Dewan Housing Finance Corporation Ltd (DHFL) on May 21 announced that it had stopped accepting fresh inflows in fixed deposits (FDs). It also stopped renewals and put premature withdrawals from existing fixed deposits on hold.
However, it allowed withdrawals in case of medical emergencies. The DHFL management said that it took these measures to manage the liquidity crunch and navigate through multiple downgrades by credit evaluators on its debt instruments.
Four days earlier, CARE Ratings had downgraded DHFL's FD programme worth Rs 20,000 crore from ‘A’ to ‘BBB-‘. CARE A signifies “low” credit risk, while CARE BBB- signifies “moderate” credit risk.
Over the past decade or two, we have heard numerous instances of company FDs defaulting or postponing their payments. How big is the FD market?
According to the National Housing Bank, there are 18 housing finance companies (HFCs), including DHFL, that are allowed to accept public deposits.
These HFCs have raised Rs 1.22 lakh crore from public deposits as on March 2018, as per Reserve Bank of India’s ‘Trends and Progress in Banking’ report for 2018.
The RBI states that besides these HFCs, 89 non-banking financial companies (NBFCs) have a licence to raise money from the public through FDs. These have raised Rs 32,600 crore in FDs as on September 2018.
Apart from these, and as per data from CARE ratings, scheduled banks and scheduled commercial banks have issued FDs totalling Rs 1.13 lakh crore and Rs 1.10 lakh crore respectively, as on March 31, 2019.
"Due to the new action by DHFL stopping premature redemptions and not taking renewals, there will be further reluctance on part of the public to commit to FD schemes of HFCs and NBFCs. This will further impair their ability to raise funds for their business," says Suresh Sadagopan, Founder of Ladder7 Financial Advisories.
Does that mean you should avoid all company and NBFC FDs?
Review portfolio of company FDs
In last one year, the debt portion of several companies including HFCs and NBFCs has become risky. The financials of some of the companies are under stress.
Sadagopan says, "If this situation continues then what we see for DHFL (i.e. renewals and premature withdrawals are kept on hold by the management) can happen with other companies' FDs as well. So, periodically review your company FDs portfolio and analyse whether the investments are in risky companies in the current market situation. Then decide whether you would like to renew or withdraw investments from company FDs you have invested."
A cursory glance through newspapers daily would give you an idea about the health of several companies that are in the news for the wrong reasons. Check if you have an FD with any such company. If the forecast looks grim, it might be wise to withdraw your investments prematurely and get out. But, do check once with your financial advisor before you take the final step.
Follow news about the company
Things change over time. The financials of your company may have looked good when invested in its FDs some years back. But over time, it is possible that the company’s financials could have deteriorated either by its own actions or merely because of downsizing or crisis in its line of business.
Sadagopan says: "Pay attention to specific news you come across and analyse how it could impact the company’s financial performance. In case, certain news can impact the company negatively take appropriate action on your FDs with that company. You can even keep that company under the scanner to analyse periodically."
For instance, in mid of the 1990s, a company by the name of Cable Corporation of India offered an FD scheme to investors. This was the first company to manufacture Polyvinyl Chloride (PVC) cables in India at that time so it became an instant hit among FD investors.
However, in the late 90s, the power sector witnessed negative growth and the company’s order book dried up. Since its income was affected, it stopped paying regular interest and principal amounts on maturity to its FD investors. The management was selling off assets one by one without disclosing it to investors. A bit of vigilance in such scenarios helps foresee the grim future and could save you from losses.
Between 2009-12, several companies came out with high-interest FD schemes, but due to the economic slowdown defaulted in repaying investors' amounts. For instance, investors in some of Jaiprakash Associates and Unitech FDs did not receive their money on maturity.
Anup Bhaiya, MD and CEO of Money Honey Financial Services says, "One has to look at the quality of the company and pay attention to micro and macro news which could impact the company/sector you have invested in. The first principle should be the preservation of capital for debt investors. Also, while investing in a debt instrument don’t take higher risks."
