If you are investing in Muthoot Finance’s non-convertible debentures, invest with your eyes wide open and understand the risks outlined here.
If you are investing in Muthoot Finance’s non-convertible debentures (NCDs), invest with your eyes wide open and understand the risks outlined here.
Muthoot Finance, an NBFC or non-banking finance company rated AA- by CRISIL, is offering the public NCDs with maturities ranging from 24 to 66 months.
The NCDs promise to give an effective pre-tax yield of 13-13.4%, depending on maturity.
The yield looks attractive given the rating of AA- which signifies a high degree of safety of principle and interest with a weaker credit outlook.
The company is the largest gold financier in India. At the moment, there is no question mark on the outlook of the company’s financials. On the face of it, the NCDs of Muthoot Finance look a no-brainer as a yield of 13% and above is not available elsewhere, where there is no market risk.
Equities’ long-term average returns are around 17%; but they come with downside risk.
Maturity returns on AAA-rated corporate papers (with maturities similar to Muthoot Finance NCDs’) are at the 9.40% levels. Government bond yields are a whole percentage point lower than AAA- rated corporate papers.
Why is Muthoot Finance offering 13% returns when returns on higher safety credits are 3.5% to 4.5% lower? Is there a catch somewhere? Is Muthoot Finance finding it difficult to raise money at lower levels of yields because of the market perception of its credit? Or, are the offered returns higher due to tight liquidity conditions forcing lower rated borrowers out of the market?
Muthoot Finance has to lend at over 18% interest rates for it to make money. Can borrowers afford to service such high interest rates? And if they cannot, would there be a default on loans?
Gold as a security has its own market dynamics. If gold prices crash, Muthoot will suffer a loss as the value of the security would be lower than the value of the loan.
Financiers of equity had faced huge problems in this market before, when the value of equity fell below the value of loans. Gold is not as volatile as equity, but it comes with its own risks in the form of market prices and physical storage.
Investors in Muthoot Finance NCDs would indirectly face the risk of gold prices crashing or of poor security relating to storage of physical gold.
NCDs are illiquid. Investors will find that if interest rates come down in the economy, they would not be in a position to capitalise on falling interest rates. Government bonds and corporate bonds that have no credit risk or very low credit risk, if held for a two-year period or longer, would benefit from falling interest rates, and could give returns higher than the 13% and above returns offered by Muthoot Finance NCDs.
Equity investors looking to place equity money in these NCDs face a potentially higher loss in opportunity cost terms, if equity markets bounce back. The Nifty and Sensex are down around 20% in 2011, and there would be high chance for rebounds if interest rates fall.
If equities do not do too well, it would be due to slowing economic growth. In a sluggish economy, borrowers will definitely not be in a position to service loans at high interest rates of 18% and above.
The writer is the editor of
www.investorsareidiots.com,
a website for investors
){kind=small}
){kind=small}
){kind=small}
){kind=small}
){kind=small}
){kind=small}
){kind=small}
){kind=small}
){kind=small}
){kind=small}
){kind=small}
){kind=small}
){kind=small}
){kind=small}
){kind=small}
){kind=small}
){kind=small}
){kind=small}
){kind=small}
){kind=small}
){kind=small}
){kind=small}
)
){kind=small}
){kind=small}
)
)
)
)
)
){kind=small}
){kind=small}
){kind=small}
){kind=small}
){kind=small}