Really good calculation of yield …

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From: Sent: Thursday, December 13, 2012 7:37 AM
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Subject: PFC Tax Free Bonds Review

PFC Tax Free Bonds Review

Posted: 12 Dec 2012 08:26 AM PST

This post is written by Shiv Kukreja, who is a Certified Financial Planner and runs a financial planning firm, Ojas Capital in Delhi/NCR. He can be reached at skukreja@investitude.co.in

Power Finance Corporation (PFC) will be launching the second public issue of tax-free bonds this financial year (FY 2012-13) from the coming Friday, December 14th, 2012. The company plans to raise Rs. 1,000 crore in this issue with an option to retain oversubscription to the tune of Rs. 3,590 crore, making the total size of the issue to be Rs. 4,590 crore.

PFC plans to use the proceeds for company's lending purposes, debt servicing and
working capital requirements, subject to the terms and conditions of the CBDT Notification.

Details of the Issue

Categories of Investors

As with all these issues, the investors would be classified in the following four categories:

Category I – Qualified Institutional Buyers (QIBs)
Category II – Non-Institutional Investors (NIIs) or Corporates
Category III – High Net Worth Individuals (HNIs)
Category IV – Retail Individual Investors (RIIs)

40% of the issue is reserved for the retail investors, another 20% of the issue is reserved for the high net worth individuals (HNIs) i.e. for the individual investors investing above Rs. 10 lakhs. 25% of the issue is reserved for the institutional investors and the remaining 15% is for the corporate investors.

Rate of Interest/Coupon Rate

There is not much difference between this issue and the REC bonds issue which closed on Monday, December 10th. PFC will pay a base coupon rate of 7.36% and 7.19% per annum to the Category I, II and III investors with a maturity period of 15 years and 10 years respectively.

As with the REC bond issue, PFC will also pay an additional coupon of 0.50% p.a. to the retail investors over and above the base coupon rate, making it 7.86% and 7.69% per annum respectively. Interest will be payable annually as there is no cumulative interest option.

But, the additional incentive of 0.50% will be payable to the original allottees only who invest in these bonds during this offer period. In case these bonds are sold or transferred by the original allottees, except in case of transfer of bonds to legal heir in the event of death of the original allottee, the coupon rates will be revised downwards to the base coupon rates.

The interest earned will be exempt from tax under section 10 (15)(iv)(h) of the Income Tax Act, 1961.

Retail investors can invest up to Rs. 10 lakhs in the issue and still get the additional coupon of 0.50%. The company has decided to keep the minimum investment requirement of Rs. 5,000 (or 5 bonds of face value Rs. 1,000).

Listing, Safety and other features of the Issue

Demat account is not necessary to invest in these bonds. Investors have been given the option to apply these bonds in physical form also. Like last year, PFC bonds are going to list only on the Bombay Stock Exchange (BSE).

NRIs and foreign nationals among others are not eligible to invest in this issue. The allotment will be made on a "first-come-first-served" basis.

The issue has been rated 'AAA' by CRISIL and ICRA. The issue is secured in nature and in the event of default, the bondholders can claim a charge upon the assets of the company in connection with these bonds.

The issue will close on December 21st, 2012. The bonds will get allotted and listed within 12 working days from the closing date of the issue.

How 7.86% is fixed and will the forthcoming tax-free bond issues carry higher rate of interest?

This financial year, there is a ceiling on the coupon rates these companies can offer based on the reference Government Securities (G-sec) rate. The coupon rate for 'AAA' rated issuers cannot be more than the reference G-sec rate minus 65 basis points (bps) or 0.65% in case of retail investors and G-sec rate minus 115 bps or 1.15% in case of QIBs, corporates and HNIs.

The reference G-Sec rate is the average of the base G–sec yield for equivalent maturity reported by the Fixed Money Market and Derivative Association of India (FIMMDA) on a daily basis prevailing for two weeks ending on the Friday immediately preceding the filing of issue's prospectus with the designated stock exchange and the Registrar of Companies (RoC).

So, if the 10-year benchmark G-sec rate is 8.17% p.a. payable semi-annually, the reference G-sec rate would be equal to (((1+(0.0817/2))^2) – 1) * 100 = 8.34% p.a. Hence, 65 bps less than 8.34% p.a. is 7.69% p.a. payable annually.

Keeping this ceiling and slow economic growth into consideration, I do not think the future tax-free bond issues would be able to carry a higher rate of interest. In fact any interest rate cut by RBI due to an unexpected and further fall in economic growth would force the issuers to lower their coupon rates.

About Power Finance Corporation Limited

Power Finance Corporation is a listed Government of India undertaking with 73.72% stake held by the govt. The company provides financing to state electricity boards (SEBs), state generating companies and independent power producers (IPPs) for a range of power-sector activities including generation and distribution.

Performance of the PFC tax free bonds issued last year

Tax free bonds issued last year have given quite handsome returns to the investors in the range of approximately 15%-20% annualised. PFC tax free bonds closed at Rs. 1,086.10 on December 11th, 2012 carrying a YTM of 7.43%. These bonds paid a mid-year interest also on October 15th, 2012.

Given the current YTM of 7.43%, the rate of interest of 7.86% or 7.69% is still attractive for the retail investors in the 30% or 20% tax bracket with medium-term to long-term perspective.

REC has got a good response for its bond issue from the retail and HNI investor categories, probably because it was the first issue of these popular tax-free bonds. The timing of PFC issue is interesting as the RBI will be announcing its next monetary policy measures on December 18th. In case there is a rate cut by RBI, then the issue will become quite attractive for the retail investors and they can expect an appreciation in the market price of these bonds.

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1. Should you book profits in last year's tax-free bonds to invest in new tax-free bonds?

2. REC Tax Free Bonds Review

3. PFC Tax Free Bonds Review