Quarterly review of Prime Deposits: No time for risk-taking

Covid or no Covid, stock markets in the last six months have been quite kind to equity investors. But debt investors have had no such luck. Even though India’s Monetary Policy Committee (MPC) has been in pause mode since June after slashing its repo rate from 5.4% to 4% in the preceding eight months, the returns that savers get on their bank and corporate FDs, bonds and debt funds have continued to plumb new depths.

Prime Deposits

Rates: Falling g-sec yields, shrinking risk premiums 

Fixed deposit rates for 1-year plus from the leading banks such as SBI have dropped from 6.8% a year ago to 4.9% this month.

With RBI deploying a variety of brahmastras to keep interest rates down for Covid-hit borrowers (somehow Covid-hit savers don’t seem to matter), interest rates on government bonds have fallen too. Yields on 90-day to 1-year treasury bills, which make up a key investment avenue for money market, liquid and ultra-short bond funds, have fallen 180-190 basis points in the past year and now stand at a dismal 3.2-3.5%. While the 10-year g-sec has seen its yield decline by a lower 64 basis points, it has been rangebound at 6-6.25%. This offers little scope for playing the duration game.

The window of opportunity for investors to earn better returns by taking on higher risks in corporate bonds has shut too. In March 2020, corporate bond and PSU and Banking funds which invested in high quality corporate bonds were good buys, as AAA rated ones offered yields that were 240-280 basis points above comparable government securities (Read our well-timed recommendation in March 2020 on this). Today though, the extra return from AAA s less than 50 basis points. The spread over government securities has more than halved for AA bonds. It remains high, with yields above 9%, only for dicey BBB minus paper, which is quite susceptible to default.

Going ahead, we are of the view that market interest rates will not decline much further from here, owing to two factors. One, CPI inflation in recent months has been consistently overshooting RBI’s comfort zone of 4-6%. While the MPC has been brushing this off as attributable to one-off factors, the ‘one-off’ factors have persisted for the last six months and the September CPI inflation was at an 8-month high of 7.34%. The MPC will find it hard to ignore this to continue pruning rates further. It is evident that banks too are reluctant to transmit rate cuts beyond a point to their borrowers, defeating the purpose of further cuts.

Two, 10-year g-sec yields have been refusing to show sustained decline despite RBI’s liquidity infusion measures in recent times and have remained stuck at 6-6.25%, as markets factor in a fiscal deficit overshoot and higher government borrowings.

This means that FD investors are better off sticking to the lowest possible terms for their fixed deposits. Given that the economy is already showing signs of normalising post-Covid, the exceptional rate cuts attributable to this pandemic may wane allowing market rates to somewhat normalise. Therefore, locking into FD terms beyond 1 year is inadvisable as you could miss out on an opportunity to capitalise on a rise in rates, even if it is just a 25 or 50 basis points. 

NBFCs: Better, but not out of the woods 

If markets are assigning a lower risk premium to corporate borrowers, is it time to invest in NBFC FDs offering better rates? Well, while NBFCs are certainly able to borrow at much lower costs from the market than six months ago, we believe that FD investors still need to exercise considerable caution in investing in NBFC FDs, for three reasons.

One, NBFCs, unlike other corporate borrowers haven’t benefitted either from the blanket loan moratorium allowed by RBI or the extension enabled by the Supreme Court post August 31 2020, as the hearing on the interest petition has stretched on. Therefore, NBFC finances continue to be under pressure from having to service their own borrowings from the market and banks (in cases where the banks haven’t allowed leeway) on time, while coping with payment delays from the segments they’ve lent to.

The lockdown and manpower constraints have also affected the collection efficiency of NBFCs who lend to segments such as microfinance and MSMEs too. Given that NBFCs run far more leveraged businesses than manufacturing companies, cash flow mismatches can quickly lead to problems in liquidity, debt servicing and ultimately solvency.

