US investment firm, The Partners Group, raises expectations for private credit investments following the US Federal Reserve's interest rate reduction.
The U.S. Federal Reserve (Fed) announced a 25 basis point rate cut on September 17, 2021, and is expected to implement further reductions this year. This move is aimed at observing the impact on private credit and private markets transactions.
According to Anastasia Amoroso, chief investment strategist for Partners Group's private wealth and retirement business unit, anticipated rate cuts should benefit private markets assets. Lower costs of financing for these assets are expected, allowing for greater use of leverage.
The immediate positive impact on borrowers' debt servicing costs from rate cuts is due to the floating rate nature of the loans, typically tied to a three-month term Secured Overnight Financing Rate Data (SOFR). This could lead to an increase in M&A activity, increasing the supply of direct lending transactions in the market.
New transaction economics are expected to be more attractive due to the rate cuts, helping boost overall investment activity. Private credit is expected to benefit from lower interest expenses, higher debt service coverage ratios, and potentially modest upward momentum in spreads, partially offsetting the decrease in base rates, helping to keep all-in private credit yields attractive.
The evolving relationship between US banks and alternative credit firms may provide more opportunities for private credit lenders. With lower discount rates, valuations of assets are likely to boost, as per Amoroso.
Interest rate reductions could help to reverse the trend of an increase in payment-in-kind interest in the market. Additionally, they could alleviate the financial burden on borrowers, putting them in stronger liquidity positions, while also helping alleviate investors' concerns about default risk.
Other private markets assets likely to benefit from interest rate reductions are private equity, private infrastructure, real estate, and royalties. The trend of declining leverage ratios in transactions could reverse with interest rate reductions, increasing the opportunities for private credit lenders.
However, it's worth noting that modest spread widening could occur due to the increase in transaction supply, partially offsetting the decrease in base rates. This suggests that while rate cuts are expected to have a positive impact, there may still be some challenges to navigate.
In conclusion, the Fed's planned interest rate cuts could significantly boost the private credit market and other related sectors, providing a much-needed stimulus for investment activity.
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