REC 8.71% Tax-Free Bonds Issue – August 2013

This post is written by Shiv Kukreja, who is a Certified Financial Planner and runs a financial planning firm, Ojas Capital in Delhi/NCR. He can be reached at skukreja@investitude.co.in

Rural Electrification Corporation (REC) will be launching the first public issue of tax-free bonds for the current financial year from 30th of this month. The company is offering quite attractive interest rates to the retail individual investors with 8.26% for 10 years, 8.71% for 15 years and 8.62% for 20 years. These rates are higher by approximately 0.70% to 1.50% as compared to the rates offered last year.

REC plans to raise Rs. 3,500 crore from this issue, including the green-shoe option of Rs. 2,500 crore. Though the official closing date of the issue is September 23rd, I think the issue should get closed before that due to oversubscription.

The government has allowed REC to issue Rs. 5,000 crore worth of tax-free bonds this financial year and the CBDT notification has mandated a minimum of 70% of this amount to be raised from public issues. As the issue size is Rs. 3,500 crore, if it gets fully subscribed this time itself, I think REC would raise rest of the money through private placements only and it will become the last issue of REC this financial year.

NRIs, QFIs & “Retail Individual Investor” – Non-Resident Indians (NRIs) on repatriable as well as non repatriable basis and Qualified Foreign Investors (QFIs) are also eligible to invest in this issue. The scope of a retail individual investor, investing upto and including Rs. 10 lakhs, has got broadened with the introduction of NRIs and QFIs (as individuals). It includes Hindu Undivided Families (HUFs) also through the Karta.

So, the investors have been classified into the following four categories:-

I – Qualified Institutional Bidders (QIBs) – 20% of the issue reserved

II – Non-Institutional Investors (NIIs) – 20% of the issue reserved

III – High Net Worth Individuals including HUFs, NRIs & QFIs – 20% of the issue reserved

IV – Retail Individual Investors including HUFs, NRIs & QFIs – 40% of the issue reserved

Interest Payment Date & Record Date – As this question gets asked by many of the investors throughout the year, it is better to mention it here itself as the date is known in advance this time. Interest will be paid on December 1st every year and the record date will be 15 days prior to that.

No Cumulative Option – There is no option of taking cumulative interest at the time of maturity with these bonds. Interest will be paid annually.

Safety, Ratings & Nature of Bonds – Being a ‘Navratna’ PSU, REC offers a high degree of safety as far as your investment is concerned and that gets reflected in the ratings assigned to this issue. The issue has been rated ‘AAA’ by four rating agencies, CRISIL, CARE, India Ratings and ICRA. It is the highest rating given by each of these companies. Also, these bonds are secured in nature against certain assets of the company.

Listing – REC bonds will get listed on the Bombay Stock Exchange (BSE) within 12 working days from the closing date of the issue. Investors have the option to apply these bonds as per their choice, either in physical form or in demat form.

TDS & Minimum Investment – As these are tax-free bonds, there is no question of TDS getting deducted, whether you take them in physical form or demat form. Minimum investment required is Rs. 5,000 only i.e. 5 bonds of Rs. 1,000 face value each.

Interest on Application Money & Refund – REC will pay interest to the successful allottees at the applicable coupon rate and at 5% per annum to the unsuccessful allottees.

Tax Treatment on Sale – Listed bonds held for more than 12 months qualify as long term capital assets and if sold thereafter, would attract a flat 10% capital gain tax, without indexation benefit. However, if the bonds are sold prior to holding them for more than 12 months, then short-term capital gain tax would be applicable, as per the tax slab of the investor.

Key Attractions of these Bonds: There were many issues with the tax-free bonds issued last year. There was a huge difference between the interest rate paid to the retail investors and the interest rate paid to other investors. Also, the subsequent buyer from the secondary markets was to get a lower rate of interest. Moreover, the cut from the G-Sec rate was also set on a higher side.

I think most of those issues have got rectified this year. Here are some of the key attractions of these bonds this year:

High Interest Rates – Due to the falling rupee and the unsuccessful measures taken by the Government and the RBI to control it from further fall, the yields of the benchmark government securities (G-Secs), against which the coupon rates of these tax-free bonds get fixed, have risen sharply in the last 45 days or so. 10-year benchmark yield touched a high of 9.47% before falling sharply to 8.25%. Thanks to this jump, the company has been able to offer such attractive coupon rates, especially for the 15 years period.

