Convertible bonds are experiencing a resurgence, with companies like Super Micro Computer recently issuing zero-interest bonds worth $1.7 billion by offering bonds that can convert into shares. This trend is fueled by investors adjusting to higher-than-expected interest rates from the Federal Reserve and a bullish stock market.
In the past month alone, eight US companies, including Global Payments, NextEra Energy, Lyft, and Sunrun, have collectively raised nearly $7 billion through convertible bonds, marking the busiest period for such securities in over two years.
To entice companies further, banks are offering services like insurance to mitigate the risk of share dilution when bonds convert into shares. While these services increase issuance costs, the savings on interest outweigh the expenses. On average, companies can save between 3% to 4% in interest costs compared to regular bonds.
David Clott, a portfolio manager at Wellesley Asset Management, predicts that companies will increasingly turn to convertible bonds to refinance upcoming maturities in the coming years, driving up issuance volumes.
Convertible bonds function similarly to regular bonds but also offer the option to convert into shares based on the company’s stock price. To address concerns about diluting existing shareholders, bankers offer products like net share settlement and capped calls to mitigate the impact.
Net share settlement allows companies to settle bonds converting to stock primarily in cash, while capped calls increase the share price at which bonds convert to stock. For instance, Global Payments’ recent bond offering included a capped call, raising the conversion premium from 20% to 75%.
Additionally, companies are using proceeds from convertible bond issuances to buy back their own stock, countering short bets placed by investors betting on stock price declines.
These strategies aim to signal to shareholders that companies are managing dilution risks appropriately while taking advantage of the benefits of convertible bonds.