JM Financial’s NCD offer: Interest rate higher than FDs, but are risks worth it?

What does this NCD offer?

There are four series on offer, one with a floating rate of interest linked to the 91-day Treasury Bill’s yield and three that come with fixed interest. The five-year fixed-return series has two options: one for annual and the other for monthly interest payments.

At the highest rate of 8.3 percent annualized interest for a period of 100 months (slightly over 8 years), you can get a post-tax return of 5.4-5.7 percent a year if you fall in highest tax bracket. The NCDs will be listed on the stock exchanges. You can exit before maturity, by selling your NCDs in the secondary market. If the exit price per debenture is higher than its face value, you earn capital gains; these are subject to tax at 20 percent plus indexation, if sold after three years. If you sell your NCDs before three years, the gains are taxed at your slab rates.

What works

The issue comes with a stable and high credit rating. The interest rate offered tops what you can make in both short and long-term bank fixed deposits. The NCDs are secured against the company’s loan book.

According to Vikram Dalal, managing director, Synergee Capital, “Retail investors can consider investing in the issue given the company’s strong management and financial standing. However, it’s worth noting that the previously listed debentures of JM Financial are currently available in the secondary market at a higher yield.”

The risks

Being secured does not mean you will be able to get your money back easily in case of an adverse situation. Other existing lenders and holders of NCDs also have rights to proceeds from the same security. A majority of the company’s loan book is secured. However, in case borrowers fail to repay, monetizing the security can take time.

It’s worth noting that the company achieved its peak loan book size in September 2018 and has contracted since then. Higher provision expenses and lower contribution from asset management has also impacted income for the previous year. These are worrying signs to watch out for.

At a group level, the company’s loan book is highly concentrated towards wholesale lending, majorly from real estate and some from promoter lending and corporate loans. While the real estate sector has seen some return of momentum, it’s unclear whether this is sustainable. A persistent economic stress from the pandemic can hurt the group’s asset quality.

At the moment, however, the gross NPA level (post restructuring of 19 percent of the loan book), is at 3.5 percent and considered reasonable as per ICRA’s assessment of the financials.

According to Ashish Shah, founding director, Wealthfirst Portfolio Management, “This issue is likely to see good interest from institutional investors. For retail investors, the post-tax returns are not attractive. Moreover, the secondary market liquidity will be limited if an early exit is needed.”

Should you invest?

This is not the best alternative for risk-averse investors. The uncertainties and the risks that the issue brings aren’t worth it.

A corporate bond or a short-term income is a better option as the underlying portfolio is well-diversified.

High net-worth individuals can make small allocations, provided they have the appetite for risk. Retail investors can give this issue a miss.