Copying and distributing are prohibited without permission of the publisher.


US PP buyers stay strong on UK as SSD goes international

By Toby Fildes
17 Jun 2019

LONDON PRIVATE DEBT ROUNDTABLE The UK’s private debt market is one of the most vibrant in Europe. London is the most active centre in Europe for US private placement investing, and UK borrowers have longstanding links with that market.

PD 2019

The UK’s private debt market is one of the most vibrant in Europe. London is the most active centre in Europe for US private placement investing, and UK borrowers have longstanding links with that market. US PP investors have also found themselves very receptive to more complex infrastructure credits.

Schuldschein arrangers, meanwhile, have found it harder to make headway in the UK than in other regions such as the Nordic countries and the Benelux.

GlobalCapital brought together Schuldschein and US PP experts in London in mid-May to discuss the advancement of the private debt markets in Europe and beyond. 

Differences between the two products were discussed, such as pricing, maturities and documentation. But similarities were also apparent, including the ability for an issuer to diversify its investor base, flexibility of structures and ease of use. 

All parties remarked on how private debt has grown in importance for issuers and investors in recent years and that it has evolved from a niche product into a mainstream funding tool for companies, big and small. 

They were confident that private debt would continue to grow in prominence, despite challenges such as Brexit, a slowdown in global and European growth and a potentially resurgent loan market, thanks to a new round of cheap bank refinancing from the European Central Bank.

Participants in the roundtable were:

Louai Al-Jaafari, director, loan syndications, Raiffeisen Bank International 

Heiner Boehmer, general manager, head of international corporate clients, Helaba 

Inês Faden da Silva, treasurer, Tideway 

Simon Fretwell, head of private placements, M&G Investments 

Martin Leighton, director of corporate finance, Great Portland Estates

Ewan Macaulay, managing director, head of private placements EMEA, MetLife Investment Management

Konrad Merkofer, MTN and PP syndicate, UniCredit 

Toby Fildes, GlobalCapital (moderator)

GlobalCapital: Why are private debt markets so strong at the moment?

Konrad Merkofer, UniCredit: The markets are strong indeed — at least from the investor side. But you have to differentiate between the markets. The standalone private placement in Europe is used more for crossover and lower rated names. In that space we have had an ever-expanding investor base over the last few years, mainly because investors are looking for additional yield in the current low rates environment.

The problem in this market has been the lack of issuance — simply because bank financing has been a very strong competition. Now that seems to be changing a bit and we see a lot more interest from issuers looking at the capital markets channel for funding.

The Schuldschein is a different story. The investor base is different, but it has also been expanding over the last few years. But the pricing is a lot closer to loans, so you have always had a strong interest from issuers.

Heiner Boehmer, Helaba: My spectrum really is the Schuldschein market. Here we have seen an ever-expanding investor base over the last few years, mainly investors looking for additional yield in the low rates environment. So we have lots of investors but not enough supply. This makes for a strong market, competing well with, for example, the bank market. 

The Schuldschein market has grown quite substantially over the last 10 years; in the last two years we have seen between €25bn and €30bn issued a year, so quite solid. And it has internationalised quite a bit — up to 40%-50% of that is coming from international issuers. There are an increasing number of international investors as well. 

For issuers the main motivation is diversifying their funding base. But also now, following the Loan Market Association standardisation of terms, simplicity of documentation. The LMA’a involvement has helped give the Schuldschein a rubber stamp of approval. And let’s not forget the product offers very competitive issuing costs. 

GlobalCapital: Martin, you’re not a Schuldschein user but you are a US private placement issuer. How do you see this market performing?

Martin Leighton, Great Portland Estates: The US PP market is very strong. It has many advantages from an issuer’s perspective, which is underlined by this very large element of more demand for the paper than there is supply. It feels like it’s been an issuer’s market for some time. It’s a flexible market — lots of flexibility on currency, maturity, size, structure, etc. Delayed draws. There are just many elements to it.

Investors know the real estate sector very well — there’s been lots of issuance from it. It’s quite predictable: the banks can advise you, fairly accurately, on where you’re going to end up on your deal in terms of pricing. 

You get to know the investors very well too, which we really appreciate. They work with you in your business and you hopefully grow together.

The number one thing, from my perspective, as to why it’s a good market, is it can see through volatility. The public market catches a cold sometimes, as we see at the moment. The private market seems to be able to take a longer term view. It’s more of an invest and hold, rather than secondary trading-type set-up. And that predictability and dependability is extremely valuable.

Louai Al-Jaafari, Raiffeisen Bank International: I can talk only about the Schuldschein. My main point is that it’s a resilient market — we saw it in 2008, we saw it in the euro crisis in 2011. And we saw it before the ECB started its bond buying programme in 2016. 

Simon Fretwell, M&G Investments: Building on what Martin said, regarding the private placement market, it’s the flexibility that stands out — it makes it very attractive to issuers. 

On the investor side, the diversification is attractive. 

