The country’s largest lender, State bank of India (SBI), plans to raise Rs 1,000 crore through the subsequent series of lower tier II bonds. The bonds open for subscription on 21 February and close on 28 February.
The fact that the country’s biggest state-owned bank is issuing these bonds at attractive rates of interest and that two credit rating agencies have stamped AAA on the bonds, a complete sell out is expected. In fact SBI has already provisioned for an oversubscription, up to an additional amount of Rs 1,000 crore extra taking the amount to Rs 2,000 crore.
Attractive as they may sound, these bonds are not meant for everyone. Here’s an analysis. Check if it suits your requirements.
Since SBI is yet to make a formal announcement, we referred to its prospectus available on its website. The present issue is tranche I of SBI lower tier II bonds series 3 and series 4. Series 1 and series 2 bonds were offered in October.
Series 3 is available for a tenor of 10 years with an interest rate of 9.75% and series 4 is available for a tenor of 15 years with an interest rate of 9.95%. The interest will be paid annually on these bonds. So if you bought a bond for Rs 10,000 for 15 years, every year you will get Rs 995 as interest payment and at the end of 15 years you will get your principal amount, i.e Rs 10,000, back.
SBI plans to issue these bonds in order to raise money as banks require sufficient capital base in order to lend. Says K. Sridhar, director, eFIN Services India Pvt. Ltd, a financial consultancy and advisory firm: “Banks have deposits that are typically for one-three years. However, they give loans for longer periods of 10-15 years. These bonds are issued to bridge the gap. With SBI taking the lead, more banks are expected to come out with such bonds.”
Also See | SBI Lower tier II bonds (PDF)
These bonds are proposed to be listed on the National Stock Exchange and the Bombay Stock Exchange. Since they are dematerialized, you need to have a demat account to buy these bonds. These bonds don’t have a put option. So if you wish to redeem the bonds before maturity, you can’t do so. However, you can sell these bonds in the secondary market, i.e on the stock exchanges at the prevailing market price. Also, these bonds have a call option that can be exercised by SBI. The bank can call back the series 3 bonds after five years and series 4 bonds after ten years. In this case, the bank will pay you the interest due and return the principal value.
However unlike the earlier series, where SBI promised a mark up of 50 basis points (bps) in case it didn’t exercise the call option, this series does not offer any mark up. Typically a buy-back option is exercised in a falling interest rate regime. A fall in the interest means that the bank is borrowing at a higher rate from you through the bonds and hence by exercising the buy-back option it can avoid paying a higher interest. However in an increasing interest rate scenario, the bank will benefit since it has locked in money at a lower rate of interest.
What it means for you
The interest that you get is paid every year. This means that the interest is not reinvested and you do not get the benefit of compounding. In addition to this, you have no tax incentives in buying this bond. Also the interest that you earn every year is taxable. So if you are in the highest tax bracket of 30.90%, the effective rate of return will come down by 30.90%. So the 15-year bond offering a return of 9.95% will give you just 6.88% effectively. Taking the same example a 10-year bond offering 9.75% will effectively return 6.74%.
Also since the bonds don’t have a put option, you can’t make a premature exit. Considering the lock-in and a market sentiment that expects the rates to go up, you will not benefit from interest rate rallies. Adds Sridhar: “Even in the secondary market, debt trading is very low and if the interest rates go up then the prices of bond will go down. In a rising interest rate scenario, you will not benefit even from selling the bond in the secondary market.”
Should you buy
If you wish to accumulate a corpus after say 10-15 years, skip these bonds as they don’t compound your money. They only offer a yearly payout. For someone who wants goal-based investing, and is looking to accumulate corpus, an investment vehicle that compounds your money is very important. You will be better off in the Public Provident Fund (PPF) that returns a tax-free rate of 8%.
However if you are an income-seeking investor—senior citizen or an individual in the lowest tax bracket—you may look at these bonds. For senior citizens, these bonds make sense only after they exhaust their Rs 15 lakh limit allowed under the Senior Citizens Savings Scheme (SCSS). It returns 9% quarterly for a period of five years.
The amount you invest in an SCSS qualifies for a tax deduction under section 80C of up to Rs 1 lakh. On the other hand, SBI bonds don’t offer any tax benefits and pay interest only once a year. Says Veer Sardesai, a Pune-based financial planner: “A senior citizen should first exhaust the limit available under SCSS and then look at these bonds. Only investors looking for regular income should consider these bonds.”
Most debt fund managers are expecting one more round of interest rate hike to happen in the next two months, which they claim would also lead bank fixed deposit (FD) rates to rise for one last time this fiscal year. Long-term FDs of five years and more are in the range of 8.50-9.25%. Senior citizens get 50 bps extra. You could also look at investing in a fixed deposit since investments in an FD are more liquid and the interest is compounded.
We suggest you invest in these bonds only if you want an yearly income. Keep some money aside to benefit from FDs as and when the rates go up further. However, if you have a long-term goal in mind and debt is the vehicle of your choice, then invest your money in PPF.