NBFC Bonds: An In-Depth Guide to Non-Banking Financial Company Bonds

Non-Banking Financial Companies (NBFCs) are pivotal players in India’s financial sector, bridging the gap that traditional banks cannot fully serve. One of the investment products offered by these institutions is NBFC bonds. These bonds have become famous for investors looking for fixed-income instruments with relatively higher returns. In this comprehensive guide, we’ll explore what NBFC bonds are, how they work, their advantages and risks, and how to invest in them.

What Are NBFC Bonds?

NBFC bonds are debt instruments issued by Non-Banking Financial Companies to raise funds from investors. Unlike traditional banks, NBFCs do not hold a banking license but provide financial services such as loans, asset management, leasing, and investments. These bonds offer fixed periodic interest payments, making them attractive for investors seeking stable income.

NBFC bonds work similarly to other corporate bonds but are typically issued by institutions engaged in financial services rather than industrial sectors. Investors purchase NBFC bonds, and in return, they receive interest payments, known as coupon payments, at regular intervals. Upon maturity, the bondholder receives the principal amount invested.

Key Features of NBFC Bonds:

1. Fixed Interest Rate: NBFC bonds typically offer a fixed interest rate paid periodically. The rates are generally higher than those offered by bank fixed deposits or government bonds.
2. Medium to Long-Term Maturity: NBFC bonds usually have a tenure of three to ten years, making them a medium—to long-term investment option.
3. Taxable Interest Income: The interest income earned from NBFC bonds is taxable under the investor’s income tax slab.
4. Tradable on Secondary Markets: Many NBFC bonds are listed on stock exchanges, allowing investors to trade them before maturity.
5. Credit Ratings: NBFC bonds are rated by credit rating agencies such as CRISIL, ICRA, and CARE. The credit rating reflects the issuer’s financial strength and the likelihood of default. Higher-rated bonds are generally considered safer but offer lower returns.

How Do NBFC Bonds Work?

When you invest in an NBFC bond, you lend money to the issuing NBFC for a predetermined period. In return, the NBFC agrees to pay you regular interest (the coupon) during the bond’s tenure and the principal amount at maturity. The interest rate is fixed at the time of issuance and remains constant throughout the bond’s life, providing predictable income.

NBFC bonds can be secured or unsecured. Secured bonds are backed by collateral, while unsecured bonds carry more risk because they do not have specific assets backing them.

Example:

Let’s say you invest ₹1 lakh in an NBFC bond with an interest rate of 8% per annum and a tenure of 5 years. You will receive ₹8,000 each year as interest income, and at the end of the 5 years, you will get back your principal amount of ₹1 lakh.

Types of NBFC Bonds:

NBFC bonds come in different forms, catering to various investor preferences and risk profiles.

1. Secured Bonds: These bonds are backed by the issuer’s assets, providing more security for the investors. If the issuer defaults, the bondholders have a claim on the assets.
2. Unsecured Bonds: These bonds are not backed by collateral and carry higher risk. However, they often offer higher interest rates to compensate for the increased risk.
3. Convertible Bonds: These bonds allow investors to convert them into equity shares of the issuing NBFC at a specified price and time.
4. Non-Convertible Bonds (NCDs): These bonds cannot be converted into shares and are purely debt instruments. They are popular among investors looking for fixed income.

Benefits of Investing in NBFC Bonds:

NBFC bonds offer several benefits, making them an attractive option for fixed-income investors.

1. Higher Interest Rates: Unlike bank fixed deposits or government bonds, NBFC bonds often offer higher interest rates, which can appeal to those seeking better returns.
2. Regular Income: Investors receive fixed interest payments, which can be a reliable source of income, especially for retirees or conservative investors.
3. Diversification: Including NBFC bonds in your investment portfolio can help diversify your fixed-income allocation. Since these bonds are issued by financial institutions rather than industrial companies or governments, they add variety to your bond holdings.
4. Tradability: Many NBFC bonds are listed on stock exchanges, offering liquidity to investors who may want to exit their investment before the bond’s maturity.
5. Tax Benefits: In some instances, NBFC bonds may offer tax benefits, mainly when investing in specific schemes such as infrastructure bonds.

