Convertible debt is exceptionally attractive to investors in volatile markets because it offers the security of a bond with the upside of equity. That is why convertible debt was one of the strongest asset classes during the pandemic. In the early part of 2020, convertible debt constituted the biggest portion of equity fundraising in the financial markets. In May 2021, 97 U.S.-listed companies had issued $54.3 billion worth of convertible bonds, representing the “highest year-to-date volume ever.” In fact, the more volatile the equity markets are, the more valuable the conversion option embedded in the convertible debt becomes, and the security would be attractive to investors even if it pays a lower coupon or has a high conversion price. Convertible notes in 28 of the 97 offerings referenced above paid no interest, and the average interest rate was 1.41 percent per annum. On average, the initial conversion price of these convertible notes represented a premium of 39 percent over the trading price of the common stock at the time of the offering. Reflecting on the economic terms of these offerings, an industry specialist claimed, “These are the best terms in the history of the market... We’ve never seen anything like this.” On top of these favorable terms, investment banks are often able to offer hedging products that allow issuers to synthetically increase the conversion price of their convertible notes, limiting potential dilution of their outstanding stock if there are future conversions. As such, issuers of convertible debt are able to reduce their risk of stock dilution while minimizing interest expense and therefore cash outflow.

Originally published in Tax Notes Federal - December 6, 2021.