A word of caution. 10-year benchmark yield has again jumped back to close at 8.78% on August 27th. If the economic fundamentals of the country continue to deteriorate at the same speed as they have been doing, the yields could keep moving higher and the rupee could keep falling further against the dollar. But, I still hope India would come out of the current crisis soon and as the macroeconomic things get stabilised, these rates would look highly attractive again.

High Interest Rates, even if bought from the Secondary Markets – As per the CBDT notification – “The higher rate of interest, applicable to RIIs, shall not be available in case the bonds are transferred by RIIs to non retail investors”. So, the interest rates earned by the retail individual investors this year would remain higher even if they buy these bonds from the secondary markets subsequent to the offer period.

Your eligibility for a higher rate will depend on the number of bonds held in your name on the record date and the same will get tracked by your PAN number. Your holding should not be more than 1000 bonds per issue on the record date to get higher rate of interest.

Till last year, only the first allottees were eligible for a higher rate of interest and the subsequent buyers from the secondary markets were supposed to get a lower rate of interest. This factor will encourage the retail investors to participate in the secondary markets and thereby result in higher liquidity.

Low Differential – The differential between the rates offered to the retail individual investors and the other categories of investors has been cut down to 25 basis points (or 0.25%) only, as compared to last year’s 50 basis points (or 0.50%). This is the best step that has been taken this year. This factor would attract higher participation from the other categories of investors, both during the initial offer period as well as in the secondary markets.

I honestly think that these tax-free interest rates are very attractive. If I compare these rates with the interest rates on bank fixed deposits, the rates look quite similar, but with huge difference of tax applicability. I seriously hope India’s macroeconomic picture should start looking better in the days to come, only then we will be able to enjoy these high rates, otherwise inflation would again eat up all fruits of our hard work.

Link to Download the Application Forms of REC Tax-Free Bonds

If you need any further info or you want to invest in these bonds in Delhi/NCR, you can contact me at +919811797407

133 thoughts on “REC 8.71% Tax-Free Bonds Issue – August 2013”

  1. Final Day (or September 16, 2013) subscription figures:

    Category I – Rs. 245.36 crore as against Rs. 700 crore reserved
    Category II – Rs. 923.12 crore as against Rs. 700 crore reserved
    Category III – Rs. 759.92 crore as against Rs. 700 crore reserved
    Category IV – Rs. 1585.62 crore as against Rs. 1400 crore reserved

    Total Subscription – Rs. 3514.02 crore as against total issue size of Rs. 3500 crore

    100% allotment to all the categories of investors including Category IV retail individual investors (RIIs), except Category II.

      1. Sir,
        The link says “The core issue size will be Rs 750 crore”. REC Was 1,500 cr and with option to scale up to 3.5 k cr. please let me know if i am wrong.

  2. Day 10 (or September 13, 2013) subscription figures:

    Category I – Rs. 245.35 crore as against Rs. 700 crore reserved
    Category II – Rs. 873.02 crore as against Rs. 700 crore reserved
    Category III – Rs. 755.22 crore as against Rs. 700 crore reserved
    Category IV – Rs. 1531.80 crore as against Rs. 1400 crore reserved

    Total Subscription – Rs. 3405.38 crore as against total issue size of Rs. 3500 crore

    September 16th, Monday, the issue is getting closed. So, if Category I investors do not invest further in this issue, the Category IV investors will get 100% allotment.

  3. Day 9 (or September 12, 2013) subscription figures:

    Category I – Rs. 245.35 crore as against Rs. 700 crore reserved
    Category II – Rs. 847.84 crore as against Rs. 700 crore reserved
    Category III – Rs. 750.57 crore as against Rs. 700 crore reserved
    Category IV – Rs. 1505.73 crore as against Rs. 1400 crore reserved

    Total Subscription – Rs. 3349.49 crore as against total issue size of Rs. 3500 crore

  4. Day 8 (or September 11, 2013) subscription figures:

    Category I – Rs. 245.35 crore as against Rs. 700 crore reserved
    Category II – Rs. 847.44 crore as against Rs. 700 crore reserved
    Category III – Rs. 738.59 crore as against Rs. 700 crore reserved
    Category IV – Rs. 1473.59 crore as against Rs. 1400 crore reserved

    Total Subscription – Rs. 3304.97 crore as against total issue size of Rs. 3500 crore

    Still no change in the subscription numbers of Category I.