We do have occasional problems; but they get resolved in a fairly orderly manner. The further we get from 2007-2008, I think that this becomes more and more important.

One of the differences in recent years has been that people have stopped focusing so much on illiquidity. A lot of people used to say ‘we don’t like private placements because of the illiquidity’. But the public markets are so illiquid now, almost disturbingly so, that people have grown into the illiquidity.

PD 2019Ewan Macaulay, MetLife Investment Management: We at MIM are investing on behalf of insurance and pension companies. We’re active predominantly in the US private placement markets. The reason that we, as an insurance company, and our third party clients like the product is the diversification. I would summarise it as: the risk-adjusted return is superior in our eyes, compared with, say, a public corporate bond.

You’re getting a premium for illiquidity, which we are prepared to bear because we are long term buy and hold investors. But you also have structural protections through things like covenants, which we’ve seen over time provide a very strong downside backstop to our investments.

The other element, again from an institutional investor perspective, is it’s a great product because you can match longer term liabilities with longer term assets. You can also mix and match out to 10 years and longer, currencies, fixed versus floating. 

It’s that flexibility, which appeals to the issuers as well, because they can also try and find tenors and currencies that work for them. 

GlobalCapital: What were the attractions for you, Inês?

Inês Faden, Tideway: It was two-fold. We’ve only done one US PP, but it was very clear it was a very stable market. And there is a deep love and understanding of infrastructure. There’s a good understanding of the utility sector in the UK.

In November last year the UK public market closed early, about mid-November, due to the volatility. A lot of people moved on to US PPs. We weren’t in the market then, but talking to banks and investors, it was clear a number of UK issuers just moved on to this market.

We have an asset that is linked to inflation, so we were looking for a lot of inflation-linked debt. And because we have a government support package we have some limitations on how much hedging we can do.

It is a very bespoke market in the UK. It’s not that big but it’s big enough for our needs. We’ve issued £2.5bn of debt, of which about £1.5bn is in private placements in the UK. And there’s still quite a lot of appetite. We’ve done consumer price index-linked debt, CPI with a collar, retail price index-linked. The last five bonds were done on a green basis. We may even green the private placement retrospectively.

We have quite varied financing needs — we have a lot of different maturities out to 40 years — so the flexibility of private placements has been very helpful. That enabled us to take advantage of favourable market conditions and derisk the financing of the project, because we have a six or seven year construction period. We didn’t want to wait to raise the money.

Al-Jaafari, RBI: Ewan, do you have Schuldschein investments in your portfolio? And if not, why not?

Macaulay, MIM: The short answer is no. We’re primarily a US investor from a domicile perspective. And there are certain elements of the Schuldschein documentation that just don’t work for us as a US investor. We can get into the detail, but essentially things relating to sanctions language, etc.

GlobalCapital: How do people view private debt nowadays as a funding tool? It seems like it has moved up the agenda for most European companies over the last 10 years. Why is this?

Merkofer, UniCredit: We definitely have a variety of possibilities these days — the US PP, the Schuldschein, the Euro PP and then the syndicated loan and public bond markets. Every single product has a well defined investor base, and for issuers with different needs. In the US PP market you can get long maturities, which is one of the biggest advantages. You have the Schuldschein which offers lower costs, but a shorter maturities. 

In addition, there are now more private placement products for lower rated issuers. Back in 2007-8 they didn’t exist. And then you obviously have MTN programmes for the investment grade issuers, and if you’re a big enough issuer you also have the public market. 

Boehmer, Helaba: It’s related to the financial crisis. There was a point when issuers found they needed to diversify and not rely so much on bank funding. All the different instruments have developed over time and been customised to the demands of the borrowers, and this has helped grow the various markets.

You see this in the Schuldschein market, which has become much more international and larger.

PD 2019Al-Jaafari, RBI: The borrowers’ funding requirement has changed, or increased in the last 10 years. Refinancing has become a bigger activity in the Schuldschein market. 

It’s quite, maybe too, easy to write the use of proceeds as general purposes, and nobody really asks what it means. But behind this you can refinance your bonds, you can do acquisition finance. You could use the proceeds to build facilities. There are a range of things you can do with this term.

In the meantime blue chip corporates have become more comfortable using the product, especially when the bond markets have been volatile. Remember the automotive crisis around the VW emissions scandal? Daimler immediately switched to the Schuldschein and could issue a transaction at very competitive levels, lower than what was available in the bond market. 

Lufthansa did the same — when the bond markets were quite volatile it switched very easily to a Schuldschein. Another was HeidelbergCement, which in 2015-16 issued a Schuldschein, because at that time the bond market proved expensive. Then a year and a half later they were able to refinance it easily in the bond market, at much lower levels than in the Schuldschein market, because of the flexibility of the structure.

Fretwell, M&G: When you talk about these international companies, are you talking about what I would call the international Schuldschein? So not Mittelstand companies being sold to German-speaking investors? Rather, the ones that I would call international, are being sold to international investors across Europe, Asia etc? I do see two distinct sections of the Schuldschein market.

