Irredeemable Convertible Unsecured Loan Stock - ICULS

What Is an Irredeemable Convertible Unsecured Loan Stock (ICULS)?

An irredeemable convertible unsecured loan stock (ICULS) is a hybrid security that has some qualities of a debt instrument and some characteristics of an equity warrant. Like a bond, an ICULS pays a fixed interest coupon to the holder semi-annually or annually at a predetermined rate. Like a warrant or a convertible bond, an ICULS can be converted into common shares of stock, which can appreciate in value for the investor.

ICULs are issued by governments or companies seeking to finance existing operations or new projects. They are especially common in Malaysia, where young or financially weak companies use them to gain access to new capital.

Understanding an Irredeemable Convertible Unsecured Loan Stock

ICULS's are called "loan stocks" because investors are essentially loaning funds to the issuer. In return, investors enjoy periodic interest income until the ICULS is converted into equity from which the holders receive dividends declared.

The ICULS can be converted to equities at any time up to the expiration date. Some ICULS's require a mandatory conversion when they mature. On this date, the conversion is done automatically, regardless of whether the holder of the security surrenders them or not.

Upon issuance, the ICULS specifies the conversion ratio at which its underlying loan can be converted into stock (one of its distinctions from a conventional warrant). For example, if the conversion ratio is 20:1, this means that one ICULS can be converted into 10 common shares.

The conversion price is the price at which ICULS can be converted into common shares, and it is determined by the conversion ratio. If an ICULS is trading for a nominal value of RM1,000 with a conversion ratio of 20, then the conversion price is RM1,000/20 = RM50. The holder has no choice but to receive the 10 underlying stocks even if the current market price of the stock is less than RM50.

Pros and Cons of Irredeemable Convertible Unsecured Loan Stock

If the current market price of the stock at the time of conversion is less than the conversion price (RM40, say, using the above example), the ICULS is said to be out of the money. In this case, the holder of the security will be required to pay the difference between the conversion price and the stock price in order to receive the underlying shares. On the other hand, if the stock price is higher than the conversion price, the ICULS is in the money, and the holder receives the stipulated number of shares without having to pay any additional cost.

Special Considerations for Irredeemable Convertible Unsecured Loan Stock

The loan given to an ICULS issuer is not secured by collateral. In the event of default, there is no guarantee that holders will be able to recover their principal investments and future coupon payments. In addition, ICULS cannot be redeemed for cash (hence the "irredeemable" in their name) — a key way in which they differ from conventional convertible bonds. Since they are unsecured and can't be cashed in, ICULS are ranked low on the hierarchy of claims and are subordinate to all other debt obligations of the company.

When irredeemable convertible unsecured loan stock is converted, new shares are issued. When new shares are issued, this results in full dilution for existing shareholders in the company as the total number of shares outstanding increases, leading to a decrease in earnings per share (EPS).