In conjunction with the 25bps interest rate hike in September, the Fed, taking a hawkish stance on monetary policy, raised its economic outlook and dropped the “accommodative” language that has long been a component of its formal statement.
In August, the Bank of England (BOE) raised interest rates, citing a strong labor market and credit growth. UK economic growth rebounded in the second quarter following a slowdown in the first quarter, which the BOE attributes largely to weather. One of the most significant risk to economic growth remains Brexit negotiations between the UK and European Union.
Private debt and equity dry powder continued to build, supporting higher leveraged buyout (LBO) purchase multiples and lower credit spreads. This trend may continue to result in private credit funds and direct lenders gaining market share from banks - despite loosening regulations.
Lending standards have remained more rigorous in the lower middle-market (<$25M EBITDA), where total leverage is largely holding below 6x and financial covenants remain intact (i.e., a limited number of covenant-lite or covenant-loose transactions). At the same time, we note diminishing underwriting standards at the upper end of the middle-market (>$25M EBITDA), which we attribute to the abundance of available capital (a result of collateralized loan obligations (CLOs) and other non-direct origination sources).
Rising borrowing costs have resulted in a significant decline in refinancing activity year-to-date (YTD), particularly in the third quarter. There has been a significant shift toward opportunistic financings for growth-related purposes and leveraged recapitalizations. As economic conditions continue to stoke M&A related activities and a hawkish Fed focuses on raising rates, we anticipate that the trend away from refinancings will likely continue.
