Foreign Currency Convertible Bonds (FCCB)

FCCB or the Foreign Currency Convertible Bonds is a type of convertible bond issued in a currency different than the issuer’s domestic currency. It can be regarded as an instrument used to raise money by the issuing company in the form of a foreign currency. A convertible bond is a debt instrument with equity flavors in it, as it acts like a bond by making regular coupon and principal payments, but also gives the bondholder the option to convert the bond into stock.

Benefits of FCCB to the Issuer

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

Benefits of FCCB 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 Of FCCB

• 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.

How can you Access FCCB

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.

I) Automatic Route

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

II) 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

III) Recognized 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.
• NGOsengaged in micro finance activities can utilize the proceeds for:
  • Lending to self-help groups
  • micro credit
  • bona fide micro finance activity including capacity building.

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 at Rs. 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.

Buyback of FCCBs

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 utilizing 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%.

Wind turbine maker Suzlon has redeemed in cash the two June series of foreign currency convertible bonds (FCCBs) totally valued at $360 million. 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.