Debt investors tend to grumble about dividend financings even in the hottest of markets, and these deals are no exception. At the same time, grumbling often doesn’t stop them from calling the arranger to place a big order.

Let’s look at one of this week’s deals in a bit more detail:

AOC, which makes resins for a range of industrial purposes, is raising a $350m add-on to return cash to shareholders (the company was acquired by Lone Star in 2021) and lead arranger BofA is asking for commitments by Friday.

Even in strong markets, debt-funded dividends typically come on the heels of good earnings. And to be fair, Moody’s notes that AOC’s performance has “exceeded expectations” since its buyout.

But there’s also this: the company reported a decline in revenue for the fourth quarter of 2022, and has forecast weaker volumes and EBITDA for 2023, according to our sources.

“Bringing a dividend deal off a decreased earnings forecast? Usually it’s the other way around,” said a buysider following the deal.

Still, leverage is relatively low (under 3x through total debt) and AOC isn’t exactly short of liquidity. The orderbook for the incremental loan is understood to be strong, even if some buysiders might object to the principle of the situation.

“There is a difference between a real credit negative, like a company that levers up for a dividend to the point where it increases default risk, and a company just having the chutzpah to do something aggressive,” said the buysider.

Bird in the hand

Strong orderbook or not, the re-emergence of debt-funded dividends in a market that only weeks ago was deathly quiet is remarkable.

The loan market is sputtering back into life this year, but it’s far from booming, and while interest rates have leveled off, debt is still very expensive. “Anything dividend-wise you are still looking at low double-digit yield,” said a banker.

But the IPO market is weak and valuations are depressed, so sponsors don’t have many exit options. “The IPO market is tough and sponsors are not getting the valuations they want, so they are going to take short term dividends to push out a sale process,” said the banker.

Another factor that’s contributing is the lack of new issue supply that investors have had to contend with in recent months, as borrowing costs increased and issuers stepped back. New CLOs are ramping, and many high yield managers are sitting on cash.

This technical pressure could bode well for the likes of Savers, which is taking advantage of rebounding demand for high yield bonds to sell $500m of five-year non-call two SSNs via Jefferies.

Proceeds will be used to pay a $230m dividend to its sponsor Ares as well as pay a $21m special employee bonus; the company is also going to prepay a portion of its first lien term loan, a little sweetener that could help mitigate the impact on leverage.

To our earlier point about the IPO market, Savers filed for a potential IPO in October 2021, which is yet to materialize.

As a credit, the company has its admirers: sources pointed out that thrift and discount stores tend to perform well during recessions, and that (similar to AOC) leverage is relatively low in the mid-3x range.

“Typically bond guys like me don’t like it when debt is supposed to pay equity guys,” said one portfolio manager. “Still, when you evaluate it pro-forma, the leverage still looks attractive. I’m willing to say if it’s coming north of 10% it looks pretty good.”

Positive energy

Similar reasoning might support the dividend financing for Oryx Midstream Services.

Energy companies have dominated primary market issuance so far this year. Investors have been receptive, partly because the strong supply and demand dynamics in the oil and gas sector should be supportive for balance sheets.

Oryx, owned by Stonepeak Infrastructure Partners since 2019, is looking to place an incremental US$300m term loan B due 2028 to fund a shareholder distribution and recapitalize its balance sheet. Barclays is leading, and commitments are due by Friday.

“It’s a great business,” said one CLO manager looking at the deal. “Given it’s a tack-on, there will be a lot of demand from the current investors.” The strong investor reception for Whistler Pipeline’s buyout financing also suggests this.

Two sources did say that there had been some pushback, centered around the CSA for the transition from Libor to SOFR. Investor opposition to these adjustments has had some success, as we highlighted back in December (there was more on that this week from Bloomberg).

But with so much demand for proven companies with relatively healthy credit metrics, these dividend deals may prove too tempting to resist — even if they offend investors’ sensibilities.

“You have to rank it to other alternatives,” said the buysider. “Even if you think the ask is egregious, so long as you like the credit and the relative value is sound — you are not impaired and still have decent margin of safety — you have to look past your principles.”

AOC, Oryx, Stonepeak and Jefferies did not respond to requests for comment. Ares, Lone Star, BofA and Barclays declined to comment, and Savers could not be reached for comment.