There is an NBFC NCD on BondScanner offering 10.5% yield. Rating is A+. Tenure is 3 years. I want to invest but I realised I have never actually looked at an NBFC’s financials before buying. I know I should check the balance sheet but I genuinely don’t know what I’m looking for. Where do I even start?
Good instinct to check before buying. An NBFC balance sheet is different from a regular company’s because the entire business is lending. So what you are really evaluating is the quality of the loan book, not a product or service. Start with three numbers. One, Capital Adequacy Ratio or CAR. RBI requires NBFCs to maintain a minimum of 15%. Higher is better. It tells you how much of a buffer the NBFC has before losses start eating into bondholder money. Two, Gross NPA ratio. This is the percentage of loans that are not being repaid on time. Under 3% is generally healthy for most NBFC types. Anything above 5% warrants serious scrutiny. Three, Debt to Equity ratio. NBFCs are leveraged businesses by nature, but a ratio above 7 to 8x starts to get uncomfortable.
also check who audits them
why does the auditor matter?
The auditor is your last line of defence against undisclosed problems. A Big Four or well-known auditor signs off on the financials you are reading. If an NBFC uses an obscure auditor, the reliability of those numbers is lower. DHFL and several smaller NBFCs that collapsed had red flags around their auditor quality and related party transactions before ratings actually got downgraded. The auditor name is listed in the annual report, usually in the first few pages.
wait the annual report is publicly available? where do I find it
A few more things worth checking beyond the headline numbers. First, look at the NIM or Net Interest Margin, which is the spread between what the NBFC earns on loans and what it pays on borrowings. A healthy NBFC typically runs 4 to 7% NIM depending on segment. Compression in NIM over multiple quarters is a warning sign. Second, check the concentration of the loan book. An NBFC that has 40% of its loans to one sector or one geography is riskier than one that is diversified. Third, look at the asset liability mismatch. NBFCs that borrow short and lend long are exposed to liquidity risk if markets tighten suddenly. This is exactly what happened in 2018 with the IL&FS shock that froze short-term funding for many NBFCs.
this is a lot of information. is there a shortcut for someone who doesn’t want to go through an entire annual report?
The shortcut is the credit rating rationale document. Every time CRISIL, ICRA or CARE assigns or reaffirms a rating, they publish a detailed rationale that covers exactly these metrics. CAR, NPA, leverage, NIM, asset quality trends, management track record. It is essentially someone who has done the balance sheet work for you and summarised it in 3 to 5 pages. Download the latest rationale for the specific bond from the rating agency website before you invest. It is free and more useful than the annual report for most retail investors.
One thing the rationale may not tell you clearly is the tax treatment. Just flagging this separately. Interest from NBFC NCDs is taxed at your slab rate regardless of the rating or tenure. There is no special exemption. TDS is deducted if interest exceeds Rs 5,000 in a year per issuer. At 30% bracket a 10.5% yield becomes roughly 7.35% post-tax, which is still decent but worth building into your comparison.
okay so credit rating rationale = the shortcut. got it. and it’s free on the rating agency website
checklist before buying any NBFC bond:
CAR above 15% (RBI minimum)
Gross NPA below 3 to 5%
Debt to equity below 7 to 8x
Auditor: known, reputable firm
No sudden changes in NIM or asset quality
Read the rating rationale, it’s free and does most of the work
Post-tax yield at your slab rate, not headline