SREI Equipment Finance has recently come up with a non-convertible debenture (NCD) issue that’s offering coupon rates ranging from 8.5 per cent for 400 days to 9.6 per cent for 10 years. This route for raising funds had its high in FY 2018 where Indian companies raised a whopping ₹6-lakh crore through private placements, via 2,706 issuances. This is the second-highest issuance in terms of funds mopped up by India Inc since the private placement of corporate bonds opened in 2007.
What are NCDs?
India Inc is increasingly turning to bonds to raise funds, especially after banks tightened norms and procedures in response to scams and rising non-performing assets (NPAs).
Corporates typically raise money via this route for funding expansion plans, retiring debt, supporting working capital requirements and other general corporate purposes.
NCDs are loan-linked bonds (that cannot be converted into stocks) and usually offer higher interest rates than convertible debentures, Bank fixed deposits and Corporate Deposits. On maturity, the principal amount along with accumulated interest is paid to the holder of the instrument.
Secured and Unsecured NCDs
Non-Convertible Debentures (NCDs) are of two types- secured and unsecured. A secured NCD is backed by the assets of the company and if it fails to pay the obligation, the investor holding the debenture can claim it through liquidation of these assets.
On the other hand, there is no backing in unsecured NCDs in case company defaults.
To add to the safety, any company seeking to raise money through NCD has to get its issue rated by agencies such as CRISIL, ICRA, CARE and Fitch Ratings. A higher ratings (e.g. CRISIL AAA or AA-Stable) means the issuer has the ability to service its debt on time and carries lower default risk. A lower rating signifies a higher credit risk.
NCDs : Call or Put options
NCDs may have Call or Put options – If a company issues a ‘Callable Bond’, it means that it can be redeemed by the Issuer (company) before the bond’s maturity while a bond with a ‘Put option’ works in exactly the opposite manner, wherein the investor can sell the bond to the issuer at a specified price before its maturity.
- Higher Interest rate: The average rates in last few years have been 9-10% and most of these were issues as secured NCDs. In addition, there can be various options for interest payout such as monthly, quarterly, half yearly or annually. However, most NCDs offer annual and cumulative payout.
- Capital Gains: NCDs get listed on the nation’s main exchanges where investors can sell them before maturity. Any gain earned through selling in secondary market is termed as capital gains. What gains an investor will make depends on the interest rate scenario prevailing at that time.
- Risk : NCDs have the biggest risk in the form of its default/credit risk. The company can default on future payments and if it is an unsecured NCD, an investor does not have any recourse. Typically, a rating above AA is considered good to invest, provided the rating is by one of the top rating agencies. The second main risk is the liquidity risk. Even if an NCD get listed, low volumes (case of low rated NCDs) can deprive investors of any opportunity in exiting prematurely.
- Middling Tenures: These instruments give a stable cash flow with reasonably long investment tenures ranging from 2 to as much as 20 years. Given the risks however we would recommend investing not beyond 5-6 year issues as visibility on performance may not exist beyond that.
- No TDS: There is no tax Deducted at Source (TDS) on listed debentures.
- The option of holding debentures in ‘Demat Form’ makes your investments easy to handle & monitor.
If the NCDs are sold on an exchange before one year, short term capital gains tax at applicable rates apply depending on the tax slab you fall into . If sold on an exchange before maturity but after one year, Long Term Capital Gains Tax is applied at 20% with indexation & 10% without indexation
If the NCDs are Held till Maturity, the Interest earned is added to the total income & taxed at marginal rate of income tax depending on the tax-slab you belong to.
Ways to invest in NCDs
You may apply for NCDs during the public issue by submitting a physical form furnishing the details or in the secondary market via NSE/BSE via your trading account like the way you invest in shares.
The issue here is that tax adjusted returns on NCDs make them not so attractive for people in the tax bracket of 20% or more. In that case, investing in tax-free bonds is a better choice.
To conclude, tax free bonds are good for high tax bracket individuals, while debentures can be best suited for low tax bracket individuals.
For exchange listed bonds, visit https://nseindia.com/live_market/dynaContent/live_watch/equities_stock_watch.htm?cat=SEC
Write to our IPO Desk for further information on ongoing issues, exchange based investing, tax free issuances/bonds or email us at firstname.lastname@example.org