Muthoot Finance NCD: Go with the 2-year option

The NCDs of Muthoot offers some margin of safety in terms of loan to value, investment grade rating.

The latest in the stream of companies offering non convertible debentures (NCDs) to retail investors is Muthoot Finance, India's largest gold financing company. It is making a public issue of secured NCDs with two year, three year and five year options. We suggest that investors with some risk appetite can take up the two year NCD which offers a 13 per cent annual rate of interest.

The issue

A 13 per cent rate of interest on a debt instrument offers an opportunity for investors to obtain higher yields resulting from a rising interest rate scenario. Secondary market yields on the slightly higher rated AA securities with a residual maturity of two years, are almost two percentage points lower than the rate offered by Muthoot which makes it an attractive instrument. Deposit taking NBFCs with slightly better credit profile are offering anywhere between 9.55-10 per cent on deposits with similar tenors.

Bank deposit rates for a two year tenor stand at 9.25 per cent; however they are not fully comparable as they offer a safe alternative (deposits upto Rs.1 lakh are insured).

Apart from attractive rates, the secured nature of Muthoot's lending (loans against gold) offers some margin of safety in terms of loan to value, investment grade rating (CRISIL AA-) and strong track record with 70 years of experience in gold financing business support the investment. An AA- rating is defined as carrying “very low credit risk”, however, a minus sign indicates lower standing of the company among all the AA rated companies.

Investors can avoid the three year and five year instruments as the 0.25 percentage point higher than the two year rate of interest doesn't really make up for the risks of holding on for a longer tenure.

About the company

Gold loans account for 99 per cent of Muthoot's assets under management with predominant exposure to South India. It has a low proportion of non-performing asset (gross NPA ratio of 0.31 as of June 2011) thanks to gold as collateral. Muthoot has made profits in at least last seven fiscal years. It has 120 tonnes of gold against which it lent at average loan-to-value of 72 per cent. The issue also gives comfort from the gold price movement perspective. Gold prices may continue to remain firm for some time given its safe haven status.

The assets under management are close to Rs 18,000 crore. The interest spreads (difference between interest earned and interest expended) of Muthoot was 10.9 per cent for the quarter ended June 2011. The company has been raising money from retail investors for quite some time through private placement of secured NCDs. As of June 2011, retail NCD borrowings accounted for 26 per cent of overall borrowing. The capital adequacy ratio of Muthoot is strong at 19.2 per cent as of June 2011 as against mandatory requirement of 15 per cent.

A word of caution

Muthoot Finance is the fifth non-banking finance company (NBFC) to come up with a public issue of NCDs in the last couple of months. It is also fourth company in as many weeks to hit the market with secured NCD issue. Given such high dose of NCD issuances, investors should avoid allocating too large a portion of their portfolio to such NCDs.

The issue carries a minimum investment amount of Rs 5,000. The offer opens on August 23 and closes on September 05; with the company having an option to pre-close the issue. The allotment is on a first-come-first-served basis. The issue size is Rs 500 crore with an option to retain another Rs 500 crore oversubscription. NCD holders can trade in these debentures in the secondary market (NSE and BSE) on listing. However, investors are subject to liquidity risk given that volumes traded of such bonds are low.

Get the highest interest rate of 9.16% for tax-saving Infrastructure Bonds!‏

IFCI Ltd, the country’s oldest development finance institution, has come out with the second tranche of long-term infrastructure bonds for the current fiscal. These bonds will offer an additional deduction of up to Rs. 20,000 under section 80CCF of the Income-tax Act.


Main features

The bonds come with two maturity periods—10 and 15 years—and offer both the annual and cumulative interest payout option. You can buy either in physical or dematerialized form. They come with a lock-in period of five years after which you can trade them on BSE Ltd.

Buy-back option: This option empowers an investor to tender the bonds back to the company and redeem their investment before the maturity. For 10-year bonds, the buy-back option would be available at the end of five and seven years. For 15-year bonds, the buy-back option can be exercised at the end of five and 10 years.


What do you get?
The 10-year bond is offering an interest rate of 9.09%; the rate is 9.16% for the 15-year bond. So if you invest Rs. 20,000, your corpus would stand at Rs.47,740 and Rs. 74,472 after 10 and 15 years, respectively. If you take into account the tax implication, the post-tax return in case of 10-year bonds works out to be 10.98% for those in the 30.9% tax bracket; 10.22% for those in the 20.6% tax bracket and 9.60% for the 10.30% tax bracket. In case of 15-year bonds, the post-tax returns would be 15.35%, 14.82% and 14.40% for those in the highest, middle and lowest tax brackets, respectively.


Is the investment safe?
IFCI bonds have been rated BWR AA– by Brickwork Ratings India Pvt. Ltd and CARE A+ by CARE Ratings (Credit Analysis and Research Ltd). Rating agency ICRA Ltd has provided LA. The higher the rating, more secure is the bond. IFCI’s capital adequacy ratio at the end of September stood at 19.3%, much above the regulatory requirement. But since the firm focuses on infrastructure financing, a downturn in infrastructure sector can have an adverse impact on its finances.


What should you do?


As returns on Public Provident Fund (PPF) are not taxable, PPF works out to be better option than infrastructure bonds over 15 years. At present, even five-year bank fixed deposits score over these bonds since most banks are offering a higher interest rate than what these bonds are offering. Go for infrastructure bonds only if you have exhausted your 80C limit of Rs. 1 lakh.
IFCI bonds are offering a higher return compared with the other two infrastructure bonds—from IDFC Ltd and L&T Infrastructure Finance Co. Ltd—currently open for subscription. However, IFCI bonds have a lower rating that the other two and hence carry higher risk.