Corporate Fixed Deposits- An investment opportunity

Bank FDs (fixed deposits) have always been the most favoured debt investment instrument, for several years, on account of the safety it provides. Off late too, FDs have been in flavour but this time we are taking about corporate fixed deposits i.e. those issued by companies to raise money. Investors are attracted to these corporate FDs because of a higher interest rate it provides in comparison to a bank FD.

What is a Corporate FD?

Corporate FD is a debt instrument issued by companies wanting to raise money. This instrument is similar to that of bank FDs- money will be parked for a fixed duration at a predetermined rate of interest. The difference lies in the risk profile and hence the return.

History of Corporate FDs

This instrument is not new to the Indian market. Before the boom in the equity markets, several companies used this instrument when they were in need of funds. However, in recent years, this instrument was neglected as companies found it quicker and easier to raise money from the equity markets. Besides, it also relived them of the obligation to pay interest and the principal at timely intervals.

But in the last year and a half, the economic scenario made it difficult for companies to raise money from equity markets, and hence corporations have started tapping the debt market once again. Several large and small corporates have come out with FD issuances. Some recent examples include

In the past, investors have had their share of trouble with some companies that issued this instrument. A case in example-

CRB Capital Markets Ltd. – one of the largest non banking finance companies during it’s time, raised Rs. 180 cr via fixed deposits at very attractive interest rates (36 months- 15.5% interest, 54 months- 18.5% interest) . One fine day, the cheques issued by the company to the FD holders started bouncing and then trouble began. The company had collapsed resulting in FD holders losing their hard earned money.

Some other entities that have also reneged on the fixed deposit commitments include JVG Finance, Roofit industries, Cable Corporation of India, Prudential Capital Markets, DSJ Finance, Llyods finance and Nagarjuna fertilisers among others.

Does this mean investors should overlook this investment instrument completely?

The key to investing in this instrument is to manage risks effectively. The key risk is the risk of default by corporates.  So if you find a way to effectively pick those instruments where default risk is very low, investing in this instrument will help you earn higher returns.

How should you manage default risk?

To manage default risk, investors should look at a few parameters and then decide on which instrument to invest in. Some of the critical parameters include-

• Assess the credit worthiness of the corporate: This can be done by going through the credit rating of the instrument as it highlights the underlying risk of the instrument. Credit rating agencies would take into consideration the financial health of the company and the ability to service its financial obligations. The higher the credit rating the higher the safety.FAAA and LAAA/MAAA are the highest rating given by CRISIL and ICRA respectively on FDs. It’s best to go for instruments having these ratings. After having invested in the instrument, you need to constantly monitor its performance. Any downgrade by the rating agency should ring an alarm bell. You need to assess the reason for the downgrade and then decide whether to stay invested or exit.
• Management/ Promoter Track record: The promoter/senior management of the company plays a key role in the performance of the company. If the promoter/senior management have dubious records, it is best to avoid such companies.
• Financial Performance: Ensure that the corporate has a good financial track record and is not loss making. Companies financially strained should be avoided. After all, you need them to have the capability to pay interest and principal in a timely manner
• Rate of return: Companies paying abnormally high rate of interest should be avoided, as risk is higher. On account of high perceived risk in the market, the only way for them to attract investors is by offering high interest rates.  

It is better to stick to companies having a good standing and reputation in the market place. For e.g. Tata Group. The returns they provide may be lower, but you do not have to worry about them not being able to meet the obligation of payment of interest and principle. Also, as a precautionary measure, it is better to opt for FDs having tenure of 1-2 years so that you have an option to review the company’s performance. In case of any doubts you will have an exit option and then you could looking at investing in FD of some other company 

As an investor, it is in your interest to do a thorough a due diligence of the company you’re investing in, because your hard earned money is at risk. Do not get lured by higher returns offered by one corporate over the other. Remember they are paying you a higher return because you are taking a higher risk. Many a time’s, companies also resort to providing higher commission to brokers, to push their FDs, and in turn these brokers/agents will attract you to investing in the instrument by sharing the commission. Don’t let this small gain cloud your thinking. Invest in the FD of a company only if you’re convinced of their repayment ability.