Top-rated US companies turn to convertible bonds as rising interest rates bite

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High-grade US companies are piling into the convertible bond market — typically the preserve of junk-rated issuers — as they try to minimise rising borrowing costs caused by the Federal Reserve’s aggressive campaign of interest rate rises.

Investment-grade borrowers have sold $12bn of convertible bonds so far this year, more than 30 per cent of total issuance, according to data from Bank of America — the highest share in at least a decade and three times the average rate. Highly rated companies sold just $2bn of so-called converts in 2022, or 7 per cent of the overall market.

“We’re seeing a lot of companies who would traditionally be straight debt issuers come to the convertible market,” said Jesse Mark, global head of equity capital markets at Jefferies.

Convertible bonds are a type of debt that can be swapped for equity if a company’s shares rise to a specific price. They allow companies to borrow at a cheaper rate than a traditional bond, without the immediate dilution that would come through selling new stock.

The market has traditionally been dominated by growth-focused companies that have optimistic long-term forecasts but want to minimise their short-term interest expenses. 

At the height of the equity market boom in 2021, companies such as Airbnb, Peloton and Beyond Meat were able to use convertibles to borrow at zero per cent interest. More than half of issuance that year came from the tech sector, according to data from Jefferies. 

However, with average yields for investment-grade bonds rising to almost 6 per cent, even companies in more staid industries such as utilities, real estate and industrials are turning to the convertible market to keep costs down, with tech accounting for less than a quarter of deals.  

“Investment-grade companies need to save on coupons as well,” said Michael Youngworth, convertible bond strategist at BofA Securities. “They’re obviously plagued by the same higher financing cost backdrop that high-yield companies are.”

Investment-grade companies that have tapped the convertible market in recent months include CenterPoint Energy, Corporate Office Properties Trust and infrastructure investment group HASI.

Youngworth said that companies saved an average of 2 to 3 percentage points on their interest rates by issuing a convertible compared with a traditional bond.  

Overall convertible issuance has picked up pace in the past few months as more companies approach refinancing deadlines and as rising stock prices reduce the risk for companies of diluting their existing shareholders at low conversion prices. 

Companies have raised $6.3bn so far in September, according to data from Dealogic, which together with a $7.9bn haul in August puts the asset class on course for its busiest two-month streak since 2021 in terms of both dollar volume and number of deals. 

About $2.3tn of corporate debt is set to mature each year between 2024 and 2026, according to data from S&P Global Ratings. Analysts and market participants predicted that the impending wave of maturing debt would encourage further growth in convertible volumes. 

Until recently, chief financial officers had “the luxury of time”, Youngworth said. But now, “companies are starting to need to refinance ahead of an upcoming maturity hurdle”, with many having to pre-fund their maturing debt 12 to 18 months in advance, he added.