Rate-Mageddon or: How i learned to stop worrying and welcome higher interest rates
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YOUR GROWTH PARTNER © Hong Kong +852 2251 8329 | New York +1 (212) 763-0159 www. 375parkllc.com This document has been prepared by 375 Park Associates for advertising and general information only. 375 Park Associates makes no guarantees, representations or warranties of any kind, expressed or implied, regarding the information, including, but not limited to, warranties of content, accuracy and reliability. Any interested parties should undertake their own inquiries as to the accuracy of the information. 375 Park Associates excludes unequivocally all inferred or implied terms, conditions and warranties arising out of this document and excludes all liability for loss and damages arising therefrom. This publication is the copyrighted property of 375 Park Associates. ©2015. All rights reserved. Rate-maggedon or: How I Learned to Stop Worrying and Welcome Higher Interest Rates Given the strength of the November Jobs Report –nonfarm payrolls surged by 211,000 – and as emerging markets have begun to stabilize, it is near certain the Federal Open Market Committee (FOMC) will raise rates when they meet next week. According to the CME Group’s FedWatch Tool , the ‘Implied Probability’ of a 50-basis point increase is now above 83%. INSIGHT New Normal There is no denying that interest rates have remained at or near historic lows for some time. Following peak rates in the early- to mid-1980’s rates ‘normalized’ in the late 1980’s and in a recent report Bryon Ehrhart, CEO of Aon Benfield Americas, and Chairman of Aon Securities, Inc. noted ‘we have seen more than 30-years of [interest rate] decline.’ This includes a prolonged period of record low interest rates - nearly half of the 51-year average with the Effective Funds Rate averaging less than 20% the long-term average. x̄ (since 1954), 5.00% x̄ (since 1995), 2.73% 0% 4% 8% 12% 16% 20% New Normal? Effective Rate Since 1954 SOURCE: FEDERAL RESERVE ECONOMIC DATA (FRED) Does the prolonged period of low, interest rates signal a new normal? The short answer is yes. 375 Park expects rates in developed markets to remain below the 20- year average for the next two to three years at a minimum. While the cause of near zero interest rates may vary from market to market, the effect has been clear, fund managers pushed the envelope in search of higher returns – in some cases to make good on obligations they made more than a decade ago. This has led to an explosion of private equity activity, and assets under management (AUM) are at historic levels. Looking forward to 2020, 375 Park expects that total AUM will continue to grow as asset value accelerates. However, 375 Park analysis indicates higher interest rates have the potential to slow growth in ‘dry powder’ levels as marginal performers are forced to compete against increasing returns in other categories. In light of slowing growth in ‘dry powder levels’ mid-market will need to refine their competitive advantage to successfully close funding. The U.S. is not alone; since 2009, the Bank of England has left rates at 0.5%, while the Bank of Japan has kept rates at or near zero since 2010, and the European Central Bank lowered rates to 0.5% in September 2014. For Rate Increase: William H. Gross, Pimco co-founder ‘If only to prove that they can begin the journey to ‘normalization’. They should, but their September meeting language must be so careful, that ‘one and done’ represents an increasing possibility – at least for the next six months. The Fed is beginning to recognize that six years of zero bound interest rates have negative influences on the real economy.’ Janus Capital Investor Outlook, 2 September 2015 On Uncertainty: Reuben L. Sushman, Managing Director | 375 Park Associates ‘Uncertainty has made it more difficult for mid- market firms to measure the impact of various structured products by themselves.’ 1
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375 Park Associates insight article on the likelihood the Federal Open Market Committee (FOMC) will begin to raise interest rates in 2015 and the impact of the rate increase on mid-market companies. (C) 2015 | 375 Park Associates
Transcript of Rate-Mageddon or: How i learned to stop worrying and welcome higher interest rates
YOUR GROWTH PARTNER©
Hong Kong +852 2251 8329 | New York +1 (212) 763-0159
www.375parkllc.com
This document has been prepared by 375 Park Associates for advertising and general informationonly. 375 Park Associates makes no guarantees, representations or warranties of any kind, expressedor implied, regarding the information, including, but not limited to, warranties of content, accuracyand reliability. Any interested parties should undertake their own inquiries as to the accuracy of theinformation. 375 Park Associates excludes unequivocally all inferred or implied terms, conditions andwarranties arising out of this document and excludes all liability for loss and damages arisingtherefrom. This publication is the copyrighted property of 375 Park Associates. ©2015. All rightsreserved.
Rate-maggedon or: How I Learned to Stop Worrying and Welcome Higher Interest Rates
Given the strength of the November JobsReport –nonfarm payrolls surged by211,000 – and as emerging markets havebegun to stabilize, it is near certain theFederal Open Market Committee (FOMC) willraise rates when they meet next week.According to the CME Group’s FedWatchTool, the ‘Implied Probability’ of a 50-basispoint increase is now above 83%.
