Strong economic growth and the tailwind of available debt continue to support deal activity in the private equity space. A fair amount of this is due to new deal flow, but we are also seeing high levels of refinancing activity.
Many of our clients are improving their covenants, extending debt terms and lowering margins. With concerns growing across the market that there may be a recession ahead, it feels rather like “fixing the roof while the sun is shining”. A gloomy thought, perhaps, but we can take comfort in the fact that businesses can set themselves up for stable and secure funding out to 2025. Any deterioration in the funding markets will now be less of a worry – presuming that businesses have also pre-hedged their interest rate risk!
From our hedging vantage, the story continues to be one of interest rate divergence across the key markets. While rates continue to rise in the US, EUR rates seem unlikely to drift very far from their record lows despite QE coming to an end. This leads borrowers in EUR to either not hedge at all, or to take out some ‘bottom drawer’ insurance in the form of ‘cheap’ out of the money interest rate caps. In USD the hedging products of choice are still split between swaps and caps, and in GBP a slight bias towards caps (mainly to ensure the impact of the interest rate floor is benign). The impact of this interest rate divergence also manifests itself in the currency markets and the hedging of FX risk.
JCRA recently published an article on debt redenomination highlighting this dilemma. We are seeing a high proportion of our clients paying much closer attention to their currency exposures in general and not making the automatic decision to exploit natural hedging through debt redenomination while the interest rate differential between USD and EUR is so wide.
While it feels rather like the market is suffering from Brexit fatigue, it is certainly a topic getting as much attention now as it did in the immediate aftermath of the referendum. The looming deadline for the exit to occur, and the lack of defined relationship post the end March 2019 translates into a high level of ‘event’ risk for corporates and their private equity sponsors. If the date of March 2019 holds (which is by no means 100% certain), we expect there will be a flurry of activity of transactions in the making, looking to complete and avoid signing occurring from March 2019 and probably the three months following.
For more information, please contact Benoit De Benaze, Head of Private Equity at JCRA: Benoit.firstname.lastname@example.org.