Photo by pichmielShriram Transport (STCL) NCD issue got oversubscribed many times on day one (July 27, 2009) of the issue. This was the second issue of Non-Convertible Debentures (NCDs) to retail investors by a Non-Banking Finance Company (NBFC). The earlier issue of NCDs by Tata Capital (TCL) in February 2009 had raised 1,500 crore.
Maybe you’re among the lucky few that managed to invest in any of the two NCD issues. Or, it might be possible that you missed both issues and are regretting it now. But don’t worry, there’s going to be many more NCDs issues in the near future. To avoid the last minute rush, it is always better to be properly planned.
This post is going to discuss reasons behind the sudden popularity of NCDs and how to invest in NCDs, should you decide to make them a part of your investment portfolio.
Why there is so much demand for NCDs?
Let’s see the reason for their popularity. At present, Non-convertible debentures (NCDs) are the best debt option to invest in (beyond Section 80C) because of a host of reasons:
1.Better Returns:
Both Tata Capital NCD and Shriram Transport NCD offered interest rates which were quite attractive as compared to interest on other fixed-income options. While yield on redemption of Tata Capital NCD issue was 11.57 –12%, effective yield of Shriram Transport NCD was in the range is in the range of 10.75—11.50% which compares favorably with term deposits (TD) of banks.
If you happen to fall in the highest tax bracket (30.9%), your effective post tax returns will be 7.95 per cent based on rate of interest of 11.50% per annum. And if you’re in the middle tax bracket (20.6%), return after tax will work out to be 9.13 per cent p.a. based on interest rate of 11.50% p.a.
So, right now, NCD seems to be quite attractive investment option among debt instruments given that after-tax returns are around 8% for an investor in the highest tax bracket.
However, in future companies might lower the yield based on the interest rate movement and debt market scenario.
2. No TDS:
Unlike bank FDs or corporate FDs, there is no tax deduction at source (TDS) on NCDs offered in DMAT mode and listed on a stock exchange as per section 193 of the IT Act. However, NCDs allotted to non-resident Indians (NRIs) will be subject to tax deduction at source as per section 195 of the Income Tax Act.
3. Higher Safety:
Unlike corporate FDs which are unsecured, NCD issues by NBFCs are secured debt (NCD’s are 100% secured by assets of the company). Furthermore, both the NCD issues have received good credit rating.
However, this doesn’t guarantee 100% safety. Default risk still remains although very slight. But, default risk remains even in case of Bank FD’s beyond Rs 1lakh.
4. Good Liquidity:
NCDs offer good liquidity due to NSE listing (but listing doesn’t guarantee liquidity). If you would like to go for premature exit, basically you’ve got two options:
a. Sell on the NSE
b. Exercise put option, if available.
However, remember that exiting through secondary market (NSE) entails interest rate risk. If the interest rates fall, the value of NCD will rise (as happened in the case of TATA CAPITAL’s NCDs which were issued in the month of February 2009). And, in an environment of rising interest rates, the value of NCD’s may fall below face value.
But if you plan to hold it till maturity, then there is no-risk due to interest fluctuations.
Furthermore, there is also liquidity risk because, as of now, Indian debt / bond markets are highly illiquid (less frequent trading and insufficient volumes). So, if you plan to encash before maturity by selling on the secondary market (NSE), remember that you might not be able to do so.
How to invest in NCD’s?
If you decide to invest in non-convertible debentures (NCDs), remember the following points:
1.When to Apply:
Apply on the first day of the issue itself because the allotment of NCDs is on first come first serve basis. Chances of issue closing on the first day itself are quite high given the market’s appetite for NCDs.
2. Best NCD Option:
Cumulative option always appear to be most attractive because it offers the highest yield and allows you to reinvest the interest at the same coupon rate / interest rate (i.e., there is no reinvestment risk).
For instance, If you had invested Rs 1 lakh in, say, cumulative option (option 3) of Shriram Transport NCD offering a effective yield of 11.50% p.a. (which was maximum among all the 5 options), you will get pre-tax amount of Rs 1,72,335 at the end of 5 years (assuming Call / Put option shall not be exercised).
On the other hand, if you to would like to receive regular interest income, then you can also look for other NCD options offered such as quarterly, half yearly or annual interest payments, but interest /coupon rate offered is usually lower. And even if the interest / coupon rate is same (e.g. TATA NCD coupon rate was same for annual payment option and cumulative option) you would have to bear re-investment risk, which means that your effective yield can be lower if you’re not able to reinvest your interest income at the same or higher rate of interest (which is highly unlikely).
If you don’t want to lock your money in fixed rate instrument for long term (usually 5 years), you can consider NCD option which is having lower tenure (e.g. 36 months in case of STCL NCD issue), but here the returns are a bit lesser as compared to longest term.
Furthermore, some NCDs also allow staggered redemption; for instance, Shriram Transport NCD Option 1 offering half-yearly interest payment and option 2 offering annual interest payment had provision for staggered redemption (40%, 40%, 20% at the end of 36, 48 and 60 months respectively).
3. Mandatory Requirements:
Before filling the NCDs application forms make sure that you’ve a DMAT account (allotment is compulsorily in dematerialized form) and PAN number (irrespective of amount of application as per SEBI guidelines).
4.Instructions:
Finally, please read instructions carefully because an application form not filled up correctly is liable to be rejected.
Any further question? Please leave it in the comment box.
