The pros & cons of investing in NBFC NCDs?-Finance is needed by a company for many reasons, such as expansion, new machinery and plant, diversification, working capital requirements, etc. These needs can be met by a variety of sources, including obtaining a loan through NBFCs or banks, and raising funds via equity shares, rights, debentures, bond issues, etc.
These sources are analyzed by the company based on time required to raise the funds, different regulations regarding the method of raising funds, cost of funds and a cost/benefit analysis. Debentures are popular among companies because they can be easily issued and have fewer regulations than equity shares.
Below is a short discussion on the meaning of NCDs, and the pros of and cons of investing into NCDs. .
What are NCDs (non-communicable diseases)?
Few people are aware that there are different types of debentures a company can issue. NCDs, or Non-convertible Debentures, are issued by companies to raise capital for their financial needs. The main difference between convertible debt and NCDs, is that the first can be converted into equity securities at the request of the debentureholder, provided the company accepts it. However, NCDs cannot be converted.
NCDs tend to be unsecured, which means they are not directly secured by assets of the company. Investors must rely on their own due diligence and the creditworthiness the company to determine the viability of an investment.
NCDs, like convertible debentures also pay interest at a set rate called the coupon rate. This rate is announced by the company when issuing NCDs. The interest is paid to investors at regular intervals, such as monthly, quarterly or semi-annually, depending on the agreement made between the issuer and subscriber. NCDs have a fixed maturity period and at maturity the investors will receive the principal amount as well as the interest.
What are the characteristics of NCDs
Below are some of the most attractive features of NCDs for both companies and investors.
Different types of NCDs
NCDs can be divided into two broad categories: secured NCDs, and unsecured NCDs. Secured NCDs can be liquidated if the issuing company defaults. These NCDs have a relatively low interest rate. The most common NCD on the market is an unsecured NCD, which is backed by no asset or collateral. These NCDs have a higher rate of interest than secured NCDs.
Interest rate increases
NCDs are most appealing because of the higher interest rates offered by companies to subscribers. Unsecured NCDs offer higher interest rates than secured NCDs. The excess interest rate is a reward for the investor who has taken a risk with the company, and foregone the conversion into equity shares that convertible debentures offer. The interest rate directly correlates with the investment risk. The risk of investing in NCDs offered by low-rated companies is greater, which is reflected in higher interest rates.
Liquidity
NCDs tend to be issued by well-known companies with a high credit rating from top rating agencies. Investors are assured of the viability and returns of their investments. NCDs also have a short lock-in period, and they are listed on recognized stock markets. Investors can easily trade them and make short-term profits or sell their investment if it is not favorable. Investors can subscribe for NCDs on recognized stock exchanges, or during public issues where subscriptions are limited.
Taxation
Taxation of NCDs is the same as for any other debt instruments. Gains can be either short-term gains or long-term gains depending on how long the investor has held the NCD. Short-term capital gains will be taxed according to the applicable slab rate, while long-term gains will be taxed flat at 20% after indexation.
What are the advantages or pros of investing in NCDs
Here we discuss the key benefits of investing in NCDs.
- Higher rates of interest: NCDs offer higher rates of interest than traditional investment options such as bank FDs or government securities.
- Tradeable on the Exchange: NCDs listed on the exchange can be traded openly, making them liquid and providing an opportunity for capital growth.
- Priority charge on assets NCDs have priority over equity holders, even though they are unsecured. The investment of investors is therefore more or less regarded as a secured investment.
- Sound Investment Before issuing NCDs the creditworthiness is assessed by credit rating agencies and the RBI. Investors are more confident in the future prospects of the company.
- No TDS is taken on interest: The amount of tax that is deducted from the NCD interest is determined by your tax slab.
What are the disadvantages or cons of investing in NCDs?
Below are the major limitations of NCDs.
- Fixed Return The main disadvantage of NCDs are the non-inflationary returns. NCDs’ post-inflation return may not be as appealing as other dynamic investment options on the market.
- Subjected to tax : The returns on NCDs after taxes may be lower than other debt investment options such as debt mutual funds and hybrid mutual funds.
- Non convertible to equity shares NCDs cannot be converted into equity shares, and therefore investors are denied the opportunity to become shareholders.
- The possibility of less sound companies issuing NCDs Companies with a lower rating are at a greater risk of default, and they may not be able to return principal and interest upon maturity.
Eligibility for NCDs
SEBI’s (Issue & Listing of Non-Convertible Security) Regulations 2021 govern the issue of NCDs. These guidelines allow a company to issue NCDs if they meet certain conditions.
- The company must have a net tangible worth of at least Rs. 4,00,00,000
- The company was granted a working capital or term loan by any bank in India.
- A bank or financial institution should have classified the borrowing account as an asset standard.
The conclusion of the article is:
NCDs can be a very effective way to raise capital for businesses. Credit rating has a direct effect on the coupon rates offered by the companies. Investors also find NCDs to be a better option than traditional investments such as Bank FDs and Post Office Time deposits because the interest rates are higher.