When the UK Treasury announced on 9 October 2019 a hike in the Public Works Loan Board lending margin from 80 bhps to 180 bhps, it was anticipated that this would lead to an increased appetite from local authorities for alternative, and more competitively priced, sources of finance to fund capital projects and other spending commitments. One such source of finance available to local authorities is via the private placement market. Although a number of UK local authorities, including most recently the London Borough of Brent, have raised finance through the private placement market, the take-up, even taking into account the increase in PWLB rates, has been relatively subdued. The current financial market may however change that.
What is a private placement?
A private placement (or 'PP') transaction is similar to a bond issue but with loan notes being sold to one or more private investors rather than being listed on a public exchange. Essentially a PP constitutes the issue of a series of loan notes under which the issuer undertakes to pay specified sums at a future date.
A fixed interest rate or coupon applies.
Repayment profiles are flexible with scope either for amortisation or a single bullet repayment at maturity.
Maturity dates vary significantly but are often between 20 and 35 years.
Transactions can be structured on the basis of single or multiple drawings.
The minimum amount that can be raised under a PP tends to be about £20m or thereabouts (dependent on the investor involved) with no upper limit, although above about £250m a public bond issue may offer advantages in tapping a wider investor pool.
In contrast to a public bond, there is no requirement for an external credit rating.
How strong is the PP market?
The private placement market is very mature and is dominated in the UK by a number of institutional investors and pension funds. There is also a very well-developed investor base in the USA and Canada where the market originally developed.
PP issuance in the UK tends to be dominated by corporates, educational institutions and social housing providers. The recent London Borough of Brent transaction, reported to have raised £80m, shows the potential of tapping into this market and we would expect this to continue and increase if the current PWLB rates are maintained.
What institutional investors are looking for is strong long-term income streams from secure covenants and local authorities are an ideal potential source of such income streams.
How complex is a PP transaction?
In structure a PP transaction is relatively straightforward (although of course not as simple as a PWLB transaction), comprising effectively the issue of a series of IOUs by an issuer under a note purchase
agreement or 'NPA'. NPAs take a standard industry form but with deal specific terms being subject to negotiation.
Much of the work to secure a successful PP involves the modelling and delivery of underlying financial information. In this regard, for a debut private placement issuer, working closely with an experienced financial adviser is critical.
On timing, a PP transaction can in principle be completed in a few weeks, although for a debt issuer a longer lead in of 2 to 3 months would be prudent.
What are the principal risks?
There are two particular risks to highlight:-
1. The cost of making an early repayment may be very high. This is because such an action will trigger a 'make-whole' obligation under which the investor/s will require to be compensated for the loss of interest that they would otherwise have received in the period to the maturity date of the loan notes. The safest approach is to regard the structure embedded and incapable of collapse during its term.
2. The second practical risk is that there is no guarantee that there will ultimately be a purchaser for the loan notes. An issuer risks incurring the time and cost of structuring a PP transaction and then discovering that due to market conditions no investor wishes to purchase the notes on the terms offered. Working closely with an experienced financial adviser is key in this regard.
Top tips for a successful debut PP transaction
Our experience dictates that the following points are key to a successful private placement transaction:-
- Do not under-estimate the benefit of early engagement with arrangers and potential investors, even whilst still at the early stages of considering a potential PP.
- Your selection of financial advisers is key. Track record and experience in the private placement sector is very important. Cost alone should not be the defining factor in deciding who to appoint.
- Taking into account costs and investor appetite, the minimum PP fund raising is probably about £20m, although ideally one is looking at £35m upwards. Above about £250m, the option of a public bond is worth considering as is the obtaining of a credit rating to open up a wider pool of investors.
- The schedule for completing a PP is fluid but the minimum realistic is probably about 10-12 weeks.
- The investor road-show provides your opportunity sell your organisation to potential investors. Nobody knows more about your organisation then you do. Embrace the process.
- Lastly, there is a huge track record of successful PPs so lots of experience from advisers and investors which can be relied on and brought to bear to ensure successful delivery.
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