The Unicrunch — Lenders hope Fed’s jumbo cut brings relief

Sami Vukelj
+Peter Benson

20 September 2024•4 min read

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Rate reversal

The Fed’s decision to make its first cut in interest rates in four years will provide much needed relief for some in the private credit market.

For investors have long awaited a move from the Fed that would help grease the M&A wheels, hoping that any reduction in high rates will aid PE firms in modeling out the costs for potential acquisitions, and thus open up more LBO opportunities that private credit firms have sought after for the best part of two years.

“The bottom line is that people view this as helpful for valuations, helpful for alleviating debt burdens, and helpful for getting refinancings done,” one private credit investor told 9fin.

It’s not just M&A where the sound of relief will be heard. Such a cut should help with companies in private credit portfolios contending with high debt costs stemming from floating rate loans.

The Fed’s decision comes amid declining interest coverage ratios and margin compression private borrowers have been experiencing over recent months, and should create some breathing room for them while still leaving lenders with yields higher than they were in years past.

One private credit investor we spoke to projected that every 100bps of cuts to the base rate would translate to an 80bps-90bps reduction in the rate charged to borrowers, freeing up cash for companies who have been dealing with some of the highest rates in decades.

“Companies that have been struggling with higher interest burdens should begin to see relief, and others that were awaiting lower borrowing costs to pursue financing activities may now have increased appetite for debt solutions,” said Roger Ferguson, executive chairman of Andalusian Credit Partners in a report commenting on the rate move.

Despite the optimism lenders may express, some commentators interpreted the jumbo hike as a sign that the economy is in worse shape than expected (equity markets have shrugged off those concerns and met Powell’s “recalibration” with “jubilation”). Whatever hopes there are for M&A activity may ultimately be tempered if earnings are coming in soft across a number of sectors, likely limiting M&A activity.

The sound of the police

Much continues to be made of the environmental impact of investments and what LPs can do to curb climate change. See Maine Public Employees Retirement System as an example.

But what about the S in ESG? It’s rare to hear about social issues when it comes to private investments. Examples in the private markets to remedy representation concerns are few and far between. A few years ago, Carlyle agreed to do a $4.1bn revolver tied to diversity targets for its portfolio companies, but there has been little else.

The Illinois Police Officers’ Pension Investment Fund (IPOPIF) is thinking about the S a little differently. The investor recently updated its investment policy to protect its own beneficiaries. The statement read:

The Board recognizes that some publicly traded corporations and private owners or managers of investment vehicles may support organizations that engage in policy making activity that could undermine law enforcement officers’ ability to protect and serve their communities safely, such as ‘defunding the police,’ or that could diminish public pension sustainability or retirement security.

The pension fund initially began having discussions in July to update its investment policy and the next stage for IPOPIF is to establish proxy voting policies and processes, and come up with a list of entities that engage in activity that could undermine the police’s ability to do its job.

“The statement of principal was an important first step, but the implementation will be complex and carefully considered,” Kent Custer, CIO of IPOPIF, told 9fin via email.

No entities have been earmarked for no investment based on this criteria, he added. That will unlikely happen soon either.

While we’re not aware of any private equity sponsors or founders of HVAC companies demanding the defunding of the police, lenders may want to stay on top of the ever-evolving ESG issue that has its supporters and detractors.