HUDCO – Tax Free Bonds

Introduction

Recently, many companies have been raising funds from the market by issuing tax-free bonds. Three companies have already come out with their bonds, viz. Rural Electrification Corporation (REC), which tapped the market in early December 2012, while the issues of Power Finance Corporation (PFCL) and India Infrastructure Finance Company (IIFCL) are currently open. Joining the bandwagon now is Housing and Urban Development Corporation (HUDCO). 

In the Union Budget 2012, the government allowed some companies to raise funds up to an aggregate of Rs 60,000 crore by issuing such bonds. The move came in light of the fact that the government wished the retail investors to participate in India's infrastructural development.

About The Issue

HUDCO intends to raise funds around Rs 750 crore with an option to retain over-subscription of an additional Rs 4250 crore. The funds raised would be used by the company for lending purposes, for its working capital requirement, as well as for other operational requirements like debt servicing.

The issue will open on Jan 9, 2012 and is expected to close on Jan 22, 2012. The face value of the bonds is Rs 1000, and it has a minimum application value of Rs 5000 (5 bonds, each of FV Rs 1000). Thereafter, the application can be made in multiples of one bond (i.e. Rs 1000).

HUDCO is offering two series for investors to choose from. Series 1 is for a tenure of 10 years, with a coupon rate of 7.84%, while Series 2 is for a tenure of 15 years, with a coupon rate of 8.01%. The interest on both the options would be paid annually. The bonds would be listed only on the National Stock Exchange (NSE).

The company is offering attractive rates for different tenure as compared to other recent issues. For instance, for tenures of 10 and 15 years, REC offered coupon rates of 7.72% and 7.88% respectively, while PFC offered 7.69% and 7.86% for similar periods. IIFCL offered rates of 7.69%, 7.86% and 7.9% for tenures of 10, 15 and 20 years respectively. HUDCO is offering coupon rates that are higher by around 15 basis points for both the tenure. This will result in higher interest income in the hands of the retail individuals.

About The Company

HUDCO was established way back in 1970 and is a public sector entity engaged in financing housing and urban infrastructure projects throughout India. On the financial front, the company has posted good numbers. For FY2012, the revenue from its operations increased by 21% to Rs 2738 and the net profit grew by 14.54% to Rs 630 crore on a YoY basis. The interest coverage ratio for FY2012 stands at 1.58x, which we believe is adequate to pay off its regular interest payments. Going forward, we believe that the company would be able to pay interest to its investors in a timely manner.

Conclusion

The Indian economy is growing at good rate. As the country grows, the interest rates tend to reduce, which is evident from the fact that developed nations have very low interest rates. Hence, this would be a good investment bet for those investors those who wish to park funds for a long-term horizon.

The issue is more attractive to investors who come under the higher tax brackets (30.9%). Thus, an investor gets an effective rate of 11.35% and 11.59% for tenures of 10 and 15 years respectively. For individuals falling under lower tax brackets, the benefit tends to be lesser as the fixed deposit rates for a tenure of around 5 years are in the range of 8.5%-9% (pre-tax).

One should note that even though the bonds would be listed on the NSE, the volumes on the counter might be low and hence liquidity could be an issue. Hence, investors those who wish to invest for a longer-term horizon should go with the same. Also note that there will be no Tax Deducted at Source (TDS) on the interest earned.

While there would be more such issues in the market, those who wish to invest in tax-free bonds should invest in this issue and not wait for other offerings. This is because the interest rate is expected to come down from the March quarter of 2013, and hence, one might see companies offering lower coupon rates going ahead.

Of the two series available, we would advise investors to opt for the second one as it is offering a higher coupon rate and is offered for a tenure of 15 years.