Risks Associated with NBFC Bonds:

While NBFC bonds offer attractive returns, they come with certain risks that investors must be aware of.

1. Credit Risk: NBFCs are more susceptible to credit risk than government bonds. If the issuing NBFC faces financial difficulties, it may default on interest payments or fail to repay the principal. Therefore, it is crucial to check the bond’s credit rating before investing.
2. Interest Rate Risk: NBFC bonds are vulnerable to interest rate fluctuations. When interest rates rise, the market value of existing bonds declines. This is a risk if you plan to sell the bond before maturity.
3. Liquidity Risk: While some NBFC bonds are listed on stock exchanges, liquidity in the secondary market may be limited. If you need to sell the bond before maturity, it may not be easy to find a buyer.
4. Inflation Risk: Fixed coupon payments can cause purchasing power to be lost during inflationary periods. This risk is inherent in most fixed-income investments.
5. Regulatory Risk: NBFCs operate under regulations that differ from those governing traditional banks. Changes in regulations, such as stricter lending norms, could impact their financial health and, in turn, their ability to service their bond obligations.

How to Invest in NBFC Bonds?

Investing in NBFC bonds can be done through several channels:

1. Direct Purchase from Issuers: Investors can buy bonds directly during issuance through various platforms such as Wint Wealth, GoldenPi, and Bondskart. These platforms often offer bonds from different NBFCs, providing a wide range of options to choose from.
2. Stock Exchanges: Investors can purchase NBFC bonds listed on stock exchanges through their brokerage accounts, which allows them to be flexible in buying and selling bonds in the secondary market.
3. Mutual Funds: Another way to gain exposure to NBFC bonds is through debt mutual funds, which invest in a mix of corporate and government bonds, including those issued by NBFCs.
4. Bond Aggregator Platforms: Platforms like Dezerv and Indiabonds offer curated portfolios of bonds, including NBFC bonds, for retail and institutional investors.

Taxation of NBFC Bonds:

The interest earned on NBFC bonds is taxable per the investor’s income tax slab. Additionally, if the bonds are sold in the secondary market, the capital gains are subject to taxation based on the holding period. Long-term capital gains (LTCG) apply if the bond is held for more than 36 months, and short-term capital gains (STCG) apply for a holding period of less than 36 months.

Investors should consult with tax professionals to understand the tax implications based on their financial situation.

Popular NBFC Bonds in India:

Some well-known NBFCs issue bonds regularly in India, including:

• Bajaj Finance Ltd.
• HDFC Ltd.
• LIC Housing Finance Ltd.
• Sundaram Finance Ltd.
• Tata Capital Financial Services Ltd.

Credit agencies rate these companies, and their track records of strong financial performance make their bonds more appealing to risk-averse investors.

Conclusion:

NBFC bonds offer a compelling investment option for those looking for higher returns than traditional bank deposits. However, investors should carefully assess the associated risks, including credit and interest rate risks, and consider their investment objectives before committing to NBFC bonds. By diversifying across different issuers and understanding the financial health of the issuing NBFC, investors can potentially enhance their portfolio’s returns while managing risk effectively.

FAQs on NBFC Bonds:

What is an NBFC bond?
An NBFC bond is a debt instrument issued by Non-Banking Financial Companies to raise funds. Investors receive regular interest payments and the principal amount at maturity.

Are NBFC bonds safe?
NBFC bonds come with credit risk and may not be as safe as government bonds. It is essential to check the NBFC’s credit rating before investing.

Can NBFC bonds be traded on stock exchanges?
Many NBFC bonds are listed on stock exchanges, providing liquidity and the ability to trade before maturity.

What is the tenure of NBFC bonds?
The tenure of NBFC bonds usually ranges from 3 to 10 years.Do NBFC bonds offer tax benefits?
Certain NBFC bonds, like infrastructure bonds, may offer tax benefits under specific conditions. Consult with a tax advisor for more information.