Private placements combine the duration of fixed-rate public corporate bonds with the legal protections and covenants that are contained in most bank loans.

Relative to investment-grade public bonds, private placements offer:

• Covenants, which provide downside protection and potential for additional fee income
• Diversification through exposure to borrowers and assets that are typically not found in the public debt markets
• Yield enhancement, compensating investors for illiquidity and structural complexity

The asset class has shown to be durable in a variety of market conditions and is best suited for investment managers with strong legal and credit underwriting skill sets, along with long-standing market relationships.

Private placement bonds

Why issuers access the private market

For decades, the U.S. private bond market has provided borrowers across the globe with consistent access to term funding. This was especially apparent during the 2008-2009 global financial crisis when major debt capital markets became disrupted, yet the private placement market remained a viable place for companies to issue term debt. In the years following the financial crisis, the U.S. private placement market experienced increased cross-border issuance as a number of European banks curbed lending.

Some issuers prefer keeping financial and company information private — this may be for trade purposes or to preserve confidentiality for family-owned companies.

Private bond issues do not require registration with the SEC or a rating from rating agencies. Although the company issuing a private bond must provide detailed information for underwriting, distribution is often limited to a select group of investors.

How private placement bonds compare

Value for private placement investors

In our experience, the private bond investor universe is comprised of approximately 40-50 institutional firms. Investors consist largely of life insurance companies, in addition to asset managers and pension plans. Most of these firms have a long private bond history, although new investors have recently shown increased interest. New investors to the private bond market often work in association with experienced private placement asset managers.

In addition to structural protection, diversification and higher yields, investors value the opportunity for pre-purchase due diligence found in private bonds. Private bond holders can also build relationships with management at the time of the deal and

maintain those relationships after purchase, which can be important if covenants come into play.

Strengths and considerations for investors

Private placements provide investors an opportunity to generate higher total returns versus holding a basket of similar-rated public bonds. This is achieved by several factors:

Structural protection. Covenant protections, a key differentiator between public and private bonds, provide downside protection to investors from financial and event risk. Covenants also ensure seniority in the capital structure, which, in the case of default, typically results in higher recoveries for private placement investors, relative to public bond holders.

Covenants legally compel management to maintain key financial metrics. Examples include limits on leverage (i.e., debt/EBITDA), restrictions on asset sales and requirements to maintain minimum coverage ratios. Covenant violations can trigger default and/or compensation to bond holders through waiver or amendment fees, and pre-payment premiums that can add 10-20 basis points of additional fee income per year and coupon bumps to +50-100 basis points.

2021 Issuance by sector

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 can be strong for performing, well-covenanted private 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, operations and trade settlement 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.