Not Fully Secured

Company FDs give higher returns than bank deposits, but don't invest unless you are absolutely sure about the company's credentials
Tanvi Varma/Money Today        Print Edition: April 2015
Not fully secured

Before the advent of debt mutual funds, corporate fixed deposits were a popular investment option for investors seeking regular returns. Further, in a downward trending interest rate scenario, corporate FDs were an attractive proposition as they offered an additional return of one to three percentage points over bank FDs. However, the recent fate of some companies has put a question mark on the credibility of corporate fixed deposits leaving investors in the lurch.

One such case is that of Elder Pharma. The company had been raising money through its fixed deposit program for the past few years, but this year the company defaulted on its interest and maturity repayment. In 2012, investors flocked to the company fixed deposit scheme of Elder Pharmaceuticals by locking into a rate of 11.5% for 3 years, which was an effective yield of 13.5%. However, in January 2015 the company wrote a letter to its deposit holders mentioning its inability to repay interest and principal amount to shareholders due to a liquidity crunch. The company's financials have been in a bad shape off late. It posted a loss of Rs 72 crore for the quarter ended December 2014 with revenue of Rs 35 crore, compared to a loss of Rs 47 crore in the earlier quarter and revenue of Rs 85 crore. But Elder Pharma is not the only company in this list.

Omnitech Infosolutions, a company involved in providing IT services, was popular amongst depositors for offering a return of 12.5% on its three-year deposits. However, the company defaulted on its interest payment in 2013. In its annual report for 2013-14, the company stated the default on repaying deposit holders. The company's income from operations dipped over 50% in 2013-14 compared to 2012-13 and it posted a net loss of Rs 143 crore compared to a profit of Rs 18 crore a year ago. Investors who chased the FD of Ind-Swift Laboratories, which offered an interest rate of 12.5% on a threeyear fixed deposit and 10.5% on a one-year deposit, too suffered the hardship of recovering their interest and maturity amount when the company defaulted in September 2013. Higher borrowing costs, lack of demand and the resultant drop in profit margins took a toll on several companies, especially in the mid cap segment. According to a study by Crisil for 2013, the default rate for Crisil-rated firms rose to 346, the highest in any year. The increasing number of defaults could be attributed to the increase in number of firms rated "BB" or lower (See What the Ratings Imply) by Crisil.

Tighter norms

According to Anil Chopra, group CEO & director, Bajaj Capital, amendments in The Companies Act have made it difficult for companies to comply with the stringent provisions, resulting in a delay in making interest payment as well as refunds. First, the companies must get themselves compulsorily rated by an accredited credit rating agency like Crisil, ICRA or CARE, which is mainly a rating on the company's liquidity and ability to pay deposits on time. Also, this rating should be obtained for every year during the tenure of deposits. Companies have also been asked to keep aside at least 10% of the amounts collected as a reserve so as not to create any cash flow mismatch. Further, companies that extend their deposits to the public must have a net worth of Rs 100 crore or more and turnover above Rs 500 crore. This aims at weeding out companies that don't have the financial stability to accept deposits, as well as smaller companies that aren't serious about meeting requirements. However, it is not mandatory for companies other than NBFCs to get their fixed deposits rated. So, investors should research on those companies as well. Having said that, there are more NBFCs offering fixed deposits currently, which carry varied ratings. (See In Good Company).

Factors to consider

Investors must understand that funds raised through company fixed deposits are treated as unsecured loans and investors have limited legal recourse in case of a default. "In case of default, the investors must first file a complaint with the investor grievance cell of the company. They can then lodge a complaint with the Ministry of Corporate Affairs (MCA). They can also can file a 'winding up petition'," says Chopra. The MCA offers investors the online route for filing of complaints. If the company in which you have made the investment happens to be a listed company, complaint or grievance redressal can also be expected from Sebi.

It is understandable then, why financial planners like Gaurav Mashruwala refrain from advising their investors to invest into corporate fixed deposits. "A large number of these companies approach small investors because banks and other lenders are reluctant to lend them money," he says. Unless there is a real difference in terms of the absolute amount earned on one's investment, there is no need for investors to park their hard earned money into corporate FDs. If one were to invest into a company fixed deposit, he suggests investing in papers rated AAA+ only.

According to Chopra, there are several fixed income options available for a tenure of one to three years and these include short-term and long-term debt funds (accrual option), fixed maturity plans, etc. In the current scenario, according to Lakshmi Iyer, CIO (debt) and head, products, Kotak Mutual Fund, investment products like fixed deposits tend to secure a fixed rate of interest to the investor, thereby not allowing any potential capital gain that is likely to arise out of anticipated reduction in interest rates. Equally important is to assess the creditworthiness of the company one is lending to: in case of a credit default, one may end up losing the capital as well.

So, while it is not a bad strategy to invest in corporate FDs to secure some stability in rates, one should be cognisant of the above risks. "In a reducing interest rate environment, the essence would be to enhance ones portfolio duration, the current scenario therefore seems conducive to invest in strategies like gilt and bond funds with a one- to three-year perspective," she adds. Mutual funds are allowed to lend only to banks in the form of fixed deposits; that too for pending cash deployment. They typically have rigorous credit risk evaluation and surveillance mechanism, which allows them to monitor every credit.

Being in the fiduciary business, the AMCs therefore exercise reasonable caution while lending to the corporate sector. Further, mutual funds are well regulated by Sebi and hence the safety quotient is much higher for investments in mutual fund schemes as compared to corporate FDs.

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