The U.S. Private Placement market saw record volumes last year, with investment grade deals continuing to dominate the market. While relatively spread differential and weak covenant packages keep traditional investors out of the non-investment grade market, some investors do have appetite for well-structured deals.
The atmosphere was cheerful in Miami at the 31st annual 2018 US Private Placement Industry Forum in February. The USPP market saw record volumes in 2017, with roughly $70 billion raised via placement agents and another $8-10 billion in direct issuance. This was up from $68 billion in 2016, with $5 billion done direct.
The investor base has expanded over recent years. In addition to the historical top twenty-five U.S-based insurance companies, interest from non-American institutions has continued to grow. Non-U.S. investors include British firms M&G Investments, Aviva and Legal & General, a few Canadian firms and other European firms such as Delta Lloyd. Even French groups like AXA IM, Natixis AM or the Caisse des Dépôts have been involved, as well as German firms such as Deutsche AM, Schroders or Rivage (real estate, infrastructure).
While the development of the European private placement format has created competition for deals, conference participants highlighted the benefits of the USPP format for issuers: very long maturities, deferred delivery of funds, shelf financing, availability of non-dollar funding (the euro, in particular). Jason Rothenberg, Managing Director at MetLife Private Capital Investors, is predicted a quadrupling of the market over the next five years!
In terms of outlook, investors expect the continued lack of supply relative to demand to persist, keeping pricing in favor of issuers. Factors that could limit new issue supply include tax reforms that will drive repatriation of offshore cash, a drop in the corporate tax rate that will increase the after-tax cost of debt. The ceiling on deductible interest will certainly exert pressure on highly levered companies, but the impact on USPP issuers is likely to be more spread tightening. According to Barclays Research models, a drop in average leverage ratio (debt/EBITDA) from 2.7x to 2x for A-rated issuers, and from 3.7x to 2.8x for BBB-rated issuers could reduce bond spreads by 22 and 58 basis points, respectively.
Faced with the trend toward tighter spreads and lower illiquidity premiums (30/35 bps, investors expressed their intention to focus on the “quality” of the transactions, specifically long-term issuer relationships and quality covenants. As Peter DeFazio, Managing Director of AIG Asset Management, said, investors in USPP issues have better protections than some other markets and it is important to maintain them. According to Paul Aronson at Voya Investment Management, there has been “crazy compression” in spreads but there has not been a deterioration of the structures. Strong A-rated borrowers have been able to do deals where the only covenants are “Most Favored Lender (MFL)” clauses and some investors indicated they would consider such structures for strong BBB borrowers as well.
Conference participants discussed how the new, more granular, NAIC rating scale and new capital charges may impact the market. The number of ratings classes is going from 6 (NAIC 1 to 6) to 20. For investment grade issues (NAIC 1 and 2), capital charges for the investors are increasing, while for strong non-investment grade issues (the top of NAIC 3), the capital charges decrease. The new system is designed to provide a smoother curve and should encourage more investors to take part in strong non-investment grade deals, but the reforms are still being discussed and implementation has been postponed until 2019.
For U.S. issuers, the main takeaway is that the U.S. Private Placement market continues to be a very viable financing alternative not only for private borrowers, but also for public issuers looking for either delayed draws, smaller tranches or structured transactions. Even for strong non-investment grade borrowers, the USPP market may be worth consideration, but finding investors with appetite will take more effort.