(Recent article in Moneylife)
Indian companies are very quick to catch on to any fund raising window that opens. Just when a couple of bond issues hit the retail market and mopped up money, we have a virtual queue of finance companies lining up one issue after another. The fact that they are raising money simply because the market is conducive is borne out by the fact that they announce an issue size of three to four hundred crores, with a right to retain hundred percent oversubscription! This is as vague as one can get about using money. The standard excuse the finance companies offer is that there is business and if I get more money, I will write more business.
We do not know whether the company is geared to disburse all the money it raises. We also do not know at any point, how much the company has borrowed. We have a dated balance sheet with us. In addition to raising money through public offerings, the finance companies constantly tap the ‘private placement’ market for debt. So, the investor does not know how much money the company has raised.
The other important thing is that borrowing money from public has never been easier. I can bet that no investor knows what his money is going to be used for. There was a subsidiary of India Infoline which raised money through this NCD route. Wonder how many knew that the money was for a subsidiary, let alone know what the money is going to be used for? Maybe the offer document had details, but no retail investor has the skill and ready access to an offer document. The finance companies are happily taking advantage of easy money.
I am reminded of the eighties, when there was a craze to invest in fixed deposits of leasing companies, thanks to high interest rates and the fancy incentives paid to investors and intermediaries. The prime lure was the promised rate of return and not the credit quality. I think the same herd mentality is on display and at some point in the not too distant future, there will be some default.
All of these finance companies have to continually keep raising more and more money to keep growing. Their appetite seems to be unlimited. In fact, I look at the reported asset size of some finance companies that have grown at a furious pace and start worrying. Do these companies have the systems and processes in place? Do they have a proper understanding of their customer segment? It is one thing to be a specialist lender in one region of India and another to replicate it on a pan India basis.
This easy access to public money will make some finance companies take unreasonable risks, so that they can deploy the money. With their pockets hot, they will hire in a hurry to cater to ‘growth’, pay unnecessarily high salaries and dilute lending processes and standards. Ultimately, these companies will have to keep hitting the markets on a continuous basis, to keep the cycle intact.
Many of the lending is to the retail segment. Lending against gold is the latest ‘flavour of the day’. Things look fine so long as gold prices keep rising. There are also stories of officials in a bank that took the pledged gold of the clients and sold them off. This can easily happen in finance companies, where they give enormous discretion to their branches and advertise “loan in 15 minutes” etc., Risks will multiply with rapidly increasing headcount.
Ok. We are investing only in those companies that have a good credit rating. Well, for rating agencies, retail lending in India is a new experience. There is not enough of a track record or credit check available, to come to any definite or indicative conclusions about lending. Look what happened to the ‘micro’ finance companies. Data was robust, default rates low. All was well so long as the reach and size was small. No sooner did the resources grow, that the microfinance companies started taking high risks to deploy the money. Multiple companies lent to the same set of borrowers. Ultimately, defaults were the logical outcome of this kind of reckless lending, political interference notwithstanding. Political interference only helped the borrower to default without fear. Otherwise, he required to borrow from Ram to pay Ravi and keep the hat going around. Credit ratings can change over time. Remember, ratings are valid till they are changed. There is no assurance that the credit rating will be unchanged over the life of the debenture or bond.
More important, the bonds are going to give this kind of interest rates for maybe another year. After that, the interest rates should come down. However, your money is stuck till maturity. Secondary markets will not be easy and price discovery will not always be easy. So, if you invest in bonds, be careful. Spend ten minutes trying to understand the issuer’s business.
And a request to SEBI. All these issuers are advertising “First come, first served”. This hustles a lot of investors in to issuing a cheque first and think later. Please keep the issue open for a fixed period and ensure a pro-rata allotment when there is extra subscription. And please make the offer document make a mention of what the business of the company is and what is the borrowing that the company has done post the last annual accounts.
Please read the fine print. Do not take risks that you take on a equity share investment for a limited upside and high downside possibilities.