ecb fccb final
TRANSCRIPT
Foreign Currency Convertible Bonds (FCCB)&
External Commercial Borrowings (ECB)
So Let’s Get
Started
Money Market – A Brief Overview
Money MarketDistinguishing Features
1. Money Markets must have an original maturity of one year or less
2. These instruments are sold in large denominations
3. These instruments have very low default risk
1. Treasury Bills
2. Federal Funds
3. Repurchase Agreements
4. Commercial Paper
5. Certificates of Deposit
6. Banker’s Acceptances
Instruments In Money Market
1. Short-term obligations of the US Govt.
2. Sold through a very systematic auction process.
3. Maturities of 13 or 26 weeks.
4. Has an active secondary market.
5. Default risk-free.
6. Process: Competetive Bids.
Treasury Bills
1. Short-term funds transferred between financial institutions.
2. These are single-yield instruments.
3. Highly liquid market for commercial banks’ and savings banks’ funding
Federal Funds
1. An unsecured short-term promissory note.
2. Variable interest-rate structure.
3. Maturities range from 1 to 270 days.
4. Credit rating is important
Commercial Paper
1. Bank-issued time deposit.
2. CD’s have an active secondary market.
3. High denomination.
Certificates of Deposit
International Money Market
International Aspects of the Money Market
1. U.S. money market instruments bought and sold by foreign investors.
2. Foreign Money Market Securities
Euro Money Market
1. US $ still the major international medium of currency.
2. Eurodollar Deposits – Eurodollar Market
3. No relevance whatsoever to the “EURO” currency.
International Money Market Investments
Commercial Paper - $415bnFinancial Institutions 86.50%Corporations 10.30%Others 3.20%
Euro-Dollar Market
1. The Euro-Dollar market has no true physical location.
2. Interest rate for EuroDollar transfers – LIBOR.
3. Used by banks for overnight funding.
Euro-Dollar Certificates of Deposit
1. US $ denominated CDs in foreign banks.
2. Most maturities between one and six months.
3. No reserve requirements.
4. Higher rate of interest than US CD’s.
Euro-Commercial Paper
1. Rate about a % higher than the LIBOR rate.
2. Most of the Euro-Commercial Paper denominated in Euro.
External Commercial Borrowings - ECB
• A source of funds for financing expansion of existing capacity and for fresh investment out of territory
• External Commercial Borrowings (ECB) refer to commercial loans availed from non-resident lenders
External Commercial Borrowing (ECB)
ECB Includes
• Commercial Bank Loans
• Buyer’s Credit
• Supplier’s Credit
• Securitized Instruments such as Floating Rate Notes
• Fixed Rate Bonds
• Credit from official export credit agencies,
ECB includes
:
• Commercial borrowings from the private sector
• Window of multilateral financial institutions such as IFC, ADB, AFIC, CDC etc.
• Investment by Foreign Institutional Investors (FIIs) in dedicated debt funds
ECB Includes
Why ECB
• Scarcity of funds in the domestic market
• Cheaper than Domestic Debt
• Longer Maturity Period
Why ECB?
Why ECB
• INVESTOR BENEFIT
Specific period
Fixed return
Repatriable interest &
Borrowed amount
No owners risk
Why ECB?
Why ECB
• BORROWER Ownership Quantity Fixed rate of Interest Availability
Why ECB?
Basic Financing StructureBasic Financing Structure
Exclusions from ECB
• Investment made towards core capital of an organization viz.
• Investment in equity shares,
• Convertible preference share and
• Convertible debentures
Exclusion from ECB
Exclusions from ECB
• Equity capital
• Reinvested earnings’ (retained earnings of FDI companies)
• Other direct capital (inter-corporate debt transactions between related entities)
Exclusion from ECB
• Permitted by the Government as a source of finance for Corporate to expand their existing capacity & for fresh investment
• An annual cap or ceiling on access to ECB,consistent with prudent debt management
Policy
• Greater priority for projects in the infrastructure, Power, oil, telecom, railways, Roads & Bridges, Ports, Industrial parks, urban Infrastructure & export sector.
