Issuance of US convertible bonds — debt securities with an option to be converted into stock — has jumped this year as companies refinance their existing convertible notes and take advantage of the securities to lower borrowing costs, according to Goldman Sachs Global Banking & Markets.
US companies have issued more than $40 billion of convertibles across 63 deals, based on data from Dealogic. That’s up from $29 billion and 54 transactions in all of 2022. Convertible issuance surged at the start of the decade due to Covid-related financings, and many of those transactions now require refinancing, says Michael Voris, Goldman Sachs Global Banking & Markets’ global head of convertible bond financing, and Jan Debeuckelaer, head of US convertible bond financing.
At the same time, the Federal Reserve has ratcheted up interest rates, which is prompting executives to look for ways to reduce interest expense. Convertible notes lower a company’s cash borrowing costs compared to non-convertible bonds by giving investors exposure to the company’s equity in the future. Voris expects issuance to rise in 2024.
Fast-growing technology companies have been a mainstay of the convertible bond market, but Voris and Debeuckelaer say the rise in interest rates has attracted issuers from a wider range of industries and credit ratings. We spoke with Voris and Debeuckelaer about the types of companies that are looking to tap the convertible bond market and their outlook for the market.
How does convertible bond issuance compare to last year?
Jan Debeuckelaer: This has been a year of higher volume and larger deals.
A few weeks ago we had $5 billion of issuance in one week. That was about a fifth of the market last year in just a few days, making it one of the busiest stretches we've had since mid-2021 when the markets were in a much different place. There has certainly been a big uptick in the number of deals coming to market.
What's driving that issuance?
Jan Debeuckelaer: To start with, there’s been significant refinancing. 2022 was an odd year when there was a pause in the market broadly. People were unsure where we were heading from a rate perspective, and as we entered this year issuers became a little bit more comfortable with the new rate environment. They started to look forward and say, ‘OK, now I need to examine my balance sheet and evaluate different products.’
So we've seen new types of issuers come to our market, particularly investment-grade utilities. These companies issued convertibles to manage interest-rate exposure, reduce their floating-rate debt across term loans and commercial paper, and take advantage of a lower headline coupon.
On top of that, we had our traditional convertible issuers in the tech space that have used our product for the last cycle and are now refinancing existing convertibles to push out their maturity profile.
Michael Voris: Thematically, those last two pieces continue to be very important across the capital markets. The quantum of convertibles issued in 2020 and 2021 was extraordinary — in the neighborhood of $100 billion. But that paper largely matures in 2025 and 2026. While we've seen a material uptick in refinancing-related transactions, there's a lot more to come as we move into 2024 and 2025.
And the overlay, as Jan noted, is very different than what we've seen since the mid-2000s. We're now in a higher interest rate environment — very high short-term rates, elevated long-term rates relative to recent history — and with that comes an opportunity for convertibles from less traditional issuers. As Jan pointed out, the utility names are kind of the tip of the spear. They're constantly in a capital raising cycle, sometimes raising equity, always refinancing debt, but now with interest rates higher they’ve started issuing convertibles.
We’ve talked about this from the issuer side. What’s the perspective from investors?
Michael Voris: They welcome all the paper, and pricing dynamics have improved. Last year they were digesting the volume of issuance in 2020 and 2021 and, of course, the broader sell-off in the equity market. While more supply is good for convertibles investors, a strong equity market has been the historical driver of outperformance. When we think about types of investors, half of our market is long-only related. So they do better when the equity market is going up.
Investors also perform better when they have real coupons attached to convertibles. And in most of 2020 and 2021, coupons that we were achieving from a pricing perspective were 0%, or very close to 0%. If you're in a bear equity market that's not going up and to the right, and you're not getting any income, those types of convertibles become a hard position to hold.
We're now in an environment where the equity market is more stable and coupons are higher due to the moves in interest rates — coupons are actually similar to levels last seen in the early- to mid-2000s. So investors are getting real coupons, and they have the ability to participate in future equity upside.
We’ve talked about utilities companies and growth companies issuing convertible debt. What other sectors are active here?
Jan Debeuckelaer: BB rated, or higher quality non-investment grade issuers, were able to finance themselves at very attractive rates in the high-yield market last cycle. But they’re now looking at close to double-digit coupons for that product and are starting to look at convertibles with more focus. This trend includes industrial companies as well as some of the new energy or energy-transition-type companies.
The investment-grade wave is not just in utilities — it’s been broad based, including REITs and crossover-tech issuers. Semiconductor companies have also been a bigger part of our market this year. In general, what we're seeing is a transition from convertibles as just for growth companies to a product that is more suitable for traditional business models, as well.
What's your outlook for the convertible market for the rest of 2023 and looking out to next year?
Michael Voris: Since the start of 2020, the convertible market has definitely been the most resilient. Convertibles historically have been a market that stays open the longest, closes the latest, and reopens the fastest. These dynamics were very much in play in the period at the start of Covid relative to other financing markets.
When we think about the opportunities in the convertible market in 2024 and 2025, a big portion of activity is going to come from refinancing existing convertibles. It’s also buoyed by the fact that issuers of straight debt have to refinance a lot of paper at materially higher interest rates, which opens the aperture of potential targets for convertible issuance, as well.
We expect an increase in activity levels for 2024 and certainly 2025 just based on refinancing alone. But that's not always a huge portion of our market. There are a lot of companies that went public in 2020 and 2021 that haven't raised incremental capital yet. Those are all targets if the IPO market continues on its path. I know we just have a few data points to speak about, but those naturally become targets for convertible financing as well. And that's before we even factor in acquisition-related financing where there's a very defined use of proceeds.
So overall, I think we're in the early innings of a wave of convertible activity with refinancing leading the charge. But there's going to be more than that, and we expect to see issuance rise next year.
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