Outlook 2024: Refinancings to drive convertible bond issuance higher

By Abigail W. Adams

Portland, Me., Dec. 29 – The convertibles primary market saw a substantial uptick in issuance in 2023 with new deal volume rising more than 73% from the historic lull the previous year.

Refinancings were the name of the trade with the profile of the convertibles universe dramatically shifting as high-grade utility companies stampeded to the market.

While the primary market saw a profound increase year over year, some were surprised the market was not more active given the rate environment.

The net contraction of the convertibles universe continued in 2023 with redemptions outstripping supply.

However, the market is poised to reverse course and expand in the coming year with new deal volume expected to increase as refinancing needs become more paramount.

The steady stream of high-yield and investment-grade issuers that tapped the market in 2023 is expected to gain force in the coming year with the convertibles market a standout for cheap financing in a high-rate environment.

The pricing that issuers will command in the market will largely depend on their profile with low coupons within reach for strong credits with high vol.

However, investors will remain wary of the highly speculative companies that flooded the market during the Covid-era who are expected to struggle to refinance the fast-approaching maturities of their low to no coupon convertible debt.

With some credits priced out of the market, sources expect to see an uptick in privately negotiated exchanges or other creative financing structures from convertible issuers addressing their distressed debt.

A high-grade year

The convertibles primary market saw a substantial uptick in new deal activity over the past year, which was widely expected after the primary market logged one of the lowest volume years for issuance on record in 2022.

The primary market saw $53.58 billion price over 84 deals as of Dec. 15, according to the Prospect News database. It marked a 73% increase from the 62 deals totaling $30.92 billion that priced in 2022.

Refinancings and redemptions were the driving force of new deal activity in 2023, accounting for about 50% of the total deals to clear the market.

And cross-over issuers were a driving force of the refinancing activity.

Sources had widely expected to see an uptick in issuance from high-yield and investment-grade credits with the convertibles market a cheap financing alternative as rates sat at multi-decade highs.

However, the stampede of issuance from investment-grade utility companies was a surprise.

PPL Capital Funding Inc., a subsidiary of PPL Corp., was the first high-grade name to tap the market in 2023 with its $1 billion offering of 2.875% exchangeable notes due 2028 (Baa1/BBB+) that priced on Feb. 21.

Then came Southern Co.’s $1.725 billion offering of 3.875% convertible notes due 2025 (Baa2/BBB) on Feb. 23, Alliant Energy Corp.’s $575 million offering of 3.875% convertible notes due 2026 (BBB+) on Feb. 27 and Duke Energy Corp.’s $1.725 billion issue of 4.125% convertible notes due 2026 on April 3.

In rapid fire succession, high-grade names flooded the convertibles market in 2023 and dramatically altered the profile of the universe.

High-grade names accounted for 25% of total issuance in 2023, compared to 1.3% of issuance in 2021 and 6% of issuance in 2022, according to the Barclays report “U.S. Convertibles Outlook 2024: Steady sailing amidst macro tides.”

The majority of high-grade issuance was from utility companies. “It’s like they all had the same playbook,” a source said.

There were several factors that supported the surge in high-grade names tapping the market.

While high-grade utility companies have traditionally issued mandatories or tangible equity units, the higher rate required of those offerings made them less than attractive than a convertible bond, said Michael Youngworth, BofA analyst and author of the report “Global Convertibles Year Ahead 2024: Rates are a double-edged sword.”

There was also an element of group think. “When one company in a sector gets a deal done on favorable terms, it’s not unsurprising to see others hop on the bandwagon,” Youngworth said.

The market had also expected to see an influx of high-yield issuers tapping the convertibles market to refinance their straight debt.

And while there was a smattering of activity from high-yield credits, it was not the volume anticipated.

The road between the high-yield market and the convertibles market was also not a one-way street.

Serial convertible bond issuer RingCentral Inc. priced its first junk bond offering, a $400 million issue of 8½% senior notes due 2030 (B1/BB/BB), to repurchase its 0% convertible notes due 2025 and 0% convertible notes due 2026.

While a strong year for issuance, the volume still fell short of many sources’ expectations given the rate environment. “The market should be busy,” a source said. “I wouldn’t call this busy.”

Potential issuers were still experiencing some overhang from the destruction in their stock prices in 2022 with small cap stocks continuing to underperform in 2023.

While the Nasdaq Composite saw gains of 40% as of Dec. 11, the Russell 2000 index, which most closely tracks the convertibles market, was up 9%.

