Rating agency Standard & Poor’s has warned that the increased issuing of dividend recaps by private equity firms can hamper post-default recovery prospects.
In the first quarter of 2013, €2.3 billion of dividend recaps were completed, compared to €1.87 billion in the whole of 2012, as private equity firms are taking advantage of the buoyant European debt markets, according to a report published by S&P.
But while companies executing these transactions are “by and large performing well”, risks may rise as more highly leveraged businesses lower down the credit curve choose to do such recaps, S&P said.
The main risk – according to S&P — is more aggressive debt behaviour from shareholders, many of whom in Europe are private equity sponsors, it noted.
“In many cases, private equity firms are taking advantage of recent strong performance to releverage, in the process pushing a company’s debt-to-EBITDA ratio back to a similar level to when the original debt was put in place. In our view, this means the future growth of the company may be limited because efficiency improvements have already taken place,” S&P said.
“One of our concerns about dividend recaps is the fact that if private equity owners have taken a substantial amount of cash out of the business already, their incentive to support a company in future is lessened,” it added. According to S&P, the potential recovery prospects for debt investors post-default can be diminished by dividend recaps, depending on where investors sit in the capital structure and how the recaps are structured.
The recent spike in dividend recaps has partly been triggered by the lack of exit routes for private equity firms, according to S&P. As they have fewer options to return cash to investors, including trade sales and IPOs, they explore other routes to get liquidity.
“We have had a busy quarter, albeit one that has been dominated by refinancing and recapitalisations,” Giles Borten, head of leveraged finance, EMEA and APAC and co-head of corporate capital markets EMEA at UBS, told PEI in a recent interview about the European lending market.
But while recaps are rising, the levels are nowhere near the €11.3 billion in 2006, S&P pointed out. “The first-quarter figure is meaningful in the sense that we believe we’re only beginning to see the return of more favourable issuance conditions for speculative-grade companies in Europe. And with continuing economic uncertainty blighting the region, companies are not yet comfortable operating with higher levels of leverage,” the report stated.