NCDs offer better returns as interest rates on small savings, bank deposits move down

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Updated: May 31, 2016 9:57 AM

At a time when interest rates on small savings and bank deposits are moving down, investors can look at non-convertible debentures (NCDs) issued by Mahindra and Mahindra Financial Services.

non-convertible debenture - Interest rate NCDs cannot be converted into equity shares. After maturity or redemption, the company gets back its debenture and the debenture holder the principal invested, along with the interest accrued. (Reuters Photo)

At a time when interest rates on small savings and bank deposits are moving down, investors can look at non-convertible debentures (NCDs) issued by Mahindra and Mahindra Financial Services. It is offering a coupon rate of 9% for 120 months, 8.8% for 84 months and 8.7% for 66 months to retail investors.

Individuals investing up to Rs 5 lakh will be categorised as retail investors. Those investing over Rs 5 lakh will be categorised high-networth individuals (HNIs) and the coupon rates are lower for them as compared to retail investors. The debt instruments are being offered under nine different series for four category of investors. The non-banking financial company plans to raise up to R1,000 crore from this public issue, which is open till June 10 on a first come, first served basis. The face value is R1,000 per NCD and an individual will have to apply for a minimum of 10 NCDs.

The unsecured NCDs have been rated CARE AAA by Credit Analysis & Research (CARE) and IND AAA by India Ratings. The ratings by both the agencies indicate that the instruments have the highest degree of safety regarding timely servicing of financial obligations and carry the lowest credit risk. The NCDs will be listed within 12 days after the issue closes. Investors have the option for allotment in both demat and physical forms. Investing in NCDs makes sense for those in the 10% to 20% tax brackets, as those in the lowest tax bracket can get post tax returns of 8% for a 120-month tenure.

Mahindra & Mahindra Financial Services, part of the Mahindra Group, is a non-banking finance company with customers in rural and semi-urban areas. The funds raised through the NCDs will be used for onward lending, financing and refinancing the debt of the company and long-term working capital needs. For FY16, the company reported a total income of R6,598 crore, a growth of 9% as compared to R6,061 crore in FY15. However, net profit declined 15% to R772 crore as against R913 crore during the same period. In FY16, the company has disbursed loan of R26,706 crore as against R24,331 crore in FY15, registering a growth of 10%.

NCDs cannot be converted into equity shares. After maturity or redemption, the company gets back its debenture and the debenture holder the principal invested, along with the interest accrued. The listed debentures are treated as long-term capital assets if the non-convertible debentures are held for a period of 12 months. Analysts say one should invest in non-convertible debentures only if he can hold them till maturity.

If non-convertible debentures are sold on the stock exchange within 12 months from the date of allotment, short-term capital gains/losses (STCG) will arise. But beyond that period, it will be treated as long-term gains/losses. Interest earned from non-convertible debentures will be clubbed with the individual’s total income and taxed at marginal income tax rates.

Companies issuing non-convertible debentures offer higher rates because they carry default risk compared to bank or postal deposits. Unlike bank deposits, NCDs are not insured against any default and have longer tenure. Moreover, NCDs are not as liquid as bank fixed deposits as the secondary market for corporate bond is not that well developed in India. Which means, without a vibrant secondary market for these bonds, an investor may have to sell at a discount. Analysts say within an investors’ overall debt allocation, it is preferable not to invest more than 25% in company fixed deposits or non-convertible debentures, given their higher risk profile and poor liquidity compared to bank deposits and debt mutual funds. They also advise not to invest over 5% of one’s portfolio in companies which offer abnormally high yields.

Non-convertible debentures are of two types — secured and non-secured. The secured ones are backed by assets, wherein if the company is unable to fulfil its obligations, the assets are liquidated to repay the investors. So, secured non-convertible debentures pay lower coupons than non-secured ones.

For Mahindra and Mahindra Financial Services, one of the major risks is the volatility in interest rates as the company is dependent on net interest margins. The other risk factors include default by borrowers and inability to recover the full value of collateral or amount outstanding under defaulted loans in a timely manner.

Stay invested 

Individuals investing up to R5 lakh will be categorised as retail investors.

Those investing over R5 lakh will be categorised as HNIs.

Non-convertible debentures are of two types — secured and non-secured. Secured NCDS pay lower coupons than non-secured ones.

NCDs cannot be converted into equity shares. After maturity or redemption, the company gets back its debenture and the debenture holder the principal invested, along with the interest accrued.

Companies issuing NCDs offer higher rates because they carry default risk compared to bank or postal deposit.

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