Private equity firms are taking advantage of a frothy credit market to pay themselves record sums with borrowed money, a controversial practice that critics say benefits buyout-firm executives but can harm portfolio companies.
Companies backed by US private-equity firms have taken on $58.5bn in dividend-recapitalisation debt this year through 20 October, S&P Global Market Intelligence’s LCD unit said in response to a Wall Street Journal data request. That is more than levels of such debt for 2019 and 2020 combined. The previous full-year record of $51.1bn was set in 2013.
Such loans allow private equity-owned companies to borrow money to pay their owners a dividend, rather than investing in the company’s growth. The loans are typically repackaged into securities and sold to other investors, rather than held by the banks that issued them.
Dividend recapitalisations have surged due to investor demand for high yielding debt at a time of historically low interest rates, credit experts say. An abundance of credit and competition among lenders has also driven volume by creating more favourable terms for private-equity borrowers, with few lender protections that would restrict such borrowing.
“The market has been generous for dividend recaps. Negotiations are such that private-equity firms are able to negotiate very friendly agreements, ” including “attractive pricing alongside very generous terms,” said Christina Padgett, head of leveraged finance research and analytics for Moody’s Investors Service, a bond-rating firm.
Padgett noted that companies that have taken on dividend recaps have had low default rates, because such debt is typically only available for companies with healthy valuations and balance sheets. However, the extra debt can be burdensome, she said.
“It’s more stress on the company because you have increased interest expense. You might have a trade-off of where you’re going to spend your cash flow, to reinvest or service the debt,” Padgett said.
According to S&P’s LCD unit, the largest debt issuances tied to dividends to private-equity owners this year include:
• a $6.4bn debt issuance by Verisure AB, a company that installs alarm systems, which is backed by Hellman & Friedman
• a $3.4bn issuance by glass-repair company Belron International Ltd., backed by Clayton Dubilier & Rice
• a $3.29bn issuance by roofing company SRS Distribution, owned by Leonard Green & Co.
S&P’s LCD couldn’t verify what portion of those debt issuances was paid as dividends to the private-equity backers, rather than being used for other purposes by the companies.
None of the private-equity firms commented on the matter.
Dividend recaps have been common practice for private-equity firms since the industry’s formative years in the 1980s. They appeal to private-equity firms and the investors in their funds because they offer ready cash without having to sell an investment, and reduce the risk of investment loss.
For private equity investors, “your downside is limited with a dividend recap,” said Hugh MacArthur, head of private equity at consulting firm Bain & Co. “It allows financial owners to take chips off the table and de-risk the investment.”
Advocates of tighter financial regulation see problems in the practice.
It “flips everything with modern capitalism on its head,” said Andrew Park, senior policy analyst for private equity and hedge funds at Americans for Financial Reform, a nonprofit that advocates for stricter rules for Wall Street. “It makes no sense that a private-equity firm can pay itself a dividend while the company and its stakeholders end up assuming the liability for that dividend payout.”
Industry proponents say dividend recapitalisations have benefits. The American Investment Council, a Washington DC-based trade group for private equity, wrote in a blog post this year that dividend recaps last year represented only about 6% of total leveraged-loan issuance, that they usually involve loans to healthy companies that can bear the extra debt and that the practice benefits investors such as pension funds.
After dividend recaps stalled at the beginning of the Covid-19 pandemic last year, the practice rapidly expanded as credit markets recovered with the help of easy-money policies from the Federal Reserve.
The cost of debt that private-equity firms use is at historic lows. US junk-bond yields reached their lowest level ever this past summer and are currently around 4.3%, after touching 11% in March 2020, according to the ICE BofA US High-Yield Index. Yields on leveraged loans are roughly 4.4%, hovering near historic lows, according to the JPMorgan Leveraged Loan Index.
Credit specialists predict no letup in the flood of dividend recaps. Weaker investor protections than in the past mean private-equity firms typically have a free hand to extract dividends from companies they own.
“The weak covenants of today’s deals are sowing the seeds of tomorrow’s dividend recaps. It’s a perpetuating cycle,” said Evan Friedman, head of covenant research at Moody’s.
Write to Chris Cumming at [email protected]
This article was published by Dow Jones Newswires