and listing of NCDs with maturity over one year. RBI draft guidelines cover provisions relating to issuance of Non-Convertible Debentures (NCDs) of maturity less than one year. An extract from the guidelines {Securities and Exchange Board of India (issue and listing of debt securities)(amendment) regulations, 2012 & Issuance of Non-Convertible Debentures (Reserve Bank) Directions, 2010} is given under.

  • Definition

    For the purpose of these guidelines, Non-Convertible Debentures (NCDs) will mean secured, negotiable money market instruments with original maturity of less than one year issued by corporates (including NBFCs) to meet their short term funding requirements, issued by way of private placement with investors. The guidelines also cover NCDs with original maturity of more than one year with option attached to it, which can be exercised within a year from the date of issue.

  • Eligible Issuers

    Any corporate that fulfills the following criteria are eligible to issue the NCDs of less than one year:

    • Having a tangible net worth as per the latest audited balance sheet, of not less than Rs.4 crore;
    • The company has been sanctioned working capital limit by bank/s or all-India financial institution/s; and
    • The borrowing account of the company is classified as a Standard Asset by the financing bank/s/ institution/s.
  • Rating Requirement

    An eligible corporate intending to issue NCDs shall obtain minimum valid credit rating of P-2 or equivalent for the issue from one of the rating agencies specified by Reserve Bank of India from time to time, for the purpose.

  • Maturity
    • NCDs shall not be issued for maturities of less than 90 days from the date of issue.
    • The exercise date of option (put/call), if any, attached to the NCDs shall not fall within 90 days period from the date of issue.
    • The maturity date of the NCD shall co-terminate with the date up to which the credit rating of the issuer is valid.
  • Denominations

    NCDs may be issued in denominations of Rs.5 lakh or multiples thereof. Amount invested by a single investor should not be less than Rs.5 lakh (face value).

  • Limits and the Amount of Issue of NCDs
    • The aggregate amount of the NCDs from an issuer shall be within the limit as approved by the Board of Directors of the corporate or the quantum indicated by the Credit Rating Agency for the specified rating, whichever is lower.
    • The total amount of the NCDs proposed to be issued should be raised within a period of two weeks from the date on which the issuer opens the issue for subscription.
  • Procedure for Issuance
    • The issuer shall disclose to the prospective investors its financial position as per the standard market practice.
    • All the provisions contained in the Companies Act 1956, and the Securities and Exchange Board of India (Issue and Listing of Debt Securities) Regulations 2008, wherever applicable, shall be followed by the issuers.
    • The debentures shall be allotted in the form of letter of allotment followed by Debenture Certificate within the time frame prescribed by the Companies Act 1956.
    • NCDs shall be issued at face value and will carry a coupon rate as determined by the issuer.
  • Debenture Trustee
    • Every issuer of NCDs shall appoint a Debenture Trustee for each issuance of the NCDs.
    • Only commercial banks that are registered as debenture trustees with the SEBI shall be eligible to act as debenture trustees for issue of the NCDs.
  • Investment in NCD
    • NCDs may be issued to and held by individuals, banking companies, Primary Dealers (PDs) other corporate bodies registered or incorporated in India and unincorporated bodies, Non-Resident Indians (NRIs) and Foreign Institutional Investors (FIIs).
    • Investment by FIIs shall be within the limits set for their investments by the Securities and Exchange Board of India (SEBI).
  • Preference for Dematerialisation

    While option is available to both issuers and subscribers to issue/hold NCDs in dematerialised or physical form, issuers and subscribers should be encouraged to issue/ hold NCDs in dematerialised form. However, banks, FIs and PDs are required to make fresh investments in NCDs only in dematerialised form.

  • Roles and Responsibilities

    The role and responsibilities of issuer, Debenture Trustee and the credit rating agency (CRA) are set out below:

    • Issuer

      Issuers shall ensure that the guidelines and procedures laid down for issuance of NCD are strictly adhered to.

    • Debenture Trustee

      The roles, responsibilities, duties and functions of the debenture trustees shall be guided by these regulations, the Securities and Exchange Board of India (Debenture Trustees) regulations 1993, the trust deed and offer document.

