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THE ECONOMICS OF THE PRIVATE MARKET

Part 1:  An Economic Analysis of the Traditional Market for Privately Placed Debt

Overview of the Traditional Private Placement Market

Part 1 of this study describes and analyzes what is now called the traditional market for privately placed debt. Until the development of the Rule 144A market in 1990, it was the entire market for private debt. It continues to be the larger of the two markets. Unless otherwise noted, in part 1 the terms private placement and private debt refer only to debt securities issued in the traditional market, and the term private market refers only to the traditional market for privately placed debt. 4

Taken as a whole, the traditional and the 144A private placement markets are a significant source of funds for U.S. corporations. Their importance can be seen by comparing gross offerings by nonfinancial corporations of private and public bonds (chart 1). Between 1986 and 1992, for example, gross annual issuance of private placements by such corporations averaged $61 billion per year, or more than 60 percent of average issuance in the public market (table 1).5  In 1988 and 1989, private issuance actually exceeded public issuance, as the financing of acquisitions and employee stock ownership plans boosted private offerings. However, public issuance surged in 1991-92, partly because of the refinancing of outstanding debt, and private issuance fell. The punitive prepayment penalties normally attached to privately placed debt make refinancing unattractive to issuers even when interest rates are falling.

A similar comparison of private placements with bank loans, another major source of corporate financing, is difficult because of a lack of data on the gross volume of new bank loans and because of differences in maturity. Comparing outstanding bank loans with estimates of outstanding private placements is possible, however. At the end of 1992, bank loans to U.S. nonfinancial corporations were $519 billion, whereas outstanding private placements of nonfinancial corporations were approximately $300 billion, or somewhat more than half of bank loans. At the same time, outstandings of public bonds issued by nonfinancial

  1. Gross issuance of publicly offered and privately placed bonds by nonfinancial corporations, 1975-92.

Billions of dollars

 

Sources:  Federal Reserve Board and IDD Information Services.

  1. Average gross issuance of publicly offered and privately placed bonds by nonfinancial corporations, 1975-92

Billions of dollars, annual rate

Type of issuance

1975-80

1981-85

1986-92

Public offerings

21.0

35.6

97.0

Private placements

14.7

19.8

60.5

Source. Federal Reserve Board and IDD Information Services.

corporations stood at $775 billion. 6  In short, the private placement market has provided a substantial fraction of corporate finance in the United States.

Most private placements are fixed-rate, intermediate- to long-term securities and are issued in amounts between $10 million and $100 million.  Borrowers vary greatly in their characteristics, but most are corporations falling into one of three groups: mid-sized firms wishing to borrow for a long term and at a fixed rate, large corporations wishing to issue securities with complex or nonstandard features, and firms wishing to issue quickly or with minimal disclosure. Investors are almost always financial institutions. Life insurance companies buy the great majority of private placements of debt.

  1. Some recent academic studies have used the term private debt to refer to any debt not issued in the public bond market (and similar public markets)-for example, bank loans-and the term private market to refer to all nonpublic debt markets.  In this study, the terms refer only to private placements and their market.

  2. Data for gross issuance of private placements are from IDD Information Services and Securities Data Corporation, which obtain the data from a survey of investment banks and commercial banks serving as agents in placing the securities.  Data for private placements that do not involve an agent are not included. Consequently, reported totals probably understate gross issuance of private placements.

    Cohan (1967) presents evidence that a shift from the public to the private market occurred during the 1930s. He found that private placements represented about 3 percent of debt issuance between 1900 and 1934 but averaged about 46 percent from 1934 to 1965. As noted by Smith and Warner (1979), the relative growth in private issuance partly reflects passage of the Securities Act of 1933, the Securities Exchange Act of 1934, and the Trust Indenture Act of 1939, all of which raised the cost of public debt relative to private placements.

  3. Outstandings of public bonds of nonfinancial corporations are the sum of bonds rated by Moody's Investors Service and publicly issued medium-term notes. Private placements are estimated by subtracting the figure for public bonds from outstandings of all corporate bonds reported in the flow of funds accounts. Data for bank loans are from the flow of funds accounts.

Principal Themes of Part 1 and Key Definitions

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