Al-Jaafari, RBI: It is true that there are effectively two sections in the Schuldschein market — German-speaking (Germany, Austria and Switzerland) and international. Last year we saw Agco, a US corporate, which has an entity in Switzerland, in the market. This was Agco’s second Schuldschein in the last four years, and was quite a success. This international segment has really gained success in recent years and has captured a lot of visibility and attention.

You’ve also seen Petrobras from Brazil issuing a Schuldschein, and Etihad Airways.

Simon Fretwell, M&G: Are these placed in Germany or...?

Boehmer, Helaba: In Germany and internationally. Taking another example, we did French automotive supplier Faurecia at the end of last year. That was €500m in euros and $250m in dollars. The investor mix was 60% German and 40% international. 

GlobalCapital: So when you say international you don’t just mean Austrian and Swiss?

Boehmer, Helaba: No, I mean Asian, Middle East, even South Americans. This is one of the really big changes in recent years.

Merkofer, UniCredit: Another driver for the rise of private debt since the crisis is the low interest rate environment, with investors needing to find additional yield. 

The Schuldschein is not a market where yields are higher — in fact they are sometimes well below the bond market. But the low interest rate environment has also opened up the possibility for smaller companies to tap the capital markets, when they didn’t have that opportunity before.

All of a sudden over the last few years you have seen more and more dedicated debt funds co-focusing on this market, and that has helped to bring private debt into the consciousness of many smaller companies.

Faden, Tideway: One asset class in particular that has grown quite a lot in the past 10 years is infrastructure. A lot of institutional investors have set up teams in this space. The paper we issue is very well matched to the needs of pension funds and insurance companies. Our long-dated paper is linked to inflation, which wasn’t available in this market 10 or so years ago.

GlobalCapital: Do you think the infrastructure asset class hadn’t been particularly well served by the public bond market or the post-crisis syndicated loan market?

PD 2019Faden, Tideway: I wouldn’t say so. Actually, especially in the UK, infrastructure or utility-type borrowers have been going elsewhere because they get much better terms — whenever they go to the public market they’re very well received.

Fretwell, M&G: Over the last 10 years since the crisis, banks have changed their attitudes. Their relationship bankers used to say: ‘you come to me and we’ll do a loan.’ They might then stick a swap on, that kind of thing, to generate fees. They sometimes mentioned what they were doing to their capital markets and private placements people. But, the whole structure of the banks has changed. It’s taken years to happen in the UK but now bankers are pushing the private product more with their clients as bank capital is scarcer.

Faden, Tideway: They use the balance sheet more selectively, and use it to lead on to private placement and capital markets opportunities.

Macaulay, MIM: Talking of bank balance sheets, another element is that in the public market there are fewer banks acting as intermediaries, so there’s less liquidity in the public secondary market. That has and will continue to push some investors towards the private product, because they’re thinking: ‘well how liquid is the bond market anyway?’

Leighton, Great Portland Estates: It started out as a diversification drive — with the banks not wanting to lend and borrowers not sure that the market was going to be enough for them in the future. And it’s just spiralled, with the PP market becoming more used to providing funding to a variety of sectors. That’s meant more flexibility on, for example, currency.

Our first two issues were almost all in dollars. Nobody apart from Simon would give us any sterling. The last two issues everyone’s given us sterling. The delayed draw options are now much greater than they were before. They can be secured, unsecured, rated, unrated. The public market is somewhat limited to benchmark size, whereas in PPs you can be really flexible on sizes. There are all of these things meaning it’s appealing to issuers.

GlobalCapital: Does this explain why UK borrowers have tended to stick to US private placements
rather than go to the Schuldschein, as so many other European borrowers have? 

Leighton, Great Portland Estates: Our banks have never brought us Schuldschein when we bring them in to talk about our funding needs and markets we could access. It’s never been mentioned by them. I don’t know much about the Schuldschein market. I believe it to be quite covenant-light in structure. Personally, I’m quite happy to have some covenants if it saves me on the margin. So it wouldn’t be the first place I would look, although that is based on very limited information.

GlobalCapital: Inês, has anyone been knocking on your door with a Schuldschein? 

Faden, Tideway: No, but we have a constraint because during the construction we have a government support package, so we have limitations on how much we can do with derivatives. So we really have restricted ourselves to sterling lenders — we have limited pocket money for things like swaps.

Merkofer, UniCredit: We are not active in the US PP market, as we offer the Schuldschein and Euro PP. Whenever we hear ‘issuers are not active in those two products, they’re looking at going into the US PP market’ it is mostly because of maturity. The long maturities you get in US PP are not usually on offer in the other Euro PP and Schuldschein markets.

GlobalCapital: How damaging was the Carillion default to the furthering of the Schuldschein market in the UK?

Boehmer, Helaba: I don’t think there was any knock-on effect on the Schuldschein product in general — and if there was, it should have happened to the US PP as well, because Carillion had US PP debt.

