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Sep 17, 2012, 07.45 PM IST
Various companies are tapping money by offering NCDs at mouth watering rate of interest. Often investors get lured by the coupon offered by these NCDs and ignore key indicators of NCDs in terms of quality and future prospects. Read this space to know how to evaluate NCD offer.
It is raining Non Convertible Debentures (NCDs) these days. Various companies are tapping money by offering NCDs at mouth watering rate of interest to investors. During last one month more than three NCDs have hit the market. India Infoline Finance NCD was followed by Shriram City NCD and then came Religare Fininvest NCD. Dewan Housing is also planning to come out with an NCD shortly. It is a daunting task for investors to evaluate these NCDs and they often find themselves lost in the jungle of NCDs .In fact, most of the investors get lured by the coupon offered by these NCDs and ignore key indicators of NCDs in terms of quality and future prospects. Some investors move ahead with investment decision in a NCD based on the credit rating not realizing that credit rating can change multiple times during the life span on a NCD. So what should an investor do to evaluate a NCD and what are key indicators that he needs to look into. Here are some of them:
Check Credit Spread of NCD offer: Credit spread indicates the difference in the yield of different securities. In international markets, credit spread is often calculated as difference between coupon offered on a bond vis-a-vis coupon available on government security. In Indian context, it will be ideal to map a NCD coupon to yield on a ten year government security. Currently the yield of 10 year GOI security is close to 8.2%. As an investor in a NCD, you should check the difference between the coupon offered on NCD and the yield of government security. For example India Infoline NCD offering 12.75% as coupon had a credit spread of more than 450 basis points over GOI ten year yield indicating a high spread and high credit risk. As the credit spread increases the credit risk increases. In other words, NCDs with higher credit spread are more risky, other things remaining constant. Also important to note is that if a NCD is unsecured, the credit spread will be more.
Look at the past performance of similar NCDs of the company: Many companies come out with multiple offer of NCDs. Muthoot Finance is one such example. In cases where a company comes out with multiple issues of NCDs, it is recommended that as an investor you should check the performance of previously issued NCDs. Since NCDs are traded on stock market, price of the NCDs can give a trend. For example bonds issued by NHAI trade at higher price compared to NCDs issued by Muthoot Finance even though the coupon offered by Muthoot Finance was around 5% more than NHAI bonds. The market price of these NCDs reflects the market perception of risks in these NCDs. Price of NCDs are determined accordingly in the market.
Analyse Interest Coverage Ratio of the companies offering NCDs: Interest Coverage ratio is a relationship between the profit (EBIT) earned by a company and the interest liability of the company. Banks look at an interest coverage ratio of 1.5 to 2 times before lending to a business. At the time of investing money in NCDs, one should look at an interest coverage ratio of 2.5 to 3 times to avoid any default probabilities in future. Equally important is the fact these companies should have consistent interest coverage ratio and there should not be erratic performance in terms of this ratio.
Check Capital Adequacy Ratio: Capital adequacy ratio reflects how well the financial institution is capitalized in terms of meeting future business requirements. A high and consistent capital adequacy ratio over and above the regulatory requirement is a good sign.In India, RBI requires NBFCs to maintain a capital adequacy ratio of 15% .So check if CAR is above 15% and whether it has been consistent over a period of time. A sudden drop in CAR in a particular year needs to be investigated.
Check Non performing Assets (NPAs) of the business: NBFCs often operate in the space where the risks in lending is high. The loans given by NBFCs may turn into bad debts and become NPAs. It becomes important to check NPAs of these companies. Any rising trend in NPAs could be a cause of concern. Reducing and low NPAs are good indicators. It will a good idea to check NPAs as a percentage of profit made by the company. If profits are significantly higher than NPAs, then company is well placed to manage NPAs.
Apart from the factors mentioned above, other factors such as credit rating of the NCDs, business areas of the company and the purpose for which the amount is being raised also needs to be checked. Last but not the least one should keep exposure limited in high coupon NCDs and depending upon risk appetite decide exposure in these NCDs.
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