Private equity owners pile on debt to pay themselves dividends

US private equity firms are rushing to take advantage of lower borrowing costs by loading debt on to their portfolio companies and using the cash to pay dividends to themselves and their investors.

Corporate borrowers sold $8.1bn worth of junk-rated US loans to fund payments to shareholders in January, more than six times December’s total and the highest monthly figure in more than two years. Most were issued by companies backed by private equity firms, according to data from PitchBook LCD.

With weak deal volumes and sluggish demand for initial public offerings making it harder to offload existing investments, private equity firms are turning to such so-called dividend recapitalisations to pacify investors eager for a return on their capital.

“Credit markets are hot right now,” said a senior private equity executive. “It is a great opportunity to issue or refinance debt at a lower cost of capital.”

Companies that have done such deals so far this year include technology group IntraFi Network and chemicals distributor Univar Solutions — backed by private equity giants Warburg Pincus and Blackstone, and Apollo respectively.

The opportunity provided by the sharp drop in borrowing costs in recent months has come at a welcome time for private equity firms.

Many are facing pressure from their own investors to return some cash, which is important in attracting investors to any new funds they launch.

“There’s a lot of pent-up demand by sponsors to have market access,” said Kevin Loome, US high-yield portfolio manager at T Rowe Price. “Sponsors are under a lot of pressure to return capital to investors.”

Dividend recaps surged in popularity during the early stages of the coronavirus pandemic after the US Federal Reserve cut interest rates to near zero, but fell out of favour in 2022 and early 2023 as borrowing costs rose.

Debtholders are often wary of large volumes of dividend recaps, as they typically burden companies with higher degrees of leverage and may backfire if a borrower’s growth expectations fall short or interest rates rise.

In the deals that have taken place over the past month, Univar borrowed $450mn in new term loans to pay a dividend to its private equity owner Apollo, which had closed a more than $8bn takeover of the company six months earlier.

Warburg Pincus and Blackstone have borrowed about $800mn since December against InfraFi Network to pay themselves a large dividend. Last month, 1-800 Contacts, owned by KKR, borrowed $565mn in senior debt to repay a higher-cost $315mn junior loan and fund a $250mn payout to itself.

Debt markets rallied strongly at the end of last year, after the US Federal Reserve signalled that it had finished its campaign of aggressive interest rate rises and was expecting to make three quarter-point cuts in 2024.

Private equity-backed companies have used the Fed’s pivot as an opportunity to refinance and lower their interest burdens.

UKG, a large software company backed by investors including Hellman & Friedman and Blackstone, in January refinanced more than $7bn in term loans, cutting its interest rate, partly by increasing the use of senior debt.

The high number of loans trading above par last month also allowed more borrowers to negotiate with investors to reduce the interest rates on existing debt. So-called repricing volumes for US junk loans soared to $91.2bn in January, the highest monthly total in four years.

“We had this avalanche of repricings,” said Andrzej Skiba, head of US fixed income at BlueBay RBC GAM. “People were actually quite starved of new money loan paper . . . So that made investors more amenable to consider dividend distributions.”