IIFL NCD at 12.75% – Should you invest?

India Infoline Finance Ltd. is in the market to raise money up to an amount of up to Rs. 500 crore in the form of NCD (non-convertible debentures).

We will analyze the attractiveness of the India Infoline Finance NCD (IIFL NCD) issue.

You will also understand how to analyze important points that matter for any debenture investment.

The issue opened on 5th September 2012 and closes on 18th September 2012.

Note: This article talks about the September 2012 issue. If you came to this page when you were searching for the IIFL NCD issue in September 2013, you can click here. I still recommend reading the article for the 2012 issue first as the business profile of the company has not changed too much.

Prospectus

Any company that is issuing debentures has to upload its prospectus, a document that contains details of the issue:

  1. SEBI website
    1. Go to www.sebi.gov.in
    2. Click on Offer documents in the menu
    3. Click on Debt Offer Document
    4. Click on Final Filed with RoC (the other link is for the draft Prospectus)
  2. Its own website. In this case India Infoline Finance’s website
    1. Go to www.iiflfinance.com.
    2. Click on Investors in the menu
    3. Click on Offer Documents.
    4. Agree to the Disclaimer
    5. Download the prospectus.

Please remember that India Infoline Finance and India Infoline Ltd. which is listed on the exchanges.

What you see on the very first page of the prospectus is the following.

Public Issue by India Infoline Finance Limited, (“Company” or “Issuer”) of Un-Secured Redeemable Non-Convertible Debentures of face value of Rs. 1000 each,
(“NCDs”), aggregating upto Rs. 2,500 million, hereinafter referred to as the “Base Issue” with an option to retain over-subscription upto Rs. 2,500 million aggregating to a total
of upto Rs. 5,000 million, hereinafter referred to as the “Overall Issue size”. The NCDs are in the nature of subordinated debt and will be eligible for Tier II capital.

Unsecured

There are secured and unsecured debentures respectively. An easy analogy is a home loan that you take from a bank. The home is the security. The bank has a secured loan. If you fail to pay the bank on time, the bank can ask you to vacate your home. They will then sell the home (security) and recover their money to the extent possible.

In case of default, secured borrowers have the first right to liquidate the assets the company and take their money back. Unsecured lenders always stand in line after secured lenders. Generally, you should be wary of unsecured lending.

Secured debt and unsecured debt - priority at time of liquidation

When you buy an unsecured NCD, you are in effect lending your money to the IIFL Finance. There are secured borrowers ahead of this issue of NCDs.

Redeemable

The company will pay back the debentures when the period is over. In other words, it means they want to redeem them.

Non-convertible

Certain debentures are convertible into equity shares of the company.

In IIFL Finance’s case, they are not convertible into equity shares.

Subordinated

Like unsecured lenders come after secured lenders to collect what’s left, subordinated lenders come after all lenders who are not subordinated lenders. Again, if you subscribe to this issue you are behind other lenders who are not subordinated if it comes to the worst case.

Credit Rating

ICRA and CRISIL are credit rating agencies which rate public issues.

ICRA has rated it as AA- (stable).

CRISIL has rated it as AA-/Stable.

If you are not familiar with ratings, know that Government of India bonds are rated AAA which is the best possible rating.

ICRA rating scale

CRISIL rating scale

Terms of issue

There are multiple investment options.

Face value of NCD1000
Frequency of interest paymentMonthlyAnnuallyNot applicable
Interest rate (%)12.75 per annum12.75 per annumNot applicable
Effective yield13.52%12.75%12.75%
Redemption date72 months from date of allotment
Redemption amountRs. 1000 plus accrued interestRs. 2054.5

 

As a general rule, take monthly payments rather than annual payments. A bird in the hand is worth two in the bush. Whatever you get monthly can be re-invested again as you like.

That is why you see effective yield of 13.52% for option one. The assumption here is that you re-invest monthly interest again in an instrument yielding 12.75% per annum. This is more of a theoretical number because you might not get similar yielding instruments over the next six years.

In the last option you receive no interest over the tenure of the bond. You get a lumpsum amount back at end of 72 months (6 years). Effective yield is again 12.75%. Because you invest Rs. 1000/- and get Rs. 2054.5 back at end of 6 years. It effectively works out to investing Rs. 1000/- in an instrument which yields 12.75% per annum and re-investing interest every year again at 12.75% till the end of tenure.

This is particularly risky as compared to the other two options. Theoretically, if there were a default in the third year, then the borrowers under the last option will not have got a single Rupee in the three years. In comparison, borrowers under the first two options will have received  some interest income at least.

Summary of business

IIFL Finance is in the business of providing financing. They raise funds from banks, private parties, public debenture holders and lend the money onward. The chart below gives a breakup of the loan book as of 31 March 2012 as per the IIFL NCD Prospectus.

