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 [email protected]
Many of the investors have been waiting for the tax-free bonds to be issued during 2012-13. In the annual budget in March this year, the former Finance Minister, Pranab Mukherjee, had proposed tax free bonds to the tune of Rs. 60,000 crore for the companies in the infrastructure development or infrastructure finance space.
After waiting for more than seven months, the wait seems to be coming to an end. The notification for the tax free bonds for financial year 2012-13 has been released by the Ministry of Finance on tuesday, November 6th. Here is the Taxmann link to the notification.
NHAI, IRFC, PFC, REC and HUDCO have been allowed to issue these bonds again this year and IIFCL, NHB, JNPT, Dredging Corporation and Ennore Port will be the new entrant issuing these bonds this year. These bonds will be issued for 10 years, 15 years or 20 years. IIFCL is the only company among the ten companies which has been allowed to issue these bonds for 20 years.
Like it is done in most of the bond issues, the investors would be classified in the following four categories:-
1) Retail Individual Investors (RIIs)
2) Qualified Institutional Buyers (QIBs)
3) Corporates
4) High Net Worth Individuals (HNIs)
Most importantly, the definition for the “Retail Individual Investors†has been modified. As per the notification, Retail Individual Investors would mean those individual investors, Hindu Undivided Families or HUFs (through Karta), and Non Resident Indians (NRIs), applying for upto Rs. 10 lakhs in each issue. Individual investors investing more than Rs. 10 lakhs will be classified as High Net Worth Individuals (HNIs).
Last year, the limit for the retail investors was Rs. 5 lakhs and if you remember, REC had set the limit at Rs. 1 lakh earlier and then reset it back to Rs. 5 lakhs when the issue got a poor response on the first day of its offer period in the retail investors category.
Like last year, there would be an applicable ceiling on the coupon rates offered by the issuer companies, based on the reference Government security (G-sec) rate. The ceiling coupon rate for ‘AAA’ or ‘AA+’ rated issuer companies will be 65 basis points (or 0.65%) less than the reference G-sec rate in case of Retail Individual Investors and 115 basis points (1.15%) less than the reference G-sec rate in case of other investors like Qualified Institutional Buyers (QIBs), Corporate and High Net Worth Individuals (HNIs).
In case of issuer companies having credit rating of ‘AA’ or below, the ceiling coupon rate will be 50 basis points less than the reference G-sec rate in case of Retail Individual Investors and 100 basis points less than the reference G-sec rate in case of other investors.
Retail investors would be eligible to a higher rate of interest to an extent of 50 basis points. The higher rate of interest, applicable to the retail investors, will not be available in case the bonds are transferred, except in case of transfer to legal heir in the event of death of the original investor.
As per the notification – “The reference G-sec rate would be the average of the base yield of G-sec for equivalent maturity reported by Fixed Income Money Market and Derivative Association of India (FIMMDA) on a daily basis (working day) prevailing for two weeks ending on Friday immediately preceding the filing of the final prospectus with the Exchange or Registrar of Companies (ROC) in case of public issue and the issue opening date in case of private placementâ€.
Last year, Central Board of Direct Taxes (CBDT) had stipulated that in case of public issue, the interest rates on these bonds were not to be less than 50 basis points lower than the yield on government securities of equivalent residual maturity as reported by FIMMDA on the last working day of the month preceding the month of issue of bonds. Also, the same formula was applicable to all categories of investors. So, this year the differential gap between the interest rate for the retail investors and the interest rate for other investors has been increased to 50 basis points.
If the issuer entity has been rated by two rating agencies and their assigned ratings are different, in that case the lower of the two ratings will be applicable to the issuer company and accordingly, the company might be able to offer a higher coupon rate.
In case the issuer company decides to make the interest payments semi-annually, it will have to lower the coupon rate by 15 basis points or 0.15%.
The companies are allowed to issue these bonds either through public issues or private placements. As per the notification, at least 75% of the authorised amount of bonds issued by each entity will have to be raised through public issues. For instance, NHAI and JNPT will have to raise at least Rs. 7,500 crore and Rs. 1,500 through public issues respectively.
The maximum issue size in each tranche of a private placement can only be Rs. 500 crore. In case of public issues, 40% of each such issue will be reserved for the retail investors category.
Last year, these tax free bond issues got a super response and off late, all these bonds have given a very handsome returns to the investors. With the interest rates falling this time around, it seems to me that the bonds already listed on the exchanges would still remain in high demand. Lets see which company comes out with the first bond issue this time.
The proposed bond sale of JN Port has been assigned a AAA + rating by Brickwork Ratings. Ennore has a AA- rating from Brickwork. These ports have asked the Govt to provide comfort letters.
http://www.livemint.com/Companies/5n2oJ8tdzbIoFyArX0E4ON/JN-Port-Ennore-Dredging-Corp-may-sell-taxfree-bonds.html
Leave a message…
Off late I am seeing that IIFCL, PFC & REC have already started issuing tax free bonds. Is it true ? I dont see them in ICICI Direct to subscribe ? Can you please confirm if they have already started issuing for retail subscribers ?
