Nomura

Sector challenges driving the rise of Convertible Bond issuance

Companies and investors set to benefit from new issuance of convertible bonds as they provide flexible finance solutions to corporates and high returns to investors.

  • The convertible market has always been a good source of funding for growth stocks.
  • Given their higher upside potential, convertible bonds are generally more attractive to investors than traditional bonds.
  • 2020’s issuance has outstripped last year’s issuance levels with an 84% increase.

2020’s bond issuance (rather unsurprisingly) has centred around the most affected COVID sectors like travel, leisure and oil.

This however has presented both companies and investors with two opportunities:

This recent increase in issuance has brought some much-needed diversity to the convertible bond space. Especially in the US where technology and healthcare dominate.
It has also brought much needed yield payments to investors through the form of coupons paid on the bonds. Let’s take for example the US CB market where coupons were averaging 2.95% vs recent issuance where it has jumped to 10-13%, combined with the equity option, you can see why convertible bond investors are keen to take on future equity risk.
Convertibles are a bond with an imbedded equity option, and with equity volatility at high levels, the imbedded option within the convertible bond is inherently worth more.

This has meant that investors currently hold equity options worth much more, due to the ability of stocks to move into and out of the money more aggressively. Convertibles have the ability to reprice higher as equities move higher, but trade down less when equities trade down due to their bond element.

The more extreme the equity volatility, the greater the value due to the credit-equity correlation, and the convertible bond product’s tendency to reward balanced profiles with higher implied valuations.

Ultimately, the convertible bond asset class and recent issuance is providing additional embedded optionality from liability management exercises and offering generous change of control provisions.

Convertible Bonds Valuation Chart

As a result, the Convertible Bond Asset class is providing a large opportunity for investors globally across Japan, Asia Ex-Japan, EMEA and the US.

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