UPDATE (22 August, 2009): For FAQs regarding taxation of NCDs, comparison with FDs, risks involved in NCDs and stock exchange trading please see part 2: Top 10 FAQs about NCDs.
Maybe you’re among the lucky few that managed to invest in any of the two NCD issues. Or, it might be possible that you missed both issues and are regretting it now. But don’t worry, there’s going to be many more NCDs issues in the near future. To avoid the last minute rush, it is always better to be properly planned.
This post is going to discuss reasons behind the sudden popularity of NCDs and how to invest in NCDs, should you decide to make them a part of your investment portfolio.
Why there is so much demand for NCDs?
Let’s see the reason for their popularity. At present, Non-convertible debentures (NCDs) are the best debt option to invest in (beyond Section 80C) because of a host of reasons:
1.Better Returns:
Both Tata Capital NCD and Shriram Transport NCD offered interest rates which were quite attractive as compared to interest on other fixed-income options. While yield on redemption of Tata Capital NCD issue was 11.57 –12%, effective yield of Shriram Transport NCD was in the range is in the range of 10.75—11.50% which compares favorably with term deposits (TD) of banks.
If you happen to fall in the highest tax bracket (30.9%), your effective post tax returns will be 7.95 per cent based on rate of interest of 11.50% per annum. And if you’re in the middle tax bracket (20.6%), return after tax will work out to be 9.13 per cent p.a. based on interest rate of 11.50% p.a.
So, right now, NCD seems to be quite attractive investment option among debt instruments given that after-tax returns are around 8% for an investor in the highest tax bracket.
However, in future companies might lower the yield based on the interest rate movement and debt market scenario.
2. No TDS:
Unlike bank FDs or corporate FDs, there is no tax deduction at source (TDS) on NCDs offered in DMAT mode and listed on a stock exchange as per section 193 of the IT Act. However, NCDs allotted to non-resident Indians (NRIs) will be subject to tax deduction at source as per section 195 of the Income Tax Act.
3. Higher Safety:
Unlike corporate FDs which are unsecured, NCD issues by NBFCs are secured debt (NCD’s are 100% secured by assets of the company). Furthermore, both the NCD issues have received good credit rating.
However, this doesn’t guarantee 100% safety. Default risk still remains although very slight. But, default risk remains even in case of Bank FD’s beyond Rs 1lakh.
4. Good Liquidity:
NCDs offer good liquidity due to NSE listing (but listing doesn’t guarantee liquidity). If you would like to go for premature exit, basically you’ve got two options:
a. Sell on the NSE
b. Exercise put option, if available.
However, remember that exiting through secondary market (NSE) entails interest rate risk. If the interest rates fall, the value of NCD will rise (as happened in the case of TATA CAPITAL’s NCDs which were issued in the month of February 2009). And, in an environment of rising interest rates, the value of NCD’s may fall below face value.
But if you plan to hold it till maturity, then there is no-risk due to interest fluctuations.
Furthermore, there is also liquidity risk because, as of now, Indian debt / bond markets are highly illiquid (less frequent trading and insufficient volumes). So, if you plan to encash before maturity by selling on the secondary market (NSE), remember that you might not be able to do so.
How to invest in NCD’s?
If you decide to invest in non-convertible debentures (NCDs), remember the following points:
1.When to Apply:
Apply on the first day of the issue itself because the allotment of NCDs is on first come first serve basis. Chances of issue closing on the first day itself are quite high given the market’s appetite for NCDs.
2. Best NCD Option:
Cumulative option always appear to be most attractive because it offers the highest yield and allows you to reinvest the interest at the same coupon rate / interest rate (i.e., there is no reinvestment risk).
For instance, If you had invested Rs 1 lakh in, say, cumulative option (option 3) of Shriram Transport NCD offering a effective yield of 11.50% p.a. (which was maximum among all the 5 options), you will get pre-tax amount of Rs 1,72,335 at the end of 5 years (assuming Call / Put option shall not be exercised).
On the other hand, if you to would like to receive regular interest income, then you can also look for other NCD options offered such as quarterly, half yearly or annual interest payments, but interest /coupon rate offered is usually lower. And even if the interest / coupon rate is same (e.g. TATA NCD coupon rate was same for annual payment option and cumulative option) you would have to bear re-investment risk, which means that your effective yield can be lower if you’re not able to reinvest your interest income at the same or higher rate of interest (which is highly unlikely).
If you don’t want to lock your money in fixed rate instrument for long term (usually 5 years), you can consider NCD option which is having lower tenure (e.g. 36 months in case of STCL NCD issue), but here the returns are a bit lesser as compared to longest term.
Furthermore, some NCDs also allow staggered redemption; for instance, Shriram Transport NCD Option 1 offering half-yearly interest payment and option 2 offering annual interest payment had provision for staggered redemption (40%, 40%, 20% at the end of 36, 48 and 60 months respectively).
3. Mandatory Requirements:
Before filling the NCDs application forms make sure that you’ve a DMAT account (allotment is compulsorily in dematerialized form) and PAN number (irrespective of amount of application as per SEBI guidelines).
4.Instructions:
Finally, please read instructions carefully because an application form not filled up correctly is liable to be rejected.
Any further question? Please leave it in the comment box.
UPDATE (22 August, 2009): For FAQs regarding taxation of NCDs, comparison with FDs, risks involved in NCDs and stock exchange trading please see part 2: Top 10 FAQs about NCDs.
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