The Hindu Business Line : IDBI and ICICI bonds: Rates marked down further

AS REGARDS the IDBI and ICICI bonds that are open for subscription, the coupon rates on the various options are lower than what was offered in February.

This is in response to the 1 per cent cut in interest rates on small savings schemes announced by the Government. These bonds continue to remain unattractive for most investors.

IDBI Flexibonds 18

Tax Saving Bond: The annual interest option of the Tax Saving Bond now offers a rate lower than that of the tax saving bonds of Rural Electrification Corporation. Investors need not perceive any material difference in the credit quality of the two institutions, though REC has a better rating right now. IDBI's proposed conversion to a bank may also not significantly enhance the safety factor relative to REC. As such, its Tax Saving Bonds can be avoided in favour of REC bonds.

Regular Income Bond: There are four options on offer. The term-to-maturity of the first two options are seven years and for the other two, 10 years. Both the 7-year and 10-year options offer annual and quarterly interest payments.

Are they attractive? No. They offer an yield-to-maturity that is only around one percentage point more than that offered by government securities of similar remaining maturity. Besides, the longer term to maturity enhances the risk involved in the instrument, especially considering the restructuring that IDBI is set to go through.

Mutual funds continue to be more attractive as a long-term saving option, especially on a post-tax basis. Anyway, the small savings schemes still offer an attractive avenue to park savings. The small savings options such as the Post Office Monthly Income Scheme and the Government of India Relief Bonds, offer much better value for investors with small surpluses. These bonds may, however, be suitable for investors with large excess cash looking for opportunities to diversify.

Money Multiplier Bond: There are two options with term-to-maturities of around seven-and-a-half and nine-and-a- half years respectively. The yield-to-maturity is only a percentage point higher than government securities with similar maturities. Such yield differential will, however, interest only high-net-worth investors with large cash surpluses. However, the tax dispensation, which taxes income accrued each year, may be a negative factor. Mutual funds and insurance schemes appear relatively more attractive investment avenues from the longer-term perspective for both small and large investors.

Fixed option Floating option Bond: IDBI is seeking to limit the interest rate risk through this five-year bond. It offers to pay 7.25 per cent per annum for the first three years. For the next two years, IDBI would either pay 7.50 per cent or switch to a lower rate. The lower rate would depend on the bank rate plus a mark-up of 1.25 per cent. If IDBI switches to a lower rate, investors will have the option of exercising a put option.

The bank rate is now 6.25 per cent. If the bank rate were to move higher, then the upside for investors in these bonds is almost negligible.

These bonds will offer value to investors if the bank rate and the spread at IDBI securities trade go down. For example, assume that the bank rate goes down to 5 per cent and the spread at which IDBI securities trade declines to 1 per cent. This bond will then offer 6.25 per cent when other IDBI securities will offer only 6 per cent.

For retail investors, betting on the probability of a reduction in both the bank rate and the spread for IDBI securities does not appear a suitable proposition.

However, the bond does appear attractive on a few counts. If bank rate goes down, then investors will have the option of exercising the put option at the end of 3 years. The yield of 7.25 per cent for a 3-year investment option is attractive.

On the other hand, if the bank rate does not decline, then it would become with a term to maturity of five years. The yield of 7.34 per cent for a five-year bond compares unfavourably with that available on the six-year post office monthly income scheme.

In this backdrop, retail investors will small surpluses need not consider the fixed option floating option bond. However, investors with large surpluses looking for an opportunity to diversify should consider investing in this bond.

ICICI Safety Bonds

ICICI Tax Saving Bond: The rate offered by ICICI is lower than that of IDBI. ICICI's credit rating can be considered to be superior to that of both IDBI and REC. However, the rate offered is low. In this backdrop, investors can avoid the bonds in favour of REC bonds.

ICICI Regular Income Bonds: ICICI is offering just one option for investors — a 7-year option with a coupon rate of 6.75 per cent. This is higher than what ICICI offers on its term deposits. As such, these would per se be more attractive to such term deposit investors.

However, investors can avoid the offer given that the yield is less than 1 percentage point compared to a government security of similar remaining maturity.

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