Prime NCD Review: An NCD with attractive yields across timeframes

With capital gains on debt fund investments now subject to short-term capital gains tax irrespective of holding period, other debt instruments have become quite competitive with debt mutual funds. 

Cholamandalam Investment & Finance Company, a listed NBFC that is primarily engaged in retail financing, is making a public NCD issue of up to Rs 1,000 crore. This issue opens today (April 25, 2023). The official close date is on May 9 but it may close much earlier if it mops up the planned funds.  

Prime NCD Review : An NCD with attractive yields across timeframes

There are NCDs carrying 3 maturities in this issue – 22 months, 37 months and 60 months. The 22-month and 37-month maturities offer attractive yields of 8.26-8.3% and are a good fit for the debt portion of your portfolio. With the 60-month option offering just 8.4% we believe the additional yield you get for the longer lock-in isn’t significant. Here are more details on the issue, suitability, and how to use them in your portfolio.

Issue details – rates and maturities

Cholamandalam Investment & Finance (CIFL) plans to raise up to Rs 5,000 crore through NCD issues. This particular Tranche I that is open now targets Rs 500 crore with the option to raise a further Rs 500 crore. The amount raised will primarily be used to grow its loan book. The NCDs are secured, by way of the NBFC’s receivables. The issue carries a AA+ credit rating, by both India Ratings & Research and ICRA, making it a relatively lower risk option.

Each NCD carries a face value of Rs 1,000 and the minimum application is Rs 10,000. 30% of the issue is reserved for retail investors with another 25% for HNIs. The NCDs offer both annual interest payout and cumulative options:

Interest income will be taxed at your slab rate, whether you go for payout or cumulative options. TDS will also apply if the interest amount crosses Rs 5,000. Since the NCDs are listed, you may be able to trade on them in the secondary market – though this hinges on its liquidity. Note here that the long-term definition for reckoning capital gains for listed NCDs is 12 months. Long term capital gains are taxed at 10% (yes, tax rules haven’t changed for these yet!). Short-term capital gains are taxed at your slab rate. Long or short term capital gains (beyond the accrued interest) can be earned in the secondary market if market interest rates fall during your holding period of this NCD or if the ratings get upgraded. You can invest in these NCDs through your brokerage, if corporate bonds are part of their offering, or through your bank.

About the NBFC

CIFL is part of the Murugappa Group, and is a listed player with a Rs 69,210 crore market cap. The NBFC is a retail lender with a sizeable AUM of Rs 95,468 crore as of December 2022, a 31% growth over the year ago period. 

CIFL’s lending is primarily geared towards vehicle finance which forms 64% of its book, where it finances both new and used vehicles across the spectrum of passenger and commercial vehicles. While vehicle lenders had faced increased stress during Covid, this pressure has eased off lately with a renewed pickup in this segment. The next biggest lending segment is mortgages at 28% of its loan book – but this comprises both home loans as well as loans against properties. The recent upturn in the real estate sector should lead to reasonable growth with low delinquencies in this segment. While it is trying to venture into new businesses, these two segments are set to remain its mainstay for now. Given its focus segment, the NBFC’s loan book is predominantly rural-focused. Though rural India underwent pain just after Covid, recent months have seen an improvement in fortunes. 

CIFL’s gross NPAs thus saw a jump to 6.8% in FY-22, owing to Covid-related disruptions. However, the number has since moderated, dropping to 5.37% by the December 2022 quarter. Though not at comfortable levels yet, improving economic activity can help moderate GNPAs in coming months especially as loan growth picks up. CIFL also maintains capital adequacy ratio at 17.1%, well above the minimum requirement.

Net interest margins in its primary vehicle financing segment have seen pressure in the September and December 22 quarters, and the company is treading cautiously in some segments while pushing harder in others such as passenger vehicles. Improving NIMs in the LAP segment have helped counter this to some extent. 

The credit rating reports cite the NBFC’s strength and leadership in the vehicle financing segment, healthy liquidity and profitability, and adequate capitalisation as positives. Support from the Murugappa Group, a conservative South India based group with a good governance record, is an added positive. The reports also highlight an overall improvement in asset quality leading to lower provisioning requirements. The negatives highlighted are not immediate, primarily concerning profitability buffers to absorb credit costs and a weakening credit environment.

Call & suitability

As mentioned at the outset, options such as NCDs have become more attractive with tax benefits from debt mutual funds phased out. The yields offered on the 22-month and the 37-month options at 8.26-8.3% are attractive:

  • One, today corporate bond funds investing in AAA and AA plus bonds average about 7.6% in portfolio yield, with average maturities ranging from 2 to 5 years. This NCD’s yields, therefore, compare well to corporate bond funds and can used as a kicker to the returns whether you own debt mutual funds or FDs.  
  • Two, the spreads that corporate bonds offer over gilts have been moving up from lows, indicating that it’s a good time to look to corporate bonds. For example, the spread on 5-year AAA corporate bonds have moved up to 50-60 basis over comparable g-secs points now from 10-20 basis points in April 2022. Spreads on AA-rated paper have moved up from 75 basis points to 125 basis points. The CIFL NCD’s 37-month maturity offers a spread of 1.37 basis points over the 3-year gilt yield.
  • Three, with the RBI pausing on rate hikes, yields may not increase much further from here. Therefore, this would be a good time to lock into NCDs offering healthy yields.

In terms of suitability, the CIFL NCDs can be used as follows:

  • Income-seeking investors can go for the payout option. It offers a good higher-yield diversification from safer instruments. Do note that its best to use this NCD along with low-risk instruments such as bank/small finance bank deposits, senior citizen savings schemes, and the RBI Floating Rate bonds. 
  •  Other investors can use the cumulative option. The NCD can be used along with your current debt funds as part of your debt portfolio – you can invest in the NCD even if you have a long-term timeframe as yields are attractive. Just remember to reinvest the amount at the time of maturity! In terms of credit risk, though there’s no diversification benefit, this NCD would carry only slightly higher credit risk than a corporate bond fund. Please note that this is a hold-to-maturity recommendation.

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8 thoughts on “Prime NCD Review: An NCD with attractive yields across timeframes”

  1. Hi,

    Neither I Sec or HDFC Sec is showing this NCD. Do you know any other method to subscribe this ?

    1. Bhavana Acharya

      It was available on HDFC Sec last we checked, so it may have closed if it is not showing now. You can otherwise check with your bank if they offer it. – thanks, Bhavana

  2. nikhil.abhyankar

    How is the yield of 8% calculated?
    Is it the same for the two options because we are assuming reinvestment of paid out interest at the same coupon?

  3. nikhil.abhyankar

    The LTCG at 10% is applicable if the NCD is sold in the secondary market after holding for 12 months, and this CG will not include the interest accrued in the cumulative option.

    If held to maturity, and this is what you are recommending, then the interest will be taxed at the marginal rate.

    Is this correct understanding?

    Do I have to pay tax at marginal rate on the accrued interest if I sell the NCD before or after 12 months?

    1. Yes, you will have to pay tax on interest earned for the period that you hold the NCD. Capital gains tax is separate. – thanks, Bhavana

  4. Vittal Venugopal

    Hello Team Prime Investor. Very nice article. How can we buy these NCD’s? Are they available in Dmat form? Kindly advise. Thanks

    1. Yes, they are demat since they will be listed. Please check with your broker, it should be available if they offer corporate bonds as well. Some bond platforms also offer it. Else check with your bank. – thanks, Bhavana

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