No issuer wants to price a convertible bond when their equity is weak, a source said.

And while the convertible bond market offered a cheap financing alternative, the refinancing needs of companies were not stark in 2023.

Some may have expected a massive year for issuance based on financing costs, “but the need was not there,” Youngworth said. “Refinancing needs were relatively low.”

While the convertibles primary market delivered a 73% increase in issuance, the convertibles market saw its second year of net contraction with net supply down $19 billion in 2023 due to a substantial amount of redemptions, according to the Barclays report.

However, that is expected to change in the coming year with the market set to expand.

Refinancings will drive issuance higher in the coming year as companies have no choice but to refinance their debt.

Expansion on horizon

The convertibles market saw a substantial uptick in issuance year over year, and that pace is set to accelerate in 2024 as refinancing needs become more paramount.

Sources do not expect issuance to match the explosive growth of the pandemic era when $112.65 billion priced over 202 deals in 2020 and $93.20 billion priced over 170 deals in 2021.

However, with $2.4 trillion in non-financial debt and loans and $180 billion in convertible debt maturing over the next three years, refinancing needs are substantial.

And with rates still high, the convertibles market is well poised to capture a chunk of it.

“There’s a lot of interest in convertibles that is driven by the rate environment,” said Syed Raj Imteaz, head of ICR Capital LLC’s Convertible and Equity Derivatives Advisory team. “Headline terms are very attractive compared to other financing alternatives.”

BofA is projecting domestic issuance of $60 billion to $65 billion in 2024.

While Barclays does not project issuance, the market has the capacity to absorb $60 billion to $80 billion in new supply, according to the report.

With redemptions expected to be $40 billion to $45 billion in 2024, the domestic convertible market is looking at an expansion of about 9%, according to the BofA report.

While the dramatic rate move into the final weeks of the year may alter the forecasts, the convertibles market is expecting continued crossovers from the high-yield and investment-grade markets as companies work to refinance their straight debt.

With an uptick in issuers, the profile of the convertibles market will continue to shift.

“There will be a lot of newcomers in the market, which is great for our business,” Imteaz said. “Diversification is good for convert portfolios.”

More mature and higher-quality companies are expected to be on tap in 2024 with BofA’s Youngworth pegging several BB and BBB credits with debt maturing in 2025 as strong crossover candidates. Oracle Corp., Charter Communications and Comcast Corp. are among them.

The convertibles market will remain a standout amid high rates with crossover issuers and refinancing driving new deal volume.

However, the pricing that companies will command in the convertibles market will largely depend on their credit profile.

Credit specific pricing

The convertibles market saw a dramatic shift in pricing in the past two years with deals more optically attractive than the low to no coupons and high premiums of the pandemic era.

Of the deals to price in 2023, only seven were able to price with coupons below 1% and with premiums of 40% or higher, according to data compiled by Prospect News.

The highest percentage of deals to price in 2023 came with coupons on a 3-handle and with premiums in the 20% to 30% range.

While market players cheered on the more optically attractive terms, pricing moved in favor of the issuer.

The average cheapness of deals was 0.2% in 2023 compared with 0.82% in 2022 and 0.91% between 2018 to 2022, according to the Barclays report. BofA concurred.

“The discounts embedded in CB new deals have been fading despite the better pricing terms – a function of both the improved macro picture versus 2022 ... and negative net-new supply,” according to the BofA report.

The pricing terms sources can expect in the coming year will largely be dependent on the issuer.

While strong credits, the investment-grade convertible notes to price in 2023 carried relatively chunky yields, a product of the low vol. and large dividend on the company’s stock.

While low to no coupons will not be easily accessible, they are also not out of reach for strong credits with a high vol. stock.

“Pricing will be based on the company and their specific characteristics,” Imteaz said.

The refinancing needs of “busted” convertible notes that priced at the height of the pandemic and collapsed in 2022 will be large in coming years.

There is $4 billion of busted convertible notes net to retire in 2025 and $15 billion set to retire in 2026, according to the BofA report.

However, investors will remain wary of risky credits in the year ahead with some busted names priced out of the market.

As convertible issuers attempt to address their distressed convertible debt, sources expect to see an uptick in privately negotiated exchanges, buybacks, and other unique financing structures.

The lower quality credits that flocked to the market during the pandemic era will need to get creative to address their looming maturities, a source said.

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