Should you go for PFC's tax-free bonds?
Dec 18, 2012 (Menafn - Mint - McClatchy-Tribune Information Services via COMTEX) --After Rural Electrification Corp. Ltd, last week Power Finance Corp. Ltd (PFC), a financial institution that lends money to institutions operating in the power generation and transmission segment and equipment manufacturers, launched its tax-free bond issue -- the second in this month. These bonds are called tax free because the interest earned is not taxed. PFC's issue size is Rs.1,000 crore for this first tranche of bonds, with the option to retain oversubscription up to Rs.4,950 crore.
Features
With a face value of Rs.1,000, subscribers have to buy a minimum of five bonds. These bonds are available in two series -- 10 years tenor and 15 years tenor. The interest rate is linked to the 10-year government securities yield and the company is offering an annual coupon in the range of 7.19% to 7.86%.
Similar to the REC issue, retail investors here too get an advantage of an extra 50 basis points (bps). So you can earn up to 7.69% per annum for the 10-year bond and 7.86% per annum for the 15-year bond through the retail category. Allotment will be on first-cum-first-serve basis and 40% of the issue is reserved for retail investors.
Ratings
ICRA Ltd and CRISIL Ltd have assigned AAA equivalent to the long-term borrowings of the company. At present, you won't find many other AAA-rated bond with a pre-tax interest of 11.37% per annum, which is what compares with the tax free interest of the PFC bond with the highest coupon of 7.86% per annum. Additionally, it is a government-owned entity, hence, default risk is minimum. Even though the sector itself is struggling, PFC's net profit rose at a compounded annual growth rate of around 15% in the last three years and non-performing asset as a percentage of loans is less than 1%.
Listing and trading
Bonds can be issued in physical or dematerialized form. If you hold the bonds in dematerialized form, you will be able to exit sooner, as listing is proposed. If bonds are sold on the exchange at a premium, you will have to pay capital gains tax. Long-term capital gain is applicable on listed bonds if sold after one year and calculated as 10% without indexation or 20% with indexation. Additionally, if you sell or transfer your bonds, the buyer will get the coupon reduced by 50 bps where the enhanced coupon for retail investors is applicable.
What should you do?
While the annual interest is better than the post-tax return of around 6.2-6.6% which you can earn today on one-year fixed deposits, remember this is a 10-15 year lock-in product. Consider your long-term fixed income allocation for this issue and not money you may need after a year or two. For fixed income investors, look at allocating money to this issue after you exhaust Public Provident Fund and Employee Provident Fund limits. With interest rates expected to decline going forward, you can invest to lock in a higher rate for a long period.
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