Private bonds flourish as issuers seek tailored capital
The private placement market can provide tailored financing for corporates who are unwilling to lock into single tranche bonds or are facing difficulty obtaining bank funding.
|Nicholas Bamber, Head of Private Placements|
Nicholas Bamber, Head of Private Placements at RBS, explains why business is flourishing in the private bond market and suggests that the market could grow significantly from its current size, as more companies switch on to its charms.
Last year was the busiest year in the private placement sector since 2003, with USD45.7 billion of private bonds placed. This year, as the tough economic environment cuts traditional forms of funding for corporates, this could rise to USD50 billion. We are seeing evidence of significant demand building from companies looking to access this money by issuing private bonds, particularly from Europe. Almost USD18 billion was invested in European corporates last year, well ahead of the same point in 2010. Almost USD8 billion has already been raised by European corporates in 2012.
The private placement market is established as a route for unrated and rated companies to raise money, but many European corporates remain ignorant of the market’s potential. On top of real investor demand, it offers issuers competitive pricing and greater control over the structure of the finance provided.
More than 90 per cent of investment in private placements comes from the big US pension funds and life insurance houses, such as AIG, Metlife or North Western Mutual. They are attracted to the opportunity to benefit from the profitability of well run companies at a time when yields elsewhere are low. Other investors include UK insurers Aviva and Prudential, which controls assets of approximately GBP200 billion via its M&G fund management business.
Because these investors have their own specialist credit teams, they can individually analyse the credit risk of companies and are not tied to the opinion of rating agencies. The vast majority of private bonds sold are implied investment grade, the equivalent to an investment grade bond in the public markets. They are split into two designations called NAIC-1 (equivalent to A- or better) and NAIC-2 (equivalent to BBB+ to BBB-). These bonds can offer a comparable return to similarly rated public bonds, leading to attractive yields in the context of the current low yield environment.
Following the credit crunch of Q4 2008 the credit spreads on implied BBB bonds have come down from a worst point of 500bps over Treasuries in early 2009, when investors were reticent to invest in anything but the most attractive issuers, to around 200bps over Treasuries, as strongly increased demand has narrowed spreads. Added to this, US 10-year Treasuries have plummeted to below2 per cent, down from 3.5 per cent in early 2011, as they become the global safe haven asset of choice.
The combined effect of tighter spreads and lower Treasury yields has significantly reduced the cost of private placement funding for businesses. Average annual coupons payable have more than halved from above 8.5 per cent on NAIC-2 (BBB) bonds in 2008, to around 4 per cent at present. Working with a specialist agent such as RBS can help corporates to keep coupons down, as they can sell the credit story and create competitive tension in the orderbook by working with multiple potential lenders.
Added to this, cross currency swaps needed to convert dollars back into euros or sterling are consistently available from banks to ensure borrowers have the right financial liability.
The opportunity for corporates to lock in long-term funding is also attractive. The average length of private bonds is between seven and 12 years, longer than many banks will commit loans for. In addition, bonds can be issued in multiple tranches, reducing refinancing risk, since the debt matures at different times.
In Europe, where mid-sized firms without access to public capital markets have historically relied on banks to meet their funding needs, this combination of reasonably priced, long-term debt is alluring. At the same time that companies want to lock in funding, banks are shoring up their balance sheets with extra capital, in anticipation of impending regulation such as Basel III, and are not lending to the same extent.
RBS expects the supply / demand gap for private placements to continue despite more European corporates becoming aware of the advantages of the market.
Many large firms, that usually raise their money in the public debt markets, are also turning to private placements as the volatility of unsecured credit markets increases its attractiveness.
The private placement market is generally counter-cyclical since it is insulated from market vagaries and relies on a small base of big, stable, liquid investors. As we have noted, it is beginning to take off as it picks up the slack in bank lending and enables corporates to create a much more balanced capital structure at a historically low cost.