Investors across tax slabs can invest in the 20-year bonds.

The latest tax-free bonds in the market, being issued by Power Finance Corporation (PFC), offer better rates than the earlier issues by REC, HUDCO and IIFCL. Investors with a long-term horizon and across tax slabs can consider investing in the 20-year bonds. Those in the higher tax slabs (20 per cent and 30 per cent) can also consider the 10- and 15-year bonds.

PFC is offering retail investors (those who invest up to Rs 10 lakh) attractive rates — 8.43 per cent annually on 10-year bonds, 8.79 per cent on 15-year, and 8.92 per cent on 20-year instruments. The interest will be paid out annually.

The return on PFC’s 20-year bonds is 0.17 percentage points higher than the next best rate on similar bonds (IIFCL offers 8.75 per cent). Also, on the 10- and 15-year bonds, PFC tops the charts by giving 0.03 to 0.04 percentage points more than that offered by HUDCO. What makes PFC’s bonds more attractive is that they are rated AAA, on par with IIFCL’s bonds and a notch higher than the AA+ rating on HUDCO’s bonds.

It is a good time to lock into PFC’s bonds. The interest rates on tax-free bonds issued by public institutions are linked to yields on Government securities (G-secs). PFC is able to offer high rates because of the sharp spike in the 10-year G-sec rate to around 9 per cent in the recent past. While this has since moderated to 8.48 per cent currently, it is still close to the highs seen during the financial crisis of 2008. A sharp rise in the G-sec rate from current levels seems unlikely, and tax-free bonds in the coming months may not be able to match PFC’s rates.

PFC’s bonds offer better returns than bank deposits, after accounting for taxes. The interest received on the tax-free bonds is not subject to tax, unlike the interest received on bank deposits. The best rate being offered on 5-year bank deposits currently is 9.5 per cent. After considering quarterly compounding and taxes, this translates into an annual return of 8.83 per cent for investors in the 10 per cent tax slab, 7.82 per cent for those 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 PFC’s 20-year tax-free bonds. And for investors in the higher tax slabs (20 per cent and 30 per cent), even the 10-year and 15-year bonds being issued by PFC offer better rates than the tax-adjusted returns on bank deposits.

But before you invest in the PFC bonds, keep aside funds for your public provident fund (PPF) investment. PPF not only offers healthy tax-free returns (8.7 per cent currently) but also gives tax deduction on the initial investment up to Rs 1 lakh. So, the effective return on PPF is higher than that on tax-free bonds in which the initial investment does not get you any tax deduction.

Company details

PFC is an infrastructure finance company set up by the Government dedicated to power sector financing. Majority of its lending is to the power generation segment. The company’s loan book has grown at around 26 per cent annually over the last four years to more than Rs 1,60,000 crore as on March 2013. Its profit grew an annual 22 per cent over the same period to Rs 4,420 crore. Its gross non-performing assets as a percentage of loan assets were a moderate 0.71 per cent. Capital adequacy ratio at around 18 per cent is comfortable.

(This article was published on October 12, 2013)
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