Dividend capitalizations. That’s the name of the latest questionable practice within a firm or securities vehicle. Private-equity firms are adding to their companies’ debt loads so they can give a dividend to themselves.
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They issue new, high-yielding debt, just as income investors are scrambling for high yields in the low interest rate environment, and take the proceeds for themselves.
Yields can be as high as 10%. Debt-issued private-equity dividends have reached an all-time high of $54 billion this year.
The previous record was $40.5 billion in 2010 just as the credit markets opened up after the 2008 crisis. Last month saw a flurry of new deals.
Although the dividends are disclosed at offerings, critics say the practice loads companies with debt to the point where it burdens operations and reduces the firm’s investment exposure.
Some of the debt is issued in the form of toggle bonds that give issuers a choice
to defer payments to investors.
Some analysts says the market is letting firms get away with this for only incremental extra yield.
The upside is that the companies doing dividend capitalizations are in good financial shape compared to those who issued debt during the early 2000s. Debt issued this year averaged 4.21 times earnings compared to 5.36 times at the top of the 2007 crisis.