The Reserve Bank of India (RBI) is scheduled to announce its monetary policy on 17th September 2012. And amidst expectations that the central bank may cut rates many Non Banking Finance Companies (NBFCs) have bee-lined to raise money via non-convertible debentures (NCDs). We know that interest rates and bond prices are inversely related. So, if RBI cuts rates bond prices are bound to appreciate. And with investors sensing the same there is a huge demand for such instruments. So much so that NCD issues worth Rs 20 bn will hit the street in the next two weeks itself.
With huge competition to raise money, NBFCs are luring investors by offering higher interest rates than other corporate bonds with similar tenures. For instance, India Infoline Ltd (IIFL), whose issue opens on September 05, is offering an interest rate of 12.75% for its six year bonds. This is much better than what Shriram Transport offered (11.4%) in its issue last month.
However, the rate differential between the two should be viewed in the context of underlying collateral. Unsecured bonds typically offer higher interest due to the absence of underlying collateral when compared to secured bonds. And the IIFL issue is an unsecured one. In the event of a default, the unsecured bondholders get paid after the secured bondholders. They get paid higher rate for bearing that additional risk and uncertainty in payments if the firm defaults.
In our view, investors should not get lured by interest rates alone while subscribing to any issue. They should properly analyze the pros and cons (like issue maturity, debt rating etc) before committing their money. This is particularly important in such an environment where debt markets are seeing huge supply of issues due to lack of investment opportunities elsewhere. Equities are shunned amidst uncertain macro-economic environment. Gold seems to be making a new high every day. And real estate is out of reach for small investors. Thus, debt is the only asset class that offers a steady and safe return in this environment. Also, the fact that the rate cycle has peaked makes debt even more attractive.