Yield Enhancement. Upfront, private placements provide 15-50 basis points of additional spread relative to public bonds. The incremental yield for private placements compensates investors for the perceived lack of liquidity relative to public bonds, as well as a compensation for strong covenant protections.
Diversification. A large number of private placement issuers do not issue debt in the public debt markets, thus providing investors additional portfolio diversification. Types of issuers accessing the U.S. private placement market range from utilities, industrials, infrastructure and project finance to professional sports leagues and stadiums/arenas.
While the private placement secondary market is considerably smaller than the public secondary market, and the potential for resale can be limited for smaller transactions, liquidity is strong for performing, well-covenanted private bonds. This was evident during the global financial crisis, where some investors obtained liquidity by selling private placement bonds when they were unable to sell their public bonds.
Approximately 60 percent of transactions are not rated by a credit rating agency; therefore, investors in private placement bonds must have the capability to perform an independent assessment of credit risk. Additionally, private placement investors must also have the ability to underwrite covenant packages and legal jurisdictions.
Demonstrating the advantages
The following real-life examples of common credit events highlight the strategic advantages of private placement covenants and the protection they provide.
The value of covenants. An issuer with both public and private bonds outstanding experienced deterioration of credit fundamentals and a decline in profits following M&A activity. As a result, the public bonds fell to below investment-grade and began trading well under par. However, the strong covenants of the private placement bonds provided protection to noteholders. Although they initially fell to below investment-grade, the private placement notes were prepaid at Treasuries +50 basis points make whole shortly after the triggering event.
Ability to negotiate amendments. In another example, the cyclical downturn in energy markets tested the covenant levels of a private placement bond. Consequently, the company requested amendments to the note allowing covenants for leverage and fixed-charge coverage to be temporarily loosened. The ability to negotiate directly with company management on behalf of private noteholders resulted in limits placed on capex and dividends. Noteholders received a coupon bump as well as an amendment fee, and obtained a partial pre-payment at Treasuries +50 basis points make whole.
Expertise and experience count
Private placements demand extensive due diligence, and this responsibility falls on the buyer. Investors must have considerable legal, credit and back office resources and expertise in order to effectively evaluate, negotiate, underwrite, price and monitor private placements. Building those capabilities requires time and resources, which is why a relationship with an experienced firm that provides such expertise is so valuable.
Creating a strong private placement portfolio takes time. Investors must be selective and attentive once the investment is part of their portfolio. Proactive credit monitoring, ongoing review of covenant compliance, and periodic valuation analysis are necessary exercises in maintaining a healthy private portfolio.
It takes an experienced hand to successfully tap the benefits of the private market. Investors can find that experience by working with an asset manager who has specific private placement underwriting and legal expertise, and solid private market relationships. Securian Asset Management (Securian AM) offers investors access to over 40 years of expertise, as well as our dedicated teams of experienced attorneys, private placement analysts and portfolio managers.