Non-Convertible Debentures (NCDs) are essentially a type of debt instrument that offers a fixed return to the investor with a specified repayment timeline and cannot be converted into equity. NCDs greatly benefit investors as they offer assured returns, low risk, and tax benefits for investors. There are two primary subcategories:
Secured NCDs are backed by property or other assets that are used as security for a loan to the corporation (referred to as the “issuer”). Prior to paying bondholders’ interest or other debts, the issuer must repay these loans.
Unsecured NCDs are not secured by assets or other forms of collateral. Instead, it is dependent on the issuer’s creditworthiness and capacity to compensate investors in the event of a business operation failure. For instance, a decline in profits would have an impact on the issuer’s capacity to make interest payments on schedule without going into default.
A company can issue NCDs either through private placement or a public issue mechanism. Most companies nowadays extensively use private placement mechanisms.
Under the private placement mechanism, companies identify a select group of investors and raise finances by issuing them a private placement offer letter. The investors are also assured of their returns due to the fixed repayment timelines attached to NCDs
Generally, there are no specific eligibility criteria for companies to issue NCDs on a private placement basis. However, the subsequent listing of the NCDs is subject to the eligibility criteria specific to the respective stock exchange. The eligibility requirements related to the National Stock Exchange of India Ltd. (“NSE”) are listed in the table below:
Factors that help determine the fees and expenses incurred in the issuance and listing of Non-Convertible Debentures include the company location, value of securitized assets, fees payable to legal and financial advisors, and stamp duty payable. If the company proposes to list NCDs issued through private placement on the stock exchange, then the applicable listing fees depend on the issue size and the applicable fees of the stock exchange where it is proposed to be listed.
According to a review of the most recent private placement memoranda and term sheets, issuers are offering a coupon rate in the range of 8% to 12% on the issuance of NCDs through private placements.
The coupon rate is predetermined when NCDs are issued. Except in cases of restructuring or redemption, the coupon rate won't vary over the course of the bond's existence. For instance, if an NCD has a five-year maturity date and a coupon rate of 10%, the yearly interest will be 10% for each year the NCD remains outstanding.
The ability of the issuer to fulfil its commitments is indicated by the credit rating of the NCDs. These ratings are based on various factors, including financial performance, debt levels, industry outlook, and management quality. A lower rating signifies higher risk and vice-versa.
According to Section-193 of the Income-tax Act, 1961, NCDs are given in DEMAT form and are listed on a stock market as such not subject to Tax Deduction at Source (TDS).
Discounted Cash Flow (DCF) Analysis or Capitalization Method.
The valuation of non-convertible debentures under this method involves determining the value of the debentures based on the future cash flows they are expected to generate adjusted for the issuer’s credit risk. This method calculates the present value of the cash flows by discounting them at an appropriate discount rate. The following points must be considered while using the capitalization method to value non-convertible debentures:
Under this method the NCD being valued is compared with similar NCDs that are already trading in the market. The valuation is based on the prices or yields of these comparable NCDs. Factors such as credit rating, coupon rate, tenor, and market conditions are considered when selecting comparable NCDs.
When valuing non-convertible debentures (NCDs), there are several risks that should be taken into consideration. These risks include:
These risks may also vary depending on the issuer, market conditions, and other factors. Analysts need to carefully evaluate and mitigate these risks when valuing NCDs.
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