IIFL Finance - NCD issue - Loan book as of March 2012

Source: Prospectus, IIFL Finance NCD, Capital Orbit

The Prospectus mentions that 99% of the loan book is secured as of 31 Mar 2012. Net non-performing assets (NPAs) are 0.4% of their loan book which is fairly low and a positive point.

Mortgage finance is an area with high competition and an inherently risky business area. The ICRA rating in Prospectus mentions that Loan Against Property and Home Loans make up 89% and 11% respectively of the mortgage part of the loan book.

IIFL Finance is also financing real estate developers. The Prospectus does not carry a breakup of Loan Against Property. I would surely like to know this before I commit money to this issue.

Why is this important?

Because most properties or construction projects cannot be easily liquidated when a customer defaults. Think of a time like 2008 when the economy seemed to have come to a standstill.

A bank or an NBFC might have security on a property when they have given a loan. Security is on paper. To recover money, steps need to be taken to liquidate the asset. There might not be buyers at a good price in the market if real estate slumps.

In this case, the debenture holders bear the risk of a real estate slowdown which can potentially affect close to 40% of the lending book.

The same is the case with gold loans. These make up the next biggest chunk of their business. Gold loans have come under scrutiny by the RBI.

A drop in gold prices can hit the value of the gold and gold jewellery that is pledged by customers.

Banks are increasingly getting active in the gold loan segment. Competition can put further downward pressure on the interest IIFL Finance can charge on gold loans.

I do not find this segment of the business very attractive.

Read a recent article on the gold loan business.

Risk factors

This section in the prospectus is a must read because it is the company’s own declaration of the major risk factors that affect their business.

These are a few risk factors that I felt were particularly important.

Violation of covenant

Our Company has been in violation of the maximum permissible gearing (i.e. Total Debt/ Total Networth) as prescribed under the offer document for issue of Secured Redeemable Non-Convertible Debentures issued on April 20, 2010, during the Financial Year 2011-2012. Our Company’s gearing had grown upto 2.9 times during the FY 2011-12 as against maximum permissible gearing of 2.5 times on a Consolidated and Standalone basis. There is no guarantee that such a violation may not happen again. In the event that there are similar events of default under the terms of offer documents, it can have significant consequences on our business and operations.

 

In the past this company has violated the covenant (think of it like a promise or commitment with legal binding) in the offer document for another set of debentures they had issued. Gearing means borrowing. They had agreed to a maximum borrowing level in offer document and then exceeded it.

This is not a good precedent at all.

Quality of gold pledged with IIFL Finance

We may not be able to realise the full value of our pledged gold jewellery, due to, among other things, defects in the quality of gold. In the case of a default, we may auction the pledged gold. We cannot assure you that we will be able to auction such pledged gold jewellery at prices sufficient to cover the amounts under default.

 

This is a risk factor that will be true for most gold loan companies in India.

Liquidity

These debentures will be listed on the exchange. If you want to exit the investment by selling on the exchange be aware that there is low liquidity, a fact which is also pointed out in one of the risk factors.

Listed bonds on NSE

If you see the link above, you will notice that volumes are not very high in the debt segment.

Taxation

The interest rate return is pre-tax. Tax applicable to interest earned from debentures is as per the tax slab you fall in i.e. 10%, 20%, 30%.

Summary

Look for safety of capital (return of capital) first before you look for return on capital. An extra 2-3% should not make you forget the risks to your principal investment, as a general rule.

IIFL Finance is an NBFC which has lending exposure to areas like mortgages, gold loans and capital market financing which usually are affected first by adverse interest rate or market movements. In a stressed economic scenario with low growth and high inflation I would consider these as high-risk sectors.

The IIFL Finance NCD issue is unsecured in nature, as I mentioned earlier.

I will avoid this issue. Read the disclaimer.

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Comments

      • says

        If you read the Debty regulations carlufley, you will find that the debt raised can be secure as well as it can be unsecured. If in case, it is secured it has to be fully (or 100%) secure- there is no scope for say, 10% or 20% or say 90% debt to be secured- it has to 100% secured. To this extent I find no ambiguity in the SEBI Regulations.

  1. natarajan says

    sir,till 25.01.13 the iifl ncd was quoting @1010,but on 26.01.13 it has come down to 1001. i do not know the reason.the prices are depending on demand & supply.then why it has come down to 1001. kindly find out the reason. to my enquiry with the iifl office it was told that the company is working good.
    pl. do the needful

    • says

      Natarajan, the price that you see is driven by demand-supply as you rightly say. It is also affected by perceptions of credit risk and by interest rate expectations in the market. And this is not only for the IIFL NCD but any traded NCD. Your calling the office will not help. Price will keep fluctuating because of all the reasons I have mentioned.

