SBI plays Bond

State Bank of India (SBI) is tapping the markets with a retail bond offer once again. The previous bond offer in October was subscribed within hours of the offer opening.

Investors this time round will get interest rates of 9.75 – 9.95 per cent a yearagainst 9.25-9.5 per cent earlier. The certainty of retail investors getting allotment too is higher with half of the total issue reserved for them .

This means that at least Rs 1,000 crore of the issue is allotted to retail segment. Additionally, SBI has an option of retaining oversubscription subject to the limit of Rs 10,000 crore, only from retail investors, who is defined as anybody who subscribes for less than Rs 5 lakh worth of these bonds. These rates are only applicable to retail investors.

Background

The other long term bond options available to retail investors are mainly in the form of infrastructure bonds. Over the last one year, there has been a flood of such bond issues. However, they have a cap of Rs 20,000 to get tax savings. As the interest rates on these bonds are capped at government bond yields, they do not have any flexibility of pricing the issue at an attractive rate.

Given this background, we recommend investments in either of SBI's 10 year or 15 year options as the rates are attractive and offer a good risk-return reward.

They are more suitable for people in the lower-tax bracket. The 10-year option has an interest rate of 9.75 to be paid annually while the 15-year option is offering 9.95 per cent.

The 10-year option carries 9.75 per cent rate as against 8.75 per cent rate offered by SBI's own term deposits for ten years. Deposits rank higher on safety and are insured upto Rs 1 lakh. Another advantage is that the retail bond offers liquidity as it is will be traded on NSE post-listing.

Investors can look forward to the possibility of some gains in the bond in the secondary markets, if rates fall. Bonds issued earlier, the 15-year 9.5 per cent SBI bond is trading at 3.6 per cent above its par value, despite the rise in interest rates from the time SBI raised these bonds. The volumes traded are also good on these bonds. Around Rs 50 lakh worth of the 15-year bonds were traded in the market on February 17, 2011.

Do note that the interest received from these bonds will be taxed as part of your income. The post-tax returns on the 10-year bond will amount to 6.87 per cent, 7.8 per cent and 8.75 per cent respectively for the 30 per cent, 20 per cent and 10 per cent tax brackets. For a 15-year option, the returns would be higher at 7 per cent, 8 per cent and 9 per cent respectively.

The only disadvantage of the bond is that it has a call option ( after five years in case of 10 year bond and after 10 years for 15 year bond), but not a put option.

This means that while the bank can opt to buy back the bond, you cannot choose to sell it to the bank any time you want.

SBI may buy-back the bond from an investor if the interest rates prevailing at that time are lower. Additionally, the previous issue had offered a higher interest rate (0.50 per cent), if the call option was not exercised.

There is no such offer this time around. Investors also have to note that these Tier-II bonds are unsecured and will come after deposit and debt obligations when it comes to repayment.

Issue details

SBI is the largest bank and has a sovereign credit rating. The current issue is to improve its capital adequacy, which as of December 2010 stood at 13.16 per cent as against the mandatory 12 per cent.

The issue opens from February 21, 2011 to February 28, 2011 but may close ahead of time.

COMMENT NOW