Investment Advisory Service

Monday, 9 January 2012

Tata Capital NCDs- Why this inefficiency ?

On January 7, 2012 Tata Capital Limited NCD - Option 3 (Non Convertible Debenture) traded at an average price of Rs 1134 on the BSE. This debenture was issued in March 2009, had a face value of Rs 1000 and carried an annual coupon of 12%. At a price of 1134, the IRR for this debenture worked out to be 10.2%

Tata Capital Limited had come out with this NCD issue in February 2009.  The debentures were offering a coupon between 11-12% p.a depending on the payment option chosen by the investors. The original issue size was Rs 500 cr with an option to retain an oversubscription up to Rs 1000 crs. With equity markets in bad shape and a nice yield of 12% , this bond to be issued by the house of Tatas created a buzz in the market and the issue was oversubscribed and received Rs 2300 crs.

One important clause of the debentures which a lot of investors miss to read and the financial advisers fail to stress is the availability of the put and the call option. Under this option, after some scheduled time period as mentioned in the document, the issuer has the right to call the debentures and the investor has the right to sell (put) his debentures and take his money back. And both these situations would ideally happen in a case where the market interest rates fluctuated either in the interest of the issuer or in the interest of the debenture holder.

In Tata Capital NCD, the document stated that the put / call option could be exercised after a period of 3 years (in one series it was 3.5 years) from the date of the issue. This announcement made by the company on Saturday mentions that the company has decided to exercise the call option and the directors of the company have approved of the variation in the terms of the NCD. The coupon rate has been reduced across different series. For Option III discussed in the opening paragraph, the coupon has been reduced from 12% per annum to 10.50 % for the rest of the maturity period which is 2 years and 2 months from now.That is a sharp reduction and I concluded that market participants will factor this new development . I quickly calculated that for the IRR to remain at 10.2%, the price of the debenture should come down to Rs 1108 which is 26 bucks lower than the Saturday's closing price of 1134.

To my surprise, this announcement had no bearing today on the price of the Tata Capital NCD and the Option III NCD is still trading at Rs 1134. At this price, the IRR with the reduced coupon rate is 8.81% which is lower than the bank deposit rate for an FD of the same maturity. (Axis Bank is offering 9.3% interest for an FD with a maturity term of 2 years and 2 months). Any rational investor should ideally withdraw his money from this NCD and put it in a bank fixed deposit.

I always thought that bond market participants are more nimble compared to the participants in the equity markets.

What explains this inefficiency? The announcement is out there on the exchanges and there is no information asymmetry. The debenture size of 1500 crs is large and unlikely to escape the attention. Taxation can't explain the inefficiency. These debentures are taxable at the same rate as bank FDs.

Is there anything I am missing here ?






9 comments:

Mayur Jain said...

So you meant say to say we shouldn't invest, if the Company has the right to Call/Exercise the option which is in the interest of the issuer and not the investor.

sameer said...

Hi Ankur,
You are doing great work.
Formatting doesn't matter. every serious reader is interested in contents only.I have subscribed to your RSS feed.
Keep it up!

Best of Luck
Sameer

Anonymous said...

Jain Sahab,

Since the scheme still needs to be approved by the debenture holders, the extra Rs10 (now reduced) might be due to the option value of a possible rejection of the proposal by NCD holders.

Regards

Sunil.

Ankur Jain said...

Hi Sunil,

I don't think the move to reduce the coupon rate needs a nod from the debenture holders.

I checked the proposal as well. It says that if bonholders don't want to continue with the reduced rate, they can opt from premature redemption on March 05, 2012.

Regards
Ankur

Ankur Jain said...

Hi Mayur,

I didn't say that one should not invest in bonds with call/ exercise options.

Rather one should be cognizant about these options and factor them in the workings while investing.

Ankur

Anonymous said...

My Apologies Jain Sahab. Completely missed that one. Thanks

Anonymous said...

Hi Ankur,

I just came across this post. I had a question regarding your following statement (I quickly calculated that for the IRR to remain at 10.2%, the price of the debenture should come down to Rs 1108 which is 26 bucks lower than the Saturday's closing price of 1134.)

If I work it out (buy at year 0 -1108, year 1 interest 105, year 2 interest + face value 1105), the IRR comes to 4.72% instead of 10.2% mentioned by you. I have ignored additional 2 months of maturity to keep the math simple.

Would appreciate if you could through some light on how you calculated your IRR.

Thanks

Ankur Jain said...

Hi Anon,

I don't remember the workings now. But I would suggest you recheck the dates which you are putting in your workings.

Most likely, I sense some discrepancy there.

Regards

Ankur

Anonymous said...

Thanks for the response Ankur. I guess the numbers taken by me look ok as per your post -

(For Option III discussed in the opening paragraph, the coupon has been reduced from 12% per annum to 10.50 % for the rest of the maturity period which is 2 years and 2 months from now.That is a sharp reduction and I concluded that market participants will factor this new development . I quickly calculated that for the IRR to remain at 10.2%, the price of the debenture should come down to Rs 1108 which is 26 bucks lower than the Saturday's closing price of 1134.)

Have I missed anything?