Wall Street's Lab
The private-placement market, often an overlooked nook of the credit markets, offers a lifeline for many companies seeking to wean themselves off of bank loans
October 16, 2009
A specialized market that has for decades served as Wall Street's laboratory where new structures and issuers are introduced, private placements have become an important source of funding for companies looking to pay down debt, or what's come to be known by deal makers as "The Wall of Maturities."
The world of private placements may not be on the lips of the broader public as much as, say, the daily movements of the Dow, but this rarefied arena has allowed deal makers to introduce new deal types such as music securitizations where artists like David Bowie and James Brown sell off the rights to their music royalties.
More recently, a transaction involving the Chicago Cubs baseball franchise raised money through the sale of debt backed by Wrigley Field stadium revenues. While the pop-music royalty deals captured the public's interest, much of what goes on in private placements actually involves businesses that want to pay down debt, finance an acquisition or pay for the upgrade of equipment.
This year, a bulk of the issuance has come from industrial, utility and energy companies, and many of the deals have maturities of five to 10 years, but transactions in this specialized market can have maturities that are as long as 30 years. There is a greater sense of urgency for many issuers in the market today because fewer bank loans are available and many are set to expire, so corporate treasurers and CFOs are scrambling to secure steady financing that offers them breathing room.
While the market has been around for decades — Wall Street firms served as agents for transactions in the 1920s and 1930s — the industry's prominent players have changed. Commercial banks now play a larger role, supplanting investment banks, and some market players believe it's possible that they may be supplanted by the very buyers of these specialty deals: insurance companies.
Wall Street's special service
Private placements of debt are typically agented, as opposed to underwritten, because of nuances in Securities and Exchange Commission regulations. Bankers serve as go-betweens between a wide array of issuers and buyers of the debt. Deal pros and issuers typically hash out the specifics of a deal directly with investors — most of them insurance companies. "The investor base is comprised of credit-intensive investors," says Fiona Gallagher, head of the private placements business at Deutsche Bank, adding that the market has recently drawn in European investors such as insurance companies and pension funds that are willing to do the intensive credit work.
While the market was in existence between the two world wars, participants say it really took off in the mid to late 1970s. By the 1980s agents from firms like First Boston, Goldman Sachs and Merrill Lynch were the dominant force in assembling private placements. Commercial banks, though, have pretty much dominated the market since the 1990s.
"Commercial banks, when they came in, started to compete on fees," recalls Andy Goff, head of debt capital markets-private placements at KeyBanc. "Investment banks decided they would not compete on fees and focused on where they could make better returns. The talent moved to the commercial banks because deal flow began to increase."
For many of these newcomers, offering the service of a debt private placement complemented other bank services. One of these commercial banks, Bank of America, has been the top agent of private placements for 12-and-a-half years. This year, B of A and JPMorgan Chase are the two top market players, alone accounting for nearly half of this year's business, according to data compiled by Thomson Reuters.
Other leading agents of private placements are RBS, Barclays Capital and Citi, according to Thomson Reuters.
What keeps business managers awake at night
The credit crisis dampened private-placement activity but business has come back as broader credit market conditions improved. Earlier this year, privately placed debt issues were priced at spreads of 400 to 600 basis points over 10-year Treasuries, but credit spreads have shrunk to half of that, says KeyBanc's Goff, noting that for many issuers "the biggest concern is refinance risk a year to two from now."
According to Stephen Monahan, head of the private placements group at B of A, company CEOs are looking to change how their firms borrow. Before the credit crisis, bank debt was inexpensive and companies could readily get a five-year credit facility. But now, if these credit facilities are amended or extended, the cost of money is typically much higher and borrowing terms are more restrictive. Also, credit facilities rarely extend beyond three years. "They have to turn to other sources of liquidity," says Monahan.
"Our current deal flow is a bit of refinancing and extending maturities," says Conrad Owen, head of the private capital markets business at Mitsubishi UFJ. "Rates are now low enough that clients will borrow and pay down some bank debt."
One such company is McCain Foods, a New Brunswick, Canada-based food processor, say market participants. Proceeds from a private placement completed this year were used to refinance existing debt and pay down loans.
Others who have raised money in the private-placement market this year include Tiffany & Co., which completed a $250 million issue, BNSF Railway, which came to market with a $26.4 million offering, and Union Pacific Railroad, which raised $350 million, according to Thomson Reuters.
