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US private equity firms are rushing to take advantage of lower borrowing costs by loading debt on to their portfolio companies and then using the cash to pay dividends to themselves and their investors.
Corporate borrowers sold $8.1bn worth of junk-rated US loans to fund payments to shareholders in January, more than six times December’s total and the highest monthly figure in more than two years. The vast majority were issued by companies backed by private equity firms, according to data from PitchBook LCD.
With weak deal volumes and sluggish demand for initial public offerings making it harder to offload existing investments, private equity firms are turning to these so-called dividend recapitalisations as a way of pacifying investors eager for a return on their capital.
“Credit markets are hot right now,” said a senior private equity executive. “It is a great opportunity to issue or refinance debt at a lower cost of capital,” the person added, referring to dividend recaps.
The opportunity provided by the sharp drop in borrowing costs in recent months has come at a welcome time for private equity firms.
Many are facing pressure from their own investors to return some cash, and are well aware that doing so is key if they want to attract investors into new funds they launch in future.
“I think there’s a lot of pent-up demand by sponsors to have market access,” said Kevin Loome, US high-yield portfolio manager at T Rowe Price. “Sponsors are under a lot of pressure to return capital to investors.”
John McClain, a portfolio manager at Brandywine Global Investment Management, said that “anecdotally . . . [investors] in private equity and in private credit, they’re waiting to get distributions before they’re thinking about committing to the next round.”
Dividend recaps surged in popularity during the early stages of the coronavirus pandemic after the US Federal Reserve cut interest rates to near-zero, but fell out of favour in 2022 and early 2023 as borrowing costs rose.
Debtholders are often wary of large volumes of dividend recaps, as they typically burden companies with higher degrees of leverage and may backfire if a borrower’s growth expectations fall short or interest rates rise.
In the past month, companies that have done such deals include technology group IntraFi Network and chemicals distributor Univar Solutions — backed by private equity giants Warburg Pincus and Blackstone, and Apollo respectively.
Univar borrowed $450mn in new term loans to pay a dividend to its private equity owner Apollo, which had closed a more than $8bn takeover of the company six months earlier.
Warburg Pincus and Blackstone have borrowed about $800mn since December against InfraFi Network in order to pay themselves a large dividend. KKR-owned 1-800 Contacts last month borrowed $565mn in first lien debt to repay a higher-cost $315mn junior loan and fund a $250mn payout to itself.
Debt markets rallied strongly at the end of last year, after the US Federal Reserve signalled that it had finished its campaign of aggressive interest rate rises and was expecting to make three quarter-point cuts in 2024.
Private equity-backed companies have used that as an opportunity to refinance as a way of lowering their interest burdens. For instance, UKG, a large software company backed by investors including Hellman & Friedman and Blackstone, in January refinanced more than $7bn in term loans, cutting its interest rate, partially by increasing the use of first lien debt.
The sheer number of loans trading above par last month has also allowed more borrowers to negotiate with their investors to reduce the interest rates on their existing debt. So-called repricing volumes for US junk loans soared to $91.2bn in January, the highest monthly total in four years, though a considerably smaller share of junk loans was trading higher than face value by last week.
Market participants said repricing activity in relation to older loans had helped to fuel demand for new loan issuance. “We had this avalanche of repricings,” said Andrzej Skiba, head of US fixed income at BlueBay RBC GAM. “People were actually quite starved of new money loan paper . . . So that made investors more amenable to consider dividend distributions.”
The high volume of repricings and dividend recap loan issuance in recent weeks comes as bond sales by US investment-grade companies hit a record for January of about $180bn.
High-yield borrowers also issued more than $30bn in bonds, data from PitchBook LCD shows, while new junk loan issuance still hit more than $65bn, the highest monthly figure since September 2021.
“Yes, there’s been more supply in January, and February’s looking like it’s going to be a busy month as well,” said Skiba.