Retail investors looking to invest in tax-free bonds have ‘too many, too soon’ to choose from. As many as eight bond issues, all by Government-owned entities, are still open and due to close in a day or two.

The interest rates currently for all the eight bond issues range between 6.82 and 7.03 per cent for 10-year and 7.02 to 7.19 per cent for 15-year tax-free bonds.

Of course, for retail investors up to Rs 10 lakh, there is an additional 0.5 per cent interest (differential rate is only available for original allottees). While you may be tempted to look at the ones offering higher interest rates, it would be wise to also understand the credit risk on all these bonds. Here is a quick comparison to help you choose the right one.

Higher rating

The credit rating on five of these bonds - Power Finance Corporation (PFC), Rural Electrification Corporation (REC), Jawaharlal Nehru Port Trust (JNPT), Indian Infrastructure Finance Company (IIFCL) and National Housing Bank (NHB) is the top AAA rating.

Ideally, instruments with this rating are considered to have the highest degree of safety regarding timely servicing of financial obligations.

Among these top-rated bonds, bonds issued by PFC and REC offering highest return of 6.88/7.04 per cent for 10/15 year time horizon can be considered for investment.

Sound fundamentals

Both PFC and REC are plays on power sector reforms and expected tariff hikes by states and coal availability remain triggers for both the companies. Both draw ratings comfort from their stable earnings profile, capital adequacy and consistent asset quality.

PFC is a financial institution lending exclusively to the power sector. As of December 2012, the net interest income grew by 53 per cent, driven by margin improvement and loan growth of 26 per cent. Asset quality remained stable with gross non-performing asset (GNPA) at 0.92 per cent of loans.

REC, on the other hand, plays an important role in India’s rural electrification schemes. As of December 2012, the net interest income grew by 42 per cent, driven by margin improvement and loan growth of 25 per cent. Asset quality remained stable with GNPA at 0.41 per cent of loans.

Lower rating

On the other hand, for a slightly higher risk, HUDCO offers the best interest rate of 7.03/7.19 per cent for 10/15 year bonds.

HUDCO’s tax free bonds offer 0.15 per cent more than PFC and REC bonds. Where it lags its peers is on its AA+ credit rating. This means that the bonds are a little more risky though an AA+ rating implies a high degree of safety. However, the company, providing long-term finance for housing and urban infrastructure projects, has seen consistent slippages in asset quality. The net NPA has significantly increased from 1.44 per cent in March 2012 to 5.66 per cent in December 2012.

The verdict

While interest rates on these bonds are lower than what was offered last year and even those issued a few months ago, they still generate higher returns than post-tax returns on bank fixed deposits. Currently, FDs over three years offer an average rate of 9.0 per cent. At this rate, the after-tax return on a bank deposit is 6.2 per cent for investors in the 30 per cent tax bracket and 7.2 per cent for those in the 20 per cent bracket.

Investors with a lower risk appetite can thus subscribe to the PFC or REC bonds. For the same AAA rating, IIFCL , JNPT and NHB offer lower rates and can be ignored.

Investors willing to trade off the higher risk for a higher return can opt for HUDCO bonds. Ennore Port and Dredging Corporation can be given the go-by as they offer lower return than HUDCO in spite of a higher risk profile.

>Radhika.merwin@thehindu.co.in

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