Muthoot Finance Public Issue

Muthoot Finance, the largest gold loan company is offering secured, redeemable, non convertible debentures to public and the issue is currently on. Details of the issue are all over the media to I will not put them here. My intention is to see if there is a case for subscribing to these debentures as part of the larger asset allocation program of individuals and also  to look at how market is perceiving the previous issue by this company and other NBFCs

Per tax interest rate of 13.25 % means a post tax rate of 13.25 ,11.925% ,10.6%and 9.275% for tax payers in zero, 10%, 20% and 30% tax brackets. There is No TDS which means if you are lower tax bracket person, you do not have wait for your money to come back to you through the tax refund process ( easily a tedious and time consuming process despite efforts of the last chief of CBDT Mr Satish Chandra)

These debentures are going to be listed at BSE hence they will be treated as long term capital assets. Since there is no STT on these, you get to pay only 10% capital gain tax on unindexed basis if you hold them for more than one year whethere sold through stock exchange or through hand delivery ( this means you can transfer them to anyone including your relatives) through a simple transfer slip of your demat account.

The best debenture is buy are the cumulative options since the IRR on these bonds is little higher and there is no reinvestment risk. Left to ourselves, we will eat up the interest if we subscribed to regular return option. Of course if you need regular income( most senior citizens might fall into this bracket ) then by all means go ahead subscribe to that option. Now because these are long terms assets you can also take advantage of capital loss, short term or long term so for a little experienced player, the advantages over other investments are too good to pass up.

Safety of investment: these debentures are rated AA- primarily because of the leverage that these NBFC have. Though a moving target due to high growth, I think Muthoot leverage is almost 5-6X, the last time I checked. Obviously there is higher than a AA+ company like STFC or a AAA rated company but hey that is why they are offering you higher returns. Now the real risk in case of MUthoot according me are 1. Their ability to manage the scorching pace of growth, possibility of fraud at branch level by employees and of course if the gold prices were to fall big time then the company could be in trouble.

How does the market currently view their existing debt issued in September 2011? Yields to Maturity ( YTM ) on 2 years, 3 year and 5 years papers are 14.92%, 14.34% and 14.21% as of this morning of 26th December, giving an inverted yield curve. Volumes are highest in 5 years paper and extremely thin in other maturity.

This means that you are better off giving a miss to these issues and better off buying from the market.

How do these returns stack up against other opportunities available in the debt markets given the sad state of affairs in equities.  You could move into fixed income mutual funds ( long terms ) and gilt funds offered by practically all MFs as there is expectation of rate cut by RBI. Relatively safe, these funds are expected to provide a return of atleast 10-11% over the next one year if not more. Its better to hold these mutual funds in growth option and take advantage of lower taxation by way of capital gain of 10%, if you hold them for one year or more.

There are of course fixed deposits of banks ( FDs of companies are definitely not advisable at this juncture. You could go for FDs of banks like Tamil Nadu Mercantile Bank, Laxmi Vilas Bank, Karur Vyasya Bank etc and if you are making an FD of Rs. One lac then the safety of deposit is guranteed since these are all scheduled commercial Banks.

I do think we have not yet seen the peak of interest rates offered on FDs by banks and these rates will rise as we go along even if RBI decreases the Repo rate. I clearly remember making FDs at 11.25% at LVB in January 2009 and if you recall, RBI had started cutting rates from August onward and was done with rate cuts largely by January 2009.

Risk is in knowing what you are doing and being able to evaluate the likelihood of the identified risk factors playing out. All things considered, I would think that it is worth buying Muthoot Finance debentures from the secondary market and give the primary issue a miss. You will ofcourse be bombarded by the interested agents asking you to subscribe but be firm, ask them about the YTM on secondary market of the earlier issue and see them either give you a blank stare or slink off.

Perhaps 5-10% of your debt allocation could go into debentures of companies like Muthoot Fin and Shriram Transport Finance in the secondary market.

Happy investing.