FCCBs Demystified!!!

Author:Ravi Srikant,MBA Capital Markets,NMIMS.


What is a FCCB?

FCCB (Foreign Currency Convertible Bonds) is a type of convertible bond issued in a currency different than the issuer's domestic currency. In other words, the money being raised by the issuing company is in the form of a foreign currency. A convertible bond is a mix between a debt and equity instrument. It acts like a bond by making regular coupon and principal payments, but these bonds also give the bondholder the option to convert the bond into stock.

Benefits to the issuer

• The coupon rate is lower due to equity side of bond.
• Conversion premium adds to capital reserves.
• Fewer covenants as compared to a debenture.

Benefits to the investor

• Assured returns in the form of fixed coupon rate payments.
• Lower tax liability due to lower coupon rate.
• Ability to take advantage of price appreciation in the stock by means of warrants attached to the bond.

Disadvantages

•  Exchange rate risk due to conversion at a future date.
• When converted into equity, FCCB brings down EPS.
• In a falling stock market there is no demand for conversion to equity.

FCCB’s in the Indian context

In India, FCCBs can be accessed through automatic and approval route. Major regulators governing the FCCBs in India are Exchange Control Department of RBI and FCCB Division in Department of Economic Affairs at Ministry of Finance.

Automatic Route

•   Companies except financial intermediaries.
•   Units in Special Economic Zones (SEZ).
•   NGO’s engaged in microfinance activities.

.     Approval Routes

• Infrastructure or export finance companies.
• Banks and financial institutions which participated in the textile or steel restructuring package.
• NBFC’s to finance import of infrastructure equipment for leasing.
• Multistate Co-operative society engaged in manufacturing activities.

      Recognised Lenders

Internationally recognized sources such as international banks, international capital markets, and multilateral financial institutions such as IFC, ADB and CDC, export credit agencies, suppliers of equipment, foreign collaborators and foreign equity holders.

Allowed uses

• Investment (such as import of capital goods, new projects, modernization/expansion of existing production units) in industrial sector including SMEs and infrastructure sector. 
• Overseas direct investment in Joint ventures and Wholly owned subsidiaries.
• NGOs engaged in micro finance activities can utilize the proceeds for:
   a. Lending to self-help groups . b. micro credit  c. bona fide micro finance activity including capacity building.

                                                            Source: Edelweiss research

When the FCCBs were taken, the rupee was at values of Rs. 40-44. Today, the rupee is at Rs. 56 to a dollar. That means to buy the same number of dollars and pay back; companies need to pay 25% more. This is apart from the coupon interest, and given that if they try to pay back the FCCBs, they will end up flooding the market with buy orders, the rupee will fall even more.

This rupee fall hurts conversion as well. Consider an FCCB issue with the dollar at 44, and a conversion price of Rs. 440. That means one share = $10 worth. Today, with the rupee at Rs 56 to a dollar, even if the stock stays atRs. 440, it will be worth just $7.85 – a loss of 20%. To break even, the stock needs to be at least Rs. 560. These companies had issued bonds in the past assuming that investors would choose to convert them into equity and had not made any provisions for their redemption. 

In a report released in February 2012, rating agency Fitch had said that around 59 Indian companies face redemption of $7 billion in FCCBs during 2012. Fitch Ratings believes that about 63% of the amount due is likely to be repaid from a combination of internal accruals and fresh borrowings, with some companies paying a huge price by accessing high cost rupee finance. 17% is expected to undergo restructuring (mostly time extensions), while the remaining 20% is likely to default.

Interest expenses are expected to rise by 25%, on average, for companies that can find funding to pay off FCCBs. That's because about 80% of companies with FCCBs maturing in the rest of 2012 pay less than 2% interest on the bonds, and about 60% have a zero coupon. However, the cost of borrowing to pay off FCCBs would be much higher-about 6% for external commercial borrowings and 10%-12% for loans from domestic commercial banks.

The FCCB market is basically a limited market consisting of FII’s, Banks, Mutual Funds and HNI’s. As per a Study conducted by India Brand Equity Foundation, India Inc emerged as the biggest issuer of foreign currency convertible bonds (FCCBs) in the Asia-Pacific region in 2005. Total FCCBs issued from India were to the tune of $1.4 bn, accounting for 32.7 per cent share, while Taiwanese companies ranked second and raised $1bn.Further, out of about 30 FCCB issues in the Asia-Pacific region, 15 were from India and 6 from Taiwan.

Buyback of FCCB’s

The Government has allowed premature buyback of FCCB’s, enabling the corporate treasuries to actively manage their liability mix. The RBI has opened the window of premature buyback of FCCB’s using rupee resources subject to certain conditions. The initiation power of prepayment is vested with the issuer of bonds and not with the holder of bonds. However, the actual prepayment is subject to the consent of the holder of the bond.

The Reserve Bank of India (RBI) has recently extended the tenure for buyback of foreign currency convertible debentures (FCCBs) by Indian companies till March 2013. It also revised the norms for pricing of buyback transaction. Indian firms can now buyback the FCCBs at a minimum discount of 5 per cent on the accredited value utilising their foreign currency funds under the approval route, as against 8 per cent of book value earlier.

RCom bought back FCCB’s worth $25 million on Dec 29, 2008 and $10 million on Jan 10, 2009. Jubilant Organosys Ltd. bought back FCCB’s worth $11.1 million on Feb 5, 2009 and $45.3 million on Feb 23, 2009. Orchid Chemicals bought back FCCB’s of $37.8 million. These firms had bought back bonds at a discount 30-50 percent on the face value.

RCom had made payment of USD 1,182 million on Feb 29, 2012 to redeem the FCCBs worth USD 1,000 million issued in February 2007 and due on March 1, 2012. Industrial and Commercial Bank of China Ltd (ICBC), China Development Bank Corporation (CDB) and Export Import Bank of China (EXIM) had done the refinancing at a rate of 5%.

Indian Hotel Limited issued FCCB’s which reduced its cost of borrowing from 6.9 per cent to 3.6 per cent. Similarly, conversion of FCCB and repayment of loans reduced its interest burden by 36.5 per cent YOY from Rs.91mn in Q1FY05 to Rs. 58mn in Q1 FY06.

Jaiprakash Associates has decided to repay about Rs. 3,100 crore ($550 million) of FCCBs ahead of their September maturity. The company has committed to give a redemption premium of 47 per cent, which would give an annualised return of 7.95 per cent. The company has tied up the necessary funds from internal accruals and marginal borrowings.

Wind turbine maker Suzlon has redeemed in cash the two June series of foreign currency convertible bonds (FCCBs) totally valued at $360 million. In early June, holders of the bonds had approved the company’s proposal to extend the maturity date by 45 days till July 27. To facilitate this redemption, Suzlon sold a block of wind farms across India, the majority in Tamil Nadu, for $40 million. In late June, it entered into an agreement to sell its wholly owned Chinese subsidiary Suzlon Energy Tianjin Ltd to China Power (Tianjin) New Energy Development Company Ltd for $60 million. The remaining finance for the FCCB repayment has been tied up as a dollar denominated loan from a consortium of Indian banks.