Beware of same old unknown angel called NCD: Prime Database

Excerpts from Markets Midday on CNBC-TV18 Watch the full show » ALSO READ See what other experts are saying about markets See what FIIs are saying about the markets See what Udayan Mukherjee is saying about the markets Shriram TransFi BSE | NSE 31/05/12 Are Mutual Funds betting on Shriram TransFi? Other Stocks in this news Muthoot Finance | Manappuram Finance | Shriram City Union Finance | Religare Enterprises | Sardar Sarovar Narmada Nigam | Essar Oil |

Debentures are now re-emerging as an attractive asset class compared with equities. There are quite a few debentures on the offing for investors to pick from- Shriram Transport Finance , Muthoot Finance , Manappuram , Shriram City Union , Religare .... Considering big and established brands had defaulted on payback the previous time debentures were the flavour of the season, how must investors look at this now? Prithvi Haldea, chairman and managing director of Prime Database joins CNBC-TV18 to clear the air.

"While the policy concerns remain the same, the difference with the line-up of debentures this time is that they come mostly from NBFC," he observes. "This is not going to be a cakewalk, neither for the investors, nor the companies," he says.

Below is the edited transcript of the interview. Also watch the accompanying video

Q: Is this really difficult terrain? Previously, Sardar Sarovar as well as Essar Oil had defaulted on their debentures, big names that you would never associate with a default. Is that danger behind us because regulations have changed?

A: There has not been a significant change in the regulations, so fear of default still remains. What we saw was that the two names that you mentioned and the state of debenture issue that we saw were actually in 80s and they mainly came from manufacturing companies. They offered extremely high rates of interests and when the projects fail, or there was a lack of intent on the part of the promoters to stay back, we saw a huge number of defaults. In the 90s, we had very few issues and even the decade of 2000, there have been very few public issue of non-convertible debentures (NCDs).

What we are currently witnessing is a new kind of activity, which is basically NCDs from NBFCs. The reasons are many. One is of course that NBFCs are not able to raise capital. In an environment where people cannot borrow from banks because the bank rates have gone up, in public market, even at 1-2 percentage points higher makes sense for them. They enjoy the spread between the borrowing rates from the public and the rate at which they lend, which continues to be very attractive. So it makes sense for NBFCs to go to the public markets.

The public, on the other hand, is currently being cautious. Although, we have seen about Rs 9000 crore being raised last financial year, and this year, the number could be Rs 15,000 crore in public issues which is significant.

The point, however, is that the market still does not have a higher bias on this. I have looked at the data of all the debenture issues in the past couple of years. Most of the issues have attracted between 75,000 and one lakh investors. We are not talking of the market being on fire where people are buying up or lapping up NCDs. There is still a cause of concern and people are not totally sold on the idea of buying private sector NCDs. There are still questions of security of the debenture. There is concern of a downturn in the economy that can impact these companies. The problem could also be a regulatory gear shift, seeing what had happened, to change in regulations in the MFI sector which changed the entire fortunes of IPO plans of many MFIs.

There could be a new regulation for NBFCs, which will make their entire business plan go awry and therefore increase the chance of default. So people are still not comfortable.

I would still rather lend as an investor to a well-known manufacturing company, an asset-based company, rather than an NBFC, because the regulations are totally different and the cash flows there are different. It could have incidence of increase in NPAs in NBFCs because they are lending typically to small customers, small enterprises and the chances of defaults there are much higher than otherwise. Therefore, it's not a very easy cakewalk neither for the investors nor the companies.

Q: Do you think that it is actually going to now become tougher for more NCD issues to come forward or companies to raise money via NCDs, and what is the reason why we are seeing such subdued appetite from investors?

A: Subdued appetite has more to do with the entire historical background of NCDs being raised by private sector companies. Also, the concern of NBFCs trying to raise it's money. So the appetite continues to be down. It's not to say that the liquidity is missing or people don't have money. A lot of IPO money is going to move into NCDs.

I see that this money basically comes from bank deposits. So people are saying, I get 8-9% from banks. There's a perception that these are equally safe because safety is the primary concern when you go for an NCD. You are not looking for returns. Even one to two percentage points are a small when you compare it to what kind of returns one expects in equities. Therefore, a person is typically still looking at safety as the paramount factor.

I would not give a blanket comment that all companies are going to find it difficult.  Investors would come in case the brand is there, the company has a track record and the company can give a sense of security.  In that situation, I think you could raise even Rs 50000 crore from this market. People who look at safety in returns would be very happy to get a higher return of two percentage points from a non-banking finance company. So money is not an issue. There is a level confidence that you are able to generate.

Q: There has been an insistence from SEBI and RBI that for under one-year NCDs, they should be rated A. One expects that debentures are adequately collateralized and there is a trust that is looking at it. But in the past, the debenture trustees, as well as the supposed collateral, has never come to the aid of investors. Do you think that things have changed over there at all? How does one trust any debenture?

A: Yes, you are absolutely right. One of the important thing that you require to build the confidence is:

a) A debenture redemption reserve. That means, every year, there is enough money throwing into the reserve for the company to payback the principal, and adequate money to pay their interest. That is something that is still missing as far as I can see.

b) The role of debenture trustees, they have only earned their fees. They have never enforced the rights of the debenture holders and SEBI has been seized by the issue and going forward, debenture trustees will have to play a much more important role. We are seeing some orders coming out from SEBI.

For example, I saw last year, a couple of orders coming against few trustee companies for not having fulfilled their role. But SEBI will have to take a more aggressive stance vis-à-vis the debenture trustees because an investor looks at only the initial rating. He is not informed necessarily about all the downgrades which are happening in the company, to say that he will follow the continuing disclosure, as he is not the kind of person who is going to go to websites and look at what is happening to each companies that he has invested in.

So he, basically, believes and places a lot of trust, and this trust has to come from trustees too. They therefore have to play an important role and keep communicating to the investors, any developments vis-à-vis the companies, as well as take care of his money.