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Non-convertible debentures offer better returns than FDs

Non-convertible debentures offer better returns than FDs

Non-convertible debentures offer 2-3 percentage points more in interest than bank fixed deposits for a slight increase in risk.

Investors are always on the prowl for good investment opportunities. So when Shriram Transport Finance Corporation came out with its Rs 500-crore non-convertible debenture (NCD) issue on 27 June 2011, it was oversubscribed about five times in just three days. The issue was closed on 29 June 2011 even though it could have remained open till 9 July 2011.

Shriram Transport had reserved Rs 200 crore worth of NCDs for retail investors (investment under Rs 5 lakh), but the firm received applications for Rs 2,300 crore in this segment. Though the non-banking financial company (NBFC) chose to retain an additional Rs 500 crore, many would have missed the opportunity to get 11.3-11.6% return on their investment as the debentures were issued on a 'first come, first served' basis. If you are also among those who were late to capitalise on the opportunity, there is still hope. Several NCD issues are in the pipeline, mostly from NBFCs.

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Muthoot Finance is planning to raise Rs 1,000 crore through secured NCDs. "Manappuram Finance and Shriram City Union Finance will also hit the market. The major inflow of NCDs and bonds will come in form of tax-free bonds and infrastructure bonds in this financial year," says Anand Mehta, assistant vice-president, debt capital market, LKP Securities.

"With new guidelines from the Securities and Exchange Board of India (Sebi) and the RBI, foreign institutional investors' exposure limit to corporate bonds has increased from $20 billion to $40 billion. This is helping firms to raise funds through NCDs," Mehta adds.


NCDs might be the answer to your quest for the investment instrument that offers high returns with moderate risk while giving you the flexibility of choosing between short and long tenures.

Several companies are planning to raise money through NCDs:

>> Muthoot Finance
>> Manappuram Finance
>> Shriram City Union Finance
>> IFCI (Infrastructure bonds)


>> Interest earned on NCDs after maturity taxed as regular income
>> Gain from selling NCDs within one year taxed as short-term capital gain
>> Return from NCDs sold after one year but before maturity taxed as long-term capital gain
>> Capital gains taxed at the rate of 10% without indexation of the cost of acquisition and at 20% with indexation, which factors in inflation
"There is always demand for good-rated investment products which can offer attractive returns. Keeping this in mind, companies keep on coming with debenture issues to raise capital from the market. In the current scenario, when equity markets are not doing well, NCDs have become more important from the investor point of view as these offer attractive returns with the benefit of liquidity," says Harish Sabharwal, chief operating officer, Bajaj Capital. "There is also a separate set of investors for the debt category who prefer to invest in such issues irrespective of the equity market movement."

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An NCD is a fixed-income debt paper issued by a company. In other words, the issuer agrees to pay a fixed interest on your investment. As the name suggests, these debentures cannot be converted into shares of the issuing company like convertible debentures where investors have the option of getting shares in the issuing company on conversion.

An NCD can be both secured as well as unsecured. For secured debentures, which are backed by assets, in case the issuer is not able to fulfil its obligation, the assets are liquidated to repay the investors holding the debentures.

Secured NCDs offer lower interest rates compared with unsecured ones. If you want a regular income from NCDs, you can pick those that pay interest on a monthly, quarterly or annual basis. If you just want to grow your wealth, you can opt for cumulative option where the interest earned is reinvested and paid at maturity.

Any Indian company can raise money through NCDs if it has a tangible net worth of at least Rs 4 crore and has been sanctioned loans by banks or financial institutions which is classified as 'standard asset' and not as bad debt.

Companies seeking to raise money through NCDs have to get their issue rated by agencies such as CRISIL, ICRA, CARE and Fitch Ratings. NCDs with higher ratings are safer as this means the issuer has the ability to service its debt on time and carries lower default risk.


"NCD is better than a bank fixed deposit because the interest differential is quite significant which comes at just a slightly higher risk. The risk-return ratio is in favour of NCDs," says LKP's Mehta.

Currently, bank fixed deposits are offering an interest of 9-10% for a tenure of one to five years. In contrast, the recently concluded Shriram Transport NCD offered 11.6% for five years and 11.35% for three years to individuals.

"A bank fixed deposit or savings certificates issued by the postal department is for a maximum of five to seven years. In contrast, NCDs are available from two years to as much as 20 years. You can use long-tenure NCDs to create a retirement corpus," adds Mehta.

Fluctuating Fortunes
Fluctuating Fortunes
SBI Bonds issued in February 2011 offered 9.25% for a tenure of 10 years and 9.5% for 15 years.


An investment offering higher returns invariably comes with additional risk. "The biggest risk with NCDs is the possible capital loss in case of increase in interest rates. But investors willing to wait till maturity need not fear the same," says Vivek Karwa, a certified financial planner and director, Vridhi Investment Intermediates.

NCDs have a fixed coupon or interest which is paid to the holder of the instrument at maturity. If you sell an NCD in the secondary market when the interest rate is higher than that being offered by the debenture, your return will be less or even negative as the buyer will pay only that amount which allows him to get the return equal to the prevailing market rate. If the interest rate goes down, your effective return will be higher than that being offered on the NCD.

Apart from the risk of lower return or loss of capital, there is the risk of default by the company even though the chances are low as most of the firms are under supervision of the RBI and Sebi. "As NCDs are mostly secured against assets of the issuing company, risk of default is low. In addition, debentures of blue-chip companies have less risk as these firms have robust finances. Small companies have more risk and so offer higher rate of interest," says Jai Adiani, a certified financial planner and director,

"Amid the turbulent stock markets, NCDs offer attractive returns with the benefit of liquidity."
Harish Sabharwal
COO, Bajaj Capital
NCDs are also listed on bourses. This allows investors to liquidate the bonds even before maturity. However, there is no active market for NCDs on the wholesale debt market segment of the stock exchanges and their liquidity is low. You might not be able to find a buyer for your NCDs if their trade volumes on bourses are insignificant.

Huge debt obligations of a company mean it might have trouble repaying its debt. So you should see the debt-equity multiple of the issuing company before investing. There is no fixed acceptable level for the debt-equity ratio as it depends on the business of the company. For example, an NBFC, which is in the business of borrowing and lending money, can have a debt-equity multiple of five to six times without putting any unnecessary strain on its debt-servicing power.


Interest earned through NCDs, if held until maturity, is clubbed with your income and taxed at your marginal income tax rate. If you sell your NCDs on the stock exchange before a year then you will have to pay short-term capital gains at income-tax rates applicable to you. If the debenture is encashed after one year but before its maturity, you will have to pay capital gains tax on the effective return.

However, NCDs do not have the advantage of the tax deduction allowed for investments upto Rs 20,000 in infrastructure bonds. The latter, though, has limitations on the interest rate they can offer.

"Interest rate on infrastructure bonds cannot be greater than that of the prevailing government securities. NCDs do not have such interest rate limitations. If investors are not looking for tax exemption, NCDs are more attractive," Bajaj Capital's Sabharwal says.

NCDs provide you the opportunity to earn 2-3 percentage points higher return than other fixed-income instruments such as bank fixed deposits. Use them wisely to diversify your debt portfolio. If you are looking at a short-term investment option, NCDs can offer you the right instrument for you.

Published on: Aug 15, 2011, 12:00 AM IST
Posted by: Gaytri Madhura, Aug 15, 2011, 12:00 AM IST