EQUITY RESEARCH: IRFC Bond Issue

Tenets of Investing

IRFC (Indian Railway Finance Corporation), a dedicated financing arm of the Ministry of Railways has come up with an issue of tax free secured redeemable Non Convertible bonds with an issue size of Rs. 3,000 Crores, with an option to retain oversubscription upto Rs. 6,300 Crores.  The company offers 8.15% and 8.30% per annum to the retail customers (individual and HUF below Rs. 5 lakh investments) for bonds with maturity periods 10 and 15 years respectively. HNIs (High net worth individuals) and QIPs (Qualified institutional investors) will get interest rates of 8.00% and 8.10% p.a. for the same terms. The bonds have secured the rating of ‘AAA’ by ratings agencies CRISIL, CARE and ICRA

The tenets for application to the above bond are as follows:

Take the advantage of peaking of the interest rate cycle: The Reserve Bank of India had earlier indicated that the interest rates have peaked and further rate reduction would depend on growth and inflation. In the monetary policy meet yesterday, it has reduced the cash reserve ratio to 5.5% from 6% which highlights that the interest rate cycle has peaked and that the central bank is now attempting to increase liquidity. When the interest rates are at peak, it is the best time to invest in fixed income instruments as the value of bonds will increase with a fall in market interest rates.  Thus, with the interest rates probably at its peak, retail investors will benefit if they sell the bonds after some period when the interest rates in the market goes down enough to reward high premium.

Tax Advantage: Tax-free bonds are issued by the government entities as they are important to the government in terms of building the country’s infrastructure.  The income by way of interest on these Bonds is fully exempt from Income Tax and shall not form part of Total Income as per provisions under section 10 (15) (iv) (h) of I.T. Act, 1961. These bonds score well for those in the highest tax bracket. So if you invest 1 lakh in IRFC, and you are in the highest tax bracket, you will get an interest income of Rs 8,300 per annum for 15 years which is tax free. As against this, even if you earn a 9% interest in bank fixed deposit and you are in the highest tax bracket (30.9%) you will earn an interest of Rs 9,000 per annum but will pay a tax of Rs 2,781, so the net interest you earn is only Rs 6,219, or yield of 6.22%.

Listing Gain:  These bonds do not qualify for upfront tax savings, but the interest generated is tax-free as against the 80CCF infrastructure bonds whose interest is taxable. With the tax exemption on the interest of the bond and an effective pre-tax interest rate of 11.8% for a person who falls in the tax bracket of 30%, we expect the bond to list at a premium of around 10-12%.

Thus, the investor will get a significant return on listing premium in a very short time. To this, if we add the increase in price due to a fall in interest rate of around 1% in the coming year, we expect a further premium of 10-15%. Thus, one can expect a significant premium in the bonds in the coming years with the fall in the interest rates and the recurring tax benefit on the interest income.

Terms of the Issue

(BMA Wealth Creators: Equity Research)