SCICI Bonds: Hold and redeem

Recommendation: Hold and Redeem

Aarati Krishnan

WITH interest rates softening perceptibly over the past four years, institutions which have launched long-term bonds carrying a fixed rate of interest in 1996 and 1997, have found it expensive and difficult to meet their commitments.

As a result, financial institutions such as the IDBI have been exercising the call options on their bonds issued earlier. The IDBI has recently exercised the call option on its Retirement and Deep Discount Bonds issued in 1996-1997.

The SCICI Bonds, issued in July 1996, appear to be the latest set of bonds on which an institution has decided to exercise a call option. The ICICI (into which SCICI was merged in April 1996), announced this week that it proposes to exercise the call option on bonds floated by the SCICI in 1996. The bonds offered compounded annual yields ranging between 15 per cent and 17.75 per cent, a level of return which is difficult to attain in the present interest rate environment.

Original terms: The SCICI Bonds were launched under four options -- the Deep Discount Bond, the Money Back Bond, the Pension Bond and Regular Return Bond. Each bond has a face value of Rs 5,000 and was allotted on September 1, 1996. The Deep Discount Bond, Pension Bond and Money Back Bond are redeemable in 2023 and the Regular Return Bond in 2005. According to the original terms, the Deep Discount Bond was redeemable at Rs 3,00,000 on September 1, 2023.

The Pension Bond, in turn, offered four options. Investors could choose to receive a pension of Rs 250 per month starting from 2005, Rs 500 per month from 2010, Rs 1,000 per month from 2014 or Rs 2,000 per month from 2019. Regular Return Bonds carried a coupon rate of 16 per cent, to be paid half-yearly until September 2005. The bond was redeemed at par in September 2005.

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Compounded yield: If SCICI had stuck to the terms of the original offer, investors in the Deep Discount Bond would have earned a compounded return of 16.32 per cent on bonds held until redemption. The compounded yield on the Pension Bonds ranges between 15 per cent and 17.75 per cent, depending on the tenure of pension payment. The compounded yield on the Regular Return Bond, if held until redemption, would amount to 17.6 per cent.

Current status: The bonds have had a sporadic history of trading. Therefore, for those investing in these bonds, the exit option through the secondary market may not really be a practical option. Of the various bonds, the Deep Discount Bond -- the most-frequently traded -- was last traded at Rs 9,560 on November 28, 2000. However, the volumes of trading have been extremely thin and restricted to just one or two bonds daily. The bond has seen an appreciation in price from Rs 9,000 in August 2000.

The Pension Bond (offering Rs 500 per month) was last traded at Rs 8,400 in August 2000 and the Regular Return Bond at Rs 5100 on November 3, 2000. Therefore, though the exact modalities of the call option being exercised now are as yet unclear, investors may have to hold on to their investments for the present. The timing and the redemption value of each bond is yet to be announced by the ICICI.

That to a large extent would determine the kind of yield investors would get now. Even if ICICI sticks to the original terms to date, investors face the prospect of re-investment risk. The funds that they get would now have to be invested substantially at lower rates of interest.

This could cut into their investment plans. Also, the tax implications, especially in the Deep Discount Bond, could prove to be disadvantageous to investors. But they may really have no choice. However, going forward, the message is clear: If call options are indicated in the offer document of bond issues, they have to be taken seriously, as issuers can be expected to use such dynamic strategies, depending on the direction, level and magnitude of interest rate differentials.