Federal Reserve Interest Rate Hike Expected to Make Minimal Impact on the Middle Market

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The Federal Reserve’s move to raise its benchmark interest rate for the first time in nearly 10 years isn’t expected to have much of an effect on middle-market M&A activity, but subsequent rate hikes could.

The central bank voted Dec. 16 to raise its benchmark interest rate by a quarter of one percent, to between 0.25 percent and 0.5 percent, and it has signaled that it will continue to gradually wean the economy off the historic stimulus it fostered over the last seven years.

Interest rates will have to climb much higher before they cause problems for middle-market deals, says David Brackett, Antares Capital, which has 95 percent of its $10.5 billion loan portfolio with middle-market borrowers. While leverage levels today for middle-market M&A are at 2007 levels, the current 30- to 60-day LIBOR rates are at 0.5 percent, compared to 4.5 percent in 2007.

“You’ve got an awful lot of room before we have real challenges,” Brackett says. “We feel very comfortable that today’s capital structures anticipate and can digest a meaningful increase in interest rates.”

The possibility of the Fed raising rates has been talked about for two years, and lenders have been building cushions into their financing models to anticipate possible rate increases over time. For Alcentra Capital Corp., for example, which uses a LIBOR-plus floating rate, a LIBOR floor of 50 basis points was already figured in to its rates, says Karin (McKittrick) Kovacic, a vice president at Alcentra.

Even if the benchmark interest rates were to rise dramatically, they would have to reach the 5 percent or above range to be really scary, Brackett says. The concern with a jump in rates would be the factors behind such an increase, which would likely be inflationary pressures. But inflationary pressures aren’t anticipated as long as the economy continues to grow slowly and the Fed continues its gradual approach.

For the lower middle market, the Fed hike will have little, if any, effect on M&A in 2016, says Tricia Marks, managing director of Madison Capital Funding. Jeri Harman, CEO of Avante Mezzanine Partners, says it will take a larger rate Fed hike --possibly a full point—before the debt markets, and leverage availability and valuations in the middle- and lower-middle markets, are affected.

“I think the real likelihood is that some combination of rate hike, along with a general softening of the economy is what it would take to have a real impact on the debt markets and the M&A markets,” says Harman, whose firm is one of the most active middle-market lenders. Worries of a modest recession would put more stress on companies and their revenues.

“I think it’s a long-term concern. I think a small hike in the short term, given the amount of capital chasing deals, isn’t going to change things, at least in the lower and mid-market,” she says.

If the Fed hike is cited as an issue during deal negotiations, then it’s probably a signal of bigger problems, Alcentra’s Kovacic says.

“If it’s 25 or 50 basis points that’s going to affect a deal, then I think we’re not focused on the right things. Hopefully that’s not the case,” Kovacic says. “If it’s quarter after quarter after quarter after quarter and now you’re talking about a full percentage point, now you’re going to have to look at things a bit differently.”

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