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Dividend Deals Most Since 2007 as Loans Heat Up: Credit Markets

By Emre Peker - 2010-09-28T14:49:00Z

Speculative-grade companies are borrowing to finance dividend payments to their private-equity owners at the fastest rate since before the credit crisis, taking advantage of investor demand for high relative yields.

Banks arranged or started marketing $8.77 billion of high- risk, high-yield loans slated for shareholder payouts this quarter, bringing 2010’s total to $17.1 billion, more than five times the amount of the past two years combined, according to Standard & Poor’s Leveraged Commentary and Data.

Private-equity firms, facing a jump in taxes on capital gains next year and a slumping market for initial public offerings, are saddling their companies with more debt as the U.S. economic recovery slows. Last week, landscaping company Brickman Group Holdings Inc., which is owned by Los Angeles- based Leonard Green & Partners LP, started raising $550 million of loans to refinance debt and pay a dividend.

“We’re going to see record-breaking transactions as the fourth quarter rolls in,” said Robert Willens, president of Robert Willens LLC, who previously was a managing director in charge of tax and accounting analysis at Lehman Brothers Holdings Inc. “Companies are in the process of setting up dividend programs now so that they can get them implemented by the end of the year.”

Tax Increase

Taxes on dividends are slated to jump to 39.6 percent next year from the current 15 percent, which was adopted in 2003 by former-President George W. Bush and a Republican-controlled Congress. President Barack Obama’s budget, sent to Congress Feb. 26, would limit the increase to 20 percent.

Dividend deals make up 11 percent of this year’s $161 billion of institutional leveraged-loan issuance, double last year’s total and $3.86 billion more than in 2008, according to S&P LCD.

Elsewhere in credit markets, the extra yield investors demand to own company bonds instead of similar maturity government debt rose 1 basis point to 173 basis points, or 1.73 percentage point, according to Bank of America Merrill Lynch’s Global Broad Market Corporate Index. The index narrowed from 181 basis points at the end of August and 196 in June. Yields averaged 3.45 percent, the lowest since Aug. 24.

BP Plc is planning its first bond sale since a rig explosion caused an estimated 4.9 million barrels of crude oil to spew into the Gulf of Mexico in the largest offshore U.S. spill in history. The energy company may sell about $2 billion in debt, similar in size to an offering last August, according to BP spokesman Robert Wine in London. BP plans to issue 5- and 10-year notes through BP Capital Markets Plc, it said today in a regulatory filing that didn’t specify the sale’s size or timing.

Investment-Grade Status

BP has regained its investment-grade status in the eyes of credit investors more than two months after containing the leak, which was caused by an April 20 explosion on a rig in the Gulf. Credit-default swap prices, which soared to levels implying the debt was junk-rated after the explosion, last week declined to imply a rating of Baa3 by Moody’s Investors Service, the lowest step of investment-grade.

No oil has leaked from the well since July 15. Credit- default swaps protecting against losses on BP debt for five years have declined to 191.6 basis points as of 8:37 a.m. in New York, from at least 631 basis points on June 16, according to data provider CMA.

Markit CDX Index

A benchmark indicator of corporate credit risk in the U.S. rose for the fifth time in six days. Credit-default swaps on the Markit CDX North America Investment Grade Index, which investors use to hedge against losses on corporate debt or to speculate on creditworthiness, increased 1.1 basis points to a mid-price of 111.01 basis points at 10:20 a.m. in New York, according to index administrator Markit Group Ltd.

The index, which typically rises as investor confidence deteriorates and falls as it improves, began a new series Sept. 20 at 108.4 basis points.

Credit swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point, 0.01 percentage point, equals $1,000 annually on a contract protecting $10 million of debt.

The S&P/LSTA US Leveraged Loan 100 Index rose to 90.25 cents on the dollar yesterday, the highest since May 19.

Leveraged buyouts climbed to $85.2 billion this year from $39.3 billion in the first nine months of 2009, Bloomberg data show. While companies have raised $19.2 billion in initial public offerings this year, up 85 percent from 2009, that’s below the $67.5 billion recorded in the first three quarters of 2007, nine days before the S&P 500 Index peaked.

Brickman joined SK Capital Partners LP’s Ascend Performance Materials, J.W. Childs Associates LP-owned CHG Healthcare Services Inc., Hilex Poly Co. and Angelica Corp. in seeking leveraged loans this quarter for shareholder payouts, Bloomberg data show.

Brickman Loan

Based in Gaithersburg, Maryland, Brickman is offering lenders an interest rate 575 basis points more than the benchmark London interbank offered rate, with a 1.75 percent Libor floor, according to a person familiar with the transaction. The average new-issue spread for loans of companies with similar ratings of B+ or B was 487 basis points as of Sept. 16, according to S&P LCD.

The proposed $500 million six-year term loan B portion is expected to price at 98 cents on the dollar, said the person, who declined to be identified because the terms are private. That would boost the yield to investors to about 8 percent.

“Investors are looking at dividends and given the use of proceeds they are seeking higher yields compared to similar- rated LBO credits,” said Douglas Antonacci, New York-based head of primary loan sales at Bank of America Corp. “The market is healthy and receptive, it’s also discerning. You’re looking at the market pricing risk differently.”

‘Yield Starved’

Dividend deals rose from $880 million last year and $2.4 billion in 2008, which was down 94 percent from 2007, S&P LCD data show.

“You should be getting paid a premium yield for dividend deals,” said Cliff Noreen, president of Babson Capital Management LLC, which oversees $128.9 billion of assets. “We’re in an environment today where investors are yield starved.”

The S&P/LSTA Leveraged Loan Index, representing about 95 percent of the institutional U.S. bank debt market, gained 6.51 percent this year. That compares with a total return of 3.94 percent on the S&P 500 Index and 11.3 percent on Bank of America Merrill Lynch’s US High Yield Master II Index. So-called institutional loans are sold to investors such as collateralized loan obligations, mutual funds and hedge funds.

‘Return Expectations’

“You look at the return expectations for leveraged loans relative to other risk asset classes and they look very compelling, especially compared with equities,” Noreen said. “Dividend deals now are somewhat different than they were at the top of the market in 2006-2007. Private-equity firms probably have a better understanding of how companies will fare under a stressed economic environment and how much debt they can reasonably support.”

U.S. economic growth slowed to an annualized pace of 1.6 percent during the second quarter from 3.7 percent during the first three months of this year.

The world’s biggest economy expanded at an average rate of 2.6 percent from the end of the previous recession in November 2001 until December 2007. It will match that pace by the second quarter of next year, said economists surveyed from Sept. 1 to Sept. 8.

“In a low-growth economic environment, you can pick up a secured floating-rate instrument with decent yield and call protection and be pretty comfortable taking that risk,” Antonacci said. “The post-Labor Day LBO calendar that everybody was gearing up for has obviously made it through; the next few deals to come to market have been dividend recaps, potentially the start of a trend.”

-- With assistance from Sapna Maheshwari, Mary Childs, Tim Catts, Shannon D. Harrington in New York, Haris Anwar and Stefania Bianchi in Dubai, Phil Mattingly in Washington, Sonja Cheung, Abigail Moses and Caroline Hyde in London and Ed Johnson in Sydney. Editors: Faris Khan, Chapin Wright