What is a debenture and an NCD (non-convertible debenture)

Debenture basics and the convertible split

When a company needs to borrow, it can take a bank loan or it can issue debentures to the public and to institutions. A debenture is essentially a tradeable loan: you lend the company money, it pays you a fixed coupon at set intervals, and it returns your principal on the maturity date. Debentures are issued at a face value, commonly 1,000 rupees for a public retail issue, and they often list on the exchange so you can buy or sell them before maturity.

Debentures split into convertible and non-convertible. A convertible debenture can be converted into equity shares of the company at a pre-set ratio and date, so the holder gets fixed income for a while and then the option to become a shareholder. A non-convertible debenture (NCD) has no such conversion: it stays debt for its full life, paying interest and returning principal. NCDs are the variety most retail investors encounter, because companies frequently raise money through public NCD issues that anyone can apply to.

Secured versus unsecured, and the credit rating

NCDs are further split into secured and unsecured. A secured NCD is backed by specific assets of the company, so if the company defaults, the assets can be sold (through a debenture trustee) to repay the secured NCD holders, who rank ahead of unsecured lenders. An unsecured NCD has no such asset backing, so its holders rank lower in a default and may recover less. Secured NCDs are therefore relatively safer, and unsecured NCDs usually offer a higher coupon to compensate for the extra risk.

The single most important number on an NCD is its credit rating. Rating agencies assign grades that signal the issuer's ability to pay. A higher-rated issuer (closer to AAA) is judged safer and therefore offers a lower coupon, while a lower-rated issuer offers a higher coupon precisely because investors are taking more default risk. A fat coupon is never free: it is the market pricing in the chance that the company may not pay. Reading the rating, the security status, and the issuer's financial health together is the core discipline before buying any NCD, especially the high-coupon ones from lower-rated finance companies.

How NCDs sit in a portfolio and how they are taxed

NCDs appeal to investors who want a fixed, predictable income that can be higher than a bank fixed deposit, in exchange for taking on the issuer's credit risk rather than the near-sovereign safety of a bank deposit insured up to a limit. They suit the fixed-income part of a portfolio for an investor who is comfortable assessing credit quality, and they offer a defined maturity and a known coupon, unlike equity.

On tax, the interest from an NCD is added to your income and taxed at your slab rate, with no special concession. If you sell a listed NCD on the exchange before maturity, any capital gain follows the capital-gains rules for listed securities based on your holding period. The combination of credit risk, slab-rate taxation on interest, and liquidity that varies by issue means NCDs reward investors who do the homework on the issuer and read the rating, rather than chasing the highest advertised coupon.

NCD versus a bank fixed deposit

The most useful comparison for a retail investor is the NCD against a bank fixed deposit, because they compete for the same conservative money. A bank FD is a deposit with a bank, and deposits are insured up to a limit per depositor per bank by the deposit insurance scheme, which makes the FD very safe for amounts within that cover. An NCD is a loan to a company, with no such insurance, so its safety rests entirely on the issuer's ability to pay, which is what the credit rating signals. This is the core trade: an NCD usually offers a higher coupon than an FD precisely because you are taking the issuer's credit risk instead of relying on deposit insurance.

Liquidity and interest timing also differ. A bank FD can usually be broken early, with a small penalty, giving you a reliable exit. A listed NCD can be sold on the exchange, but the price and the ease of sale depend on how actively that particular NCD trades, which is often thin. On interest, an FD offers flexible payout frequencies and the familiar cumulative option, while NCDs come in cumulative and non-cumulative variants too. The decision comes down to whether the extra yield on the NCD compensates you for the credit risk and the weaker liquidity, a judgement that should always start with the rating and the issuer's financial health.

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Common questions on debentures and ncds.

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