Should you be investing in a non-bank NCD?
Should you invest in non-convertible debentures (NCDs) of non-banking finance companies?
May be not, given that rates are likely to come off on the back of the economy slowing down.
Credit spreads, which are attractive at present, will no longer look so as returns on government bonds and highly rated corporate bonds will be higher given credit and liquidity risk.
There have been a few NCDs floated by companies in the AA and AA- rating scale and there will be more to come down the line.
The yields offered are eye-catching, prompting the issues to be oversubscribed many times.
The hook for such investments is the yield offered and the visibility of the company in the press and media.
The correct way to look at investments in NCDs is the way a bond trader or a bond fund manager will.
The trader and the fund manager will look at credit spreads, liquidity and the opportunity cost of not investing elsewhere.
The bond fund manager will have constraints on the amount he can invest in the NCD given a scheme's objectives and regulatory limits.
Let us look at the recent NCD issues and judge whether they are attractive to a trader or a fund manager.
Credit spread is the difference in yield between the NCD and the corresponding maturity government bond.
The IIFL NCD, which matures in 2014, is compared with a government bond maturing in 2014. The government bond yield annualised is 8.35% and hence the credit spread of IIFL three-year maturity NCD yielding 11.70% is 235 basis points.
Are the credit spreads attractive for the NCDs?
Credit spread reflects the credit potential of the NCD issue and its liquidity in the secondary market.
The issuers are rated AA or AA- by rating agencies, which reflect reasonable safety.
The fact that all the issuers belong to the NBFC sector, liquidity is a question mark.
Secondary market liquidity for non-bank NCDs is low and for papers rated below AA+ it is even lower.
Traders will definitely think twice about looking at such bonds despite credit spreads at over 200 bps. Bond fund managers may look at it if their view on credit is good and potential for downgrade is low.
On a credit-spread basis, the NCDs are in line and not very attractive with the current state of interest rate markets where government bond yields are trading at close to multi-year highs.
However, the spreads are unlikely to go down soon given that liquidity is low and there are credit concerns in the economy.
The economy is in a rough patch with the Reserve Bank of India raising policy rates to multi-year highs on the back of rising inflation expectations.
GDP growth is forecast to come off by 50-100 bps from 2010-11 growth levels of 8.6%. High interest rates coupled with slowing down economy will place stress on loan books of banks and NBFCs.
There are other fixed income investment opportunities.
Government bonds are the first choice given their risk-free status and correlation to interest rates. Interest rates are at multiyear highs with five year maturity government bond yields trading at around 8.25% levels. Interest rates are expected to come off down the line as inflation cools off on the back of monetary tightening, fiscal control and a slowing economy. Lower interest rates will benefit government bonds the most and returns on these risk free and liquid bonds can go up to levels of over 12% if interest rates cool off by 100 bps in one year.
Highly rated AAA corporate bonds in the three and five year maturity bracket are trading at yields of 9.4%.
Falling interest rates will benefit AAA corporate bonds more than AA or AA- NBFC bonds and yields on the former will fall much faster than the yields on the latter.
Investments in three and five year corporate bonds can yield as much as 11.4% and 13.4% if yields fall by 100 bps in one year.
Highly rated corporate bonds have much better liquidity than low rated non-bank NCDs.
The opportunity cost of investing is high in NCDs of non-bank issuers as interest rates are expected to fall down the line.
The lack of liquidity will prevent investors from exiting the NCDs to invest in longer maturity government bonds or corporate bonds.
If the economy suffers a downturn, NBFC portfolios will be under stress leading to credit spreads moving higher due to worries on downgrades. Investors lose out on falling interest rates plus rising credit spreads and yields on NBFC NCDs will not be attractive.
Should you invest in non-convertible debentures (NCDs) of non-banking finance companies?
May be not, given that rates are likely to come off on the back of the economy slowing down.
Credit spreads, which are attractive at present, will no longer look so as returns on government bonds and highly rated corporate bonds will be higher given credit and liquidity risk.
There have been a few NCDs floated by companies in the AA and AA- rating scale and there will be more to come down the line.
The yields offered are eye-catching, prompting the issues to be oversubscribed many times.
The hook for such investments is the yield offered and the visibility of the company in the press and media.
The correct way to look at investments in NCDs is the way a bond trader or a bond fund manager will.
The trader and the fund manager will look at credit spreads, liquidity and the opportunity cost of not investing elsewhere.
The bond fund manager will have constraints on the amount he can invest in the NCD given a scheme's objectives and regulatory limits.
Let us look at the recent NCD issues and judge whether they are attractive to a trader or a fund manager.
Credit spread is the difference in yield between the NCD and the corresponding maturity government bond.
The IIFL NCD, which matures in 2014, is compared with a government bond maturing in 2014. The government bond yield annualised is 8.35% and hence the credit spread of IIFL three-year maturity NCD yielding 11.70% is 235 basis points.
Are the credit spreads attractive for the NCDs?
Credit spread reflects the credit potential of the NCD issue and its liquidity in the secondary market.
The issuers are rated AA or AA- by rating agencies, which reflect reasonable safety.
The fact that all the issuers belong to the NBFC sector, liquidity is a question mark.
Secondary market liquidity for non-bank NCDs is low and for papers rated below AA+ it is even lower.
Traders will definitely think twice about looking at such bonds despite credit spreads at over 200 bps. Bond fund managers may look at it if their view on credit is good and potential for downgrade is low.
On a credit-spread basis, the NCDs are in line and not very attractive with the current state of interest rate markets where government bond yields are trading at close to multi-year highs.
However, the spreads are unlikely to go down soon given that liquidity is low and there are credit concerns in the economy.
The economy is in a rough patch with the Reserve Bank of India raising policy rates to multi-year highs on the back of rising inflation expectations.
GDP growth is forecast to come off by 50-100 bps from 2010-11 growth levels of 8.6%. High interest rates coupled with slowing down economy will place stress on loan books of banks and NBFCs.
There are other fixed income investment opportunities.
Government bonds are the first choice given their risk-free status and correlation to interest rates. Interest rates are at multiyear highs with five year maturity government bond yields trading at around 8.25% levels. Interest rates are expected to come off down the line as inflation cools off on the back of monetary tightening, fiscal control and a slowing economy. Lower interest rates will benefit government bonds the most and returns on these risk free and liquid bonds can go up to levels of over 12% if interest rates cool off by 100 bps in one year.
Highly rated AAA corporate bonds in the three and five year maturity bracket are trading at yields of 9.4%.
Falling interest rates will benefit AAA corporate bonds more than AA or AA- NBFC bonds and yields on the former will fall much faster than the yields on the latter.
Investments in three and five year corporate bonds can yield as much as 11.4% and 13.4% if yields fall by 100 bps in one year.
Highly rated corporate bonds have much better liquidity than low rated non-bank NCDs.
The opportunity cost of investing is high in NCDs of non-bank issuers as interest rates are expected to fall down the line.
The lack of liquidity will prevent investors from exiting the NCDs to invest in longer maturity government bonds or corporate bonds.
If the economy suffers a downturn, NBFC portfolios will be under stress leading to credit spreads moving higher due to worries on downgrades. Investors lose out on falling interest rates plus rising credit spreads and yields on NBFC NCDs will not be attractive.
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