Rural Electrification Corporation (REC) has come out with a tax free bond issue offering 7.72% and 7.88% to the retail investors for a tenure of 10 years and 15 years, respectively. Interest received on the bond is fully exempt from income tax. The pre-tax yield on the bond for the highest tax bracket investors, therefore, works out to 11.17% and 11.40% for 10 years and 15 years, respectively, which is higher than the 8.5-9% yield on bank fixed deposit and other stable fixed income instruments. Given that REC is a government owned company, credit risk is very low. Hence, the REC tax free bond appears attractive vis-à-vis other fixed income instruments currently available for long term fixed income investment.
The Central Government, in exercise of the powers conferred by Section 10(15)(iv)(h) of the Income Tax Act, 1961, authorises REC to issue during FY12-13, tax free, secured, redeemable, non-convertible bonds up to Rs 5000 crore. Pursuant to the CBDT circular, the company has raised Rs 500 crore through private placement. Hence, the shelf limit stands reduced to Rs 4500 crore.
REC tax free bond comes with a coupon rate of 7.72% and 7.88% for 10 years and 15 years, respectively, for a retail investor and is the highest permissible rate that can be offered. The coupon on bond issued under the tax exempt clause is related to the prevailing Government Securities rates. The ceiling in the coupon rate for a AAA rated issuer is fixed at 65 basis points below the reference G-sec rate* for the retail investor and 115 basis lower for others.
It may be noted that the differential rate for retail investors shall be applicable only to the original allottee. In the event of sale/transfer by the original allottee of bond, the subsequent allottee will get the rates of the other investor's category. Hence, in order to get a higher coupon it is advisable to subscribe to this new issue now.
The bonds will be listed on both stock exchanges. The 10 year and 15 year REC tax free bond issued last year is currently trading at a yield of around 7.10% and 7.56%, respectively. All 10 year tax free bonds issued last year are currently trading at 7-7.5% yield to maturity (YTM) and have provided gains of 4-5% to existing investors. Given that interest rates are expected to decline, there can be a similar capital appreciation possibility over the next six months to one year.
We expect G-Sec rates to be lower supported by OMOs conducted by the RBI and possibility of a rate cut in the last quarter of the current fiscal year. Therefore, further issuance may come in at lower rates. Hence, it is advisable to lock in the current coupon rates.
Interest income on the bond being tax exempt pre tax yield works out to 11.17% and 11.40% for 10 years and 15 years, respectively, which is higher compared to 8-9.5% offered on bank FD or other stable bonds. Hence, the bond also scores over other fixed income instrument.
REC is engaged in financing and promotion of power generation, transmission and distribution including renewable energy projects throughout the country. State electricity boards are primary borrowers. A lot has been talked about the bad health of the SEBs. However, REC being a government owned organisation, investors may not be too concerned about the financial health of the company even if default from SEBs continues.
We believe the bond is a good investment option for a fixed income investor given its tax exempt status, good coupon rate and issuance from a government backed company.
Other issuers that are authorised to issue tax free bonds for FY13:
Indian Railway Finance Corporation (IRFC) India Infrastructure Finance Company Limited (IIFCL) Housing and Urban Development Corporation HUDCO) National Housing Bank (NHB) Power Finance Corporation (PFC) Jawaharlal Nehru Port Trust Dredging Corporation of India Ennore Port Limited National Highway Authority of India (NHAI) Disclaimer: The views and investment tips expressed by investment experts/broking houses/rating agencies on moneycontrol.com are their own, and not that of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.
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