Private equity investors pile up debt to pay dividends

US private equity firms rush to capitalize on lower borrowing costs, by putting debt onto their portfolio companies. They then use the cash they generate to pay dividends both to themselves and to their investors.

In January, corporate borrowers sold $8.1bn in junk-rated US loan to fund shareholder payments. This was more than six times the total of December and the highest figure for a month in over two years. According to PitchBook LCD data, the majority of these loans were issued by companies that are backed by Private Equity firms.

Private equity firms have turned to so-called “dividend recapitalisations” to satisfy investors who are eager to see a return on capital.

A senior executive in private equity said that the credit markets were hot at present. It is an excellent opportunity to refinance or issue debt at a reduced cost of capital.

Some of the companies that have made such deals this year are technology group IntraFi Network, and chemicals distributor Univar Solutions. Both are backed by Warburg Pincus, Blackstone and Apollo.

Private equity firms have welcomed the opportunity presented by the dramatic drop in borrowing rates in recent months.

Many are facing pressure from their own investors to return some cash, which is important in attracting investors to any new funds they launch.
Kevin Loome is the US high-yield Portfolio Manager at T Rowe Price. He said that sponsors are clamoring for market access. Sponsors are being pressed to return capital to their investors.

Dividend recaps were popular in the early stages after the coronavirus outbreak, when the US Federal Reserve cut rates to near zero. However, they fell out of favor in 2022 and 2023 due to rising borrowing costs.

Debtholders often are wary of large dividend recaps as they can burden companies with greater degrees of leverage. They may also backfire if the borrower’s expectations for growth fall short, or if interest rates increase.

The deals made over the last month involved Univar borrowing $450mn to pay a new term loan to its private equity owners Apollo. Apollo had acquired the company for more than $8bn six months prior.

Warburg Pincus, Blackstone and other investors have borrowed $800mn against InfraFi Network since December to pay themselves an enormous dividend. Last month, 1-800 contacts, owned by KKR borrowed $565mn of senior debt to pay off a junior loan with a higher cost and fund a payout of $250mn to themselves.

The debt markets surged at the end last year after the US Federal Reserve announced that they had ended their aggressive campaign of interest rate increases and were expecting to make three-quarter-point reductions in 2024.

The Fed’s pivot has given private equity-backed firms the opportunity to refinance their debt and reduce their interest rates.

UKG, a major software company backed in part by Hellman & Friedman, Blackstone and other investors, refinanced over $7bn of term loans in January, reducing its interest rate in part by increasing the use senior debt.

Last month, the high number of loans that traded above par allowed more borrowers and investors to negotiate to lower interest rates for existing debt. The so-called repricing volume for US junk loan soared to $91bn in January. This was the highest monthly amount in four years.

Andrzej skiba, the head of US Fixed Income at BlueBay RBC GAM said: “We experienced this avalanche” of repricings. People were starved for new money loan papers. . . This made investors more willing to consider dividends.”