Going back to why the Schuldschein is not offered to some borrowers, or in some jurisdictions, it is because of the banks that operate in those markets. 

UK and US banks tend not to run around offering Schuldschein products. They tend to be established US PP players and as a result, they offer US PPs, which means the product is very established in those markets, such as the UK.

Fretwell, M&G: Carillion was a little different, coming back to the point about traditional and international investor bases. Carillion was bought by the international investor base, so it didn’t poison the Schuldschein market’s traditional investor base. You could say: ‘well, it was just one of these deals’.

Steinhoff would probably be a little harder to explain to clients, but Carillion seemed to be just one of those unlucky episodes. 

Boehmer, Helaba: Nowadays we see 150 deals a year in the Schuldschein market. This means that over five or six years you are going to see 500 or 700 deals and there is bound to be a default in there somewhere.

GlobalCapital: It’s a credit market, it’s going to happen. But the second part of the question is: do you see the UK as a promising market?

Boehmer, Helaba: I still haven’t given up hope on it! I would also love to see the UK banks entering the market and promoting the product. We have seen tremendous traction in France in recent times, where we have done four or five Schuldscheine in the last six months. Meanwhile, the Nordics are quite strong and the Benelux is there too. Of course the currency in the UK is different, which might explain it partly, but that shouldn’t be too big an issue.

GlobalCapital: We all agree that the US PP and Schuldschein have performed very well in the post-crisis years. Of course, in that time financial markets have been supported by extraordinary monetary policy measures. A vast amount of liquidity has been pumped into markets, including corporate credit. So what’s going to happen to private debt markets over the next year or so, as special measures end?

Al-Jaafari, RBI: While there has been a fair amount of volatility in the public bond markets, especially at the end of last year and the beginning of this, the Schuldschein market has pretty much carried on regardless. Investors are still very liquid.

One other important point is that the Schuldschein investor does not mark its portfolio to market. It’s a buy-and-hold-to-maturity market, where the asset is issued at par and held at par. That gives us a competitive advantage over public bonds and other public placement products.

PD 2019Boehmer, Helaba: Regarding the impact of the end of quantitative easing, we think it’s really driven by issuers’ demand — which itself is a product of a well functioning economy. So as long as the economy’s growing and, for example, there’s M&A activity, we believe the markets will stay strong. 

Macaulay, MIM: The US PP market’s been proven to be pretty resilient through the ups and downs of economic cycles. And if anything, as an insurance company, if you’re worried about where the economy’s going you may actually position yourself into private placements and away from other asset classes, because of the downside protection.

So US PP demand will likely remain pretty strong, and that counter-cyclicality should help support it. And then the question is — what about supply and whether issuers are looking to issue, if rates are rising, for example?

Fretwell, M&G: Quantitative easing is way above my paygrade. So I have no idea how it will pan out. But there is an institutional base who’ve got to invest this money. And private placements, relative to the public markets and the loan market, are small in comparison. 

So we, in a way, are infill and the reason we’re infill is because we have flexibility. So, like Ewan, I’m hopeful there will still be a clear need for private placements. 

Our pricing expectations may change going forwards. Ewan mentioned the illiquidity premium. That varies, depending on how aggressive the market is and where we see ourselves in the cycle.

The one constant, and I like to talk about it every year, is that in private placements we’ve learnt from the downturn — we have to have financial protections and that’s something we won’t give up. It’s a very orderly market in that sense.

GlobalCapital: Martin, is the loan product coming back as a financing tool in any way?

Leighton, Great Portland Estates: Just not seeing it. I received a market update email from a bank a couple of days ago, talking about the public versus the private market. It said for the public market, on the new issue front, renewed volatility had taken its toll on investor sentiment. Some upward pressure on new issue premiums, the market was noticeably weaker, and undoubtedly more cautious. A number of issuers stood down.

Then it talked about the private market. As usual, US PP investors remained disconnected from, albeit not oblivious to, the day-to-day volatility in broader markets. Very diplomatic.

Investors have plenty of cash to put to work, leading to very efficient execution and impressive pricing outcomes. We see that continuing. At the moment, the PP market is extremely strong. We certainly don’t see it falling away, the way we’ve seen the other markets do.

Fretwell, M&G: It’s a bit like the game where you drop the rat down the pipe and you have to hit it when it comes out the other end. 

In the public market it’s an opaque pipe, you really don’t know when it — the deal — is going to come out and you have to try and hit it. And it’s really hard to time it properly. Whereas the private placement market is a transparent pipe. You know the deal’s coming, you can see when it’s coming, and you can act accordingly.

Unless there is a big disconnect in the market, we will not, just because the market’s got a little bit of volatility on the day we decide to price, pull a deal and say, ‘well, that was that’, as seems to happen in the public market. 

We can do that, because again we are not the bulk of the market. The majority of the deals in our investor’s portfolios are going to be publics.

 And we have other protections as well, as Ewan said. It is not as simple as purely the price, there is a little bit of squidginess in our willingness to invest.