Policy
Trade Credits
• Credits extended for imports into India directly by the overseas supplier, bank and financial institution for maturity of less than three years
Trade Credits
Inflow of ECB
Ways of Raising ECB
• Automatic Route– Do not require RBI permission
• Approval Route– Do require RBI permission
Ways of raising ECB
Automatic Route
• Loan agreement in compliance with ECB guidelines
• Real sector- Industrial sector- Infrastructure sector
• Capital intensive projects
• No need of RBI permission but they can take recourse to approval route.
Automatic Route
Eligible Borrowers
• Companies ( Except financial intermediaries)
• Units in SEZ
• NGO engaged in micro-finance
• Individuals, Trusts, Non-Profit Organization are NOT able to raise ECB
Eligible Borrowers
Recognized Lenders
• International Banks
• International Capital Markets
• Multilateral FI
• Export credit agencies
• Suppliers of equipments
• Foreign Equity holders
For ECB up to $ 5m, minimum equity of 25% should be held by lender
For more than $ 5m, minimum equity of 25% should be held by lender and debt to equity ratio should not exceed 4:1
For ECB up to $ 5m, minimum equity of 25% should be held by lender
For more than $ 5m, minimum equity of 25% should be held by lender and debt to equity ratio should not exceed 4:1
Recognized Lenders
Amount & Maturity
• Max. Amount $ 500 m or equivalent during a Financial year.
– ECB up to $ 20 m in financial year with MIN AVG maturity of 3 years
– ECB above $ 20 m to $ 500 m in financial year with MIN AVG maturity of 5 years
Amount & Maturity
Restricted Areas
• Investment in capital markets
• Working capital, general corporate purpose
• Repayment of existing rupee loans
• Lending purposes, acquisition of existing shares
Restricted Areas
Parking of Deposits
• Overseas until actual requirement in India– Deposits, COD, other products offered by bank
– Deposits with overseas branch of bank of an authorized dealer in India
– T bills or other monetary instruments with 1 year maturity
– All liquid instruments
Parking of deposits
Prepayment
• Up to $ 5 m : Allowed with out RBI approval
• Minimum average maturity period is applicable for respective loan.
Prepayment
Refinancing of existing ECB
• If fresh ECB is at lower cost
• Outstanding maturity of original ECB is not changed
Refinancing of existing ECB
Approval Route
• Prescribed application from through AD to RBI
• RBI permission is required
Approval Route
Same as in Automatic route
• Recognized lenders & borrowers
• Parking of ECB
• Prepayment of ECB
• Refinancing of ECB
Same as Automatic Route
All-in-Cost Ceilings
• 150 bps over 6 month LIBOR for 3-5 years
• 250 bps over 6 month LIBOR for above 5 years
• Expenses in Indian currency – Commitment fee, pre-payment fee
• Expenses in foreign currency– Interest, other fees & expenses
All-in-cost-ceilings
Security
• Left to the borrower
• Creation of charge over immovable assets and financial securities in favor of lender is subject to regulation of FEMA
Security
INTRODUCTION
• A financial marketplace where debt instruments, primarily bonds, are bought and sold is called a bond market
• Also known as the debt market• Limited to a small group of participants.• Lacks a central exchange.
WHAT IS A BOND?
• A bond is a debt security. When you purchase a bond, you are lending money to a government, municipality, corporation, federal agency or other entity known as the issuer– Bonds issued by corporations or the US government are
usually taxable– Bonds issued by state governments or municipalities
are usually exempt from tax
• Maturity• Redemption Features• Credit Quality• Interest Rate• Price • Yield• Tax Status
VARIABLE THAT EFFECT THE VALUE
1.Short-term notes: maturities of up to 4 years;
2.Medium-term notes/bonds: maturities of five to 12 years;
3.Long-term bonds: maturities of 12 or more years.
MATURITY
• Bond with a redemption provision usually have higher return to compensate for the risk that the bonds might be called early– CALL Option: provisions that allow or require
the issuer to repay the investors’ principal at a specified date before maturity.
– PUT Option: option of requiring the issuer to repurchase the bonds, at a specified time, prior to maturity.