In the year since Wall Street's credit well went from wet to dry to wet, the greatest lesson learned by many company managers is the need to always have a readily available source of credit. It is a concern that has permeated how analysts track companies and this, in turn, impacts managers of many corporations.
"With the credit disruption of the last two years, the top agenda item of [company] boards and [company] analysts is 'what are you going to do about that looming debt maturity," says B of A's Monahan. As he sees it, the "natural assumption of 'oh, we'll refinance it' does not work'" anymore, spurring many company treasurers and CFOs into action. "Banks are more cautious on credit. So, there is a natural desire [among company managers] to diversify funding sources and lengthen maturities," Monahan says.
The concerns about readily being able to refinance a loan or any other debt are confirmed by various data that suggest many banks are still skittish about lending. For those who can get a loan, chances are it will be pricier or the terms will be tougher.
A survey of loan officers conducted by the Federal Reserve in July found that banks continued to tighten standards and terms on all major types of loans amid lingering concerns about the broader economy and less tolerance for risk. In addition, spreads on loan rates remain costly, according to the Fed survey, which found that lending standards likely will remain tighter than they have over the last decade until at least the second half of 2010.
"This [private placements] is one of the few outlets for many issuers," Gallagher says, noting that the market remained largely open throughout the most intense periods of the credit storm. "Even throughout the financial crisis, flexibility in the market never wavered." Some of this, she says, may be because investors are willing to accept creative structures, something that lowers the cost of money for issuers and cannot readily be done with an SEC-registered public deal. "One area where the private placement market has been creative is project financing," Gallagher added. "The bank [loan] market was where most project financing was done. Now the private placement market is filling that project financing side."
In addition to roping in a wider range of financing, private placements have been important source of capital for utilities facing capital expenditures. "They have capital expenditures they have to finance," related to the installation of pollution control equipment, says Goff.
Utilities that have turned to the private placement market this year include Newfoundland Light and Power, Kentucky Power Co., and CH Energy Co.
Meanwhile, not all companies that turn to the private placement market are publicly traded. In the case of B of A, half of the Charlotte banking giant's private placement team's work involve private companies. "Most private companies have no interest in issuing in public [debt] markets," says Monahan, who estimates that 70% of the dollars raised by his team are for private businesses.
While the pace of private placements of debt has dropped off from the years before the credit market storm — in 2007 issuance was roughly $42 billion and in the 1990s it hit $50 billion — underwriters of the deals have been able to manage a drop in their deal flow by raising deal fees. To date, the top 15 private-placement agents have completed 59 deals worth $10 billion. Last year 164 deals worth just over $28 billion were completed.
B of A's Monahan declined to offer details about fees he charges, and Owen alsodeclined to offer specifics about fees. However, Monahan says "there has been a repricing of services," meaning it costs more to hire an agent to get a deal done. "Right now, with the tremendous focus on liquidity and execution, people are less concerned with the cost of banking fees. They [company treasurers] are much more concerned about execution quality and whether their deal gets done."
Meanwhile, the market may be amid yet another stage of its evolution. Deal makers say that the end buyers, insurers, have stepped in to deal with issuers directly, cutting out Wall Street agents.
Market participants say that MetLife and New York Life have been particularly active in going directly to issuers. Some market players fear that if this takes away enough deal volume, some Wall Street firms may not be as focused on the market. Whether this is a permanent situation is uncertain, given that credit markets have undergone shock treatment since Lehman Brothers' bankruptcy. "The reality is that with volume down, some insurers feel they need to take matters into their own hands," says Owen.
Deutsche's Gallagher, though, is not alarmed by the shift in roles. As she sees it, issuers turned directly to buyers of their debt as a response to the credit markets being frozen. "At the beginning of this year and at the end of last year, when the overall markets were volatile, that may have been attractive to some issuers," she says.
KeyBanc's Goff says the direct approach to issuers by investors has actually been around for some time and it's not an issue that raises much concern for him. He didn't see the direct-placement approach as a way to save on costs by cutting out Wall Street's private-placement agents, but more of an attempt to snare deals to put money to work. "In the case of marketed transactions there is no assurance that a particular investor gets any bonds," Goff says. "By going direct they have a better chance of being involved in a major way with that issuer. It's more of a hunger for deals."
(c) 2009 Investment Dealers' Digest and SourceMedia, Inc. All Rights Reserved.
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