Are long-term negotiable certificates of deposit a good investment?
Well, for one, that's quite a mouthful. If you haven't seen the newspaper ads yet, these are investment instruments being offered by
Banco de Oro (the first in the country) and Citibank.
What is a long-term negotiable certificate of deposit (LTNCD) anyway? Let's break it down:
- Deposit: It's a bank deposit product. So it's insured by the PDIC (up to P250,000).
- Certificate of Deposit: Better known as a CD. So it earns interest. And it's debt instrument offered by a bank. But CDs, as we commonly think of, are short-term and non-negotiable. This is a new animal.
- Negotiable: That means you can sell them before the maturity date at the current market price.
- Long-term: In this case, we're talking about 5 years and 1 day, making the interest income exempt from withholding tax, if it's kept that long.
So it's like a deposit in that a bank issues it and it is covered by the PDIC. Yet, it's also like a bond because it's negotiable and long-term and pays interest every quarter. In other words, it's a hybrid product.
And it's marketed as a better alternative to government Treasury bills (T-bills) and to an ordinary bank deposit like a time deposit or a regular CD. Well, is it?
Let's take a look:
LTNCD vs. T-bills1.
Safety. T-bills, by nature, are safer because they are issued by the government. LTNCDs are issued by a bank, which is obviously not as safe as the government. However, they are covered by PDIC up to P250,000, so they are as safe at least up to that amount. And given the track record of the issuing banks, they are quite safe.
2.
Affordability. It's not exactly true you need at least P200,000 to buy T-bills while you only need P100,000 to buy LTNCD. You can buy T-bills directly for P100,000. But you don't need that much to buy government securities. Retail Treasury Bond
(RTBs) are available for as little as P5,000 (although some banks require at least P100,000). Alternatively, you can invest in fixed-income mutual funds (
bond funds) for P10,000 or so, which invest in all types of government securities and corporate bonds (however, they are not insured).
3.
Income. Indeed, LTNCDs have a premium over the 91-day T-bill. But look, we're comparing apples to avocados. LTNCDs are 5-year instruments; 91-day T-bills are, well, 91-day instruments. Wouldn't a long-term Treasury Bond be a better benchmark? Keeping LTNCDs for 5 years at a small premium over a 91-day T-bill doesn't sound like a great investment.
4.
Liquidity. Okay, you can sell them before the maturity date. But you can do the same with government securities.
5.
Taxes. Probably the only real advantage of LTNCDs is that, if you keep them for the entire period, your interest won't be subject to withholding tax. T-bills are subject to 20% withholding tax. However, if you sell your LTNCD before that, it's subject to the same 20% tax.
LTNCD vs. Time Deposit
1.
Safety. Both time deposits and LTNCDs are issued by a bank, and are covered by PDIC up to P250,000. No advantage there.
2.
Affordability. You need just P1,000 to put money in a 90-day time deposit.
3.
Income. The rate for a 91-day T-bill is about 5-6%, add a premium and you get a rough idea what to earn from an LTNCD. Here, they are superior to a time deposit of a typical commercial bank, which offers about 4-5% for a 364-day time deposit at P100,000. But some banks, particularly savings and rural banks (disclosure: we have a rural bank), offer higher yields, such as double your money in 5 or so years time deposit products (about 15% compounding).
4.
Liquidity. You're stuck with a time deposit to earn the full interest. But if you choose a short-term time deposit, as little as a month, it's practically liquid.
5.
Taxes. If you place money in a long-term time deposit (5 years and 1 day), just like the LTNCD, the interest is tax-free. For short-term time deposits, it's subject to 20% withholding tax, so the net interest may actually be comparable to a short-term time deposit.
The verdict?
If you're not keeping LTNCDs for 5 years, government securities like T-bills and RTBs are still safer and better investments (as LTNCDs won't be tax-free). If you're holding on to them for the entire maturity period, compare the interest rate that you will earn from the LTNCDs not with the rate of a 91-day T-bill but with a comparable 5-year Treasury Bond or Fixed Rate Treasury Note. Even if they're subject to the 20% withholding tax, the net interest rate would be higher. So, LTNCDs still lose against government securities.
Compared to time deposits, LTNCDs may just have a comparable rate on a net basis to short-term time deposits, since they'll also be subject to withholding tax. And if you're looking at 5-year investments, you can find long-term time deposits (5 years) that offer much higher rates.
So, are LTNCDs a bad idea? Well, I don't see distinct advantages. As a comparable substitute and for diversification purposes, maybe. But as a superior alternative, I think not.
