FCCBs, ECBs drag profits as rupee sheds nearly 22% in 2008

FCCBs, ECBs drag profits as rupee sheds nearly 22% in 2008

Mumbai: Indian firms with foreign liabilities—external commercial borrowings (ECBs) as well as foreign currency convertible bonds (FCCBs)—are facing translation losses averaging 12% of the profit before tax (PBT) reported in fiscal 2008, says Credit Suisse Securities (India) Pvt. Ltd.

Translation losses, which arise from currency fluctuations, have increased as the rupee fell sharply against the US dollar this year.

The rupee’s exchange value has declined nearly 22% in 2008, from a peak of 39.265 in January to 50.29 on 1 December. The currency, which closed at 47.665 on Wednesday, is down 17% year to date but is expected to strengthen further.

Firms such as Aban Offshore Ltd, Essar Oil Ltd, Asahi India Glass Ltd, Ispat Industries Ltd and Reliance Natural Resources Ltd, are facing the biggest translation losses as a percentage of their profits, Credit Suisse said in the report.

Also See Lost in translation (Graphic)

Foreign currency debt for India’s non-banking companies, which stood at Rs1.4 trillion in March, could now be at about Rs1.79 trillion based on a 25% depreciation in the value of the rupee, according to an estimate by Credit Suisse.

The resulting added liability of about Rs34,900 crore “represents about 12% of corporate India’s (minus banking companies) PBT for financial year 2008," Credit Suisse analysts Sanjay Mookim, Nilesh Jasani and Rajasa K. said in their 4 December report titled, ECB/FCCB Accounting.

Over the past three years, the telecom sector has raised the maximum number of FCCBs, followed by pharma, information technology, metals, construction and auto sectors.

Technology firm Subex Ltd tops the list of FCCB issuers whose stocks are trading way below the conversion price. Subex shares ended Wednesday at Rs35.10 on the Bombay Stock Exchange (BSE), nearly 95% below its conversion price of Rs656.

Stock prices of other firms such as Era Infra Engineering Ltd, Moser Baer Ltd and Bajaj Hindusthan Ltd are also trading 90% or more below their FCCB conversion prices.

Analysts fear the declining rupee could now compel companies to change their accounting methods. Many companies had booked translation gains in their profit and loss accounts in fiscal 2008, but may now seek to insulate their profits from translation losses.

According to Indian accounting norms, translation losses or gains can be booked straight to the carrying costs of fixed assets. As a result, “investors in companies with foreign debt should take a deeper look into balance sheets", Credit Suisse said.

Companies such as Reliance Communications Ltd (RCom) and Hindustan Construction Co. Ltd have already started booking translation losses.

Firms can also choose from other methods to account for FCCB redemption premiums. “On average, stock prices are 78% below FCCB conversion prices," the brokerage said.

Still, only a few companies, such as technology firm Geodesic Ltd, have amortized FCCB redemption through their profit and loss statements, as practised globally. Amortization relates to repaying a mortgage with regular payments that cover both principal and interest.

Instead, companies such as Tata Steel Ltd, Tata Motors Ltd, Sintex Industries Ltd, Firstsource Solutions Ltd and Mahindra and Mahindra Ltd are treating FCCB redemptions as a one-time write-off to securities premium on their balance sheets.

Other companies such as Suzlon Energy Ltd, GTL Infrastructure Ltd, Aurobindo Pharma Ltd, Bharat Forge Ltd, Educomp Solutions Ltd and Amtek Auto Ltd have accounted for FCCB redemptions as contingent liabilities, putting themselves at risk of a large one-time hit on earnings on redemption.

On 11 December, the Business Standard newspaper reported that RCom plans to buy back its FCCBs, which are trading at a lower price, through rupee resources. RCom had raised $1 billion through FCCBs, placing it among the largest FCCB issuer from India, but the bonds are trading at a 35% discount to the issue price.

The Reserve Bank of India (RBI), however, allows premature buy-backs of FCCBs only up to $50 million using rupees. RBI allows such buy-back only if there is a minimum discount of 25% on the book value of outstanding FCCBs.

As per the RBI data, FCCBs raised by Indian companies in the past three years total $15 billion.

“We believe RBI’s FCCB buyback policy is a welcome move but grossly inadequate," brokerage Reliance Money Ltd, part of the Reliance-Anil Dhirubhai Ambani Group, said in a 15 December report.

There is speculation that RBI could announce more support measures to companies that have outstanding FCCBs for buy-backs or to meet redemptions. This is because Indian commercial banks hold the credit risk for the bulk of the FCCBs issued by domestic companies.

Foreign banks that subscribed to these bonds pay a carry fee to foreign branches of Indian banks and pick equity on conversion of the bonds. But if the bonds do not convert, and if the Indian issuer defaults at the time of the loan maturity, the hit is on the Indian bank, which holds the credit risk.

Tata Motors also has close to $1 billion worth of outstanding FCCBs. Tata Steel has raised $875 million through FCCBs, or about 26% of its profits in fiscal 2008. Ranbaxy Laboratories Ltd has raised $440 million, while Jaiprakash Associates Ltd and Suzlon Energy Ltd have raised $400 million and $300 million each.

HDFC Ltd’s $500 million FCCBs are due to mature by August 2010, while Tata Chemicals Ltd has $150 million maturing in January 2010. Tata Power Ltd’s $200 million FCCBs will mature in February 2010.

Companies whose FCCBs or tranches mature in 2009 include Jindal Stainless Ltd, Wockhardt Ltd, Jubilant Organosys Ltd, Zee Entertainment Ltd and Tata Motors.

Graphics by Ahmed Raza Khan / Mint