Macaulay, MIM: The other thing that helps is that our mandate is not necessarily to outperform an index — we’re not trying to dip in and out of a market. We are there as a buy-and-hold investor matching assets and liabilities.

So you’ve got the luxury as an investor to look through shorter term volatility. Now of course you are still looking at the longer term prospects. You’re not completely disconnected from what’s going on in the broader world. But you’re thinking more about ‘will this investment pay me back in 10 years’ time?’

It doesn’t really matter whether it’s going to go up or down in terms of value, that doesn’t really concern us, because we’re buying and holding. So it’s a better position to be in.

Faden, Tideway: From an issuer perspective, the appeal of the private market was that we also had some debt certainty, we had visibility. And for our board, given that we had to issue a lot very quickly from virtually nothing — we had the equity, we had the big RCF but nothing else — there was not a great appetite to get into the public market. It was much better to start with a few private placements, establishing the reputation, establishing the credit level. And then only after 18 months we moved to public markets.

Boehmer, Helaba: I just want to flip the question of why certain products work and don’t work in certain jurisdictions. Given how well the US PP product works in the UK, why doesn’t it work on a similar basis, for example, in Germany?

Fretwell, M&G: If you look at the issuance since the last downturn, say 2011-13, there was a significant volume out of Germany and the Netherlands, and they have both since retreated. The UK, meanwhile, has been constant, just under or just over a fifth of the total issuance. 

PD 2019We occasionally get a large French issuer, then nothing — we just haven’t seen consistent issuance from continental Europe. It used to be double the sub-10% of the total market that it is today. 

And my guess, talking to people, is the strength of the banks. Corporates are getting the capital they need at a price they’re happy with. They do give a bit away in terms of maturity, but they’re very happy with the banking relationships they’ve got. 

I don’t think that’s entirely the case in the UK. So I would say it is a difference in the structure of the banking markets in continental Europe versus the UK. 

But you’re right, where are the continental issuers? We’ve seen quite a few out of Spain and Italy, places like that, but not the traditional German issuance. 

Al-Jaafari, RBI: If you carve out the blue chip corporates in Germany, let’s say the public ones, you are left with typically very strong mid-cap German corporates, which prefer to consider a Schuldschein issuance rather than a bond, where they have, for instance, to provide a prospectus. So the Schuldschein gives them the comfort to issue transactions with less transparency than the US PP market. The Schuldschein market tends to be more covenant-light for strong corporate credits.

Fretwell, M&G: That’s true, but that was also the case before the financial crisis. There has been a change that the German corporates just haven’t come to our market. As I say, I think it’s the banking sector in Europe, and particularly Germany, that is causing this.

Macaulay, MIM: Well it’s competition, isn’t it? It’s competing products and a lot of liquidity. So issuers have lots of options. Having said all that, Simon’s right, the US PP market has seen a decrease in volume from continental Europe, over a five year period. But over the last 12-18 months it’s started to rebound somewhat. Perhaps not back to where it was in 2011 or 2012, but it is starting to come back.

You’re starting to see issuers that maybe have Schuldscheine and US PPs, for example, and they’re looking at both products and saying, ‘OK, if I want seven year euros I’ll do a Schuldschein, but if I want 15 or 20 years in dollars then US PP is my natural home’. Some issuers are becoming more sophisticated and going down both paths. 

And indeed, some issuers have been to the Schuldschein and US PP markets more or less in parallel, to cover off different maturities. So that may well be the way the market evolves over time.

GlobalCapital: Inês, you’ve used delayed draws in your transactions — some people felt you pushed the market quite hard in getting them. Does this represent a secular shift in the market?

Faden, Tideway: It is something others have done. But we found that the investors really wanted to have this paper, and maybe for some of them there were windows of opportunity. We have a finite amount of debt to issue and they wanted a piece of it, so they were willing to accept the deferral.

But because of this long term view, this buy-and-hold, and the matching of liabilities, they have a lot of visibility into the future. So in the same way that we have — we are building this tunnel, we need money in four years’ time — they have the visibility of their liabilities and know when they need to place money.

Merkofer, UniCredit: How does pricing work for these deferral periods?

Faden, Tideway: That is an interesting discussion. At the end of the day we look at the all-in price — a margin over Gilts and also the coupon. Investors will want to price in several components, including the deferral, the inflation-linked element and, for CPI issuance, also the wedge between RPI and CPI. We have found that investors will have different views on the various pricing components, so it’s difficult to put a price on deferral. But it has come down — the premium we paid for deferral has come down from when we first issued almost three years ago.

GlobalCapital: Have you brought it down lower than some expected?

Faden, Tideway: Yes. And the comparison with some of the public side pricing is interesting. Last year we issued a private MTN, one of the CPI inflation-linked deals, at 245bp over Gilts. That includes the ‘wedge’ between RPI-linked and CPI-linked bonds, which might have been 80bp or 100bp. The bond also had a four year deferral. 

