Prime Bonds: A privately placed bond with attractive risk-return pay off

Last week, we announced the beginning of our coverage of privately placed bonds. Today, we’re issuing the first of such calls. The private issuance of this unlisted bond was done on March 4, 2022 and it is now available as a secondary sale of privately placed bonds. Our report and recommendation here is on this secondary sale.

Muthoot Fincorp, a non-deposit taking, systemically important NBFC registered with the RBI, has come up with a private placement offer of unlisted, unsecured bonds aggregating to Rs 50 crore (as subordinate debt eligible for Tier II capital). The proceeds of the issue will be used for capital requirements and financing purposes, after meeting expenses related to the issue. The secondary sale of these privately placed bonds is now available through PhillipCapital (India). 

The issue has an A+ stable credit rating from both Crisil and Brickwork Ratings, indicating higher risk. Its other NCDs and bank loan facilities have a similar rating and the ratings have remained stable. The rating has been assigned at a group level, considering the financial and business risk profile of the entire group, including non-gold businesses. 

The details of the issue and our rationale are given below.

The company and business

Muthoot Fincorp (called in the market as Muthoot Blue) is part of the Muthoot Pappachan Group with diversified business interests ranging from financial services, to hospitality, inflight catering, infrastructure for information technology, automobile sales and services, to real estate. 

Muthoot Fincorp is one of the three largest gold loan NBFCs in India. It operates a network of 3,658 branches across 24 states, although South India accounts for ~62% of the loan portfolio. At the standalone level, gold loans accounted for ~95% of the loan portfolio while SME loans accounted for the rest as of end-September 2021. At a group level, though, gold loans accounted for 66% of the Rs 25,837 crore AUM, while the share of microfinance stood at 21%. Our reference to financials and metrics will be on a standalone basis for the gold financing company and not at a group level.

Business positives

#1 Healthy liquidity

As an investor in a debt instrument, liquidity of a company is important from the perspective of regular payments of interest and principal. On this front, Muthoot Fincorp scores well. 

Its Asset Liability Management (ALM) statement as of December 2021 shows positive gaps in the up to 1 year bucket. It is noteworthy that 86% of its loans are less than 6 months old which means they get repaid soon, generating cash. Otherwise, the gold is auctioned to recover the loans. As of December 2021, the company had Rs 2615 crore liquidity – in the form of Rs 1910 crore of cash and cash equivalent and Rs 705 crore of unutilised bank lines. Against this, total debt repayments would be Rs 2,126 crore (including operating expenses but excluding CC/working capital demand loan limits that are typically rolled over). This healthy liquidity provides comfort on its debt servicing capability.

#2 Secure business and comfortable Loan to Value

It is important that you know that this issuance of privately placed bonds is unsecure. And it is a subordinate debt. A subordinate debt will be repaid only after creditors but ahead of perpetual bonds and equity shares. Hence, the issuance per se has an element of risk. However, this risk is mitigated by the fact that the underlying business of gold loan is one secured by gold assets.

In the case of such asset backing, loan to value (LTV) is an important metric to understand.  LTV compares the size of a loan with the value of the asset that is used as a security. This helps understand how much of the risk the lender is undertaking. The LTV profile as of September 2021 provides comfort that the loan value is less than half of the asset backing. It is for this reason that gold loan as a business makes for secure lending and lower risk of non-recoveries.

#3 Capital adequacy

Capital adequacy ratio (CAR) – a metric that is used to measure the amount of capital to the company’s risk weighted assets and current liabilities. At the end of September 2021, Tier 1 CAR for Muthoot Fincorp, on a standalone basis, was 14.28% (12.09% at the end of March 2021) - comfortably above the prescribed Tier 1 capital of 12%. On a consolidated basis, Tier 1 CAR at the end of September 2021 was 12.09%. 

It is to be noted that since Muthoot Fincorp has been raising more of Tier II capital (perhaps not wanting to dilute its high promoter shareholding of 78.75%), the Tier I capital, though above regulatory requirement, is significantly lower than listed peers such as Muthoot Finance or Manappuram Finance.  

However, Muthoot Fincorp’s total CAR (Tier I and II) improved to 19.84% as at 31 Dec 2021 from 16.85% as at 31 March 2021, providing comfort.

#4 Other metrics comfortable

Disbursements: Muthoot Fincorp’s disbursements have not been easy post Covid and this trend continued in FY-22 as well. Disbursements as of FY 21 stood at Rs 38, 744 crore while during the 9-month ending 2022, it was Rs 25,570 crore.

However, disbursements have seen an uptick on a quarterly basis. Disbursement for the December quarter increased to Rs 11,084 crore from Rs 7,894 crore in the September quarter. 