  5. I understand that Category IV is already over subscribed. I have planned to submit application tomorrow. Is there any chance to get alloted since the total subscription is still less than the max? Or is it strictly by category? Please let me know. Thanks,

    1. Firstly, it is by each category and in case there is under subscription in any of the categories, then it will get allotted to the Category IV investors first. So, now onwards, Category IV allotment will solely depend on how Category I investors invest in this issue. I think it is better to avoid this issue now and wait for the next issue.

  6. Day 7 (or September 10, 2013) subscription figures:

    Category I – Rs. 245.35 crore as against Rs. 700 crore reserved
    Category II – Rs. 760.54 crore as against Rs. 700 crore reserved
    Category III – Rs. 734.63 crore as against Rs. 700 crore reserved
    Category IV – Rs. 1432.09 crore as against Rs. 1400 crore reserved

    Total Subscription – Rs. 3172.60 crore as against total issue size of Rs. 3500 crore

    So, now that the retail investor category has got oversubscribed, I think the retail investors should not further invest in this issue. If, at any point of time, the Category I investors pour a further Rs. 455 crore in this issue, then the retail investors applying now onwards will not get any allotment.

  7. Thanks Shiv for prompt reply.
    Since exchanges were closed fron 7-9, how can we get the latest figures?
    Actually I want to apply but not sure if there is any scope of allotment.

    1. These are the latest figures Anuj. The bidding will start today again. I think the retail portion will get oversubscribed today. If you apply early in the morning today before 12 noon, there is quite a good chance that you’ll get 100% allotment. If this issue sees undersubscription in the QIB category, then the retail investors will get allotment beyond Rs. 1400 crore.

  8. Hi,
    I am a person who falls in 30% tax bracket. Why would this tax free bonds will be beneficial for tax purposes for me if NCD of AAA rated private companies with yield of 10% can be availed by FMD/debt funds. I can certainly take advantage of indexation in debt funds to bring down my tax liability.

    Why should a person in 30% tax bracket should invest in such bonds. Do you think that CPI is going to decrease drastically in next 5 years? Or are there some rules in DTC which would impact taxation of debt mutual funds?

    I always invest in growth option of debt mutual funds and never in divident option. So dividend distribution tax is not much of a concern for me.

    1. Hi Sanjay,

      I never say debt funds/FMPs are a bad option. They are also good investment options and one should invest in them to diversify their debt portfolio. They also invest in these tax-free bonds and NCDs etc. But, by investing directly in tax-free bonds, you can save on the expenses that debt funds/FMPs charge and earn higher rate of interest yourself. There are many NCDs which are yielding 12-15% and are about to mature in 1-3 years, this way you can earn more than FMPs. You are just required to research somewhat.

      1. Default risk of private firms is very big concern for me. So I do not invest in NCDs of private firms directly. I buy FMP in the hope that Fund Manager will do due diligance of default risk and FMP also has lower expenses. For example, I invested in “HDFC FMP-XXVII-1875D” in the hope to lock in to higher yield at the same time to decrease the risk as it invests in AAA rated NCD.
        About the debt funds : they are also supposed to make investment in high yield and low risk debt of private firms. I feel okay to pay 1 to 1.5 % expense ratio for that due diligence.

        Another reason I prefer to invest via mutual funds is my portfolio size remains manageable.

        It would be great if you can write article on how to evaluate dynamic bond funds on that perspective.

        1. Personally, I invest in Mutual Funds when I feel it is beyond my abilities & expertise to do it on my own. What equity funds do or FMPs do, I think I can do majority of it on my own, so I rarely invest in equity mutual funds or FMPs. At the same time, they have there own positives also, like good research team for equity funds and favorable taxation rules for FMPs. I invest in Gilt funds bcoz I think I cannot invest in G-Secs on my own.

          In your case, I dont think HDFC FMP 1875 days is going to give you more than 9% pre-tax returns. At the same time, you can invest in corporate NCDs like SBI bonds, IFCI bonds, STFC bonds etc. & earn around 11-12% pre-tax returns yourself. But, if the differential is lower at around 1% or so, then you are right to take MF’s help to manage your money. Paying 1-2%, for something you cannot do on your own, is perfectly fine.