Two, NBFCs find it easy to manage their cash flows and debt servicing when their disbursements are growing at a fair clip and they are earning healthy spreads on their loans, over and above their borrowing costs. In the last six months, borrowing costs have moderated but then so has loan growth for NBFCs. For some NBFCs, loan offtake has fallen sharply as their borrower segments are under stress due to income or job losses.

Demand for vehicle finance, appliance purchases, commercial real estate and MSMEs are still reported to be only at 50-70% of pre-Covid levels. NBFCs focussed on these segments are thus facing the prospect of shrinking revenues. Home loan NBFCs alone are seeing normalcy returning more quickly with home loan demand reported to be back at 80-100% of pre-Covid levels. More prudent NBFCs have also responded to moratorium related stress by going slow on fresh lending in the past six months to conserve capital and manage liquidity, leading to flattish or declining revenues and profits.

Three, with a significant proportion of both retail and corporate borrowers opting for moratoriums, NBFCs across the board face the prospect of a spike in bad loans in the coming months. Home loan NBFCs are again expected to be least affected by defaults, while vehicle financiers expect 10-15% stress, while segments such as microfinance or MSMEs may see higher stress.

Over the last two quarters (April-June and July-September),  most NBFCs have sharply raised their provisions towards bad and doubtful loans in anticipation of a spike in defaults the coming months and tried to shore up their capital through fresh equity infusion or fund raising, so that they don’t fall foul of RBI norms. But the slowdown in disbursements, taken with the higher provisions means that most NBFCs will have to make do with flat or declining revenues and a sizeable dent to profits from higher provisioning in the coming months. This will leave them with weaker debt servicing ability and capital buffers.

While better-run NBFCs focussed on the less-affected segments will no doubt ride out this storm, there’s not enough financial information available in the public domain today for FD investors to sift between the NBFCs that will be shaken by the coming turbulence and those which will weather it.

Given that a post office time deposit which is Central government borrowing, is offering 5.5% currently with SCSS at 7.4%, NBFC FDs offer hardly enough compensation for the risks that could yet materialise. 

For NBFCs who have been prudent enough to already make more-than-adequate provisions, the next few quarters may bring positive surprises as their lending resumes and profit rebounds, while capital buffers remain unchanged.

Unfortunately, with the moratorium effectively preventing the timely recognition of NPAs (non-performing assets) in the NBFCs’ books, the current Gross NPA and net NPA, profit and capital adequacy numbers reported by NBFCs do not present a true picture of the actual state of their profitability, liquidity or financial position.

Right now, with NBFCs’ quarterly numbers hiding more than they reveal, it is quite difficult to distinguish the NBFCs that have better weathered the Covid-related pain from the worse-off ones. What’s more, with their borrowing costs easing, even NBFCs operating in the riskier segments such as consumer and vehicle lending are offering rather modest deposit rates of sub-7%. Mahindra Finance and Bajaj Finance for instance currently offer FD rates of just 5.7% and 6.7% for 1-year FDs.

Given that a post office time deposit which is Central government borrowing, is offering 5.5% currently with SCSS at 7.4%, NBFC FDs offer hardly enough compensation for the risks that could yet materialise.

Small Finance Banks which also offer better deals on their FDs suffer from the same risks as NBFCs given that they lend to small-ticket borrowers and MSMEs who have been hit hard by the crisis.  

In light of the above, we recommend the following to FD investors: 

  • Given the ultra-low rate scenario and the possibility of improvements over a 6 month to 1-year time frame, lock into current rates for the lowest possible terms of upto 1 year.
  • The post office schemes, though they appear to offer low rates on absolute terms, are attractive as they offer significant premiums over market interest rates despite being sovereign backed. 1-3 year post office time deposit rates have been retained at 5.5% for the October to December 2020 quarter, while T-bills of comparable maturity are trading at 3.5-4%. The SCSS at 7.4% offers a 120 basis point spread over comparable g-secs.
  • FDs from leading banks such as SBI and ICICI Bank have become unattractive as their 1-year FD rates (4.9-5%) are now below small savings schemes despite their higher risk profile
  • FDs from sound and high quality NBFCs such as HDFC, Sundaram Finance and Sundaram Home Finance, offering 5.7% for 1 year do not offer much of a risk premium over post office schemes but offer the convenience of better service and can act as good diversifiers 
  • To obtain better rates on your FDs, it would be best to wait for the rate cycle to pick up over the next 6 months to one year. But if you absolutely cannot do without higher rates right now, consider locking into the Post Office Monthly Income Scheme (6.6%) rather than add more NBFC FDs.  