Study the company's background and credit rating
You should research the companies’ financials while investing in an FD scheme. It is not everyone's cup of tea to scan the financial results of a company, but do try and find out. There are several online portals that help you to go through the historical financial results of the company.
Rachit Chawla, Founder and CEO of lending and investment advisory platform Finway says, "You should analyse the management of the company and how their core competencies compare to peers. Get information about the debt on the company in the last five years. Also check historically, whether the interests were paid on time with the principal amount on maturity."
It is important you do some research on the directors and promoters of the company. This will give you a fair idea of whether the company is secure enough for investment purposes.
Again, read the newspapers, magazines, digital news or any information about the company you can get a hold of. Well-known names that come with a track record do instil some confidence, but if the name of the company doesn’t ring a bell, it is best to do some groundwork.
You should also check the credit rating of the company before investing in that company’s FD. Joydeep Sen, founder of financial advisory firm wiseinvestor.in says, "You should consider FD schemes from companies with AA or higher ratings (signifies safe and secure) from credit rating agencies and from reputed business groups, to have trust on the financials and intentions."
These ratings are a measure of the company’s ability to pay the interest as well as principal to its investors, and a high rating means no or very low probability of default. Financial institutions such as CRISIL, CARE, Brickwork and ICRA rate the companies and their FDs. And while credit ratings have come under clouds due to recent events, especially since Infrastructure Leasing & Financial Services (IL&FS), they still remain one of the main parameters to judge a company’s health.
Know premature penalty charges
Typically, we recommend investments to be made for the long run. But in company FDs, it’s best to stick to a five-year term. Anything longer than this makes it tough to predict a company’s trajectory, typically. This way you can keep a watch on the company’s rating and financials. Moneycontrol recommended the same for several non-convertible debentures (NCDs) which hit the market so far this year.
As per RBI norms, an investor needs to stay invested in company FDs for a minimum lock-in period of three months. Post this lock-in, premature withdrawals are allowed from company FDs (including HFCs and NBFCs) but it attracts penalty charges which vary among companies. So, you need to be aware of it while investing.
What if the company defaults? Is your FD secured?
Although company FDs assure regular interest where there is an interest payment option and then, of course, your principal payment, they rank a notch below bank FDs as far as safety is concerned. Here’s why.
Company FDs are typically not secured against the assets of the company, so the chances of default in payment of interest and principal are significantly higher than banks.
Further, the repayment of principal and interest in the case of bank FDs are secured by the Deposit Insurance and Credit Guarantee Corp up to a sum of Rs 1 lakh. That’s not the case with company FDs, including those by HFCs and NBFCs. So, in your company defaults, investors have little recourse and can lose all the money including the interest in case the company defaults.
Navin Chandani, Chief Business Development Officer, of an online aggregator of financial products BankBazaar.com says, "Make sure that the returns are realistic, typically 2-3 percent more than a bank FD of similar tenure. But if the returns are much higher, that is a red flag. Unusually, high returns on a company FD comes with greater risk."
One of the reasons why the company offers high-interest rates is to compensate investors for its low credit rating and that is another red flag.
For instance, in 1999 and 2000 Roofit Industries and sister company Sun Earth Industries collected around Rs 72 crore from thousands of investors. These companies were offering lucrative interest rates around 15 percent per annum to lure investors in a fixed deposit scheme. These companies stopped paying regular interests and then the principal amount on maturity to FD investors from 2001. Almost, two decades have passed away but investors still haven’t received interest and principal amount from these companies. In June 2017, Roofit filed for insolvency and the case is with the National Company Law Tribunal (NCLT); the court set up to resolve bankruptcy proceedings.
Not all company FDs are bad. An informed decision and cautious approach would ensure that you don’t trip over your company FDs and at the same time, earn returns higher than those you get from bank FDs. A bit of homework helps, though.
Before investing in any company FDs, carefully go through the application form, financial statements of the company and other information pertaining to the company offering the fixed deposit. Check with advisors or distributors about the company’s past interest paying track record as well.