LBO Firms Seen Ratcheting Risk With Dividend Deals: U.K. Credit

Private-equity firms from BC Partners Ltd. to Advent International are selling bonds to pay themselves dividends from their U.K. companies at levels last seen before the credit crisis.

Borrowers controlled by buyout firms raised 1.1 billion pounds ($1.8 billion) of bonds this year to help fund payouts, according to data compiled by Bloomberg. That’s the most since the boom times between 2005 and 2007, according to Moody’s Investors Service.

The resurgence in dividend deals is fueling concern that corporate credit quality is being undermined, with Standard & Poor’s saying they represent “aggressive financial policy.” They can worsen a company’s leverage ratio of debt to earnings and hinder recovery in the event of default, according to the ratings firm.

“Extracting a dividend gives a private equity firm less skin in the game,” said Philip Milburn, an Edinburgh-based fund manager at Kames Capital, which oversees the equivalent of about $84 billion. “If they’ve made a good return already and have less money invested then it may give the sponsor the mentality to roll the dice a little with their remaining stake.”

Borrowing Costs

Private-equity firms are being encouraged to sell bonds by record-low borrowing costs, with average yields on junk debt in pounds falling to 6 percent this year, according to data from Bank of America Merrill Lynch. Average yields on the debt in euros fell to an all-time low of 4.9 percent last month.

Officials for London-based BC Partners and Advent, who wouldn’t be identified citing company policy, declined to comment.

Phones 4u Finance Plc sold 205 million pounds of 10 percent payment-in-kind toggle notes through its parent company Phosphorus Holdco Plc to pay dividends to shareholder BC Partners in September. The Newcastle-under-Lyme, England-based company was placed on review for a downgrade by Moody’s when it announced the sale of the notes, which can pay coupons with cash or debt.

BIS Warning

The securities, which were rated eight levels below investment grade at Caa2 by Moody’s, fell 2.7 pence on the pound since they were sold to 96.3 pence, Bloomberg data show. The Bank for International Settlements warned this month that about 30 percent of global issuers of PIKs before the financial crisis have since defaulted.

“These types of deals are used as a risk transfer mechanism by private equity into the high-yield market,” said Steven Mitra, a London-based partner at hedge fund LNG Capital LLP. “I am not a fan of them.”

Advent International’s DFS Furniture Holdings Plc issued 200 million pounds of 7.625 percent bonds and 110 million pounds of floating-rate notes in March to help fund payouts.

Brighthouse Group Plc, the furniture and white goods supplier owned by Vision Capital, raised 220 million pounds of 7.875 percent securities rated B- by S&P.

An official at London-based Vision said there was no-one available to comment.

The average rating of borrowers selling debt for dividends fell one step this year to B, five levels below investment grade, S&P said in a note published Dec. 10.

“If the use of proceeds begins to favor shareholders over bondholders then average credit quality will decline,” said Leon Grenyer, the London-based head of European high yield at Morgan Stanley Investment Management, which manages $360 billion of assets globally.

High Risk

Investors are more willing to buy high-risk debt because the speculative-grade default rate fell to 2.7 percent at the end of November from 2.8 percent a year earlier, according to a report from Moody’s Dec. 8. That compares with an average of 4.7 percent since 1983.

Notes sold with the main purpose of paying dividends to shareholders represented 7 percent of sterling-denominated high-yield transactions this year, up from zero for the previous three years, according to data from Moody’s.

“Some people say that by taking out equity capital or a shareholder loan, it indicates less of a commitment of the sponsor to the company,” said Chetan Modi, managing director of European leveraged finance at Moody’s in London. “Their direct exposure to the credit is reduced. Use of proceeds should be looked at in the context of looser structures and poorer credit quality.”

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