Difference Between Callable and Non-Callable Debentures

Non-Convertible Debentures (NCDs) are debt instruments that can provide regular interest income. () However, before going ahead with the investment in any particular NCD, there is one aspect that is easily overlooked, whether the NCD is callable or non-callable.

This feature can affect how long your money stays invested and how predictable your investment duration and cash flows are. This article explains what callable and non-callable NCDs are and the differences between them.

What are Callable NCDs?

A callable NCD is an instrument that allows the issuing company to redeem the NCD before its maturity as stated in the terms provided in the offer document. Let us understand this with an example. Imagine you invest in a 10-year callable NCD. As per the terms, the issuer can exercise the call option after 3 years. If the issuer exercises this option, your investment ends before the original 10-year maturity.

This raises one question: why would a company do this?

One reason could be a change in interest rates. If borrowing costs fall, an issuer may want to replace relatively expensive debt with cheaper borrowing. A call option gives the issuer greater flexibility to manage its debt. For an investor, however, early redemption can create reinvestment risk. You may receive your money back earlier than expected and then have to find another investment. If interest rates have fallen, comparable investments may offer lower returns.

What Are Non-Callable NCDs?

Non-callable NCDs do not give the issuing company any right to stop the debentures before maturity. Once you invest, the NCD remains outstanding until its scheduled maturity, unless another provision of the issue terms applies. Your investment has a more certain scheduled maturity date than a callable NCD. This provides certainty about the investment duration and the scheduled cash flows, subject to the issuer meeting its obligations.

Difference between Callable vs Non-Callable NCDs

Factors to Check Before Investing in NCDs

Investors should read the offer document and understand the specific terms of the issue before investing in an NCD.

• Call option: Check whether the issuer has the right to call back the NCD and from which date.
• Maturity: Understand when the principal is scheduled to be repaid.
• Interest rate and payment frequency: Check the coupon rate and effective yield, as well as the frequency of interest payments - monthly, quarterly, annually, or upon maturity.
• Credit rating: A rating can provide information about credit risk, but it is not a guarantee that the issuer will repay your money.
• Security: Is the NCD secured or unsecured? Also check the underlying security or the asset cover provisions.
• Liquidity: If the NCD is listed, check whether there is an active market. Listing does not guarantee that you will always find a buyer at your preferred price. SEBI's regulations govern the issue and listing of non-convertible securities, and the applicable regulatory framework should be checked for the specific NCD issue.

FAQs

Are callable NCDs riskier than non-callable NCDs?

They have an additional feature that can affect the investment period: the issuer may be able to redeem them early. This can increase reinvestment risk for investors. However, overall NCD risk also depends on factors such as the issuer's creditworthiness, security, and liquidity.

Can an investor refuse a call on a callable NCD?

Generally, if the issuer exercises a call option according to the terms of the issue, the investor cannot simply choose to continue holding the NCD. The exact conditions should be checked in the offer document.

Do callable NCDs always offer higher interest rates?

Not necessarily. The interest rate depends on several factors, including the issuer, credit risk, tenure, and market conditions. A callable feature may be reflected in pricing, but there is no universal rule that every callable NCD must offer a higher rate.

What happens when a callable NCD is called?

The NCD is redeemed according to the terms specified in the issue documents. The investor receives the applicable redemption amount, after which the investment ends.

Is a non-callable NCD completely risk-free?

No. Non-callable only describes the issuer's ability to redeem the NCD early. It does not remove credit risk, liquidity risk, interest-rate risk or other risks associated with debt investments.