Buyout Funds Chasing Dividends in Europe Sour Leveraged Loans

(Bloomberg) -- Private equity firms are spurring the companies that they own to raise leveraged loans in Europe to pay dividends, potentially damaging credit quality and exposing buyers of such debt to greater risks, Bloomberg strategist Ruth McGavin writes.

Red-hot demand and lukewarm supply have compressed the cost of borrowing in the region’s senior credit market to the lowest since the financial crisis. Buyout sponsors are seizing the opportunity to raise cheap loans to extract dividends as an interim alternative to selling down their stakes.

Ten companies have sought to recapitalize via the loan market so far this year in order to pay a dividend, following on from the 12 that did so in the second half of last year, according to data compiled by Bloomberg. By contrast, in the first half of 2016, when the loan market was weaker, only two borrowers paid dividends financed through the same route.

A drop in the expected recovery rate of senior secured loans that undergo dividend recapitalizations shines a light on the deterioration of credit quality as leverage increases. Fitch Ratings, in a recent note, said the rate dropped to 55 percent on deals that have recapped since the second quarter of 2016, down from 62 percent beforehand. Senior debt increased to 5.3 times core earnings on average, from 4.0 times for these firms, according to the ratings company.

Borrowers including Spanish leisure park operator Portaventura, U.K. forecourt retailer Motor Fuel Group Ltd., and France’s Albea Beauty Holdings are among those that have raised loan financing to pay a dividend this year. German plastic film maker Klockner Pentaplast GmbH is in the market this week, and European Camping Group SAS is preparing to raise a dividend financing later this month.

Both Portaventura and Albea resorted to loan financing after efforts to find a new owner fell through.

Regulatory Restraint

In November, the ECB’s new guidelines on leveraged lending come into force, and these may make European banks wary of arranging dividend recaps, especially if the new capital structure is more levered than the original one.

The ECB’s rules require banks to show they have taken particular caution "where the transaction is a refinancing of an existing borrower at an increased level of leverage compared with respective leverage levels at origination or previous refinancing."

However, it won’t be known until well into 2018 how strictly the ECB will apply these guidelines and what impact they will have on lending practices.

Dividend recaps can in any case be problematic for arranging banks because the rise in leverage means they are in theory unpopular among loan investors.

Private equity firms are sometimes forced to soften the terms of the request to make it more buyer-friendly. Sponsor PAI for instance made a small reduction to the size of the dividend it took from Labeyrie Fine Foods earlier this year when lenders put up resistance.

However, in practice there has been little sign of leveraged loan investors rejecting dividend requests outright in Europe - such is their eagerness for paper. Indeed, Portaventura wrapped earlier syndication of its recap last week at a tighter price than initially offered.

To contact the reporter on this story: Ruth McGavin in London at rmcgavin1@bloomberg.net.

To contact the editors responsible for this story: Tom Freke at tfreke@bloomberg.net, V. Ramakrishnan, Chris Vellacott