THE ECONOMICS OF THE PRIVATE MARKET
Evidence That a Credit Crunch Occurred
Recent events in the below-investment-grade segment of the private placement market qualify as a credit crunch because gross issuance or originations for below-investment-grade debt declined substantially and spreads on such debt increased sharply, whereas spreads on investmentgrade private placements held steady or declined. A general increase in the riskiness of borrowers cannot account for these phenomena. The decline of issuance may have been accomplished partly by nonprice rationing, but we have no quantitative evidence to support such a claim, and market participants' remarks about nonprice rationing were mixed.
Data from three separate sources confirm a reduction in issuance of below-investment-grade private placements. First, gross issuance by below-investment-grade, nonfinancial corporations fell more than 50 percent in 1991, a much steeper drop than that seen in issuance by investmentgrade corporations (table 12). 147 As a percentage of gross offerings, below-investment-grade issuance declined from 16 percent in 1990 to 9 percent in 1991. Data for 1992 indicate that issuance remained depressed, although the percentage was slightly above that in 1991. Second, although total commitments by major life insurance companies to purchase private placements remained roughly constant from early 1990 through mid-1992, the proportion of below-investment-grade issues dropped sharply in the middle of 1990, from 21 percent in the first half of 1990 to 11 percent in the second half of that year. Since then, the percentage has varied between 31/2 percent and 71/2 percent (chart 16). 148 Third, the reduced rate of gross purchases indicated by the survey is also evident in insurance companies' holdings of below-investment-grade securities. Holdings of such securities at all life insurers fell 11 percent in 1991, whereas holdings of investment-grade securities rose nearly 12 percent. As a result, speculative-grade private bonds as a percentage of all private placements in insurance company portfolios declined from 19.8 percent in 1990 to 16.7 percent in 1991. The low rate of commitments to purchase below-grade private placements in 1992 led to a further decline in their share to 15.3 percent last year.
Accompanying the decline in gross issuance and outstandings has been a sharp increase in yield spreads on below-investment-grade private placements. According to market reports, before 1990 the difference between yields on BB- and BBB-rated private placements with comparable terms was about 100 basis points; since then, the difference has been as high as 250 basis points. 149 Although data are unavailable for periods before 1990, the relative movement in yields on BB and BBB private bonds is confirmed in the spreads reported in the ACLI survey (charts 17 and 18). 150 During the first half of 1990, the spread between yields on BB private placements and comparable Treasury securities was about 300 basis points, compared with 190 basis points on BBB private placements. From that time, the spread on BB bonds moved up to almost 425 basis points in the second quarter of 1991, but more recently it has retreated to around 350 basis points. During the same period the BBB spread drifted down to 180 basis points. Similarly, the spread on A-rated private placements varied little over the past three years. 151
The substantial increase in spreads over Treasuries for BB private placements cannot plausibly be attributed to a general increase in risk associated with the slowdown in economic activity because such an increase in risk should have also led to an increase in BBB spreads. In fact, those spreads declined. Similarly, although the slowdown might have caused issues to be more concentrated at the low-quality end of the risk range that each rating category spans, leading to an increase in average spreads for each rating category, such a mechanism should have affected both BB and BBB spreads. The data thus indicate that, within the below-investment-grade segment of the private placement market, for a given level of risk loan prices went up whereas the volume of loans went down. These facts support our assertion that a credit crunch occurred within that market segment.
16. New commitments to purchase below-investment-grade placements as a percentage of total commitments by major life insurance companies, 1990-92