What is Non-Convertible Debenture?
Non Convertible Debenture (NCD) is a debt instrument issued by corporations, financial institutions, or government entities to raise capital. It is a form of long-term borrowing that offers fixed interest payments to investors over a specified period of time.
The term “non-convertible” indicates that the debenture cannot be converted into equity shares of the issuing company. Unlike convertible debentures, which provide an option for the debenture holder to convert their investment into equity shares at a predetermined conversion ratio, NCDs are purely debt instruments.
Non-convertible debentures typically have a fixed maturity period, which can range from a few months to several years. During this period, the issuing entity pays periodic interest to the debenture holders at a predetermined coupon rate. At the end of the maturity period, the principal amount is repaid to the debenture holders.
NCDs are usually listed on stock exchanges, allowing investors to trade them before their maturity date. They are considered relatively safer investments compared to equities, as they offer a fixed income stream and priority in repayment in the event of liquidation or bankruptcy of the issuing entity. However, the interest rates on NCDs are generally higher than those offered on traditional bank deposits, reflecting the higher risk associated with corporate debt.
Investors interested in NCDs should carefully assess the credit rating of the issuing entity to evaluate the risk involved. Credit rating agencies provide ratings based on the entity’s financial strength and ability to meet its debt obligations. Higher-rated NCDs generally offer lower interest rates but are considered less risky, while lower-rated NCDs may provide higher yields but carry higher default risk.
What are The Features of Non-Convertible Debenture?
Non-convertible debentures (NCDs) are debt instruments that do not have the feature of conversion into equity shares. Here are the major features of non-convertible debentures:
- Fixed interest rate: NCDs offer a fixed rate of interest throughout the tenor of the debenture. The interest rate is determined at the time of issuance and remains constant until maturity.
- Regular interest payments: Non-convertible debentures pay regular interest to the debenture holders. The frequency of interest payments (monthly, quarterly, semi-annually, or annually) is specified in the debenture agreement.
- Maturity period: NCDs have a specified maturity period, which represents the duration of the debenture. It can range from a few months to several years, depending on the terms set by the issuer.
- Redemption at maturity: Unlike convertible debentures, non-convertible debentures are repaid in full at the end of the maturity period. The principal amount invested by the debenture holders is returned by the issuer along with the final interest payment.
- No equity participation: non-convertible debentures do not provide the option for conversion into equity shares of the issuing company. The debenture holders do not have any ownership rights or equity participation in the company.
- Credit rating: NCDs are usually assigned a credit rating by credit rating agencies based on the issuer’s creditworthiness and the terms of the debenture. The credit rating provides an assessment of the risk associated with the debenture and helps investors make informed decisions.
- Secured or unsecured: non-convertible debentures can be either secured or unsecured. Secured debentures are backed by specific assets or collateral, which serves as security for the debenture holders. Unsecured debentures, on the other hand, do not have any specific collateral backing.
- Subordination: In some cases, non-convertible debentures may be subordinated to other forms of debt in the company’s capital structure. This means that in the event of bankruptcy or liquidation, the non-convertible debenture holders have lower priority for repayment compared to senior debt holders.
- Call and put options: non-convertible debentures may include call and put options. A call option gives the company the right to redeem the debentures before maturity, usually at a predetermined price. A put option provides the debenture holder the right to sell back the debentures to the company before maturity.
What are The Types of Non-Convertible Debentures?
Non-convertible debentures (NCDs) come in various forms, depending upon the terms and features set by the issuing company. Here are some common types of non-convertible debentures:
- Secured Non-Convertible Debentures: These debentures are backed by specific assets or collateral, which provides an additional layer of security for the debenture holders. In case of default or bankruptcy, the secured assets can be liquidated to repay the debenture holders.
- Unsecured Non-Convertible Debentures: Unlike secured debentures, unsecured NCDs do not have specific collateral backing. In case of default or bankruptcy, the debenture holders have a claim on the company’s general assets, but they do not have a specific claim on any particular asset.
- Subordinated Non-Convertible Debentures: Subordinated debentures have a lower priority of repayment compared to senior debt holders in the event of bankruptcy or liquidation. This means that if the company faces financial distress, the senior debt holders will be repaid first before the subordinated debenture holders.
- Callable Non-Convertible Debentures: Callable debentures give the company the option to redeem or “call back” the debentures from the debenture holders before the maturity date. This feature allows the issuer to retire the debt early if it deems it financially beneficial. The call option may be exercised at a predetermined price or premium.
- Puttable Non-Convertible Debentures: Puttable debentures provide the debenture holders with the right to sell back the debentures to the company before the maturity date. This allows investors to have an exit option if they wish to liquidate their investment before the maturity period.
- Fixed Rate Non-Convertible Debentures: These debentures offer a fixed rate of interest throughout the tenor of the debenture. The interest rate is determined at the time of issuance and remains constant until maturity.
- Floating Rate Non-Convertible Debentures: Floating rate debentures have an interest rate that is not fixed but fluctuates based on a reference rate such as a benchmark interest rate. The interest payments are adjusted periodically to reflect changes in the reference rate.
- Zero-Coupon Non-Convertible Debentures: Zero-coupon debentures do not pay regular interest like traditional debentures. Instead, they are issued at a discount to their face value and redeemed at the face value upon maturity.
- Listed Non-Convertible Debentures: Some NCDs are listed on stock exchanges, allowing investors to buy and sell them in the secondary market before their maturity. This provides liquidity and flexibility for investors.