PD 2019Our public bond, which has a shorter maturity, was trading at the time at about 130bp. So we got very compressed terms on the deferral. But I think the investor had the exact place to put the debt and they were happy.

GlobalCapital: Is this a technique that the Schuldschein market would consider adopting?  

Boehmer, Helaba: We do see delayed drawdowns in Schuldscheine, but for weeks or months, not years. A lot of the investors are banks, and with delayed drawdowns you have capital requirements and that costs money, and therefore it is difficult for them.

GlobalCapital: How happy are US PP investors with such long delay periods as Inês managed to secure?

Macaulay, MIM: One of the reasons deferrals are growing is that it doesn’t really cost investors much. The opportunity cost is relatively low. We would often look out at the forward curve and ask ‘what should we be getting in compensation for this?’

The forward curve is very flat at the moment, which means it’s very cheap, so that works for both the issuer and the investor. So we’re not requiring too much compensation. 

Now, of course, that may and probably will change at some point. So deferrals may not be a permanent feature — we shall see. But I think it is also an example of the private placement market trying to innovate and remain flexible and relevant to issuers.

Merkofer, UniCredit: And it’s guaranteed that you will be the investor when it comes to a drawdown?

Macaulay, MIM: Yes, you’re committing to it as of today, committing to funding within the agreed timeframe. Everyone’s got the certainty.

Fretwell, M&G: We’ve got very low interest rates at the moment. Will they go on forever? If you don’t believe they will, you should do a forward funding now. 

And a lesson from history: we’ve had a number of issuers historically, who’ve got coupons of say 6% or 8%, and when rates went down they weren’t thinking, ‘Oh didn’t we do well because we had a forward funding?’

So it just depends where you start from. With rates where they are, why wouldn’t you do a forward funding if you can get away with it? Because they can’t go much lower.

Faden, Thames Tideway: We’ve been saying that for a couple of years. But if you wanted to raise RPI-linked debt today it would be really difficult. We would have to price RPI at minus 50bp-70bp. And although we priced one of our deals a bit below zero if we adjusted the price, when you get to minus 50bp-70bp most investors are not prepared to do it. 

Fretwell, M&G: Yes. It’s one of the interesting things about pricing if coupons are negative. 

GlobalCapital: You hinted, Simon, that delayed draws might not be around when rates start to go up again. Is that your view?

PD 2019Fretwell, M&G: We’re in an abnormal market at the moment in terms of interest rates. It’s abnormal as well in the sense that corporates know what their funding requirements are. While we’ve had a bit of M&A, it’s been flat for six or seven years — and it’s only about half the level it was before the downturn. Corporates just aren’t functioning normally. They’re borrowing to do some refinancing, which is not really investment. Mid-markets aren’t doing acquisitions either. They’re gearing up to pay out dividends and shareholder returns. So it’s an abnormal market. Brexit has hardly made it easier.

Investors can only do a certain amount of forward funding, as well. It can only be a minority of their book, because they also don’t know what their liabilities are going to be. Quite a lot depends on what insurance products they sell. You tell your insurance sales force, ‘you need to sell this so customers get a rate of 5%, and then we on the investment side, we will achieve the 5% for you’. So it’s useful for some, but it’s not going to be the main meal.

GlobalCapital: Simon, you win the booby prize for mentioning Brexit first. But Martin, how has the lack of certainty affected you as a UK issuer?

Leighton, Great Portland Estates: We’ve not wanted to issue around the times of maximum Brexit uncertainty, but you just get to the point where you have to issue. So there have been US PP deals done in the real estate sector, right at times of really peak uncertainty. 

At some point clearly it’s going to have some kind of concrete impact. But for now it’s just very difficult to plan around it.

In the UK real estate sector, there have been nine US PP issues over the last 12 months, and only two in the public market. And none in the public market since October. So if peak Brexit uncertainty has been over the last seven or eight months, the PP market is still going strong. 

There’s obviously a limit to how much the PP investors can look through these major macro events. But the message still remains remarkably constant. It’s almost business as usual.

Fretwell, M&G: We actually priced five deals in December. It was a strange month because the public markets gapped out, big time. And we had a Brexit date, I can’t even remember which one and why it was important, but there was a date when we thought the markets might be very volatile, or that we wouldn’t actually be able to get a Gilt price. But we priced five deals with no problem at all.

It was exceptionally busy for us. As Martin says, we just carry on. We’ve got to be pragmatic. It’s different from the public markets, we’re not knee-jerk. It’s not the price that came up on your screen at 9.30am and then ‘do we go or not go?’ We have deals. We’ve worked on them. We think they’re good, long term investments, and we carry through. 

And as Martin says, we just don’t know what’s going to happen. We assume the world is going to continue to turn, and we operate on that basis, and I think our portfolio managers think likewise. They’re the ones who make the investment decisions, we give advice on the credit.. 

Leighton, Great Portland Estates: And actually, there was such a number of deals being pulled forward from, say, March 2019 back into December last year, to avoid what was thought to be the key Brexit date. 

