PFC bonds: Attractive rates come with sector risk

Power Finance Corporation (PFC), the largest power financier, came with its first public issue of tax-free bonds only a couple of days after the National Highway Authority of India (NHAI) offer opened.

The rates offered by the bond are attractive for investors in the higher tax brackets of 20 and 30 per cent, as the interest paid out is tax-free.

PFC is offering an 8.2 per cent annual payout for the 10 year option and 8.3 per cent for the 15 year option, same as NHAI. Of the two issuers offering same rates though, PFC carries more risks than NHAI.

Why risky

In spite of secured lending with low non-performing assets (NPA), the huge accumulated losses and high debt levels of the power distribution sector and shortage of fuel for power generation are key concerns for stakeholders in power sector including PFC.

Fuel supply risk and execution delays are bigger concern for PFC as these directly affect its borrowers who are predominantly power generation companies. Private projects (accounting for 8.7 per cent of the total loan book) are especially vulnerable to fuel supply risk and execution delays, which may put pressure on the asset quality.

The risk of payment defaults by the State electricity boards to generation projects is also rising.

The respective State governments are supporting the distribution companies in near term. Over the long term, distribution sector reforms such as revising tariffs annually and reducing transmission and distribution losses are expected to improve the financial standing of these electricity boards and reduce the counterparty risk for its borrowers.

On a positive note, PFC continues to enjoy a credit rating that gives it the ‘highest investment grade', with a capital adequacy of 18.2 per cent as of September 2011. The March 2011 maturity pattern of PFC's loan book shows that 57 per cent of the loans are maturing beyond 2015-16 by which time power sector reforms may start yielding benefits. The gross NPA ratio of PFC was 0.22 per cent as of September 2011. The quasi government nature of PFC, also makes for a very low possibility of default.

Who can invest

Tax free bonds offers are most suitable for investors in higher tax brackets (20 per cent and 30 per cent). Investors with stomach for risk and high net-worth individuals (investment above R.5 lakh) can consider investing in PFC, given the probability of lower allotment in NHAI.

The advantage of PFC is that investors can put lower sums in it than NHAI with a minimum application amount of Rs 10,000 as against Rs 50,000 for NHAI. Investors of PFCs infrastructure bonds (80 CCF) should limit their exposure to this bond issue.

Attractive rates

Even as a couple of more bond issues are lined up, investors can consider locking in at current rates offered.

The interest rates offered on tax-free bonds are based on government security yields. The rates offered by tax-free bonds should not be more than 50 bps below government security yields of the same maturity, for a public issue. The 10-year government security yield has peaked in November 2011 and is down by 30 basis points during December. This suggests that future tax-free bond offers may offer lower interest rates.

Issue details

Issue size: Rs 1,000 crore with an option to retain an additional Rs 3,033 crore.

Offer period: December 30 2011 to January 16, 2012 (the offer can be pre-closed)

Who can apply: Resident Indians and non-resident Indians (investment in rupee), institutions, trusts and societies.

Reservation: 25 per cent reserved for retail investors; 25 per cent reserved for High Networth Individuals.

Allotment: First come first served.

Listing: Bonds will be listed on exchanges and will entail capital gains tax on exit through secondary market.

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