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Tax-free bond sales may not repeat last year’s success

IIFCL to sell Rs.500 crore bonds in the first leg of a planned Rs.10,000 crore sale
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First Published: Sun, Nov 11 2012. 11 10 PM IST
IIFCL chairman S.K. Goel says the lower rate offered by the government vis-a-vis last year is not a hindrance, rather it reflects the market rate. Photo: Ramesh Pathania/Mint
IIFCL chairman S.K. Goel says the lower rate offered by the government vis-a-vis last year is not a hindrance, rather it reflects the market rate. Photo: Ramesh Pathania/Mint
Updated: Mon, Nov 12 2012. 01 21 AM IST
Mumbai: India Infrastructure Finance Co. Ltd (IIFCL) plans to sell Rs.500 crore worth of tax-free bonds on Monday, the first tranche of its planned Rs.10,000 crore sale, even as some brokers and bond dealers are sceptical about the success of such securities this year.
This is the first such sale, following a 6 November government notification that permitted quasi-government and private infrastructure companies to sell a total of Rs.53,500 crore worth of tax-free bonds.
Around 10 companies, including IIFCL, are expected to sell tax-free bonds this fiscal to retail investors, qualified institutional buyers (QIBs), companies and high-networth individuals (HNIs).
The Rs.53,500 crore figure is lower than the current fiscal year’s budget projection of Rs.60,000 crore for such bonds but more than the Rs.30,000 crore raised in the last fiscal. However, dealers are sceptical about the success of these bonds as far as the participation of companies are concerned. Besides, brokers are also not very enthusiastic of selling these bonds, owing to the lower fee offered this time.
The government had for the first time allowed infrastructure companies to sell these bonds to raise funds last year.
The rates offered on these bonds, if sold by AA-rated companies, will be half a percentage point less than that of government bonds of identical maturity for retail investors and one percentage point less for other investors.
If the issuer has a higher rating, the rates will fall even further—minus 65 basis points (bps) for retail and 115 bps for other investors. One basis point is one-hundredth of a percentage point. If the interest payment is on a semi-annual basis, the rates stand to fall by another 15 bps.
In the year ended 31 March, the rates offered on similar bonds were also half a percentage point lower than government securities but the rates did not fall further.
For an AAA-rated bond, where HNIs and QIBs invest, the rates on offer for a 10-year paper roughly now comes to around 7.06%. The 10-year bond yield is at 8.21% now.
For retail customers, though, the rates will be at around 7.56%.
These bonds were a major success last year but that is unlikely to be repeated this year as the higher rate of interest to retail investors will not be available in case the bonds are traded.
There was no such restriction last year and the bonds are currently available at the secondary markets at around 7.5% yield. The buyers of new bonds will have no other option but to hold them for 10-15 or 20 years (in case of IIFCL bonds) if they want high interest rates.
Also, a move by the Reserve Bank of India (RBI) earlier this year could put a damper.
Section 372A of the Companies Act, 1956, bars companies from investing in other companies’ loans and debentures below the bank rate—a reference rate by RBI.
The bank rate was 6% until February 2012 when RBI raised it to 9.5%.
The central bank of the country subsequently cut it to 9% in April and since companies will offer lower interest rate on tax-free bonds, companies will not be eligible to invest in these. Companies accounted for about 20-25% of last year’s total bond buying.
Firms can circumvent this if they include the tax advantage that the investors will get and show an inflated yield. However, according to the bookmakers for these deals, companies will not want to do that as it adds to accounting complications and the rules are not clear on this.
S.K. Goel, chairman of IIFCL, doesn’t think this should be a problem. Besides, the lower rate offered by the government vis-a-vis last year is not a hindrance, rather it reflects the market rate, said Goel.
But the brokers are not convinced.
“Last year, the government offered a higher rate and the response was excellent. But this year, probably to compensate that, they are offering very low rates,” said a book builder for these bond issuances who did not want to be named.
“Besides, the fee structure is low and a disincentive for investment bankers.”
The brokerage for the bond issuances is 0.05% for QIB, 0.1% for firms, 0.15% for HNIs and 0.75% for retail investors. Also, the total issue expenses, consisting of brokerage, advertising, printing and registration etc., shall not exceed 0.5% of the issue size, the government notification said.
In 2011-12, the commission was a flat fee of 1.25% of the issue size for public issues. For private placements, though, the commission was capped at 0.1-0.2% of the issue size.
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First Published: Sun, Nov 11 2012. 11 10 PM IST
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