Are you confused between NCDs and FDs ?

Now a days many companies such as India Infoline Finance Ltd, Shriram City Union Finance has came out with Non-Convertible Debenture (NCD) issues. There are some confusion among the investors what are these NCDs and how different are they from Fixed Deposits (FDs)?

Like Fixed Deposits (FDs), infrastructure bonds and tax-free bonds, companies use NCDs as another route to raise capital. For investors, an NCD is another investment option available on the debt side.

Similarities between NCDs & FDs

NCDs and FDs are similar in a few ways. For example, like FDs, the NCDs are issued by companies for varying time periods such as 400 days, three years, five years.

You can choose to receive the interest at maturity (cumulative option) or choose to receive it at certain intervals (non-cumulative option) if you require regular cash flows, just like you do for FDs. While bank and company FDs are not credit rated, both NBFC FDs and NCDs are rated by agencies such as CRISIL, ICRA or CARE.

Like in company FDs, the credit rating on NCDs serve as a important factor  to differentiate the less risky offers from the more risky ones. For example, NCDs from both Manappuram Finance and Shriram City Union Finance were open simultaneously in August 2011, but while the former was given an AA- rating by CARE, the latter was rated AA, a notch higher, by the same agency. For both FDs and NCDs, the interest is not tax free. It is taxed under the head ‘Income from Other Sources’ at the slab rates.

Differences between NCDs and FDs

There are some distinction between these instruments. First, NCDs can either be secured or unsecured. A ‘secured’ NCD would mean that, in case the company is liquidated, the NCD holders would be given a priority in repayment of money due to them as they are secured by a charge on any of the assets of the company.

In this context, unsecured NCDs will be riskier, but companies compensate this by providing comparatively higher interest rates on these. The same with NCDs, having a lower credit rating.

In FDs, there is no concept of secured or unsecured FDs. Bank FDs are generally covered by deposit insurance upto Rs 1 lakh.  As this insurance is not available for other FDs, they are comparatively riskier.  Secondly, investments in a five-year FD from scheduled banks are entitled to deduction under Sec 80C. NCDs of a similar tenure don’t enjoy this benefit. Besides, if FD interest is higher than Rs 10,000, tax is deducted at source (TDS) itself. There is no TDS for NCDs. Unlike FDs, they are mostly issued in demat form. Hence, investors may require a demat account.

The most important difference is that unlike FDs, NCDs can be listed and traded in the stock exchange, although the liquidity may not be too high. A downward movement in interest rates for example, could lead to appreciation in the value of the NCD. Selling the NCDs in the market will attract short/long-term capital gains tax.

If you have any query about investment and any financial product. please feel free to ask me.

Regards,

Arvind Trivedi

Certified Financial Planner

arvind.trivedi79@gmail.com