Company Deposits – Caveat Emptor
January 20, 2011 1 Comment
When inflation is high and interest rates on term deposits and bonds are low,or when fixed income instruments start offering equity like returns during liquidity crunches, company fixed deposits become tempting.Here are a couple of things to consider to rein in your greed.
- No one became a billionaire via company deposits, unless he owned the company taking the deposits, so hold your horses!
- Company deposits can be tax inefficient,so think twice before sticking your in money here.
- A company FD is an unsecured debt so if a company is liquidated,FD holders are paid after debenture holders and commercial lenders. By then there might not be enough to pay back the principal, much less interest.Liquidation proceedings take time so even whatever little money might be returned to you will take a while to come.So avoid companies with accumulated losses.
- Along with ability to pay there is the matter of a willingness to pay.There are instances of companies vanishing after collecting money.So avoid companies you don’t know already know about.If you try to read up on the company,you might be influenced by planted material.Also avoid companies that do not pay regular dividends because they are often run by promoters who have no intention of sharing anything with anybody other themselves.Prefer companies with a good reputation.Having invested in building a reputation they are not likely to risk it by defaulting.Avoid companies with poor servicing standards.Chasing after your own money is a real drag.
- During periods of tight liquidity banks offer FDs with unconventional tenures such as 111,333,555,999 days etc.Rates for these and some conventional tenures are often higher than company deposits and covered by deposit insurance.
- Not all companies offer higher rates to senior citizens while banks do so for most deposits.
- Some companies offer higher rates to share holders but only if they own 100 or more shares of the company.
- Premature exit from a company FD might involve running from pillar to post,shooting off letters and giving reasons for the premature withdrawl.Closures before three months from acceptance might be a no- no.Also where banks charge a penal interest of 1% on premature closure,companies charge 2-5%.
- Consider transaction charges.Some companies insist on a DD payable at the place of the registered office . They do not accept outstation cheques.Not all companies offer ECS for interest warrents so check that they make payment via at par cheques.
- Companies offer higher rates for a reason-the risk is higher in company deposits and the companies can’t get a regular bank to lend to them cheaper.Company deposits offer 2-3 % more than bank FDs of a similar tenure.At the higher end of the spectrum are the companies that are having trouble getting money from institutional lenders.14% percents are really risky and anything above 15% is likely to be a ponzi scheme.
- Companies often want larger deposits than banks.So reducing overall portfolio risk by splitting up investments becomes difficult.
- NBFCs have to compulsorily carry a rating from Crisil/Icra/CARE as per RBI requirements.Go only for AA and AAA ratings.Avoid A ratings.Manufacturing companies and construction companies do not have to get their offerings rated.So avoid little known companies or those that have defaulted or delayed payments before.
- Avoid companies under investigation or in troubled sectors.In case of smaller investment amounts the higher rates offered often don’t translate to a meaningful increase in the interest amounts to compensate for higher risk of capital and investing bigger amounts is foolhardy.
- In case of two tenures having the same rate, prefer the lower tenure.Try to avoid longer lock-ins as the prospects of a company might really change in the time span
- Unless the money invested is very small,considering the portfolio size ,opt fot the interest option over a cumulative option . Better to have out some of the money than risk it all.
- Do the math to see exactly how much more the extra half percent or quarterly/semi-annual compounding works out to given the principal to be invested.Sometimes the pittance , especially post-tax, is not worth taking on a greater risk and losing sleep.
If company deposits still look exciting , then go ahead by all means but take the precaution of ensuring that no more than 10% of the portfolio value – wise is invested in any one single company and pick an assort ment of companies in different sectors to spread out the risk.Good Luck!