You can check our latest list of Prime Deposits here. Please choose the income or cumulative option based on your need. We have different options in each.  

You might also want to read about our approach to fixed deposits here.

Looking for income option in retirement? Read our review of HDFC Life Sanchay Plus

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13 thoughts on “Quarterly review of Prime Deposits: No time for risk-taking”

  1. Madam
    Thanks. IDFC First bank has been offering 7.0 percent rate of interest on deposits more than 100,000. It is interesting to note that their SB rate is marginally higher than their highest FD rate. Does it make sense to park the funds in their SB . Vaidyanathan is a well respected banker from ICICI bank who will lead the bank to greater heights.
    Thanks aand regards

    1. The coming few months are expected to be some of the most challenging for lenders as the moratorium is lifted at some point and the real NPA and provisioning picture shows up in bank books. This is not a good time to invest in relatively new banks which have had a recent change in strategy. Moreover while 7% appears to be a good rate on a relative basis on an absolute basis it certainly isn’t enough compensation for risks.

  2. Nice article madam. I am NRI, so cannot invest in post office FD. Also it doesnt make sense for me to invest in debt funds, as I would rather invest in NRE FDs which are tax free. What is your view about Yes Bank or IndusInd Bank FDs. Locking in at 7% for 3 years? Yes bank is now bailed out by SBI and they have already returned back the special liquidity funds to RBI of 50,000cr. Their deposits have grown 30% in the september qtr. So it seems they are out of the woods. Even though profitability of Yes bank is a question mark, that is for the shareholders. But for the deposit holders, it seems, we will get out 7% interest and while shareholders will suffer from the higher cost of funds and hence lower profitability.
    Would like to know your views!
    Thanks in advance!

    1. Would not advise either as the coming months are expected to be very challenging for lenders and 7% simply doesn’t compensate for the risks that could materialise. Waiting out the next 6 mths in safer options can help you get similar rates from far safer deposits. On Yes Bank despite the recent signs of turnaround, gross NPAs of nearly 17% before Covid bad loan recognition show that there could be substantial pain left. Even after the recent growth Casa is far less than it was before the crisis.

      1. Thanks madam, but isnt it worth, monitoring the bank ratios. It is not like the bank will suddenly go down. There will be signs to look out for, in a list bank. Yes bank writing was on the wall for a long time. But IndusInd is not the same league. We should spread our money across banks. But like a small percentage of like 10% of networth in these banks and then we track them and in case of any visible issues, we could move our money out.

        RBI in its recent policy has said, if inflation comes down, they will cut rates, so we cannot be sure that rates have bottomed out. In 2004 and 2005, 10yr bond yield went closer to 5%. So we could have rates go even lower. There is a probability and then we will be stuck with low rates at the time of renewal.

        1. Sure sir, you can definitely look at small exposures. When we take those calls ourselves it is difficult as most investors go overboard on where rates are high. So we can’t afford it. You can, with some discipline. Vidya

  3. Satya Sudhakarudu Jonnalagadda

    Interest scenario and the indication that
    interest rate cycle is likely to turn upwards from now is correct.


  4. Thanks Madam, nicely explained article. Is it best option to park money in Short term Debt fund, safetywise as well as liquidity wise.

  5. Pawandeep Singh Chhabra

    Thanks Aarti for the nicely summarized article. One query, any reason why RBI floating rate bonds not considered – carrying good rate, floating should take care of future upward movement of rates though it comes with a lock in.
    Request your views.

    1. Hello Sir, Technically, it is a bond, not a deposit. So we have it in our income porfolios as well as retiree portfolios. thanks, Vidya

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