Conversion premiums fall, investors insist on stiffer conditions.
A raft of issuances in the second half of 2009 had sparked hopes that foreign currency convertible bonds (FCCBs) were back in demand. However, the deal flow since has not kept pace with expectations.
Inherent weakness in the overseas debt market and stiffer conditions demanded by investors were likely to keep volumes subdued, said investment bankers.
An FCCB is a convertible bond issued in a foreign currency which allows holders to convert these into equity. FCCBs can be converted into equity only if the stock of the issuer is higher than a pre-determined conversion price. If the market price is unable to reach the conversion price over the tenure of the FCCB, the instrument works like a bond and the issuer has to redeem the amount.
FCCB volumes jumped from a paltry $24 million in 2008-09 to $2.88 billion in 2009-10. But, these are still far from the 2007-08 figure of $5.6 billion.
“2009-10 on a broad basis saw much higher volume than in 2008-09. But, the growth number may be misleading, as the market is not open for all issuers and structures,” said Nishikant Das, director of debt capital markets at Standard Chartered Bank.
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In October 2009, seven companies, including blue-chip ones such as Sesa Goa and Sterlite Industries, raised a total of $1.87 billion, kindling hope the FCCB market was headed towards its 2007 heyday. However, the deal flow has slowed since then. In the fourth quarter of 2009-10, there were only three issues, out of which two were less than $50 million in size, according to data from the Reserve Bank of India.
Investors’ insistence on stiffer conditions is one of the reasons for fewer issuances. Gone are the zero-coupon structures, which exempted issuers from paying periodic interest. In this, the issuers were required to pay only the accumulated interest on maturity in case the bonds were not converted into equity.
Also, conversion premiums have come down significantly, as investors do not want to be saddled with bonds that they are not able to convert into equity because the conversion price is too high.
According to bankers, till 2007, FCCB issuers could charge a premium of high as 55-60 per cent over the prevailing stock price. Now, these have fallen to 10-20 per cent on an average.
“Pre-crisis, the FCCB market was massively distorted by demand for equity optionality by hedge funds rather than the funding need of issuers. Now, sanity has returned and zero-coupon structures are no more the norm and conversion premiums are modest,” said Tarun Kataria, managing director and head of corporate, investment banking and markets at HSBC.
“The hunger for optionality was a by-product of excess leverage in the system, which is no longer the case today. We will bring to the market a couple of FCCBs in the coming weeks, which will reflect the appropriate balance of issuer need and investor appetite,” he added.
Bankers say there has also been a shift in the profile of investors.
“In 2007, there were a large number of technical investors who used hedging techniques on FCCBs. Now that the technical investors are gone, we have what are called long-only investors who treat the instrument like equity. Long-only investors buy into the growth story of a company,” said StanChart’s Das.
Another reason for subdued volumes is that capital expenditure by Indian companies is still far less than the pre-crisis levels.
“There is restriction on end-use of funds raised through FCCBs. Since FCCB money is not allowed to be used for working capital needs and capital expenditure by Indian companies is still not back to pre-crisis levels, the volumes are subdued,” said a senior executive from Citi.
With credit spreads for Indian companies rising in the wake of sovereign debt crisis in Greece, FCCB issuers may have to contend with higher coupon rates on their bonds.