Should you invest in high yield NCDs?

With no upcoming tax-free bond issues, fixed income investors face a dearth of investment opportunities. While one can buy listed high-yield tax free bonds in the secondary market, they come at a premium. In this situation, high yield seekers veer towards corporate fixed deposits or non-convertible debentures (NCD). NCDs are more in demand as they offer higher yields than corporate FDs. Edelweiss Housing Finance’s recent NCD was fully subscribed on Day One. Three others—Dewan Housing Finance, Srei Infra Finance and India Infoline—are slated to hit the market soon. So should investors consider them for their fixed income portfolios?

NCDs offer around 100-200 bps more than bank FD rates, and around 100 bps or 1 per cent more than corporate FDs. Edelweiss Housing Finance’s Rs 500 crore NCD issue carried an interest rate of 9.57 per cent per annum in the monthly interest payment option or 10 per cent per annum for an annual interest option over a tenure of 120 months. The 36-month and 60-month tenure NCD offered 9.5 per cent and 9.75 per cent respectively. To put this in context, SBI currently offers 7 per cent interest on its FDs of tenure more than three years. The yield on 10-year government bonds is at 7.31 per cent.

Upcoming NCD offers are expected to carry similar coupon rates. Even after considering post-tax return, a 9.5 per cent debenture yields around 7.6 per cent and 8.55 per cent for those in the 20 per cent and 10 per cent tax bracket respectively. Unlike corporate FDs, NCDs can be bought in dematerialized form and are freely tradeable, making them more liquid. However, liquidity on the exchange can be poor at times, preventing the investor from exiting the instrument at the right price or time. Says Deepak Shenoy, CEO, Capitalmind, a financial analytics firm: “Even though yields are tempting, it may be difficult to buy at current prices, particularly if you are looking to build a sizeable portfolio”.

Besides, when these bonds are bought in demat form, there is no TDS. This saves individuals the trouble of filing forms 15G/H to claim exemption. But in case of NCD in physical form, TDS is applicable if the annual interest payout is more than Rs 5,000.

Another benefit NCDs offers over corporate FDs is the chance of fetching capital appreciation on principal, if interest rates soften during the tenure of the instrument. This is because bond prices and interest rates move in opposite directions, offering you a chance to sell them at a profit, instead of holding on till maturity. “In an environment where interest rates are headed lower, it makes sense to opt for bonds instead of FDs,” says Shenoy. However, do not expect high capital appreciation in corporate bonds as they typically have lower tenures than government bonds. Longer tenure instruments are more sensitive to interest rate changes. For taxation, NCDs are eligible for long-term capital gains after a year. Gains realised after a year from purchase is taxed at 10 per cent (without indexation). Interest earned on these NCDs is added to the individual’s income and taxed as per the applicable slab.

Credit profile matters
Experts caution against blindly following higher yield. Says Tanwir Alam, MD, Fincart: “Higher yields are on account of the higher risk premium.” Before investing in NCDs, check out the company’s financial health and credit profile. Avoid betting outside wellestablished names. Check the credit rating of the issuer. It is advisable not to buy any NCD with credit rating lower than AA. Lower rating comes with higher coupon rate, but also a higher default risk. Investors should ideally assess a company based on its business profile. “Consider the reputation of the issuer group before investing,” says Suresh Sadagopan, Founder, Ladder 7 Financial Services.



Buying listed bonds
If you want even higher coupon, you may consider any of the existing NCDs on the exchange. Several are offering attractive yields. However, avoid investing in instruments maturing in the next few years. As interest rates are expected to bottom out in coming months, opting for an NCD maturing in the next 12-18 months will expose you to reinvestment risk.

Also, the short residual maturity means these will not see much capital gains owing to reduction in interest rates in the interim.