Evaluating Non-Convertible Debentures (NCDs) – Should Retail Investors Dive into Fincorp Offerings?

For retail investors in India, Non-Convertible Debentures (NCDs) from financial corporations (FinCorps) offer an intriguing investment avenue. Positioned as a relatively secure, fixed-income instrument, NCDs present an alternative to traditional bank deposits. But are they the right choice for every investor? Here’s an analysis of the pros and cons to help you decide.

Pros of Investing in NCDs from FinCorps

1. Attractive Returns: NCDs typically offer higher interest rates compared to fixed deposits, often providing 150-175 basis points more. This makes them appealing for investors seeking predictable income while benefiting from a fixed rate over the investment term.
2. Secured Options Available: Many FinCorps offer secured NCDs, which are backed by company assets. In case of default, investors may recover a portion of their investment through asset liquidation. Secured NCDs, though generally lower in interest compared to unsecured ones, add a layer of security, reducing risk for cautious investors.
3. Fixed Income and Tax Benefits: With regular interest payments, NCDs can provide a steady income stream. Additionally, certain NCDs qualify for tax benefits, making them potentially advantageous for investors in higher tax brackets.
4. Ratings Transparency: Credit ratings from agencies like CRISIL and ICRA provide insight into the issuer’s creditworthiness. A high rating (such as AAA) typically indicates a lower risk of default, giving investors some assurance about the issuer’s financial health.
5. Liquidity Options for Listed NCDs: Some NCDs are listed on stock exchanges, allowing investors to exit before maturity by selling them on the secondary market. This liquidity feature can be crucial for those who may need to access their funds early.

Cons of Investing in NCDs from FinCorps

1. Credit and Default Risk: Although credit ratings provide some security, they are not failproof. Defaults in the financial sector can still occur, as seen in past cases. Unsecured NCDs, in particular, carry higher risk since they are not backed by assets.
2. Interest Rate and Inflation Risks: NCDs lock in a fixed interest rate, which could be a disadvantage if market rates rise. Higher inflation can also erode the real value of returns, making NCDs less attractive if inflation remains high over the investment period.
3. Liquidity Challenges for Unlisted NCDs: Unlisted NCDs are harder to sell before maturity. Investors in such instruments may face difficulty finding buyers, particularly during financial market downturns, limiting their ability to exit early if necessary.
4. Regulatory Vulnerability: The NBFC sector is sensitive to regulatory changes, which could impact NCD returns. Since 1998, the RBI has implemented stricter guidelines for NBFCs, and further changes could potentially affect investor returns.
5. Call Option Risks: Some NCDs come with a “call” option, allowing issuers to redeem them before maturity. This can disrupt income planning for investors who expect returns until the full term.

Bottom Line for Retail Investors

Investing in NCDs from FinCorps can offer retail investors a balanced approach to income generation with relatively high returns compared to FDs, especially when secured options are available. However, investors must assess their risk tolerance, considering the credit rating of the issuer, the liquidity of the NCD, and any regulatory impacts. For conservative investors, opting for high-rated, secured NCDs with fixed terms may provide the stability they seek, while those with a higher risk appetite might explore unsecured options for potentially better returns.

Before committing, retail investors should carefully review NCD terms, check for liquidity and call options, and align choices with their financial goals and risk capacity.