REDEMPTION FEATURES
• Agencies assigns its ratings based on an in-depth analysis of the issuer's financial condition and management, economic and debt characteristics, and the specific revenue sources securing the bond.
Credit Ratings
Credit Risk Moody's Standard and Poor's Fitch
Prime Aaa AAA AAA
Excellent Aa AA AA
Upper Medium A A A
Lower Medium Baa BBB BBB
Speculative Ba BB BB
Very Speculative B, Caa B, CCC, CC B, CCC, CC, C
Default Ca, C D DDD, DD, D
CREDIT RATING
• FIXED: Stays same until maturity; ie: buy a $1000 bond with 8% fixed interest rate and you will receive $80 every year until maturity and at maturity you will receive the $1000 back.
• FLOATING: adjustable to prevailing market rates.
• PAYABLE AT MATURITY: receive no payments until maturity and at that time you receive principal plus the total interest earned compounded semi-annually at the initial interest rate.
INTEREST RATES
• The amount you pay for the bond– Newly issued bonds will pay close to their face-
value– Traded bonds fluctuate in response to changing
interest rates• Bonds traded higher than their face-value are said to
be sold at a premium• Bonds traded lower than their face-value are said to
be sold at discount
PRICE
• Yield is the return you actually earn on the bond--based on the price you paid and the interest payment you receive
• Two Types of Yields– Current Yield: annual return on the dollar amount paid
for the bond and is derived by dividing the bond's interest payment by its purchase price
– Yield To Maturity: total return you will receive by holding the bond until it matures or is called.
YIELD
• As a general rule: the bond market, and the overall economy, benefit from steady, sustainable growth rates.
• But steep rises in economic growth can lead to inflation, which raises the costs of goods and services for everyone, leads to higher interest rates and erodes a bond's value.
INTEREST RATE - INFLATION
• Municipal: issued to raise money for schools, hospitals, highways, etc.
• Corporate: debt obligations issued by private and public corporations
• Zero-Coupon: Bonds with no periodic interest payments (introduced to the marketplace in 1982)
CATEGORIES OF BONDS
• Government bonds• High yield or "junk" bonds• Inflation-linked bonds• Euro bonds• Extendible & retractable bonds• Foreign currency bonds• Zero coupon or "strip" bonds• Convertible bonds
TYPES OF BONDS
Introduction
• FCCBs mean bonds that are issued by an Indian company and subscribed by non resident in foreign currency, that are convertible into equity shares of the issuing company, either in part or in whole on the basis of equity related warrants attached to the debt instrument.
• Interest is also paid in foreign currency.
Salient Features
1. Quasi-debt instrument
2. ‘Call’ and ‘Put’ option
3. Lesser interest component
4. Zero coupon Bonds
5. The redemption of FCCB
6. YTM (2% to 7%)
Salient Features (Contd)
7. Generally issued by Corporate having high promoter shareholding
8. Pricing of FCCB
9. The foreign holder of FCCB can trade the FCCB in part or in full.
10. Right to convert FCCB into Equity
FCCB v/s ECB
• FCCBs are basically debt instruments that are convertible into equity, either in part or in whole on the basis of equity related warrants attached to the debt instrument
• ECBs are simple debt that continue to remain debts and cannot be converted into equity.
Valuation of FCCB
Components:
1. Bond: The Present Value of the bond component is arrived at by discounting the future cash flows at LIBOR + credit premium.
2. Equity: The value of call option on equity is arrived at as per Black Sholes model.
- Value of the bond would be higher of the two + accrued interest
Key Statistics
Regulations
• Automatic Route and Maturity – US$500mn.
• Permitted End Uses of Proceeds of Issue – import of capital goods, JV, WOS, acquisition of shares in PSU divestments, Refinancing.
• Not permitted End Uses – Capital market, real estate.
• Pricing of the Shares to be issued on Conversion– Average of weekly high and low for two
weeks/six months immediately preceding the relevant date*
*Relevant date – 30 days prior to the day on which general meeting was held.
