US CB Market Explodes Amid High Interest Rates... "Win-Win for Both Companies and Underwriters"

Top Companies Flock Together as "100 Trillion Won This Year"
Quick Fundraising Hits Two Targets with Low Interest Rates

As market interest rates have surged, driving up borrowing costs, an increasing number of U.S. companies are facing the risk of credit rating downgrades. With even high-quality companies flocking to the convertible bond (CB) market?which has traditionally been a funding channel for financially vulnerable, low-credit companies?to avoid downgrades, the U.S. CB market is expanding explosively. CBs offer the advantage that issuing companies can raise funds at relatively low interest rates, while investors can enjoy a 'two birds with one stone' effect through bond interest and capital gains from stock price appreciation.

On the 6th (local time), major foreign media reported that due to the Federal Reserve's (Fed) aggressive tightening policy, market interest rates have risen sharply, putting U.S. companies at risk of credit downgrades. The average corporate bond interest rate for investment-grade companies has more than doubled to 5.7% compared to 2% in March 2021. Since the global financial crisis, central banks worldwide have maintained a long period of low interest rates through rate cuts and quantitative easing to prevent bubble collapses, but the situation has changed with the Fed's shift to a tightening cycle.

To control inflation that has been difficult to contain, there are even forecasts that the Fed will shift to a big step (a 0.5 percentage point increase in the benchmark interest rate), maintaining uncertainty in monetary policy. Recently, various economic indicators such as inflation, employment, and consumption have all remained strong, leading to expectations that the Fed will pursue even stronger tightening measures. Currently, the U.S. benchmark interest rate stands at 4.5?4.75%, and the market expects it to exceed 5?5.25% by the end of the year.

As the Fed's aggressive tightening continues for an extended period, concerns over corporate credit rating downgrades are growing. Experts evaluate that borrowing has become more difficult for companies as interest burdens increase and the cost gap between investment-grade and speculative companies widens. Dedi Hodgson, Global Co-Head of Syndicated Loans at Morgan Stanley, said, "Companies are now more focused on protecting their credit ratings," adding, "There is no appetite for leverage that risks falling below investment grade."

[Image source=Reuters Yonhap News]

The borrowing situation for low-credit companies is even more challenging. The annual interest rate for companies with low credit ratings averages 9%, nearly double the level below 5% from two years ago. Andreas Bernstorf, Head of Equity Capital Markets (ECM) for Europe at BNP Paribas, pointed out, "Market access for low-credit companies has deteriorated and funding costs have increased significantly compared to 18 months ago, before the tightening cycle began."

Companies facing blocked funding channels are turning to CB issuance as an alternative. According to financial information provider Refinitiv, the volume of CB issuance in the U.S. in February reached its highest monthly level since November 2021. This marks an explosive rebound after last year's CB issuance plummeted to two-thirds of the previous year's level. Tami Serve, Head of Americas Debt Capital Markets at Morgan Stanley, evaluated, "Demand in the CB market is growing explosively."

CBs have characteristics of both bonds and stocks, allowing investors to earn bond interest income and capital gains from stock price appreciation. Due to this conversion feature, companies can raise funds at lower interest rates than regular bonds. When CBs are converted into stocks, the amount to be repaid at maturity disappears, resulting in a win-win effect of reducing debt.

Josh Schaeffer, Managing Director at accounting firm Equity Method, said, "CBs have become the cheapest funding method for both high and low credit rating companies." Wall Street expects this year's CB issuance volume to reach $65 billion to $70 billion (approximately 84.5 trillion to 100 trillion KRW), more than double last year's amount. Craig McCracken, Co-Head of ECM at Wells Fargo, said, "2023 will be a groundbreaking year for the CB issuance market."

This content was produced with the assistance of AI translation services.