The leveraged loan market is warming up after a frosty start to the year. But the improved conditions have collided with a slowdown in M&A action during the first quarter, leading to a surge in dividend financings as originators stretch to fill the new issue pipeline, according to Debtwire data and multiple buyside and sellside sources.
So far this month, issuers have closed USD 3.1bn of new loans to finance dividend distributions, Debtwire data shows. The recent blitz, headlined by the likes of Staples and Lonestar Generation, compares to just USD 1.3bn in dividend loans raised in all of 1Q19.
Moreover, it means that around 11% of new institutional loan issuance in 2Q19 so far has been to fund dividends, up from 4% in 1Q19 and 2% in 1Q18.
Exemplifying the trend this week are new offerings from Flexera, Digital Room and ThoughtWorks. Other borrowers such as New Day Aluminum—formed out of Noranda Aluminum’s bankruptcy—have recently held talks with lenders to explore similar ideas.
The sudden craze for such transactions contrasts with a sharp decline in dividend recap activity last year, when M&A-related issuance dominated the leveraged loan market.
As of October 2018—just before the global market selloff led leveraged finance markets to shut down early for the year—dividend recap issuance was roughly USD 12bn, compared to around USD 28bn for the same period in 2017.
Lingering investor unease from the late 2018 selloff depressed M&A activity in early 2019, said two senior syndicate bankers. "The M&A deals that would have come in April, May and June would have needed to be signed off in January and February, and that never happened because of the market dislocation,” said one of the bankers.
Indeed, the recent surge in dividend loan financings still hasn’t gotten the syndicated institutional leveraged loan asset class back on pace to match 2018 volumes. Loan issuance to date in 2019 sits at USD 50bn, down from USD 130bn at this point last year.
In addition to an M&A drought, the slide in loan issuance is due in part to the Fed’s decision to stop hiking interest rates, which has driven investors away from floating rate assets, the sources noted.
The rush of dividend-related loan issuance also comes as the CLO market—one of the biggest buyers of new loan deals—recovers from a slow start to the year, when elevated liability spreads led to higher funding costs, weighing on new CLO formation.
New CLO issuance was USD 36bn in 1Q19, down only modestly from USD 44bn in 1Q18, according to CreditFlux.
As well as benefitting from stronger CLO demand, debt-financed dividends could also be buoyed by the hot private debt market, where direct lenders are taking down a growing number of new second lien loan offerings through private placements, sources said.
For example, PlayPower—a maker of playground equipment sponsored by Littlejohn & Co—is currently in the market with a USD 340m TLB to finance a dividend. The deal is accompanied by a USD 100m privately placed second lien.
The dividend trend has also been driven by reverse enquiry from loan investors, added the syndicate banker.
“Accounts can’t find paper to buy on names they like because those names have seen a massive pull to par over recent weeks, so they’ve been looking for opportunities to buy something they like but get more OID,” the banker said.
After dropping sharply during the 4Q18 selloff, loan bids found their footing in 1Q19 and have inched higher over recent weeks. The average loan bid is just shy of 97 as of yesterday (24 April) up from a low of around 94 at the end of last year, according to data from Markit.
As this increased demand drives loan spreads tighter, borrowers are also considering repricing transactions, sources added. “In the past couple of weeks we’ve got lots of calls from credits we work with about possible loan repricings or dividend recaps,” said a leveraged finance lawyer.
Stability in capital markets over recent weeks could usher in more M&A-related leveraged loan supply—such as sponsor-backed LBOs—later this year, said the lawyers and one of the bankers.
However, with equity markets now roaring back—the S&P 500 and the Nasdaq hit closing records on Tuesday—company owners may be tempted to consider IPOs as an alternative to debt-financed buyouts, sources added.
Recent public equity offerings have attracted outsize demand. Earlier this month, for example, online trading platform Tradeweb—partly owned by Blackstone-backed Refinitiv—increased the size of its offering and priced it above the marketed range.
“The equity markets have been doing so well, especially some recent tech IPOs,” said one of the lawyers. “Maybe we start to see that become an exit strategy [for leveraged companies] too.”
by Will Caiger-Smith