Regulations
Benefits to Investors
• Capital Protection guaranteed• Greater return potential- Bull market• Redeemable at maturity if not converted.• Much of the upside on equity/debt protects the
downside.• Lower tax liability as compared to pure debt
Benefits to Issuer Company
• It is a low cost debt• Higher Leverage – if conversion takes place.• The impact on cash flow is positive, as
redemption premium is payable only if the stock price is less than the conversion price.
• FCCB do not dilute ownership immediately• Mostly FCCB’s are issued to suit the company
needs.
Limitations
• FCC Bonds are ideal for the bull market but for bear market it remains a matter to be thought
• If the investors do not go for conversion then company liability increases
• Remains as debt in the balance sheet until conversion
• Foreign Exchange
Accounting Treatment for FCCB
• No specific Accounting Standard
• Now- AS31 Financial Instruments Presentation
• Mark to market for derivatives instruments
Translational losses-Foreign Exchange
• Companies did provide for changes in forex losses
• Deteriorating rupee – Eg: Jaiprakash Associates
• Few companies have fixed the value of dollar at the time of issue. eg:Aurobindo Pharma at Rs.45.145 per dollar
Taxation
• Taxation- yet another reason• Interest payments and tax on dividends paid until
conversion are subject to deduction of tax at source
• Conversion of FCCBs into shares does not give
rise to any capital gains liable to income-tax in India.
• Transfer of FCCBs made outside India does not give rise to any capital gains liable to tax in India.
Indian Cos in Catch 22 Situation
• Suffered huge MTM losses due to positions for hedging for FCCB payments
• Current stock price << Conversion Price• Cos will have to pay out the Face Value during
maturity of FCCB
• Increase in the Debt Equity Ratio• Cos are cash strapped• FCCB maturing period – Starts at End of 2009,
Peaks in 2011
Indian Cos in Catch 22 Situation
Premature Buyback of FCCBs
• RBI / Govt. allowed cos to prematurely buyback FCCBs form Dec2008
• The window was initially open till March 2009
• Has been extended to Dec 2009
Advantage of Buyback to Cos
• Reduction in Interest Costs
• No provision for MTM losses
• Buyback at discount due to current economic condition
Guidelines for Prepayment of FCCB
General Conditions
• Initiation of prepayment - vested with the issuer of Bonds
• Pre-payment - subject to the consent of the holder of the bond.
• Pre-payment - not exceeding the face value• Bonds purchased from the holders – cancelled, not
be re-issued or re-sold.• Funds for making such prepayment - not be by
resorting to fresh external debt.
Guidelines Under Automatic Route
• Buyback value of FCCB be at a minimum discount of 15% on the book value
• Funds used for the buyback shall be out –
1. Existing foreign currency funds OR
2. Out of fresh ECB raised
Norms For Fresh ECB
• Co-terminus with outstanding maturity of original FCCB
• Maturity less than three years
• Cost ceiling - 6 months Libor plus 200 bps as applicable to ST borrowings
Guidelines Under Approval Route
• Buyback value of FCCB be at a minimum discount of 25% on the book value
• Total amount of buyback shall not exceed USD 50 million
• Funds used for the buyback can be out –
Internal accruals i.e. Rupee resources
Internal Accruals (IA)
• Includes - Retained earnings
• Does not include – Share Capital , Premium on issue of shares
• To meet buyback through IA – Money reqd. for buyback should be less than Co’s retained earnings
Tata Motors reset FCCB conversion price
• $ 990mn raised
• Currently at a discount of 33-47%
• Reset price 20-50 per cent lower than the current conversion price
• Repayment through ECB
Japanese Yen
RComm buyback of FCCB
• Rise in stock price
• FCCB amounting to $1 million at conversion price of Rs. 661
• Buyback through tenders
Suzlon FCCB restructuring
• Three important things involved:– Issue of new bonds – Buyback of the existing bonds – Same bonds but new terms and conditions
• Out of USD 500 million zero coupon convertible bonds USD 131 million will get restructured
ECB not that Easy
• Risk Aversion among international lenders
• Downturn stock’s FCCB are at discount
• Negative Rating by S&P
• Challenging RBI pricing norms
Orchid
• Operating in Pharma Sector
• FCCB worth $ 193mn
• FCCBs are significantly out-of-cash
• High leveraged financials
Thank You