Market Analysis – 64111504 – Convertible stock

Executive Summary

The global market for new convertible stock issuance is experiencing a strong recovery, with an estimated $91 billion issued in 2023, rebounding sharply from a subdued 2022. The market's 3-year CAGR has been volatile at est. -8% due to a peak in 2021, but forward-looking projections are positive. The primary opportunity lies in leveraging the current "higher-for-longer" interest rate environment, which makes the lower coupon rates of convertibles highly attractive for corporate financing compared to traditional debt. The key threat remains macroeconomic uncertainty, which can dampen both issuer and investor appetite.

Market Size & Growth

The global Total Addressable Market (TAM) for new convertible stock issuance is estimated at $91 billion for the full year 2023, a significant increase from the $38 billion issued in 2022. Looking forward, the market is projected to grow at a CAGR of est. 5-7% over the next five years, driven by favorable interest rate differentials and corporations seeking flexible financing solutions. The three largest geographic markets for issuance are 1. United States, 2. EMEA (Europe, Middle East & Africa), and 3. Asia-Pacific, with the U.S. consistently accounting for over 50% of global volume.

[Source - BofA Global Research, Jan 2024]

Key Drivers & Constraints

1. Interest Rate Environment (Driver): Higher prevailing interest rates make the lower coupons on convertible instruments (typically 1-3% lower than straight debt) a compelling cost-of-capital advantage for issuers.
2. Equity Market Volatility (Driver): Moderate to high equity volatility increases the value of the embedded conversion option, making the instrument more attractive to investors seeking upside participation with downside protection. Extreme volatility, however, can be a constraint.
3. Corporate Financing Needs (Driver): Companies, particularly in the technology and healthcare sectors, use convertibles for growth capital, M&A financing, and refinancing existing debt without immediate equity dilution.
4. Regulatory Simplification (Driver): The adoption of FASB's Accounting Standards Update (ASU) 2020-06 in the U.S. simplified the complex accounting and earnings-per-share (EPS) calculations for convertibles, reducing administrative burdens and increasing their appeal to issuers.
5. Investor Appetite (Constraint): A significant "risk-off" sentiment in the market can reduce demand from the specialized hedge funds and outright investors that are the primary buyers of this asset class.
6. Underlying Stock Performance (Constraint): A sustained downturn in an issuer's stock price can lead to the instrument being "busted" (trading far out-of-the-money), effectively behaving like expensive debt and failing to achieve the goal of equity conversion.

Competitive Landscape

The underwriting of convertible securities is a highly concentrated market dominated by global bulge-bracket investment banks. Barriers to entry are high, requiring significant capital for underwriting commitments, extensive distribution networks, and deep regulatory expertise.

⮕ Tier 1 Leaders * J.P. Morgan: Consistent market leader with a dominant global platform and strong balance sheet for large-scale deals. * Goldman Sachs: Premier advisor, particularly strong in structuring complex convertible deals for the technology sector. * BofA Securities: Top-tier underwriter with a massive distribution network and strong presence in the U.S. market. * Morgan Stanley: A leading franchise with deep expertise in equity-linked products and strong relationships with institutional investors.

⮕ Emerging/Niche Players * Mizuho Financial Group: Expanding its U.S. presence and gaining share by offering competitive terms and balance sheet commitment. * BNP Paribas: A strong European player actively growing its equity-linked origination capabilities in North America. * Piper Sandler: Focuses on mid-market deals, offering specialized industry expertise in sectors like healthcare and financial services. * Jefferies: Known for its aggressive and agile approach, often leading deals for growth-oriented, non-investment-grade companies.

Pricing Mechanics

The pricing of a convertible security is a hybrid valuation, combining the characteristics of a straight bond and an equity call option. The primary component is the "bond floor," which represents the present value of its coupon and principal payments, providing a theoretical minimum value and downside protection. This value is determined by the issuer's credit spread over a benchmark risk-free rate (e.g., U.S. Treasuries).

The second component is the value of the embedded equity conversion option. This gives the holder the right to convert the security into a fixed number of common shares. Its value is calculated using option-pricing models (e.g., Black-Scholes) and is driven by the underlying stock price, strike price (conversion price), time to maturity, volatility, and interest rates. The final issuance price is a negotiation between the issuer and underwriters, balancing a low coupon (issuer benefit) with an attractive conversion premium (investor benefit).

The three most volatile elements influencing a convertible's value are: 1. Underlying Stock Price: Varies daily; a broad market proxy like the S&P 500 has a 1-year volatility of ~15%. 2. Implied Volatility (VIX Index): Has fluctuated between 12 and 20 over the past 12 months, a range of ~67%. 3. Benchmark Interest Rates (e.g., 5-Yr US Treasury): Yields have moved between 3.5% and 4.8% over the past year, a change of ~37%.

Recent Trends & Innovation

• Rise of "Green" Convertibles (2022-2024): A growing number of issuers are marketing convertible securities with a "use of proceeds" designation for ESG-related projects, tapping into a dedicated pool of sustainable investment capital.
• Accounting Simplification Drives Issuance (Jan 2022): The mandatory adoption of ASU 2020-06 for most public companies has removed major accounting headaches, directly contributing to the rebound in issuance volumes seen in 2023.
• Focus on Structured Deals (2023): In a choppy market, there has been an increase in structured convertible investments, such as private placements (PIPEs) and deals with call spread overlays, which allow issuers to effectively raise the conversion premium and reduce potential shareholder dilution.
• Tech and Healthcare Dominance (2023): The technology and healthcare sectors continue to be the most active issuers of convertible stock, accounting for est. >50% of total deal volume as they seek growth capital. [Source - S&P Global Market Intelligence, Dec 2023]

Supplier Landscape

Note: Market share for underwriting is highly variable year-to-year and deal-dependent.

Regional Focus: North Carolina (USA)

North Carolina, particularly the Charlotte metropolitan area, is a significant hub for financial services in the United States. Demand for convertible issuance from NC-based corporations is moderate, primarily from the region's growing technology, life sciences, and industrial sectors. Local capacity for underwriting and managing these transactions is High. Charlotte is the corporate headquarters of Bank of America and a major corporate and investment banking hub for Wells Fargo and Truist. This provides direct access to Tier 1 and regional underwriting desks, legal counsel, and administrative support, reducing the need to rely solely on New York-based teams. The state's favorable corporate tax environment and deep pool of financial talent further support local execution capabilities.

Risk Outlook

Actionable Sourcing Recommendations

1. Diversify Underwriter Panel & Mandate Competition. For any planned issuance, engage at least one Tier 1 leader and two Tier 2/Niche players in a competitive bidding process. This creates pricing tension on underwriting fees, which can range from 1.5% to 3.5% of proceeds. Targeting a fee at the lower end of this range through competition can yield significant savings, especially on deals over $250M.
2. Negotiate Call Spread Overlay Providers Separately. If using a call spread to increase the effective conversion premium, solicit bids for this derivative component separately from the lead underwriter. While the lead bank often prefers to execute the entire package, sourcing the overlay from a broader set of derivatives desks can reduce its cost by est. 5-15 basis points, directly improving the all-in cost of capital for the transaction.