  2. Aditya says

    Dear Kunal, any idea how this measures up to FMPs? I am looking at FMPs but can’t find a way to research the various FMPs… I found it easier to analyze bond funds, but somehow the category average returns of 8-9% don’t appeal that much, vis a vis the 31 yr CPI of 9.5%. At the moment, NRIs get tax free FDs bearing 9-9.25%. I would value any suggestions you have on how one could beat this fixed income return without taking undue risk?

    • says

      Hi Aditya, good to hear from you again.

      FMPs by themselves will give decent returns roughly as per whatever paper is available in the market at the time they are launched. The benefit with these FMPs is that one can claim indexation or double indexation (as the case may be)
      http://articles.economictimes.indiatimes.com/2013-03-18/news/37815066_1_cost-inflation-index-long-term-capital-gains-mutual-fund-investments

      There is a risk in FMPs. Recall what happened in 2008 when there were FMPs that had invested in real estate company debt instruments. When people wanted to redeem they faced problems.
      http://www.rediff.com/money/2008/oct/08fmp.htm

      One may opportunistically buy non-convertible debentures from good issuers. But these opportunities are fleeting. There was a time around November 2012 if I am not mistaken, when you could buy Tata Capital NCD series N4 at prices which gave you an effective rate of over 10.5% post tax. The financials of the company were not inspiring. Return on equity of around 8% if I remember right. But here you take a call that the house of Tata would not default.

      I would trust a Tata company to take care of debt-holders.

      In today’s environment, you have bond funds as an option if you have an expectation that interest rates will fall. I am not sure they can fall too much from here. So I don’t know whether they will go too far above 8-9% (as you also mention).

      So, all in all, I don’t find anything that looks like it will beat inflation and not add undue risk.

      • Aditya says

        Thanks for your reply. It has clarified my own tentative conclusion. I’ve been breaking my head over the last week trying to find good fixed income return.

        And every avenue has issues. Corporate bonds, CD, CP etc. just don’t seem to be easily available to the retail investor. And the ones listed on the exchange can be viewed in a single page view. NCDs have low volumes, low liquidity & high tax if held to maturity. FMPs, bond funds etc. are ok, but not really inflation beaters net of fees & tax. Bonds which are tax free are great, but only if you happen to time the interest rate right to get a capital gain; otherwise you get a YTM below 8%. And then what to do with the cash proceeds?

        For a person who wants a fixed income portfolio which can be rotated easily with largish amounts, without doing too much individual security research, taking mild risk to beat inflation, it’s not easy at all. I hope Indian bond markets develop more to provide direct offerings to retail investors / exchange listing, plus bond index funds. Until then, high dividend yield stocks plus bond funds / FMPs it is.

        Why is the GOI taxing fixed income instruments so aggressively (even indexation is only 75% of CPI), while leaving equity relatively untouched? Surely our fiscal burdens can be met through some way that does not require the depreciation of earned wealth of our own citizens. I’m thankful because I can afford an equity oriented long-term portfolio, but I can’t help feeling the average aam aadmi must be hit really hard by this.

        • says

          But this is the tragedy of our markets. The common man is left with negative real rates (nominal rates – inflation). I for one don’t trust even the official CPI. I feel inflation that we face practically is higher.

          And then the Finance Minister Chidambaram wonders why people are buying gold. If one wants to invest for 3-4 year period then one would not put money in equity. What should the common man do? They trust gold as an asset in a time when FDs do nothing for him.

          It’s disgusting, if you ask me. Negative real rates to me is plain and simple loot. The silent tax which no one blames the government for broadly. There is a department behind income tax. Inflation comes along silently and the government plus the banking sector are responsible. Credit growth from the banking sector which adds to inflation (part of M3 component of money supply) is eventually controlled by the RBI itself.

          I recommend you read a book called The Dying of Money by Jens Parson. You should be able to get the Ebook. It is out of print. It’s brilliant.

          • Aditya says

            Thanks Kunal, I will be getting the book and going through it.

            Completely agree with you; the commitment to providing real interest rates of at least zero or above is just not there. Govt & banks are taking advantage of the lack of widespread awareness of the difference between real and nominal. Moreover, this is a global phenomenon, with short-term instruments in the United States having artificially depressed yields due to QE. All the more important that equity investors allocate more to debt-intensive sectors which are getting credit subsidized by fixed income investors.

            On the positive, it looks like we are reaching a point where it might be a good idea to start buying bonds again – if we can get access. Another possibility is to build an international fixed income portfolio, with dollar holdings. The yields will be going up from now, and dollar inflation is not as high as INR. There are diverse options for those who cannot afford bonds, such as preferred shares etc. though it requires risk appetite. I am investigating brokers like Interactive Brokers etc. and hope to find a viable solution.

