Private-equity firms from Bain Capital to Onex Corp. are raising loans through companies they own to pay themselves dividends at a pace that exceeds even the frothy days leading to the worst financial crisis since the Great Depression.
Borrowers controlled by buyout firms are on pace to raise more than $11.5 billion this month through dividend deals, a record and up from $3.6 billion in April, according to Standard & Poor's Capital IQ Leveraged Commentary & Data. Beats Electronics LLC, the headphone maker founded by rapper Dr. Dre and Geffen A&M Chairman Jimmy Iovine, is meeting lenders tomorrow to seek $700 million in such loans, according to people familiar with the situation who declined to be identified.
An increasing number of borrowers are taking advantage of investor demand for relatively high yields as the Federal Reserve keeps benchmark interest rates at about zero for a fifth year. Rather than refinancing debt at lower interest rates or funding expansion, dividend loans do little more than add leverage.
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"Raising debt and leverage to fund a dividend weakens a company's credit profile," Lenny Ajzenman, an analyst at Moody's Investors Service in New York, said in a telephone interview. "Using the proceeds for acquisitions or capital expenditures is less clear cut as far as its effect on the issuer's credit profile."
Loan Prices
Leverage, or debt-to-EBITDA (earnings before interest, taxes, depreciation, or amortization), for U.S. speculative-grade borrowers tracked by S&P's Capital IQ LCD rose to 4.8 times this month, up from 4.1 in April and from a post-crisis low of 3.5 times in February 2009. Loan prices climbed to 98.88 cents on the dollar on May 9, the most since July 2007, according to the S&P/LSTA U.S. Leveraged Loan 100 Index. The debt has returned 3.2 percent this year, after gaining 10.5 percent in 2012.
About $33 billion of loans have been raised this year to support payouts according to S&P Capital IQ LCD. Dividend volumes in the U.S. speculative-grade market is "on pace for a record year," Morgan Stanley analysts wrote in a May 17 report.
Such financings are on the rise as the pace of leveraged buyouts (LBOs) slows. The amount of capital controlled by private equity firms that has yet to be invested increased to about $366 billion in May, according to data from Preqin Ltd. At the same time, loans supporting buyouts plunged to the lowest level since August 2012, S&P's Capital IQ LCD data show.
"With a light LBO calendar, capital markets desks on the Street are looking for seasoned leveraged credits to pitch dividend deals to," Douglas Antonacci, a New York-based managing director and co-head of loan sales at Bank of America Corp., said in a telephone interview. The bank is the biggest underwriter of leveraged loans in the U.S.
Confidence Boost
Elsewhere in credit markets, a gauge of U.S. corporate credit risk declined the most in more than three weeks as consumer confidence rose in May to the highest level since February 2008. The Markit CDX North American Investment Grade Index, a credit-default swaps benchmark that investors use to hedge against losses or to speculate on creditworthiness, dropped 2.5 basis points to a mid-price of 73.3 basis points at 11:28 a.m. in New York, according to prices compiled by Bloomberg. The measure fell by as much as 3.1 basis points, the biggest intraday decline since May 3.
The Conference Board's consumer confidence index rose to 76.2 this month, the highest level since February 2008, from a revised 69 in April, data from the New York-based private research group showed today. The S&P/Case-Shiller index of property values increased 10.9 percent from March 2012, the biggest 12-month gain since April 2006, a report showed today.
The credit-swaps index typically falls as investor confidence improves and rises as it deteriorates. The contracts pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt.
The U.S. two-year interest-rate swap spread, a measure of bond market stress, added 1.83 basis points to 16.83 basis points as of 11:34 a.m. in New York. The gauge widens when investors seek the perceived safety of government securities and narrows when they favor assets such as corporate bonds.
GE Bonds
Bonds of Fairfield, Connecticut-based General Electric Co. are the most actively traded dollar-denominated corporate securities by dealers today, accounting for 3.9 percent of the volume of dealer trades of $1 million or more as of 11:57 a.m. in New York, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.
About $293.2 billion of loans have been made this year, compared with $465.7 billion in all of 2012, according to S&P's Capital IQ LCD. Issuance has been bolstered by growth in collateralized loan obligations and inflows into mutual funds that buy the debt.
More than $36 billion of CLOs have been raised this year, according to JPMorgan Chase & Co. The bank is forecasting managers will create about $70 billion of CLOs this year, compared with $55 billion in 2012, the biggest year since the market collapsed during the financial crisis.
Leveraged loans and high-yield, high-risk bonds are rated below Baa3 by Moody's and lower than BBB- at S&P.
"Demand for loans has been very strong this year and hence the ability to get dividend deals done," Adam Richmond, a credit strategist at Morgan Stanley in New York, said in a telephone interview. "The cost of debt is cheap, making it an optimal time for companies to issue debt."
Investors have poured about $26.2 billion into funds that purchase bank loans this year through May 23, according to Bank of America. Fed Chairman Ben S. Bernanke told U.S. lawmakers May 22 the central bank could taper its $85 billion monthly bond purchase program designed to spur growth and lower unemployment if it can be confident of sustained gains in the economy.
"From a timing perspective, there may be incentive to get debt deals done now ahead of the typical summer slowdown and ahead of any tapering of bond purchases by the Fed, which could lead to rising rates," Richmond said.
Beats Electronics
Dividend transactions, which fund payouts to owners and increase leverage without enlarging the asset base supporting the debt, "weaken credit quality," Moody's analysts led by David Keisman in New York wrote in a May 1 report.
The U.S. speculative-grade default rate rose to 3.1 percent in April from 3 percent the prior month, according to Moody's.
While Moody's Liquidity-Stress Index rose to 3.2 percent in mid-May from a record-low 2.8 percent at the end of April, most U.S. speculative grade companies have enough liquidity to withstand "tepid" growth in revenue and a sluggish economy, analysts led by Tom Marshella wrote in a May 15 report.
Barclays Plc, Citigroup Inc., and JPMorgan are arranging a $500 million term loan and $200 million line of credit for Santa Monica, California-based Beats Electronics, Bloomberg data show. The company obtained a $225 million term loan last July for working capital, Bloomberg data show.
Onex's Carestream Health Inc., a provider of medical supplies, may pay interest at 3.25 percentage points to 3.5 percentage points more than the London interbank offered rate (Libor) on a $1.85 billion, first-lien term loan due in six years and at 7.5 percentage points more than Libor on a $500 million second-lien portion maturing in 6.5 years, Bloomberg data show.
Both loans for the Rochester, New York-based company won't have financial maintenance requirements, meaning there are no provisions restricting companies from loading up on debt.
Air Medical Group Holdings, a provider of air-ambulance services, will pay interest at a fixed rate of 7.625 percent, or in additional debt at a 75 basis-point premium on a $200 million loan to fund a payout to Bain. Such payment-in-kind, or PIK, payments allow borrowers to repay lenders with more debt. A basis point is 0.01 percentage point.
Emma Thompson, a vice president of investor relations at Onex Corp. in Toronto, didn't return a telephone call seeking comment. Alex Stanton, a spokesman for Bain at Stanton Public Relations and Marketing, declined to comment. Jessica Bass, a spokeswoman for Beats Electronics, didn't respond to an e-mail seeking comment.
"Investors are eager for yield and issuers are responding," Morgan Stanley's Richmond said. "If rates stay low and volatility stays low, we'll continue to see more of this activity."
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