Higher-for-longer: What Consequences for PE?

Higher-for-longer: What Consequences for PE?

A cura di Gabriele Malloggi

“The higher-for-longer environment is leading to a major shift in the corporate ecosystem”, as noted by Allianz Global Investors’ global chief investment officer for equities, Virginie Maisonneuve. The prolonged anticipation of elevated rates is causing impactful reverberations throughout the economy: businesses, both large and small, are grappling with debt refinancing challenges, while governments face escalating costs associated with their pandemic-era borrowings.

In contrast, the private equity sector previously capitalized on the abundant and low-cost debt during the decade and a half of low interest rates, rapidly acquiring numerous companies and establishing themselves as the new financial titans. The looming question is how companies, whose operations flourished in a low-interest rates environment, will adapt if rates keep ‘higher for longer.’

Patrick Dwyer, a managing director at NewEdge Wealth, pointed out: “Borrowing costs were cheap and the liquidity was there. Now, it’s not there. Private equity is going to have a really hard time for a while”. Private equity firms are particularly vulnerable to interest rate fluctuations due to their investment funding model, involving a mix of equity and debt tailored to the firm’s strategy, the target company, and prevailing market conditions.

The impact of rising rates extends beyond affecting debt costs: it influences cash flow projections and, consequently, the overall financial stability of investments, highlighting the sector’s heightened sensitivity to interest rate changes. Consequently, private equity groups are increasingly resorting to diverse financial engineering strategies.

Some are resorting to substantial borrowing against the pooled assets of their funds to generate the necessary cash for dividend payments to investors, eliminating the need to seek additional investments to support companies struggling under hefty debt burdens. Another tactic involves transitioning away from making cash interest payments, conserving short-term liquidity but adding to the overall outstanding debt amounts. These strategic shifts underscore the sector’s efforts to navigate the evolving financial landscape amid persistent high interest rates.

Whatever strategies will be deployed, one thing is for sure: the private equity market is to change forever.

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