What are NCDs? Definition, risk factors, tax implications and more
DHFL NCD 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.
At a time when returns on fixed deposits (FDs) are not attractive and volatility in equity markets is rising, non-convertible debentures (NCDs) appear to be the new fad among investors looking for secure investment options. Just today, JM Financial launched its NCD worth Rs 300 crore at 9.2-9.7 per cent coupon rate with an option to retain another Rs 400 crore. Housing finance firm DHFL last week launched its NCD worth Rs 3000 crore with a green shoe option of Rs 9000 crore, totalling Rs 12,000 crore. 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.
Experts believe if one has excess capital to lock in for few years, NCDs are definitely a better choice than FDs. The prevailing rates on FDs are ruling around 7 per cent.
Murthy Nagarajan, Head-Fixed Income, Tata Mutual Fund believes NCDs are the flavour of the season as these are being offered at attractive coupon rates.
“Locking your money for 5-10 years at a coupon rate of 9-10 per cent is definitely a good option,” he said, adding retail investors must check promoters' credibility, and the credit rating history before subscribing to the issue.
Lakshmi Iyer, CIO — Debt & Head Products, Kotak Mahindra Asset Management Company echoed similar thought, adding it's a win-win situation for issuer and investors both.
“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,” said Lakshmi Iyer, CIO — Debt & Head Products, Kotak Mahindra Asset Management Company.
So, what are NCDs?
NCDs are debt financial instruments with a fixed tenure. These are issued by companies to raise capital for business purposes. Unlike convertible debentures, NCDs can't be converted into equity shares of the issuing company at a future date. The interest rate on NCDs is higher than traditional instruments and these are fairly liquid too i.e. one can sell their NCD before maturity in secondary market.
The interest income on NCDs is taxed as per individual’s tax slabs. But, a short-term capital gain tax is levied if someone sells it on the exchange within a period of one year. After one-year, long-term capital gains tax is imposed at 20 per cent rate with indexation.
“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,” said Nagarajan of Tata MF.
Three risks factors to keep in mind:
Interest rate risks
Interest rates look set to go up as global crude oil prices are back on a rising spree, and with this, the high-inflation era. While the assured return on maturity is mostly certain, redeeming your investment before maturity in the secondary market may not fetch one good rates as bond prices fall when interest rates go up.
“Interest rate risk can be mitigated if individuals hold the investment up to maturity. So allocate that proportion of money where you are sure, you do not require immediate liquidity,” Iyer suggested.
Although NCDs are listed on the stock exchange, people willing to exit prematurely may not find buyers in the secondary market, especially so for low-rated NCDs. "NCDs are semi-liquid to illiquid in the sense that investors may not get any takers in the secondary market due to low volumes," said Iyer.
By investing in an NCD, investors do run the risk of the company defaulting on the future payment. To mitigate that, one should thoroughly check the credibility of the concerned firm. Rating agencies like Icra, India Ratings and Crisil etc evaluate NCD issuers and assign a credit rating to the company based on its ability to generate cash consistently and pay investors on time. For example, DHFL issue was rated AAA, while JM Financial has AA rating on its issue.
All-in-all, NCDs are definitely a better choice than FDs for low risk takers. However, post-tax returns are attractive only for those in lower income tax slab.