Private Placement Buyers Turn To Junk In 98

In one of the more popular moves for private placement bond buyers in 1998 - at least prior to the Russian default - investors last year continued to move down the credit scale in search of higher yield. According to results from the annual survey of Private Placement Letter, a sister publication of High Yield Report, buy-siders put a greater emphasis on mid- to low-triple-B securities as well as junk bonds.

By early 1998, spreads, which had been steadily tightening over the course of the decade, had reached levels of extreme emaciation. Faced with this price compression, investors adopted a number of strategies to pick up extra yield, one of which was participating in lower-quality, riskier transactions.

The evidence of the shift to high yield offerings is largely anecdotal, but it definitely is there, sources said.

"I think in '98, the investor continued to go down the risk spectrum to get more yield," says Allen Weaver, senior managing director at Prudential Insurance Co. His group, Weaver said, did about twice as much below investment grade buying that year compared to years past.

While Prudential dumped almost $8 billion into the market last year, Pacific Life, a $2 billion investor, also reported a greater focus on lower-quality product. The group more than doubled its spending in NAIC-4 investments to $33 million, compared with $15 million the year prior. It also spent $172 in NAIC-3 investments in 1998, $10 million more than the $162 million spent the year prior.

Indeed, many investors are in the private market primarily for one reason: the yield advantage. "We seek privates to get a yield advantage over publics," one source says, rather matter-of-factly.

"I think a big trend was the movement from single-A to triple-B-minus to get spread," says Scott Ingles senior vice president at American General Investment Management. "We increased our below investment grade and equity buying."

The preference for lower-quality, higher-yielding opportunities was expressed by both large and small investors.

Principal Financial Group, which focuses on triple-B-minus and triple-B names, saw "tremendous" opportunity in that segment of the market, according to Dick Waugh, vice president of securities analysis and strategy at the company. "Finally you could get paid for credit risk."

NAIC-2 credits, considered the lower investment grade credits, still soaked up the majority of investment from buy-siders last year, taking the title from the higher rated NAIC-1 investments that reigned the year prior. NAIC-2 investments rose sharply to capture a 45% market share, up from 36% the year prior.

NAIC, or the National Association of Insurance Commissioners, assigns ratings to private placements for the insurance companies, which make up the bulk of the buy side in the private placement market.

Even though a number of investors moved down the credit scale, some investment-grade buyers maintained their dedication to safer, higher-credit-quality deals.

"In general, we feel we never see enough higher-quality stuff," says Chris Pahlke, vice president at American United Life Insurance Co., who added that his group's "hit ratio," a proportion based on deals done over deals offered, was lower last year than in 1997. "It's different perspectives that make markets," he adds. - Akil Roper