Private-Equity Cash-Out

In a normal recession (let alone the fastest economic contraction in the history of the economy) many businesses will look to conserve cash, curtail expenses, and minimize risk.

For private equity-owned businesses during the pandemic, the strategy has been the exact opposite.

Priority #1: Dividend To Shareholders

With interest rates at all-time lows and the Fed supporting every corner of the credit market, private equity firms have been taking on significant sums of debt to fund shareholder dividends:

• Dividend recapitalizations, as these payouts are known, shot up more than 25% this year to over $29 billion, according to S&P Global Market Intelligence’s LCD.
• Tech firms that staved off the pandemic relatively well accounted for many of this year’s larger payouts. KKR took in $560 million this July from Epicor Software and Blackstone Bumble dating app’s parent corporation.

While dividend-recaps have always been part of the private equity playbook, a subtle regulation change in 2017 has ignited the recent fervor.

Quick History Foray: In 2013, the FDIC and the Office of the Comptroller of the Currency issued guidance that limited leveraged buyouts to six-times a company’s EBITDA (a proxy for cash flow). But in 2017, with new guidance from the Government Accountability office, regulators announced they would no longer punish banks for violating the six-times EBITDA restriction

Animal spirits ignited – and now roughly 40% of leveraged loans tied to corporate mergers and buyouts boost debt above that threshold, according to data from Covenant Review.

Why It Matters

Unlike the activity that precipitated the financial crisis, many of the leverage is not held on the balance sheets of the “too big too fail” financial institutions. As a result, some say there the increase in leverage doesn’t result in more systemic risk.

But Last week, the Financial Stability Oversight Council — a panel of regulators led by Treasury secretary Steven Mnuchin — warned that courts could get overwhelmed with coronavirus-fueled bankruptcy filings, causing a log-jame that prevents borrowers from quickly quickly restructuring their debts, forcing many into liquidation.

The Takeaway: For now, it’s a boom time. The private equity industry has grown from $1.5 trillion under management to $4.7 trillion as of this year.