Corporate or company fixed deposit (FD) is one of the investment instruments that have caught the fancy of many investors owing to the higher interest they offer than bank deposits, apart from the flexibility they provide in terms of regular income and maturity. However, company FDs can be a very good investment option if you know how to separate wheat from the chaff, i.e. how to differentiate between a good fixed deposit scheme and a bad one.

A good understanding of the instrument is important before you decide to invest. You must consider certain critical factors before picking a company FD. Let’s discuss those factors at length

Rationale for Company FD

Companies have regular requirements for capital that can be raised through various sources such as IPO, FPO, bank loan and debentures. However, companies might find it difficult to come up with an IPO or FPO owing to market conditions, wherein they may not be able to find enough subscribers. Also, this process involves huge expenses. Therefore unless companies are fully confident in terms of being able to raise money through equity route they may avoid an IPO or FPO. Similar is the case with debentures, where there may be issue related expenses and are open only for a certain period during which they may or may not be able to raise money. As for bank loans the rates may be higher as a result of which companies may find it difficult to raise money through banks while maintaining their cost of capital.

Company FD, on the other hand, is the deposit companies (including NBFCs) invite from investors for a fixed period and pays pre-determined interest, just like bank FDs. Companies come up with FD with approval from RBI and/or other approving authorities like National Housing Bank or NHB, in case of housing finance companies). The amount of money that can be raised is defined by criteria specific to the industry and as per the approving authority’s guidelines. For example, it is five times the net owned funds for housing finance companies under the directions laid down by NHB.

 

Factors to Watch Out For

Generally, the rates offered by companies are higher than the bank fixed deposits. Hence it makes it an attractive investment and also a good medium to raise funds for companies. However from an investor’s point of view, high interest rates cannot be the only criteria. There are various questions an investor should seek an answer to.

Company Background: An investor should have a brief idea on the working of the company and where this money invested by you might be utilized. It might be used for lending money, working capital requirement or to clear short-term debt obligations. Unlike in an IPO or a debenture issue where the objects of the issue is clearly mentioned, there is no such thing in case of FD.

Rating: Most of the companies issuing fixed deposit get itself rated by independent rating agencies such as CRISIL, ICRA and CARE. The rating is based on the repayment capability of the amount the company is raising through FD. The rating agencies will study the company’s cash flows, liquidity position and profitability before arriving at the rating. Typically a ‘AAA’ rated company is supposed to be the safest (highest safety) followed by AA+, AA, AA-, A+ etc in order such that A indicates adequate safety. The rating D is for default.

It is generally observed that a company with higher rating generally offers lower rate compared to a lower-rated company but it may vary if the two companies belong to different categories such as NBFC and Housing Finance Companies.

Tenure: This is one of the most important parameters that needs to be looked at. An investor should know his/ her investment tenure and should invest in an FDs such that it matures in line with their requirement. The corporate FD’s tenure varies from 6 months to 7 years, depending on the category the company falls in — NBFC or housing finance or manufacturing. Each of the categories has defined tenure range for which it can accept deposits.

Minimum Investment amount: Minimum investment amount varies from company to company and even within the company depending on the interest payment frequency option. Some companies even offer higher interest or additional interest for single deposits above a certain limit. This way, if one is investing higher amount one might get additional interest benefits.

Interest Payment Frequency: This is another most important parameter if an investor is looking for regular income. Generally, the interest payment frequency options are monthly, quarterly, half-yearly, and annually. An investor should also consider FD based on his/her cash flow requirements. If an investor is looking for a monthly income, he/she should consider FD scheme that offers monthly interest option.

There is another option — cumulative option — wherein the principal and compounded interest amount is paid at maturity. However the one factor an investor has to watch out for is the compounding frequency. The frequency of compounding can be quarterly, half-yearly or even annually and the effective interest rate varies accordingly. Higher the number of compounding in the holding period, higher will be the effective interest rate.

Interest Rates: Once an investor has zeroed in on a few corporate FDs based on ratings and available tenures, the next aspect to be looked at is the interest rate. The reason is because there might be companies which might give very high rates (the interest rate is at the discretion of the company board) that might draw investors’ attention but it may not be the perfect investment.

The best way to choose a corporate FD would be to scrutinize various FD schemes based on the above discussed parameters and zero in on two or three FDs which fit in one’s criteria and then choose on the basis of interest rates. It is also better to take some pain yourself or ask your advisor to do the exercise for you and make investment based on mutual consent.

Premature Withdrawal Conditions: Although FDs are for a certain period and do not offer liquidity, there are certain clauses where premature withdrawal is possible after a certain period of time. This feature may not be a part of the selection criteria but an investor needs to explore this option for unwarranted circumstances.

Taxation: The interest from corporate FD is added to an investor’s income as income from other sources and taxed as per the tax bracket of the investor. Since TDS is not applicable for interest amount up to Rs 5000, investors can split their investment amount in such a way so that the interest earned on one FD may not cross Rs 5000 in a financial year.

Company FD Vs Bank FD

Although company FDs offer higher interest rate than bank FDs, one of the biggest risks with the former is that they are unsecured. This means, in case a company defaults, investors in the company’s FD are not guaranteed anything. In case of bank FD, on the other hand, Deposit Insurance and Credit Guarantee Corporation ensures that Rs 1 lakh per bank is repaid to the customer in case of a default. Nonetheless, since corporate FDs are rated, they have a very high safety level.