Should you buy L&T Finance NCDs? Which option?

  • Coupons in the range of 8.15-8.60 per cent for different tenors
  • Bonds offer spreads of 90-95 basis points over markets
  • Infra and real estate loans in the portfolio of L&T Finance and group companies pose risks
  • The 3-year bonds can be bought by high risk investors alone

Sorry, L&T Finance has closed this Rs 1500 crore offer 13 days ahead of schedule, after being over-subscribed. Don’t worry though. We will keep you posted on other upcoming opportunities.

L&T Finance, a non-deposit-taking NBFC, is seeking to raise Rs 1,500 crore from a public issue of Non-Convertible Debentures that is open from December 16 to December 30, 2019. The bonds carry a face value of Rs 1000 each and the minimum application amount is Rs 10,000, with multiples of Rs 1000 thereafter. The bonds are secured against the company’s receivables/assets/immovable property. It plans to use the money to lend to its customers, repay earlier debt and for other corporate purposes. 

Bond Features

This offer allows investors to choose between 6 different NCD options. The rates of interest also vary for different categories of investors. Of the four categories of investors specified by the company, only two are relevant to individuals. Individuals investing upto Rs 10 lakh are ‘retail’ and placed in Category IV. Those investing more than Rs 10 lakh are ‘high net worth’ and placed in Category III. In this analysis, we will only be discussing the options for investors falling in these two categories.

  36 months 60 months 84 months
Monthly pay-out interest rate 8.15% 8.29%
Annual pay-out interest rate 8.45% 8.60% 8.65%
Cumulative option effective yield 8.46% 9.01%

Individuals looking to invest for 3 years (36 months) can choose between interest payouts at monthly intervals, interest payouts at annual intervals and a cumulative option. The monthly option offers an interest rate of 8.15 per cent per annum. The annual option offers 8.45 per cent per annum. The cumulative bond will pay back Rs 1275.81 at the end of 3 years, translating into an effective yield of 8.46 per cent. 

Risk vs Rewards in Bonds

Individuals looking to invest for 5 years (60 months) can choose from monthly interest payout at 8.29 per cent or annual payout option at 8.6 per cent. Those looking to invest for 7 years (84 months) have only one annual interest payout option offering 8.65 per cent. The bonds carry no Put or Call options. This means that both investors and the company cannot opt to redeem the bonds before their maturity. The bonds will be listed in the secondary markets where investors can exit before term. But bond prices in the market can go above or below the face value and liquidity may be thin.

At the time of writing this, AAA-rated NBFC bonds in the market (including PSUs) offered a yield of about 7.5 per cent for 3 years and 7.7 per cent for 5 years. With interest rates at 8.45 percent for 3 years and 8.60 per cent for 5 years, L&T Finance bonds therefore offer spreads (extra returns) of 95 basis points for 3 years and 90 basis points 5 years over comparable bonds. This indicates their higher risk profile.

Business analysis

L&T Finance is a 100 percent subsidiary of L&T Finance Holdings which is a 63.8 per cent subsidiary of L&T. While L&T Finance Holdings is a listed entity, L&T Finance isn’t. Only the parent’s quarterly financials are in the public domain.

But CRISIL’s rating report contained in the prospectus has a lot of financial details on the NBFC. According to it, L&T Finance managed total loans of Rs 50,127 crore as of September 30 2019, made up mainly of micro loans (26 per cent), farm equipment loans (16 per cent), two wheeler loans (12 per cent), real estate financing (22 per cent) and infrastructure loans (14 per cent).

Recent problems in the NBFC space have mainly centred around real estate finance and infrastructure funding. This riskiness reflects in L&T Finance’s Gross NPA ratio of 4.76 per cent and net NPA ratio of 2.44 per cent as of September 30 2019. However, these numbers have moderated since the March 2019 quarter. Besides, the company’s total gearing, at 5.02 times as of September 30 2019, compares well with peers.

However, as just one of the NBFCs in L&T Financial Holdings’ portfolio, L&T Finance’s fortunes are quite intertwined with those of other companies in the group. The consolidated numbers of group entities carry higher risks than the standalone numbers of L&T Finance. On an aggregate basis, CRISIL’s numbers show that the L&T financial services entities had total loan assets of Rs 1,00,257 crore as of September 30 2019.

This was made up mainly of infrastructure finance (31 per cent), infrastructure debt fund (8 per cent), real estate finance (16 per cent), home loans (7 per cent), micro loans (13 per cent) and farm equipment loans (8 per cent). Apart from this, the group had fee-based businesses such as mutual fund and wealth management outfit. Reflecting the riskiness of the loan portfolio, the group had Gross and Net NPAs of 5.98 per cent and 2.83 per cent as of September 30 2019. These are on the higher side compared to other top-rated NBFCs in consumer and truck finance. The gearing at the consolidated level was 6.4 times, again higher than some peers as well as the standalone entity.

Going forward, the management hopes to maintain asset quality and keep gearing in check by veering away from infrastructure towards retail lending and focussing more on fee-based activities. The L&T reputation has however contributed to reasonable funding costs and liquidity for the group. The consolidated liquidity position as of September 30 2019 showed projected assets exceeding liabilities for all periods upto 1 year, after factoring in funds availability from L&T and lender banks.

Credit ratings

The bonds in this offer are rated AAA with a stable outlook by three rating agencies – CRISIL, CARE and India Ratings. However, in their rating rationales, all three agencies have noted asset quality worries in the infrastructure portfolio, concentration risks in the wholesale portfolio and the high debt of the group as key risks to their ratings. They have relied on capital support from the parent (L&T) and the strategic importance of the financial services business to assign their ratings. They’ve also relied on assurances by the management that the group will change focus from wholesale to retail lending, restrict its overall gearing (debt-equity ratio) and improve its asset quality. If the management fails to deliver on any of these aspects, or if the parent L&T decides to reduce focus on this business, the bonds can suffer a downgrade.     

Investors can stay with the 3-year options and avoid locking in for 5 or 7 years, given that the bond markets may offer opportunities to capitalise on better rates over these longer time frames.

Our take

In the backdrop of the ongoing NBFC funds crunch, the loan composition of L&T Finance and its group companies present a relatively riskier option for retail investors to park funds. However, the backing of a strong parent such as L&T and spreads of 95 basis points offered on this issue result in attractive interest rates in a low-rate scenario. We therefore think that L&T Finance NCDs can be considered by investors with a high risk appetite. The bonds are avoidable for investors including retirees, who seek safety of capital.

Investors can stay with the 3-year options and avoid locking in for 5 or 7 years, given that the bond markets may offer opportunities to capitalise on better rates over these longer time frames. The L&T Finance bond should make up a limited portion of your fixed income portfolio (say upto 5 per cent) after exhausting safer options available in government-backed schemes.

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