Corporate Fixed Deposits: Things to know before investing

Company deposits or popularly known as Corporate FDs are the debt instruments offered by companies to public. These deposits are similar to bank fixed deposits but usually carry higher than bank's average fixed deposit rates and thus attract lot of investors. But it should be remembered that just assurance of a fixed return doesen't make company FDs risk free.
If the company is financially weak, they may not even be able to pay interest, at times, even the principal amount. In the 1990s, many investors lost their hard-earned savings because they were lured by high returns and didn't try to understand how the company would generate the money to repay the deposits.

So what is the risk of default?
The corporate deposits are typically unsecured, which means that you cannot lay your hands on the assets of the company if it lands in financial trouble and is liquidated. In that event, your turn to receive your money will come only after the secure lenders of the company are repaid. In a bank deposit, your money is deployed more diligently as banks are regulated by the RBI. Banks use your money to lend customers after assessing their creditworthiness. Companies, on the other hand, use the money for their own projects or sometimes for their working capital. The risk profile of such projects can be high. The banking system also generates enough liquidity to repay your deposit if you want to withdraw it before it matures.

So how to select which company deposit scheme to choose?

Check following points before investing in any corporate deposit.

Credit rating: Start by looking at the credit rating of the deposit that you are examining. The RBI requires non-banking finance companies such as HDFC and Dewan Housing Finance to get their deposit instruments rated. This will be prominently displayed in the application form. HDFC, for instance, has a triple A (displayed as AAA) rating from Crisil, the highest rating awarded for an investment-grade instrument. Ansal Properties & Infrastructure, on the other hand, has a Fitch Rating of B- (for long-term debt), which denotes speculative grade and low margin of safety.

Look for a triple-A rated company and do not settle for anything less than a double-A rating. This process will automatically weed out companies with high financial and business risks.
Non-finance companies are not regulated by the RBI. Many of them, while getting a rating on their long-term or short term instruments, do not specifically get their fixed deposit rated. Also, the credit rating is often not available to a prospective depositor. The deposit of Jaiprakash Associates is one such example. You have two ways to overcome this limitation. If the company is a prominent one, an Internet search of its rating should throw you results. Crisil, ICRA, Fitch and CARE are agencies that do most of the ratings. You can look in their websites as well. If not, take a closer look at the company's financials that will be disclosed in the application form.

Company Financials: For non-finance companies, look at the balance sheet for debt — secured and unsecured loans. If this sum is over twice the net worth (share capital plus reserves and surplus) you may have reason to be cautious. One other additional check, if you have access to the company's profit and loss account, is to verify the annual interest costs. See if the profit before interest and taxes covers the interest costs by at least two times. The lower the coverage, the more strapped the company is, in servicing your interest.

High rates: If the deposit offers 1.5-2-percentage points more than a top-rated company, verify the nature of the company's business and whether it is a profit-making entity. Jaiprakash Associates' deposits carry 2.5 percentage points higher interest than HDFC's Platinum deposit. Remember, higher returns come at the cost of assuming higher risks.

Listed entities: Prefer listed entities to unlisted ones, unless the latter are government-backed, such as Hudco. Listed entities file a good part of their business and financial information with the exchanges. This makes access to information easy. While you can explore unlisted but public companies, such as Sundaram BNP Paribas Home Finance, avoid partnership or private limited companies. These are less regulated and disclose little information.

Check history: You can also consider inspecting if the company has high number of complaints or defaults in the past. In general, it is best to refrain from little-known names even if your agent recommends it. Remember the agents are paid a hefty commission to promote these FDs.

When you investigate the company's history, always check with your agent and other depositors on how promptly the company provides the FD receipt or pays the interest.

Many companies now take anywhere between 45 and 60 days to issue a receipt if you are not in the same city as the company's processing division. Such delay speaks of poor service.

Fine print: Always read the fine print in the application form. Much of the terms and conditions relating to issues such as premature withdrawal are buried in the second page of the application form. If you are renewing the deposit, look for any change in the terms from the time you deposited.

Once you have zeroed in on you investment, remember to avoid locking into corporate FDs for more than three years. A company's future is tough to predict beyond this, and any deterioration in business or financials normally start hurting a company over a 2- to 3-year period.

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