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Real returns on tax-free bonds are higher as income from NCDs is taxable, but your money will be locked for 15 years
Debt investors always rued the fact that it is not easy to sell their non-convertible debentures on the exchanges. These debentures are hardly traded and many a time one has to offload them at a discount. However, L&T Finance is changing the game. L&T Finance will open a repurchase window every month where NCD holders can submit the repurchase application. The repurchase offer for July is currently open and investors can submit their applications till Tuesday (July 10). NCD holders already have the option to sell their holdings on the National Stock Exchange, where they are listed. As per the buyback option, each debenture holder can tender a maximum of up to 100 debentures for buyback per quarter. The maximum number of debentures bought back by the company per quarter across all series shall not exceed 500,000 on a first-come first-serve basis.
According to investment experts, if the L&T Finance's offer meets positive response from investors, other companies are likely to follow suit. Also, it will encourage investors to buy more NCDs, as their biggest grouse of illiquidity will be a thing of the past. As for investors in L&T Finance NCDs, investment experts believe that investors should assess the situation before rushing to encash the money. "Participating in this buyback offer is not mandatory. You can choose to stay invested in these NCDs or sell it on the stock exchange where it is listed. If you are in the high tax bracket, it may make sense to opt for the buyback option or sell these NCDs on the stock exchange and buy tax-free bonds of PSUs, such as NHAI or PFC, which will give you a higher yield.
To begin with, you have to find out whether tendering your NCDs in the buyback option or selling it on the stock exchange work better for you. Take the case of L&T Finance – N3 option. The debenture matures in January 2017 and pays a coupon of 9.95%, compounded annually.
The face value of the debenture is . 1,000 and it will be redeemed at . 2,025 at the end of the tenure. Right now the debenture is trading at . 1,288 on the NSE, while L&T Finance has offered to buy it back at . 1,286.26. This means you get a slightly better price at the exchange, but you also have to remember that these debentures are not traded frequently on the exchange and you may get a lower price if you were to sell a large number of them at one-go. Also, you will incur brokerage charges when you sell it on the stock market. However, in the case of L&T Finance – N4 option, which matures in September 2019 and carries a semi-annual coupon of 10.24%, the repurchase price is . 1,035.27, while the price at which it is traded on the market is . 1,069. In this case, it might make sense to give your NCDs through the stock market, provided you can take the risk of illiquidity in the market. L&T Finance N5 and N6 options mature on March 10, 2013, which is just eight months away.
The coupon payable is 8.4% in case of the semi–annual option and 8.5% in the annual option. Interest income on NCDs is taxable. So if you get an interest of 8.5% and are in the highest tax bracket, the effective yield comes out to 5.87% per annum. Now compare this with the NHAI tax-free bond, which has a 'AAA' rating, with a coupon of 8.3% per annum, for a tenure of 15 years and trades at . 1,085, thereby giving you a tax-free yield of 7.73% per annum. However, do keep in mind that these bonds have a tenure of 15 years, and do it only if you can remain invested for that time frame. Similarly, a 15-year PFC tax-free bond with 'AAA' rating and a coupon of 8.3% per annum is available at. 1,078, giving you a yield of 7.79% per annum.
So if your income falls in the highest tax bracket, selling the NCDs and switching to PSU bonds of NHAI or PFC is one option for you. At a time when interest rates are expected to fall, besides the higher return, you also move into a product with a longer tenure.
In case interest rates were to drop, a bond with a longer maturity could give you a higher capital appreciation.
However, this may not work for everyone. If you are not liable to pay tax on your income, it would be better to remain invested. For example, in the L&T Finance – N4 option, where the coupon is 10.24% per annum, it makes sense to be invested as comparable bank deposits could offer you a lower return of about 9-9.5%
Happy Investing!!
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