Sunday , 25 June 2017

Fixed Deposit

What is a company fixed deposit?
APART from banks, even Non Banking Finance Companies (NBFCs) offer fixed deposits.

What is a company fixed deposit (FD)? How does it work? Is it safe? Let’s answer these questions on company FDs.

What is a company FD?
It is a fixed deposit scheme offered by a company. It works similar to a bank deposit where you earn interest income.

Is it safe?
It may not be as safe as a bank deposit. This is primarily because banks in India have the backing of the central government. Company deposits enjoy no such benefit.

Furthermore, company deposits are ‘unsecured’. This means, you have no lien on any asset of the company, in case it goes into financial difficulties and is wound up.

How do I find out if a company FD is safe?
NBFCs that offer FDs need to mandatorily get them rated by rating agencies such as CRISIL, ICRA, CARE, etc. However, manufacturing companies do not have any such compulsions.

Check the rating of the FD before you put your money. For instance, a company FD with a AA rating can be considered a good investment.

Also, check the company’s past record in making timely interest payments before you invest.

Returns offered by company FDs?
Company FDs offer much higher returns than bank FDs, since they entail higher risks. The higher the risk, the higher is the interest rate offered. So, be careful before choosing a company with say a 15 per cent coupon rate as against one with a 11 per cent coupon. While the higher return may be tempting, the safety is lower. Since you are investing in FDs because you are risk averse, it may make more sense to go with companies that have high ratings.

Do the due before investing in company FDs
As much as 55% of Indian savings find their way to bank fixed deposits. Over the past one year, fixed deposit interest rates from nationalised banks have gone down from 8-9% to around 6-6.5% now for a period of 1-3 years.

“With fixed deposit rates from banks coming down, investors seeking higher returns from fixed income products are investing in company fixed deposits,” which has recently started distributing company fixed deposits. Company fixed deposits work for investors seeking assured returns higher than that offered by bank fixed deposits.

Here are some key points you need to keep in mind while investing in company fixed deposits.

  • Security: Company fixed deposits are unsecured. In case of bank fixed deposits, the Deposit Insurance and Credit Guarantee Corporation of India guarantees repayment of Rs 1 lakh in case of default. There is no such guarantee offered in company deposits and the safety of your deposit depends on the financial position of the company.

    This means, as a depositor, you have no lien on any asset of the company, in case it goes into financial difficulties and is wound up. Your turn to get your money back would come only when secured lenders have been paid. So do not invest in unknown companies.

  • Risk v/s return:  Today, investors could expect around 5-8% from income funds, depending upon whether it’s an ultra liquid fund or a long-dated income fund. Schemes like the post office NSC and PPF give you a 8% return, but are locked in for six years and 15 years, respectively.

A corporate like Tata Motors or Mahindra & Mahindra would offer you an interest rate of 8-8.5% while smaller companies like Avon Corporation or Ind Swift offer you an interest of 11-12% for a year. It’s a simple investment philosophy. “You trade return for risk”.

Definitely, the risk involved while investing in smaller companies is higher. Unless you need income regularly, you should prefer cumulative schemes to regular income options since the interest earned automatically gets reinvested at the same coupon rate, resulting in better yields.

  • Check parentage & financials:  You can check with distributors or with friends about the credentials of the promoters and their past track record. Opt for companies that pay dividends and are profit making. Avoid loss-making companies or those who do not pay dividends. If a company has made a one-off exceptional loss in a particular year, but has a good parentage and past track record, you could consider it.

Also, it is important to check the servicing standards of the company. How quick are they are in dispatching interest warrants and principal amount is something you shohttp://localhost/theequitymarkets/wp-admin/post-new.php?post_type=pageuld know. However, if the company is relatively new, or has been making losses continuously and its promoters are relatively unknown, then it would be better to avoid it.

  • Ratings are important

For NBFCs, RBI has made it mandatory to have an ‘A’ rating to be eligible to accept public deposits. Investors should go only for AAA or AA-rated schemes. Go for shorter tenures such as 1-3 years. This way, you can keep a watch on the company’s rating and servicing, and also have your money back in case of an emergency. Watch out for any adverse news on the company you have invested in and take necessary action if need be.

  • Liquidity

Most companies accept fixed deposits for a period ranging from 1-5 years. Compared to mutual funds or bank fixed deposits, company fixed deposits are rather illiquid. In most cases, premature withdrawal is not allowed before completion of three months. If you wish to withdraw between the third and the sixth month, you get zero interest income.

If you wish to withdraw between the sixth and the 12th month, you get 3% less than the guaranteed return. Also, for those staying in non-metros, in case the company’s banker does not have an account in their respective city, they would have to get a demand draft (DD) issued at a location where the company head office is located.

Similarly, when the company pays back the principal amount, the cheque may take time to clear. FDs are not listed and non-transferable. Interest income from fixed deposits is taxable. So if you are in the highest tax bracket, weigh your options accordingly. If there is a probability, you may need the money before a year, it is beset not to park it in company fixed deposits.

Do not put all eggs in one basket
“Depending on an investor’s risk profile, s/he could consider putting 5-15% of his or her investments in company fixed deposits,”. So if you have Rs 10 lakh to invest, it would then be worthwhile putting around Rs 1 lakh in company deposits for the extra Rs 3,000 per annum.

However, if you have a mere Rs 10,000 to invest, it may not make sense to invest it in company fixed deposits for the extra Rs 300, especially when your next door bank offers you more convenience and flexibility of investments. While opting for company deposits, diversify your risk by spreading your deposit over a large number of companies engaged in different industries. “Overall, investors could have as much as 10% of the total FD investments in one particular company,”.

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