How to Evaluate Unlisted Bonds: Key Metrics for Investors (Part I)

As the bond market has become more accessible to investors, we have developed a knowledge series on Unlisted bonds in India. This series will help people to make more informed decisions while investing. This would be a 5  part series focussed on

1. Evaluation of Unlisted bonds
2. Understanding Senior Secured Bonds
3. Bond Rating Explained
4. How to Sell Unlisted Bonds
5. Case Study on Bond Evaluation

Introduction- Unlisted Bonds

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 maximize 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. 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 debt instruments backed by assets or collateral, which gives bondholders a claim on the collateral if the issuer defaults on the bond. Thus, secured bonds are far less risky than 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 minimize the risks. The credit risk of a senior secured debt is relatively low.
• Allotment Date and Maturity Date: The period between a bond’s allotment date (or date of issue) and maturity date gives you the bond’s tenure.
• 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

1. 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.
2. 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.
3. Consider Liquidity Concerns
   Unlike listed bonds, unlisted bonds often have limited marketability, so platforms need to provide detailed information on the bond’s liquidity. 

Process of Evaluating Bonds

Evaluating bonds involves assessing the issuer’s creditworthiness. Credit Analysis is the process of evaluating a borrower’s creditworthiness using different financial ratios and metrics. It involves financial diligence and analyzing the issuer’s capital structure.

Evaluating a bond involves analyzing its credit risk, particularly the borrower’s inability to meet its financial obligations on time, known as default risk.

Unlike an equity investor, a bond investor is more focused on protecting downside risk and does not care too much about high growth as the upside is limited for him

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 concerning 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. 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 concerning 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 amortization.
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 like 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 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 like 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 analyzing 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

Explore Tapinvest

Tap Invest provides a well-curated selection of bonds, emphasizing 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

Explore 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 maximize your investment’s potential. 

FAQs

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.