U.S. firms increasingly turn to convertible bonds amid rising interest rates

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U.S. firms increasingly turn to convertible bonds amid rising interest rates
Credit: © Reuters.

In response to the Federal Reserve's aggressive interest rate hikes, top-tier U.S. companies are increasingly resorting to the convertible bond market to alleviate escalating borrowing costs. This year, investment-grade borrowers have issued $12 billion in convertible bonds, making up over a third of total issuance, according to Bank of America (NYSE: BAC )'s data. This marks the highest proportion in at least a decade and triples the average rate. In contrast, these highly-rated companies only issued $2 billion in such bonds in 2022, representing just 7% of the market.

Convertible bonds, which can be converted into equity when a company's share price hits a certain threshold, provide businesses an opportunity to secure funding at lower costs than traditional bonds without immediate dilution of their holdings through new stock sales. Historically, growth-oriented companies with positive long-term forecasts have dominated this market as a strategy to reduce short-term interest expenses.

Tech firms such as Airbnb, Peloton (NASDAQ: PTON ) and Beyond Meat (NASDAQ: BYND ) capitalized on the equity market surge in 2021 by using convertible bonds to borrow at zero per cent interest. Tech sector offerings made up over half of that year's total issuance. However, with average yields for investment-grade bonds nearing 6%, even entities in traditionally stable sectors like utilities, real estate and industrials are now turning to convertible bonds to maintain lower costs. Currently, tech-related deals represent less than a quarter of transactions.

In recent months, investment-grade companies including CenterPoint Energy (NYSE: CNP ), Corporate Office Properties (NYSE: CDP ) Trust and infrastructure investment group HASI have tapped into the convertible market. According to Michael Youngworth, BofA Securities' convertible bond strategist, these companies have managed to save between 2 to 3 percentage points on their interest rates compared to issuing conventional bonds.

Convertible bond issuance has picked up pace in recent months as more companies face refinancing deadlines and rising stock prices reduce the risk of diluting existing shareholders at low conversion prices. In September, firms raised $6.3 billion, following a $7.9 billion haul in August, setting the asset class on course for its busiest two-month period since 2021 in both dollar volume and number of deals.

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