It’s a classic investment dilemma: if you want a low-risk investment, forget high returns; if you chase high returns, be prepared to take on risks. Usually, investment instruments that marry the two categories impose a longer lock-in.
There’s an alternative though. We suggest you take a look at L&T Finance Ltd’s recent issue of non-convertible debentures (NCDs) that are open till 22 February. Read on to find out whether they suit your needs.
What are these?
L&T Finance, a subsidiary of construction firm Larsen and Tourbo Ltd, is a non-banking finance company (NBFC). Just like a bank, it borrows money from one person and lends it to another who needs it. One of the ways it can raise money is by issuing NCDs to the public.
These are essentially debt instruments that they issue to investors for a fixed time frame—it’s like taking a loan from the investors. After the tenor gets over, the investor gets the money back. In the interim period, the company pays you interest. It works like a fixed deposit.
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L&T Finance NCD has a tenure of three years, though you can sell it on the stock exchange if you wish to exit prematurely. It will be listed on the National Stock Exchange as well as the Bombay Stock Exchange. You need to have a demat account to be able to invest in it.
Are they safe?
L&T Finance NCDs are secured debentures and come with a credit rating of AA+, which indicates “instruments with high safety for timely servicing of debt obligations” and those that “carry very low credit risk”, according to Credit Analysis and Research Ltd (CARE), one of the two rating agencies that have rated L&T Finance NCDs.
Company fixed deposits may offer higher interest rates than L&T Finance NCDs, but most of them are not rated, which could be risky. Bank fixed deposits are secured to a maximum limit of Rs1 lakh even though they are perceived to be one of the safest institutions on account of stringent regulations.
We looked at the company’s balance sheet and checked out its debt-equity ratio. A debt-equity ratio of two means that its debt is twice that of its equity.
“Typically, a debt-equity ratio of 1.5 is acceptable, though non-banking finance companies have a higher debt allocation because their main business is borrowing and lending of money,” says Arvind Chari, debt fund manager, Quantum Asset Management Co. Ltd. Debt fund managers claim that a debt-equity ratio of five to eight is acceptable for an NBFC.
As per its prospectus, L&T Finance’s debt-equity ratio will rise 6.24 times after this issue. Its non-performing assets (NPA) ratio or the proportion of bad loans to its total loans stands at 2.79% of its net advances, up from 2.04% of its net advances as on March. N. Sivaraman, senior vice-president (financial services), L&T, says: “The higher NPA was due to a bad financial year that ended on March 2009. Some of our payments of that particular financial year got delayed which got reflected in our September 2009 figures. It’s a negligible portion, though. That is being corrected.” It’s credible parentage instills comfort.
L&T Finance NCDs offer an annual interest rate of 8.50%. If you opt for the semi-annual option, your interest rate will be 8.4% per annum. So, Rs10,000 invested will fetch you interest payments of Rs420, twice a year, taking your total interest income to Rs840 (8.4% of Rs10,000). There is no tax deducted at source for NCDs that come in the dematerialization mode, such as this one. There is no cumulative option.
Comparatively, bank fixed deposits offer around 6.25-7.25% interest per annum. Some companies offer fixed deposits at higher rates but they don’t come with a credit rating.
Your other alternatives are intermediate- and long-term bond and gilt funds. These are mutual fund schemes so they won’t assure you any income against debentures. As interest rates are expected to go up this year, long-term bond and gilt funds are likely to lose money (interest rates and market prices of debt papers tend to go in opposite directions).
If you’re seeking regular income, bond and gilt funds don’t work. They can offer you better appreciation if you are willing to allow your money to accumulate over a long period of time.
How are they taxed?
Interest income is taxed at marginal income-tax rates. If you sell the NCDs on the stock exchange before a year then you will have to pay short-term capital gains at income-tax rates applicable to you. Withdrawals after a year impose 10% tax without indexation and 20% with indexation.
Who should invest?
Look at L&T Finance NCDs only if you wish to receive regular income as it does not offer a cumulative option. It offers an avenue to diversify your debt allocation.
Although the coupon rate is not very high, it’s better than what banks are offering at present for a similar tenor. Veer Sardesai, Pune-based financial planner, says: “The tenor of three years is reasonable and doesn’t lock your money for too long.”
Graphics by Yogesh Kumar / Mint