Bonds For The Risk-Averse

ICICI has decided to come in to the market again, riding on the success of their earlier launch. But this time, thanks to the dream of India going global, the rates are considerably lower and consistent with the overall market conditions. This dream has been the bane of investors, hitting them where it hurts most and has caused resentment amongst those depending upon the fixed income yield for their subsistence. Such investors are now, perforce, shifting to risky avenues.

Even though some companies still give more than 14 per cent on their fixed deposits and have a rating, even if not Triple-A, that ensures Adequate Safety, I still feel that investors dependent on fixed income will do well to take a good look at the present ICICI offer.

The present issue has three options: Money Multiplier Bond, Regular Income Bond and Tax Saving Bond. Let us take a closer look at each of these bonds:

Money Multiplier Bond

This is equivalent to the former Deep Discount Bond and offers six options, all of them with an issue price of Rs 3,000. This amount offers a yield to maturity (YTM) ranging from 11.98 to 13.09 per cent depending on the tenure. For instance, in three years and seven months Rs 3,000 grows to Rs 4,500 (YTM: 11.98 per cent), Rs 6,000 in five years (YTM: 13.00 per cent), Rs 12,000 in 11 years (YTM: 13.42 per cent), Rs 24,000 in 17 years (YTM: 13.00 per cent), Rs 48,000 in 22 years and 7 months (YTM: 13.05 per cent), Rs 1 lakh in 28 years and 6 months (YTM: 13.09 per cent).

Regular Income Bond

This bond is issued at Rs 5,000 per bond with a choice of three interest payment schedules, all paid to you as post-dated cheques. In the monthly option you have to purchase a minimum of six bonds, so the minimum purchase price is Rs 30,000. With an interest rate of 12 per cent you end up with a YTM of 12.68 per cent. The half-yearly and the annual options are both available on the purchase of a minimum of two bonds costing Rs 10,000. But you earn interest at a higher rate in the annual option (12.75 per cent) compared to the half-yearly (12.25 per cent). Correspondingly, you get a higher YTM of 12.75 per cent in the former option and 12.63 per cent in the latter.

Tax-Saving Bond

These bonds offer immunity against long-term capital gains tax under Sections 54EA or 54EB. Alternatively, these are also eligible for benefit of tax rebate under Section 88 with the increased ceiling of Rs 70,000 (for infrastructure investments). It may, however, be noted that though as per the law the lock-in for Section 54EA and Section 88 is three years, the ICICI tax-saving bonds specify a term of five years for both Sections 54EA and 88. But the term for Section 54EB has been synchronised with the required lock-in of seven years. I wish ICICI had applied the same principle in the case of Sections 54EA and 88.

These ICICI bonds earn taxable income at 12 per cent for Section 88 and 54EA in a five-year tenure and at 12.5 per cent for 54EB. In the wake of the current fall in rates, these returns can only be reasonable at best.

Though PPF is arguably a safer avenue than the Bonds, offering 12 per cent tax-free (against ICICI bond 12 per cent taxable), assessees will benefit immensely by turning to ICICI for the extra contribution of Rs 10,000 offered under Section 88.

One might say that 12 per cent taxable is equal to 8.4 per cent after tax for those in the 30 per cent tax bracket, 9.6 per cent in the 20 per cent zone and 10.8 per cent in the 10 per cent one. In that case, should we not wait for another infrastructure issue with superior returns to those of ICICI? Yes last year we witnessed good issues like Konkan Railway and MKVDC. But in a falling interest rate regime, a bird in hand is worth two in the bush.

The latest bonds of ICICI have some features worth noting:

Call and Put Options

In the previous issue, ICICI had retained the right to make premature redemptions on prespecified dates (call option). Similarly, the investor had the right to withdraw his investments (put option). Most investors did not like these options for a simple reason. If and when ICICI exercised the call in a falling interest scenario, an investor would find himself inundated with funds on his hands at an absolutely wrong time, with nowhere to go. In a laudable action, ICICI has eliminated this tension from the present issue. There are no call and put options. If the investor needs the funds for some specific personal need, he can always sell the bonds in the market, albeit at a slight loss.

Applicability of Section 80L

The current offer document states that the benefits of Section 80L are available, ... subject to provisions to the said Section, if the clarification issued by CBDT at the time of issue of 16 per cent Redeemable Bonds in the nature of promissory notes by the Company in 1993, is accepted by the Income Tax authority having jurisdiction over the concerned recipient of income.

Can I interpret this declaration to imply that the investor is at the mercy of individual ITOs? It appears that CBDT itself is unsure about the applicability of Section 80L to bonds of financial institutions like ICICI. Section 80L(vii) encompasses interest on deposits with a financial corporation. But it is doubtful whether bonds can be treated as deposits.

Looking for a solution elsewhere, we find Section 80L(ii) encompasses interest on debentures issued by any institution as the government will permit by a notification. IDBI applied for a notification while launching its Flexibond-I in March, 1996. After a lot of deliberation which took a year and three months the CBDT, vide Notification No 10381 dated June 30, 1997 allowed 80L applicability only to Regular Returns and Easy Exit Bonds. The delay caused problems for all those who had received the interest and filed returns for the year.

It may also be noted that Section 80L was not extended to Deep Discount Bonds, in spite of the fact that the difference between the redemption price and the issue price is treated as interest. Thereafter IDBI, IFCI, SCICI and ICICI have launched several issues, but I am not aware of any CBDT notification on this subject. I strongly feel that the investor will do well to assume that 80L is not available to the Bonds. I wish ICICI had highlighted this uncertainty in their offer document.

Security

The offer document states, The Money Multiplier Bond Options II to VI, Regular Income Bond Option I and all the options of the Tax Saving Bond would constitute direct, unsecured and subordinated obligations of the Company and will be subordinated and postponed to the payments in respect of all prior obligations of the Company whether for principal, interest, return or otherwise.. The Money Multiplier Bond Option I and the Regular Income Bond Option II & III will constitute direct, unsubordinated and unsecured obligation of the Company and shall rank pari passu.

This inclusion in the offer document raises certain queries. What was the necessity to make some options subordinated and the rest unsubordinated? Do the bonds of other financial institutions like IDBI, IFCI have a similar unsubordinated structure?

Oversubscription

In case the subscription of Tax Saving Bonds exceeds the amount permitted to be retained, ICICI will make reasonable efforts to provide full allotment for Tax Saving Bonds in consultation with Sebi. It is possible that ICICI will try to protect the interest of small investors by giving them full allotment. In the current falling interest rate regime, does the ICICI bond issue a good investment? Finally, you are the best judge.

If you want to earn a fixed income on your savings, consider ICICIs latest bond issue