Investors can make money from Muthoot Finance NCD

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As the interest rates are close to peak, many fixed-income investors are trying to lock-into instruments which offer high rates of interest.

To attract such investors, after a pause of four months, Muthoot Finance has come up with its second public issue of non-convertible debentures (NCD). 

Muthoot Finance, the largest gold loan company in India, is offering 13-13.25 per cent interest rates on 2, 3 and 5 year tenors. It also has a product which doubles your money in 66 months offering a pre-tax yield of 13.46 per cent.

Investors can consider subscribing to Muthoot Finance's secured NCDs, in light of the very attractive interest rates. However, investors should avoid exposing too much of their debt portfolio to this bond, given the risks inherent to the business. 

We think the company's reliance on a single lending product, namely gold loans, carries risks. The rates on the two year option are better than that on deposits from companies with similar credit ratings such as Shriram Transport (9.75 per cent), Dewan Housing Finance (10.5 per cent) and Mahindra Finance (10 per cent).

Given that only annual payout is offered it is a tough to calculate effective yields in the companies. In case of a two-year option, annual interest post-tax works out to 10.7 per cent, 9.5 per cent and 8.3 per cent respectively for an investor in the 10 per cent, 20 per cent and 30 per cent tax brackets (provided they pay tax, as there is no tax deductible at source).

Key Positives

Secured nature of the business with attractive net interest margins, low non-performing assets, credit rating of Crisil AA- (which implies high degree of safety regarding timely servicing of financial obligations and very low credit risk) are key positives.

These offset the risks from the company's heavy reliance on gold loan business and focus on South Indian market. The 63 per cent loan-to-value for the September quarter provides a margin of safety against gold price volatility.

Another advantage which Muthoot Finance enjoys is that the company's loan portfolio is of short-term nature, but the company is increasingly raising longer-term borrowings which reduce the refinancing risk for the company.

More than a 70 year track record in gold financing also gives confidence in the company, however, over the last few years the growth in the company has been very aggressive thanks to sharp rise in gold prices.

Capital adequacy ratio is also another concern as the capital is being consumed very fast by the company due to high rate of growth.

Muthoot Finance may have to raise equity next fiscal. The company's assets under management have grown at 81 per cent over the last four and a half years ended September 2011.

The issue carries a minimum investment amount of Rs 5,000.

The offer has already opened and closes on January 7 2012; with the company having an option to pre-close the issue. The allotment is on a first-come-first-served basis. The issue size is Rs 300 crore with an option to retain another Rs 300 crore oversubscription.

NCD holders can trade in these debentures in the secondary market (NSE and BSE) on listing.

However, investors are subject to liquidity risk given that volumes traded of such bonds are low.

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