How to Evaluate Unlisted Bonds: Key Metrics and Tips for Investors
Unlisted bonds are bonds that do not trade on public exchanges. They offer unique opportunities for investors to diversify their portfolios and secure higher yields. However, investing in unlisted bonds requires careful evaluation to mitigate risks and maximise returns. This article will guide you through the essential metrics, evaluation methods, and tips for investing in unlisted bonds, including a look at the top platforms.
Key Metrics to Evaluate Unlisted Bonds:
When assessing unlisted bonds, consider the following metrics:
| Metric | Description |
| Credit Rating | Measures the issuer’s creditworthiness, typically by agencies like CRISIL or ICRA. Higher ratings indicate lower risk. For example, bonds like MoneyView’s senior secured bonds often have ratings available to help gauge risk. Credit rating is also an indication of the borrower’s trustworthiness. |
| Yield to Maturity (YTM) | Shows the return if the bond is held until maturity. You can review specific yields on Tap Invest, such as Hella Infra bonds. Yield to Maturity is often considered more important than the actual Coupon Rate offered. This is because YTM reflects the total expected return on a bond if held until maturity, while the Coupon Rate only reflects the annual payout in a percentage term. YTM is the total amount the bond owner receives when it matures, expressed as a percentage. This makes YTM a more comprehensive indicator of the actual return from the bond over its maturity period. |
| Coupon Rate | The annual interest rate is either fixed or floating. Options like Bira bonds offer specific coupon structures for income-focused investors. A bond’s coupon rate is the annual interest rate paid to bondholders as a percentage of the bond’s face value. |
| Liquidity | Reflects how easily the bond can be sold on the secondary market. Unlisted bonds generally have lower liquidity than listed ones. |
| Issuer’s Financial Health | Analyses the issuer’s financial background to assess stability. Tap Invest’s listings, including MoneyView, often provide insights into issuer health. |
| Tax Efficiency | Determines the bond’s tax implications, such as exemptions on interest income, which can vary. |
Besides the above, several other indicators can be assessed to evaluate a bond. Let’s have a look at a few additional considerations:
- Secured or Unsecured: A bond may be backed by security. Secured bonds are thus debt instruments backed by assets or collateral, which gives bondholders a claim on the collateral if the issuer defaults on the bond. Secured bonds are thus far less risky than the unsecured ones.
- Senior Bonds: A bond may also be a Senior bond, meaning it would have a higher priority than other types of debt and equity when it comes to repayment in the event of a company default. This, again, serves to minimise the risks.
The credit risk of a senior secured debt is relatively very low.
- Allotment Date and Maturity Date: The period between a bond’s allotment date (or date of issue) and maturity date gives you the tenure of the bond.
- Payouts: One key detail to be noted is the bond’s Payout scheme. Usually, interest payments are made on a monthly basis, while the principal amount is repaid on maturity. Monthly payouts appeal to those seeking a steady fixed cash flow.
Key Tips for Evaluating Unlisted Bonds:
- Review the Issuer’s Creditworthiness
Assess issuers’ credit ratings to understand repayment capacity. For instance, Hella Infra and MoneyView bonds available on Tap Invest provide credit details that help gauge potential risk. - Understand the Bond’s Yield and Returns
Check the bond’s yield-to-maturity (YTM) to assess potential returns. Higher-yield bonds like Bira bonds offer competitive returns but should be reviewed for associated risks. - Consider Liquidity Concerns
Unlike listed bonds, unlisted bonds often have limited marketability, so platforms like Tap Invest provide detailed information on the bond’s liquidity. Bonds like those from MoneyView may be ideal for investors willing to hold them to maturity.
Process of Evaluating Bonds
Evaluating bonds has much to do with assessing the creditworthiness of the issuer. Credit Analysis is the process of evaluating the creditworthiness of a borrower by using different financial ratios and metrics. This involves financial diligence and analysing the capital structure of the issuer.
Evaluating a bond involves analysing the credit risk of the bond and, in particular, the inability of the borrower to meet its financial obligations on time, which is known as default risk.
Ratios for Credit Analysis
- Leverage Ratios
Leverage ratios place a ceiling on debt. It reflects the level of capital financed through debt and indicates a company’s ability to meet its financial obligations.
| Total Leverage Ratio | Total Debt ÷ EBITDA Represents the obligations of the bond issuer in relation to its cash flow generation capacity. A high Total Leverage Ratio means that the company has huge amounts of debt in relation to its cashflow generation capacity and thus indicates a higher risk. |
| Net Leverage Ratio | Net Debt ÷ EBITDA Similar to the Total Leverage Ratio, the Net Leverage Ratio helps determine the debt levels the issuer has taken relative to its cash balance on the balance sheet, which could be used to repay its debts. |
| Senior Debt Leverage Ratio | Senior Debt Leverage Ratio measures a company’s ability to meet its senior debt obligations using its earnings, most often EBITDA or operating income (EBIT). This is particularly important for senior bonds that have a higher claim during repayment on default. |
- Coverage Ratios
While leverage ratio puts a ceiling on the levels of debt in comparison to different financial parameters of the borrower like cash balance, etc., coverage ratios determine a floor for the company’s cash flows so as to be able to pay its interest obligations. Basically, it’s an indicator of whether the company’s cash flows can sustain its interest payment expenses.
