Infrastructure is a critical component in development of a country. However in India, investment in infrastructure has slowed considerably over past few years owing to relatively high interest rates. With an aim of boosting the stalled investment cycle, the government recently allowed 13 Public Sector Undertakings (PSU) to raise Rs 48,000 crore through issuance of tax free bonds in the current fiscal. To attract investors, interest component of these bonds has been kept out of the purview of any tax. The coupons would remain at discount to reference government security.

Rural Electrification Corporation Limited (REC) is one among those companies that have been allowed to raise money. REC has been granted permission to collect Rs 5,000 crore by issuing tax free bonds in the current fiscal. In the first tranche, the company intends to issue tax free bonds worth Rs 1,000 crore with an option to retain over subscription upto Rs 2,500 crore.

Company Overview

REC, a 'Navratna' Central Public Sector Enterprise (PSE), was incorporated on July 25, 1969 under the Companies Act 1956. The company enjoys the status of 'Infrastructure Finance' Company. It ranks high on performance among PSEs. REC focuses on meeting credit requirements of the power sector.

Business and Financial Analysis

The main objective of REC is to finance and promote rural electrification projects all over the country. It provides financial assistance to State Electricity Boards, State Government Departments and Rural Electric Cooperatives for rural electrification projects that are sponsored by them. As per as sub-sectors are concerned, REC focuses on companies belonging to power generation and those engaged in power transmission and distribution.

REC follows a healthy business model. The borrowing cost of the company has been one of the lowest in the industry while its asset quality is robust and stable. This enables the company to maintain stable Net Interest Margins (NIM). In Financial Year (FY) 2012-13, the net profit of the company went up 35%. The company has a total loan book of over Rs 1.27 lakh crore. Net Non-Performing Assets (NNPA) ratio stood at 0.39% as on March 31, 2013 which low considering its large loan book size.
 

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

Issuer	Rural Electrification Corporation (REC) Ltd.
Offering	Public Issue by Rural Electrification Corporation Limited of Tax Free, Secured Redeemable Non-Convertible Bonds of Face Value of Rs 1000/- each in the nature of debentures having tax benefits under Section 10 (15)(iv)(h) of the Income Tax Act, 1961. The issue size is Rs 1000 crore with an option of retaining over subscription upto Rs 2,500 crore thus aggregating to Rs 3,500 crore.
Rating	'CRISIL AAA'/Stable by CRISIL, 'ICRA AAA' by ICRA, "CARE AAA" by CARE & "IND AAA" by IRRPL (formerly Fitch Ratings India Private Limited)
Security	The Bonds issued by the Company will be secured by way of first / pari passu charge on the book debts of the Company, other than those that are exclusively charged/earmarked to any trustee/lender(s) of the Company, and/or any other security as may be agreed between the Company and the Trustee, pursuant to the terms of the Bond Trust cum Hypothecation Deed with a minimum security cover of one time of the aggregate face value amount of Bonds outstanding at all times. Further details pertaining to the Security are more particularly specified in the Bond Trust cum Hypothecation Deed.
Face Value	Rs 1,000 per bond
Issue Price	At par (Rs 1,000 per bond)
Minimum Subscription	5 bonds and in multiples of 1 bonds thereafter
Tenure	Bond Series 1A:10 years Bond Series 2A:15 years Bond Series 3A:20 years Bond Series 1B:10 years Bond Series 2B:15 years Bond Series 3B:20 years
Coupon rate	Bond Series 1A:8.01% p.a. Bond Series 2A:8.46% p.a. Bond Series 3A:8.37% p.a. Bond Series 1B:8.26% p.a. Bond Series 2B:8.71% p.a. Bond Series 3B:8.62% p.a.
Interest Payment	December 1st of every year and on redemption date of the respective bond series
Trustee	SBICAP Company Ltd.
Listing	BSE & NSE; NSE shall be the Designated Stock Exchange for the Issue. The Bonds are proposed to be listed within 12 Working Days from the Issue Closing Date.
Depository	National Securities Depository Limited and Central Depository Services Limited
Registrars	Karvy Computershare Private Limited
Issuance	In dematerialized as well as in physical form
Issue Open Date	August 30, 2013
Issue Close Date	September 23, 2013
Eligible Investors
Category I	Foreign Institutional Investors and sub-accounts (other than a sub account which is a foreign corporate or foreign individual) registered with SEBI including Sovereign Wealth Funds, Pension and Gratuity Funds registered with SEBI as FIIs Mutual Funds registered with SEBI; Alternate Investment Funds subject to investment conditions applicable to them under the Securities and Exchange Board of India (Alternative Investment Funds) Regulations, 2012 Public Financial Institutions Scheduled Commercial Banks Multilateral and Bilateral Development Financial Institutions State Industrial Development Corporations which are authorised to invest in the Bonds; Insurance Companies registered with the Insurance Regulatory and Development Authority; Provident Funds with minimum corpus of Rs.25 crores, which are authorised to invest in the Bonds; Pension Funds with minimum corpus of Rs.25 crores, which are authorised to invest in the Bonds; 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 army, navy or air force of the Union of India; Insurance Funds set up and managed by the Department of Posts, India
Category II	Companies within the meaning of section 3 of the Companies Act; Statutory bodies/corporations Cooperative banks Trusts including Public /private charitable /religious trusts Limited liability partnerships Regional rural banks QFIs not being an individual; Societies registered under the applicable law in India and authorized to invest in Bonds Other legal entities, subject to compliance with their respective applicable legislations Partnership firms in the name of the firm.
Category III	Investors applying for an amount aggregating to above Rs 10 lakhs across all Series of Bonds in this Tranche - I Issue Resident Indian individuals Hindu Undivided Families through the Karta; Non Resident Indians on repatriation as well as non- repatriation basis; and QFIs being an individual.
Category IV	Investors applying for an amount aggregating upto Rs 10 lakhs across all Series of Bonds in this Tranche - I Issue Resident Indian individuals Hindu Undivided Families through the Karta; Non Resident Indians on repatriation as well as non-repatriation basis; and QFIs being an individual

