Fund managers are reluctantly shopping for up the debt being pumped out by firms to pay their personal fairness homeowners bumper dividends, as an absence of recent mortgage provide and low yields restrict buyers’ selection of different enticing investments.
Buyout corporations attempting to boost money from their investments have been turning to so-called dividend recapitalisations at a file price. Such offers give them juicy money payouts however are sometimes unpopular with bond buyers apprehensive concerning the impression of the bigger debt pile on the corporate’s monetary well being.
Final month Belron Group, which owns automotive windscreen restore firms within the US and UK, launched a dividend recap wherein it will elevate €8.1bn and pay a €4.4bn dividend, within the largest such deal on file, based on PitchBook LCD.
However despite the fact that the dividend almost doubled Belron’s total debt from lower than €5bn to virtually €9bn and led ranking businesses Moody’s and S&P International to downgrade Belron deep in to junk territory, the deal was nonetheless massively oversubscribed, with demand greater than seven occasions increased than out there debt.
“All of us hate dividend recaps — as a bond supervisor, you simply hate them,” stated one investor who adopted the deal and requested to not be named. “However that’s what the market is true now, and if I’m getting flows of capital, I’ve bought to purchase one thing, so I recover from that.”
The deal highlights the dilemma going through many debt fund managers, who’re cautious of being deprived by personal fairness corporations eager to extract money from their portfolio firms however, with debt markets so buoyant, are confronted with an absence of enticing funding alternatives. US excessive yield credit score spreads, the borrowing value premium above Treasuries, fell beneath 3 per cent this month for the primary time for the reason that 2008 international monetary disaster, based on knowledge from the Federal Reserve Financial institution of St Louis.
General, web leveraged mortgage provide in September hit minus $6.2bn, that means that extra loans had been being repaid than issued and marking the most important deficit since February 2022, based on Fitch. Buyers, bankers and analysts count on dividend recaps to stay in style till provide recovers.
“The theme of dividend recaps in 2024 and 2025 will solely get louder however buyers proceed to show themselves very selective on credit,” stated Chris Bonner, head of US leveraged finance capital markets at Goldman Sachs.
“The true query will likely be: are buyers prepared to capitulate and purchase more durable [lower quality] credit, or are they nonetheless going to solely focus their consideration on up-in-quality names?”
The quantity of leveraged loans backing dividend recaps hit a file of greater than $17bn in September, and quarterly volumes are at their highest in three years. Refinancings accounted for greater than 71 per cent of high-yield bond issuance from October 2023 to September 2024, the best share in a 12-month interval since at the least 2016, based on LevFin Insights.
A recent study by Abhishek Bhardwaj, Abhinav Gupta and Sabrina Howell discovered that whereas dividend recaps improve the possibility of final result for an organization’s homeowners, they make corporations riskier and “elevate the spectre of unhealthy outcomes for employees”.
“You might have an prompt response to a dividend recap: it’s destructive,” stated one bond investor, including that not each such transaction was a nasty deal however that when it got here to issuers, “it’s a must to watch out when it comes to who’s going to be extra aggressive than others.”
Different buyers imagine that, so long as the corporate is wholesome sufficient to tackle the extra debt, then such offers are value investing in.
“From our perspective, it’s deal,” stated one other bond supervisor, referring to the Belron deal. “Is it low cost? Most likely not low cost — it’s truthful worth. But when you consider the financial backdrop we’re confronted with at present . . . you need to personal regular, steady companies with money movement in this kind of setting.”
A Moody’s report on Thursday discovered that, of 66 dividend paying firms it examined, solely 5 suffered defaults. Whereas “high personal fairness corporations gorged on extra debt” to fund dividends, “defaults following debt-funded dividend transactions stay scarce as a result of these offers are usually finished by higher-rated LBOs [leveraged buyouts],” it stated.
Many buyout teams are turning to dividend recaps after struggling to return money to their buyers, due to the sluggish tempo of mergers and acquisitions and the unappealing prospects offered by flotations, that are hindering them from leaving their investments.
The shortage of accessible choices for fund managers means the excessive demand for Belron’s debt is no surprise, despite the fact that the deal is “purely a method to return cash to shareholders”, stated Lyuba Petrova, head of North America leveraged finance at Fitch.
“Actually, lenders can vote with their {dollars} whether or not they need to keep within the deal or not,” Petrova stated. “However proper now, there’s a web destructive provide.”
In September Focus Monetary Companions — which, like Belron, is backed by Clayton, Dubilier & Rice — carried out the sixth-largest personal equity-backed dividend recap on file, based on PitchBook. Funding agency 3i this 12 months carried out its eighth dividend recap of Dutch retail Motion, this time to pay itself a windfall of nearly €1.1bn.
Belron declined to remark. Clayton, Dubilier & Rice didn’t reply to a request for remark.
With rates of interest on the best way down and default charges set to stay low, dividend recaps are prone to proceed, stated buyers. Nevertheless, a pointy financial downturn may change that.
“Large image, a lot of these actions are nonetheless fairly minor and fairly muted,” stated Ashok Bhatia, co-chief funding officer of mounted earnings at Neuberger Berman. However “if progress slows considerably . . . that’s when the piper must receives a commission.”
