Buying bonds from fintech platforms? Convenience might come at cost of safety

Over the past 1.5 years, I have received many queries about direct bond investments available on bond platforms. Given the attractive yields of 9.5 percent to 12 percent per annum, there is rising interest in these bonds.

Most of these bonds are non-convertible debentures issued by non-banking finance companies. Some bonds are secured by collateral and covered bonds come with an extra cover pool that can be utilised in case of default.

Investors are flocking to these bonds, believing them to be a superior alternative to bank fixed deposits. But do they really understand what they’re getting into?

What investors get

Returns, returns and more returns and the ease of investing. When was it so easy in the past to buy bonds with a click? But is the ease of access to these bonds making investors ignore basics? Having more financial choices is good, but can be bad in the absence of the right disclosures.

Ratings and other issues

All platforms highlight ratings. But ratings alone cannot be the benchmark to choose a bond. Let us not forget the rating debacles with Infrastructure Leasing & Financial Services and Dewan Housing Finance Corporation.

Moreover, all rating companies are not considered at par. Ratings from some established rating companies are more acceptable than ratings from others.

Some platforms offer bonds of state government-promoted companies. In fact, some have classified these for senior citizens and promote them as safe bonds. In the past, there have been cases of delays in state government-backed company bonds. Just having the state government as a promoter doesn’t make them sovereign debt. In fact, state government-promoted companies carry political risk and come under the IBC.

Investors are also buying ‘BBB’-rated bonds, based on hearing the company’s name in the media – for example, a new bank or startup with PE backing. But does that qualify them to be creditworthy? Even if they are secured or have a cover pool attached, a ‘BBB’ bond is best avoided.

One must check the security/covered pool. One of the sites lists the security as gold/vehicle/property/consumer/agri/card receivables and the pool security as personal loan/student loan/MSME loan receivables.

The problem is the difficulty in liquidating the loans given as security. Property takes time to sell and most of the other loans are given to people who are in need of funds. Credit card and personal loan receivables offer weak security compared to fixed assets. Further, the platforms will not help in recoveries and investors do not have the financial muscle to go after the issuer.

Finally, the platforms are not regulated and there is no legislation on bankruptcy protection, unlike in Western countries, where the cover pool is kept outside the bankruptcy estate of the issuer.

Reasons to be wary of lower-rated bonds

1) The platforms distributing the bonds are not regulated. This means there are no standardised disclosures or settlement or redressal systems.

2) The issuer and security are not good enough. Most bond issuers on these platforms are rated A and below. While A means adequate safety, it comes third in the rankings, below AAA and AA. This is not a desirable investment unless investors understand the risks and have the time and resources to track the financials of the underlying company and the ability to exit when they want to.

Further, the collateral provided may not be an exclusive charge, or financial institutions may have the first charge on the security. The security itself, as explained earlier, may not be enough or easy to access.

3) Enforcing collateral is cumbersome for individual investors. The largest banks are not able to recover dues from borrowers for years. It is unlikely individual investors have the wherewithal to do so.

4) The rates given to customers are very low for the credit profile. Individual investors have no way to check the right yields. Platforms make a good spread on these transactions, much more than the expense ratio charged by mutual funds. Higher costs never bode well for investors.

5) Most of the bonds available for purchase on the platforms are unlisted bonds, which are completely illiquid and investors are dependent on the platform to find them a buyer.

6) There is no deposit guarantee insurance and or sovereign guarantee. Hence, do not expect the government to help you in case of issues.

The key parameter to consider while choosing a bond is the quality of the issuer. Good quality issuers will not offer high interest rates, but you can expect return of capital. In the absence of highly rated, tax-efficient bonds, investors are better off sticking to professionally managed debt-oriented mutual funds.

Do not wait for a bad event to start looking deeper into alluring investments. Stay away from things that look too good to be true.

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