 

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

• Is there a lock-in period for these bonds?
  
  No, these bonds do not have any lock-in period. Post listing, the bonds can also be purchased and sold in the secondary market 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?
  
  No. The bond holder will have an option to take delivery in physical form. In case of Bonds are being issued in physical form, the Company will issue a Consolidated Bond Certificate for investments made under all series of Tranche- 1.
   
• 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.
  
  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. For sale after a holding period of one year, the long term capital gains will be taxable at 10% without any indexation benefit.
   
• Can a minor apply to these bonds?
  
  Yes, a minor can apply for these bonds, but only through a guardian.
   
• Can one apply in joint names?
  
  Yes, one may apply in a joint name (not exceeding 3). 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.
   
• 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.
   
• Can NRIs invest in these bonds?
  
  Yes. NRIs are eligible to invest in these bonds provided pre-specified conditions are satisfied.
   
• Is there any preset allotment quota for Category IV investors?
  
  Yes. Of total issue, 40% is reserved for category IV applicants. However, within these limits, the bonds will be allotted on first come first serve basis.
   
• In whose favour the cheque is to be made?
  
  Resident Applicants should draw Cheques /Drafts in favour of 'REC Tax Free Bonds 2013 - Escrow Account - R'. While Non Residents applicants including NRIs, should draw Cheques /Drafts in favour of "REC Tax Free Bonds 2013 - Escrow Account - NR Repat" Or "REC Tax Free Bonds 2013 - Escrow Account - NR Non-Repat" depending on the nature of investment.
   

PersonalFN View:

In the view of PersonalFN REC tax free bond provides an excellent investment opportunity as the rates offered are quite attractive. Moreover, there's no restriction on a bondholder to hold bonds mandatorily for a particular period of time. Investors may sell or buy these bonds anytime on the exchanges. Hence investors need not worry much about liquidity in case of immediate need for funds.

Central government holds about two third of REC's total outstanding shares which shores up the confidence in the company. Thrust on Rural electrification in coming years, through various government initiatives, will ensure the healthy growth in loan book of the company. However, one needs to keep an eye on the deteriorating health of state electricity boards, the largest borrowers of REC.

The ticket size has been purposefully kept lower for greater retail participation and thus it is well within the reach of retail investors. Further, the quota of 40% reserved for retail investors enhances the chances of getting allotment. The special rates are being offered to category IV investors. For a person who falls in the maximum tax bracket (and category IV), effective yield (i.e. after factoring in for tax benefits) comes at around 10.7%, 11.3% and 11.2% on bonds with maturity profile of 10 years, 15 years and 20 years respectively.

We believe that REC tax free bond is an attractive offering considering the rating profile of the issue and competitive yield (compared to post tax yield on other fixed income instruments) for those in the maximum tax bracket.

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

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