What are pros & cons of investing in NBFC NCDs

When the interest rates start going down, many savvy investors prefer locking in their funds in NCDs issued by non-banking financial companies as they offer lucrative interest rates for a more extended period.

Jul 01, 2021 11:07 IST India Infoline News Service

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Over the years, the RBI (Reserve Bank of India) has significantly tightened the guidelines for NBFCs (Non-Banking Financial Companies) on how they can raise money through NCDs (Non-convertible Debentures). When the interest rates start going down, many savvy investors prefer locking in their funds in NCDs issued by non-banking financial companies as they offer lucrative interest rates for a more extended period.

What are NBFC NCDs?

Non-convertible debentures are a popular way of raising funds for the NBFCs. If you review the NCD market, you will find that most of the borrowers are from the NBFC segment over the years. It is a debt instrument and popularly used by the NBFCs and other companies to raise long-term capital through the public issue of shares. The NCDs have a fixed tenure, and the investors receive regular interest at a specific rate on their investment.

Types of NCDs

There are two types of non-convertible debentures, which are discussed below.

● Secured NCD
As the name suggests, the secured non-convertible debentures are a much safer investment option among the two kinds of NCDs. Such NCDs are backed by the company’s assets. This means if for any reason the company fails to pay interest to the investors, they can recover their dues by liquidating the company’s assets. However, the interest rate for secured NCDs is low.

● Unsecured NCD
Unsecured NCDs are a riskier investment option than secured NCDs as the company’s assets do not back them. Therefore, if the company fails to pay, the investors have no choice but to wait until they receive the payments. However, the interest rate offered by unsecured non-convertible debentures is higher than secured NCDs.

Pros and Cons of NBFC NCDs

Pros

● Every NBFC that aims to raise money through NCD is rated by agencies like Fitch Ratings, CRISIL, ICRA and CARE. Therefore, you can be sure that the information provided is verified and the chances of fraud are zero.
● Since the non-convertible debentures issued by the NBFCs are closely monitored and regulated by the Reserve Bank of India, it is beneficial for the investors. The interest rate keeps fluctuating on other investments, and therefore, in such conditions, the NCDs offer attractive returns for a more extended period.
● Generally, the NBFCs NCD rate of interest is higher by up to 150-175 basis points than the interest you may receive from investments in bank fixed deposits. And, since most NBFCs that issue NCD are reputed and well capitalised, you can be sure that there is minimal risk in investing in them as an investor.
● Another significant advantage of investing in NBFC NCD is that when the market starts falling, the investors tend to enjoy capital appreciation.
● The NCDs typically have a first or second charge on the issuer’s assets. Thus, they are a relatively secure and safer investment option compared to other forms of unsecured investments.

Cons

While there are many advantages of the NCD investment, as an investor, you must be cautious about the risks involved in NCD before investing. The common risks include-

● Non-banking financial companies are a heterogeneous class of assets; there are high-class and low-quality NBFCs. As an investor, you must be careful about investing in NCDs issued by the NBFCs and decide only after reviewing the credit rating of the NCD. Credit rating is essentially an expert opinion on the repayment capacity of the issuer, and it is advised to invest only in high-rated NBFCs to minimise the risk.
● NBFC as an industry is quite vulnerable to various rules and regulations. The NBFCs in India learnt this lesson the hard way in 1998 when the Reserve Bank of India imposed strict regulations on NFBCs in terms of asset classification. And, the sector continues to remain vulnerable to macro regulatory risks.

Final Word

Thus, NBFC NCDs investment has many pros and cons. So, if you are looking to invest in NCD, do your due diligence in understanding its various aspects before deciding. But generally, experts suggest that NBFC NCDs are an ideal investment option only for those investors who have a high-risk appetite and are willing to lock their funds at a higher returns rate. 

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