Once-lucrative FCCBs are a bitter pill to swallow

By Rohan Ghosh Roy and Juieen Nag, Trilegal
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Riding on the buoyant stock markets over the last few years, Indian corporates embraced foreign currency convertible bonds (FCCBs) as a preferred financing option. Most FCCB issuers bet on equities continuing the bullish run and bondholders exercising the conversion option prior to maturity (as opposed to redeeming the bonds), and, as a result, had not set aside adequate funds for the redemption of these bonds.

Rohan Ghosh Roy Associate Trilegal
Rohan Ghosh Roy
Associate
Trilegal

Given the current state of the economy, the scarcity of funds and the steep fall in share prices of almost every issuer, redemption, and not conversion, has become the looming reality for these corporates – turning a once lucrative financing option into a bitter pill that most issuers are finding difficult to swallow.

To address this unexpected turn of events, the Reserve Bank of India (RBI) has provided issuers with an option to prematurely buy back FCCBs at a discount, utilizing either the issuer’s internal rupee accruals (with prior RBI approval and at a minimum discount of 25% to the book value of these FCCBs) or any available foreign currency resources and/or fresh ECBs (at a minimum discount of 15% to the book value of these FCCBs).

However, very few companies appear to have been able to capitalize on this opportunity until now, despite the buyback window only being open till 31 March. Recent media reports suggest that the unavailability of adequate internal resources, coupled with the inability of issuers to raise fresh debt in these tough market conditions is proving to be the stumbling block for corporates seeking to use this window of opportunity.

Given this factual backdrop, issuers could explore the option of extending the tenor of the outstanding bonds to have them mature at later date when the markets will hopefully be more conducive. The RBI has indicated that the extension of FCCBs would be permitted at the current external commercial borrowing (ECB) all-in-costs for the relative maturity. Additionally, since the RBI has abolished all-in-cost ceilings for all ECBs until 30 June (with prior RBI approval), a restructuring package that would extend the maturity of the bonds at higher all-in-costs for the extended relative maturity (which could still be cheaper than domestic debt), may now be a viable option for issuers to explore (with the prior approval of the RBI).

To make such extensions more attractive to bondholders, issuers may also consider restructuring the terms of the bonds, either by resetting the price at which the bonds convert into equity (strike price) and/or resetting the coupon payable.

Juieen Nag Associate Trilegal
Juieen Nag
Associate
Trilegal

There are, however, several challenges to resetting the strike price. First and foremost, the share prices of several issuers are now considerably lower than the Securities and Exchange Board of India floor price that was fixed at the time of FCCB issuance. In fact, there are some cases where the fall in share prices has resulted in the face value of outstanding bonds being higher than the total market capitalization of the issuer, based on current trading prices. In such cases, given that the minimum possible reset strike price will still be considerably higher than current market prices, resetting the strike price alone may not be a very feasible option.

Even in cases where resetting the strike price is a viable option, lowering the strike price would lead to a dilution of promoter equity – the lower the strike price is reset, the more significant the dilution of promoter equity. Promoters are therefore unlikely to be very receptive to the liberal use of this option. However, in situations where a default has already occurred under the terms of the bonds or where there is a possibility of the occurrence of an event of default, promoters may be more receptive to resetting strike prices.

Another relevant factor that plays a pivotal role in considering a strike price reset is the potential impact of the reset on the trading prices of the issuer’s stock. Resetting the strike price significantly lower may have an adverse impact on already battered share prices – something that issuers would be quite keen to avoid.

Alternatively, issuers also have the option of refinancing their FCCBs. Refinancing would have to be out of the proceeds of a fresh ECB/FCCB raised at a lower all-in-cost as compared to the retiring FCCB, while maintaining its minimum maturity. However, given the conditions attached to this option, it is unlikely that issuers would be able to consider this as a workable option in these economic conditions.

If all else fails, issuers have to gear up to redeem their bonds on the maturity date. Issuers could raise funds for redemption either through a fresh issue of capital or by raising fresh debt. However, if the markets continue to be volatile and unpredictable, a fresh issue of capital may not be possible, in which case the only resort would be to raise debt at considerable costs. Whatever the option chosen by India Inc to tackle the issue of outstanding FCCBs, one thing is for certain: we have an interesting and eventful period ahead of us.

Rohan Ghosh Roy and Juieen Nag are associates at Trilegal in Mumbai. Trilegal is a full-service law firm that advises on corporate and commercial law in India and provides commercially oriented legal advice in relation to all sectors of the economy. The firm has offices in Delhi, Mumbai, Bangalore and Hyderabad and has over 100 lawyers, some with experience at law firms in the US, the UK and Japan.

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