Corporate fixed deposits: Use laddering strategy to tackle rate uncertainty

Chasing high returns by investing in lower-rated instruments could result in loss of principal

Recently, Bajaj Finance raised corporate fixed deposit (FD) rates by up to 45 basis points. Shriram Finance, on the other hand, reduced its deposit rates by 15 to 35 basis points.

 

“Divergent deposit-rate movements are therefore largely driven by each institution’s business outlook, credit demand, funding needs, and margin calculations,” says Vishal Dhawan, founder and chief executive officer (CEO), Plan Ahead Wealth Advisors.

 

Amid divergent rate movements by players, investors need to decide how much credit risk to take, and whether to lock in for the short or long term.

 

Why corporate FDs merit attention

 

Investors go for corporate FDs because they offer higher interest rates than bank FDs. “Corporate FDs are currently offering a significant yield advantage over bank FDs,” says Santosh Agarwal, CEO, Paisabazaar.

 

Weigh the risks

 

Corporate FDs carry risks that investors must assess carefully. The first is credit risk. The company may default on interest and principal payments if its financial health declines.

 

Agarwal points out that corporate FDs do not enjoy the  ₹5 lakh statutory insurance cover that the Deposit Insurance and Credit Guarantee Corporation (DICGC) provides to bank deposits. “The absence of statutory insurance means that the investor’s entire capital is at risk,” says Abhishek Kumar, Sebi-registered investment advisor and founder, SahajMoney.com.

 

If a non-banking financial company (NBFC) fails, the investor becomes an unsecured creditor with limited recourse. “The legal and recovery process after an NBFC failure can be long, uncertain, and emotionally draining,” says Vijay Kuppa, CEO, InCred Money.

 

Investors also face concentration risk if they place a large portion of their savings with a single issuer.

 

Understand credit rating

 

Ratings indicate the issuer’s repayment capacity. “Investors should ideally invest in AAA-rated companies because higher ratings imply higher income certainty and capital protection,” says Agarwal. A higher interest rate on a lower-rated FD is compensation for taking on more credit risk.

 

Investors cannot afford default or delayed repayment if they are investing for important goals. “For such goals, use AAA- or AA+-rated FDs. AA-rated FDs may be considered where the investor has surplus money and no short-term goal attached to it,” says Arvind Rao, founder, Arvind Rao and Associates, a personal finance advisory firm.

 

Avoid going below an AA rating. “The extra 100–200 basis points you might earn on moving from AA to BBB is not worth the risk of losing a meaningful portion of your principal,” says Kuppa.

 

Lower-rated FDs often come with liquidity concerns, longer lock-ins, and higher penalties for premature withdrawal.

 

“Try to earn higher returns by staying invested for longer rather than going lower on the rating scale,” says Kuppa.

 

Investors can mitigate credit risk by diversifying across issuers within the investment-grade band of AA and above. “Not more than 35–40 per cent of the allocation should be locked in with any one issuer,” says Rao.

 

He adds that investors should allocate around 70–75 per cent of their funds to AAA-rated FDs and the balance to AA-rated FDs to earn slightly higher returns. Diversification can prevent one company’s downgrade from destabilising the investor’s entire portfolio.

 

Check ratings once every quarter after investing and again at the time of renewal.

 

Track rating downgrades. “A downgrade from AAA to AA+ or from AA+ to AA does not warrant an exit,” says Rao. Investors should instead review the reasons for the downgrade and understand how the issuer’s outlook has changed.

 

A multi-level downgrade, however, is a serious warning sign. “A downgrade from AAA to AA- indicates material deterioration in the issuer’s financial situation or fundamentals,” says Rao. He adds that in such cases, investors should bear the penalty and exit rather than risk their principal.

 

Watch the rate cycle

 

Interest-rate movements are currently being driven by the inflation outlook and the rupee’s depreciation. The war in West Asia could push up inflation through higher crude oil prices. Food-price pressure could rise if the monsoon is weaker than normal. Fertiliser price increases could also add to inflationary pressure.

 

“Interest rates could move upwards if inflationary pressures increase. On the other hand, they may come down if economic growth slows,” says Dhawan.

 

Avoid long lock-ins

 

Investors should avoid locking into a longer tenure at present, when the interest-rate outlook is uncertain. “Longer tenures are appropriate when it appears unlikely that rates will rise further,” says Dhawan.

 

A longer tenure carries another risk. “The longer the tenure, the greater the risk of the issuer’s financial position weakening during the deposit tenure,” says Dhawan.

 

In the current environment, investors would be better served by laddering their investments across one-, two-, and three-year maturities. Laddering protects investors from being locked in at a low rate if yields move up.

 

Understand exit rules

 

Premature withdrawal rules can vary across issuers. Liquidity tends to be low in the first three to six months. In most cases, investors may not be able to withdraw the money at all during this period.

 

After this initial period, premature withdrawal before maturity usually involves a penalty of around 1–2 per cent.

 

The interest rate paid depends on the period for which the investor holds the deposit. If an investor takes a five-year deposit but withdraws after two years, the applicable rate would be the two-year deposit rate. “The penalty would be deducted from the two-year deposit rate,” says Dhawan.

 

Investors should, therefore, align the FD tenure with their investment horizon.

 

Check financial fundamentals

 

Besides return, credit rating, and tenure, investors should examine the company’s financial fundamentals. The company should be profitable and be able to service its debt comfortably. “Check the interest-coverage ratio and debt-to-equity levels,” says Kumar.

 

Examine the company’s historical record of making timely payments to depositors and research the promoter group’s reputation. “The company should not operate in a sector facing significant structural or regulatory headwinds,” says Kumar.

 

Are they right for you?

 

Investors with a moderate risk appetite who want a slightly higher yield than traditional bank deposits may consider corporate FDs. They are better suited for investors in lower tax brackets.

 

Conservative savers who prioritise capital protection should avoid them. “Retirees should avoid corporate FDs because of the lack of safety. Investors in the highest tax bracket may also avoid corporate FDs due to their tax inefficiency,” says Kumar.

 

Keep exposure limited

 

Take limited exposure to corporate FDs. “It should not exceed 10–20 per cent of the total fixed-income portfolio,” says Kumar. He adds that the majority of debt allocation should stay in secure avenues such as government securities, Public Provident Fund, or high-quality bank deposits.

 

Investors seeking higher returns may also consider small finance bank FDs. Spread money across multiple small finance banks. The amount should be up to ₹5 lakh in each bank so that it enjoys deposit insurance coverage.

 

Do not ignore ratings in the pursuit of higher returns. “Use corporate FDs as a tool for capital preservation, not as a return driver,” says Kuppa.

 

Finally, remember that these are not bank FDs. A corporate FD is an unsecured loan to an NBFC. “If an NBFC faces financial stress, the investor is a creditor in a queue rather than a protected depositor,” says Kuppa.