Non-convertible debentures, or NCDs have become the latest fad among investors who are looking for secure investment options sue to the unattractive returns on fixed deposits (FDs) and rising volatility in the equity market. Recently, JM Financial has launched its NCD worth Rs 300 crores at 9.2-9.7% coupon rate and with an option to retain another Rs 400 crores. Also, the Housing finance firm DHFL launched its NCD Rs 3000 crores with a green shoe option of Rs 9000 crores, totalling Rs 12,000 crores, last week. Impressively, the issue that offered 8.56-9.1 per cent interest rate received robust response and closed on May 24, well ahead of planned closure on June 4.
What are NCDs?
Non-convertible debentures are debt financial instruments that have a fixed tenure. Companies mainly issue the NCDs to raise capital for their business purposes. These NCDs cannot be converted into equity shares of the issuing company to a future date, unlike the other convertible debentures. One can easily sell their NCD before maturity in secondary market as the interest rate on NCDs is higher than traditional instruments which are fairly liquid.
Why are NCDs a better choice?
According to the experts, NCDs are definitely a better choice than FDs if one has excess capital to lock in for a few years and since they are being offered at attractive coupon rates, NCDs definitely are the new flavour of the season.
Lakshmi Iyer CIO — Debt & Head Products, Kotak Mahindra Asset Management Company said, “NCDs are a good way for issuer to diversify the mode of its borrowing, and since it’s a public issue, retail investors can participate and benefit from the relatively higher interest rates, explaining how it is a win-win situation for both the issuer as well as the investors.
Although, the interest income on NCDs is taxed as per individual’s tax slabs, but, if someone sells it on the exchange within a period of one year, then a short-term capital gain tax is usually levied. The long-term capital gains tax is imposed at 20% rate with indexation after a year’s time.
Nagarajan of Tata MF said, “So far as taxes are concerned, there is a marginal tax on interest income, and if you buy it in your wife’s or child’s name, taxation will be even lower.”
Major risk factors to focus upon
There are three risk factors which need to be kept in mind:
1. Interest rate risks
With the high inflation-era, as the global crude oil prices are back on the rising spree, the interest rates also go up and due to this bond prices might also fall which can prevent you from redeeming your investment before maturity in the secondary market, despite there being an assured return on maturity.
2. Liquidity risk
Even though NCDs are listed on the stock exchange, people who would be willing to exit prematurely might not find buyers in the secondary market, especially for the low-rated NCDs.
3. Credit risk
Investment in NCD causes a risk of the company defaulting on the future payment. In order to alleviate that, investor should be thoroughly checking the credibility of the concerned firm. Rating agencies like Icra, India Ratings and Crisil etc. assess NCD issuers and allocate a credit rating to the company based on its ability to generate cash constantly and pay investors on time.
For example, DHFL issue was rated AAA, while JM Financial has AA rating on its issue.