GlobalCapital: It’s a slightly theoretical question, but would a UK issuer manage to sell a Schuldschein to the German market right now, given the uncertainty Brexit is creating?

Merkofer, UniCredit: The only thing we’ve seen on the private placement side since the referendum is that certain funds in Europe can only invest in the European Union, according to their mandates. 

They’ve obviously stopped buying UK names, but that has happened very soon after the referendum. 

Also it’s probably not very smart to launch a UK name on a day when you have high Brexit volatility. 

Boehmer, Helaba: First of all, we would sell it to the international investor base. So yes, I think it’s feasible. We’re just at this moment discussing one. 

But of course there are other things to think about. We were recently talking to a French issuer who said he didn’t want to have UK investors in his book. I don’t know what his motivation was, but he didn’t want the complication Brexit would bring. Perhaps he didn’t want to have to explain the presence of UK investors to his board, or to whomever. 

So it makes life a bit more complicated, but I still believe it would be feasible, yes.

Al-Jaafari, RBI: Why should it be difficult? We are now seeing Asian borrowers issuing Schuldscheine. We are talking about the UK, a European country with solid corporates.

Why should we challenge if they can place or not? The only thing I’m afraid of is that maybe the media and politicians make it out as a big story, and then investor behaviour might be affected.

Spain, Italy are also good countries in terms of corporates who can tap Schuldschein markets. Why should we be afraid of UK corporates?

Merkofer, UniCredit: There are a couple of Spanish deals in the market at the moment, so yes. 

GlobalCapital: The US PP market and the Schuldschein have different systems of credit rating, or credit analysis, in the shape of the NAIC ratings for US PPs and the ratings provided by Landesbanks to savings banks in the Schuldschein market. How important are these systems, and do they need reform?

Macaulay, MIM: Talking for the US PP market, the system’s been in place for many a year. US private placement investors are used to it and it seems to function fine, from what I can tell. So I don’t see any great need for change. It’s like anything in the financial industry — there’s regulation, and people just get on with it.

GlobalCapital: There has been discussion over whether the NAIC capital weight buckets could change, to encourage more lower grade issuers to raise US PPs — to lessen the cliff effect between solid investment grade and marginal or sub-investment grade. Has there been any news or development around that? 

Macaulay, MIM: There’s been some talk as you say, but nothing’s come into play yet. I guess time will tell.

GlobalCapital: OK, so swapping over to the Schuldschein, is the system working?

Boehmer, Helaba: Yes, although you should take out the comment about Landesbanks providing some kind of rating that everyone relies on. All the investors do their own credit work. Full stop.

GlobalCapital: It sounds great, but is that efficient?

Boehmer, Helaba: The Schuldschein needs a certain amount of time between the launch and close, which is typically five or six weeks. Technology will help because information will be more easily accessible and communication between investors and issuers will be more transparent and faster. So we believe timings will shorten a bit, but will never be three days. It will maybe be cut by one or two weeks over time. But it’s on the basis that everyone does their own credit assessment.

Fretwell, M&G: NAIC ratings are given after the deal is done, so they cannot be part of an investment decision. And the NAIC has changed anyway because it was understaffed and had a lot of credit work to do. It didn’t necessarily work as efficiently as some of the US institutions would have liked, so the NAIC decided to accept private letter ratings. Which is an element that the investors can influence, through their choice of rating agency, that they weren’t able to beforehand.

Macaulay, MIM: Yes — to the question how would you grow the low triple-B space, one area that has allowed it to grow is these private letter ratings. People are able to get past the capital charge concerns they would otherwise have had.

Leighton, Great Portland Estates: The NAIC feels like a pretty blunt tool to me. We don’t really know how it works. It’s highly opaque. Investors, other than from the capital allocation perspective, don’t seem to pay much attention to what they say anyway. And it’s not particularly relevant to us, frankly.

GlobalCapital: Can these different private placement markets learn from each other about how to attract new issuers or investors?

Fretwell, M&G: We could offer you documentation. We’ve got more pages than you do!

Al-Jaafari, RBI: And the covenants as well!

Faden, Tideway: That is one. The US PP market takes a little bit of getting used to. Once you do one, I can imagine that then it’s easy, but the first time, for someone coming from a different market, it can be quite complicated and different.

GlobalCapital: That is what they say — it’s tough the first time round, but as part of that process, you’ve won the loyalty of investors and they have got to know you properly. In return they stick with you through good times and bad. By and large is that true?

Faden, Tideway: Well, we’ve only done one, but we have seen continued investor interest from the market, so I would say yes.

Macaulay, MIM: Yes, that’s true. A lot of what we do is repeat business. We try and position ourselves as a relationship investor. 

And you’re right, for the issuer there’s the learning curve in terms of documentation, but once you’re up that curve it is a lot easier just to reissue using much the same documents. So it does become a lot more efficient the second time round. 

Faden, Tideway: Like us, a lot of UK utility finance is structured as whole business securitizations. So we have a common terms agreement that you have to overlay on the US PP documentation. But because investors have done this for quite a while there is knowledge in the market. So we didn’t find it that difficult, because others had been there before us. 

