Can you afford to ignore the REC tax-free bonds?

Rural Electrification Corporation (REC) opened its issue of tax-free bonds 2013-14 yesterday and the issue closes on 23 September 2013. The issue size is up to Rs 1,000 crore with an option to retain oversubscription up to Rs 2500 crore aggregating up to Rs 3500 crore. Keep in mind this is the Tranche 1 series, and the bond is a secured redeemable non-convertible bond and does not come with either call or put option.

Features: The face value is Rs 1,000 per bond and the minimum amount of application is Rs 5,000 across all series on bonds. The bond is available in three series - 10 years tenure (Tranche 1 - Series 1), 15 years tenure (Tranche 1 - Series 2) and 20 years tenure (Tranche 1 - Series 3). And the company is offering an annual coupon rate of 8.01 percent, and 8.46 percent and 8.37 percent respectively. As a retail investor, you will get extra 25 basis points (bps). And, the coupon rate per annum stands as 8.26 percent, 8.71 percent and 8.62 percent. While the annualised yield for retail investors is also the same. The new rates are higher than last year’s rates by 0.70-1.50 percent.

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Ratings: CRISIL, CARE, IRPL and ICRA have assigned AAA (Stable) to the bonds. Also REC is a Government of India enterprise. Hence, the default risk is minimum.

Finer Details: You can hold the bond in both, physical as well as demat form. But, if you plan to trade the bond, it has to be in a demat form. BSE is the designated stock exchange for the Issue. As much as 40 percent of the issue is reserved for retail investors.

Tax: Interest from the bond does not form part of total income, and hence it’s a tax-free bond. But, when you sell the bond on the exchange, you will have to pay capital gains tax. If you sell the bond post 12 months, the capital gain will be calculated as per 10 percent without indexation. If you are not the original allottees of the bond and bought it later in the secondary market, the coupon rate will be lower by 25 bps then the applicable coupon rate for the retail investor.

Should you invest?

This bond is offering a pretty good rate of return, that too tax-free. Hence, the post-tax return you earn on this bond is better than what you would have earned for a fixed deposit (around 6.9 percent post-tax for those in the highest tax bracket if FD rate is 9.50 percent). This bond will work well especially for those in the highest tax bracket. Keep in mind, that these bonds are available in three tenures of 10, 15 and 20 years and hence come with a long-term lock in period. Of course, you will be able to trade these bonds on the exchange. But, getting a buyer for the bonds may turn out to be difficult as it depends on the market conditions then.

In the current uncertain economic environment, with falling rupee accompanied by choppy markets and gold going on a trip of its own, the yields of benchmark Government securities have risen. The rate you get for these bonds are linked to the G-Sec rate. Hence, the current bond offer is giving better rates than last year’s offer. With the economy in a mess, investors don’t have many investment options apart from Fixed Maturity Plans (FMP) which seems to have make a comeback.

Before investing in these bonds, do look into your long-term fixed income allocation. Once you have exhausted your PPF and EPF, you could look into investing in these bonds. We highly recommend these bonds for risk-averse, long-term investors. You can read the bond prospectus here. To know more about tax free bonds in general, read this Firstpost story.