Are tax free bonds (Tranche-I) from PFC worth investing?
Dec 19, 2012

Author: PersonalFN Content & Research Team

Power Finance Corporation (PFC) one of Navratna Public Sector Undertaking (PSU) registered with the RBI as a Non-Banking Financial Company (NBFC) is at present offering until December 21, 2012, its tax-free secured redeemable non-convertible bonds for subscription. But before we go to the details of the offer and the yield one will fetch, here’s an overview about the company followed by business analysis.

Company Overview

PFC is classified as an Infrastructure Finance Company (NBFC-ND-IFC), and is incorporated with an objective to provide financial resources and encourage flow of investments to the power and associated sectors, to work as a catalyst to bring about institutional improvements in streamlining the functions of its borrowers in financial, technical and managerial areas to ensure optimum utilisation of available resources and to mobilise various resources from domestic and international sources at competitive rates.

The company was conferred the status of Navratna by the Department of Public Enterprises (DPE) in 2007, and is a Government of India (GoI) entity, who has a well-established relationships with State Governments, regulatory authorities and major power sector organisations, Central and State power utilities, as well as private sector power project developers. The company has thus far expanded it projects that represent forward and backward linkages to the core power sector projects, including procurement of capital equipment for the power sector, fuel sources for power generation projects and related infrastructure development. The company being an NBFC and classified as an Infrastructure Finance Company (IFC) in 2010, enables them to effectively capitalise on available financing opportunities in the power sector in India and as a Government owned company loan made by them to Central and State entities in the power sector, are exempt from Reserve Bank of India’s (RBI's) prudential lending (exposure) norms (which are otherwise applicable to non-government owned entities in the power sector). Having said that the company strives to lend to Central and State entities in the Indian power sector by following prudent lending norms and guidelines approved by the Ministry of Power (MoP). Likewise for lending to non-Government entities in the power sector, it follows the norms stipulated by the RBI.

The company’s primary sources of funds include equity capital, internal resources and domestic & foreign borrowings. It currently enjoys highest credit rating (of "CRISIL AAA/Stable" and "ICRA AAA") for long-term domestic borrowings and “P1+” and “A1+” from CRISIL and ICRA, for its short-term borrowing.

Business Analysis

PFC provides various services and financial products like Project Term Loan, Equipment Lease Financing, Discounting of Bills, Short Term Loan, and Consultancy Services etc. for various power projects in generation, transmission, and distribution sector as well as for renovation & modernization of existing power projects to generate revenue.

Apart from funding, PFC is also entrusted the responsibility to exploit new opportunities in the area of consortium lending, lending to capital equipment manufacturers and fuel supply projects and related infrastructure development projects, renewable energy and Clean Development Mechanism (CDM), and equity funding.

Company’s total loan assets stand at Rs 1,45,967.26 crore as on September 30, 2012, as against Rs 1,10,421.25 crore as on September 30, 2011 – which is an increase of 32%. The total operating income of the company from the aforementioned activities stood at 8,131.38 crore as on September 30, 2012, thereby registering a growth of 34.4% from the figure posted last year on the same date. The net operating profit of the company even after providing for extraordinary reported stood at Rs 2,008.37 crore for the half year ended September 30, 2012, reflecting a jump of 81.7% as compared to half year ending of last year (i.e. September 30, 2011). As on September 30, 2012, the company has extended long-term loans and advances to the tune of Rs 1,23,286.97 crore (an increase of 10.1% since the last financial year), while the company has reduced its lending for short-term loan purpose by -51.7% since the last financial year, thereby placing the exposure at Rs 2,986.74 crore as on September 30, 2012.

As far as companies own exposure to its borrowings is concerned, long-term borrowing have increased by 10.1% since March 31, 2012 to September 30, 2012, placing the figure for September 30, 2012 at Rs 1,05,580.72 crore. Likewise in case of short-term borrowings there’s an increase of 15.1% since March 31, 2012 figure of Rs 4,071.20 crore. The company had Non-Performing Assets (NPAs) worth Rs 1,358.47 crores as of March 31, 2012, which represented 1.04% of their total loan assets on same date. But a noteworthy point is that the company’s capital adequacy ratio which indicates a company’s ability to absorb losses stands at 15.38% as of March 31, 2012, which is little over the RBI’s limit of 15.00%.

