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With a rising stock market, foreign currency convertible bonds (FCCBs) are back on the agenda of Indian companies, to raise money abroad. However, Indian banks, having earlier burnt their fingers on providing credit insurance for previous FCCB issuances, are very cautious. They have had the experience of having to pay for companies that had defaulted on bond payments.
Larsen & Toubro (L&T) has recently been in the market to raise $200 million through FCCBs. Many companies are in the process of getting their shareholders' approval for using this route to raise money.
A senior treasury executive at State Bank of India said FCCBs as an instrument gained prominence whenever equity markets perked and stayed that way. This time, though, public sector banks are going to be selective and thorough in structuring such deals.
FCCBs are bonds that can be converted into equity at maturity. If the share price of the issuer has fallen since the issue, the investor can ask, instead, for redemption of the bonds in cash. Deep Mukherjee, senior director, India Ratings, said FCCBs are an equity bull market instrument. Going by experience, in the first round it is large-size Indian companies with substantial business in international currencies which opt for this route and can also manage the repayment obligation.
During the bull run prior to the global financial crisis in 2008, many listed Indian companies raised large amounts through this route. The expectation was that investors would convert bonds into equity shares, as market prices ruled high. Faced with the downside of volatility after the global crisis happened, Indian stock markets also took a beating. The shares of companies which had issued FCCBs were trading at a huge discount to the conversion prices. The bond holders did not convert the instrument into equity shares. Hence, these companies were saddled with the liability to pay the principal amount and coupon on the maturity of the bonds, especially during 2011-2013. Many of them did not have the resources to make repayments.
In 2011, the Reserve Bank of India in its Financial Stability Report had flagged the risk from problems faced in servicing FCCBs. Some were able to renegotiate for more time and raise resources to pay investors. Some had defaulted on payment and the debt service obligations fell on banks, which had issued credit-linked notes, a type of credit insurance.
According to a trader at the convertible market in London, it will take some time for the market to pick up, particularly for mid-cap issuers. The first signs of recovery would happen, he said, with large-cap companies. Investors were, he said, not looking at present for Indian issues due to the recent experience of defaults. Currently, investors want better pricing, which companies like L&T are not offering. In six to 12 months. "We can hope for some recovery in this market for Indian issuers," he said. Investors want a small difference between the conversion and market price.
Mukherjee said large companies can repay FCCBs. It is the tier-I and tier-II companies, some wet importers, which are at risk.
They have limited ability to service repayment for the principal if the bonds are not converted into equity. When Indian companies with such a profile look for raising funds through FCCBs, prospective investors will look for credit insurance from Indian banks.
