Debt Watch. Bet on NCDs from M&M Finance

Investors looking for alternatives to bank deposits can consider parking some of their surplus in Mahindra & Mahindra Financial Services’ public issue of non-convertible debentures (NCDs). Given the sharp fall in deposit rates, investors can earn a higher return by investing a portion of their surplus in the NCD.

Mahindra & Mahindra Financial Services is offering NCDs across three tenures — seven, 10 and 15 years.

The interest rate offered under these three options for a retail investor is 7.85 per cent, 8 per cent and 8.05 per cent respectively. The NCD is non-cummulative with an annual interest payout.

Given that rates are close to bottoming out, it may not be the right time to lock into rates for a long period.

Nonetheless, the company’s seven-year NCD, is a good option for investors, even if deposit rates start to move up in two to three years’ time. The rate differential between Mahindra Finance’s NCD and comparable bank deposits now makes it an attractive offer.

Scoring well on returns Mahindra Finance’s seven-year option offers 7.85 per cent, which works out to a post-tax return of 7.1 per cent, 6.5 per cent and 5.9 per cent for investors in the 10 per cent, 20 per cent and 30 per cent tax bracket respectively.

The interest rates offered are better than bank deposit rates. Banks, on an average, are offering rates in the range of 6.5-7 per cent on deposits of over five years.

The highest rate is offered by RBL Bank at 7.35 per cent. This is still 50 basis points lower than that offered by Mahindra Finance’s NCD.

Even if one assumes deposit rates to rise after two to three years, giving an opportunity for depositors to re-invest at higher rates, Mahindra Finance’s NCD scores well on returns.

At best, returns from both bank deposits and the NCD will be at par.

Given that there is still some uncertainty on when and by how much deposit rates will start to move up, investors can invest in the NCD for now.

The NCD issue has been rated “AAA/stable” by India Ratings and Brickwork, indicating highest degree of safety regarding timely servicing of financial obligations and lowest credit risk. However, remember that NCDs are not insured like deposits (up to ₹1 lakh). Also Mahindra Finance’s NCDs are unsecured.

Other options Non-banking financing companies (NBFCs) with similar risk profile (rated AAA) usually offer deposits up to a maximum of five years.

Bajaj Finance and Shriram Transport Finance, for instance, offer a higher 8.05 and 8.25 per cent respectively, but for deposits up to a maximum of five years. While these rates are higher than that offered by Mahindra Finance’s seven-year NCD, there is an element of re-investment risk that investors need to consider after five years.

Dewan Housing Finance’s Aashray Deposit Plus, offers longer tenure deposits from 4-10 years at 8 per cent. This is similar to the rate offered by Mahindra Finance under its 10-year option.

Since Mahindra Finance’s NCDs are proposed to be listed on BSE, it gives investor an opportunity to exit before the maturity of the bond, and shop for higher rates. However liquidity of the bond in the secondary market will matter.

Mahindra Finance, a subsidiary of Mahindra & Mahindra, focusses on customers in the rural and semi-urban markets. It finances purchases of utility vehicles, tractors, cars, commercial vehicles, construction equipments etc.

While Mahindra Finance, has over the years increased its financing vehicles of other manufacturers, it continues to enjoy the strong parentage of M&M.

The company’s asset under management stood at ₹46,776 crore as on March 2017 against ₹40,933 crore as on March 2016, a growth of about 14 per cent.

The company is adequately capitalised with Tier I and overall capital adequacy at 13.2 per cent and 17.6 per cent respectively, as on March 2017.

Some risks to note The company’s weak asset quality has been a concern. NBFCs are required to tighten their NPA (non performing asset) recognition norms and bring it at par with banks by March 2018.

After following a 150 day-cut off, the company transitioned into 120 day norm from the March 2016 quarter. This has led to GNPAs move up in recent years — from 5.9 per cent in FY-15 to 9 per cent in FY-17.

This increase in bad loan provisioning has impacted profitability. The company’s return on equity has fallen from 15.5 per cent in FY15 to 6.4 per cent in FY-17.

Demonetisation also impacted the company’s collections. Moving to the 90-day norm by FY18 can result in increase in GNPAs and, hence, impact earnings.

Also, the company carries a tad lower ‘AA+’ rating on its other long-term debt instruments by Crisil (based on the latest information on the Crisil’s website).

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