Context

• Recently, several companies have announced public issues to raise funds through Non-Convertible Debentures (NCDs).

• At a time when fixed deposit rates are in low single digits, these NCD offerings look lucrative.

What are Non-Convertible Debentures (NCDs) ?

• For retail investors, non-convertible debentures (NCDs) were an attractive source of income until two years ago. However, a spate of defaults in the financial sector in the last three years has made this a risky area now.
• Still, investors can consider investing in NCDs after evaluating the issuer’s profile.

  

• NCDs are debt financial instruments that companies use to raise medium- to long-term capital. 
• The major players in the NCD market are housing finance companies, gold loan companies and non-banking financial companies (NBFCs) which found it a good avenue for funds with the decline in interest rates in the system.
• Apart from retail investors, banks, mutual funds and insurance companies also invest in NCDs.

What are the benefits of Non-Convertible Debentures (NCDs) ?

• Besides, NCDs offer various other benefits to the owner such as high liquidity through stock market listing, tax exemptions at source and safety since they can be issued by companies which have a good credit rating as specified in the norms laid down by RBI for the issue of NCDs.
• In India, usually these have to be issued of a minimum maturity of 90 days.

What is the risk due to defaults?

• Although NCDs are generally considered safe fixed-income instruments, some recent defaults have made investors cautious.
• NCDs can be either secured by the issuer company’s assets, or unsecured.
• Certain issuers, with credit rating below investment grade, had in the past issued both a secured NCD and another unsecured one through the same offer document, with different credit ratings.
• The risk is high in the case of unsecured NCDs, even though they offer high interest rates.
• Credit rating of the issuer is a key factor to consider before investing in any NCD.

What should retail investors look for?

• At a time when bank FDs are offering interest rates between 5.5–6%, it is easy for investors to get lured into debt instruments offerings 9%.
• However, there are a few things that investors need to keep in mind before comparing the two. While bank deposits of up to Rs 5 lakh are insured through deposit insurance, they are also liquid and investors can break them whenever they need funds.
• But NCDs are not insured, and their liquidity depends on how liquid the paper is and on the market dynamics at that time.

Source: IE

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