Last Calendar year i.e. 2017 was not that good for Debt Mutual funds. It was disappointing for all the new investors who entered into the debt markets seeing the 2016 performance as well as the first quarter (Post demonetization) of 2017. This normally happens when past returns become the only basis of Investments.
Now after experiencing 2017, Non-Equity investors are seeking investment options other than Debt mutual funds assuming RBI will not cut rates further and moreover, expectations of a rate hike in the medium term is mounting up.
One of the options that is gaining curiosity among investors is the Perpetual bonds.
This article is about the Perpetual bonds in India, its features, risks associated and taxation.
Perpetual Bonds in India – What exactly it is?
Perpetual bonds as the name suggests are perpetual in nature, means they do not have any maturity date. Only the issuer has the option of calling it backut the buyer of the bonds cannot sell it to the issuer before the call option is exercised by the issuer. Generally, the call option dates are every 5 years from the bond issuance date.
However perpetual bonds in India are listed on stock markets, so if an investor wants liquidity then they can sell the bonds on the stock exchange.
These bonds are generally issued by large manufacturing companies or by banks to fund their long-term capital requirements. In banks, the perpetual bonds come under as Additional Tier 1 bonds which gives it features of Quasi Equity. Which Means that in case of bank winds up then the Investors in Perpetual bonds will be paid last but before equity investors. (Read: What is Equity?)
Besides this, the coupon (Interest) payment on these bonds depends on the current year profitability of the issuing bank. If the bank is not in profits or does not satisfy the minimum capital adequacy requirement as laid down by RBI then it has the option of not paying the interest of that particular year.
However, in February 2017 RBI came up with a circular and allowed banks to pay the Coupon on Perpetual bonds from the Reserves/surpluses or carried forward profits. This goes down well with the investors and increased the demand for Perpetual bonds in India.
To compensate this risk, the yield in these perpetual bonds are generally 200-300 basis points higher than the government securities rate.
Perpetual bonds in India – Issues available
These bonds due to high liquidity risk, moderate Interest rate risk and low to moderate credit risk, are offered with a minimum ticket size of Rs 10 lakh. In the initial offering, ticket size is way too high which may go to Rs 50 lakh or more, and thus only institutions participate in that.
For retail or HNI investors perpetual bonds are available only through the Secondary market. And the Price depends on the Current and expected interest rate scenario.
Some of the offerings of perpetual bonds issued in India as available today are as below:
Perpetual Bonds in India – Risks
The attractive high coupon comes with many risks. You may assume higher the coupon, higher will be the risks.
- Liquidity Risk – These bonds do not have any maturity date. You cannot sell it back to the issuer. The only liquidity available is through the secondary market which again depends on the demand of the bonds and Interest rate scenario.
- Interest rates risk – Since perpetual bonds in India will be listed in the stock market so any rise in general interest rates will impact negatively to the price of your bonds; however, fall in rates will impact positively too. But all this will only impact the price of the bonds and not the coupon rate on which you have invested. So, if you stay invested till the call date, then you will not be impacted by Interest rate movements.
- Credit risk/Default risk – As per the terms of these bonds interest payments are to be made through the current year profits and if that does not suffice then from Feb 2017 RBI has allowed dipping into Reserves and surplus. But in case of the bad financial state of the banks, and non-compliance of RBI capital adequacy norms, then the payment towards the interest as well as capital may be fully or partially written off at the option of RBI
Perpetual bonds in India – Taxation
The Annual coupon from the perpetual bonds will be added to the total income of the investor and taxed as per the Income tax slab one falls in.
But if the bond gets sold in the secondary market and Investor makes long-term capital gain (after holding period of 1 year), then the LTCG will be taxable at 10% (without Indexation)
Perpetual bonds in India – Should you buy?
I always say that there is no investment product is devoid of risk. It’s just that when you understand risk then you take a calculated investment call and also steps to manage that risk.
The Interest and principal default risk in perpetual bonds are somehow curtailed by GOI ownership. You may find comfort in Nationalised banks being guarded by the government of India. The recent capitalization announcement in Dec 2017, of 2.11 lakh crore in banks by the government is an example where the government may pitch in to support the banking system. Still, risks are risks.
The high yields on the Perpetual bonds are definitely attractive, but you need to look at it from the taxation perspective too. Post-tax interest is what you actually enjoy.
Also, do look at the other bond options available. There are tax-free bonds, Secured NCDs, Banks Tier II bonds are available in the Secondary market for your comparison. And moreover, Debt mutual funds also have different category of funds, which are well managed and well suited to many clients, with a tax efficient structure.
So, chose wisely as per your goals and risk profile.
Hope you find the article on perpetual bonds issued in India useful. Do share it with your friends to help them make wiser financial decisions. If you have any question, feel free to hit the comments button.