DEFINITION of Irredeemable Convertible Unsecured Loan Stock - ICULS

An Irredeemable Convertible Unsecured Loan Stock (ICULS) is a type of security that can be used to purchase underlying common shares. It is similar to a warrant except that it is subject to the conversion ratio. In essence, an ICULS provides the benefits of a bond until it is converted to an equity.

BREAKING DOWN Irredeemable Convertible Unsecured Loan Stock - ICULS

To raise money for operations and project financing, governments and companies may issue debt or equity to investors. In some cases, a security that falls in between what is classified as debt and equity may be issued instead. These securities are formally known as hybrid securities. A type of hybrid security common in Malaysia is the Irredeemable Convertible Unsecured Loan Stock (ICULS).

An Irredeemable Convertible Unsecured Loan Stock (ICULS) is a hybrid security in that it has some qualities of debt and some characteristics of an equity warrant. As a debt instrument, ICULS pays a fixed interest coupon to the holder semi-annually or annually at a predetermined rate. Like equity warrants, ICULS can be converted into shares which can appreciate in value for the investor. In effect, investors enjoy periodic interest income until the ICULS is converted into equity from which the holders receive dividends declared. ICULS can be broken down into certain characteristics, including:

  • Loan Stock: This is a security issued by a company for a loan made to it by investors
  • Unsecured: The loan given to an ICULS issuer is not secured by collateral. In the event of default, there is no guarantee that holders of this security will be able to recover their principal investments and future coupon payments. Since they are unsecured, ICULS are ranked low on the hierarchy of claims and are subordinate to all other debt obligations of the company.
  • Convertible: The ICULS can be converted to equities at any time up to the expiration date. Some ICULS require a mandatory conversion on the maturity date. On this date, conversion is done automatically, regardless of whether the holder of the security surrenders them or not.
  • Irredeemable: This feature of an ICULS means that the security cannot be redeemed for cash, which means the requirement for a credit rating is exempted. This allows financially weak companies to gain access to new capital through the ICULS market.
  • Nominal Value: ICULS have a nominal value which is usually set at RM1.00 and are tradeable in board lots of RM1,000.00 nominal amounts.
  • Conversion Ratio: When issued, ICULS highlights the conversion ratio at which the securities can be converted into cash. For example, if the conversion ratio is 20:1, this means that 1 ICULS can be converted into 10 common shares.
  • Conversion Price: 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. If the current market price of the stock at the time of conversion is RM40, for 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 shares without having to pay any additional cost.

    When Irredeemable Convertible Unsecured Loan Stock are 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).