BackScrutinize company FD before investing
Tread with caution because high returns can dazzle investors and make them ignore their money's safety
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In the past six months, many banks have cut interest rates on fixed deposits (FDs). Some have cut up to 50 basis points (bps) for select maturities. One basis point is one-hundredth of a percentage point. India’s largest lender, State Bank of India (SBI), for instance, offered 8.50% per annum on its one-year FD in January; in July, the rate was 8%. Similarly, ICICI Bank Ltd, India’s largest private sector bank, has reduced the interest rate on its one-year FD from up to 9% annually in July last year to 8% now, according to Apnapaisa.com, an online financial product distributor.
The fall in bank FD rates intensified this year after the Reserve Bank of India (RBI) began reducing policy rates since January. In fact, the fall in bank FD rates has been such that they now offer lower interest than small savings schemes such as Post Office Monthly Income Scheme (POMIS) and National Savings Certificate. For instance, SBI is offering interest rates of 8% on FDs with maturities of five years and above whereas POMIS and National Savings Certificate are offering 8.5% on five-year deposits.
In such a scenario, company FDs may look more attractive to investors looking for higher rates.
Like bank FDs, in company FDs, too, the company takes a deposit by offering you interest at a predetermined rate and a defined tenor. Usually, company FDs offer rates that are 2-3% higher than bank FDs because they have to pay higher interest to banks for borrowing money.
However, also like bank FDs, AAA-rated corporate FDs have seen a drop in interest rates. “In the past one year, we have seen a 50-bps drop in interest rate for AAA-rated company FDs. This is because as long as companies are giving about 100 bps above bank FD rates, there will be takers for company FDs," said Srikanth Meenakshi, founder and director, FundsIndia.com, a platform that distributes mutual funds and company FDs.
AAA-rated company deposits normally give 50-100 bps above bank FDs. There are also companies that offer interest rates as high as 13-15%. But before you put your money in a high yielding company deposit, analyse them carefully. Here’s how.
Credit rating comes first
Most investors tend to look at just the interest rates while investing in a corporate FD. But this is not the right approach. To make a proper selection, first look at the credit rating, which indicates the company’s health. Company deposits generally come with credit ratings from rating agencies such as Crisil Ltd, ICRA, Fitch Ratings Ltd, and CARE Ratings. The highest rating is AAA, which denotes a high level of safety. If a company deposit has this rating, it means that the chances of it defaulting on payment of interest and principal are minimal.
“Even within a given rating grade, choose the company with a better reputation. For instance, in case of NBFCs (non-bank finance companies), the RBI (Reserve Bank of India) has made it mandatory for them to have an A rating to be eligible to accept public deposits. You should go further and look at only AAA schemes," said Srikanth.
Avoid companies rated lower than AA as these may be risky. If a company FD comes with no rating, stay away from it.
You could dig deeper and read the company’s financials. If the company is not paying regular dividends or if its balance sheet shows losses, these are red flags.
Safety of principal
Unlike bank FDs, company deposits are not completely secure and carry the risk of default—which means that you may lose your principal if the company is unable to meet its commitments. Though NBFCs, too, are regulated by the RBI and companies by the Registrar of Companies, the risk of loss of capital remains. However, in case of bank FDs, deposits are always insured up to 1 lakh by the Deposit Insurance and Credit Guarantee Corp.
Another way to check a company’s quality is to see if deposits is the company’s primary business. “A company whose primary business in deposit will be safer than those companies who carry out deposit as a secondary business," said Srikanth. For instance, companies such as Shriram Transport Finance Co. Ltd, Dewan Housing Finance Ltd and Mahindra and Mahindra Financial Services Ltd run deposits as primary business, while it is secondary for those such as LIC Housing Finance Ltd and PNB Housing Finance Ltd.
Risk in rates
Once you decide on a company, the next step is to choose the schemes that have given a better return. Company deposits with AAA rating give 0.50-1% higher interest rate than bank deposits but lower than unrated or lower-rated corporate FDs. For instance, an FD by Shriram Transport Finance Co. Ltd, rated AAA by Fitch, offers 9%, 9.25% and 9.5% returns on deposits of one, two and three years, respectively. Omaxe Ltd, rated BBB- by CARE, offers 11.5%, 12% and 12.5%, respectively.
Once you have chosen the company and interest rate, look at the preferred option for returns. Normally, interest is paid on monthly, quarterly, half yearly or yearly, or on maturity. “If you don’t need a regular income, opt for cumulative schemes as these give higher yield (interest earned gets reinvested at the same coupon rate). Yield will depend on frequency of compounding," said Dilshad Billimoria, director, Dilzer Consultants Pvt. Ltd.
Remember that tax is deducted at source if the interest from company FDs exceeds 5,000 in a financial year.
Also, though a company FD may offer higher returns, liquidity is lower than bank FDs. A bank FD can be terminated by paying a penalty in the shape of getting returns 1% lower than what was offered. The cost of premature withdrawal of company FDs is much higher at 2-3%. So, if there is a 3% withdrawal penalty on a 9% FD, one will only get 6%, which is taxable. Make sure you match your asset class based on your goals and not on returns.
Customer service
A company’s servicing standards are important. “Opt for a company that is prompt in sending interest warrants or the principal cheque. You don’t want your money to be stuck even after maturity period is over," said Srikanth. Some companies fare badly in communications. “If there are company FDs with similar ratings and interest rates, choose the one with better customer service," said Suresh Sadagopan, a Mumbai-based financial planner.
Of course, 12% return is better than 9%. But that’s not the full story. Go beyond returns; safety of your money is also important.
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