Alex Alston, CFA - Co-head of private placements and
Frank LaTorraca - Co-head of private placements
A broad range of insurers are seeking private debt to complement public holdings
Private placements currently average 30% of US life insurers’ bond allocations (source: Barclays Research), while non-US and other types of insurers have increasingly been considering privately placed debt (classified as all nonpublic debt) to complement traditional investment grade holdings in their fixed income allocations. This has resulted in elevated demand that has continued apace in 2018. Below, we review that trend and our current outlook for this space as the year winds to a close with interest rates rising.
Large life insurers have a long history of accessing the US private placement market, in large part because these securities generally have characteristics well suited to insurers’ investment programs — including incremental yield, diversification benefits, capital efficiency, and structural protections that enhance recoveries. The low yield environment of recent years and increased regulatory demands have compounded the challenges for insurance investment firms. As those firms seek to meet the future funding requirements of their liabilities, we believe private debt holdings are often well-suited to help meet the challenges.
Through the rearview mirror
This year shaped up to be much of the same in many respects for the US private placement market. Issuance failed to keep pace with 2017’s torrid pace, as volume through the end of the third quarter ($45.9 billion) was down approximately 18% versus last year’s nine month adjusted number ($55.9 billion) according to Bank of America. We suspect that the decline is probably overstated as it compares unadjusted 2018 volume to adjusted 2017 figures. However, although down from last year’s historically high issuance, 2018 volume reflects a return to the norm in the context of recent years’ issuance barring 2017. Unsurprisingly, the technical imbalance persists, with deals in the market continuing to be oversubscribed. While spreads remain somewhat compressed relative to prior years, the covenants and structural benefits, hallmarks of the private placement market, remain intact.
Issuance has remained broadly spread across sectors. Once again there was a healthy supply of infrastructure transactions, and an even healthier demand for those deals. We have also seen a rise in non-traditional credit tenant leases, many of which were land-only deals and/or had some real estate aspect that complicated the ability to simply underwrite the lessee as a “look-through” corporate credit. Utilities continued to be well represented, accounting for 21% of issuance (source: Private Placement Monitor Datafield), and education issuance also remained strong (both sectors offer significant duration that is attractive to many insurers, given long investment horizons and the need to match long-dated liabilities).
There has been a slight improvement in credit quality, albeit still skewed towards the BBB category, with A- or higher credit quality comprising 35% YTD volume (versus 28% for full year 2017) based on data from Private Placement Monitor. Reported spreads in this quality bucket ranged from 77 to 180 basis points. The BBB category comprised approximately 65% of YTD volume through the third quarter, with reported spreads ranging from 95 to 355 basis points. Once again, high yield issuance was less than one percent of total volume. US-domiciled companies were responsible for 53% of 2018 YTD volume issuance, while US dollar-denominated issuance comprised 76% of the market volume. Euro and pound sterling issuance accounted for 5% and 12%, respectively. Borrowers continue to capitalise on the flexibility afforded by the market, with 29% of issuance thus far subject to a delayed funding. (source: Private Placement Monitor Datafield)
Once again there was a healthy supply of infrastructure transactions, and an even healthier demand for those deals.
Given the more modest issuance in 2018, the supply of transactions has been no match for the continued growth in demand for US private placement assets. The technical imbalance has continued to result in frequent market oversubscription, with some deals three to four times oversubscribed. In an environment of already oversubscribed deals, we find strong agent relationships matter more than ever in building an allocation to private placements. Agents don’t need to show most deals to the entire market in order to garner sufficient bids and fill out their books. And for broadly syndicated deals, the differences between favorable and unfavorable allocations can be meaningful.
Although spreads remain compressed, we have seen an increase in yields on the back of lower priced US Treasuries. Despite the year over year slowdown, we still anticipate an acceleration in issuance over the next year or two, as companies look to lock in lower funding costs. We also remain vigilant to rising interest costs precipitating negative credit migration in the medium term.
Ultimately, we expect the US private placement market to exhibit controlled growth on the supply side, moderated by the structural discipline of industry incumbents. Spreads will continue to ebb and flow with the credit cycle, similar to the experience of public credit markets. Interest from nontraditional investors that have not yet accessed the market may wane in some environments, but we expect strong demand to continue from the incumbent investor base, as well as from new investors that have gotten a taste of the benefits afforded by the US private placement market.
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