Some of the Non-convertible debentures (NCDs in short) which were floated not too long ago are still quoting at really good yields if held till maturity which I guess most people, not in need of immediate money, would think of doing.
In the scenario of falling interest rates, NCDs protect the investor from the falling returns on the fixed income instruments. The Cumulative Option protects the investor from the Reinvestment Risk as the returns (interest) are reinvested at the pre-fixed rate for the entire duration. Interest rates on five-year bank deposits now range between 9.25-10.75 per cent which is set to fall in future. Note that most of these NCDs are secured by way of the company’s long terms assets and hence though slightly risky do not usually bounce if from well rated corporate/NBFCs.
For e.g. consider Tata Capital NCD Option IV (Cum.) is currently available on the BSE @1389 (including 1% brokerage, slightly on the higher side). It matures on/has a buyback option on 5th Mar. 14 @1762.35 giving a yield of 12.65%.
Similarly India Infoline NCD Option II is available @1023 (excl. brokerage) but matures on 18-Dec-14 @1446.18 giving a yield of 12.22%.
Long term capital gains on listed securities are taxed at the rate of 10% without indexation or 20% with indexation whichever is lower. However, as the benefit of cost indexation is not available in case of bonds and debentures, long term capital gains from NCDs are always taxable @ 10.30 per cent (including education cess of 3%) without indexation.
So it might make a lot of sense to buy these currently. If you sell these on the exchange, u pay only 10.3% as above, and if you hold them to maturity, you pay your normal rate i.e. 30.3% (assuming the highest tax bracket) but since these are about a couple of %age points higher than a bank FD, the net gain is still quite good.
A comparison between the two instruments is as follows:
| | Bank FD | NCD |
| Amount (Rs) | 10000.00 | 1389.00 |
| Duration (Years) | 3 | 2 |
| Coupon (Rate)% | 10 | |
| Amount on maturity (Rs.) | 13449.00 | 1762.35 |
| Pre-tax annualized yield (%) | 10.38 | 12.65 |
| Post-tax annualized yield (%) | 7.39 | 8.90 |
Still better, if you were to sell this NCD on the exchange, you will only have to pay 10% without indexation or 20% with indexation whichever is lower, increasing the yield further.
This is just an illustrative example and the actual values may vary slightly depending upon the exact date , compounding frequency etc. (for e.g. I have taken the period in calculation of the NCD yield as 2 years while it should actually be a tad higher from Feb ’12 to Mar ’14).
Thus it makes a win-win situation for the investor if here were to take advantage of the NCDs listed on the exchanges – you get higher returns either way - hold them to maturity or sell them on the exchanges. Going by the general expectation of softening of interest rates by RBI going forward, these NCDs would appreciate in value on the exchange making the latter also a very much viable option.
The other NCDs which I checked on were from IIFL and L&T Finance which are available for purchase on the exchanges. There may be more of these such as those from SBI, Shriram Transport etc who have all launched them in last couple of years.
I just got a letter yesterday that Tata Capital is reducing its interest rates from 12% to 10.5%, assuming the proposal is accepted at the meeting of NCD holders. With the interest rates expected to head downwards over the next few quarters, going by RBI’s recent pronouncements, I can’t really blame them. Last month, RBI cut the CRR (the amount of deposits banks need to park with it) by 0.5% to 5.50%, but kept its policy rates unchanged. So, it appears to be a matter of time when they will start lowering the rates. However, the question that needs answering is what happens to the investors who subscribed to its original NCDs as well as those who purchased it later form the stock exchanges?
ReplyDeleteIn 2009, Tata Capital was the first company in a long time to issue NCDs, especially after the 2008 credit crisis that hit markets worldwide, including India. Since money wasn’t available cheap for companies, an NCD issue at a higher-than-market interest rate was an instant hit and investors lapped it up.
Though the tenor of Tata Capital NCDs was 5 years, it came with a put/call option after 3 years. That 3-year period just got over in January 2012, and Tata Capital is using this opportunity to reduce its coupon rate. Tata Capital has not yet exercised its put option, but instead has proposed a reduction in its coupon rate. It has proposed a new interest rate of 10.50% on its cumulative option, down from 12% earlier. In other words, if you are an NCD holder, you would have earned 12% in the last three years. Should you decide to stick around for the next two years till maturity, you would earn an interest rate of 10.50%. They are either giving an option of going ahead with lower rates or sell it back to them in the buy back (with accrued interest @12% in the Cumulative option). The other option is to sell it on the exchanges if you can which may be a difficult proposition given the low levels of liquidity (there are hardly any/only a handful of buyers or sellers on most days).
What you, the investor, should do depends on the alternative options available in the market. Assuming that you invested in the NCDs because you wanted assured returns, your main options are bank fixed deposits and company fixed deposits. Tata Capital’s new rate of 10.50% is higher than most two-three year bank FDs. Company fixed deposits may offer slightly higher returns, but check their credit rating. Go for companies that are rated “AAA” (the highest level credit rating), such as HDFC Ltd and Hudco that are offering 9.65% and 9.70%, respectively. Companies with low credit rating or with no rating will offer higher interest rates, but they don’t inspire confidence (such as real estate companies).
From the taxation point, it will be the same as an FD, i.e. the interest would be clubbed with your regular taxable income taxed at your nominal rate. However, since this is more than what a bank FD currently gives you, with the same tax treatment, it would give you more. Also, if you do get an opportunity to sell it on the stock exchanges after 1 year, you will only be taxed @10.3%.
As feared, I just received confirmation that the interest rate for the Cumulative option has been changed from 12 to 10.5% annually compounded.So the returns will be lower but all the other scenarios regarding post-tax returns still hold good.
DeleteThe revised interest rate will be applicable for the residual tenor till 05-Mar-14. Holders of the cumulative NCDs should send in their written consent by 26-Mar-12.
If u are not happy with the change, then u can still redeem the NCDs between 05-Mar-12 and 03-Apr-12 using your Put option.
If u don't do either of the above then company will exercise its Call option and redeem the NCDS on or before 02-Jun-12.
Holders will soon hear from Tata Capital in this regard.