No Second Chance
The timing for the IDBI Flexibonds 2 issue may not be right. With most individuals looking for tax-saving schemes in the fourth quarter of the financial year, a fixed income scheme without tax benefits is the last thing on ones mind.
Moreover, the returns on the Flexibonds 2 issue, which closes on January 23, 1997, are over a per cent lower than the Flexibonds I issue which came out in February 1996. Consider this: the coupon payment has reduced from 16 per cent semi-annually (which is 16.64 per cent annualised) to 15.5 per cent annually on the regular income bond.
Yes, interest rates have dropped in the period but these returns make any AAA-rated fixed deposit even from a manufacturing company more atttractive considering the up-front discounts. On Flexibonds 2, the up-front discount is around 1 per cent.
Surplus funds, anyone? Individuals who are left with a surplus after they are through with tax-saving investments can definitely consider investing in this issue. The other category that the financial institution is targetting is those who missed the first time.
But it may be worth your while to wait for the next set of issues from the other two financial institutions, ICICI and IFCI. Last time too, they had followed IDBI and yields had gradually increased. And even assuming theirs are at the same yields, the products may be more suitable. Infrastructure projects are also expected to hit the market next year which will give better returns and also section 88 benefit. Like the Maharashtra Krishna Valley Development Corporation and Konkan Railway which had a better yield than Flexibonds 2.
Besides, there are more attractive finance company fixed deposits and bond issues in the market. But despite the comparitively low yield, there are some instruments here that may be attractive to some investors.
The bonds: Super Deposit Bond: This is a regular income bond payable annually. There are two options; option (A) pays a coupon of 24.5 per cent starting two years from the date of allotment for six years. Option (B) pays an interest of 15.5 per cent starting immediately from the date of allotment for eight years. The minimum amount to be invested is Rs 5,000 (5 bonds). The yield on option (A) is 15.58 per cent and that on option (B) is 15.54 per cent.
Double Money Bond: This is a variation of the deep discount bond but investors can accrue interest income on a yearly basis unlike in the deep discount bond where the entire income accrues at the time of redemption and is considered as interest income. Thus interest income needs to be accounted for every year for tax purposes but is available only at the end of the tenure.
This bond too has two options: double the investment in 4 years and 9.5 months or make it four times in 9 years 7 months. The minimum application on this bond is Rs 5,000. The yield on both the bonds is 15.56 per cent.
Monthly Income Bond: This carries a monthly coupon of 15 per cent and the minumum investment is Rs 5,000. This bond has the highest yield of 16.08 per cent among all the products.
Deep Discount Bond: This is priced at Rs 5,500 and matures to Rs 2 lakh in 25 years. This is the only bond where both the investor and IDBI have the option of early redemption at various periods (see chart). The highest yield here is on the full maturity of 25 years at 15.46 per cent and the lowest is on the first call/put at 4 years, 3 months at 15.1 per cent.
With the entire income being accrued as interest income, there is little charm left in the deep discount bond. There is one way of bypassing the interest income.
The original bondholder can sell the bond to a relative or a friend and book capital gains on it. The relative/friend can pay interest income on the difference between the redemption value and purchase price. The only problem is that the investor will have to repeat this deal everytime before a call option, which is not a very pleasant thought.
Other factors: If investors already have enough financial institution bonds applied in the first round, then there is little reason to buy this bond unless a certain instrument appeals to the investor. The tenure for most bonds except the deep discount bond is fixed at eight years and IDBI does not have the right to call the bond in the entire tenure. This is a major advantage for the investor who can lock-in to an eight year investment.
Poor secondary market. A minus point about bonds is that there is a poor secondary market and most trades are distress sales. IDBI is planning to bring about liquidity by appointing four of the lead managers as market makers to provide liquidity. This is a positive step.
Encashment. IDBI is also offering a facility for encashment before maturity for the Super Deposit Bond and the Monthly Income Bond. During the second year, it is 11.5 per cent and during the third year, it is 13 per cent. This is around the same level as the public sector bank fixed deposits but much lower than private sector and foreign bank rates.
Loans. You can also borrow against these bonds. IDBI has arranged with 12 banks to provide a loan against these bonds. SBI Home Finance has also agreed in-principle to accept these bonds as security.
Investor profile: Let us take a look at the investor profile that can be attracted by these bonds. We can split them into those who expect regular income and those who prefer income in lumpsum.
For those who fit the first profile, the Monthly Income Bond is attractive at 16.08 per cent. But a finance company fixed deposit will give a much better yield.
The first option of 24.5 per cent interest is, however, also quite attractive, especially if the person is retiring in the next two years or if your child requires to go to college after two years. Even the interest is payable on April 2 every year, which leaves enough room to pay for the next years college fees.
The second option is not too atractive as any fixed deposit gives a similar return. Then there is the question of locking in to a tenure of eight years. Since fixed deposits are available for a maximum tenure of five years, the marginal benefit is only for three years, which can be easily compensated for by a slightly higher return on the five-year deposit.
For those who expect lumpsum income, the deep discount bond is avoidable. It can be called by IDBI at several stages and if interrest rates are down, IDBI is bound to call them. Even if IDBI does not call them, the problem of managing these bonds undermines the return.
In fact, the second option of the Double Money Bond should be preferred as it is possible to lock in to a 15.56 per cent return for nine years and seven months.
Of the lot, then, only options (A) of the Super Deposit Scheme and (A) of the Double Money Bond are really worth considering.