L&T Finance, SCUF, Muthoot Homefin, Magma Fincorp NCDs on offer: Which is the best pick?


Three of the four non-convertible debenture (NCD) issues announced recently have opened for subscription. The NCD issues of L&T Finance (LTF), Magma Fincorp Shriram City and Muthoot Homefin (subsidiary of Muthoot Finance) opened on April 8, while that of Shriram City Union Finance opened on April 5.

Between the four firms, there are 38 options across tenures of two to 10 years for investment.

Here’s an analysis of the issues that look interesting and those that can be avoided?

What’s on offer?

Broadly, there are five tenures across the NCDs on offer; 2-year, 3-year, 5-year, 8-year and 10-year give or take a few months in some of the NCDs, depending on which firm’s NCD we’re talking about. The interest rate on offer is between 8.89 percent and 10.74 percent <see table below>. Except the L&T Finance NCD that closes on April 18, the other three NCDs (Shriram City Union, Magma Fincorp and Muthoot Homefin) close within the first eight days of May.

Though NCDs are fixed return yielding instruments, things could still go wrong in the worst of times. A bank fixed deposit is perceived to be safer, even over and above the Rs 1 lakh insurance cover per deposit. But that doesn’t mean NCDs are to be ignored; they generally offer higher interest rates than bank FDs. For instance, as per BankBazaar.com, State Bank of India offers 6.85 percent on a 3-5 year fixed deposit. The four NCDs offer 9-10.5 percent interest rates (effective yield) for their monthly payment option.

Nevertheless, the big question in an investor’s mind is: Will these NCDs pay timely interest and the principal back at maturity? There are three parameters that help answer this important question.

Credit rating

Look at the credit rating of an NCD. A credit rating signifies the financial strength of a company as analysed by a rating agency. It also tells you how likely it is for the company to pay its interests on time as well as the principal. The higher the credit rating, the better the firm is. L&T Finance NCD scores here as it comes with the highest credit rating of all the NCDs on offer; its credit rating is ‘AAA’. As per ICRA’s rating scale, ‘instruments with this rating (‘AAA’) are considered to have the highest degree of safety regarding timely servicing of financial obligations. Such instruments carry the lowest credit risk.’

The other three NCDs, Shriram City Union, Magma Fincorp and Muthoot Homefin (India) come with a credit rating of ‘AA’. As per Crisil’s rating scale, a AA rating indicates that ‘instruments with this rating are considered to have a high degree of safety regarding timely servicing of financial obligations. Such instruments carry very low credit risk.’

Vikram Dalal, Founder and Managing Director, Synergee Capital Services says: “Even though ‘AAA’ rating is better and preferable than a ‘AA’ rating, people can take a calculated risk and opt for NCDs that are rated AA and above.”

Recovering to pay back in time

An NCD’s payment capacity greatly hinges upon how efficiently its own borrowers repay their dues back. Keep an eye on the firm’s non-performing assets (NPA) figures.

Here too, L&T Finance scores. As per company annual reports and presentations, its net NPA in the financial year 2017-18 was 2.34 percent, down from 5.02 percent in the preceding year. For Magma Fincorp, the net NPA for the financial year 2017-18 was 5.2 percent, down from 5.6 percent in the previous year.

Lower the NPA, the better is the firm’s ability to repay its own borrowings. Shriram City Union Finance’s NPA levels are a tad better; for 2017-18, its net NPA was 3.43 percent, but it went up from 1.79 percent before that.

How effectively a non-banking finance company recovers its dues also depends on who the borrowers are. As per L&T Finance’s tranche prospectus, 24.6 percent of its loans have been lent for vehicle purchases, and 14 percent of its assets under management (AUM) have been lent to real estate, including builder loans. The latter is risky, but 14 percent of the AUM loan is within limits.

Magma Fincorp’s borrower profile tells us that it operates in urban as well as rural areas. It has a mix of first-time borrowers like transport operators, including taxi drivers, small farmers as well self-employed with informal income, those with low income with low eligibility for traditional financing and small and medium enterprises.

A large chunk of Shriram City Union Finance’s borrowers is small enterprises, followed by those who take loans to buy two-wheelers and loan against gold.

Lastly, it is important to check out how much of a firm’s own borrowings are split between the short-term and long-term. An NCD is categorised a long-term borrowing in the books of a company. If a large chunk of loans is long term, it effectively means the asset-liability mismatch is that much lower. A large chunk of short-term borrowings exposes the firm to the vagaries of interest rate movements if, say, the interest rates rise and it is forced to borrow incrementally at higher interest rates.

“If the majority or relatively higher chunk of a firm’s resources raised are short-term in nature, it means that the propensity of asset-liability mismatch is relatively higher in that company. This is not healthy,” says Joydeep Sen, Founder, wiseinvestor.in.

As per Bloomberg figures, just 15 percent of L&T Finance’s FY18 borrowings are short-term. This has come down in recent years. For Shriram City, nearly 41 percent of FY18 borrowings (on a consolidated basis) were short-term, rising steeply from about 10 percent in FY16. For Magma Fincorp’s nearly 71 percent of borrowings (on a consolidated basis) were short-term in FY18, up from 63.80 percent a year before.

Where should you invest?

The good news is that all NCDs on offer- and across all tenures- are ‘secured’. A secured NCD bodes well because in case the company sinks and has to sell its assets to repay its lenders (including you the investor), NCD holders stand among those who are first in line to get back the dues. However, it must also be noted that none of these NCDs come with a put/call option. This means if you wish to exit before maturity, your only hope is to sell your NCDs on the stock exchange. Lack of buyers in the debt market is always a concern.

If you wish to invest over a five-year term or more, opt for a firm that comes with as high a credit rating as possible. L&T Finance NCD makes the cut here.

Avoid Magma Fincorp for now. Its interest rates are the highest and tempting but that is also because this public NCD issue is its first-ever.For a tenure of up to five years, we would recommend L&T Finance for a conservative investor. But for those fine with a bit more risk, Shriram City Union Finance is also a good option as it offers a two-year as well as three-year option and a slightly higher interest rate as well. A very low NPA level of Muthoot Homefin (0.36 percent net NPA; as per its tranche prospectus) and its narrow loan portfolio of focusing just on housing loans also makes it a good NCD option for an aggressive investor.


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