Are NCDs a good bet in current scenario? Find out

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August 31, 2021 2:19 PM

NCD is a financial instrument that is used by companies to raise long-term capital through a public issue.

With interest rates trending low in a post-Covid scenario with abundant liquidity, it may be worthwhile to lock in the high yield of nearly 10%, available with NCDs.

What are NCDs: Non Convertible Debenture (NCD) is a financial instrument that is used by companies to raise long-term capital through a public issue. NCDs have a fixed maturity date and investors receive a fixed interest rate. Some debentures can be converted into shares after a certain point in time at the discretion of the owner. However, this is not possible in the case of NCDs. That’s why they are known as non-convertible.

There are two types of NCDs: Secured NCDs that are backed by the company’s assets, which means that if the company fails to pay, investors can claim payment through liquidation of assets.
On the other hand, Unsecured NCDs are not backed by the company’s assets and hence they are riskier than Secured NCDs. Investment in a debt instrument like an NCD offers high inflation adjusted returns compared to traditional debt investments and hence are a good addition to an investor’s portfolio based on their risk appetite.

Are NCDs a good bet?

With a coupon rate of close to 10% per annum, an NCD issue stacks up higher in comparison to other debt products. In the present landscape, the interest rate on a term deposit with a nationalized bank like SBI fetches around 5.4% while liquid funds offer anywhere between 2.8% and 3%. Also, the NCD coupon rate is much higher than 10-year government securities which currently offer 6%. With interest rates trending low in a post-Covid scenario with abundant liquidity, it may be worthwhile to lock in the high yield of nearly 10%, available with NCDs.

What are the NCDs on offer currently?

There are two NCD issues open currently — one by Muthoottu Mini and another by Edelweiss Financial Services. Here’s a quick look at how they stack:

How should one choose?

Coupon rate: Consider a company with a higher coupon rate i.e. Interest rate offered by the issuer. For instance, Muthoottu Mini Financers Ltd’s 15th NCD issue offers effective annualized yield of up to 10.22% per annum on redemption for Secured NCDs and 10.41% pa for Unsecured NCDs. It has a Base Issue Size of Rs 125 crore, with an option to retain over-subscription up to Rs 125 crore, aggregating up to a total of Rs 250 crore.

The Edelweiss Financial Services’ (EFSL) NCD is also offering an effective yield of up to 9.7% which is highly lucrative given the low interest rate structure of the economy currently. The NCD issue is secured in nature, meaning if the company faces any financial crisis, then investors’ interest will be put on priority and they will be paid back their principal amount together with the applicable interest rate, if any. This de-risks the investment compared to unsecured NCDs. While the coupon rate is attractive, an existing investor of EFSL or group company NCD will be entitled to an additional pay out of 0.2 per cent per annum.

Tenure: NCDs usually have a maturity period of 30, 60 or 120 months. In an uncertain environment, investors can benefit from the monthly cashflow by opting for the monthly interest option. Edelweiss offers a monthly interest option that helps you get monthly cashflows.

Credit Risk (Security, nature of business): It is the company’s credit performance. Invest in an NCD which is secure, having a higher credit rating.

Muthoottu Mini’s 15th NCD issue is rated as ‘CARE BBB+’: Stable (Triple B Plus: Stable) by CARE Ratings Limited.

CRISIL has reaffirmed the EFSL rating of AA- (Negative) on the confidence of the improving credentials of the company. Also, the NCDs have been rated A+ (Negative) by ICRA and AA (Negative) by Acuite Ratings. The ratings signify that these NCDs come with a low credit risk.
While the ratings by the rating agencies signify the associated risks, it can largely be attributed to the weak external credit environment, on account of which agencies have remained conservative. However, the diversified nature of the business as well as the strengthening measures undertaken by the company with stable liquidity levels and a strong balance sheet should definitely put investors at ease.

Repayment track record: One should check the repayment track record of the issuer on both the interest and principal.

With the Covid-19 second wave nearing the end, we are beginning to see a swift economic recovery. This may work for a few well-managed NBFCs. Investors looking for regular income and high interest rates may find these offers an attractive bet. However, you should invest only after completing your research work or after talking to your financial advisor because NCDs are riskier than bank fixed deposits and many other safe investment options.

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