High risk bonds
High risk bonds are those bonds that have higher chance of default. The issuer's ability to pay interest on the bonds and pay back the principle on maturity is low due to weak financial health.
High risk bonds are rated close to default by the rating agencies and carry high yields. There are categories of investors willing to take risk on high risk bonds.
Credit enhancement through guarantees and collateral
High risk issuers normally can raise money from the bond market at very high interest cost, which adds to their financial burden. Ideally, if high risk issuers can get funds at cheaper rates, they can improve their financial performance, especially at times when business cycle is improving for them. They can even start to repay high cost debt and come out of a debt trap.
There are ways by which high risk issuers can raise funds at lower interest rates. A guarantee by a strong creditworthy entity can help the issuer to issue bonds at lower yields. Collateral from promoters, either cash or assets or equity can help issuers raise funds at lower yields. Guarantees and collaterals improve the credit rating of the bonds, which brings down the cost of funds for the issuer.
Recently traded yield level of some credit enhanced bonds:
Date | ISIN | Issuer | Coupon (%) | Maturity | Yield (%) | Rating |
27-May-21 | INE888F08030 | AJMER VIDYUT VITRAN NIGAM LIMITED | 9.8 | 30-Mar-31 | 8.82 | BBB(CE) |
27-May-21 | INE572F11273 | RAJASTHAN RAJYA VIDYUT PRASARAN NIGAM LIMITED | 0.0 | 31-Jan-27 | 9.02 | A-(CE) |
28-May-21 | INE888F08030 | AJMER VIDYUT VITRAN NIGAM LIMITED | 9.8 | 30-Mar-31 | 8.82 | BBB(CE) |
31-May-21 | INE888F08030 | AJMER VIDYUT VITRAN NIGAM LIMITED | 9.8 | 30-Mar-31 | 8.75 | BBB(CE) |
02-Jun-21 | INE540P07350 | U.P. POWER CORPORATION LIMITED | 10.2 | 20-Jan-28 | 9.31 | AA(CE) |
02-Jun-21 | INE540P07335 | U.P. POWER CORPORATION LIMITED | 10.2 | 20-Jan-26 | 9.29 | AA(CE) |
02-Jun-21 | INE572F11273 | RAJASTHAN RAJYA VIDYUT PRASARAN NIGAM LIMITED | 0.0 | 31-Jan-27 | 9.37 | A-(CE) |
High risk bonds turn low risk
High risk bonds that are covered by guarantees or collaterals see what is known as credit enhancement. On its own, high risk issuers can issue bonds at only very high yields but with credit enhancement, the issuer can issue bonds at lower yields. Such bonds will always trade at higher yields than bonds that carry similar rating and this offers investors a yield pick up. However, liquidity is low in such bonds and there should be a good liquidity risk premium for investors.
INRBonds rates such credit enhanced bonds through a proprietary risk model and helps investors with valuing the bonds correctly.
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