US Companies Turn to Convertible Bonds to Navigate Interest Costs Amid Subdued Fundraising Landscape

In a notable trend, US companies are increasingly turning to the convertible bonds market as a strategic move to manage interest costs in an environment otherwise marked by subdued corporate fundraising. The data from LSEG reveals a substantial 77% surge in convertible debt issuance over the past year, reaching a total of $48 billion. This surge positions convertible bonds as one of the few segments within capital markets to return to pre-pandemic levels after the market downturn experienced in 2022.

Experts predict that this surge in convertible bonds is likely to persist throughout 2023 as companies navigate the challenge of refinancing a wave of maturing debt. While convertible bonds have traditionally been favored by younger technology and biotech firms, the current landscape witnesses more established companies entering this space, driven by the Federal Reserve's interest rate hikes, which have elevated borrowing costs even for investment-grade companies.

Bryan Goldstein, who advises companies on convertible deals at Matthews South, notes a shift in perception, stating, “Historically converts had sometimes been seen as one of those spivvier products that investment-grade names stayed away from. Now some big-name issuers have come to the market, that narrative has shifted — it is seen as an attractive product on its own merits.”

Convertible bonds offer borrowers a compelling proposition with lower interest rates compared to traditional bonds, all without the immediate dilution for shareholders that would result from selling new stock. Despite the total issuance in 2023 being lower than the record levels witnessed in 2020 and 2021, the figure of $48 billion significantly surpasses the average of $34 billion observed in the decade leading up to 2019.

This surge in convertible bonds stands in stark contrast to other segments of the financial markets, such as initial public offerings, follow-on share sales, high-yield debt, and leveraged loans, where activity remains well below pre-pandemic levels.

The potential savings for borrowers opting for convertible bonds are substantial. The average yield on conventional investment-grade bonds has risen from 2.5% at the start of 2022 to 5.2% today, while average junk bond yields have increased from 4.9% to approximately 7.8% during the same period. In contrast, companies like car-sharing giant Uber have issued convertibles with interest rates of less than 1%.

Michael Youngworth, convertible bond strategist at Bank of America, highlights that convertibles typically trim between 2.5 and 3 percentage points from the debt's interest rate, resulting in significant annual savings for deals similar to Uber's.

Recent weeks have seen various companies tapping into the convertible bond market, including utility giant PG&E and energy group Evergy. These moves were part of broader strategies, with both companies issuing convertibles to pay down existing non-convertible term loans.

The surge in convertible bonds is attributed, in part, to the looming maturity wall that companies are set to face. US investment-grade companies have a record $1.26 trillion of debt to refinance over the next five years, as indicated by an October report from rating agency Moody’s. Junk-rated companies also face a significant debt burden, with $1.87 trillion across both bonds and loans.

Ken Wallach, co-head of global capital markets at law firm Simpson Thacher, underscores the ongoing popularity of convertibles, stating, “Converts are going to stay popular because we have a massive maturity wall that’s about to hit.”

The proposed regulations are currently open for public consultation until January 22, allowing stakeholders to provide input and potentially influence the final form of these measures.

By fLEXI tEAM