Collection efficiency: Muthoot Fincorp has traditionally boasted of a good collection efficiency record ranging from 95-97% in the past 2 years (97.5% as of March 2021). However, it is likely that this number could have come down as suggested by both NPAs and reduction in auctions. Still, historical numbers provide some perspective on business efficiency. 

In terms of collections, the company had average collections of around Rs 3,400 crore on monthly basis during the December 2021 quarter.

Risks

#1 Higher NPAs

The gross NPAs at the standalone level stood at 2.87% as on September 2021, against 1.92% as on March 2021. However, the gross and net NPAs saw a spike to 4.88% and 3.55% at the end of December 2021. Though the NPAs were higher primarily due to the SME portfolio, the gross and net NPA ratios in gold loans too spiked to 3.35% and 2.83% as of December 2021, weakening from 1.10% and 0.56% as on 30 Sep 2021.

At this juncture, we are not overly concerned about this as it appears to be mainly on account of limited auctions (conducted for the recoveries), caused by the third wave of the covid pandemic during the third quarter of FY22. A pick up in auction can see the gold loan NPAs reduce.

#2 Group asset quality concerns

The group’s microfinance business, housed under subsidiary company Muthoot Microfin, has been an area of concern with deterioration in asset quality, similar to many other microfinance companies, post-pandemic. Gross NPAs stood at 9% at the end of September 2021 while it was at 8% at the end of March 2021. This is in line with the stress reported by other microfinance companies.  As a group, SME loans have reduced to around 4% of the group’s AUM as of December 2021 compared with 8% 3 years ago. Still, given the significant linkages between the group, this does remain a risk. 

It is also to be noted that the operating environment has become tougher for gold loan companies, as acknowledged by the 2 listed plays. Competition lending at lower yields was cited as a reason. The same may be the case for Muthoot Fincorp as well. However, a slow turnaround in microfinance businesses and the recent spike in gold prices can provide some cushion.

Suitability of the bond issue

We believe the coupon of 10.26% provides some cover for the risks involved in the business environment and from a rising rate scenario. The risk mitigating factor comes from the business itself being gold backed. 

This apart, there is also some cushion should there be a situation where there is a downgrade by any rating agency. In the event of downgrade, the bond’s coupon shall increase by 25 basis points for every notch from the date of such rating downgrade. 

At present, the spread of a 10-year A+ NBFC over similar period G-Sec is 3.19% (Source: Care Ratings). Muthoot Fincorp’s present privately placed bond, with a maturity of under 6 years has spread of 4.22% over a 5-year G-Sec, providing a good cushion. But as rates rise, you might bet better options in other instruments too. Hence, make sure you spread your investments across time frames as rates rise. 

1. This issuance is suitable only for very high-risk investors who can hold the bond for close to 6 years. As an unlisted bond, you cannot liquidate them. While dealers may provide some means to offload, you should primarily view this as a buy and hold option.
2. You can consider about 10% of your bond portfolio in this option. Overall, such bonds should not account for a majority of your portfolio. You should exhaust safe investment options before exploring these. Ensure you do not depend on this for your primary income stream and have other safer options. 
3. This issue requires a minimum investment of Rs 2 lakh (Rs 1 lakh face value but minimum RTGS amount allowed is Rs 2 lakh). 
4. There is only a monthly pay out option. Interest will be taxed at your slab rate and is subject to TDS. 
5. You need to ensure that you spread your bond holdings and not restrict it to one instrument. 

Please read our launch article on coverage of privately placed bonds to know whether such bonds are first suitable for you before you invest in them.

Since this is a secondary sale of a privately placed bond, there is no guarantee on how long it will be available. It might last a few days to a couple of weeks. You will need to open an account with the dealer before you buy these bonds.

We have explained the process for account opening and investing in the bonds through PhillipCapital (India) below. Please note that PrimeInvestor neither has any commercial agreement nor is it operationally involved. Please follow the instructions in the link below and write to the contact email of the PhillipCapital (India) team mentioned there for any support. 

How to open an account and invest – process explained

With inputs from Chandrachoodamani NV

Disclaimers

1. PrimeInvestor has a non-commercial partnership with PhillipCapital (India) specifically for receiving information on bond issuances. 
2. PrimeInvestor does not receive, directly or indirectly, any commission or any other reimbursement in any form – from any of the parties involved in the issuance. We are not brokers nor distributors. 
3. PrimeInvestor is not involved in the onboarding process nor in the execution of these transactions and as such is not liable for any acts of commission or omission. We will be unable to take on any kind of operational queries regarding these transactions. 
4. Our responsibility is limited to recommending these products based on information available to the best of our knowledge. Despite best effort on due diligence, there is a risk of default in these instruments. 
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