| Interest Coverage Ratio | EBITDA ÷ Interest The interest coverage ratio represents the borrower’s cash flow generation in relation to its interest expenses. Unlike Leverage Ratios, a higher interest coverage ratio represents greater room for interest payments and, thus, reflects lower risk. |
| EBIT Coverage Ratio | EBIT ÷ Interest Expense Reflects the ability of EBIT or Earnings before Interest and Taxes to service interest expenses. This ratio is specifically useful if the issuer is engaged in a cyclical business with fluctuating depreciation and amortisation. |
| Capex-Adjusted Coverage Ratio | (EBITDA – Capex) ÷ Interest Expense Reflects the ability of EBITDA to service interest expenses by removing the capex expenditure from EBITDA. This is particularly useful if the issuer of bonds is a capital-intensive company with cyclical capex requirements. |
| Fixed Charge Coverage Ratio | (EBITDA – Capex – Cash Taxes) ÷ (Cash Interest Expense + Mandatory Repayment) It reflects the issuer’s ability to meet fixed charges such as interest, lease, and loan payments (usually in the nature of non-discretionary debt obligations) from its earnings (EBITDA). |
The higher the leverage ratios and lower the coverage ratios, the greater the risks associated with the issuer. This indicates a higher default risk for the borrower, and thus, it must be compensated by offering higher yields to make up for the additional risks undertaken.
Debt Covenants in Credit Analysis
Debt covenants are contractual terms and conditions associated with a debt, in this case, an unlisted bond. These terms obligate the issuer to refrain from certain activities or maintain certain financial thresholds. You can find these covenants in the bond indentures, which are the legal documents that specify the issuer’s financial and legal obligations with respect to the bond.
Investors are advised to evaluate the debt covenants associated with a bond, which is a factor in deciding the bond’s face value and yield. Stricter the covenants, lower the risk and lower the yield.
Covenants can be primarily of three types:
- Affirmative covenants impose obligations on the borrowers to carry out certain tasks throughout the tenure, such as regular tax compliance, ensuring legal compliance, maintaining insurance coverage, etc.
- Negative covenants impose restrictions on the issuer to refrain from certain activities, such as limitations on M&A activities, limitations on taking more debt, etc.
- Financial Covenants in the nature of incurrence covenants require an issuer to maintain certain financial thresholds to ensure the issuer’s ability to repay.
Collateral Coverage in Credit Analysis
Assessing the collateral coverage as part of credit analysis is essentially preparing for the worst-case scenario of liquidation if the issuer defaults. Collateral coverage calculates the value of the liquidated collateral to assess the extent of coverage of all claims. Evaluating the collateral involves assessing the debt agreements of the issuer with other debtors and analysing the issuer’s capital structure to assess the seniority of claims.
The purpose behind this is to ensure that the bondholder is able to at least recover the principal amount in case of a default by the issuer.
Platforms to Invest in Unlisted Bonds:
Investing in unlisted bonds is now more accessible, with various digital platforms offering options from companies like Hella Infra, MoneyView, and Bira (B9 Beverages). These platforms make it simpler for investors to find and invest in quality bonds, broadening their portfolio with ease. Below are some platforms I have personally used.
- Tap Invest
Tap Invest provides a well-curated selection of bonds, emphasising transparency, risk analysis, and ease of access. Investors can start with as little as ₹10,000, making it accessible for varying budgets. The platform offers options like Moneyview and Bira bonds, each with detailed information on security, returns, and risks, helping investors make well-informed decisions. - Altifi
Altifi enables retail investors to invest in fixed-income securities and offers both listed and unlisted bonds on its platform. Altfi lists only those bonds to which its parent company, Northern Arc, subscribes. It focuses on bonds issued by companies with strong credit, which the parent company, Northern Arc, has comfort in underwriting.
Advantages and Risks of Investing in Unlisted Bonds
Advantages:
- Higher Yield: Unlisted bonds often offer higher yields than listed bonds, making them attractive to income-focused investors.
- Portfolio Diversification: Adding unlisted bonds to your portfolio can help diversify risk across different types of assets and sectors.
- Potential Tax Benefits: Some unlisted bonds offer favorable tax treatment, especially on interest income.
Risks:
- Lower Liquidity: Unlisted bonds generally lack the liquidity of listed bonds, making selling them before maturity challenging.
- Credit Risk: Issuers may have lower credit ratings, indicating a higher chance of default. Hence, careful evaluation is crucial.
- Interest Rate Sensitivity: Unlisted bonds, especially those with fixed rates, can be sensitive to interest rate changes, impacting their value and attractiveness.
Conclusion:
Investing in unlisted bonds can be a valuable strategy for those seeking higher returns and portfolio diversification. By understanding key metrics, evaluating issuer creditworthiness, and by choosing the right platform you can make informed decisions to maximise your investment’s potential.
FAQs On Unlisted Bonds:
1. What are unlisted bonds?
Unlisted bonds are not traded on public exchanges, providing an alternative fixed-income investment for portfolio diversification.
2. Are unlisted bonds safe?
Unlisted bonds carry various risks, such as credit risk and lower liquidity. Before investing, assessing the issuer’s financial health and creditworthiness is essential.
3. How can I buy unlisted bonds?
You can buy unlisted bonds through platforms like Tap Invest, BondsIndia, or Wint Wealth, which offer retail access to these bonds.
4. Can I sell unlisted bonds before maturity?
While it’s possible, selling unlisted bonds before maturity can be challenging due to their lower liquidity in the secondary market.
5. Are there tax benefits with unlisted bonds?
Some unlisted bonds may offer tax exemptions on interest income, but this varies by bond type and region.
