REC Tax Free Bonds

 I just applied for 1L worth of tax free bonds from the Rural Electrification Corp (REC) whose IPO opened today. This appears to be the last opportunity this year to buy tax free bonds and the application window is open till 12Mar (very small really). Unless you have pigged up heavily on fixed income, this issue should warrant more than a cursory glance by you. Here are the salient points from the prospectus (click here):

• Ratings: “CRISIL AAA/Stable”, “CARE AAA” , “FITCH AAA(ind)” and “[ICRA]AAA”. So from that perspective looks to carry a low credit risk
• No one’s underwriting the issue. No one wanted to or did the AAA ratings make REC say no to middlemen?
• Usual 3 categories but NRIs absent from the scope. Sad. This is apparently to ensure that the allotment etc gets done within this FY and some folks say that involving our foreign bhais will slow down things. In any case the previous issues by NHAI, HUDCO etc took more than a month to get listed.
• Interest of 8.13% for 10 yr and 8.32% for 15 yr bond for Category III (retail rats). 750 crores (25%) of the issue is reserved for Category III which means if more than 75,000 individual applications come in at cut-off, then the allocation game of dice will play out. Allotment will be made on a first come first served basis. In case it gets oversubscribed (which I assume it should) then if your application reached the bankers one day prior to the date when oversubscription occurred, you’d get the FCFS treatment else you’d get proportionate to your application amount. So it pays to apply early. The recent NHAI tax free issue was oversubscribed by 2.5 times.
• The NHAI tax free bond, while it took its sweet time to list, jumped up immediately when it listed on 7/8 of Feb’12. It went up some 2 – 3% during listing time – which means that tax-free bonds are best bought during their IPOs and not from the secondary markets.
• The 09.15 G-Sec maturing on 2024 (12 years to go) is trading at yield spreads of 8.27% – 8.28%. (http://www.ccilindia.com/OMHome.aspx)
• Interest will be payable yearly on 1Jul. Would’ve been nice for Category III to get a cumulative interest option. Even then, 10 yr bank deposits offer less than 10% today and when you bake in the tax benefit (if you are in the highest tax bracket, these bonds give you a return of ~11.5% or so.
• While you can apply in lots of 5 bonds (fv 1000/- each) you can sell one bond at a time, if you wish. Given heavy institutional interest for the 10 year paper, liquidity and therefore demand is likely to be high on that and therefore price of the bond on the secondary market (will list & trade on BSE) should be higher. If RBI does start dunking down interest rates towards the latter part of the year, then the price will canter up more. But capital gains tax will apply.  

It was good that IRFC’s (which is the financing arm of Indian Railways) budgeting went a bit awry (their plan size for FY11/12 was cut by 16%) and they could not use up their quota of tax-free bonds. That slack got transferred to REC instead of the Government allowing railways to roll over its unutilized portion to next FY. The Government had allowed INR 30,000 crores to be raised by infra sector PSUs during the current FY via the tax free bonds route. Assuming an interest payout of 8% this translates to a servicing cost of 2,400 crores. Assuming a low tax rate of 20%, this translates to INR 480 crores of income forgone by the Government which means a margin give up of 1.6%. But I guess that’s small change if you get INR 300 bn of capital in a year to fund infra building…

This is surely a good thing – I hope that the FM announces an even higher quota for the next FY.