Dividend recapitalisations are on the rise again – not just in the upper mid-market and large-cap space but also in the core mid-market.
Fitch Ratings released a report last week that showed the dividend recapitalisation market spiking during April and May after a lull that began in November.
For April, 13 percent of the month’s total loan volume was dividend recapitalisation deals, or $3.6 billion, according to data from the New York-based ratings agency. That is the highest amount since October, which saw $4.4 billion in such transactions. There has been $11.2 billion deployed in these deals so far this year.
While usually a strategy for the larger market, Joshua Clark, a director at Fitch Ratings, told Private Debt Investor that the trend exists in the mid-market too. Dividend recapitalisations in the mid-market made up approximately $1 billion, or 27 percent, of loan volume during April, he said, citing LevFin Insights data. So far in May, it has represented around $500 million, or 33 percent, of mid-market loan volume.
“Honestly, I think it’s been a slowdown in M&A issuance volume [driving the growth in the deal type], and that has created an opportunity for sponsors to launch dividend recap transactions,” Clark said. “There is a strong investor demand and lower volume. Investors have to put their money to work.”
Lenders are eager to get involved right now, Karen Davies, a managing director at Huntington Bank, told PDI. She hasn’t seen hesitation from lenders this quarter, who typically give those transactions pause if there are fears of a downturn. Huntington looks to target companies with between $5 million and $75 million of EBITDA for these types of transactions.
Dividend recapitalisations are a way for lenders to retain deal volume in a loan portfolio with high turnover and hold on to good assets, she said. Davies added that when she meets with private equity sponsors to talk about new dealflow, it’s not just add-on acquisitions – dividend recapitalisations are always part of the conversation.
Lenders could be almost anyone within the private credit space, from banks to non-bank lenders, Khizer Ahmed, a managing director and head of debt solutions at TP ICAP, told PDI. Ahmed, who works as a fund finance matchmaker, said that he has also noticed an uptick in dividend recapitalisations, especially as sponsors get increasingly comfortable with fund finance solutions.
“The involvement of non-bank lenders goes to the fact that they are keen on generating diversified returns in their portfolios,” Ahmed said. “The more sophisticated ones appear willing to consider making their balance sheets available if the right opportunity comes along. It’s a tool for GPs that some of them seem to be comfortable using.”
However, this strategy does include an extra layer of risk. While it boosts returns for private equity sponsors, it adds additional leverage, which Fitch predicts to be around 1.5x on average. Adding debt to a company’s balance sheet can increase the risk of financial distress if economic conditions take a turn for the worse, Ahmed noted.
“Understandably, it is a type of transaction that is not the most beneficial for the company,” Fitch’s Clark said. “It typically results in increased leverage, which can affect the credit profile and recovery prospects in the event of a downturn.”
A downturn doesn’t necessarily mean a financial crisis; it could also be industry-specific dislocations from trade wars or tariffs.
However, Huntington Bank’s Davies said that, as with many investing decisions, dividend recapitalisations are not always the best solution for every opportunity, and many sectors provide stable areas to increase leverage. She added that Huntington will sometimes approach companies that are de-levering due to success to offer a dividend recapitalisation product.
“A dividend recap is not necessarily viewed favourably for every company, especially depending on the industry,” Davies said. “I wouldn’t say every space is viewed opportunistically for dividend recapitalisations, such as brick-and-mortar retail, automotive and building product industries, or for businesses that are heavily cyclical or have significant revenue concentration.”
As signs point to the ever-looming turn in the credit cycle holding off at least through 2019, she sees dividend recapitalisations as an area of growth for the year.
“M&A activity is very favourable for 2019, and dividend recap will be part of it,” she said.