Look beyond interest rate of NCDs

Mumbai: It is just the beginning of FY 2020 and already four non-convertible debentures (NCDs) have hit the market. Interest rates on these NCDs range from 8.70% to 10.75% per annum.

If the higher interest rate is tempting you to consider NCDs, here is what you should know before investing.

NCDs flood the markets

The companies have rushed to offer NCDs to raise money to do their business of lending, besides looking for diversification. “After the latest credit crisis, every financier would like to have a diversified channel to borrow for the lending business. Though NCD was on our radar for 15 months, we didn’t go ahead with it then. After IL&FS crisis, the Reserve Bank of India (RBI) has become far stricter on the asset-liability mismatch. Companies need longer-term funds and retail NCD is a source where you are raising money for a minimum period of three years,” said Kailash Baheti, group chief finance officer, Magma Fincorp Ltd.

In case of Shriram City Union, the NCD issue was planned about six months ago to broad base liabilities. “The regulatory clearances and preparation of prospectus meant that we could float it now,” said Y.S. Chakravarti, executive director and chief operating officer, Shriram City Union.

The companies believe there is good market appetite for issuers with pedigree, AAA rated, strong parentage, corporate governance standards and robust risk management mechanisms. The money raised by the companies will be used for lending, investments, existing liabilities or loans, business operations and working capital requirements. “Up to 75% of the money raised will be utilised for the purpose of onward lending, financing and refinancing of the existing loans of the company and the remaining amount will be utilised for general corporate purposes,” said L&T Finance Ltd spokesperson.

Should you have NCDs in your portfolio?

According to analysts, investors got skeptical of AAA-rated companies after the IL&FS crisis. “After IL&FS a lot of retail investors and asset management companies got skeptical on NCDs. A AAA-rated company going down was a big setback. Also, a lot of bigger NBFCs took a while to get back to the market and raise money via NCDs. NBFCs also had asset-liability mismatch, which was highlighted in the crisis. Meanwhile, funding from other sources started drying up.

Typically, these NBFCs get funding from banks and asset management companies. It took a couple of months to get corrected. Now that has changed and there is appetite for NCDs,” said Dharmesh Desai, head, products and NRI business, IIFL Securities. If you are looking to invest, don’t just look at the returns. Firstly, evaluate the company that is offering the NCDs based on performance, credit rating and repayment capacity. Remember that the interest rate you earn from NCDs is taxed at slab rate and hence, is not a tax efficient investment instrument.