Speculative-grade companies are borrowing to finance dividend payments to their private-equity firm 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 volume to $17.1 billion, more than five times the amount issued in the last two years combined, according to Standard & Poor’s Leveraged Commentary and Data.
Private-equity firms seeking to beat the 2011 increase in taxes on capital gains, and with initial public offerings less than a third of where they were when the stock market peaked in 2007, are saddling companies they acquired 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 in the loan market 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.”
Taxes on dividends are slated to jump to 39.6 percent next year from the current rate of 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 that permeated debt markets in 2006 and 2007 before the credit seizure make up 11 percent of this year’s institutional leveraged-loan issuance of $161 billion, which is double last year’s total and $3.86 billion more what was raised in 2008, according to S&P LCD.
Elsewhere in credit markets, BP Plc regained its investment-grade status in the eyes of bond investors as default swaps on its debt declined. Ford Motor Co. plans to sell $500 million of debt backed by dealer payments through its finance arm. Dubai is planning its first sale of bonds since state-owned Dubai World announced plans in November to delay payments on $24.9 billion of debt, roiling global markets. General Electric Co. bonds were the most actively traded U.S. corporate securities by dealers.
Credit-default swaps protecting against losses on BP debt for five years fell 2.9 basis points to 189 as of 5:24 p.m. in New York, according to data provider CMA. The contracts have declined from at least 631 basis points on June 16.
BP’s equity plunged and swap prices tied to its debt soared after an explosion on board the Deepwater Horizon in the Gulf killed 11 workers on April 20 and spewed an estimated 4.9 million barrels of oil into the Gulf of Mexico. No oil has leaked from the well since July 15.
The derivatives contracts declined enough to imply the London-based company is rated Baa3, the lowest step of investment grade, Moody’s Corp.’s capital markets research group said today. Moody’s Investors Service grades the company’s debt A2, four levels above the implied rating, Bloomberg data show.
A benchmark indicator of corporate credit risk in the U.S. rose for the fourth time in five trading 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 1.4 basis points to a mid-price of 110, according to index administrator Markit Group Ltd. In London, the Markit iTraxx Europe Index of 125 companies with investment-grade ratings rose 0.5 to 113.25.
The indexes typically rise as investor confidence deteriorates and falls as it improves. 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.
In the new-issue market, NBC Universal Inc. sold $5.1 billion of debt to help pay for its majority purchase by Comcast Corp. in the third-biggest U.S. debt transaction this year, Bloomberg data show. Comcast is expected to complete its purchase of 51 percent of NBC Universal by year-end, GE Chief Executive Officer Jeffrey Immelt said in a Sept. 24 memo.
Ford last issued so-called floorplan debt in March, selling $1.13 billion of the bonds, which dealers use to finance cars on their lots, according to data compiled by Bloomberg. The offering may be sold as soon as tomorrow, according to a person familiar with the transaction. In July, Dearborn, Michigan-based Ford sold $1.39 billion of bonds backed by loans to consumers.
GE, based in Fairfield, Connecticut, was most active in the bond market with 123 trades of $1 million or more, according to data from Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. Sprint Nextel Corp., with 34 trades, was the most active in junk bonds, which are debt rated below Baa3 by Moody’s and lower than BBB- by S&P.
In emerging markets, relative yields rose 2 basis points to 282 basis points, or 2.82 percentage points, according to JPMorgan Chase & Co. index data.
Dubai hired Deutsche Bank AG, HSBC Holdings Plc and Standard Chartered Plc as joint lead managers for a dollar bond offering, the government said in a statement today. Dubai last sold bonds in October, when the Department of Finance raised $1.93 billion from five-year Islamic notes. The latest sale will be the first after state-owned Dubai World announced plans in November to delay payments on $24.9 billion of debt, roiling global markets.
The S&P/LSTA US Leveraged Loan 100 Index rose to 90.25 cents on the dollar today, the highest since May 19.
The loan market is heating up along with leveraged buyouts, which 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.
Based in Gaithersburg, Maryland, Brickman is offering lenders an interest rate 5.75 percentage points more than the London interbank offered rate, with a percent 1.75 Libor floor, according to a person familiar with the transaction. Libor is the rate banks charge to lend to each other. That compares with an average new-issue spread of 4.87 percentage points as of Sept. 16 for loans of companies with similar ratings of B+ or B by S&P, according to S&P LCD.
The company is offering to sell pieces of the $500 million six-year term loan B portion of the financing to investors 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., which arranged the most of that type of debt in the U.S. based on Bloomberg data. “The market is healthy and receptive, it’s also discerning; you’re looking at the market pricing risk differently.”
The amount of dividend deals is up 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.
“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 in 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. Since May, the median estimate of economist surveyed monthly by Bloomberg News has declined to 1.9 percent from 3.1 percent for the third quarter.
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.”
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