Around one-fifth of India Inc’s estimated $7 billion foreign currency convertible bonds (FCCBs), due for redemption in 2012, have an extremely high likelihood of default while another 17 per cent of the FCCBs due this year is likely to be restructured (mostly through maturity extensions), according to a Fitch Ratings report.
Although this leaves 63 per cent or around two-thirds of FCCBs with high likelihood of redemption, it still sets an alarmist tone for Indian companies who issued equity convertible bonds in the past.
Fitch studied 59 companies whose FCCBs are due in 2012. The companies were divided into four broad groups with respect to FCCB redemption possibilities — likely to redeem, likely to restructure, likely to restructure with significant distressed debt exchange features and default/imminent default with low recovery.
Of the 31 corporate houses in the ‘likely to redeem’ category, five are better-placed to redeem their FCCBs using a financing option of their choice. While the remaining 26 companies have a relatively weaker financial profile, they would still be able to access low-cost ECB funding or even high-cost domestic debt. At least some of these 26 companies would exhibit deterioration in their interest coverage due to their somewhat limited access to funding options, compared with the other five companies, according to the rating agency.
The nine companies in the ‘likely to restructure’ group which, despite having a reasonable business model, are currently experiencing stretched liquidity and stressed cash flows. The ultimate FCCB payment is likely to be driven by the sale of identifiable, non-encumbered assets. Such FCCBs have a high likelihood of undergoing restructuring involving a maturity extension but are unlikely to have significant distressed debt exchange features, says Fitch.
The remaining 19 companies have a high likelihood of default on their FCCB payments or restructuring the FCCBs with significant distressed debt features. 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. In the event of default on FCCB payment, the recovery may be low given their unsecured nature, said the report.
Some of the FCCB investors have purchased credit protection measures, like credit-linked notes and credit default swaps, from various institutions, including the overseas branches of Indian banks. This may provide a motivation to some banks to provide ECB loans to some companies to refinance the FCCBs. In such an event, the redemption rate is likely to improve from the current estimated level of 63 per cent.