Oct 18, 2013

TAX FREE BOND ISSUE OCTOBER 2013


Interest rates on bond issues may fall going ahead. Invest now.
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Invest in new bond issues as rates may fall going ahead

by

Nikhil Walavalkar, ET Bureau | 17 Oct, 2013


Tax-free bonds have caught the investor imagination lately. Housing and Urban Development Corporation’s (HUDCO) taxfree bond issue has raised Rs 2,405 crore when it closed on October 14. According to market participants, new issues from Power Finance Corporation (PFC issue is currently open) and National Hydroelectric Power Corporation (NHPC) are likely to mop up even bigger amounts from retail investors.

However, amid the euphoria - 8.92 per cent tax-free interest for 20 years - there is a bit of confusion among retail investors. Many of them are wondering whether they should wait for a few more days or weeks for new issues with even higher rates. For example, many investors were extremely eager to subscribe to HUDCO bond issue when it opened a month ago, but had second thoughts about the issue when PFC announced that it was offering 8.92 per cent for 20-year term. Suddenly, the coupon of 8.76 per cent for 15-year tenure that HUDCO offered looked too little.

Now, NHPC also has matched the interest rates offered by PFC and investors are - well, to put it mildly - greedy. They would like to take their chances and would like to wait for better returns.

However, investment experts are busy asking their clients to put their money in the on-going issues. "Do not wait for higher interest rates. You should lock-in your money in the ongoing tax-free bonds as the interest rates may move down gradually," says Deepak Panjwani, head-debt markets, GEPL Capital. And institutional and high net worth investors, are seen subscribing to his views. On the first day of PFC issue, it got bids worth Rs 2,332 crore against the maximum issue size of Rs 3,875 crore.

Should You Join the Party? 
Sure, you don't have to base your investment decisions on others in the market, but a look at the macro-economic factors indicate a possible fall in interest rates. RBI has reduced interest rates on marginal standing facility to banks to 9 per cent from 9.5 per cent recently. Put simply, banks can now raise funds for a period of up to 14-days at 9 per cent. Market participants believe this is the first step towards unwinding of all strict measures that RBI has taken to stop the fall in the rupee.

If this theory holds, you may see tax-free bond issues with lower interest rates in future. It is true that short-term rates may take cues from such events and head downwards soon, long-term interest rates may take some more time as inflation expectations continue to be moderate.

For September, wholesale price index, a gauge of inflation, stood at 6.46 per cent against 6.1 per cent in August, primarily due to high food prices. However, experts bank on inflation tapering off in coming months. Towards the end of the year, we should see food prices going down due to arrival of new crops, which should partly address food inflation.

Another major component of inflation has been the rising prices of LPG and diesel, which many believe would be halted because of the upcoming elections. Though a hike in key rates by RBI in October cannot be ruled out, market participants believe the long-term rates should start falling in the medium term. "We cannot ignore the dwindling growth. IIP numbers for August stood at 0.6 per cent. As US dollar stabilises against the rupee, RBI's focus should shift to boosting growth and it will gradually start reducing interest rates," says Vikram Dalal, MD, Synergee Capital Services.

As and when RBI decides to bring down interest rates, the coupon on the forthcoming tax-free bonds may not be as high as PFC and NHPC. As the interest rates start their movement downwards, borrowers may decide to wait for a while before hitting the market with their new issues.

This may deprive you an opportunity to invest at higher rates, experts say. Borrowers would be keen to issue bonds at lower interest rates. 

A case in point is SBI, which on October 10 reduced the interest rates by 50 basis points to 8.5% on bulk deposits for seven days to 60 days. Such moves may force you to invest at lower interest rates.

What Should be Your Strategy? 
"These bonds are very good investment options for retired individuals. They can simply buy and hold these bonds to enjoy timely tax-free income," says Abhishek Gupta, CEO, Moat Wealth Advisors. They are a good option for even those in active service as they can earn tax-free returns. Also, it is assured for a longer period of 15 to 20 years.

"You may choose to invest in staggered manner. Invest a major chunk of your investible money in both PFC and NHPC," says Deepak Panjwani.

Do not wait for the last day of the issue as it may be subscribed early, even in the retail category. A small component of your money can be kept with you for future bond issuances if you are expecting even higher coupon, though most experts ascribe a very low probability to such a scenario.

You can also play the interest rate cycle using 20-year bonds. If the interest rates fall by 100 bps over next one year, you will witness double-digit capital gains on these bonds, in addition to the taxfree interest.
Experts point out that investors in the first series of tax-free bonds issued two years ago have already booked profits in the secondary market. The biggest advantage here is the negligible credit risk, which should keep these bonds in demand in the secondary market, which will ensure liquidity for investors.
POWER FINANCE COMPANY LTD
(PFC)


Oct 14 - Nov 11
Product Note
NATIONAL HYDROELECTRIC POWER CORP LTD (NHPC)
Oct 18 - Nov 11
Product Note
INDIA INFRASTRUCTURE FINANCE CO LTD (IIFCL)
Oct 3 - Oct 31
Product Note
Bond Coupon Rates for Retail Investors

Company Rating 10 yr 15 yr 20 yr
PFC [CRISIL] AAA/Stable 8.43 8.79 8.92
NHPC [ICRA] AAA 8.43 8.79 8.92
IIFCL [ICRA] AAA/Stable 8.26 8.63 8.75
 


Pre-Tax Bond Yield (PFC & NHPC)
for Comparision with other investment opportunities


  10 yr 15 yr 20 yr
Tax Free Coupon rate 8.43 8.79 8.92
       
Tax Rate Pre-tax yield
10.30% 9.40 9.80 9.94
20.60% 10.62 11.07 11.23
30.90% 12.20 12.72 12.91


HDFC Ltd (AAA Rated) offers 9.75% for 15-month investment. In comparison, the tax free bonds from AAA rated government companies offer a much better yield. And are for a longer tenure. Remember that in the long run, interest rates are expected to fall.

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