Tata Motors takes retail debt route for raising funds

Tata Motors has been trying to raise funds by offering debt securities to retail investors. The public offering of debt securities if successful will reduce some liquidity problems which the company is facing because of the Jaguar Land Rover.

Tata Motors has appointed Tata Securities, Kotak Securities, and JM Financial as the authorised brokers for this offer know as "Tata Motors Fixed Deposit Scheme". A retail investor will require to deposit a minimum amount of Rs 20,000 (and thereby in multiples of Rs 10,000) to participate in the scheme. The deposits for 1 year carry an interest rate of 10% p.a. For 2 years the interest rate is 10.50% p.a. and for 3 years it is 11.00% p.a. The income tax will be deducted at source from the amount of interest payable to the depositor in accordance with the provisions of the Income Tax Act, 1961 if it exceeds Rs.5,000 in a financial year.

Tata Motors has long term credit rating of AA+ and AAA for its debt instruments. It has made profits after tax of over 2000 crores in FY08.

	(Rs. in crores)
Year	Profit before tax	Profit after tax
2007-08	2,576	2,029
2006-07	2,573	1,913
2005-06	2,053	1,529

Moreover, its leverage ratio is also not high. However, its debt/equity ratio has increased from 0.44 in FY04 to 0.7 in FY08. Still, Tata Motors has enough profits to easily service its debt. Its interest coverage ratio was 7.0 in FY08.

Balance Sheet (Rs. in crores)
	As at	As at
Liabilities	31.03.08	31.03.07
Share Capital	386	385
Reserves & Surplus	7,454	6,484
Secured Loans	2,462	2,022
Unsecured Loans	3,819	1,987
Deferred Tax Liabilities	976	787
Current Liabilities
& Provision	10,657	7,728
Total	25,752	19,394

	As at	As at
Assets	31.03.08	31.03.07
Fixed Assets and
intangible Assets (Net)	10452	6395
Investments	4910	2477
Current Assets, Loans
and Advances	10384	10512
Misc. Expenditure	6	10
Total	25752	19394

Though Tata Motors has strong fundamentals, the macroeconomic situation is adverse and its acquisition of JLR is adding extra burden on its performance. However, with a strong balance sheet and backup of the biggest group of India Tata Motors should be able to wither off these concerns and emerge out of this crisis.

This however doesn't eliminate the risk that in near future it may see its credit rating getting downgraded. Hence, the question: is the spread between interest rates offered in the scheme and risk free rate adequate enough to compensate for the risk. It is more favorable to Tata Motors as it has a very strong brand reputation and the risk free rates are on downward movement thereby increasing the spread and making the scheme a very attractive investment option.

Retail debt market in India

The top Indian stock exchanges, BSE and NSE, offer trading in debt instruments for retail investors. The Retail trading in Debt Market was started in January 2003. All investors who have equity broking account can trade in the Retail Debt Market. The debt instruments available for trading are government securities (G-Secs or Gilts). Government securities are issued by government and have no default risk (sovereign bonds). Government issues these securities through auction to major players like banks and other financial institutions. After that trading on these securities occur in secondary market. Government pays coupons (equivalent to annual interest) on these securities to its holder. G-secs are characterized by the coupon rate (usually expressed annually) and maturity (the time after which the securities can be redeemed). The returns from a G-Sec are the coupon payment every six months (half the annual coupon rate) and the face value payment at the maturity.

G-sec are a cost-effective way of raising long term money for government and it is a long term secure investment for investors. It has the lowest risk and the coupons provide regular stream of money. Unlike fixed deposits an investor can liquidate these securities in the secondary market depending on liquidity requirements. It has the lowest risk and the coupons provide regular stream of money. Unlike fixed deposits an investor can liquidate these securities in the secondary market depending on liquidity requirements.

There is tax benefit associated with the G-sec investment. Apart from having no tax deduction at source, G-sec offer tax rebate of Rs 3000 under Sec 80L of IT act.

About government securities

Face value = Rs. 100
Minimum size = 10 units
Credit Risk = NIL

Coupon rate = total interest paid by the government to the G-Sec holder.
This coupon amount in paid in two equal instalments (half of coupon rate every six months)

Maturity = the date till which the G-sec is issued for. At maturity government pays back the amount equal to the face value of the security.

Accrued Interest rates
Since government securities pay interest at fixed interval of 6 months, anyone buying G-sec from secondary market is entitled to the partial interest payment depending on when he buys the security. For example, if an investor buys G-sec which has its coupon due after next 4 months, he/she will have to pay to the seller the interest for 2 months in addition to the market price. This is also called the interest accrued. In NSE and BSE trading systems, the accrued interest is added to the price of the G-sec while entering the quote on the system.

Dirty Price and Clean Price
The price of G-sec without the accrued interest is known as Clean price while Dirty price includes the accrued interest.
Dirty Price = Clean Price + Accrued Interest

Valuation of G-Secs
The price of G-sec is relatively easier to obtain than the price of an equity. The cash flow in the case of G-Sec are known with certainty. The only debatable factor is the discount rate at which these cash flows will be factored since they will be available at a future period. Knowing it, one can easily discount the cash flow streams with their respective discount rates to bring down their present value. The discount rate is all that creates some uncertainity and involves different parties trading actively to make profit.
Working reversely since the price of a market traded G-Sec is available one can find the effective discount rate which the market is assuming. This rate is termed as yield-to-maturity.

Premium and Discount
The face value of a G-Sec is Rs 100 but it can trade anything above or below 100. When it is trading above 100 it is said to be trading at premium and on the other side when it is trading below 100 it is said to be trading at discount.
Generally the premium and the discount for a G-Sec depends on its coupon rate and prevailing discount rate. A G-Sec having coupon rate more than the current discount rate is likely to trade above Rs 100 and hence at premium to its face value.


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Bond/ Debt Instrument Credit Rating System

Issue credit rating is rating of companies into different categories based on their creditworthiness. These ratings can be looked as an indication of the default risk associated with that debt-instrument.

The rating is generally based on numerous factors including the financial condition of the company, the currency denomination in which the bond/debt instrument is issued, etc. Credit rating agencies look at the likelihood of fulfillment of the financial obligations. They measure the capacity of payment of the company, nature of the obligation and provisions, is any, present in the obligation.

Credit rating companies have two different rating systems for long-term (> 1 year) and short term (<1 year)

Ratings above BBB/Bbb (inclusive) are considered as of Investment Grade, while lower ratings come under Junk bond category. The junk bond doesn't mean that it is worth nothing. The junk bonds are speculative grade bond and they offer higher yields because of higher risk. However, because of higher default risk these bonds are not recommended for pension funds etc, where capital protection is a prime concern.

The short term rating system is similar but uses different codes for each category. While Standard & Poor’s and Fitch give ratings of A-1+, A-1-, A-2, A-3, B, C, &D, Moody’s rates them as P-1, P-2, & P-3. A-1, A-2, A-3 are equivalent to P-1, P-2, & P-3. A-1+ and AA- correspond to AAA and AA, used in long-term ratings. Moody’s P-1 includes both AAA and AA. A-3 and P-3 correspond to the lowest amongst the investment grade equivalent to BBB. While Moody’s doesn’t rate sub-prime short-term debt issues S&P, Fitch have ratings B & C which are similar to BB, B & CCC, CC, C of long-term issue.

The top credit rating agencies of the world are shown below.