POSTED BY October 24, 2011 COMMENTS (93)ON
We recently saw few Non convertible Debentures coming into market like Shriram Transport Finance NCD, Muthoot Finance NCD and Manappuram Finance NCD. A lot of investors wanted to invest in these NCD’s and many did. But does each of the investors understand what NCD is and how it works? What are the risk factors associated with NCD in India? Let’s look at it…
To understand non convertible debentures, it would be a good idea to understand convertible debentures first. As the name says convertible debentures are those debentures which are converted to normal equity shares after a specified term. Till that time these debentures earn regular income in form for interest but once they are converted to equity shares, they are just like normal shares.
Hence non convertible debentures (NCD’s) are those debentures which are not convertible to equity shares. NCD in India more or less work like company fixed deposit, where you are lending a company to get some interest income and your money back after few years. You need to check the rating of that bond. Such debt bonds are normally rated by credit rating agencies like CRISIL. A good rating indicates reasonable assurance of safety and return of principal as well as interest.
A NCD can be a secured NCD and unsecured NCD.
Secured Non convertible Debentures (NCD) are backed up by some assets which can be liquidated for paying off the bond holders incase something goes wrong. For this reason, the returns on secured NCDs are lower than unsecured NCDs. See a discussion on Tata Capital secured NCD on our forum
Unsecured Non convertible Debentures (NCD) are the ones which are not backed by any assets and incase company is in financial crunch, there can be an issue in paying back the bond holders. Only after the payment is made to every entity which has some security, the unsecured NCD bond holders have any chance of getting back their money. So that’s the reason why these NCD’s have high interest rates.
The transparency in NCD is another issue, a lot of companies have come up with NCDs to raise capital, but a common man does not have time and ability to study the NCD and how safe it would be. Look at the following comment:
Can an NBFC disburse all the money it raises? Investors also do not know how much the company has borrowed. The only document for analysis is a (dated) balance sheet. In addition to public offerings, NBFCs constantly tap the ‘private placement’ market for debt. So investors don’t know the total debt burden. There was a subsidiary of India Infoline which raised money through the NCD route. How could investors know that the proceeds were going to be utilised for a subsidiary? In the 1980s, there was a craze for fixed deposits from leasing companies, thanks to high interest rates and fancy incentives paid to investors and intermediaries. The lure was the promised rate of return and not credit quality. The same herd mentality is on display now. At some point, there will be some defaults. – via moneylife
Taxation on NCDs is just like debt funds. If you sell your debentures before a year, the profits will be added to your income and you will pay taxes at the same rate as per your income tax slab. But for any profit made by selling it after a year, you will pay tax of 10%, if indexation is not done, or 20% if the indexation is done.
Did you invest in any NCD ? Did you knew how NCD worked ?