REC Tax-Free Bonds: A Good Opportunity For Long-Term Investment

Introduction

Tax-free bonds were given a nod in the Union Budget 2011-2012 and an aggregate amount of Rs 30,000 crore was the limit given to some of the companies to raise funds. In the Union Budget 2012 - 2013, the limit was doubled to Rs 60,000 crore. The objective of the government for issuing such kinds of bonds is to allow retail individual’s funds to participate in the growth of infrastructure development in India.

In this context, Rural Electrification Corporation (REC) is tapping the market to raise up to Rs 5,000 crore by issuing tax-free bonds in one or more tranches by March 2013. Of the total funds, the company has already raised around Rs 500 crore in the month of November 2012 and hence the remaining amount of Rs 4500 crore would be raised through the markets. The issue opens on Monday, Dcemeber 3 and will be closing on Monday, December 10. Of the total issue size, 40 per cent is allocated to retail individuals, 15 per cent each to no institutional investors (NIIs) and high net-worth individuals (HNIs) and the remaining 30 per cent to qualified institutional investors (QIBs). The funds raised would be used for general lending operations, achieve other associated business objectives and to discharge the existing debt obligations which were undertaken for business operations. 

About REC

Rural Electrification Corportaion (REC) is engaged in the financing and promotion of transmission, distribution and generation of power projects, including renewable energy projects, throughout India. As on September 30, 2012, its outstanding loan stood at Rs 1.11 lakh crore, growing at the rate of 24 per cent on a YoY basis. Of the total outstanding loan, around 82 per cent is towards the public sector entity, around 7 per cent towards the central PSUs and the remaining 11 per cent towards private companies. Further, the company is among those 16 public sector enterprises which enjoy the Navratna status because of operational efficiency and financial strength.

On the financial front, for the first half of FY13, the net interest income (NII) of the company increased by 31 per cent to Rs 2,445 crore while the net profit grew at a stupendous rate of 42 per cent to Rs 1,831 crore on a YoY basis. The net interest margin (NIM) for the same period increased by 23 basis points to 4.65 per cent, which is very commendable. However, it faced some headwinds when came to asset quality its NPA increased by 13 basis points to 0.38 per cent on a YoY basis.   .

About The Issue

The minimum application amount for the issue is of Rs 5,000, (i.e. five bonds of face value of Rs 1,000) and then one can apply in multiples of Rs 1,000.

Conclusion

We at Dalal Street Investment Journal (DSIJ) continue to believe that the Indian economy is growing at a very rapid pace but in the longer duration we may not see the same kind of higher interest rates which are being offered now. As the country grows, the interest rates tend to reduce, which is evident from the fact that a developed economy offers very low interest rates. Therefore, this type of an issue is a good opportunity for individuals who wish to invest keeping in mind a very long-term horizon.

Further, we believe that the issue is more attractive to investors who come under the higher tax brackets. In case of an individual who comes under the highest tax bracket of 30.9 per cent, for the first option s/he gets an effective yield (pre-tax yield) of 11.17 per cent while for the second option the yield is 11.40 per cent. For individuals falling into a smaller tax bracket, the benefit tends to be less as the fixed deposit rates for a period of around five years are in the range of 8.5 to 9 per cent (pre-tax).

These bonds are unlike the tax-saving infrastructure bonds which have a minimum lock-in period of five years and where the interest is taxable. Even though these bonds will be traded in the market one should note that the volume at the exchanges would be quite low. Hence, liquidity could be one of the problems. Also, there will be no tax deducted at source on the interest earned. We believe that those who are looking for investing in such kind of issues should grab the opportunity and not wait for the second tranche (in case it comes out) or for any other company that may have plans of tapping the market shortly.

In our opinion, such kind of issues, going ahead (especially coming in the March quarter of 2012), would carry a coupon rate which would be lower by around 15 to 30 basis points  than the current offering. Hence you can invest in the bond if you have a clear long-term horizon and do not require funds in the short run. Investing in the second option is better than the first one.