Rate differential, equity headroom may spur FCCB binge

Foreign currency convertible bonds (FCCBs) are seen coming back in vogue in the new year as firms junk high-cost domestic borrowings for cheaper foreign debt.

FCCBs allow companies to raise foreign currency through debt that can be converted into equity.

“A strong domestic economy and elevated inflation levels are likely to keep the Reserve Bank of India hawkish. Interest rates are likely to remain at higher levels for the next few quarters,” said Prashant Sawant, analyst with the London-based KNG Securities LLP.

“However, interest rates in developed markets, especially the US, the UK and the eurozone, are likely to remain much lower. Higher domestic cost of borrowing would make India Inc seek lower-cost debt in overseas markets. Therefore, during 2011, some revival in FCCB issuance is highly likely,” he said.

Hemant Mishr, managing director, head-global markets, (South Asia), Standard Chartered Bank said FCCBs were not really good from a convertibility perspective in the current year.

“There was a mismatch between investors’ expectations and what issuers were happy to offer as the conversion premium. But now we are seeing investors’ appetite across a broader spectrum of investors for quasi-equity instruments out of India,” Mishr said.

The momentum is unlikely to change massively unless the markets run ahead of themselves, Mishr said, adding, “Investors are keen on putting in money.”

The demand situation and signs of revival in developed markets would also put the capex cycle back on the burner.

“This would require additional funding either via equity or debt. Overseas investors are willing to invest in Indian market provided the market provided much greater transparency and corporate governance,” said Sawant, pointing out that FCCB investors prefer companies with a decent market cap and substantial free float.

Money market sources said Sintex Industries and Financial Technologies (India) are planning to come up with FCCB issuances worth $100 million each.

Last week, Videocon Industries raised $200 million through convertibles.

“If there is an expectation of strong equity performance, there is always an incentive for the investor to go in for FCCB. Otherwise, in these issues, investors generally get a lower coupon compared with a standard bond. If the end-investor feels the company’s stock has got a lot of upside, he will have appetite,” said Gopal Bhattacharya, head of global markets (India), Societe Generale.

But the Street doesn’t expect a redux of 2004-05, which was perhaps the busiest year to date for Indian convertibles.

“There will be some interest due to high borrowing cost in India, but it is unlikely that it will revive to the scene five years back,” said Vinod Wadhwani, director, Ambit Corporate Finance.

That’s because, Wadhwani said, in the past there have been cases where there were defaults by companies which caused severe pain to convertibles holders.

“Now they will be cautious. There are also restrictions on the end-use of FCCBs — such as the money can’t be invested for acquisitions in India nor it can be used for investments in real estate and capital markets,” he said.

The all-in-cost ceiling for raising money through FCCBs is 300 basis points over the 6-month London inter bank offer rate (Libor) for 3-5 year maturities and 500 basis points over 6-month Libor for maturities over five years.

All-in-cost includes rate of interest, other fees and expenses in foreign currency except commitment fee, pre-payment fee and fees payable in rupees.

The payment of withholding tax in Indian rupees is excluded for calculating the all-in-cost. The 6-month Libor was at 0.46 on Tuesday.