MTNL bond default: What retail investors can learn from it?

Kolkata: PSU MTNL has defaulted on bonds payments to the tune of Rs 8,659 crore at the end of July, the company disclosed to the stock exchanges. The firm's total debt reached Rs 34,577 crore on July 31 -- bank loans Rs 8,659.09 crore, sovereign guarantee bond Rs 24,071 crore and a loan for DoT for paying Sovereign Guarantee Bond interest of Rs 1,921 crore. But what are bond defaults and what lessons does the above piece of news have for retail investors, who are gradually considering investing in bonds more and more and equity markets experience turbulence.

The point to note is that a bond default take place when an agency that has issued a bond fails to pay interest/principal to the bondholders. The bonds on which MTNL defaulted carried sovereign guarantee. Retail investors should be aware of what bond defaults are, when can it happen.

Bond holders usually pin their hopes on payments for cash flow. Bonds are safer instrument compared to equity and equity-linked instruments such as mutual funds. Bondholders usually do not apprehend defaults from issuers of bonds. Therefore, if bond defaults occur, they can cause liquidity problems for investors. However, it must be said that the sovereign guarantee of MTNL bonds will eventually save the bondholders from loss. However, in the case of such an eventuality in bonds of private issuers, it could well be that investors will be completely at a loss about recovery timelines.

This uncertainty and unpredictability with payments can disrupt portfolio stability, performance, and cash flow planning. Retail investors must be prepared for such risks by ensuring appropriate diversification and maintaining a mix of investment-grade and government bonds for steady performance.

Investors need to do proper due diligence before investing in a bond and in this matter one should check ratings to the instrument assigned by agencies such as CRISIL and ICRA. The ratings range from AAA (highest safety, lowest risk) to D (default). Obviously the e higher the rating, the better since higher-rated bonds generally offer safety. Analysts say individual investors should consider ratings with their own due diligence. Also one must consult a qualified personal finance specialist.

Bond holdings should be diversified across issuers and maturities. Bonds with sovereign guarantee are always preferable since the government is liable to pay. The bond issuer's financial condition must be regularly kept under watch. The bond lexicon includes terms such as "grace periods" and "trustee roles". One must know them. "Grace period" usually refers to the time between the issue date of the financial instrument and the first principal repayment. The length of this grace period is specified in the bond's contract. Also, a bond trustee collects the funds to pay interest and principal on the bonds and receives financial and other periodic reports from the issuer. If a bond issuer defaults, the trustee notifies the bondholders and if necessary, enforces the bond obligations.