Market Analysis – 64111505 – Convertible preferred stock

Executive Summary

The global market for new issuances of convertible securities, including preferred stock, is a significant channel for corporate financing, with an estimated $85 billion in new issuances in 2023. While the market has seen volatility, the projected 3-year CAGR is a modest 2-3%, driven by a normalization of interest rates and continued demand for growth capital. The primary opportunity for our firm lies in leveraging increased competition among underwriters and favorable market windows to secure flexible, lower-cost capital compared to straight debt or equity. The most significant threat is market volatility, which can rapidly close issuance windows and adversely impact achievable terms.

Market Size & Growth

The global Total Addressable Market (TAM) for new convertible security issuance is highly cyclical, influenced by macroeconomic conditions. After a peak in 2021, the market has normalized. Projections indicate a return to steady, albeit slower, growth over the next five years as companies refinance existing debt and fund strategic initiatives. The three largest geographic markets for issuance are 1. North America, 2. Asia-Pacific (APAC), and 3. EMEA, with North America consistently accounting for over half of the global volume, driven by the tech and healthcare sectors.

[Source - S&P Global Market Intelligence, est. Q1 2024]

Key Drivers & Constraints

1. Interest Rate Environment (Driver/Constraint): In a lower-rate environment, the low coupon on convertibles is attractive to issuers. As rates rise, the relative cost advantage over straight debt diminishes. However, high rates can also make equity financing more dilutive, keeping convertibles a viable "hybrid" option.
2. Equity Market Volatility (Driver): Higher stock volatility increases the value of the embedded conversion option. This allows issuers to offer a lower coupon, making the instrument cheaper. For investors, volatility provides a greater potential for upside, increasing demand.
3. Demand for Growth Capital (Driver): Technology, biotechnology, and other high-growth sectors are primary issuers. They use convertible structures to raise significant capital with less immediate dilution than a common stock offering and fewer covenants than traditional debt.
4. Regulatory & Accounting Changes (Driver): The adoption of ASU 2020-06 in the U.S. simplified the complex accounting for convertible instruments. This has removed a significant barrier for potential issuers, making the instrument more appealing from an administrative and financial reporting standpoint.
5. Investor Appetite (Constraint): The dedicated investor base for convertibles is sophisticated but finite. A flood of new issuances or a "risk-off" shift in market sentiment can saturate demand, leading to less favorable terms for issuers.

Competitive Landscape

The "suppliers" in this market are the investment banks that underwrite, structure, and distribute these securities. Barriers to entry are exceptionally high, requiring significant regulatory licensing, a strong balance sheet, and deep relationships with institutional investors.

⮕ Tier 1 Leaders * J.P. Morgan: Dominant market share with a vast global distribution network and a strong balance sheet for bought deals. * Goldman Sachs: Premier brand and structuring expertise, particularly for complex transactions and large-cap issuers. * BofA Securities: Top-tier player with a strong presence across all capital markets products and a large U.S. footprint. * Morgan Stanley: Leading advisor to the technology sector, a key source of convertible issuance, with strong equity-linked structuring capabilities.

⮕ Emerging/Niche Players * Jefferies: Strong middle-market focus and growing presence in healthcare and technology verticals. * Mizuho Financial Group: Expanding its U.S. capital markets presence, offering competitive terms to win market share. * Piper Sandler: Deep expertise in specific sectors like healthcare, offering specialized research and investor access. * Latham & Watkins / Skadden, Arps (Legal Advisors): While not underwriters, these top-tier law firms are critical partners in structuring and executing deals, and their expertise is a key selection factor.

Pricing Mechanics

The "price" of a convertible preferred stock is not a single figure but the combination of terms an issuer can achieve. The pricing is determined through a book-building process led by underwriters, balancing issuer and investor objectives. The core components are the coupon (annual dividend payment), the conversion premium (the percentage above the current stock price at which shares can be converted), and call/put provisions. These terms are modeled using option-pricing theory (e.g., Black-Scholes models) to determine the instrument's theoretical value.

The final terms are highly sensitive to market conditions at the time of issuance. The three most volatile elements impacting the "cost of capital" are: 1. Underlying Stock Volatility: A key input in pricing the conversion option. A 5% increase in implied volatility can potentially lower the required coupon by 25-50 basis points. 2. Issuer-Specific Credit Spread: This spread over the benchmark risk-free rate determines the "debt" value of the instrument. A ratings downgrade or negative market perception can widen spreads by 50-100+ basis points almost overnight. 3. Market-Wide Risk Appetite: In a "risk-off" market, investors demand higher coupons and lower conversion premiums. This sentiment can shift dramatically in a matter of days, changing achievable terms significantly.

Recent Trends & Innovation

• Rise of "Green" Convertibles (2022-2024): Issuers are increasingly structuring convertible securities with use-of-proceeds tied to ESG projects. This can attract a broader, dedicated investor base and in some cases result in a marginal pricing benefit, or "greenium."
• Post-Peak Normalization (2023): Following a boom in 2020-2021 driven by the pandemic-era need for liquidity, issuance volumes have returned to more historically average levels. Issuers are now more strategic, often using proceeds for M&A or refinancing rather than general corporate purposes.
• Focus on Structured Call Spreads (2023-2024): To mitigate potential dilution from conversion, issuers are frequently executing an overlaying "call spread" transaction simultaneously with the convertible offering. This effectively increases the conversion premium, providing more upside before dilution occurs.
• Impact of Accounting Simplification (Effective Jan 2022): The full adoption of FASB's ASU 2020-06 has made convertible instruments more attractive to a wider range of U.S. public companies by simplifying EPS calculations and eliminating complex bifurcation accounting.

Supplier Landscape

This table outlines the top underwriters (suppliers) for equity-linked securities, including convertible preferreds. Market share is based on global league table rankings for new issuance volume.

Regional Focus: North Carolina (USA)

North Carolina presents a robust environment for both the issuance and investment of convertible securities. The state's demand outlook is strong, anchored by two key ecosystems: the financial services hub in Charlotte (home to Bank of America's HQ and Truist) and the dense concentration of biotechnology, pharmaceutical, and technology companies in the Research Triangle Park (RTP). These growth-oriented RTP companies are prime candidates for issuing convertible preferred stock to fund R&D and expansion. Local capacity is excellent, with major underwriters having significant operations in Charlotte, providing on-the-ground expertise. The state's stable regulatory environment and competitive corporate tax structure further support a favorable climate for capital formation activities.

Risk Outlook

This assessment evaluates the risks associated with sourcing capital via convertible preferred stock.

Actionable Sourcing Recommendations

1. Mandate Underwriter Competition to Reduce Fees. For any planned issuance, require formal proposals from a mix of 3-4 banks, including at least one Tier 1 and one industry-specialist niche player. This competitive tension can reduce underwriting fees by 15-25 bps and improve pricing terms by leveraging different distribution strengths. Track fee structures and league table performance quarterly to maintain a pre-qualified list of potential underwriters.

2. Implement a "Shelf & Strike" Strategy. File a universal shelf registration with the SEC to enable rapid market access. Concurrently, work with the Treasury team to pre-model issuance scenarios and define target "strike zones" for key metrics (e.g., stock price, market volatility). This allows the company to execute a deal within 48-72 hours to capitalize on favorable, but often brief, market windows, potentially saving 50-100 bps on the coupon.