Companies Shelling Out Billions to Beat the 'Fiscal Cliff'
Companies are racing the clock to hand out billions in special dividends before year end—and some of them are taking on debt to do it.
Fearing a tripling of dividend tax rates next year, companies have found one-time payouts and early payments of quarterly dividends as a way to beat some of the impact of the "Fiscal Cliff."
Taking advantage of super-low interest rates, companies have been issuing debt at a record rate this month. Some say they plan to use the proceeds to fund dividends and share repurchases.
"I think what you're seeing is a reaction to the lack of clarity around the tax laws, and that's what Treasurers and CFOs are doing," said Joel Levington, managing director of corporate credit at Brookfield Investment Management.
Christopher Reich of Thomson Reuters IFR points out, for instance, that Murphy Oil in its prospectus Tuesday also said that it would use the proceeds of its more than $600 million offering of 5-year, 10-year and 30-year bonds to fund its previously announced special dividend, among other things.
On Tuesday, issuance for the month surpassed $100 billion, making it the busiest November ever and on track to possibly be the busiest month of 2012, according to IFR.
Companies are using debt to fund payouts for different reasons. "I think what you're seeing is there's largely a mismatch with significant cash balances that are overseas. Companies won't repatriate that money given the tax implications. While there is cash there it's not really useable for a dividend or share repurchase," he said.
At the same time, credit quality is peaking, says Levington. "What I mean is you're going to see companies use leverage in 2013, whether it's in the form of cash to fund dividends, or more likely for acquisitions and share repurchases. That will be a trend that you'll see throughout the year," he said.
In the case of Costco, S&P removed its investment-grade ratings from credit watch positive, as the company planned to offer $3.5 billion of senior unsecured notes, mainly to fund the dividend.
The dividend tax rate, now 15 percent, is set to expire Dec. 31, and ahead of that investors have been dumping dividend paying stocks, like utilities. But they've also been eyeing a whole other group that are or could be paying special one-time dividends.
The concern is that the dividend tax rate could revert to 39.6 percent for the highest tax bracket if Bush tax cuts are not extended for the wealthy, as proposed by President Barack Obama.
The new Affordable Care Act—or Obamacare—also includes a new 3.8 percent tax on dividends and other investment income for wealthy taxpayers, and that would take the dividend tax rate up to 43.4 percent. At the same time, capital gains taxes, now 15 percent, could rise to their former rate of 20 percent.
"I think the dividend rate will go up, but not as much as the stance of Obama at the present time," said Wharton School finance professor Jeremy Siegel. "I don't think it will be all that much different, but it is going to be higher."
The special payouts, therefore, make sense.
"It's smart," Siegel said. "Just like people taking capital gains now. It's smart." (Read More: Even Muni Bonds May Be Targeted in 'Fiscal Cliff')