De-Jargoned | Foreign currency convertible bonds

De-Jargoned | Foreign currency convertible bonds

What is an FCCB and how it works

A foreign currency convertible bond (FCCB) is a type of convertible bond issued by Indian companies in a currency different from the rupee. Thus, a company raises capital in foreign currency through FCCBs. Several FCCB commitments are set to mature in the near future.

The instrument is a mix between equity and debt. Investors holding this security receive regular coupon payments, which gives it a debt flavour, and at maturity or any other specified time investors have the option to convert these bonds into equity shares. The price for conversion is typically predetermined at the time of issuance of the FCCB. These kinds of securities are usually issued when equity markets are doing well, but there is no way to be sure that markets will be in a similar state at maturity.

How is it relevant for you

While it seems a bit complicated and as retail investors you may not really be interested, you should be aware that the conversion option chosen by the holder of the FCCB can have a material impact on the balance sheet of a company and thereby its share price. While you are unlikely to be an FCCB holder, as a retail investor it helps to know what the impact will be on the company issuing the FCCB.

What happens when FCCBS are converted to equity

This usually happens when the current market price is higher than the conversion price of an FCCB. So the holder converts at a low price and sells the shares in the market at a higher price, pocketing a profit. When FCCBs get converted into equity shares, they add to the existing shareholder capital of the company, increasing its equity base. This results in diluting the earnings or profits for existing shareholders. However, it may not have a material impact on the share price since the possibility of diluted earnings is usually factored in.

What happens when fccbs remain as debt

If the holder chooses not to convert the bonds into equity, the issuing company can either redeem the bonds at the end of the tenor or extend the tenor and keep the bonds as debt on the balance sheet. In case the latter happens, the liabilities side of the balance sheet will show additional debt. This will also increase the debt-equity ratio of the company. A higher ratio indicates high debt, which can result in earnings fluctuation on account of interest expense. Currency changes between the currency of issue and the rupee can also impact the value of such debt. The interest rate applicable on an extended term would most likely be renegotiated at current rates. This kind of development in turn can have an adverse impact on the share price.

So if you have bought stocks of any company that has issued FCCBs, keep track of the development at maturity and reassess the fundamentals of the company.