The leveraged finance market's summer recovery breathed fresh life into dividend financing, with issuers tapping loan accounts for $6 billion of dividend-related new issues during July -- the most since March -- and a further $2.5 billion over the first 10 days of August.
The summer's burst of loan activity brings dividend-driven loan volume to $30.3 billion over the first seven months of 2012, versus $35 billion during the same period in 2011. Still, recap activity remains on pace to exceed the all-time high of $49.3 billion from 2007, assuming conditions remain strong.
By contrast, high-yield bond recaps went missing entirely in July and early August despite hot market conditions, and they continue to lag far behind last year.
Bond recap volume totaled $7.4 billion in the year to July, down from $19 billion in the same period in 2011. Therefore, total dividend-related leverage financing is down 30%, to $37.7 billion, year-over-year.
As this suggests, loans' share of the overall recap pie grew to a commanding 80% between January and July, from 65% during the first seven months of 2011.
The reason dividend financing has skewed toward loans this year is the outsized influence of private equity firms in this financing segment. PE firms, arrangers explain, want to preserve the option of tapping the initial public offering market or selling off portfolio companies unencumbered by the no-call periods and high prepayment fees associated with bonds.
PE-backed firms, in fact, account for most of July's recap activity, thanks in part to a big boost from several marquee deals. Booz Allen Hamilton Inc., which is public but still largely owned by Carlyle Group, for instance, tapped the loan market in July for a $1.025 billion term loan backing a dividend. This financing piggybacks on a $1.50 per share (or roughly $200 million) special cash dividend that Booz paid out in available cash. Other prominent PE portfolio companies to issue recap loans in July include West Corp. (Thomas H. Lee Partners LP and Quadrangle Group LLC), Genpact International Inc. (General Atlantic LLC and Oak Hill Capital Partners) and Dunkin' Brands Inc. (public, but backed by Bain Capital LLC, Carlyle and THL).
With so many big recaps in the mix, 2012 has been the year of the dividend for PE firms. Consider that as of Aug. 10 Standard & Poor's Leveraged Commentary & Data has tracked $13 billion of dividends financed with leveraged loans, versus $18 billion of equity invested in new leveraged buyouts. That means that sponsors collectively have withdrawn 72 cents of dividends for every dollar of fresh capital they've invested in a new LBO (again, this is for deals backed by leveraged loans). Said another way, 43% of PE capital flow has been out of issuers via dividends -- surpassing the prior high of 33%, from 2010.
Looking ahead, participants expect dividends to remain a major source of loan supply. For one thing, arrangers say that though screening activity for new LBOs has picked up recently, most of these potential deals will not materialize until the fourth quarter. That will leave plenty of room to issue dividend deals in the months ahead when technical conditions allow.
Also, PE firms are still focused on generating liquidity for limited partners that have seen relatively few liquidity events since the bear market of 2008-2009. In 2012, for instance, LCD has tracked 31 sponsor-to-sponsor deals, while S&P Capital IQ lists 14 PE-backed IPOs. By comparison, there have been 52 dividend deals alone so far this year through which PE firms have extracted 60% of their original capital commitment, on average.
This year's dividend deals are less ambitious than those executed during 2011 -- most of which were inked in the first half, when the market was running on all cylinders. On average, issuers have added 1.3 turns of leverage via recaps -- to 4.1 times, from 2.8 times pretransaction -- versus 1.7 turns in 2011.
As usual, lenders are taking a more cautious approach to dividend deals than LBO deals. The reasons here are obvious: Recaps extract equity, while LBOs are packaged with new capital. Thus, the average 4.1 times pro forma debt multiple of 2012 dividend deals is inside the 4.8 times average of large corporate LBOs.
For this reason, in part, recaps have produced a lower rate of default historically than the broader leveraged loan population. The cumulative default experience of 2004-2007 recap loans, for instance, is 6.9%. That compares with 7.9% for all other deal purposes. n
Steven Miller manages Standard & Poor's Leveraged Commentary & Data business.