After the issue of non-convertible debentures (NCDs) by L&T Finance Ltd in February, Shriram Transport Finance Co. Ltd, a non-banking finance company (NBFC) whose main business is truck financing, has hit the debt market and issued NCDs. It plans to raise Rs500 crore through secured and unsecured NCDs. The company gives loans to commercial vehicle owners, especially truck owners, to buy as well as repair vehicles. Should you invest in them?
What is it?
Just like a fixed deposit, an NCD is a loan that a company takes from you for a fixed term. In the interim, you get interest. You need a demat account to invest in these; you can sell these on the National Stock Exchange once they get listed.
An NCD comes with five options having tenors between five and seven years. Options I and II have a put/call option, which means premature redemption is allowed. An NBFC, too, can call back the debentures and return your principal before maturity. Says R. Sridhar, managing director, Shriram Transport Finance: “We will offer the ‘put’ option once the term requirement is completed. Whether or not we will ‘call’ back the NCD is something we will decide when the need arises. In the past, we have never exercised the ‘call’ option.”
Also See Option III: Phased Payout (Graphic)
While option III has a staggered payment facility, option IV doubles your money after six-and-a-half years. Option V is similar to option I, except that it offers higher interest rate as it is “unsecured” and matures after seven years.
Reserved and unreserved: The reserved portion is meant for investments up to Rs5 lakh, while the unreserved portion is for investments of at least Rs5 lakh. The reserved portions offer higher interest rates.
Also See Fixed Returns: What’s on Offer (Graphic)
Secured or unsecured: Of the five options that an NCD has on offer, there are two unsecured options; a first for retail investors in India. Options I, II and III are secured and options IV and V are unsecured.
As these are unsecured, or not backed by any asset, they carry higher interest rate. If the firm dissolves, secured debenture holders will have the first right to claim their money. “Unsecured bonds are rated lower because they carry higher risk. Shriram is a strong company and chances of liquidation are remote. Cash flows for both secured and unsecured debt is on a pari passu basis,” said an official from a credit rating agency who did not want to be named.
Is it safe?
Since timely payment of your interest and principal is crucial in an NCD, we checked out the company’s financial health; three key ratios in its financial statement:
Debt-equity ratio: It tells the extent of a firm’s borrowing (debt) for every unit of equity (a firm’s own money) it has. At present, Shriram’s debt-equity ratio is 7.37 times; after the issue it will rise to 7.53. N. Sethuram, chief investment officer, Shinsei Asset Management (India) Pvt. Ltd, said NBFCs can, typically, borrow around 10 times their own net worth and so a debt-equity ratio of around seven “should be okay”. We had asked him about the norm, without naming the firm as fund managers are not permitted to talk about individual companies.
NPA ratio: Expressed in percentage terms, this is the proportion of a firm’s loans that have gone bad and those that the company can’t recover out of the total loans it has disbursed. Shriram’s non-performing assets (NPAs) for FY10 is 0.75%. “Our NPA has always been below 1%,” says Sridhar. “An NPA of 1% is good for an NBFC,” adds a Mumbai-based fund manager, on condition of anonymity.
CAR: Every financial institution in India is mandated to maintain a certain portion of capital as a proportion of loans it has lent, also known as the capital adequacy ratio (CAR). This ensures that the firm is in good financial health. Tier I capital is, typically, the larger proportion of CAR. It’s considered the bank’s own capital and the bank need not return it. A firm can also borrow to raise its tier II capital (like debt; money that needs to be returned) and spruce up its balance sheet. The unsecured debentures will be part of the firm’s tier II capital.
As per guidelines issued by the Reserve Bank of India (that also governs NBFCs), an unsecured debt above five-and-a-half years maturity qualifies as tier II capital. An NBFC has to have a CAR of 12%, 8% of which should be tier I capital. A firm can raise 50% of its tier I capital as tier II capital. “Shriram has 20% CAR, 15-16% is tier I, which means that we can raise about 7.5-8% as tier II capital,” says Sridhar.
Should you invest?
If you are a senior citizen and want regular income, first maximize your limits in Senior Citizens Saving Scheme 2004 (Rs15 lakh) and Post Office Monthly Income Scheme (Rs9 lakh in a joint account). These are government-backed and there is no chance of default.
Next—and for investors in their 40s or 50s—watch out for the term and ensure you’re fine with sticking around for a long time. Typically, since interest payments and principal repayment of an NCD or a company fixed deposit depends on the firm’s financial health, it bodes well to keep the term short. Shriram NCD comes with a term of at least five years, though option I (5 years) allows you to withdraw after three years and option II (7 years) allows you to withdraw after five years. Option III (5 years) pays back your principal after three years in a staggered fashion.
For the risk-averse, we suggest option III as it starts giving back your principal after three years. Assuming you stay invested till maturity, you will earn yield of 10.5%.
We also like option I that offers a yield of 9.75%; your principal is invested for five years and you don’t run the risk of spending it by getting your principal early. Avoid option V as seven years is too long for a company NCD. Go for options IV only if you can take the risk. Remember, it doesn’t come with a put/call option and the money doubles only if you stay invested till six-and-a-half years.
Graphic by Yogesh Kumar/Mint