Leighton, Great Portland Estates: The number of lawyers working in this space seems to be very small, which could be a disadvantage, but actually it works quite well. It means if you have a question on your covenant structure or anything else in the documentation, the lawyer who’s advising you has probably done a third or half the deals in recent years anyway, and almost knows what you’re going to say before you say it. 

So even if it is your first deal, there’s quite a lot of hand holding you can have.

GlobalCapital: One of the downsides of the Schuldschein is that in the event of some sort of credit issue, when it comes to a restructuring, it can get very complicated because every single investor has as much right as anyone else, and you have to deal with them all separately. This might be 130 institutions who probably won’t co-ordinate with each other, or don’t have to. Is this something that can be worked on? Or would that change the essential character of the Schuldschein?

Boehmer, Helaba: The LMA standard hasn’t addressed that. But this hasn’t stopped the market so far, so I don’t know if it is a big issue or not.

Fretwell, M&G: To be fair to the Schuldschein market, you do have a kind of lead bank that will direct the investors. So there is some kind of informal syndication. 

One of the criticisms of the US PP market is that you’ve got a whole bunch of investors and they are all separate. We don’t have a lead, we don’t have a syndicate, and we have to self-organise, generally with the help of a lawyer. But it hasn’t proved to be too much of a problem in recent years —investors seem to get on with it. 

GlobalCapital: We’ll see at some stage whether it does work properly, because eventually the cycle will turn. We’ve seen a massive increase in, for example, Schuldschein volumes over the last five or six years. There are bound to be blow-ups and it will be interesting to see how the market copes.

Fretwell, M&G: Not having financial covenants makes it a lot easier. Those deals require fewer amendments!

GlobalCapital: How about the outlook? Can we expect the markets to keep growing, as they have done over the past three years?

Merkofer, UniCredit: Private debt in general will grow, as long as rates stay low. Maybe bank financing will be less plentiful available. And investors are looking for yield. So yes, I’m very positive, as long as rates stay as low as they are now.

Boehmer, Helaba: One reason why I believe the market will continue to grow is that new banks have joined the club to promote the product. For example, in the last one or two years you have seen Nordic banks such as SEB arranging deals, as well as Dutch banks such as ING. The hurdle for entry is fairly low.

Al-Jaafari, RBI: I agree. We saw a record year in 2017 with €30bn. This year to date, we are already at €11bn. Meanwhile, the leading banks have a pipeline of between three to five transactions each, and investor appetite remains strong, so the prospects are good.

Whether we will see the €30bn again, it is too early to say. But we are seeing new borrowers from Asia, for example, entering the market, which definitely boosts its image.

GlobalCapital: Reliance, from India?

Al-Jaafari, RBI: Tianjin Rail Transit Group Co has become the first Chinese Schuldschein issuer, marking another step in the Germany-centreed debt market’s global expansion.

GlobalCapital And what about US private placements? Are you positive on the outlook for this market? 

Fretwell, M&G: Yes. Our main competition is the lending banks. They’re not getting any stronger. They’re not getting any more motivated to go back to being the main lenders to corporates.

They’re getting a lot more focused on capital efficiency. So that’ll be good.

And then what’s happened is that slowly more sectors have come to the market — a few years ago we didn’t really have housing associations, universities and schools. Now, they’re established and investors are getting comfortable with them. 

Meanwhile, look at the average length of US PPs — it’s still between seven and 10 years. This means that, because 70%-80% of the market is repeat business, you have got a natural renewal base of, say, 13% a year. So it’s slowly accreting.

Macaulay, MIM: New verticals are definitely opening up and investors are interested in new areas. Simon touched on some, such as education, but we’re also seeing a bit more in the aviation space. A bit around sports financing as well. These have all been quite strong areas in the US. Investors are interested in these newer areas, maybe even local authorities. We’ve not seen anything yet, but who knows? Maybe that could be an area that takes off.

Fretwell, M&G: The Public Works Loans Board is the immediate block to more council issuance. At the moment, councils get excellent rates from the PWLB. We already do business with them on the real estate side  — we do deals with councils, just as we do with the universities on a real estate basis, where we have them as tenants. 

We can structure deals like that so that they don’t have to borrow directly. But direct to a council — I think that’s a big step away.

Faden, Tideway: One other factor to consider is the withdrawal of the European Investment Bank. From 2016 to 2017, lending to the UK fell very sharply, by 70%, and they have virtually stopped since. And of course they operated in some of these sectors, such as infrastructure, universities and housing. I think the EIB had lent £5bn to universities in the four or five years before the referendum.

Fretwell, M&G: One thing we haven’t touched on is how private placements have worked well in regulated markets, such as utilities. However, this could all change if there is a step change in regulation, which could come about with a change in government. It’s a focus for us, as, being a UK institution, we have exposure on the public side. 

By Toby Fildes
17 Jun 2019