Should I invest in L & T Finance NCD Issue?

Investments can be considered in L&T Finance’s secured non-convertible debentures (NCD), especially the longer-term options as they offer attractive rates and provide a hedge against the interest rate volatility over a 10-year period. With banks’ term deposit rates hovering in the 6.5-8 per cent range across comparable tenures, the rates offered by the debenture appear attractive.

However, investors can give the five-year quarterly and semi-annual options a skip. For one, they offer lower rates of interest compared to many fixed deposit options with similar or marginally higher credit risk.

Locking into the shorter term options also appears unattractive given the expectation that interest rates will trend up over the next few quarters.

The NCD has received LAA+ and CARE AA+ ratings (both indicating ‘investment grade’) from ICRA and CARE respectively. This apart, diversified revenue stream, high proportion of capital adequacy and reasonable growth prospects of segments such as commercial vehicles, micro-financing, where the company has recently set foot and which have high yields, are the key investment arguments.

About the company
L&T Finance was set up 15 years ago as a SME financing company to fund its parent company’s vendors and distributors. Today, it has evolved into a full-fledged NBFC that provides equipment financing, tractor and commercial-vehicle financing, micro-financing and lending against shares. The company has 311 branches and points of presence.

L&T Finance had an advance book size of Rs 5,218 crore. Ninety per cent of the loans are secured by assets. The advances book is divided into corporate finance group (37 per cent of loans) and retail finance group (63 per cent of loans). Construction equipment, other retail financing such as tractor and farm equipment financing, CV financing are major segments in that order, according to the management. Most of its borrowings come from bank loans (69 per cent) followed by commercial paper and NCDs.

In the previous fiscal, the company’s interest income grew 38.3 per cent over 2007-08 to Rs 830 crore but due to the prevailing slowdown the profits fell 14 per cent to Rs 98 crore.

The interest spread is 2.7 per cent for the company, which has fallen due to increase in the borrowing costs and higher provisioning for the NPAs (non-performing assets). After providing for Rs 22 crore, the net NPA ratio is at 2.04 per cent, up from 0.7 per cent in 2007-08.

The company has a comfortable capital adequacy of 16 per cent and debt-equity ratio (post issue) of 6.68 times. .

Choosing the best option :

The issue is secured by the receivables of the company and 50 per cent of the capital raised in NCD is set aside as debenture redemption reserve.

Of the four options, the 88-month cumulative and the 10-year semi-annual one are good investment options. In the light of the new Tax Code that is expected to come into force from 2011, the post-tax returns of these longer-term options appear more attractive. For instance, for an individual earning Rs 6 lakh per annum, the cumulative option which gives pre-tax yield of 9.5 per cent on an accrued basis may yield only 7.2 per cent as he is in the 30 per cent tax bracket.

However, if the new Tax Code comes into force, the post-tax yield will increase to 8.7 per cent as he would be in the 10 per cent tax bracket. Investors can consider the cumulative option as it reduces the re-investment risk as the accrued interest continues to grow at the same rate, maintaining the yield-to-maturity at relatively higher levels.

The other instrument with similar tenor is Kisan Vikas Patra, which has 1.55 percentage points lower spread over the NCD.

The semi-annual 10-year option, on the other hand, is a one of its kind for the retail investors issued by any NBFC which provides an annualised return of 10.24 per cent, semi annually over a period of 10 years. The only other retail option for such a long tenor is a 10-year government bond with a coupon rate of 6.94 per cent.

A cumulative option is attractive for those who do not require a periodic payout. Investors seeking regular payout may choose the interest payout options.

One advantage of the current NCD issue is that it can be traded on the NSE which makes the bonds liquid. Any major increase in the price of the NCD would present the investor with an opportunity to cash out, especially if interest rates reach a ‘trough’. But investors do not face downside risk. Even if the price of the NCD falls in the secondary market, investors can redeem it at par value on maturity.

For example, the Tata Capital NCD (option 4), with a coupon rate of about 12 per cent and face value of Rs 1000, trades at Rs 1,130 giving an annualised return of more than 25 per cent because of the fall in yields of most debt instruments.

Apart from the exit option that enables selling the NCD in NSE, company may also announce buybacks from time to time and investors can voluntarily retire their NCD.

Risks
The limited track record of L&T Finance in some of its segments may create business risk. There are signs of revival in segments in which L&T Finance has exposure, but it is uncertain if the recovery will uncertain.

The NPAs have continuously trended up for the last four years from 0.1 per cent to 2 per cent and may continue to put pressure on company’s earnings for next few quarters.

Keep visiting EquiTipz for more updates on this NCD issue.

Source: Hindu Business Line

Tata Capital NCD: Should you invest?

GIVEN the continuing downturn in the economy on the back of what is gradually transpiring into a worldwide recession, safety of capital has become of paramount importance. However, the government on it's part, in a bid to encourage growth, has been releasing massive amounts of liquidity in the economy through its monetary policy. This has resulted in the returns on popular fixed income investments like bank FDs etc steadily dwindling.

In such a scenario, Tata Capital Ltd.’s Non Convertible Debenture (NCD) issue that offers an effective rate of return between 11.5 to 12 per cent pa (depending upon the option chosen) is a very attractive opportunity for investors seeking regular income along with safety.

About the issue

- The issue is open from February 2 to February 24, 2009.

- The issue is open only to resident Indians and NRIs cannot apply.

- These NCDs are issued in demat form only, so you need to have an active demat account.

- The minimum amount that you can invest is Rs 1 lakh in the case of monthly interest option and for the remaining it is Rs 10,000.

- There will be no tax deduction at source (TDS) on the interest earned.

- The debentures are offered in four options: monthly, quarterly, annual and cumulative interest

The rate of return and other features of the issue are detailed in the table below.

Is there a lock-in?

Though the NCDs have a tenure of five years, they do have a liquidity feature in terms of a put and call option as pointed out in the table. (‘Put’ refers to the right of the investor for early redemption whereas ‘call’ refers to the right of the company to call for premature redemption).

The instruments can also be traded on the exchange and the market price would be the cum-interest price as on the date when you sell it.

Taxation

The interest will be taxable in the usual course. That is, the interest that you receive monthly, quarterly or cumulatively on maturity will be taxed as other income, that is, added to your total income and taxed thereof.

If you decide to sell at the stock exchange, it will be treated as a long-term capital asset if held for more than 12 months immediately preceding the date of sale.

The long-term capital gains tax will be taxed at 10 per cent without indexation of cost. And if you sell within 12 months, short-term capital gains will be applicable in accordance with the Income Tax Act at your regular tax slab.

Safety

The safety aspect is what sets NCD apart from its other fixed income counterparts. In legal terms, they constitute direct and secured obligations of Tata Capital Ltd. and shall rank pari passu and with all their other existing direct and secured borrowings. Consequently, the claims of NCD holders will be superior to the claims of other unsecured creditors and other investors. That means,if the company were to wind up, NCD holders will rank above all unsecured creditors and other investors.

You may know that other fixed income investments such as bank or company FDs do not offer such security. Bank FDs are insured for a maximum of Rs 1 lakh whereas a company FD is an altogether unsecured debt. In other words, if the company were to default, the FD holders do not have a legal right on the assets of the company. A relevant example is the fixed deposit of coincidentally another Tata Group entity - Tata Motors.

Though the interest rate is more or less comparable, what makes the NCD score over the FD issue (notwithstanding that both issues are from the same group) is the risk-return factor. In this case, the NCD issue is secure whereas the security of the FD issue depends upon the health of the automobile industry in general and Tata Motors in particular.