After getting into messy legal battles with promoters and faced with the prospect of more defaults, foreign lenders are putting additional conditions on companies that are raising money issuing foreign currency convertible bonds (FCCBs).
Lenders, usually foreign funds that specialise in FCCBs, are now demanding that assets, including shares owned by promoters, shares in subsidiaries and property, be pledged as collateral to secure these loans. This changes the character of the instrument itself, which were inherently unsecured. Such collateral is being insisted on for fresh loans, as well as restructuring, putting further pressure on the beleaguered issuer firms.
The move will affect at least two dozen companies faced with a near-default situation, which are either looking for a restructuring or refinancing options. According to a recent report by rating agency Fitch, 19 companies have high likelihood of default on FCCB payments or require serious restructuring. "In this group, at least eight have already defaulted in other debt obligations. Given their significantly weakened cash flow, unsustainable debt levels and existing default status, the prospect of recovery actions by domestic lenders against a number of these companies is high," the report said.
Besides, nine other companies have been put in the 'likely to restructure' group which, despite having a reasonable business model, are currently experiencing stretched liquidity and stressed cash flows.
Some of the large fund houses that have invested in Indian companies via the FCCB route include DE Shaw, QVT Advisors and Alchemy.
FCCBs are debt instruments issued in a currency different than the issuer’s domestic currency, with an option to convert these into shares of the issuer company. While FCCBs are similar to bonds, as they make regular coupon (interest) payments, they also give the bondholder an option to convert the bond into stocks. FCCBs are inherently unsecured.
“The cost of funding has changed due to defaults, such as Wockhardt and Zenith Infotech. Now, we are demanding collateral for FCCB loans,” said a senior official with a fund. Last year, hospital chain Wockhardt had agreed to repay dues in instalments after lenders moved court. Last week, Business Standard had reported that lenders led by QVT Advisors had moved the Bombay High Court to wind up Zenith Infotech.
According to the official, investors have come a long way since 2006-07 when money was free, the markets were bullish and people did not focus on such safety factors. "Though the winding-up provision is part of the FCCB contract, investors now are looking for additional security measures. The arrangement is not inconsistent with the RBI’s ECB framework,” the official added.
Companies in the mid- and small-cap segment, who most need the funds, are the worst hit. “There have been few defaults in the repayment of FCCBs, and bondholders are worried of such incidents happening in future. Especially with markets opening up for raising funds, these investors might look at some security or collateral. However, this will be restricted to smaller firms,” said Hiranya Ashar, chief financial officer of Rolta.
“Loans in the $10 million to $50 million bracket to companies outside the top 20 list are the ones that are affected,” said a merchant banker, who structures these loans.
Skepticism about increase in share prices is another key reason, say experts. In the heady days of the bull run, FCCB loans were seen as a win-win for both promoters and lenders. However, following the crash in the stock prices and slowdown in corporate profits, these loans have become riskier.
Ashvin Parekh, national leader, Ernst & Young, said the move is a result of investors losing comfort in the instrument following unfavourable movements in share prices. "An FCCB is essentially a contract between the issuer and the lender. So, the existing lenders at the point of recycling and the new ones in case of fresh lending, are free to demand any further assurances from the issuer. After the first experience, where the proposed value increase has not materialised, investors have lost their comfort in the instrument. That’s why they are demanding collateral now. The regulatory framework will not affect the contract between the lender and the issuer,” he added.