Before investing in the NCD of a company, be aware of the credit ratings. Credit rating agencies, such as Icra, Crisil, Fitch, etc. rate companies based on their credit risk and degree of safety regarding timely servicing of financial obligations.
With falling interest rates on bank fixed deposits, investors are looking for other options to earn assured fixed returns, NCDs (Non-convertible debentures) being one of them.
NCDs let investors lock into a higher interest rate for longer periods, even in a falling interest rate scenario. NCDs are offered by companies looking to raise funds, and usually, they offer interest rates higher than those of post office schemes, or bank fixed deposits, if held till maturity.
However, do not worry if you haven’t invested in NCDs yet. NCDs of AAA-rated finance companies are traded on the stock exchanges. For instance, you can look at NCDs of L&T Financial Services, Edelweiss Finance & Investments (EFIL), Edelweiss housing finance limited, Mahindra & Mahindra Financial Services, Tata Capital Housing Finance, etc.
Experts suggest before investing in the NCD of a company, be aware of the credit ratings. Credit rating agencies, such as Icra, Crisil, Fitch, etc. rate companies based on their credit risk and degree of safety regarding timely servicing of financial obligations.
Here is what you need to know
Types of NCDs – Debentures are issued by a company when it wants to raise money from the public. These are of two types debentures – convertible debentures and non-convertible debentures. Convertible debentures can be converted into an equity share at the time of maturity. Non-convertible debentures (NCDs), on the other hand, cannot be converted into equity shares at the time of maturity.
NCDs are further divided into two types: secured NCDs, and unsecured NCDs. Secured NCDs have control over the assets of the issuing company, whereas with the unsecured NCDs there is no backing from the company, in case it defaults.
Interest Rates offered – In a high-interest rate scenario, NCDs are known to offer high rates of interest to investors. In the last few years, the average interest rate has been around 8-11 per cent in the case of secured NCDs. Currently, they are yielding 7.6 to 9 per cent. Most NCDs come with the option of annual and cumulative pay-out, however, investors can also choose from other pay-out options such as monthly, quarterly, half-yearly, or annually.
NCDs vs. FDs – The State Bank of India currently offers an interest of 5.4 per cent on its 5-year domestic deposits. NCDs, on the other hand, offer a return of 7-9 per cent, depending on the lock-in period. Hence, this investment option holds the advantage over bank-deposits, allowing investors the option to lock into better interest rates for a longer tenure.
NCDs are listed on the BSE and NSE and provide liquidity over a longer tenure. However, most investors go in for bank FDs because of the easier access and the liquidity they provide.
Tax implications – Depending on the NCD term, gains from NCDs are taxed. However, they are taxed differently from interest on bank deposits. For instance, if NCDs are sold 1 year in advance, short-term capital gains on NCDs are taxed as per the income slab of individuals. If the investments are sold after 1 year but before maturity, they are taxable as long-term capital gains. Hence, if an investor is holding for a period of less than one year, then any gain made from the sale will be taxed as per his/her tax slab.
Experts suggest one should always strategize and manage liquidity and risk. Therefore, NCDs are an ideal alternative to bank FDs and debt funds, given they are issued by AAA-rated finance companies with higher credit ratings.