The risky business environment does not make it good enough
Muthoot Finance, a non-banking finance company (NBFC) primarily providing gold loans to individuals is looking at raising a corpus of Rs2,500 million through an issue of non-convertible debentures (NCDs). The NCD issue offers debentures of five types on basis of tenure and yield and are termed as option I to option V. The sequence of five options is depicted below:
Is the issue worth investing in? The issue enjoys a credit rating of AA- from ICRA and CRISIL, similar to NCD issues of Religare Finvest and India Infoline, with a highest interest rate of 12.40% for option III, whose tenure if five years or 60 months. The interest rate is lower than 12.75% of Religare Finvest. But remember that higher interest rates carry with them, a higher risk.
The NCD of India Infoline was of a subordinate nature, which means in case the company gets liquidated the principal debtor will be serviced before the investors investing in this NCD issue. The Religare Finvest NCD is in the form of secured debt with ‘first floating pari passu charge’, which means that the debt is fully secured and is not subordinate to other debt providers. In case of liquidation of the company, your debt is secured against immovable property of the company, if any. In case of Muthoot Finance, the NCD issue, besides being covered with ‘first floating pari passu charge’ on immoveable assets, is also covered by ‘first floating pari passu charge’ on current assets, book debts, loans and advances and receivable including gold loan receivables, both present and future. In short, the NCD issue is covered 100% at any time.
In terms of the risk in investing in the NCD, it is calculated basis the business environment that the issuing company operates it, since that only governs whether the company will be able to pay the promised return or not.
The Muthoot Finance issue is risky since the company’s financial performance is particularly vulnerable to volatility in interest rates as well as of gold prices. The collateral against which the company offers loans may suffer erosion in value by the time principal amount is recovered.
Read earlier articles on gold in Moneylife here: Gold: All told , Gold loans at last draw RBI’s attention, Muthoot Finance NCDs—should you go for it?, Gold loan companies and their murky underbellies, The remarkable financial pyramid of gold loan companies, What makes gold finance companies shine bright?.
Although the company has grown over the recent years, thanks to a huge run up in gold prices, it carries contingent liabilities to the tune of Rs4,679.1 million as on 31 March 2012, which could have an adverse effect on its financial condition. In addition to that the provisioning for gross NPAs for the year ended 31 March 2012 is marginally over 13%. The prospectus further states that “should the overall credit quality of our loan portfolio deteriorate, the current level of our provisions may not be adequate to cover further increases in the amount of our non-performing assets.”
The issue prospectus does not say anything about how the funds raised through the NCD issue would be utilised. It says that “We have not entered into any definitive agreements to utilise a substantial portion of the net proceeds of the Issue” and also that “Our management will have broad discretion to use the net proceeds and you will be relying on the judgment of our management regarding the application of these Net Proceeds. Our funding requirements are based on current conditions and are subject to change in light of changes in external circumstances or in our financial condition, business or strategy.”
The debt equity ratio will be 6.37 after subscription of Rs5,000 million in aggregate for NCDs, which is very high considering the risky environment that the business operates in. The issue has come up in a marginally falling interest rate situation, when the profitability of all lending companies is expected to take a hit. Considering all these factors it is best to avoid this issue.