    • Credit Rating Agency (CRA)
      • Code of Conduct prescribed by the SEBI for the CRAs for undertaking rating of capital market instruments shall be applicable to them (CRAs) for rating the NCDs.
      • The CRA shall have the discretion to determine the validity period of the rating depending upon its perception about the strength of the issuer. Accordingly, CRA shall, at the time of rating, clearly indicate the date when the rating is due for review.
      • While the CRAs may decide the validity period of credit rating, they shall closely monitor the rating assigned to issuer’s vis-à-vis their track record at regular intervals and make their revision in the ratings public through their publications and website.

The NCD we have seen can be secured by assets or can be unsecured. A secured NCD is one where they earmark certain assets that will be sold off to pay the bond holders in case of default.

In the case of bankruptcy – secured debt holders will be paid first by selling off the secured assets. Whatever is left is used to pay off unsecured debt holders, and then whatever is left (which is usually nothing) is given to the shareholders. That’s why it’s said that secured debt is relatively safer than unsecured debt for bond holders.

Benefits of investing in NCDs

If one is looking for an investment that generates fixed income periodically, NCDs may be an ideal investment as it offers.

  • Higher rate of interest as compared to fixed deposits, postal savings or similar investments.
  • If the bonds are listed, liquidity as one can sell it in the secondary market before its maturity
  • If listed bond possibility of capital appreciation i.e. one can sell your bond at a price higher than your cost price in the market

Features of Non-Convertible Debentures

  • Returns: 

    The first thing that stands out in favor of NCDs is surely the interest rate that it offers.Unsecured NCDs give higher returns than secured NCDs. This is because unsecured NCDs have no underlying asset to give value to the debentures. This makes it more risky and hence higher returns are promised. Interest is paid through Direct Credit / ECS / RTGS / NEFT mode.

  • Maturity: 

    There are different types of debentures with different maturities. RBI has stipulated that the maturity must not be less than 90 days. Maturities range from 90 days to as long as 10 or even 30 years.

  • Risk: 

    High rated Non-convertible debentures generally exhibit lower credit risk. NCDs lose value when interest rate in the system goes up and gain when the interest rate declines. However when the NCD is held till maturity one is likely to realize the promised return and the risk due to movement in interest rates will not be there.

  • Liquidity:

    One can sell debentures in the secondary market before maturity if it is listed.

  • Tax:

    Returns on non convertible debentures are taxed as income.There is no tax deduction at source (TDS) if you invest through the DEMAT mode. Income tax on the interest income will have to be paid at the time of declaring one's income.

Things to be considered before investing in NCDs

Ratings:Rating agencies use simple alphanumeric symbols to convey credit ratings. For example, rating agencies assign credit ratings to debt obligations on three basic scales: the long-term scale, the short-term scale, and the fixed deposit scale. AAA is the highest Credit rating by indicating highest safety. Higher rating indicates timely servicing of debt obligations by the issuer and lower amount of credit risk.

Payback History Of Company:You must do a research and background study of the company, which is issuing the bond; after all it is your money. Check if the company has any history of default on its payment. If so it is unwise to invest in these instruments. However if the company has a good consistence history of repayment to its creditors then it is better to invest in NCDs of that company.

Secured and Non Secured NCDs:If the company in whose NCDs you have invested is wound up (closes down), it’s important for you to know where you stand when the company repays its debts. The order in which the Company repays its debts depends upon the ranking of the bonds based on the security Bonds are either secured against assets or unsecured. If the bonds are secured, in the event of winding up of the company, it would sell off the assets against which the bonds were secured and repay the investor.

Listing & Liquidity:Debentures (convertible and/or non convertible) can be listed on a stock exchange, providing opportunities to accumulate additionally or to sell them and exit earlier than the tenure of the debenture. But investors have to be careful about the price movement of the instruments, which in turn depends upon the interest rate movements and the applicable coupon interest rate payable on them. More the liquidity better it is for the investor.

Varying Tenures:Redemption periods usually range from 2-15 years. One should choose the tenure on the basis of his/her own personal financial goals and risk appetite.

Interest Payout Options:Depending on the requirement of the investors, one could look at different interest payout options offered by NCDs such as monthly, quarterly, half-yearly or annual interest payments.