Corporate FDs not necessarily good bets than bank FDs

Bank | admin | January 20, 2011 at 8:55 am

Companies are keen to borrow from retail investors, given the liquidity crunch in the market. A popular method is fixed deposits, similar to the products banks offer. Individuals who seek regular income welcome company FDs. “Investors, especially retirees and those in the last years of employment, consider such fixed deposits,” says Anil Chopra, Group CEO, Bajaj Capital.

Companies such as HDFC, Mahindra and Mahindra Financial Services, PNB Housing Finance, Hudco and Exim Bank offer 7.5% to 8.5% on money deposited for a year. Returns rise up to 12% for a year with companies such as El Forge , which makes steel forgings, and hospitality company Neesa Leisure.

Generally, higher risks accompany higher returns. Some companies compound interest every quarter or half year, amplifying returns. Senior citizens earn more in certain company fixed deposits. You can receive interest every quarter, half year or year or on maturity, subject to terms and conditions.

Which is better?

Banks that offer FDs with unconventional tenures such as 111, 333, 555 and 999 days offer higher interest rates than companies. HDFC hands out 8.9% on a two-year FD for senior citizens. In contrast, HDFC Bank offers 9.5% on a fixed deposit that matures in two years and 16 days and ICICI Bank 9.75% on its 990-day FD to senior citizens.

IDBI Bank offers 10% on 1,100-day FDs to senior citizens. In the case of FDs of even financially sound companies, the minimum investment is generally higher than what banks demand. Likewise, a premature exit from company FDs is not as simple as with bank FDs.

You might have to run from pillar to post, shoot off letters and even give reasons for premature withdrawals. Depositors make more money if they pick FDs of riskier companies. But instances of companies vanishing after collecting money are many.

Remember, you invest in FDs only because you hate risks. Here are some key points that will help avoid pitfalls.

Evaluate the risks

An investor faces different kinds of risks while investing in company FDs. The first is default risk, which means, on maturity, a company might default on payment. The second is that a company FD is unsecured debt. If a company collapses and is liquidated, debentures holders and commercial lenders have the first claim on proceeds. A company FD holder is often left with little.

“Fixed deposits offering assured returns are in a way riskier than mutual funds that offer market-linked returns,” says Uday Merchant of Mumbai-based Merchant Investment Consultancy. Bank FDs are insured up to `1 lakh by RBI offshoot Deposit Insurance and Credit Guarantee Corporation. There is no such insurance on company deposits.

Look for the rating

Non-banking financial companies that offer FDs must get the instruments rated by agencies such as Crisil , Icra and CARE. But manufacturing companies are free of this guideline. FDs of developers are not rated though most offer attractive interest rates.

You can count a company FD with a AA rating as a good investment. Also, check a company's record in handing interest payments.

Pick carefully a company with say, a 12% coupon rate over another with an 8% coupon. The higher return is tempting, but safety could be lower. It pays to pick companies with high ratings as such FDs are tied to risks.

Picking company and sector

Look at a company’s business and sector. If one were to choose between a realty company and an auto financier, the risk of non-performing assets is higher for the former. Defaults on a car loan will be smaller than a builder’s rising cost of loans due to unsold apartments.

Hidden costs

Unlike bank deposits, company FDs carry hidden costs. The first cost is in the form fixed deposit of liquidity. Closures before completing three months from the date of acceptance are a no-no. Premature closures attract penal charges of 2-5%. Banks charge nearly 1% for early FD withdrawal. There are also transaction costs. Some companies insist on a demand draft payable at the place of the registered office. Electronic clearing services for payment of interest warrants are also not pervasive.

So should you invest?

Experts say it is safe to invest in FDs of companies like HDFC and Mahindra. Others may not be worth the trouble, given that bank FDs currently offer up to 10% annual returns. That’s not all. “Since company fixed deposit rates are not compensating the higher risk investors are exposed to, bank fixed deposits are a better investment option,” says Abhishek Gupta, a certified financial planner with Mumbai-based Moat Wealth Advisors.

Source: Economic Times