Thanks, Karthik
Hi Karthik… IIFCL, PFC and REC have not been issuing these bonds to the retail investors. That is the reason they are not available with any of the brokers like ICICI Direct etc. REC has filed DRHP with SEBI and will be out with its public issue very soon.
what is the coupon offered by IIFCL tax free bond? when does it end and what is the current subscription?
Hi Shashwat… IIFCL has been issuing these bonds to the investors other than the retail investors through private placements. These offerings open and close on the same day. IIFCL has done a couple of placements so far and the rates offered were 7.21% p.a. for 10 years, 7.38% p.a. for 15 years and 7.41% p.a. for 20 years.
So for retail investors can we expect 7.%-8%?
It would be 50 basis points (0.50% p.a.) higher than the above mentioned rates i.e. 7.71% for 10-year bonds, 7.88% for 15-year bonds and 7.91% for 20-year bonds. But only during the initial offer period. Buying from the secondary markets would push them back to the same rates.
There is news item about issue of tax free bonds in January 2013. Pl see the news at
http://epaper.financialexpress.com/68800/Financial-Express-Mumbai/17-November-2012#page/2/1
Thanks Mr. Arun for the link!
I stand corrected on the volumes and value– but still not v large.
Liquidity is a problem in the bond market.
Thank you.
The value traded is not v high– 14 lacs, 18 lacs, with 99% delivery on NSE.
This was quite helpful.
Thanks everyone for an interesting discussion.
I have been watching the price of 2012 bonds move upwards steadily… and somehow the interest does not justify the current premium and brokerage over investing at 7.75%… am I missing something here?
Or people are going for what is certain over what may be tentative, the interest on bonds issued 2013 ?
No body is clear about the terms for 2013 bonds. The interest rates on new bonds could be substantially lower if their IPO comes after fall in interest rates by RBI. Investors are therefore flocking for old bonds. In my personal opinion, the prices for 2012 bonds do not justify investment and you better wait for 2013 bonds.
Hi Austere,
I think the upmove in the prices of these tax free bonds is the result of buying interest from the institutional investors/mutual funds. I think they are buying these bonds due to various reasons – 1) They expect overall interest rates to head lower in future. 2) They also had an idea that tax free bonds this year would carry a lower rate of interest as compared to the last year. 3) Their transaction costs/brokerages are lower than that of the retail investors, so they dont mind buying them from the secondary markets, if they spot the opportunity. 4) They would get a lower rate of interest of 7.25% this year, if the coupon rate for the retail investors is set at 7.75%. 5) Last year’s NHAI and PFC tax free bonds did not carry the “Step-Down” feature, so the buyers would still be getting the same coupon rates.
What is the current “Reference G-sec rate”? Is there a website where this information is available?
Can we assume that the Reference G-sec rate would be roughly around 0.25% lower than now, if Mr. Rao obligies in January?
Hi Deepak… The reference G-Sec rate is not a readily available rate and has to be calculated, so you wont find it anywhere. Moreover, the G-Sec yield might or might not move by the same quantum as the RBI rates move, not even the same direction sometimes when the expectations are not met.
With announcements of tax free bonds from various government backed companies likely shortly, I am sure this excellent website will be flooded with interesting queries – one being choice between already issued 2012 bonds and the new bonds. The investors normally overlook the liquidity aspect and fous only on current yield while making decisions. The tenure of bonds being 10/ 15 years, liquidity is very important. The 2012 bonds have shown reasonably easy liquidity at least for small investors who want to sell say bonds up to Rs 1,00,000 during last 6 – 10 months since their issue. This is more because of the the rate arbitrage due to falling rate scenario. The bond market in India being small, how liquid the bonds will be in future is yet to be seen.
Further, the calculations made by various experts do not include transaction costs. If you want to trade the bonds like shares, pl do not overlook the impact of transaction cost on your investment decision. The transaction cost when you purchase such bonds could be Rs 5 – 10 per bond of face value Rs 1,000 or market price of Rs 1,050 – 1,100. This will push the actual yield to be lower than that shown by experts.
I have done calculations for various 2012 bonds available for purchase in secondary market using their closing price on 12-Nov-2012 and find that through their current yield may vary, the yield to maturity for all of then is by and large the same – 7.2% for 10 years and 7.4% for 15 years tenure. Those who are likely to sell their bonds in near to mid term in/ after Mar-2013, should buy HUDCO bonds to book short term losses. For investors likely to keep the bonds for long period, all bonds are similar.
The Government notification for 2013 tax free bonds is available on website http://www.taxmann.com/taxmannflashes/whatsnew.aspx?sid=13099
There has been a popular notion that this year these bonds will have a meager demand. Is that true ?
