With traditional bank lending under strain, an alternative form of corporate funding is taking off, as Elliot Wilson reports
Nothing just happens – there’s always a trigger at work somewhere. For Europe’s fast-growing private placement market, the catalyst occurred at the nadir of the financial crisis. Strong corporates seeking to refinance loans or secure fresh funding turned to traditional banking partners, only to find an industry tearing itself apart. That’s when it clicked. Companies needed to diversify their forms of funding away from traditional bank lending – or follow the route to oblivion.
Fortunately, there were options. Once virulently allergic to the bond markets, European corporates have since taken to them like a duck to water. Private debt funds set up by buyout firms, investment banks and asset managers act as financing tools for mid-sized regional enterprises desperate for working capital.
Then there’s the private placement (PP) industry. Simple in nature – it allows corporates to sell securities with medium to long-term debt maturities directly to a small number of private investors – the PP market has been around forever in the United States, where it predates bank loans. British, Irish and Australian firms discovered the product from the mid-1990s.
But the real transformation has taken place in the heart of old Europe, hardly a hotbed of financial innovation. In Germany, the Schuldschein market, key to the country’s thriving Mittelstand mid-size sector, is growing in leaps and bounds. And France has embraced the product like a long-lost friend. Just two years ago, the product barely existed. Then French food group Bonduelle issued six-year Euro PP notes using traditionally styled bond contracts with additional covenants. Domestic investors snapped up the sale.
By the end of September, according to data from financial information provider Dealogic, Euro PP issuance by French corporates had topped £15 billion, with issuance also surging in the Netherlands and the Nordic region. UK corporate PP issuance rose 10 per cent on an annualised basis to £4.8 billion in the year to November 3. Global corporate private placement volumes topped £100 billion over the same period, putting the market on track for a record year.
Even the most powerful FTSE 100 companies see private placements as a viable financing tool on a par with the eurobond market
Many corporates have no other choice but to tap the private market for funding. European Central Bank data shows bank lending to mid-sized corporates falling in 2014 for the fifth straight year, creating a long-term shift towards new forms of direct lending. In the UK, the product has become a mainstream source of funding rather than a niche product. Even the most powerful FTSE 100 companies see private placements as a viable financing tool on a par with the eurobond market.
Issuers love the market’s simplicity and cost efficiency. They don’t need to apply for a formal credit rating, draft a prospectus or list a security. They save cash by avoiding an expensive underwriting fee. Then there’s the relative privacy as the deal isn’t plastered around the world by newswires. Private placements, says Angus Whelchel, co-head of private capital markets at Barclays, “can open an issuer up to different and diverse group of investors” than they may find in the public bond market. They also typically benefit from better pricing and terms. Deals are more flexible by nature, allowing an issuer to mix, say, five-year with nine-year debt, while blending multiple currencies into a single, multi-tranche trade.
Investors, flush with liquidity, are in turn anxious to put capital to work. And while US institutions still make up more than two thirds of the PP market, more European accounts are starting to dial into deals. Earlier this year, Britain’s biggest pension fund manager, Legal & General, said it would begin investing in private placements, joining M&G, the investment arm of insurer Prudential.
There are risks, to be sure. If a firm goes belly-up, so does an investment and, with private placements remaining largely unregulated, due diligence is key. So new investors need to have solid and sophisticated credit analysis risks systems in place, as the illiquid nature of the market makes it tricky to offload debt quickly and easily.
Yet such risks remain largely quantifiable. And besides, there are bigger factors at play here. With European banks still hobbled by debt and facing a slew of new regulations set to kick in later this decade – rules that will further crimp lending opportunities – it’s hard to see corporates turning their back on private placements any time soon. Viewed from any angle, this is a market on the rise.