          • says

            Yes, negative real rates are the reality in most places around the world.

            The dollar holding bit makes sense over multi-year periods. I agree. India has a multi-decade history of rupee depreciating against the dollar.

            Do share what the terms and conditions of Interactive Brokers when you talk with them. I would like to know. Thanks.

  3. Pramod Puri says

    Hi Kunal,
    I have been reading your comments from time to time, which are very informative.
    RBI is coming out with Inflation Bonds in near future. Are they open for general public?
    Also please give your opinion on the same.
    Thanks
    Pramod

    • Aditya says

      That would be an informative and enjoyable post topic. My own understanding is that they are giving WPI + coupon. Depends on the size of the coupon then, because from a consumer perspective WPI is an understatement of inflation. Lots of ifs: coupon, tax treatment, liquidity etc. At some point I feel that the cost of funding would be so high fiscally, that it would become infeasible unless the rates are hiked for the entire market & money supply is controlled to bring inflation down.

    • says

      Aditya already has replied on the WPI inflation reason. As individuals we face CPI which is way higher than the WPI. Almost double. It makes more sense for a peg to the CPI instead of WPI.

      I will do a post on it soon Aditya. Thanks for the suggestion.

    • says

      Sumit, the liquidity in many of these NCDs is low. There is not much you can do but wait for liquidity to appear. This is true not only for IIFL but other NCDs which have been issued in the last few years.

    • K S MURTHY says

      Dear Kunal Pawaskar !
      A very good analysis and a lay man can understand. Thanks for good work. By the by Sriram group always without any time bound accepts Debentures and Bonds. Recently I saw their Subhikha Bonds. Can you post the analysis report on risk of these bonds.

      Thank you

      • says

        Thanks.

        I did not understand your comment about Sriram Group accepting without any time bound.

        Subhiksha Bonds are issued by Shriram City Union Finance if I remember right. You can look at my views on this company which I had shared last year. The business analysis part would not change too much.

  4. says

    Dear Kunal

    I am a NRI and I want to purchase NCD either from IIFL or Muthoot Finance, by my SB account of India, which one is recommended by your opinion, please post the comments and also advise whether it is safe or what….?

  5. says

    Dear Kunal,
    Hi,

    If I go with companies FDs like Jagatjit Industries Limited and Bajaj Finance Limited also offering good returns like 12% per annum, how about this offer to be invested…….?

    Somehow, we need your xpert advise for our investmnet to be generated source of income other than to
    depends overseas employment only……….

    Please advise……….?

    Regards,
    Syed/Riyadh (KS.A)

    • says

      I don’t think company FDs are a great choice for individual investors, Syed. For the fact that there are too many cases of people who have lost money in company FDs when the FD issuers who face financial problems. There is lack of diversification. An example, you can invest Rs. 10,000 in one company’s FD or you can invest Rs. 10,000 in a debt mutual fund scheme. The mutual fund scheme will have at least 15-20 plus investments across companies. I think this serves you better. Even if one investment goes bust, you are better protected in the MF scheme.

      To put money in a single company’s FD you need to answer whether you are able to analyze the company’s financials. If you cannot or do not have the time, you are at risk.

      Also, consider tax bracket when it comes to FDs. If you are in highest tax bracket, the return of 12% becomes 12% less 30%, yielding 8.4%. If you invest in mutual funds you have better options of taking capital gains tax instead which can work out lower.

      So, two advantages come to my mind, diversification and taxation.

  6. says

    Hi Kunal,Can you pls suggest me where to invest money to get better yield than FD.My Goal is in short to medium term say in 3-5 years i need to get 12-15 % yield p.a.[after tax deduction]

    • says

      Hi Sai,

      None of the options on the debt side that I know can fetch you 12-15% yield post tax.

      There are some tax free bonds nowadays that can give you returns in the range of 8.5%-9%. NCDs can give you post tax returns in the range of 8-8.5% if you are in the 30% tax bracket. If you are in lower tax brackets your returns will go up. Liquid funds if held for more than a year with the growth option are not bad till liquidity in the system is relatively tight. Regular debt mutual funds face risk of NAV decrease if interest rates increase. With the high inflation nos. they should increase further.

      That is the quandary for a debt investor. There is nothing that is effectively beating inflation.

      The only hope that I see are inflation indexed bonds. There are some issues that are there in these instruments which are to be launched soon in that there are penalties for early withdrawal.

  7. says

    Hey outstanding blog! Does running a blog such as this take a great deal of
    work? I have no expertise in computer programming however I was hoping to
    start my own blog soon. Anyways, if you have any suggestions or tips for new blog owners please share.
    I understand this is off topic but I simply wanted to ask.
    Thanks a lot!

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