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The US convertible bond (CB) market appears to be piquing the interest of investors and offering a new source of funding for the US companies, capital markets sources told dealReporter.
There appears to be some level of stability in the market now compared to 2008, said Martin Haycock, Executive Director of Convertible Bond Marketing at UBS.
The opening up of the CB market offers companies the opportunity to diversify their capital bases, particularly for BBB companies that are finding the costs of the debt markets prohibitive.
With traditional debt and equity markets being selective, the convertible market continues to be a source of capital for companies across all sectors that are either in growth mode or need balance sheet restructuring, according to Venu Krishna, Head of Equity Linked Securities at Barclays.
Issuance by investment grade companies confirms the latter, and Haycock noted that companies currently enquiring about a capital raise to refinance maturing debt or raise capital are increasingly looking at the convertible bond space.
There have been few investment grade issuances in the US CB space this year.
Alcoa (NYSE: AA, BBB-/Baa3), Newell Rubbermaid (NYSE: NWL, BBB-/Baa3), Autoliv (NYSE: ALIV, BBB-), Johnson Controls (NYSE: JCI, BBB/Baa2), and Newmont Mining (NYSE: NEM, BBB+) were among the companies that raised around USD 2.7bn in the US.
In the I-grade space, which is expected to dominate convertible issuance this year, coupons and conversion premium varied from 3% -11.5% and 15%-30%, respectively.
Newell’s issuance this week closed with a coupon of 5.5% and conversion premium of 30%. Earlier this month, Alcoa issued its convertible with a coupon of 5.25% and a conversion premium of 22.5% while Johnson Controls mandatory convertible closed with a coupon of 11.5% and 30% conversion premium.
Both Alcoa and Newell’s issues closed higher -- Newell at USD 345m from a planned USD 250m and Alcoa from an initial amount of USD 250m to USD 500m.
According to this news service, BorgWarner (NYSE: BWA, BBB/Ba1) and Sunoco (NYSE: SUN, BBB/Baa2) are currently considering issuing convertible notes to refinance upcoming maturities. BWA, as reported yesterday, is considering up to USD 300m in mixed equity and convertible notes offering as renegotiation with its lenders could lead to the USD 600m credit facility being cut in half.
Haycock further noted that the current pricing being offered on convertible notes are relatively cheap. A convertible bond trader added the volatility in the equity markets, as well as attractive coupons offered on the notes, compared to straight debt have been primary drivers for recent issuance.
Average coupons are higher compared to 2008 while average conversion premiums are lower, making convertibles a more desirable asset class to certain investors, according to the trader.
Looking ahead, Krishna estimates that the convertible bond market has capacity to absorb at least USD 38bn of issuance in 2009. If you factor in the USD 8bn of buyback of convertibles by issuers and non-traditional buyers - including fixed income managers and value equity investors - coming into this space, the capacity could go up to USD 60bn, he added.
Last year the Barclay’s convert index was down around 36% driven sharply by falling equities, widening of credit spreads, a collapse in financial issuance of preferreds/mandatory convertibles, regulations related to the short sale rule, and redemptions at convertible arbitrage funds, according to a Barclay’s report.
Ashish Shah, Head of US Credit Strategy at Barclays Capital, said during a press briefing at the bank’s New York-headquarters on Wednesday that companies with a credit rating on the lower end of BBB are choosing equity dilution over paying corporate debt coupons of 10-12%. He said these companies are opting to combine convertible notes with some equity upside.
Lower rated or troubled names/sectors view converts as a more viable option in the near term as it lowers their near-term cost of financing, while feeling a lot like debt. If the company does well, it can end up being a very expensive source of financing, but at that point it is considered a ”good” problem to have, noted a capital markets source.
Year to date, and as of 26 March 2009, the US Convert Market as defined by the Barclays Capital Composite Convertible Index is up 4.75% while their US HY Index is up 5.98% and the US Credit Index is down 2.08%. In comparison, the DJIA is down 8.85% and the S&P 500 down 7.13%.
Unless there are major negative macro economic events such as continued economic weakness, or credit quality weakening, the market remains open to issuers according to all sources.
“Anyone who needs capital should look at convertibles as it is very competitive compared to debt and equity markets,” Krishna stated.
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