How Different are NCDs Corporate FDs?

Corporate FDs issued by the NBFC arms of various businesses (e.g., Bajaj Finance, Mahindra Finance, HDFC) in recent times have emerged as a viable investment avenue for financially savvy investors who are desirous of parking a slice of their surplus funds in debt instruments. Companies often see this as a speedy route to raise the capital they need to grow the business. These are attractive since they provide a richer yield of, say, 9-11.5%, over a fixed term of 12 to 60 months. Compare this with the average 8.5% interest returned by bank FDs. However, there are some risks around corporate FDs versus comparable bank FDs. And the risks are real. 

Key among the risks is the likelihood of default by the company concerned especially considering that corporate FDs are not backed by collateral of any kind, which means the investor cannot recoup the capital by selling her/his corporate FD receipts. Whereas in case of a bank FD, there is a deposit insurance cover of INR 5 lacs; RBI is likely to step in and restore normalcy at a troubled bank, the logic being that the government cannot let a bank fail. At least that’s the experience so far. Short-term corporate FDs are ideal because it’s difficult to forecast their performance accurately for the longer term and are suited for go-getters with a higher risk appetite. However, put hard-earned money only on AAA or AA rated corporate FDs, even though these offer a lower interest rate. Consider issuing companies that have been in business for at least 15-20 years and returned dividends on a consistent basis, year after year, to shareholders. There is no capital gains tax on corporate FDs, however, they are liable to be taxed based on the holder’s tax bracket.

Since 2011, several top-rated domestic companies have been raising much-needed funds, especially for business expansion in India’s financial market through the issuance of non-convertible debentures (NCDs). NCDs are fixed income instruments that typically carry relatively higher rate of interest than bank FDs, and this is usually paid either monthly, annually over a fixed tenure, or as cumulative interest at the end of the tenure. Of course, cumulative interest options fetch slightly higher returns, while monthly/ annual payouts provide liquidity from time to time. Investors in NCDs, on average, stand to earn 2-3% more than their counterparts who have chosen to park their funds in bank FDs.

NCDs with ratings from “AA” to “AA/Stable” fetch an effective annual return of 8.9-11.28 % over a tenure of 24-60 months. Apart from overall reputation and repayment history of the issuer, retail investors are showing an increasing appetite for NCD products that are rated highly by one or more external risk advisories (CRISIL, ICRA, CARE, Fitch, etc.). The higher the rating, the lower the risk, and lower the interest rate as well. The safety of an NCD depends further on whether or not it is secured. In the unfortunate instance where the issuing company goes out of business, the claims of NCD holders, since these are backed by some of the company assets, have a higher priority than those by unsecured creditors.

An NCD is an ideal investment destination for retail investors who feel that they would like to earn more than PPF, NSC, and FDs, and don’t mind the added risk and would like to build more of fixed income exposure in their investment portfolio. Both NCDs and FDs (whether issued by companies or banks) are taxed at maturity, based on the holder’s tax bracket. There’s one other catch with NCDs though, when sold prior to maturity on the stock exchange, proceeds from NCDs attract capital gains tax.