The loan market’s July recovery has breathed fresh life into dividend financing, with issuers tapping loan accounts for $3.8 billion of dividend-related new issues during the month (as of July 20). That’s the largest monthly sum since April and is up from just $750 million in June.
July’s burst of loan activity brings dividend-driven loan volume to $28.2 billion in the year to date, 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.
By contrast, high-yield bond recaps have gone missing entirely in July despite hot market conditions, and they continue to lag far behind last year.
Bond recap volume totals $7.4 billion in the year to date, down from $19 billion in the same period in 2011. Therefore, total dividend-related leverage financing is down 34%, to $35.7 billion, year-over-year.
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 IPO 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 Booz Allen Hamilton. Although the issuer is now publicly held, it’s still largely owned by Carlyle.
PE firms also are punching above their weight in the year to date, at 79% of recap loans, versus 48% of overall volume. That’s at the wide end of the historical range:
As this implies, 2012 has been the year of the dividend for PE firms. Consider that as of July 20, LCD has tracked $11 billion of dividends financed with leveraged loans, versus $17 billion of equity invested in new LBOs. That means that sponsors collectively have withdrawn 65 cents of dividends for every dollar of fresh capital they’ve invested in a new LBO (again, this is for deals backed by leveraged loans).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, 39% 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.
For another, PE firms remain 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 29 sponsor-to-sponsor deals, while S&P Capital IQ lists 14 PE-backed IPOs. By comparison, there have been 44 dividend deals alone so far this year through which PE firms have extracted 66% of their original capital commitment, on average.
Dividend financing, by the numbers
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 hitting on all cylinders. On average, issuers in July added 1.2 turns of leverage via recaps – to 4x, from 2.8x pre-transaction – 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 4x pro forma debt multiple of 2012 dividend deals is inside the 4.8x 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 to 7.9% for all other deal purposes. – Steve Miller