Waiting for RBI rate cut? Lock in some money in high-yielding corporate FDs first

RBI-rate-cut

Corporate fixed deposit schemes are in the limelight these days amid volatility in the equity market and hope of a rate cut by the Reserve Bank of India (RBI) on Wednesday.

These financial instruments usually provide 50-150 basis points more return than bank fixed deposits. However, corporate fixed deposits come with higher risk as any headwinds for the business can lead to a company defaulting on payment of interest as well as principal.

With an interest rate of around 8.50 per cent per annum for three years, corporate fixed deposit schemes are looking attractive at a time when your bank fixed deposits are giving around 7.50 per cent returns. It looks even more lucrative if one considers the lacklustre performance of the equity market, which has not gained much in this calendar year till date.

Domestic equity indices BSE Sensex and NSE Nifty50 had given 5 per cent negative return in calendar year 2015.

Companies from housing finance sectors and NBFCs mostly offer these corporate fixed deposit schemes.

For instance, DHFL is offering a wide array of fixed deposit products with interest rates ranging from 8.25 per cent to 8.50 per cent for various tenures. Senior citizens, armed forces personnel, widows and loan borrowers get an additional interest of 0.25 per cent, which makes the interest rate quite attractive.
High value deposits of Rs 50 lakh and above also enjoy this additional interest benefit of 0.25 per cent. DHFL-Aashray Deposit Plus is giving a return of 8.25 per cent for one year and 8.30 per cent each two years and three years.

Fixed deposits from Shriram Transport Finance-Shriram Unnati and Shriram City Union Finance BSE -0.05 % are giving an interest rate of 8.94 per cent (cumulative interest option) for three years.

Cumulative interest option normally generates better yields as the interest earned on the financial instrument gets reinvested at the same coupon rate.

Other corporate fixed deposit schemes from Kerala Transport Development Finance Corporation BSE 1.54 % and Bajaj Finserv BSE 0.05 % are also offering around 8.50 per cent and 8.30 per cent interest rates, respectively, to investors.

Precautions required
As an investor, you should always check the rating given to a corporate deposit scheme by agencies like Crisil BSE 0.01 % and CARE. If the rating of the company is AAA, it is considered safe and secure. If the rating is lower, there could be risks involved.

In the case of DHFL, a AAA (FD) credit rating from CARE and BWR FAAA rating from Brickworks indicate highest degree of safety.

Shriram Transport Finance-Shriram Unnati has FAAA rating from Crisil and MAA rating from ICRA BSE 2.41 %. FAA rating of Crisil on any financial instrument shows a strong degree of safety regarding timely payment of interest and principal.

Look at the tax part too
Interest on fixed deposits is taxed at marginal rate and, hence, the applicable tax bracket determines net yield.

Naveen Kukreja, Chief Executive Officer and co-founder, Paisabazaar.com, said: “For someone in 10 per cent bracket, effective return would be somewhere around 7.2 per cent and for those in 30 per cent bracket, return would be close to 5.6 per cent.”

Should you invest?
One cannot compare apples with oranges. So it is not wise to compare equities with different asset classes. Figures suggest equities generate higher return over long term, say 3-5 years.

“For a one-two year horizon, equities can be volatile and generate negative returns given the current valuations. For shorter duration, corporate FDs can be an attractive investment option. However, we do expect corporate FD rates to come down in future as interest rates are expected to fall further over the next 12 months,” Kukreja said.

Harsh Roongta, a Sebi-registered investment adviser, said: “Corporate fixed deposits offer higher rate of return compared with bank FDs, but they come with higher risk. Investors can buy corporate fixed deposits having higher ratings for safer and better returns. My advice is, one should never invest in FDs with ratings below AA.”

Anil Rego, chief executive officer & founder, Right Horizons said, “Corporate FDs offer better return compared to bank FDs. The current scenario reflects declining interest rates; which means more demand for high coupon corporate fixed deposits.”

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