With downgradings more commonplace than ever before, fixed deposits are fast becoming a four-letter word. And the lesson that investors are learning is that interest rates should not be the only determining factor when selecting a company.
The profile of investors who opt for company fixed deposits (FDs) are generally those who put their money in bank fixed deposits. And the reason for reallocating their funds from the banks to the companies is due to higher returns. What the investor fails to realise is that the move from bank deposits to company deposits also implies a shift in the corresponding risk.
Always remember that in a company, the security is not as you would get in a bank, says K S Harshan, vice president (forex), ICICI Banking Corporation. The Deposit Insurance and Credit Guaranty Corporation insure deposits up to Rs 1 lakh. Should a company declare bankruptcy, the FD holder is last on the list. Since company deposits are not secured against the assets of the company, secured lenders like financial institutions and banks have to be cleared first.
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Interest rate mania: So why should high interest rates not be the criteria in selecting a company? The entire argument can be summed in the risk-return profile. Investors on the look out for the best rates received a shot in the arm last year when non-banking finance companies which complied with credit rating and prudential norms were granted total freedom in fixing their interest rates on deposits (the rest have a 15 per cent limit). Thanks to that we now have companies offering 18 per cent per annum and coupling it with kickbacks, to use the exact words of a finance manager who indicated early-bird incentives and up-front discounts.
The average cost of funds subsequently goes up to 20 per cent. They then lend it at 25 per cent to high risk companies. With the PLR hovering around 14 per cent, reliable companies will get their funding from banks. The high risk ones will be the ones willing to pay above 20 per cent for funds.
The problem with investors is that they are thrilled about the post-dated cheques and the monthly, quarterly or half-yearly in-come they will receive. They fail to look at the security of the principal, says Harshan.
Lesson one: ask yourself how secure your money is. The higher the rate of interest, higher the risk. Since high yields could well amount to junk bonds, it is better to opt for stable returns, advises G Ramachandran, chief financial officer, Times Guaranty Financials Ltd. Surely the few thousands more are not worth the sleepless nights.
Faith in the broker: How far should you trust your broke? Brokers till today play a significant role, says Adesh Gupta, joint president, Birla Global Finance. Incidentally, the vice president of a finance company claims that brokers in certain parts of India like Pune, have investors cheque books with them giving them full authority in investing their funds where they please.
Since 90 per cent of the investors are not informed, brokers, incentives and upfront discounts rule the market with brokers commissions ranging from one to 10 per cent. But brokers tend to promote companies which give them higher commssions.
Its obvious that it is very difficult for an investor to track the safety of the company. And not just safety but consistent safety. Even if investors are genuinely interested in obtaining details of the company that they plan to invest in, actually getting the information is no easy task. So that brings us to the next factor: the rating.
The rating game: Rating only indicates that everything is hunky-dory as of now. It is no indication of the future, says an official with a private bank. ITC Classic Finance, for example, invested 62 crore in one scrip (Jai Prakash Hotels). While another finance company that commenced operations with much hype is now in the doldrums. The reason: the company resorted to short term borrowing (fixed deposits) and the money found its way into long term funding which happened to be stocks and virtually venture capital.
Companies are downgraded after everybody knows that it is on the wrong track, says a financial analyst. With surveillance so low, what is the relevance, he questions. When we rate we look at the future too. Future strategy for assets, what business they want to be in and future deployment of funds. But if the entire market turns topsy turvy, we cant be blamed, explains Subodh Shah, executive director, Crisil.
Incidentally, Crisil rules the rating game with a 75 per cent slice of the market. They are currently monitoring around 1,200 with a staff of about 140. The companies are reviewed monthly, bi-monthly or even weekly, depending on the company and industry. Or, in the case of a HLL or Asian Paints, once a year.
Abroad it is a totally different ball game where S&P and Moodys downgrade immediately. So if IBMs corporate sales fall, the company is immediately put on the watch list, says Ramachandran.
Care officials are quick to point out that early this month they put Modern Syntex (India) Ltd and Modern Terry Towels Ltd under credit watch due to the liquidity and other problems that are being faced by the companies.
Madhavan Menon, vice president, Birla Global Finance, claims that one cannot blame the rating agencies as they are doing a good job. Information is available periodically. It is not the case whereby information is constantly being pumped into the system. They have to wait for the audited financial information. So there is a time lag. The rating system is still evolving, he justifies.
Whats the option? The information needed to make a sound decision is not available to the investor. And he definitely will not be in any position to analyse it. Truck financing, for instance, is looked upon as a good business. It is an asset which earns returns and there is the comfort of repossession and a secondary market. This one is closely followed by auto finance. However, with plant and machinery tools, repossession is difficult and the resale value low.
Investors often go in for the perceived rating. If they come across a Tata Finance or Birla Global they wont even bother to check out the rating because their perception of the company is excellent. By this logic, in Northern India A V Birla will command a more solid reputation than Sundaram Finance. However, as you go down South, the reverse will hold true. So rating tends to add to investor perception and is not viewed as the principal criteria.
All said and done, rating does play an important role. It is very difficult for a company to raise funds without a rating, says Shah. And if we do not get the relevant information, we either dilute or dont give the rating. In the absence of any other yardstick then, your best bet as a depositor when braking to a halt before this parking lot is to opt only for the highly rated companies.