Also everyone is expecting the rate of interests to be lower than previous year. Is it worthful to invest in these even this year ? Can you please let me know your thoughts ?
Hi Karthik… Retail demand will primarily depend on the interest rates these companies are going to offer. Interest rates will definitely be lower this year. Almost all the factors, primarily being 0.50% interest rate differential, suggest that there will be lesser demand from other categories of investors.
Even the supply will also be muted this year. NHAI is not sure of issuing these bonds this year and the govt. has already reduced the bond issue size to Rs. 53,500 crore from Rs. 60,000 earlier.
But, I think the response will still be good if the interest rates for the retail category are somehow fixed at around 7.75% or more.
Thanks for the reply Shiv. You mean to say it is ideal to subscribe to these if interest rate for retail is >= 7.75%. Right ?
I did not necessarily mean that. 7.75%+ is just an indicative interest rate, I think, good enough to attract retail participation in the present interest rate scenario and looking at the current YTMs already listed tax-free bonds are offering. Whatever changes happen here onwards might also change the outlook for these bonds.
I made a google search for current 10 year GSEC rate. Among the URLs listed, the first one was fimmda.org. Per this website the current rate is 8.15%. We can thus expect the rates between 7.0 – 7.65 percent depending upon the tenor and rating.
Thanks Arun!
8.15% is semi-annualised. So, you can add another 0.15% to the above rates, making them 7.15% to 7.80%. Right?
Thanks.
I didn’t understand the concept of ceiling coupon rate and why it is lower than G-Secs? I probably need to read the details, but shouldn’t the yield always be higher than for corresponding G-Secs?
Hi DJ… Interest earned on G-Secs is taxable and it is tax free here with these bonds. The effective yield for an investor in the 30% or 20% tax bracket is higher with these bonds. Coupon Rate Ceiling is there as the govt loses tax revenues due to these bonds.
Hi Shiv.. Duh! I forgot about the tax implication. Somewhat defeats the purpose of the tax free nature of the bonds… if the effective yield after tax is going to be the same. No free lunch anywhere…
For 30.90% tax bracket investor, 8.30% tax free (last year) = 12.01% taxable;
For 20.60% tax bracket investor, 8.30% tax free (last year) = 10.45% taxable;
This year the interest rates have fallen somewhat. Lets see what coupon these companies offer this time.
I don’t know if its useful to use tax bracket rates for comparison. Isn’t the more appropriate comparison against a long term gilt debt fund, which would incur 10% tax?
Tax bracket comparison is done as these bonds carry fixed interest rate on the investments like FDs. Debt funds do not provide any fixed interest income. Also, more than 95% fixed income investors are invested in FDs and only a few percentage investors are invested in Gilt Funds or Income Funds.
Fair enough. Its not right to compare a portfolio of bonds to a single issue. The large difference in tax rates is interesting though…
Last year’s 8.30% NHAI Tax-Free bonds have already given around 15% returns in the last 9-10 months and still there is buying happening in the secondary markets. That shows there is huge interest for these kind of bonds, if the coupon rates are good.
Actually, it seems like DTC will do away with lower taxes on debt LTCG and interest income. If so, maybe such tax free issues need to be evaluated under those rules, which will make them more attractive. With the DTC guidelines, debt funds LTCG and dividends (or rather interest income) will be taxed at the income tax rate… under those rules, it will make sense to invest in debt as much as possible via equity oriented funds or tax free bonds. Any thoughts on this? Thx.
I’m least interested in “What after DTC”. I’ve never seen some investor-unfriendly moves in the last budget before the elections and hence do not expect any retrospective moves. If DTC and GST are introduced in the next six months or so, I’ll move all my debt investments to equity. I’m already bullish on equities.
Good point that the changes might not be retrospective. Probably a good call to be bullish if DTC/GST gets done. 🙂
dear Mr. Shiv
Thanks for timely information regarding tax free bonds. My question which probably every investor will like to know out of these which one should be bought and how much safe they are. Are these bonds chargable to the Govt of India Funds and guaranteed by GOI.
Thanks once again
Dear Mr. Brij Kumar Singh,
These bonds do not carry any sovereign guarantee by the Govt. of India, rather these are rated by the rating agencies. The higher the credit rating, the more safe the bond issue is considered. But, as these are government organisations, these bond issues are considered relatively safe. Which one is to be bought depends on several factors, including the offered interest rate, and can only be determined once the issues are open for subscription.
Thanks a lot for the details, Shiv.
Could you please update this thread (or reply in a comment) when the final dates are out…
Sure Deepak, that will be done without saying!
Thanks Shiv for the details!
You are welcome Amlan!
hi!
kindly let me know what is better and why —
Investing Tax Free Bonds in Forthcoming Primary issues or in the existing secondary market?
Hi Ramesh!
It is a difficult call to take till the time these companies announce the coupon rates on their respective issues. I’ll try to do a post on this topic once the issues start pouring in.