What is NCD? Should you invest in NCDs?

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What is NCD? Should I invest in NCDs?

In recent past, you might have seen number of advertisements in newspapers / business news channels, where companies offering lucrative rate of interest for investment in their NCDs.  Recent NCD Issues

  • Muthoot Finance Limited NCD
  • Religare Finvest Limited NCD
  • Mannapuram Finance Limited NCD
  • Shriram City Union Finance NCD
  • India Infoline Financial Limited NCD

Most of these NCDs were offering interest of 11-14% p.a

Lets understand what is NCD and whether you should invest in it.

 

What is NCD

Full form of NCD – Non Convertible Debentures

In simple words, debenture is an instrument by which company raises money from public for a specified duration and pays a fixed rate of interest. It is like taking loan from public at interest.

There are normally two types of debentures:

Convertible Debentures:  They can be converted to Equity at maturity

Non Convertible debentures:  They do not have option to convert into equity. At maturity, principal amount is paid along with the accumulated interest to the debenture holder.

There are two types of NCDs – Secured & Unsecured

Secured NCD is backed by the assets of the company. If the company fails to make re-payment at maturity, the assets can be liquidated to pay the debenture holders.

Unsecured NCD is not backed by specific assets. If the company defaults, they will be treated as normal creditors.

 

Rating of NCD Issue

All NCD Issues must be rated by agencies such as CRISIL, FITCH etc. A higher rating such as AAA means the company has ability to re-pay its debentures on time and there is less default risk.

 

Interest Rates

In the current high Interest rate scenario, NCDs are offering higher rates to investors.

As many banks are offering fixed deposits at 8-10% which are less risky & have low default probability, companies offer higher interest of 12-15% on NCDs to attract investors. Normally the Interest offered by NCD is 2-5% more than Bank FD.

Company with low rating offers higher interest as compared to company with High rating.

Do not just go by offered Interest rate while investing in NCD.  Consider following risk:

 

Check the Issue Rating: 

Before making any investment decision, the investor should understand that there is a default risk and the company can default on the future payment. Agencies like CRISIL or CARE rate the NCD based on various parameters related to credibility. AAA rating considered to be highest on safety. It is relatively better to invest in NCD issue which is AA / AAA rated.

 

Check the Companies Business & end use of funds

Take a look at the Companies business & financials to understand the financial status of the company. Any use of funds other than core business can be matter of concern.

 

Liquidity Risk

Though NCDs are listed on stock exchanges, their traded volume is low. There is low level of awareness about NCD & typically investors hold NCD till maturity. Due to low volumes, the investor may not get opportunity to exit early at better prices. However, Bank FD is highly liquid & can be liquidated when required without any loss of capital.

DO NOT try to use this as a product to trade interest rate cycles. Buy it for investment purposes only if you plan to hold it till maturity.

 

Taxation Aspects

 Interest:  Interest earned on NCD is treated as other Interest incomes. It is included in “Income from other Sources” at subject to tax at normal slab rates.

 Capital Gain:  If you decide to sell the NCDs on the stock exchange before maturity, capital gains can also arise.

Short Term Capital Gain: If you sell the NCD before one year, any gains arising will be Short term capital gain and will be subject to tax as per normal slab rates.

Long Term Capital Gain: If you sell the NCD after one year, any gains arising will be Long term capital gain and will be subject to tax at 10.30% without indexation. (taxed at concessional rates u/s 112 of IT Act as NCD is listed security) Cost indexation benefit is not available in case of debentures.

 

How to invest in NCD

Primary:  You can invest in NCD at time of public issue though your online broker or offline by submitting form & cheque at collection centres.

Secondary Market: As NCDs are listed on stock exchange, you can buy these through brokers. However, in secondary market, the NCD price may be different (interest rate will be same) which will affect the effective yield / return.

For e.g.   Bond Face value: Rs 1000 &   Interest Coupon rate: 12%

If Invested at time of Public Issue, the investor will pay Rs 1000 and will get Rs 120 as Interest. Thereby earning a return of 12%.

If invested in secondary market, if the NCD price is 900, investor will invest Rs 900 and will get Rs 120 as Interest, thereby earning a return of 13.33%

If invested in secondary market, if the NCD price is 1100, investor will invest Rs 1100 and will get Rs 120 as Interest, thereby earning a return of 10.9%

DMAT account is compulsory to invest in NCD as all recent NCDs need to be compulsorily in DMAT form.

 

 How will I get Interest on NCD

The interest shall be credited to the respective Bank account registered with the demat account through ECS on the due date for interest payment.

 

Put & Call Option

Some NCD comes with Put & Call Option

Put Option:  Investor has right to sell the NCD back to the company after a specified period. Put option is favourable for Investors when the Interest rate in market is rising. They can then sell this low interest debenture early and invest money at higher rates.

Call Option: Company has option to repay the NCD prematurely. Call Option is favourable for company when the Interest rate in market is falling. They can then pay this high interest debenture early and raise money from market at lower rates.

 

Should you invest in NCD?

Though NCD may not be the best instrument to invest, it is a good option to include it in debt component of your portfolio. You should consider investing only in high rated NCDs upto 15-20% of your debt portfolio.

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