Advantages And Disadvantages of Non-Convertible Debentures: –
Non-convertible debentures (NCDs) offer several advantages and disadvantages for both issuers and investors. Here are some pros and cons of non-convertible debentures:
Advantages for Investors:
- Fixed Income: NCDs provide investors with a fixed rate of interest throughout the tenor of the debenture. This makes them an attractive investment option for individuals seeking a stable income stream.
- Lower Risk: Compared to equity investments, non-convertible debentures are generally considered to have lower risk. They offer a predetermined return and repayment of principal at maturity, providing more certainty compared to the volatility of stock markets.
- Diversification: NCDs allow investors to diversify their investment portfolio by including fixed-income securities. This can help reduce overall investment risk by spreading it across different asset classes.
- Listed and Tradable: Some non-convertible debentures are listed on stock exchanges, providing liquidity to investors. This means that they can be bought or sold in the secondary market before maturity, allowing investors to exit their investment early if needed.
Disadvantages for Investors:
- Lack of Capital Appreciation: Non-convertible debentures do not offer the potential for capital appreciation like equity investments. The return is limited to the fixed interest payments received throughout the tenor of the debenture.
- Interest Rate Risk: NCDs are subject to interest rate risk. If market interest rates rise after the debenture is issued, the fixed interest rate of the debenture may become less attractive compared to current market rates.
- Default Risk: There is always a risk of default associated with any debt instrument, including non-convertible debentures. If the issuer fails to make interest payments or repay the principal amount at maturity, investors may face financial loss.
- Lack of Equity Participation: Unlike convertible debentures, NCDs do not provide investors with the opportunity to convert their investment into equity shares. This means that investors do not benefit from potential future growth or appreciation of the company’s shares.
Advantages for Issuers:
- Lower Dilution: By issuing non-convertible debentures, companies can raise funds without diluting their equity. This allows them to maintain control over the ownership and decision-making of the company.
- Fixed Interest Payments: NCDs allow companies to make fixed interest payments to debenture holders, providing a predictable cash flow obligation.
Disadvantages for Issuers:
- Higher Interest Costs: Non-convertible debentures often have higher interest rates compared to other forms of debt financing, such as bank loans. This can increase the overall cost of borrowing for the company.
- Lack of Flexibility: Once issued, the terms of non-convertible debentures cannot be easily changed. The company is obligated to make fixed interest payments and repay the principal amount at maturity, which may limit financial flexibility.
- Limited Investor Base: NCDs may have a limited investor base compared to other types of debt or equity instruments. This can affect the company’s ability to attract a diverse range of investors and may impact the liquidity of the debentures in the secondary market.
Calculation of Non-Convertible Debentures:
- Interest Payments:
A. Determine the coupon rate: The coupon rate is the annual interest rate specified in the debenture. For example, if the coupon rate is 6% and the face value of the debenture is $1,000, the annual interest payment would be $1,000 x 6% = $60.
B. Calculate the periodic interest payment: Divide the annual interest payment by the number of interest payment periods per year. For instance, if the interest is paid semi-annually, the periodic interest payment would be $60/2 = $30.
- Maturity Value:
A. Determine the face value: The face value, also known as the principal or par value, represents the amount that will be repaid to the debenture holder at maturity. For example, if the face value is $1,000, this would be the maturity value.
B. Calculate the total interest earned: Multiply the periodic interest payment by the number of interest payment periods over the debenture’s tenor. For example, if the debenture has a tenor of 5 years and interest is paid semi-annually, there would be 10 interest payment periods. If the periodic interest payment is $30, the total interest earned would be $30 x 10 = $300.
C. Add the total interest earned to the face value: The maturity value of the debenture would be the face value plus the total interest earned. Using the example figures, the maturity value would be $1,000 + $300 = $1,300.
Examples of Non-Convertible Debentures:
- Reliance Industries Limited: Reliance Industries, one of India’s largest conglomerates, has issued non-convertible debentures. These debentures are typically offered with fixed interest rates and various maturity periods.
- Tata Motors Limited: Tata Motors, an Indian multinational automotive manufacturing company, has issued non-convertible debentures to raise funds for its operations and expansion. These debentures may be secured or unsecured, and they offer fixed interest payments to the debenture holders.
- HDFC Ltd: HDFC Ltd, a leading housing finance company in India, regularly issues non-convertible debentures to fund its housing finance operations. These debentures provide fixed interest payments to the investors and have specific maturity periods.
- ICICI Bank Limited: ICICI Bank, one of the largest private sector banks in India, has issued non-convertible debentures to raise capital. These debentures are typically listed and traded on stock exchanges, providing liquidity to investors.
- Apple Inc.: Apple, one of the largest technology companies in the world, has issued non-convertible debentures to raise funds for various purposes, including capital expenditure, acquisitions, and share repurchases. These debentures typically offer fixed interest payments and have specific maturity periods.
- Verizon Communications Inc.: Verizon, a telecommunications company, has issued non-convertible debentures to finance its operations and expansion. These debentures provide fixed interest payments to the investors and have specific terms and maturity dates.
- Pfizer Inc.: Pfizer, a multinational pharmaceutical company, has issued non-convertible debentures as part of its capital raising activities. These debentures offer fixed interest payments and have specific maturity periods.
- Ford Motor Company: Ford, one of the largest automobile manufacturers, has issued non-convertible debentures to fund its operations and research and development activities. These debentures may be secured or unsecured and offer fixed interest payments to the debenture holders.
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