Private placements market update August 2022

Private placements (July 2022)	15-year	20-year	25-year	30-year	35-year
Fair value spread U.K.	1.60%	1.70%	1.80%	1.95%	2.05%
Fair value spread U.S./Canada	1.65%	1.70%	1.85%	1.70%	—
Gilt yield	2.44%	2.49%	2.49%	2.45%	2.35%
All in cost U.K.	4.04%	4.19%	4.29%	4.40%	4.40%
All in cost U.S.	4.09%	4.19%	4.34%	4.15%	—1

¹ U.S. investors lend in sterling. Pricing is impacted by currency and swaps. Best offers generally out to 30 years.

The PP market sits between the banking market and the public bond market and offers more flexibility in terms of amounts, drawdowns, and redemption profiles than the public bond market. Furthermore, PPs are less covenant restrictive and intrusive than bank debt. In current volatile markets, it also enables larger borrowers to tailor the terms and size of an issue to demand rather than take on the visible execution risks of a large benchmark bond in the public markets.

The PP market has remained strong and open despite wider macroeconomic volatility and continues to be a stable source of debt capital for Housing Associations (HAs). 2022 has seen strong issuances from the sector driven by good levels of demand from investors (both U.K. and North American).

The PP market has met the demand of borrowers looking to lock-in long term funding where:

• The volume does not justify the issue of a benchmark bond and amounts as small as £25M are possible though transactions of at least £40M are preferred.
• A deferred drawdown profile and/or amortising repayments better suit the cashflow of the business. In particular, investors will lend on the basis of deferred drawdowns of between 1–5 years.
• The issuer does not wish to obtain a credit rating; however, this will restrict the number of investors who could potentially bid.
• Long-term unsecured funding is being sought.

Key pricing considerations

UK investors

U.K. investors price relative to secondary trading levels in the public markets focusing on similar credit comparisons and then adding an illiquidity premium.

Over the past six months, HA secondary spreads in the public markets have widened by c.40–50bps. This has seen overall pricing push up to c.4%–4.5% across the curve. Market volatility has also increased the premium that has to be paid on new issues (“New Issue Premia” or “NIP”) to c.10–30bps.

PP investors cannot easily trade in and out of their investments so they charge an illiquidity premium on top of this – generally this will be between 10–25 bps. However, occasionally if an investor has a particular requirement that an issuer can meet, there is no premium. Also, we are seeing meaningful ESG discounts for issuers who outperform their ESG KPIs which can effectively negate the illiquidity premium.

U.S. and Canadian investors

The largest group of private placement investors are U.S. insurance companies who lend widely in the U.K. but often in U.S. dollars. Over the past 10 years, an increasing number of U.S. and Canadian investors have offered to lend in sterling. This is very efficient as given the size and credit of these institutions, they can execute the necessary cross currency swaps at much lower cost than most borrowers using the market.

U.S. investors will base pricing on USD Public Market comparables (with a regulatory rating of NAIC-1 – equivalent to A category S&P/Fitch/Moody's ratings) which include some U.S. residential REITs and most regulated U.S. utilities. By investing overseas, they are looking for a higher return for an equivalent or better credit. Where they lend in sterling, they also have to take into account the cross currency and interest rate swaps to move from fixed rate dollars to fixed rate sterling. This involves multiple steps and for comparison purposes, we have combined these into a single translation adjustment which will vary with U.S., CAD and U.K. rates and the foreign exchange rate.

The cost or benefit provided by the cross-currency swap can move sharply over relatively short periods of time either adding to the margin over US treasuries – or reducing it significantly. In general, when sterling is rising against the USD there is a benefit - allowing U.S. investors to be more competitive in GBP spread terms - while when it is weakening there is a cost.

Picking a private placement arranger is therefore dependent on whether the borrower is focusing on the U.K. or North American market. Only some arrangers are licensed to operate in North America, and it is important to find out which can approach this market before making a decision. Access to onshore U.S. investors here is key, rather than via their U.K. offices, in identifying true value differentials.

U.S. investors will also generally require a rating of ‘A-‘ or better as without it, there is a danger that the borrower is treated as an NAIC-2 which attracts a higher cost of capital. US utilities and REITs comps are often NAIC-1.

Chart 1 below highlights the evolution of credit spreads for NAIC-1 rated issuances in the US. Chart 2 then looks at the relative value gain (or loss) generated from U.S. investors in GBP terms (fair value) for similar credits when compared to spreads offered by U.K. investors (Chart 2). In short, the U.S. investors tend to price more competitively than U.K. investors driven partly by their comps as well as the value derived from the cross-currency swaps.

Other developments

Covenants: Generally, PP investors look for asset cover, income cover and some ask for limitations on gearing. Since the beginning of COVID-19, there have been a number of covenant developments: PP investors were much quicker than the banks in recognizing that EBITDA-MRI covenants were no longer fit for purpose. EBITDA only ICRs are now standard in the market – and with low multiples. On the other hand, the area where covenants have become tighter is around merger where more and more investors are moving from no restrictions to requiring consent, albeit ‘not to be unreasonably withheld’ or a minimum rating hurdle.

Credit focus: U.S. investors now generally require a credit rating – of A-/A3 or above for best pricing, whereas U.K. investors are still content to invest in unrated PPs though there is generally a premium for this. Regulatory ratings have become a key focus for investors, and some will not invest in borrowers with a G2 rating.

Investors continue to run a comprehensive due diligence exercise with increasing focus on fire safety, EPC ratings and zero carbon spend. Expectation is that most issuers now have indicative costs in their business plans reflecting both the path to EPC C minimum by 2030 and achieving zero-carbon by 2050.

Finally, the impact of inflation on business plans and operating margins remains the key topic for this year. Investors are keen to understand the level of conservatism applied in both business plans assumptions and any impact (delays) on the development pipeline/aspirations.

ESG: ESG is less important to North American Investors than U.K. investors who are keen to lend on a Use of Proceeds or Sustainability Linked basis. The latter works very well in the PP market and significant discounts are available.

Process

The PP market is very competitive and if North American Investors are involved, there is a clear auction style process designed to obtain best pricing and best covenants.

The PP process takes between 4–6 weeks to pricing. It involves preparing marketing materials, a roadshow (virtual or in person), and 1:1 meeting with investors before formal bids are submitted and transaction is priced. The Investor presentation and the NPA are the two key marketing documents that need to be prepared ahead of launching roadshows. Key to a successful transaction is to deliver a strong credit story and to set out the nature of the facility being sought – amount, maturity, requirement for deferred drawdowns, any special feature e.g., higher proportion of shared ownership security etc. This will generate a range of offers which can be mixed and matched to obtain the best overall pricing.