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Tax-free REC bonds are a good bet for those in 30% tax bracket, say experts
December, 01st 2012

Power sector lender Rural ElectrificationBSE 0.66 % Corporation's (REC) 4,500-crore tax-free bond issue, which opens for subscription on Monday, presents an opportunity for investors to lock in money at higher yields and earn tax-free interest income. REC bonds, with a coupon rate up to 7.8%, will have takers in the secondary market once rates start moving downwards, wealth managers said.

The tax-free bonds, distributed under two series of 10 years and 15 years, offer coupon rates of 7.22% and 7.38%, respectively, for institutional and high net worth investors (HNIs). The company has also offered an additional interest of 0.5% for retail individual investors with investments up to 10 lakh. However, these bonds carry a step-down clause - the coupon gets reduced by 50 basis points for retail investors once the bonds get listed or the ownership of bonds changes hands.

"It is a good issuance... People falling under the 30% tax bracket should invest in these bonds," said Raghvendra Nath, MD of LadderupBSE 0.00 % Wealth Management.

According to Mr Nath, investors should take a long-term view on the bond issuance. It could be a part of the core fixed income portfolio, he said.

"On a pre-tax basis, the yield comes to about 11.4%. This is quite good considering the current interest rate scenario. Also, once interest rates start coming off, there will be higher accruals for bond investors. This being a long-term issuance, investors are also protected from issues like re-investments risks," Mr Nath said.

Last year, issuers offered up to 8.30% on similar tax-free bonds, but that may not be the case as yields on government bonds have come down by about 40 basis points over the last one year. The coupon offered on these tax-free bonds is linked to the yields on government bonds. Currently, the benchmark 10-year G-Sec is trading at 8.19% per annum.

The highlight of this issuance is the fact that REC, as per the directive of the Central Board of Direct Taxes, has set aside 40% of the issue to retail investors. "A 40% allocation is good enough to meet the entire retail investor demand," said a merchant banker involved with the issue.

According to wealth managers, HNIs may split their applications into smaller amounts (and in the names of the family members) to invest through the retail investor quota. "By doing so, they will get 0.5% higher coupon rate than what they would get under the HNI quota," a Mumbai-based debt arranger said.

"The retail portion is attractive because of the higher coupon rates. One has to see how HNIs and institutions react to the issuance. At 7.2-7.3%, these segment of investors have better fixed-income products in the market," said Hrishikesh Parandekar, CEO & group head (broking, wealth management and asset management), Karvy Group.

The REC bond issue is part of the government's budgetary plan to allow 10 state-run companies to raise as much as 60,000 crore selling tax-free bonds before March.

National Highways Authority of India, Housing and Urban Development Corp, National Housing Bank, Indian Railways Finance Corp, IIFCL, Ennore Port, Jawaharlal Nehru Port and Dredging CorporationBSE 1.27 % are among companies permitted by the government to sell tax-free bonds.

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