Confident that companies are in for a period of calm after the volatility of 2008-09, investors are lapping up risky corporate fixed deposits. Are they underplaying the default risks?
Corporate fixed deposits (FDs) offer higher interest rate compared to bank deposits. Within that, many FDs offer even higher for higher risk. According to financial advisors, many companies are in the market offering FDs with higher returns which investors are keen to buy—disregarding the higher risk inevitably attached to them. But corporate FDs are unsecured loans and many periodically default, leaving investors in the lurch. There are many instances were companies have defaulted with cheques, delay in receipts payment and non-payment of maturity amount.
Currently TV18, Ansal Properties and Infrastructure, Ind Swift Ltd, Jai Prakash Associates Ltd and Surya Roshni Ltd are offering an interest rate of 12% for a three-year FD, while Avon Corporation Ltd, Sejal Glass, Talbros Automotive Components Ltd and Damodar Threads Ltd are offering even higher rates for the same tenure.
Companies tend to provide a higher commission to brokers in order to push their FDs. Some of this brokerage is shared with investors. For instance, “the FDs of Television18 are getting a good response because it is paying a commission of 3%,” says a distributor. “No one is interested in selling HDFC Ltd bonds despite it being a good and safe product because they are paying lower brokerage.”
One of the biggest distributors of FDs are those who were selling mutual funds earlier. “Small distributors of mutual funds have now started selling corporate FDs,” said an IFA, “because mutual funds are no longer attractive to sell now that entry loads have been abolished.”
The problem is, “there is no regulation of FDs. Investors practically have no one to complain to”, says a financial advisor. It is only non-banking financial companies (NBFCs) that are regulated. According to RBI guidelines, NBFCs should have an ‘A’ rating in order to accept public deposits. However it is pertinent to ask if the ratings hold any water, as many investors don’t know when an FD is downgraded.
The FD market is tainted by all sorts of malpractices. “Some companies which don’t have a good financial track record give old application forms. They don’t print new forms because the companies have to show balance sheets of the last three years,” said an IFA.
Corporate FDs were popular in 1990s when bank interest rates were high, companies found it hard to get bank loans and banks were reluctant to lend to all but blue-chip companies. “There were a lot of NBFCs that were giving commissions as high as 6%-8%, and the distributors knew that they are dicey products. That was the time CRB Capital Markets Ltd and Prudential Capital Markets Ltd had defaulted,” said Yogin M Sabnis of VSK Financial Consultancy Services Pvt Ltd. “You will find many complaints against Lloyd's Finance Ltd due to its non-refund on capital if you take a cursory glance through the consumer complaints forum site.
“Everybody who invests should read the caveats carefully and then invest. I think there’s nothing wrong with corporate bonds because they fetch high returns. People once invested in bonds which were not even rated,” said Rajesh Jha, CEO, Jain Investment.
If an investor wishes to exit the FD, he has to send a request letter for a premature encashment. Some companies even demand an explanation for the exit. Very often, investors have to run from pillar to post to get their deposits back. This is a trick followed by even solvent companies.
Moneylife had earlier reported (see here) how a senior citizen and a shareholder of Jaiprakash Associates had to wait for two months to get his FD principal back. The company did not revert to any of his complaints through email. Jaiprakash in its response denied that it had received any complaint from him. This indicates that the company may have provided a misleading email address on the application form. The investor got back his money after Moneylife wrote about this case.
“I would rather discourage them from investing in FDs even if they provide a higher interest rate. FDs don’t require rigorous regulatory approvals. The due diligence is very high when a company approaches a bank or a financial institution,” said Vivek Rege, MD, VR Wealth Advisors Pvt Ltd.
Talking about the recovery process, Mr Rege says, “The law takes its own course. It’s a very long process. One of my investors told me that there is a special room in the High Courts dedicated to resolving such complaints. Looking at the way the Indian legal system functions, it’s definitely not a quick-fix solution for investors.”