The details of the offering (Tax free bonds) are as follows:

Eligible Investors
Issuer	Power Finance Corporation (PFC) Limited
Offering	Public Issue by PFC Ltd. of tax free bonds of face value of Rs 1,000 each, in the nature of secured, redeemable, non-convertible debentures, having benefits under section 10(15)(iv)(h) of the Income Tax Act, 1961, aggregating Rs 1,000 crore with an option to retain an oversubscription upto the Shelf Limit (i.e. Rs 4,590 crore).
Rating	'CRISIL AAA/Stable' by CRISIL &, 'ICRA AAA' by ICRA,"
Security	The Bonds proposed to be issued are secured by a charge on the book debts of the Company and/ or identified immovable property by a first/ pari passu charge, as may be agreed between the Company and the Debenture Trustee, pursuant to the terms of the Debenture Trust Deed to be created within three months of the Issue Closing Date, in accordance with the SEBI Debt Regulations.
Security Cover	At least 100% of the outstanding Bonds at any point of time.
Face Value	Rs 1,000 per bond
Issue Price	At par (Rs 1,000 per bond)
Minimum Subscription	Rs 5,000 and in multiples & in multiples of 1 bond thereafter (i.e., Rs1000)
Tenure	Tranche-1 Series I: 10 years Tranche-1 Series II:15 years
Coupon rate	Tranche-1 Series I: 7.19% p.a. for category I, II, III; and extra 0.50% for category IV investors Tranche-1 Series II: 7.36% p.a. for category I, II and III; and extra 0.50% for category IV investors
Frequency of Interest Payment	Annually
Trustee	IL&FS Trust Company Limited
Listing	BSE
Depository	National Securities Depository Limited and Central Depository Services Limited
Registrars	MCS Limited
Issuance	In dematerialized form and physical form
Issue Open Date	December 14, 2012
Issue Close Date	December 21, 2012
Deemed Date of Allotment	Deemed Date of Allotment shall be the date on which the Directors of the Company or any committee thereof approve the Allotment of the Bonds for each Tranche Issue.
Category I	Public Financial Institutions, scheduled commercial banks, multilateral and bilateral development financial institutions, state industrial development corporations, which are authorised to invest in the Bonds; Provident funds and pension funds with minimum corpus of ' 25 crores, which are authorised to invest in the Bonds; Insurance companies registered with the IRDA; National Investment Fund set up by resolution no. F. No. 2/3/2005-DDII dated November 23, 2005 of the Government of India published in the Gazette of India; Insurance funds set up and managed by the army, navy or air force of the Union of India or set up and managed by the Department of Posts, India; Mutual funds registered with SEBI; and Alternative Investment Funds, subject to investment conditions applicable to them under the Securities and Exchange Board of India (Alternative Investment Funds) Regulations, 2012.
Category II	Companies within the meaning of section 3 of the Companies Act and bodies corporate registered under the applicable laws in India and authorised to invest in the Bonds.
Category III	The following Investors applying for an amount aggregating to above Rs 10 lakhs across all Series of Bonds in the Issue: Resident Indian individuals; and Hindu Undivided Families through the Karta.
Category IV	The following Investors applying for an amount aggregating upto and including Rs 10 lakhs across all Series of Bonds in the Issue: Resident Indian individuals; and Hindu Undivided Families through the Karta

Note: PAN card is mandatory for subscribing to these Bonds. A self-attested copy shall be enclosed along with the application form. Investors (across all categories) will also have the following options available at the time of subscribing to the issue:

Tranche-1

Series I

Series II

Minimum Application/ Face Value

Rs 5,000

In Multiples of

Rs 1,000

Tenor

10 years

15 years

Interest Payment

Annual

Put /Call Option

None

Coupon

Category I	Category II	Category III	Category IV
7.19%	7.19%	7.19%	7.69%

Category I	Category II	Category III	Category IV
7.36%	7.36%	7.36%	7.86%

Yield on Redemption

Category I	Category II	Category III	Category IV
7.19%	7.19%	7.19%	7.69%

Category I	Category II	Category III	Category IV
7.19%	7.19%	7.19%	7.86%

(Source: Draft prospectus registered with SEBI. & PersonalFN Research)

Well, after reading the details of the tax free bonds (as provided above), there may be still some more questions cropping up, which are answered hereunder:

For what purpose the proceeds from the bond issue will be used?

The funds proposed to be raised through the Issue shall be utilized towards lending purposes, debt servicing and working capital requirements of the company. The proceeds from the issue will be utilised only upon creation of security (as stated in the table above), receipt of the listing and trading approval of the company. The Issue proceeds shall not be utilized for providing loan to or acquisition of shares of any person who is part of the same group or who is under the same management as that of PFC.
Is there a lock-in period for these bonds?