          With tax-free bonds, my point is that I’m getting 8.71% tax-free for the next 15 years. No MF scheme gives such tax-free returns for 15 years. At present, interest rates are higher. Say, anytime in the next 5-7 years, I’m able to get 10-15% returns due to their capital appreciation, my total returns would be more than 10.50% annually. I will feel happy with those returns and I am not required to pay 1-2% extra to MFs for doing it on my behalf.

          I have been thinking of writing a post on Dynamic Bond Funds for quite a while now, but have failed to do so. But, will do that soon for sure.

          1. Thanks a lot for such a detailed and prompt reply. I was really positively surprised.

            I just read in some websites that AAA NCD yield has gone above 10% and based on that I invested in that FMP. May be I was very naive in doing that.
            I came to know that SBI dynamic bond fund has 1.7% expense ratio and it has hevaily invested in long term gilt. Now I am wondering whether to invest in this fund or some other dynamic bond fund.

            1. Thanks for your kind words Sanjay !!

              That is the biggest problem with dynamic bond funds. Suppose, I have a view that the interest rates are going to rise and I should invest in a dynamic bond fund which has a least exposure to gilts or high duration securities.

              I search about it and invest in one such fund, but, a few days later, the fund manager changes his view to invest in securities with a high duration. If the rates actually rise, I’ll find myself trapped in it and my portfolio will suffer losses. So, it is better to invest in a fund which invests as per your own objective.

  9. I am bit confused about your figures above. As per the link that you gave, the allotted amount for Category 4 is 4000000 bonds. If per bond price is Rs1000, then the max is Rs 400 crore
    only. The Rs. 1310.16 crore is correct. The column after this, says the subscription is already more than 3 times. If the max amount is Rs 400 crore then 3.x times of Rs400 crore is Rs1300 crore. Am I missing something? I would like to know where do you get the Rs 1400 crore reserved.

    1. Hi Sundar,

      Rs. 400 crore is as per the base issue size of Rs. 1000 crore. But, Rs. 1400 crore is as per the total issue size of Rs. 3500 crore. 40% is reserved for the Category IV and 40% of Rs. 3500 crore is Rs. 1400 crore.

  10. Day 6 subscription figures:

    Category I – Rs. 245.35 crore as against Rs. 700 crore reserved
    Category II – Rs. 752.83 crore as against Rs. 700 crore reserved
    Category III – Rs. 722.33 crore as against Rs. 700 crore reserved
    Category IV – Rs. 1310.16 crore as against Rs. 1400 crore reserved

    Total Subscription – Rs. 3030.68 crore as against total issue size of Rs. 3500 crore

  11. Day 5 subscription figures:

    Category I – Rs. 245.35 crore as against Rs. 700 crore reserved
    Category II – Rs. 724.33 crore as against Rs. 700 crore reserved
    Category III – Rs. 718.96 crore as against Rs. 700 crore reserved
    Category IV – Rs. 1220.14 crore as against Rs. 1400 crore reserved

    Total Subscription – Rs. 2908.78 crore as against total issue size of Rs. 3500 crore

  12. Day 4 subscription figures:

    Category I – Rs. 230.35 crore as against Rs. 700 crore reserved
    Category II – Rs. 718.40 crore as against Rs. 700 crore reserved
    Category III – Rs. 715.26 crore as against Rs. 700 crore reserved
    Category IV – Rs. 1121.74 crore as against Rs. 1400 crore reserved
    Total Subscription – Rs. 2785.75 crore as against total issue size of Rs. 3500 crore

  13. Hi Shiv,

    Thanks so much for day to day updates on the subscription.

    One question though – The amounts being shown as reserved for various categories are assuming the greenshoe option right ? Can we assume that REC will use those allocations for sure ? Or they can allocate somewhere between 1000Cr to 3500 Cr of the total issue size ?

    My application went in on the second day in Cateogry III. So just want to ensure I will be alloted 100% of my application size.

    Also, just as a rough estimate, how much gain can be anticipated on these bonds in short term ? Is 10-15 % likely ?

    1. Hi Sagar,

      It is highly unlikely that REC will not accept oversubscription. If they had any such intention, then they would have closed this issue by now. You’ll get 100% allotment for sure.

      Please define your short-term, do you mean listing gains or short-term for you means 6-9 months ??

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