Redemption Time

On January 17, Reliance Communications (RCom) tied up a loan of $1.18 billion (`6,125 crore) with a consortium of Chinese banks for seven years at an interest rate of about five per cent. The company will use the loan to redeem its Foreign Currency Convertible Bonds (FCCB), which were reportedly in the region of`6,696 crore in financial year 2011/12. Despite the redemption, however, the telecom player will still have a net debt exceeding `30,000 crore.

AnFCCB investor receives shares from a borrower at a pre-fixed conversion price on maturity of the bond. If the conversion price is lower than the market price, theFCCB holder can convert the securities into shares. But if it is higher, the holder would likely redeem the bonds.

“This is the largest refinancing in the history of FCCBs by any Indian company,”said an RCom release. In truth, RCom had no choice but to create history. When it raised $1 billion in February 2007, the conversion price RCom had fixed was a sky-high `661.2 per share. A day before it announced the loan tie-up, its share price was `86.40.

Many companies tapped the FCCB route during the boom period of 2005 to early 2008. “The conversion price on such bonds was 25 to 150 per cent higher than the prevailing stock price at the time of issuance and they carried zero or very low coupons,” said the Reserve Bank of India (RBI), in a June 2011 report. (Coupon: interest rate on a bond when it is issued.) “Estimates show that a very large proportion of these FCCBs may not get converted into equity, thus requiring their refinancing at the much higher interest rates prevalent today.”

The S&P CNX Nifty is trading 20 per cent below its early-2008 high, and the stock prices of FCCB issuers are trading at far lower levels. In addition, FCCBs worth more than $7 billion are maturing by March 2013, the RBI report noted (they are normally issued for more than five years). “More than a few firms potentially face severe funding problems in the next two years,” it added.

In December last year, RBI again warned that there are fewer foreign sources of lending as a result of risk aversion following the European debt crisis. It also said the rupee’s sharp depreciation would raise the cost of redemption.

For example, Jaiprakash Associates has $354.5 million worth of FCCBs outstanding that are due in September 2012. These FCCBs have a pre-agreed fixed conversion exchange rate of `40.35 a dollar, which would have a mark-to-market impact of nearly 25 per cent at the prevailing exchange rate of `50.33 a dollar.“FCCBs carrying zero or low coupons would need to be replaced with domestic borrowings, whose rates are much higher today,” the RBI said.

The apex bank’s premise of dependence on domestic borrowings could be based on the fact that banks in Europe and the US, traditionally the biggest source of External Commercial Borrowings (ECBs), have shrinking balance sheets today. But Indian companies may approach Chinese, Japanese and West Asian lenders instead.

“The RCom deal indicates that unconventional sources may be tapped for dollar funding,” says the research head of a broking firm. Concurring with him, the CEO of a company with sizeable FCCB exposure points out that Chinese banks have large amounts of money to lend.“But the challenge is in raising equity in this market,” he says. (Raising equity would keep the debt-equity ratio from climbing.)

However, refinancing FCCBs through fresh borrowings could just postpone the problem, at a higher cost.