The NCD rush: Dont get swayed by returns

Aug 08 2014, 02:37 IST
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Summarysome companies are launching fixed deposits and non-convertible debentures (NCDs) offering higher interest rates than bank fixed deposits.

some companies are launching fixed deposits and non-convertible debentures (NCDs) offering higher interest rates than bank fixed deposits. While these may look attractive, individual investors must look at the credit profile of the companies launching them.

One must invest in company deposits for the short term. In general, two categories of companies float public fixed deposits non-banking financial companies (NBFCs) and those in manufacturing, utilities, real estate and services. As per Reserve Bank of India (RBI) rules, an NBFC will have to procure a credit rating from one of the rating agencies, and it has to be disclosed to the investor in the prospectus. The RBI has made it mandatory for NBFCs to have an A rating to be eligible to accept public deposits, but it is not mandatory for others. Analysts say as a rule, an investor must choose a rated company fixed deposit over an unrated one. Instead, one can deposit money in bank fixed deposits, which are safer than unrated company fixed deposits.

Higher rates should not be the only reason to lap up NCDs. Experts say one should see where the company lends, and if it does in sectors like real estate or power, it is better to be cautious the fundamentals in these sectors are still not strong. Before investing in NCDs, one must look at their past lending performance, cash flows and business risk to ensure it does not default on payments after maturity. If NCDs are sold on the stock exchange within 12 months from the date of allotment, an investor will have to pay short-term capital gain (STCG) tax. Beyond a year, it will be treated as long-term capital gain (LTCG).

While companies are offering much higher rates for both deposits and NCDs, investors must understand that the risk-reward matrix is totally different. First and foremost, NCDs are not as liquid as bank FDs as the secondary market for corporate bonds is not very well developed. So, without a vibrant secondary market for these bonds, an investor may have to sell the NCDs at a discount. For bank deposits or even corporate deposits, one can go for premature withdrawal after paying a penalty.

Moreover, NCDs can never be converted into equity or preference shares. After maturity or redemption, the company gets back its debenture and the debenture holder gets back the principal invested, along

with the interest accrued. All NCDs are fixed income debt

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