Enjoy tax-free interest on HUDCO, IRFC bonds:: Business Line

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Only if you hold on to tax free bonds till maturity, you suffer no tax during the entire tenure of the bond and get full benefit of the higher rates.

Following the success of NHAI and PFC, Indian Railway Finance Corporation (IRFC), the financing arm of the Ministry of Railways and Housing and Urban Development Corporation (HUDCO) have come up with public issues of secured, tax-free bonds .

While the rates are a tad lower than the ones offered by the earlier tax-free bonds, retail investors (i.e. those who invest less than Rs 5 lakh ) in both the issues would get marginally higher rates.

Unlike traditional deposits and debentures where interest is taxed at the usual slab rates, interest is tax-free in these bonds. However, these bonds shouldn't be confused with infrastructure bonds which enjoy tax deduction under Sec 80CCF or capital gain bonds offered by REC and NABARD.

Tax free bonds can be traded in the market. Any gains from sale of these bonds will be treated as capital gain and will be taxed depending on the holding period of the bond. Therefore, it is advisable to hold on to these bonds till maturity as only then, you suffer no tax during the entire tenure of the bond and get the full benefit of the higher rates.

INTEREST RATES ATTRACTIVE

Since FD interest is taxable, for a retail investor in the 30 per cent tax bracket, fixed deposits have to offer close to 11.8-11.9 per cent interest to match the tax-free interest rate offered by IRFC and HUDCO. Today, the highest rate offered on bank deposits of more than 5 years maturity is only 10 per cent. The payout in these bonds is hence attractive for investors in higher tax brackets Besides, given the low credit risk profile of these companies and no limits on investments, tax-free bonds are a superior option.

While both options are attractive, HUDCO has slightly better rates. However, HUDCO's credit rating (a measure of credit risk) is Fitch AA+ which is one notch lower than IRFC's AAA rating (CRISIL). But given that both are quasi-government organisations investors can split their investments equally between both these bonds issues.

Investors should give a thought to the 15 year bonds as there are very few debt instruments (outside small savings schemes) that are long-term and at the same time liquid. Considering that interest rates are at their peak now, the current rates attractive for those with a long term investment horizon. First, it is tough to get post-tax returns of 8.3 per cent every year on any other instrument over the period of 15 year as interest rates could be very volatile during this period. Second, investors may have to manage their portfolio more actively and take higher risk to get decent pay out on other instruments.

IRFC is the sole arranger of finances for the Ministry of Railways.

ABOUT IRFC

It borrows money from the market on behalf of Indian Railways, acquires assets (rolling stock such as wagons, coaches, locomotives) and leases it to railways. As of March 2011 IRFC's net outstanding lease to Railways stood at Rs 43,158 crore.

It adopts a cost plus model which allows the company to pass-on interest rate risk and exchange rate risk. Additionally, IRFC can also approach railways to pay a portion of lease in advance if any temporary liquidity mismatch arises, thereby reducing the liquidity risk. The non-performing assets are nil as it invests only in viable projects.

The debt equity ratio is at 9.7 times as of September which is high as compared to other non-banking finance companies. However, the government from time to time has been infusing equity into the company. The net profit for the half year-ended September 2011 is Rs 201 crore.

ABOUT HUDCO

HUDCO is a financing arm of the government which provides financing at relatively lower cost for housing and urban infrastructure development.

It has disbursed close to Rs 29,835 crore and Rs 46,692 crore for housing and infrastructure projects respectively. The company enjoys low debt-equity of 2.8 times, good net interest margin (close to 4.5 per cent) and also gets capital support from the government frequently. The one key concern for HUDCO is that it is exposed to customers with risky credentials such as local government bodies and troubled state governments. The gross NPA ratio as of March 2011 was 5.46 per cent, however, HUDCO has been conservatively providing for these NPAs. The Net NPA ratio as of March 2011 was 0.19 per cent.