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Here are 10 things to consider before investing in them

In a rising interest rate environment, fixed income investors are spoilt for choice.

The benchmark yield on 10-year government securities is on a roll. Government security rates have crossed the 8 percent mark, was at 8.18 percent on September 11, 2018 raising prospects of higher interest rates in the economy.

In less than two years, the 10-year Government security (G-sec) rate has gone up over 2 percentage points — on December 3, 2016, it had touched a low of 6.24 percent and since then it is on the rise.

In a rising interest rate environment, fixed income investors are spoilt for choice. Banks increase rates on fixed deposits (FDs). Companies raising money through deposits offer higher rates than FDs. Further, there are non-convertible debentures (NCD) issued by companies or Non-Banking Finance company (N.B.F.C.) on offer.

There has been a horde of NCDs in the market and few more are expected from companies such as DHFL, Tata Capital financial Services, Indiabulls Commercial Credit, Aadhar Housing Finance etc ..

Compared to company fixed deposits, NCDs offer competitive rates and are considered more secure. However, are NCDs a better investing alternative than a bank fixed deposit? Here is a look at some of the important features of the two to help you decide.

1. Interest rate

Currently, while most banks are offering around 7 percent per annum over 3-5-10 year periods, NCDs are offering up to 9 percent or even higher over the same tenure. With interest rates headed upwards, it is likely that upcoming NCD issues will offer even higher rates than those available now.

2. Taxation on Interest income :

For both bank FDs and NCDs, the interest earned during the year is to be added to your total income and hence it is entirely taxable as per your income tax slab. Both bank FD and NCDs suits those in the lower tax brackets.

Both the instruments have a tax that would be deducted. But, there is no TDS on NCDs at the moment, while fixed deposits have a TDS depending on the nature of the deposit. If it is a company fixed deposit, there is a TDS of interest income if the same exceeds Rs 5000 (unless form 15 G/H is submitted) for the financial year. On the other hand a bank deposit attracts a TDS if the interest income crosses (across branches)  Rs 10,000 during the course of the year (unless form 15 G/H is submitted).

Another thing to keep in mind is that while tax-saving 5-year bank FDs come with tax benefits under section 80C of the Income Tax Act, there is no such benefit on NCDs.

A plus point of NCDs held in demat form is that tax will not be deducted at source (TDS). However, in case of NCDs held in physical form, TDS will be there from interest payable on such NCDs

3. Probability of capital gains/loss

There is no possibility to earn capital gains or incur capital loss in bank FDs or when NCD’s are held till maturity. However, when interest rates fall or increase, the value of listed NCDs accordingly changes. When interest rate falls, bond prices go up resulting in capital gains (when transferred in secondary market) and vice versa.

4. Tenure

Bank FDs are available for a period as low as 7 days to as long as 10 years. At times, longer tenures will offer higher rate of interest, however, the differential may not be much. Most NCDs offer tenures ranging from 1 to 10 years, with longer tenure NCDs offering substantially higher return.

5. How to invest

For bank FDs, one can invest by walking into a bank branch or online. For investing in an NCD, one needs a demat account with any brokerage house. Remember, a demat account with a discount broker will not help. Also, NCDs may not be on offer all through the year and issuers launch them for a certain period only.

6. Periodicity of Interest payments

In a bank FD, one may choose to opt for any frequency of interest payments such as monthly, quarterly, half-yearly, annual or cumulative. However, in NCDs, not all issues will carry such options.

7. Ability to Sell 

Fixed Deposits can be considered as more liquid. For example, in case of a bank deposit, you can easily redeem them at the bank. In the case of NCDs, you may not be able to sell large quantities at the exchange. You would have to wait for the tenure to expire and then surrender the same to the company for redemption.

8. NCDs Could be a Little More Riskier than Bank Fixed Deposit

In August 2018, the government had withdrawn the Financial Resolution and Deposit Insurance (FRDI) Bill from the Lok Sabha. Bank deposits will continue to be insured under the Deposit Insurance and Credit Guarantee Corporation (DICGC). Under the DICGC rules, each depositor in a bank ( across all branches ) is insured up to a maximum of Rs 1 lakh for both principal and interest amount held in the same capacity and same right. However, there is an implicit guarantee on the deposits at least with the mainline commercial banks as the government won’t allow them to fail as seen in the past.

The safety of money invested in NCDs is subject to the ratings and the nature of the debentures. Relying entirely on ratings is not suggested as it has been seen in the past that even highly rated issues have defaulted in repayment of funds. It’s not the company that issues the NCD that gets rated but the issue itself. So, the rating is subject to revision or withdrawal at any time by the rating agencies.

Further, the NCDs themselves can be either secured or unsecured. In case of secured NCDs, the claims of the secured NCD holders are superior to the claims of any unsecured creditors as the former would constitute secured obligations of the company. The unsecured NCDs are not secured by any charge on the assets of the company and will be subordinate to the claims of all other creditors. Hence, even if the unsecured NCDs offer a slightly higher return, avoid them.

9. Listing on The Stock Exchanges

NCDs are listed on the stock exchanges, while fixed deposits are not. However, non-convertible debentures tend to have poor liquidity. You cannot sell large quantities through the exchanges.

10. NCDs Can Be Converted Into Equities

Earlier, we had full convertible debentures, which could be converted to equity shares. These days we do not see any fully convertible debentures. There’s no question of fixed deposits getting listed on the exchanges.

What you should do

Whatever debt portion one needs to invest in a bank FD or NCD, it’s better to spread it across banks, and maturities. Ultra-conservative investors should stick to bank deposits while others may consider investing in NCDs after carefully evaluating the company’s reputation, financials, ratings etc before investing funds to them.


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July 2024