Bond Watch. Muni bonds: Higher returns with moderate risks for fixed income investors

Despite being one of India’s longest-running development finance pilots, the country’s municipal bond market has not caught individual investor attention. Such bonds have usually been been privately placed and minimum ticket sizes have been high. But the muni bond scene recently received a fillip when Indore Municipal Corporation came out with green municipal non-convertible debentures and got an overwhelming response — with an overall subscription of 5.91 times the issue size. With more cities expected to tap markets in this way as they test waters, here is a lowdown on muni bonds.

What they are

A municipal bond, commonly known as a muni, is a bond issued by municipal bodies seeking to tap capital markets. Municipalities are allowed to issue bonds to raise money to fund public infrastructure. Typically, muni bonds have high face value (₹10 lakh) and that is one reason why they were out of retail investors’ purview. But as we saw in the Indore green muni bonds case, they offered 8.25 per cent coupon rate (payable half yearly) and were floated with a face value of ₹1,000. This could form a template for other retail muni bond launches in future. Investment tenures could range between 3, 5, 7 and 9 years.

The interest income earned on investment made in municipal bonds and capital gains are not exempt from tax. Tax at source is deducted on interest. There are no special tax benefits so far.

Some of these muni bonds are listed on the exchanges, but before snapping them up from the bourse do check if they have good trading volumes. So far, volumes have been incipient. Muni bonds from healthy issuers could have sufficient liquidity in the secondary market.

What about safety?

A quick glance at rated municipal corporations in India shows that they carry AA ratings (AA-, AA, AA+). Some of them carry B+ ratings too. This indicates muni bonds are not low-risk if you compare them to Government of India (G-Secs) or State government bonds (SDLs).

Do note that muni bonds may not be backed by government guarantees since they are floated by Urban Local Bodies (ULBs) and civic agencies. But, one may expect the State government to step in if there are any financial difficulties. Also, to attract retail investors, muni bond issuers are expected to come up with fully secured bonds through escrow on revenue streams.

While there are no reports of municipal corporations defaulting on payments, the ratings tell you that they are more comparable with corporate bonds. Yields of AA-rated corporate bonds in 3-5 year tenure are in the 8.5-10 per cent range, while 10-year benchmark G-Sec yield is at 7.3-7.4 per cent.

While you may not directly purchase muni bonds, your debt mutual funds may take exposure. We now have a Nifty India Municipal Bond Index. Presently, the index has 28 municipal bonds of 10 issuers, all having credit rating in the AA rating category. The basket holds investment grade municipal bonds issued by municipal corporations domiciled in India across maturities. The index could be a reference, fully or partially, for investment vehicles that take significant muni bond exposure.

Health of issuers

If you are a hard-nosed fixed income investor, there will be only a handful of municipal corporations or ULBs if you have high creditworthiness threshold. We are yet to come across a AAA-rated municipal corporation in India. Many such issuers do not have buoyant revenues apart from property tax (high dependence on State government grants in the form of GST compensation), information disclosures remain poor and revenue leakage is high. At the same time, some municipal bodies have strong financial risk profile, driven by healthy operating surplus, nil debt and strong liquidity, and good service arrangements.

We have also come across instances of issuer non-cooperation red-flagged by rating agencies. For instance, a recent CRISIL Ratings report says it has been consistently following up with The Kolkata Municipal Corporation through letters and emails, among others, apart from telephonic communication. However, the issuer has remained non-cooperative. If you want to consider muni bond exposure, do check out the rating reports on such bond issuances by credit ratings agencies as they can provide you a good overview on the financials.

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