An increasing amount of cash continues to flow into the US private placement market, which means it’s likely to attract a greater number of larger deals. Even with new issuance records being set, the investors will be asking themselves where they can find even more deals.
According to the report by Macquarie IM, the year 2017 saw record numbers in terms of private placement volume, with issuance totaling somewhere around $66bn. The third quarter of 2018 saw deal volume rise 3% in comparison to 2017 (629 deals in Q3 2017), as dollar volume was increased by 51% ($22.2B through Q3 in 2017).
Despite that, investors find themselves in a delicate position, as capital flows into the market keep outgrowing the increase in supply, leading to a higher level of competition to get deals done.
The discrepancy between demand and supply continues to be a challenge for the market. Finding and tracing the source of the additional capital flowing is difficult due to the fact third party organizations have some of it managed by US life insurance companies.
With investors allocating more funds to the asset class and some new names surfacing among them, the depth of the market has increased, and so has its ability to absorb bigger deals, as well as a larger quantity of them. The transactions are also getting larger on average.
Which areas show growth?
The real estate investment trust sector is one of the more notable areas of growth. As is the case with smaller, regional regulated utilities, this is probably due to changes made to index eligibility criteria for public debt. The newest index criteria update dictates that a single bond tranche now needs to be as big as $300m to be listed in the Bloomberg Barclays US Aggregate Bond Index, up from $250m previously.
We’re seeing a shift from the public to the private debt market, as companies trying to create a smoother maturity schedule wish to take advantage of the flexible conditions on offer. The illiquidity premium, which had previously had a significant amount of influence on US private placement pricing, has now practically disappeared thanks to higher levels of lender competition. On the other hand, the premium in the public market remains considerable, even for sub-benchmark size deals.
Still, there are certain players who have downplayed the impact of this change, citing rising interest rates as the more important reason behind the growth of the private placement market.
Whatever the case may be, preliminary 2019 figures indicate that Real Estate Investment Trusts and project finance will continue to be big areas of supply in the upcoming period. Project finance in particular has seen significant growth on the market, mostly as a result of features such as bid-style financing, delayed drawdown and committed financing for M&A becoming available at a lower cost.
The illiquidity premium was not the only thing which has eroded in the highly competitive investment environment - some investors are also prepared to forgo protections which were considered market standard until recently. One such example is swap breakage language in foreign currency transactions.
There are two ways foreign currencies can be offered in the private placement market - they can either be provided by investors with enough foreign currency liabilities needed to match, or they can be created synthetically via a swap that matches the tenor of the note.
Investors usually have higher credit ratings than the issuers, which means it is more logical for the swap to be performed by the former, as the cost will be passed on to the borrower through the coupon.
These kinds of deals normally require that swap breakage language be included in the documentation, so as to ensure the investor is made whole in the case the borrower has to repay the debt early.
However, it seems swap breakage language has not appeared at all in some deals, all because confident investors are trying to offer borrowers the optimal terms. Another reason for this is perhaps related to the investors’ intention to hold an asset in the same currency as the swap.
If a foreign private placement has to be repaid earlier than expected, the investors could take a position in government bonds or they could participate in another foreign currency issuance.
Others, however, are still not comfortable making deals without the swap indemnification protection, citing the credit quality of the borrower as an important factor in deciding whether to forgo it.
A new source of deals on the horizon
The revision of the NAIC’s capital charge regime is very much worth paying attention to, according to observers of the private placement market.
What NAIC does is regulate the US private placement market through the means of imposing risk-based capital requirements on the US insurers considered the bulk of the investor base. Currently, the considerable difference between the capital charges for NAIC 2 (related to triple-B credits) and NAIC 3 (related to double-B credits) presents a major disincentive to invest in sub-investment grade credit, which also means it creates a strong incentive to hold BBB-equivalent paper.
Going in a new direction
Recent proposals are built around the idea of subdividing the five existing NAIC ratings into 19 bands, which would soften the difference between double-B and triple-B and possibly open up new opportunities on the market.
It seems private placements investors would be willing to take on below investment grade debts with a good credit background and structure, as they would be able to price it more efficiently than in the past.
The reform has shown glimpses of potential, but some time will have to pass before we can properly assess its impact on the private placement market.