New tax-free bonds take the sheen off older issues

Radhika Merwin BL Research Bureau | Updated on November 23, 2017 Published on October 19, 2013


With interest rates of new offerings up, prices of older bonds are down 3-7%

Even as issuers such as Power Finance Corp and NHPC woo investors with tax-free bonds at attractive rates, similar instruments issued last year have been slipping in the secondary market. They now trade 3-7 per cent below their issue price.

With the Government allowing 13 public-sector companies to raise funds through tax-free bonds this year, there have been many such offers.

Rising market interest rates have made returns from these bonds very attractive. Bonds from Rural Electrification Corporation (REC), the first to hit the market this year, offered interest rates of 8.01 per cent and 8.46 per cent for the 10- and 15-year options, respectively.

PFC offer

But the latest issue, by Power Finance Corporation (PFC), offers 8.18 per cent and 8.54 per cent for 10- and 15-year tenures, respectively. Last year, similar bonds offered no more than 7.4 per cent . Though tax-free bonds are issued for 10-, 15- or 20-year tenures, they are listed on stock exchanges to provide liquidity.

With newer bonds offering better returns, prices of older tax-free bonds have fallen in the secondary market. For instance, the older 10-year REC bonds are now quoting at about Rs 962 (face value Rs 1,000) in the secondary market. This is at a 4 per cent discount to its issue price. The earlier tranche of PFC bonds quote at Rs 960 in the secondary market, at a 4 per cent discount to the issue price.

Low trading volumes

Market players warn that selling the older bonds even at a discount is not easy due to low trading volumes. “High Networth Individuals mostly hold the bonds till maturity and do not trade in them. They liquidate their investments in the secondary market only when in need of funds,” explains Ashish Shanker, Head, Investment Advisory, at Motilal Oswal Private Wealth Management.

Going by the trading history of REC bonds on the BSE, the bonds did not trade for several days and when they did, the volumes ranged between 5 and 600 bonds a day.

Phone trades

The secondary market in tax-free bonds lacks not just liquidity, but transparent pricing, as well. Trading in these bonds takes place over the phone via a broker, instead of through an online platform as in the case of stocks. There is no order-matching system as in the case of equity or Government securities, say market players. An investor who wants to buy an older bond places an order with the broker, who then finds a seller to complete the trade.

Fluctuating rates in recent times have made price discovery even more difficult. “With bond markets becoming highly volatile in the last two-three months, opacity in pricing has become even more acute,” says Shanker. “The on-screen quotes are actually a misrepresentation of prices. Most of the time actual trades happen at negotiated prices.”

Not buys?

Do older bonds at a discount present a buying opportunity? One attraction could be their Yield-to-Maturity. YTM is the effective return you can earn on a bond by way of interest and repayments, by buying it at its current price. Some of the older bonds, which can be bought at below par value, offer YTMs of 8.5-8.6 per cent today.

But even affluent investors aren’t tempted. Liquidity is an issue. And “even if interest rates are elevated and there are bonds at attractive prices, one should first consider the credit quality of the issuers. Considering the macro environment, it is better to invest in ‘AAA’ or ‘AA+’ rated instruments only”, advises Suyash Choudhary, Head of Fixed Income, IDFC MF.

Published on October 19, 2013
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