ICULS (Irredeemable Convertible Unsecured Loan Stock) is a hybrid security that has been growing in popularity, with a market size of $38 billion from over 372 issuers in 43 countries. While similar to convertible bonds, ICULS has a linear payoff profile where the value decreases linearly as the underlying equity price decreases, unlike convertible bonds which have a call option-like profile. Understanding the differences between ICULS and convertible bonds is important for accurately valuing ICULS on financial statements and managing the greater downside risk potential of ICULS compared to convertible bonds.

1. June 10, 2015 Bloomberg Brief Corporate Treasury 1
ICULS GUEST COMMENTARY BY JUSTIN ONG, ERNST & YOUNG
What Treasurers Should Know About Managing Risks Arising From ICULS
The global convertible bond market is
estimated to be worth more than $500
billion. Within this segment, the
Irredeemable Convertible Unsecured
Loan Stock has been gaining in
popularity, growing at a rate of 56 percent
in the past five years. This security has
more than 372 issuers from 43 countries
across the world with an estimated
market size of $38 billion. Along with this
newfound enthusiasm for the ICULS
come misconceptions about the security.
Investors conflate ICULS with warrants
and convertible bonds — because of their
similarities — and companies perform
subsequent valuations of ICULS based
on this misunderstanding.
An ICULS is a hybrid instrument that
starts off as a bond and eventually
changes into equity. Investors enjoy
periodic interest income until the ICULS is
converted into equity from which the
holders receive dividends declared.
Similar to convertible bonds, ICULS
have periodic interest payments and the
right to purchase the underlying equity in
the future. The conversion of ICULS into
the underlying equity is mandatory upon
the maturity date, whereas the convertible
option of the convertible bond will be
exercised only under favorable market
conditions.
Chart 2 compares the payoff profile of
ICULS with a convertible bond with
similar terms. Both have three years to
maturity, an annual coupon of 10 percent,
par value of $1,000, conversion price of
$10 per share and conversion ratio of one
bond to 100 underlying equities. Where
the convertible bond payoff profile
resembles that of a call option, an ICULS
has a linear payoff profile. The values of
the two securities diverge when the equity
price is below $10. Unlike the convertible
bond, the value of the ICULS decreases
linearly as the underlying equity price
decreases from $10 to $2. Due to
mandatory conversion, the ICULS holder
must convert the security to stocks even if
it is unfavorable to do so.
An ICULS can be interpreted as a
hybrid instrument, consisting of a straight
bond and equity where its value can be
derived from the sum of the two
instruments. A complete understanding of
the ICULS enables market practitioners to
value ICULS appropriately, to minimize
the mispricing risk and to present more
accurate valuation in financial statements.
In addition, investors may better manage
risk arising from ICULS, which has a
greater downside risk potential compared
with a convertible bond.
Justin Ong is the lead of Ernst & Young
Quantitative Valuation practice in Malaysia.
The views reflected in this article are the views of
the author and do not necessarily reflect the views
of the global EY organization or its member firms.
ICULS Gaining Popularity in Recent Years
ICULS Has Linear Payoff Profile, Unlike Convertible Bonds