NCDs provide interest income, but look at credit rating before investing

NCDs are debt instruments that can’t be converted into equity or stocks.
Muthoot Fincorp unveiled its fifth issue of secured redeemable non-convertible debenture (NCD) to raise Rs 480 crore on Thursday. This is the second issue to be announced within a week. 

Tata Capital’s NCD issue, which was launched on Monday, is already fully subscribed. 

NCDs are debt instruments that can’t be converted into equity or stocks. If you are someone who wants to get a piece of this pie, you need to choose the right one for you.

Credit rating

Mumbai-based tax expert Balwant Jain says, “Of all the parameters one should look into, credit rating is paramount.” After all, the credit rating shows the likelihood of the underlying issuing company defaulting on its interest and principal payment. 

Jain says, “A rating of ‘AAA’ shows the highest quality or that the probability of default is extremely low. The next level is ‘AA’, where the default probability is still considered fairly low.” 

Likewise, ‘BBB’ and a higher rating mean it’s worth investing in as there is a relatively low risk of default. Never let only returns be your parameter — interest coupon offered is inversely linked to the credit rating; you get a premium yield for investing in lower-rated securities with more risk.

Income Tax Slab Rate for AY 2020-21 for Individual

Payout options

The second parameter to consider is the payout option. Anuj Shah, Mumbai-based certified financial planner, says, “NCDs come with a fixed maturity date. Interests can be paid along with the principal amount, either monthly, quarterly, or annually, depending on the fixed tenure specified.” 

At times, you get the added option of receiving interest on a cumulative basis. Here, you do not get interest payments throughout the NCD’s tenure, but as a lump sum amount on maturity. Know your money need — short-term, long-term or regular income and then pick the tenure accordingly. For regular income, go for the accumulated interest option as compounding results in a better yield.

Taxation

Abhinav Angirish, founder, InvestOnline, says,” NCDs are taxed according to the slab rate of the investor. Hence, if the investor is in the high tax bracket of 30 per cent, he will have to pay 30 per cent tax on the interest accrued. However, the investor can get indexation benefit if he holds the NCDs for more than a year. If NCDs are sold before completion of one year, the short-term capital gains have to be paid at normal tax rates.” 

If you sell NCDs after a year or more or before the maturity date, long-term capital gains will be applicable at 20 per cent with indexation.

Other parameters

Jain says, “Credit rating will reflect other parameters. But if you want to consider a few more, you can like interest coverage ratio (ICR), capital adequacy ratio (CAR), liquidity, provisions for non-performing assets, level of debt and the like.” 

ICR shows how well a firm can pay interest on outstanding debt. CAR measures the company’s capital and sees if the company has sufficient funds to survive potential losses. 

Stay away from any company that has allocated 50 per cent or more of its total assets towards unsecured loans. 

Most NCDs are listed on the stock exchanges. Many believe that at times if you want to exit, it could become challenging to find a buyer, especially for small investors with small volumes. However, many advisors believe liquidity is a function of several factors mentioned above, and higher rated ones have decent liquidity.

Some planners do not recommend these products. Others think they are good options, compared to fixed deposits (FDs). Angirish says, “If the person is in high tax bracket, his post-tax returns will be considerably lower, which make them unattractive. However, NCDs are ideal investment instruments for those in a lower tax bracket or do not have taxable income since they offer a higher interest rate than bank FDs.”


Business Standard is now on Telegram.
For insightful reports and views on business, markets, politics and other issues, subscribe to our official Telegram channel