Capital Markets

Convertibles Still Attractive, Says S&P

Interest-rate considerations could prompt a rise in new issues.
Stephen TaubMarch 25, 2004

Low interest rates and tight spreads will enable issuers to capitalize on the attractive financing conditions in the convertible debt market this year, according to Standard & Poor’s.

Although no interest-rate hike is forecast for the remainder of 2004 either in the United States or Europe, expectations that interest rates have reached an inflexion point could prompt a rise in new issues, the rating agency added in a new survey.

S&P examined the last round of interest-rate hikes in the United States, which started in June 1999 and lasted until June 2000. Convertible bond issuance increased by 44 percent in the 12 months after the first interest-rate action, compared with the 12 prior months.

“In this round, even though broad equity indices globally have recorded visible gains since the start of 2003, the potential to capitalize on equity appreciation potential in specific sectors has certainly not yet been exhausted,” added Diane Vazza, head of Standard & Poor’s Global Fixed Income Research group.

One caveat: If stock prices resume their upward move, an increasing number of companies may choose to issue low-cost equity instead of debt.

In the year to date, the high-technology sector has been the most active issuer of new convertibles following a record performance in 2003.

Companies issuing convertibles are using this prolonged period of low interest rates to pay down existing debt, reduce overall leverage, refinance existing debt, rebuild reserves for potential acquisitions, or fund research and development, pointed out S&P.

Lower-rated borrowers — particularly at the BBB-minus rating level — are especially taking advantage of the favorable borrowing conditions.

On the demand side, net new flows into convertible securities mutual funds increased to $1.3 billion in December 2003 from $114 million in December 2002. In the first two months of 2004, net new flows into convertible funds were up 27 percent from the prior year.

Total 2003 convertible issuance reached near-record levels of $145.6 billion, slightly below 2001’s record total of $146.2 billion.

Convertibles gained market share in 2003, accounting for 7.9 percent of total new debt issuance compared with 5.5 percent the prior year. In 2004 to date, convertible issuance has surged to $20.1 billion in the period ended March 10 compared with $17.5 billion in the corresponding period a year earlier.