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WorldNovember 1 2013

Private bond market proves its mettle

The US private placement bond market is proving popular with mid-sized European companies and those that lack credit ratings. American investors, starved of supply, hope the trend lasts a while longer. 
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Private bond market proves its mettle

When the BBC – the UK's state television and radio broadcaster – sought funding for its commercial arm earlier this year, it turned to an unusual place to get it. Rather than calling on its existing banks, the BBC chose to issue a bond for the first time. But it did not sell a public deal. Instead, it tapped the private placement (PP) market.

The BBC, in a deal led by Barclays and Lloyds Bank, managed to raise $259m – or £170m – of seven-year debt from eight investors, most of them large US insurance firms.

The broadcaster was drawn to the private bond market for several reasons. It wanted to diversify its investor base beyond the banks that it usually sources its financing from, and lock in a longer maturity than the five years they typically offer. It was initially only seeking about £100m, an amount that might have been too small for the public market (thanks to the bond being oversubscribed, it was ultimately able to take more). And although it had sold commercial mortgage-backed securities previously, which were rated, it did not have a standalone credit rating.

“We were attracted to the private market because of the size of the deal we were looking for,” says Stephen Wheatcroft, the BBC’s treasurer. “It was on the cusp of what would have worked in the public market and avoided the need for a direct public rating and the filing requirements associated with a public deal.”

The allure of privacy

The private bond market is dwarfed by the public one. But, as the BBC’s transaction showed, it has many advantages over its bigger brother. The very fact that it is private – even senior bankers in the industry admit they usually find out about rivals’ deals only after they have been priced, if at all – helps to lure certain companies, especially those that are not listed and do want their financial details made widely available.

“There are some companies, particularly private or family-owned ones, that have strict confidentiality surrounding the disclosure of financial statements or about their business,” says Angus Whelchel, head of private capital markets at Barclays. “For them, this market can be very attractive.”

Borrowers also like the market’s relationship-driven nature. They usually meet the majority, if not all, of their eventual investors beforehand. Secondary trading is a rarity, which means that issuers do not have to fret about their bond prices falling rapidly during periods of volatility. And deals can usually be concluded quickly. “We had seriously been considering a private deal for a couple of years,” says Mr Wheatcroft. “Once we had decided to do one, it only took about 10 to 12 weeks before we actually got it done. It was an efficient process.”

Aggressive market

The dollar-denominated PP market is the most active one, although a small amount of sterling, euro and Canadian dollar issuance takes place. Supply in the US has been fairly high in the past few years, but has still lagged the level of demand. In 2012, companies sold a record $54bn of private bonds, according to Bank of America Merrill Lynch. “Demand is reliable and there’s plenty of it,” says Steve Monahan, the bank’s head of US private placements. “That’s resulted in an aggressive market.”

Thanks to the high demand and interest rates in the US being near all-time lows, financing is cheap. “It’s a good time for an issuer, and a challenging one for investors,” says Paul Aronson, head of PP origination at ING US Investment Management.

For investors, the situation has not been helped by the decrease in supply in 2013. Volumes for the first eight months, while still strong by historical standards, were about 15% down on those from the same period in 2012. Supply from US issuers was up slightly, but dollar issuance from foreign companies fell. “Normally, we don’t have a summer break in the private market,” says Tony Fordham, a managing director at Royal Bank of Scotland. “But this year, we did. In July, global dollar issuance was $1.7bn. That compared with $4.3bn in 2012. Going back 14 years, only two Julys were quieter.”

Analysts say the dip was partly a result of a rise in US interest rates from late May following a speech by Ben Bernanke, chairman of the Federal Reserve, that spooked investors into thinking he was about to slow his quantitative easing programme. But they stress that, in the long run, the private placement market is less sensitive than the public one to changes in monetary policy. “It’s more beholden to merger and acquisition volumes and the overall strength of the economy,” says Mr Monahan.

Third-quarter pick-up

Private placement activity in 2013

Bankers say it is too difficult to predict with any accuracy PP volumes for 2014. But they are optimistic that in November and December 2013, supply will be fairly heavy, based on issuance having picked up after July’s lull. There were almost $5bn of bonds in August and a similar amount in September. European companies have printed several large deals since the mid-year lull, including property firm British Land, which sold $300m of notes, and German chemical group BASF, which issued $1.25bn of debt in the biggest private deal so far this year. “The market is still very buoyant and continues to be supply-constrained, given the demand from investors,” says Mr Whelchel.

Private bond investors in the US are bullish about the prospects for the country’s economy and say they have few concerns about a bubble building in the corporate market. “Our general view on US credit is that things are better than they were three or four years ago,” says Mr Aronson. “Companies are in better shape from a balance sheet perspective.”

Investors have also taken comfort from the recent performance of their portfolios. During the height of the US economic slump, losses on private bonds were typically less severe than those on public deals. Bankers say this was a result of the covenant packages on PP deals being stricter than those in the public market, something that meant that private bond issuers were less able to carry out bondholder-unfriendly actions during the boom years up to 2008.

“In the majority of private placements, there are financial covenants, usually a leverage test and sometimes a coverage test of some sort,” says Mr Monahan. “That protects bondholders against companies doing equity-friendly transactions such as leveraged recaps or leveraged acquisitions.

“If a company did do one of those things, private bond investors could ask to be paid at the make whole level. Rather than watching the value of their bonds go from par to 80, they would instead get paid out at about 110.”

European PPs to emerge?

For the past two years, US issuers have accounted for only about 40% to 45% of dollar-denominated private bond supply. In 2012, 38% of deals by volume were from Europe, mainly the UK (Australian companies made up most of the rest of the supply). American investors have flocked to European deals, not just because supply is too low for their liking, but because such transactions tend to come from firms of a bigger size and with stronger ratings than US borrowers. Northern European firms are particularly popular, although bankers say their counterparts from countries such as Spain, Portugal and Italy would not be dismissed out of hand. Exemplifying this, there have been several Italian deals this year, including one of $130m in April from Amplifon, a company that makes hearing aids.

Private placements have never gained much traction among investors outside the US. This is to a large extent down to capital markets being shallower elsewhere, including Europe, where companies have traditionally relied on bank debt to a far greater degree than their counterparts across the Atlantic. Recently, there have been signs of growth in the sterling and euro private placement markets. Analysts say that since the 2008 financial crisis, European firms have started to diversify from loans into bonds. This has mainly played out among blue-chip borrowers, which tend to issue public deals when they tap the capital markets. But more unrated and mid-sized companies from the continent are issuing bonds than at any time in the past, which in time could lead to the development of a European private placement market rivalling that in the US.

The US market’s dominance is likely to persist for a while, however. Analysts say that even when European investors are keen to buy the private bonds of a European company, they often cannot match their American peers for price. The BBC’s deal demonstrated this. Even though it needed to put in place a hedge to eliminate the foreign currency risk, a dollar bond still proved cheaper than if it had tried to raise £170m in sterling. “In the seven- to 12-year part of the curve, dollar investors are proving to be the most competitive on price,” says Mr Fordham of RBS. “Some UK investors would love to buy a BBB [rated] industrial firm. But US investors are beating them on price nine times out of 10.”

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