NBFC Bonds

What are NBFC bonds?

NBFC bonds are bonds issued by NBFCs (Non Banking Financial Institutions). Some examples of NBFCs are Bajaj Finance Ltd., Shree Ram Finance Ltd.

Types of NBFC Bonds

NBFCs issue many types of bonds. NBFC with a tenure of less than 1 year are called Commercial Papers (CPs). Apart from CPs, NBFCs issue long term instruments like MLDs (Market Linked Debentures) or NCDs (Non Convertible Debentures)

NBFC bonds versus NBFC fixed deposits

NBFCs can issue bonds as well as fixed deposits (12-60 months).

As soon as one reads ‘fixed deposit,’ one thinks about the safety of capital it promises. But this safety is a default for banks (especially big banks like HDFC, SBI and the likes) and not fixed deposits of NBFCs. This is because the government insures bank FDs up to Rs. 5 lakh per individual. This insurance doesn’t extend to NBFCs. Additionally, NBFCs run a business that’s considered to be riskier than the business of banks.

Hence, NBFC bonds are safer than NBFC fixed deposits. Further, the tax treatment of bonds is better than FDs. If held for 3 years or more, you get the benefit of indexation.

Who should invest in NBFC bonds?

Investors with a moderate risk appetite can invest in NBFC bonds. High rated NBFCs like HDFC Ltd. can provide safety of capital and regular interest payments through their bonds.

What is the taxation on NBFC bonds?

Taxation of interest of NBFC bonds: Interest earned from NBFC bonds is taxed as per your marginal income tax slab rate.

Taxation on capital gains of NBFC bonds: For listed SBI bonds, the long term (more than 36 months) capital gains tax rate is 10% and the short term (less than 36 months) capital gains tax is the investor’s marginal income tax slab rate. For unlisted Non Banking Financial Corporation bonds, the long term (more than 12 months) capital gains tax is 20% with indexation benefit and the short term (less than 12 months) capital gains tax is the investor’s marginal income tax slab rate.

The above taxation doesn’t apply if the NBFC bond is an MLD (market linked debenture)

Are NBFC bonds safer than bank bonds?

NBFCs run a slightly riskier business than banks. While banks lend money to borrowers who have a history of timely loan repayments, NBFCs cater to lower rated borrowers. Hence, NBFC bonds are slightly riskier than bank bonds.

It is important to note that there are exceptions to this thumb rule. For example, a AAA-rated NBFC bond is safer than a BBB-rated private bank bond.

Risks of investing in NBFC bonds

NBFC bonds have similar risks as other Types of Bonds. They are credit default risk, interest rate risk, reinvestment risk and liquidity risk. Among these, interest rate risk and liquidity risk can be eliminated by holding the bond until maturity. Credit default risk can be managed by investing in bonds issued by high rated NBFCs (like AAA and AA)

Advantages of investing in NBFC bonds

NBFC bonds are perfect for moderate risk investors seeking higher than FD return from debt instruments. The yield of NBFC bonds is higher than both NBFC fixed deposits and bank bonds. However, this also comes at a higher risk.

How to identify the best NBFC bonds?

The best NBFC bonds for you may be different from the best NBFC bonds for someone else. Here’s how you can identify the best NBFC bonds.

1. Credit rating: Are you a low-risk investor or a moderate risk investor? A low risk investor should invest only in AAA-rated NBFC bonds. A moderate risk investor can consider a lower rated bond.
2. Yield and interest rate: You want the yield and interest rate on the bond to be high. Because they are inversely related to credit rating, it is important to strike a balance between the two depending on your risk profile.
3. Maturity date: It is a good idea to align your investment time frame with the balanced maturity of the bond. This way, you increase your likelihood of holding the bond until maturity. Holding the bond until maturity eliminates interest rate risk and liquidity risk.

By filtering in the above manner, you can find a list of the best NBFC bonds for your money.