When we talk about non-convertible debentures (NCDs), we mainly focus on the yield. However, there are a few more points that you should consider before recommending an NCD to your clients.
Credit rating
Credit rating denotes the ability of the bond issuer to repay the debt. Generally, the rating varies from AAA (highest) to D (in default – lowest). Higher the bond rating, lower the chances of default. Generally, NCDs having lower credit rating offer higher coupon to compensate for the additional risk. It is prudent to recommend AAA rated papers to your conservative clients. You can recommend AA+ or AA papers to your clients having higher risk appetite and desirous slightly higher returns.
Interest offered
Investors invest in NCDs as they offer higher interest than bank FDs. Thus, it is an important parameter for consideration.
The interest rate offered by the NCD is called coupon. While recommending NCDs you need to match the risk-return profile of your client to the risk-return profile of the NCD.
Tenor
NCDs are available for multiple tenures - 3, 5 and 10 years. Recommend appropriate tenure based on your client’s cash flow requirements.
Three points to remember while looking at bond tenure are –
Longer the tenure more the bond sensitivity to interest rate. Therefore, if your client is planning to sell the bond midway, he needs to be comfortable with the interest rate risk. However, if the client plans to hold the bond until maturity then he is immune from the risk.
Longer tenure bonds also tend to be riskier as it is difficult to predict the business condition 10 years down the line.
On the other hand, recommending shorter tenure bond if your client is planning to invest in debt for long term can increase re-investment risk.
Payment frequency
Bonds offer a variety of interest payment options (monthly, quarterly, annually). Choose the interest option most suitable for your client. Investors can use NCD interest income to take care of their monthly expenses.
Analyse the promoter
Understand why the promoter is raising money from the market. Is it to fund his short-term expenses or long-term investments? Generally, companies should raise long-term debt from the market to fund long-term capital investments. In addition, also analyse the company’s financials to see if it will be able to support the interest payments from its cash flows.
