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IIFCL or Hudco Tax Free Bonds: Just Avoid

11 Oct

With the India Infrastructure Finance Company Ltd (IIFCL) hitting the street, the tax-free bond market is becoming rather crowded. Though it has been allowed to raise an additional Rs 8,171 crore in this fiscal year, the company’s first tranche will try to collect only up to Rs 2,500 crore. IIFCL is the third company to come out with a public issue of tax-free bonds in this financial year

The IIFCL issue that hit the market on 3 October collected Rs 209 crore on the first day. Since both the IIFCL and Hudco issues are in the market simultaneously, which one should you go for?

 

There are rating differentials between them. IIFCL is AAA rated, while Hudco is only AA+ rated. Experts, however, say that a one notch rating difference will not matter if the investor plans to hold the bonds till maturity. “Since both are government companies and also highly rated (even AA+ is a good rating), both are practically risk-free.

For investors in the higher tax slabs, tax-free bonds offer more than bank deposits. Today, the best rate on five-year bank deposits is 9.5 per cent. After considering quarterly compounding and taxes, this translates into an annual return of 7.82 per cent for investors in the 20 per cent tax slab and 6.8 per cent for those in the 30 per cent slab. This is lower than the return one can get from tax-free bonds. The interest on tax-free bonds is paid out annually.

But before investing in the tax-free bonds, keep aside funds for your public provident fund (PPF) investment that not only gives healthy tax-free returns (8.7 per cent currently) but also tax deduction on the initial investment of up to Rs 1 lakh. The initial investment on the tax-free bond does not get you any deduction.

IIFCL is among the major financiers of infrastructure projects in the country. As on March 2013, it had disbursed loans of Rs 26,582 crore. Its consolidated profit in FY13 grew almost 50 per cent over the previous year to Rs 1,009 crore. Its net non-performing asset ratio at a consolidated level was a moderate 0.76 per cent.

 

The rating differential will come into play if you want to sell these bonds later. An AAA paper usually commands a better price than AA+ paper in the secondary market.

Do not invest for listing gains. REC’s tax-free bonds have already slipped below the issue price due to the number of firms planning to hit the market soon. However, the Gsec yield may start falling once the rupee stabilises. So there might be an opportunity for capital gains in the medium term.

 

 

I am not sure we can trust either IIFCL or HUDCO for 10 years! The IIFCL business model is highly flawed, and very recently RBI’s Deputy Governor questioned the rationale for a dedicated DFI (as IIFCL is) in today’s market where universal banks are ruling the roost. IIFCL rides on the shoulders of other consortium members, lending up to 20% of the project cost and having no in-house capacity for project appraisal or monitoring. HUDCO is a near-miracle in surviving, and has to be looked at as a doubtful case over a 10-year horizon. As the world found out, credit-rating companies have imperfect hindsight, and are practically blind when they are trying to predict the future. Lehman Brothers was just the most recent example, with the 2008 financial disaster still fresh in the investors’ minds.

 

 

This continuous flow of offers for TAX FREE bonds shows that Govt is badly in need for funds. However, investors are pouring in their hard earned wealth. It is expected that nothing happens here like NSEL. Else public will never trust any entity in the financial market of India

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Posted by on October 11, 2013 in Uncategorized

 

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