Academic journal article Federal Reserve Bulletin

Recent Developments in the Market for Privately Placed Debt

Academic journal article Federal Reserve Bulletin

Recent Developments in the Market for Privately Placed Debt

Article excerpt

The market for privately placed debt has undergone major changes in the past three years. Life insurance companies, the principal buyers of privately placed bonds, have significantly reduced their purchases of debt securities issued by below-investment-grade borrowers. In addition, the adoption of Rule 144A in 1990 by the Securities and Exchange Commission has spawned a new market for private debt that is similar to the public corporate bond market.

These changes have focused attention on a market that normally receives little publicity because private issuers need not publicly disclose information about themselves or their transactions. Private placements are securities that are exempt from registration with the Securities and Exchange Commission (SEC) by virtue of being issued in transactions that involve no public offerings. (Although "private placements" may be either debt or equity securities, in this article, the term refers only to privately placed debt.) In keeping with the absence of a public offering, private placements are typically offered only to a limited number of well-informed investors, usually institutions, which also generally do not disclose information about their transactions.

The private placement market has long been a significant source of long-term, fixed-rate funds for U.S. corporations. Since 1990, however, below-investment-grade borrowers have found the availability of funds in the private market to be sharply reduced, as life insurance companies have confined their acquisitions almost exclusively to investment-grade bonds. This change in the composition of their purchases has occurred because of public concern about the quality of insurers' assets and because of a regulatory reclassification in 1990 of many private placements from investment grade to speculative grade. The reluctance of insurance companies to lend to riskier borrowers, coupled with the failure of other institutions to fill the void, has shut off many medium-sized companies supply of long-term debt financing. Because any significant return of insurance companies to this segment of the market depends on an improvement in the quality of their other assets, the availability of credit in the below-investment-grade segment of the private market may continue to be limited for some time.

The change induced in the private market by Rule 144A has occurred during the same period but is much different in nature. Rule 144A allows large, sophisticated institutions - defined as qualified institutional buyers (QIBs) - to trade private placements freely among themselves. Relying on the rule, securities firms have begun for the first time to underwrite some new issues, distributing them to QIBs. (Before the adoption of Rule 144A, the conditions under which private placements could be resold effectively prevented the underwriting of private securities.) The advent of underwritten offerings has created a market segment that has many characteristics of the public corporate bond market. This market segment differs significantly from the traditional private market, and it has proved especially attractive to foreign corporations, which can avoid the disclosure requirements of a public offering while still enjoying many of the benefits of the public market. Though the 144A market is still developing and small in size, it could be a major step toward the integration of U.S. and foreign bond markets.

Overview of the Private Debt Market

The private placement market has characteristics in common with both the bank loan and the public bond markets. All three markets are important sources of funds for US. corporations. But, as in the bank loan market, borrowers in the private placement market tend to be less well known companies that require lenders to engage in extensive due diligence and loan monitoring. As in the public bond market, private placements are securities, and their issuance is very often assisted by an agent, who provides many of the services performed by underwriters of public bonds. …

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