3 things you should know about corporate fixed deposits
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With the interest rates at multi-year low, corporate fixed deposits (FDs) which usually offer higher rates than the banks, have been gaining investor attention. Here, we look at three factors that investors should note before investing in corporate FDs.
Beware of yield claims
Many corporates offering fixed income products try to woo customers by advertising high yields.
For example, take the recent fixed deposit offer by Hawkins Cookers. The company offers eight per cent interest rate for a 36-month deposit and for a cumulative deposit, the interest is being compounded monthly. Here, while the coupon rate is eight per cent, the yield on the investment will be higher.
The annualized yield is generally determined by finding out ‘rate’ in the compound interest formula – Final amount = principal (1+rate/period)^period; period in the form of number of years. By using this, the Hawkins Cookers FD yield comes to 8.3 per cent
Beware, yields announced by some of the corporates are calculated differently, as a result of which they look higher than what they actually are.
Muthoot Capital Services’ 5-year fixed deposit, for instance, offers eight per cent interest for the annual cumulative option.
Since the interest is being cumulated annually,the yield will be the same as the coupon rate.. However, Muthoot has indicated that the yield on this FD is 9.39 per cent. This could be because the firm calculated yield based on the simple interest formula where Interest = Principal * Rate of interest * Period.
Thus, it is imperative to verify if the yield advertised by the corporate is right, before falling for high advertised yields on cumulative deposits.
For this, one can use the ‘Rate’ function in Excel that calculates the yield using compound interest formula.
Check our detailed article on how to use the Rate function here – https://tinyurl.com/Rate-function .
Safety aspect
Looking out for an AAA rating for the corporate deposit is one way in which you can ensure higher safety levels. But a high credit rating does not mean your FD is secured or is backed by a guarantee.
Corporate FDs generally come as unsecured debt products. Since the debt given by you is not backed by any assets of the company, investors will have little recourse in case of any default of any principal or interest by the company.
For example, DHFL fixed deposit holders had to take significant haircut as the company went bust in 2019. The company, taken over by the Piramal group, is paying only part of the total outstanding dues to its creditors including fixed deposit holders.
Dues here will be paid under the waterfall mechanism, under which secured creditors get the top priority followed by employees (salaries) and only after that, unsecured financial creditors like FD holders come in.
Bank FDs score higher in this aspect, as the DICGC (Deposit Insurance and Credit Guarantee Corporation) is required to pay the depositors the insured amount of up to ₹5 lakh (inclusive of principal and interest).
Hence, it is essential that you spread your deposits across banks, corporates and NBFCs and not put all your eggs in one basket.
Stiffer lock-in rules
One must keep in mind that corporate fixed deposits come with slightly more stiff withdrawal conditions than banks
For most corporate fixed deposits, one cannot withdraw the deposit within three months from the date of deposit (unless on the unfortunate event of death of the subscriber).
If withdrawn after three months but before six months, no interest will be payable on the fixed deposits. Even after that, a penalty of about two percent is charged by many.
On the other hand, the pre-mature withdrawal conditions for an FD with SBI includes a penalty of 0.5 per cent (1% for deposits above Rs 5 lakh) and an interest rate 0.50 – 1 per cent below the contracted rate. However, no interest will be paid on deposits which remain for a period of less than 7 days.
For premature withdrawals, HDFC Bank levies a penalty of 1 per cent on the applicable rate. However, penalty for premature withdrawal will not be applicable for FDs booked for a tenor of 7-14 days.
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