Dividend Recap Recovery Risk = ‘Hollow Threat,’ Moody’s Finds

  • Creditors fare no worse than in other defaults
  • Overall recoveries just over 60 percent
  • Lower tranches bear brunt of losses

A dividend recap is one of the most controversial arrows in the sponsor’s quiver. The additional layer of debt promises to raise risks for lenders, especially pre-existing lenders who may find themselves pushed lower down in the company’s capital stack. But Moody’s, in a report headlined “Hollow Threat,” found that recapped companies that defaulted had an average “family-level recovery” of 61 percent for their credithttp://cmswebvision.tfn.com/CMS/storyEdit.aspx?storyCode=21085270#ors, higher than 55 percent among 1,000 credit defaults.

The view that “recaps ‘hollow out’ companies is not borne out by recovery data, which show family-level recoveries in line with corporate averages,” wrote David Kelsman, a senior vice president at Moody’s and the lead author of the report.

For bank debt at the top of the capital structure, recoveries averaged nearly 90 percent, and recapped companies performed better on those loans that other categories of borrowers that defaulted, according to Moody’s analysis, which was drawn from the firm’s “Ultimate Recovery Database,” which has details on bonds and loans dating back to 1988.

Recaps do weaken credit quality, with 18 percent of such companies receiving downgrades, the rating agency said. But it also determined that because their default rates were consistent with non-recapped companies that defaulted, “the ratings properly accounted for the increased credit risk attributable to these transactions,” the report said.

To conduct its analysis, Moody’s looked at 16 companies that defaulted between 2001 and 2010 after executing a dividend recap, comparing them to a universe of 1,000 corporate defaults. This is a relatively small sub-set of the recap universe; Moody’s said that 2012 alone saw at least 101 dividend recap transactions, worth $31.6 billion. Half of those transactions occurred in the fourth quarter, as sponsors raced to complete their deals before the “fiscal cliff” at the end of the year that promised higher tax rates.

While the dividend recap is typically viewed as a mechanism used by buyout shops, more than a quarter of the recapped companies in the sample that defaulted did not have a private equity sponsor, Moody’s said.