The Federal Reserve has warned that investing in US stocks can be a risky way to get financing

 

The Federal Reserve has warned that investing in US stocks can be a risky way to get financing
The Federal Reserve has warned that investing in US stocks can be a risky way to get financing


The Federal Reserve has warned that investing in US stocks can be a risky way to get financing.

Several companies in the US, which have been highly rated, have issued convertible bonds to raise billions of dollars this year. Bankers said this signals a change in the market that was previously only available to companies with limited options for obtaining funds.

Investment grade companies usually do not issue convertible securities because doing so reduces the value of their shares, as it may involve giving up shares at a price lower than their market value. Consequently, creditworthy companies prefer to raise money through investment bond markets instead, as it is a more cost-effective method.

PPL Corporation and Southern recently raised a combined $2.4 billion through convertible note offerings, which are investments that allow companies to issue securities at lower interest rates than regular bonds. This is the first time utility-grade companies have done this in 20 years.

Investment-grade firms have issued $8.5 billion in convertible bonds this year, which could lead to an overall market turnover of between $65 billion and $70 billion for 2021 - more than double the amount collected in 2022.

Wells Fargo's co-head of capital markets, Craig McCracken, has noticed a growing interest in convertible bonds coming from more investment-grade companies. He believes that 2023 will have significantly more issuance of these bonds than 2022.

Getting financing at a low cost.

The US Federal Reserve's recent attempts to curb inflation have created unusual market conditions, which encouraged some investment-grade companies to enter the convertible bond market. However, the inflation rate staying strong in spite of the Fed's action has made it hard to predict what will happen with stock prices and interest rates in the future.

Hybrid Investments

Convertible bonds are a type of hybrid security that combine aspects of regular bonds and stocks. They pay out interest like normal bonds, but their value also depends on the company's share price, as they can be converted into shares. Having this hybrid nature can reduce certain risks while introducing new ones.

Investors purchased PPL convertible notes at face value (100 cents on the dollar) earlier this week. By Friday, the bond was trading at a premium of one cent (101 cents).

Howard Needle, portfolio manager at Wellesley Asset Management, purchased the bond because investors were expecting the company's stock price to increase.

PBL (NYSE:PPL) stock has seen an increase of 19% since October 2020, when it was at its lowest of $23.28.

Convertible bonds are attractive to utility companies such as PPL in a rising interest rate environment, as they can boost potential returns for investors. This confidence makes the offering successful in raising funds.

Investment grade companies in sectors other than those directly affected by rising interest rates are unlikely to issue convertible bonds, as the product would be less appealing to investors.

PPL was able to raise $900 million through a five-year convertible note with an interest rate of 2.875%, and a two-and-a-half year Southern note with a yield of 3.875%. These rates are lower than the average yield for investment grade corporate bonds, which is 5.48%.

Convertible bonds are becoming more appealing to higher-rated companies due to their potential for cost savings, as well as changes to the accounting rules that took effect in 2022, according to Wells Fargo's McCracken.

Last year, a US accounting rule that required companies issuing convertible bonds to add hypothetical interest expense to the bond, resulting in an increased cost of issuance, was canceled.

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