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Crowded house: USPP fan base grows despite foreign rivals

While the large US insurance companies remain the bedrock of the US private placement investor base, slim pickings elsewhere in the capital markets are pushing other kinds of investors to look at the product. But with demand for paper already far outweighing supply, market participants do not necessarily see this as a boon. Richard Metcalf reports.

The US private placement market’s established, core investors — the big US life insurance groups such as MetLife, Prudential and New York Life — are in many ways the key to its unique appeal. 

With bags of cash and an appetite for long term assets, they also possess the drive and sophistication to dig into deals the public bond markets shy away from.

But while US insurers dominate the market, accounting for 80%-90% of its buying power, according to placement agents, new names are increasingly getting in on the action.

“Every market is overbid, at least from the standpoint of the past few years, and people are getting frustrated at their allocations so they’re trying to venture out and look at different ways to invest,” says Angus Whelchel, London-based global head of private placements at Barclays. “One of those outlets, particularly for European investors, where they haven’t had as much representation, has been the private placement market.”


7.1

Diving into USPPs as an investor is not for the faint-hearted — it is assumed that investors will buy to hold, and secondary trading volumes are tiny — but placement agents report an increase in asset managers and even corporate pension funds getting comfortable with the limited liquidity in recent years.

“I think deepening the market by bringing new investors into the market is a positive for all issuers,” says London-based Siobhan Duffy, managing director for private placements at NatWest Markets, the investment banking arm of Royal Bank of Scotland that was rechristened in September 2016. “It’s something we’re at the forefront of developing.”

While interest among European-based investors is on the rise, some of them have been active in the market for many years, says Duffy.

Among those newer to the market, several placement agents mention the increasing prominence of UK insurance group Legal & General, which has recently made several high profile hires.

Nicholas Bamber, an experienced private placement originator at RBS for many years, joined L&G’s asset management division as head of private assets in January 2016, initially with a focus on European transactions. In January this year, the London-based insurer recruited another private placement veteran, Calum Macphail, from M&G.

Meanwhile in Asia, Aflac, the US insurance company with a big Japanese business, is rumoured to be eyeing a return to the market. 

Under Eric Kirsch, appointed chief investment officer in 2011, the insurer had pulled back from private debt after a bad experience with yen loans to European banks in the wake of the eurozone debt crisis.

Supply-demand imbalance

While the expansion of the investor base is good news for issuers looking for competitive pricing and terms, some market participants point out that it actually exacerbates the existing supply and demand imbalance.

Lack of supply has repeatedly been highlighted as a leading concern in industry surveys of investors, and placement agents say that while volumes continue to grow — up to $65bn of USPPs were issued in 2016 — demand for the notes remains twice that or more.

This imbalance spurs investors to go to ever greater lengths to expand their repertoire in terms of issuer industry, deal structure and currency, attempting to lure unrated borrowers that have not tapped the capital markets before away from their relationship banks and sidestepping intermediaries to reach out directly to established clients.

It is this experimental disposition that leads some insiders to refer jestingly to the US private placement market as “the R&D department of the capital markets”.

The latest experiments going on in the financial laboratory, the results of which are keenly awaited by issuers, centre on the question of how far in advance investors are willing to price and commit cash that will not be disbursed all at once.

So-called ‘delayed draw’ features are getting longer and cheaper, say placement agents. For a three month delayed draw, there is typically no premium, six months costs about 10bp and 12 months adds roughly 15bp-20bp to the spread, although it depends on the deal.

“Investors can sharpen their pencils if they think it’s going to improve allocation,” says Peter Pulkkinen, New York-based head of US private placements at BNP Paribas.

Delayed draw is particularly useful for companies planning to refinance forthcoming maturities, and gives the product an advantage over public market deals.

“If you look at some of the issuers that have been to market over the last year, if they had ratings — and some do — they could go to the public bond markets in their home markets, but they’ve chosen to do US private placements either because it’s less expensive to raise non-US dollar currencies here than locally or they can get features like delayed settlement,” says Conrad Owen, managing director and head of private capital markets at MUFG in New York.

In March 2016, for example, when SSE, the UK energy, phone and broadband services company, raised about £500m in seven, 10 and 11 year maturities from 19 US and UK-based investors, it chose to subject 80% of the proceeds to a six month delayed draw to avoid negative carry.

The SSE transaction also demonstrated the US private placement market’s flexibility on tenor and tranche size, which is in large part due to the lack of concern about liquidity and secondary trading.

Going down the curve?

The only limit appears to be that the issuer must be considered investment grade, at least for now.

Some market participants hope that changes to the capital charge regime for US insurers could tempt some to dabble more in the high double-B rated arena, but any shifting toward high yield credits is expected to be marginal.

The capital charge regime is overseen by the National Association of Insurance Commissioners. All debt bought by US insurance companies in the private placement market is assigned an NAIC designation which determines how costly it is for them to hold.

As things stand, there is a cliff between companies rated NAIC 2 and those rated NAIC 3, which is the equivalent of the border between Standard & Poor’s BBB- and BB+ ratings, all but shutting sub-investment grade credits out of the market.

Tweaking capital charges

But the NAIC has been discussing making the regime more granular, splitting bands 2 and 3 into three grades each using pluses and minuses, and reducing the sizes of the steps up in capital charges between investment grade and speculative grade credits.


7.2

Placement agents say the changes are expected to make higher rated debt more expensive for insurers to hold and speculative grade debt less expensive, incentivising investors to look further down the credit spectrum at cross-over credits or improving high yield names and opening up a new source of deals.

“If their capital charge is reduced and there isn’t as big a penalty for insurance companies to invest in those types of entities, that will help those types of entities access this market, absolutely,” says Brian Bates, a London-based partner at law firm Morrison & Foerster, who focuses on private debt. “And that type of development would be very helpful in allowing these big insurance companies to make more investments in that category of issuer.”

Owen says: “That’s my hope. Many years ago, this market used to do a lot more business with what you would call straight non-investment grade credits. 

“That has not been the case for a long time, so I’d be happy, for sure, if this change meant that our market was more aggressive in looking at the higher quality double-B-type credits.”

Guidance is expected from the NAIC later this year or early next year on how the new capital charges will work, but there are some voices attempting to temper any expectations of a flood of speculative grade issuance.

“I think the market is already open to sub-investment grade issuers but in reality we get very limited supply because in many cases slightly shorter term debt is more attractive to them,” says Duffy.

“If you’re a non-investment grade issuer on an improving curve, you’re not going to pay a premium for long term debt.”

Discerning buyers

“The US private placement market does not buy just anything that’s put in front of it,” says Pulkkinen.

“If you have a less attractive story, technicals in the market mean people will take their time to review your deal and do their credit work — it will get a second look — but we’re not really seeing our guys cave on structural protections.”

That is not expected to change, because one thing that is not altering in US private placements is the buy-and-hold mentality.

Secondary trading is estimated to represent just 7%-10% of activity in the market, but unlike in public bond markets, that is considered a strength as it allows the unusual, bespoke, unrated and small deals that are the hallmark of the asset class.   

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