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A valuable route to diversifying debt

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IDFC Infrastructure bonds.

M.V.S. Santosh Kumar

Investors who would like to diversify their debt options can take exposure to the infrastructure bonds floated by IDFC, preferably the cumulative option.

IDFC is the second NBFC (after IFCI) to raise long-term infrastructure bonds and the first one to come up with a public issue. These bonds are eligible for 80 CCF tax benefits, which allow tax exemption on the initial investment of up to Rs 20,000.

The post-tax yields for investments up to Rs 20,000 would be similar to yields of tax savings deposits of banks. Currently, SBI capgain fixed deposit for five years has a interest payout of 7.5 per cent; same as that of IDFC with a buyback option. Investments can be done through demat accounts, which makes the offer hassle-free for equity investors.

Investment options

These instruments are secured and are available in four series with coupon rates between 7.5 per cent and 8 per cent (see table for rates and options). Of these, the most attractive option is the cumulative scheme with a buyback (7.5 per cent interest compounded annually) after five years.

This scheme gives a post-tax annual yield of 13.5 per cent over a five-year period, for those in the highest tax slab. For investors in 10 per cent and 20 per cent tax brackets, the post-tax yields work out to 9.1 per cent and 11.1 per cent respectively. Investors who choose to exit after five years stand to benefit the most.

The series without buyback option have coupon rate of 8 per cent in order to incentivise long-term investments (10 years). But in longer-term options the post-tax yields fall.

For instance, cumulative option without buyback and coupon of 8 per cent gives 9.9 per cent annual yield, spread over a ten-year period.

As all the options are listed on the bourses, one can exit through the market. This option would help improving the yields as the sale of such instruments would entail lower tax outgo (capital gain tax is lower than tax on interest). For a 7.5 per cent cumulative scheme with a buyback option, selling in the market would give an additional 1.6 percentage point annual yield over a scheme, which is bought back by the company, assuming that the market price and bond value are the same. The capital gains tax has been calculated in keeping with the likely rates that would prevail after the introduction of the Direct Taxes Code.

However, such exit (market exit) is exposed not only to interest rate movements but also to higher impact costs in the event of limited liquidity.

Suitability

These instruments are only suitable for investors who have run out of their 80 C tax exemption limit, as instruments such as National Savings Certificate have better yields as compared to infrastructure bonds. Deposits with banks for five year terms may offer yields comparable or better than these bonds, if stripped of their 80CCF benefits.

Investors have an option of investing in various schemes as long as the investment is at least Rs 10,000. Therefore, investing in two units of Rs 5,000 each in cumulative options with buyback and without buyback option also makes sense.

As the monetary tightening may continue due to persistent inflation, the 10-year government yield may get pushed to above 8 per cent levels, allowing infrastructure financing companies to price their future bonds at a higher coupon rates (before March 2011).

About the company

IDFC, which is present across the financial sector value chain, has a credit rating of FAAA from ICRA — which denotes highest investment grade. The capital adequacy ratio of the company stood at 26 per cent, making it one of the most under-leveraged NBFCs.

The company has a well managed asset-liability book and strong risk management systems towards reducing or minimising the default risk. Around 82.5 per cent of the company's exposure is in energy, transport and telecom — sectors that have huge growth potential — and majority of the loans are secured, reducing the risk of asset quality slippages. The Net NPA ratio as of June 30 is around 0.15 per cent. The consolidated net profit for the year ended March 2010 was Rs 1,064 crore.

The issue closes on October 18. The allotment is on a first-come, first-serve basis. Investors may note that there may be three other institutions – REC, PFC and LIC — wanting to raise funds using the infrastructure theme over this fiscal by issuing similar bonds.

Related Stories:
IDFC to issue tax-saving, long-term infrastructure bonds to raise Rs 3,400 cr

(This article was published in the Business Line print edition dated October 10, 2010)
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