Playing a risky game

IIISL offers high rates on secured non-convertible debentures. But here are some factors to consider before you go for them.

India Infoline Investment Services (IIISL), a subsidiary of India Infoline, is making an offer of secured non-convertible debentures with an annual interest rate of 11.7 per cent on the 3-year and 40-month options and 11.9 per cent interest on the 5-year option. Though the interest rates on offer are high, this appears to be an option for investors with high risk-taking ability.

About the business

IIISL is a non-banking finance company which predominantly lends to individuals against their mortgages and shares. It also provides margin funding to investors. Loan against gold and medical equipment are relatively new products in its portfolio. Mortgage loans accounted for 59 per cent of the portfolio while capital market products had a 29 per cent share.

Counting the pluses

The coupon rate offered by IIISL is high at 11.7 per cent (for 36 months) for an investment grade debenture. IIISL is rated AA minus by CARE and ICRA. AA rated paper today trades at yields of about 10.05 per cent in the bond market. Deposits of companies such as Unitech, Plethico Pharma and Ansal Housing and Infra are offering 12 per cent for a similar tenor. Banks, which rank much higher on safety, currently offer a maximum of 10 per cent for 36-month deposits.

The IIISL NCD issue is also secured against the immovable assets and receivables (current and future). Additionally, IIFSL has to create a debenture redemption reserve of 50 per cent the value of debentures issued through the public issue.

Though IIISL has a capital market exposure, the loan book is moving towards mortgage and gold loans which are less volatile than equity shares in the current scenario. IIISL has been aggressively expanding its branch network and as of June 2011, it had 524 branches across 148 cities.

The loan book size is Rs 3,920 crore as of June 2011 with less than one per cent being non-performing assets. It earns attractive interest spreads of close to 5 per cent and has high levels of capital to support future loan book growth. Around 90 per cent of the loan book is floating in nature allowing it to pass on rising costs.

The debt-equity ratio at 1.7 times (as of March 2011) is low compared to the 4-5 times normal with NBFCs.

The gross non-performing asset ratio is low at 0.44 per cent as of March 2011. The loan tenor (barring mortgage loans) is usually less than a year. Around 99 per cent of its loan book is secured against assets.

The minuses

The company has limited operational track record with loan portfolio gaining a meaningful size only over the last 3-4 years.

Mortgage market and gold loan markets are highly competitive which could constrain the scalability of operations. The more cyclical operations- loan against shares, promoter funding and funding against commercial entities may lead to high NPAs if the liquidity situation worsens. The loan to value ratio also is high at 90 per cent in some cases.

The NPA recognition norms for NBFCs are less stringent than those for banks, with NPAs being recognised after being due for 180 days, as against 90 days with banks. NBFCs are more vulnerable to interest rate cycle than banks as they do not have access to low-cost funding.

IIISL has seen its credit ratings being upgraded only recently in July to (ICRA) AA- from LA+. The sustainability of these ratings would need watching. Plus, quite a few mutual funds do not invest in debt instruments rated AA- or below.

The company has a high capital adequacy ratio of 29 per cent, however, at high rate of growth sooner than later they may be required to raise capital. Capital infusion from the parent may hold the key. Here, IIISL has increasingly been contributing to the parent's profits. In the June quarter, 56 per cent of the parent's profit before tax was contributed by IIISL as against 38 per cent contribution during FY11 fiscal.

Options

If investors are inclined to take the risk, the 36-month option with annual payout of interest may be the best alternative. The 40-month option is a cumulative option (interest payout at the end of the period) while the other two options have annual interest payout. The minimum investment in the issue is Rs 5,000. These instruments will trade in the exchanges but the liquidity may be low as it is with existing listed NCDs. The offer closes on 12 August 2011, with the company holding an option of pre-closing the issue. Allotment is on a first come first serve basis.

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