Essar defaults on FRN repayment

Financial institutions, which rejected the company’s refinancing proposal, had asked the company to extend the maturity of the FRNs for another five years. In such an event, the company,which had contracted the FRNs at a coupon rate of 260 basis points above Libor, may have to renegotiate the coupon on the extended paper and settle for a higher rate.

Essar Steel, the flag ship of the Essar group, termed the default as “a delay in payment to bond holders” and added that though avoidable it “is not an unprecedented situation”. The company justified its stand stating that there have been several instances of South Asian companies, forced by harsh economic circumstances delaying repayment of loans to international investors. The total debt of the company is Rs 4,400 crore from domestic financial institutions, banks and external commercial borrowings.

Essar Steel had raised $ 250 million from the international market in the form of FRNs for a period of five years in 1994. FRNs are bonds with variable interest rates and Essar Steel opted for this route to take advantage of the low interest rates. Essar was India’s first private sector company to issue FRNs in the international capitalmarket. The tenure of the FRN was five years as per the guidelines of the Ministry of Finance, which stipulated maximum borrowing period of five years. The proceeds of the FRN were used for the construction of the steel plant at Hazira.

“The company was well aware that repayment of the FRNs in 1999 could not be done from the surpluses generated from the operations. This was acknowledged by IDBI (the lead financial institution who have carried out project appraisal for the company) in their appraisal suggesting that on due date in 1999, the notes would need to be refinanced. Normally, debt raised for large capital intensive projects like steel industry are repaid over 12-15 years. However, due to the non-availability of long term international funds as well as Indian government regulatory restrictions at that time, the company had to raise funds for a five-year maturity period only,” Essar said.

In April 1998, Essar Steel had almost closed a $ 400 million foreign currency borrowing programme to meet theFRN redemption requirement. But this was shelved following the international sanctions in the aftermath of the nuclear tests by the Government of India. “The only way to avoid a default was by approaching domestic institutions for refinancing the FRN,” Essar clarified.

The company has now projected a rosy outlook. “With the improving economic conditions and rising steel prices, the outlook for steel industry and Essar Steel appears better. The global steel industry is cyclical in nature with regular ups and downs in demand. In fact the viability and long term profitability of steel plants is calculated over a 20-year period. The global steel industry went through one of the toughest period in the last three years. World steel prices, which were in the region of $ 400 per cent tonnes when Essar Steel’s project was being implemented, nose-dived to a 20-year low of $ 180 by 1998,” it said.

Essar said steel prices are back on northerly course, having improved by $ 50 a tonne to $ 240. “According to PeterMarcus, the world-renowned authority on the steel industry, the steel prices are expected to touch a mind boggling $ 450 per tonne by year 2000. This would improve the cash flows of a low cost producer like, Essar Steel, tremendously,” it said.