Foreign Currency Convertible Bonds (FCCB)

&

External Commercial Borrowings (ECB)

Money Market A Brief Overview

Money Market
Distinguishing 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

Instruments In Money Market

1. Treasury Bills 2. Federal Funds 3. Repurchase Agreements 4. Commercial Paper 5. Certificates of Deposit 6. Bankers Acceptances

Treasury Bills
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.

Federal Funds
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

Commercial Paper
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

Certificates of Deposit
1. Bank-issued time deposit.
2. CDs have an active secondary market. 3. High denomination.

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 - $415bn
Financial Institutions Corporations Others 86.50% 10.30% 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 CDs.

Euro-Commercial Paper
1. Rate about a % higher than the LIBOR rate. 2. Most of the Euro-Commercial Paper denominated in Euro.

External Commercial Borrowing (ECB) 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

ECB Includes ECB includes

Commercial Bank Loans

Buyers Credit
Suppliers 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

Why ECB 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

Basic Financing Structure Basic Financing Structure

Exclusion from ECB Exclusionsfrom ECB

Investment made towards core capital of an organization viz. Investment in equity shares,

Convertible preference share and

Convertible debentures

Exclusion from ECB Exclusionsfrom ECB

Equity capital Reinvested earnings (retained earnings of FDI companies)

Other direct capital (inter-corporate debt transactions between related entities)

Policy
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.

Trade Credits Trade Credits

Credits extended for imports into India
directly by the overseas supplier, bank and financial institution for maturity of less than three years

Inflow of ECB
7000
SOURCE DNA Money,20 Dec 08

6,673 6,990

6,212 4,827

6000
5000 4000 3000 2000 1,761 3,934 3,959 4,077 4,136

1,559

$(mn)

1000 0

Ways of raising ECB Ways of Raising ECB

Automatic Route
Do not require RBI permission

Approval Route
Do require RBI permission

Automatic Route AutomaticRoute

Loan agreement guidelines in compliance with ECB

Real sector- Industrial sector- Infrastructure sector Capital intensive projects No need of RBI permission but they can take recourse to approval route.

Eligible Borrowers 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

Recognized Lenders RecognizedLenders

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

Amount & Maturity 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

Restricted Areas RestrictedAreas

Investment in capital markets Working capital, general corporate purpose Repayment of existing rupee loans Lending purposes, acquisition of existing shares

Parking of Deposits 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

Prepayment Prepayment
Up to $ 5 m : Allowed with out RBI approval Minimum average maturity period is applicable for respective loan.

Refinancing of existing Refinancing of existing ECBECB

If fresh ECB is at lower cost Outstanding maturity of original ECB is not changed

Approval Route ApprovalRoute

Prescribed application from through AD to RBI RBI permission is required

Same as Automatic route Same as in Automatic Route

Recognized lenders & borrowers Parking of ECB Prepayment of ECB Refinancing of ECB

All-in-cost-ceilings 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

Security Security
Left to the borrower Creation of charge over immovable assets and financial securities in favor of lender is subject to regulation of FEMA

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

VARIABLE THAT EFFECT THE VALUE Maturity Redemption Features Credit Quality Interest Rate Price Yield Tax Status

MATURITY 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.

REDEMPTION FEATURES 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.

CREDIT RATING
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
Prime Excellent Upper Medium Lower Medium Speculative Very Speculative

Moody's
Aaa Aa A Baa Ba B, Caa

Standard and Poor's

AAA AA A BBB BB B, CCC, CC

Fitch
AAA AA A BBB BB B, CCC, CC, C

Default

Ca, C

DDD, DD, D

INTEREST RATES 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.

PRICE The amount you pay for the bond Newly issued bonds will pay close to their facevalue 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

YIELD 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.

INTEREST RATE - INFLATION 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.

CATEGORIES OF BONDS 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)

TYPES 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

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.

Regulations

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.

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 FCCBs 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

Indian Cos in Catch 22 Situation Increase in the Debt Equity Ratio Cos are cash strapped FCCB maturing period Starts at End of 2009, Peaks in 2011

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 Cos 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
Bond Amount
$100mn-march 2006

Bond Amount
$ 300mn- April 2004

Bond Amount
$ 100mn-April 2004

Conversion Price
Rs. 1001.39

Conversion Price
Rs. 780.40

Conversion Price
Rs. 573.10

Maturity Date
Feb 19, 2011

Maturity Date
March 28, 2009

Maturity Date
March 28, 2009

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 stocks 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