December 7, 2012 / 2:35 PM / in 5 years

RLPC: Mid-market dividend volume nears record high

NEW YORK, Dec 7 (Reuters) - U.S. private equity-backed middle market issuers are seeking dividend recapitalization loans in record numbers ahead of a widely expected post-New Year hike in tax rates. The strength of the credit markets and unmet investor demand for M&A and LBO deals has further intensified the rush to ink debt-funded dividend deals while the window is open.

Currently, both dividend income and capital gains are taxed at a rate of 15 percent. With the Bush era tax cuts again slated to expire, dividend income could be taxed as ordinary income, as it was historically. Such a change would nearly double the rate levied on dividends for those earning above $250,000 annually. The rate on capital gains could rise to 20 percent.

“The tax law changes are the big driver, but what makes that type of deal more robust is the lack of new deals, good liquidity and strong technicals,” said one middle market lender.

Quarter-to-date, middle market dividend recap issuance, including completed and in-process transactions, soared to $5.53 billion, up from just over $500 million in 3Q12, according to Thomson Reuter LPC data.

Dividend recap volume is on target to reach an all-time high in 4Q12, both in terms of dollar amount and as a percentage of middle market sponsored dealflow. So far this quarter, dividend loans represent a hefty 30 percent of sponsored issuance.

If you can get a recap done and take a dividend, sponsors are doing it, one middle market buyside investor said. “Anybody and everybody is trying to push through a dividend recap,” he added.

The 4Q12 combined tally of completed and in-process deals already surpasses the $4.36 billion recorded in 4Q10 when the impending expiration of the Bush tax cuts precipitated a wave of dividend loans, only to see the tax cuts extended by two years.

“The last gasp of dividend recap deals are trying to get done,” noted a second lender, who observed that some sponsors have surfaced with dividend deals for multiple portfolio companies.

In the last two weeks alone, at least half a dozen financial sponsor-backed middle market borrowers have launched dividend recap loans just in time to seal the deals before year-end in order to monetize investments in portfolio companies. Among the dividend deals in market, some issuers are also seeking to reduce borrowing costs on existing debt by refinancing at lower interest rates.

Hearthside Food Solutions launched a $433 million recapitalization loan led by GE Capital to refinance debt and to fund a dividend to financial sponsor Windpoint Partners. The deal marks the company’s second dividend this year and comes roughly six months after it tapped investors for the previous deal.

Citadel Plastics is in market with a $271 million first/second-lien dividend recap loan also led by GE Capital . The company was acquired in a leveraged buyout by Huntsman Gay in February. The deal, which is to refinance debt and to fund a dividend, is talk at LIB+450-475 for the first-lien piece. The $155 million LBO loan cleared at LIB+525.

While the dividend deals have piled up, investors cite more pushback in recent weeks with respect to increasingly aggressive leverage levels, looser structures and downward pressure on pricing.

“Pricing is inching back up,” said the first lender.

With an eye on portfolio performance, investors are picking and choosing with more selectivity. Accounts are trying to strike a balance between putting money to work and some cautiousness with respect to credit quality and company performance.

All deals get done, but at a price, noted the second lender.

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