No, these bonds do not have any lock-in period. The bonds can be purchased and sold on the exchange at the prevailing market prices. However, the bonds will be redeemed only on maturity as there are no buy back options.
Is interest on these bonds Tax Free?

Yes, interest on these bonds is tax free.
Will TDS be deducted from the interest payment?

These bonds are tax free and hence not subject to TDS.
Is demat account mandatory to invest in tax free bonds?

The bonds can be allotted either in demat or physical form. However, they can be traded on the exchange in demat mode only.
Are investments in these bonds eligible for deduction u/s 80C?

The sum invested in these bonds is not eligible for any deduction under section 80C, 80CCF or 54EC. The interest on these bonds is tax free. Thus no income tax would be required to be paid, nor will it be subject to TDS. However, capital gains on these bonds are taxable like normal corporate bonds.

Thus, if the bonds are sold within one year of the date of purchase, the short term capital gains arising would be subject to tax at slab rates (i.e. marginal rate of taxation). For sale after a holding period of one year, the long term capital gains will be taxable at 20% with indexation benefit or 10% of capital gain without any indexation.
Can a minor apply to these bonds?

Yes, a minor can apply for these bonds, but only and only through a guardian.
Can one apply in joint names?

Yes, one may apply in a joint name. However, the demat account will also be required to be held in joint name and the order of applicant shall be the same as appearing in the demat account. Moreover, all payments will be made out in favour of the first applicant as well as all communications will be addressed to the first named applicant whose name appears in the application form and at the address mentioned therein.
Who will get the interest in case of joint application?

In case of joint application, interest will be accounted to the first holder only.
My demat account is in joint name, but I want to apply is a single name?

In case of a single application, demat account of the same single applicant would be necessary. Joint demat account would not do.
If I'm an NRI can I invest in these bonds?

No, NRIs are not eligible to invest in these bonds.
How will the allotment take place in case of oversubscription of the issue?

In case of an oversubscription, allotments to the maximum extent, as possible, will be made on a first-come first-serve basis and thereafter on proportionate basis. It is noteworthy that full allotment of bonds shall be given to the applicants on a first come first basis up to the date falling 1 (one) day prior to the date of oversubscription and proportionate allotment of bonds to the applicants on the date of oversubscription. Moreover the company has the discretion to close the Issue early, irrespective of whether any of the portion(s) are fully subscribed.
In whose favour the cheque or demand draft is to be made?

Cheques/Drafts have to be made in the favour of:

"PFC Tax Free Bonds 2012 - Escrow Account"

Moreover, crossed "A/C PAYEE ONLY" cheques should be drawn.

One can also apply to these tax free bonds by availing the ASBA (Application Supported by Blocked Amount) facility. As an ASBA applicant you are required to specify details of the ASBA Account in the application form and the relevant SCSB (Self-Certified Syndicate Bank) shall block an amount equivalent to the application amount in the ASBA account specified in the Application form. Thus upon the receipt of intimation from the registrar, the SCSBs shall on the designated date, transfer such blocked amount from the ASBA account to the Public Issue Account in terms of the Escrow agreement.

OUR VIEW:

In our view these interest tax free bonds provide an excellent investment opportunity as the rates offered are quite attractive. The ticket size (of Rs 5,000) has been purposefully kept lower for greater retail participation and thus it is well within the reach of retail investors. Moreover, there no restrictions on holding the bond for a particular period and hence investors may sell or buy these bonds anytime over the exchange (provided an investor has a demat account).

PFC tax-free bonds are luring especially for Category IV (due to 0.50% additional coupon) investors and within them too, those who are in the higher tax bracket (of 30%), since the gross yields which one enjoys is 11.1% and 11.4% on series 1 and series 2 bonds respectively (which have tenor of 10 years and 15 years respectively).

The fundamental of the PFC seem to be soundly place with the capital adequacy ratio being a little over the stipulated 15.0% limit (prescribed by the RBI), which adds to the safety of the issue. PFC is India’s largest infrastructure financing company and has loan book of around Rs 1.4 lakh crore as on September 2012, of which 84% was to the power generation sector. But it is noteworthy that about 63% of its loan book is towards state sector accounts, and in the present times many state electricity boards are sailing through rough waters. Nonetheless, thus far, the profitability of the company has been modest with a growth of 15.7% over last financial year.

In case you wish to invest in the above instrument, you can email us at info@personalfn.com or contact us on 022-6136 1200