What Is Non-Convertible Debentures?

Non-convertible debentures (NCDs) are financial instruments that companies use to raise capital. These debt instruments offer a predetermined interest rate and have a fixed maturity period. NCDs provide a structured way for companies to secure long-term funds without diluting ownership, as they do not grant investors any equity stake. They represent a commitment from the issuer to repay the principal amount along with regular interest payments over a specified term.

Key Features of Non-Convertible Debentures

Non-convertible debentures are distinct because they cannot be exchanged for equity shares of the issuing company. The fixed maturity period for NCDs typically ranges from one to ten years, though some specific entities, such as infrastructure finance companies, can issue them for longer terms, up to 30 years.

Interest payments on NCDs are generally fixed and are known as coupon rates, which are determined at the time of issuance. Investors can often choose from various interest payment frequencies, including monthly, quarterly, semi-annually, annually, or a cumulative option where interest is paid at maturity along with the principal. The face value of an NCD represents the principal amount for which the debenture is originally issued, forming the basis for interest calculations and the final repayment to investors. Companies often list NCDs on stock exchanges, which provides liquidity by allowing investors to buy or sell them in the secondary market before their maturity date. The credit rating assigned to an NCD by agencies reflects the issuer’s financial health and its ability to meet repayment obligations, which is a significant factor for investors considering these instruments.

Classifications of Non-Convertible Debentures

Non-convertible debentures can be categorized based on various attributes. A primary distinction lies between secured and unsecured NCDs. Secured NCDs are backed by specific assets of the issuing company, which act as collateral, offering investors a layer of protection in case of default. This asset backing generally makes secured NCDs less risky and may result in slightly lower interest rates compared to their unsecured counterparts.

Unsecured NCDs, conversely, do not have any specific assets pledged as collateral; investors rely solely on the issuer’s creditworthiness and financial standing for repayment. Due to this increased risk, unsecured NCDs typically offer higher interest rates to compensate investors. NCDs are also classified as redeemable or non-redeemable; redeemable debentures have a specific maturity date when the principal is repaid, while non-redeemable (perpetual) debentures do not have a fixed maturity date, with interest paid indefinitely. Furthermore, NCDs can be registered or bearer; registered NCDs record ownership, with payments made to the named holder, whereas bearer NCDs grant ownership and payment rights to whoever possesses the physical instrument. Some NCDs may also feature callable or putable options, allowing the issuer to redeem them early (callable) or granting the investor the right to demand early repayment (putable).

Lifecycle of Non-Convertible Debentures

The lifecycle of a non-convertible debenture begins with its issuance, as companies offer these instruments to raise capital. Issuance typically occurs either through public issues, made available to a broad investor base, or via private placements, offered to a select group of investors. The process involves board approval by the issuing company and the appointment of intermediaries, such as merchant bankers, who manage the offering. A detailed offer document or prospectus is prepared, outlining the terms and conditions of the NCD issue, including the interest rate, maturity period, and use of funds.

Following the issuance, investors participate in the subscription and allotment phase, applying for NCDs, which are then allocated, often in dematerialized (electronic) form. Throughout the debenture’s term, regular interest payments are made to the debenture holders, according to the chosen frequency, such as monthly, quarterly, or annually. At the end of the specified maturity period, the NCD reaches its redemption phase, where the principal amount is repaid to the debenture holders. The issuing company is responsible for arranging the necessary funds, notifying debenture holders in advance, and updating their records to reflect the repayment. After issuance, NCDs can also be traded on stock exchanges in the secondary market.

Non-Convertible Debentures Compared to Other Instruments

When compared to convertible debentures, the fundamental difference is that NCDs do not provide the option for conversion into the issuing company’s equity shares. This non-convertibility often leads companies to offer higher, fixed interest rates on NCDs to attract investors, as there is no potential for capital appreciation through equity ownership.

NCDs share similarities with bonds, as both are debt instruments. Bonds can be issued by various entities, including governments and corporations, while NCDs are typically issued by corporate entities. Some bonds may include convertibility features, unlike NCDs, which are strictly non-convertible. NCDs are generally considered a form of corporate bond, but the term “bond” encompasses a broader range of debt instruments that may have different structures or security features. Compared to traditional bank loans, NCDs represent marketable securities that companies issue to a wider public base, diversifying funding sources beyond conventional bank borrowing.