INSIGHT
New Normal
There is no denying that interest rates haveremained at or near historic lows for sometime. Following peak rates in the early- tomid-1980’s rates ‘normalized’ in the late1980’s and in a recent report Bryon Ehrhart,CEO of Aon Benfield Americas, andChairman of Aon Securities, Inc. noted ‘wehave seen more than 30-years of [interestrate] decline.’ This includes a prolongedperiod of record low interest rates - nearlyhalf of the 51-year average with theEffective Funds Rate averaging less than20% the long-term average.
x̄ (since
1954),
5.00%
x̄ (since
1995),
2.73%0%
4%
8%
12%
16%
20%
New Normal? Effective Rate Since 1954
SOURCE: FEDERAL RESERVE ECONOMIC DATA (FRED)
Does the prolonged period of low, interestrates signal a new normal? The shortanswer is yes. 375 Park expects rates indeveloped markets to remain below the 20-year average for the next two to three yearsat a minimum.
While the cause of near zero interest ratesmay vary from market to market, the effecthas been clear, fund managers pushed theenvelope in search of higher returns – insome cases to make good on obligationsthey made more than a decade ago.
This has led to an explosion of private equityactivity, and assets under management(AUM) are at historic levels. Looking forwardto 2020, 375 Park expects that total AUM willcontinue to grow as asset value accelerates.However, 375 Park analysis indicates higherinterest rates have the potential to slowgrowth in ‘dry powder’ levels as marginalperformers are forced to compete againstincreasing returns in other categories. Inlight of slowing growth in ‘dry powder levels’mid-market will need to refine theircompetitive advantage to successfully closefunding.
The U.S. is not alone; since 2009, the Bank ofEngland has left rates at 0.5%, while the Bank ofJapan has kept rates at or near zero since 2010,and the European Central Bank lowered rates to0.5% in September 2014.
For Rate Increase: William H. Gross, Pimco co-founder
‘If only to prove that they can begin the journeyto ‘normalization’. They should, but theirSeptember meeting language must be socareful, that ‘one and done’ represents anincreasing possibility – at least for the next sixmonths. The Fed is beginning to recognize thatsix years of zero bound interest rates havenegative influences on the real economy.’
Janus Capital Investor Outlook, 2 September 2015
On Uncertainty: Reuben L. Sushman, Managing Director | 375 Park Associates
‘Uncertainty has made it more difficult for mid-market firms to measure the impact of variousstructured products by themselves.’
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YOUR GROWTH PARTNER©
Hong Kong +852 2251 8329 | New York +1 (212) 763-0159
www.375parkllc.com
This document has been prepared by 375 Park Associates for advertising and general informationonly. 375 Park Associates makes no guarantees, representations or warranties of any kind, expressedor implied, regarding the information, including, but not limited to, warranties of content, accuracyand reliability. Any interested parties should undertake their own inquiries as to the accuracy of theinformation. 375 Park Associates excludes unequivocally all inferred or implied terms, conditions andwarranties arising out of this document and excludes all liability for loss and damages arisingtherefrom. This publication is the copyrighted property of 375 Park Associates. ©2015. All rightsreserved.
Rate-maggedon or: How I Learned to Stop Worrying and Welcome Higher Interest Rates
INSIGHT
What Does A Rate Increase Mean for Mid-
Market Firms?
Increased competition in the private moneymarkets will force mid-market firms toexplore a structured approach through acombination of debt and equity offerings.This will require the expertise to implementan effective capital management program.
The true impact of a rate increase dependson the maturity of a company’s debt profile.For example, if a company were to refinanceas much as 50% of their debt profile in thenext six months, a 50-basis point increasein Federal Reserve’s Effective Funds Ratewould equate to an additional 1% in interestpayments per year. Depending on theterms, this could increase to nearly 5% inadditional interest payments per year if theFederal Reserve ‘normalizes’ rates from cur-rent levels to the 3% range by 2017.
Most mid-market firms, especially thoseunder $100 million in revenue, lack theresources to manage their debt profiles andaccording to 375 Park Managing Director,Reuben L. Sushman, ‘uncertainty has madeit more difficult for mid-market firms to
$-
$1,000
$2,000
$3,000
$4,000
$5,000
Billion
s
Growth in Dry Powder will Slow
Unrealized Portfolio Value
Dry Powder
SOURCE: 2015 PREQIN GLOBAL PRIVATE EQUITY & VENTURE CAPITAL REPORT, 375 PARK ANALYSIS
Forecast
measure the impact of various structuredproducts by themselves.’ This uncertaintyhas also made it more difficult for lenders tounderwrite mid-market debt. Industryanalysts report October marked the fifthstraight monthly decline in mid-market loanlevels - reaching their lowest levels sinceFebruary 2009.
While a clear rate direction will help mid-market firms more accurately forecast theircost of capital, it will also strengthen theU.S. dollar. On the plus side, a strongerdollar will allow those mid-market firms withhealthy balance sheets to target strategicacquisitions internationally and sellers willbenefit from higher valuations as foreigninvestors seek to expand their holdings inthe U.S. However, a stronger dollar willdrive up the cost of U.S. exports whilediminishing the value of foreign earnings.To remain competitive, mid-market firmswill need to hone their value propositions,including ramping up operational excellenceactivities, and capital managementmechanisms including foreign exchange.
Insight
Given the Fed’s reticence to raise rates inOctober 375 Park believes a minimum 25basis point rate hike is a near certainty nextweek. This will signal the beginning of arate normalization cycle that couldincrementally add 200 basis points to theFed’s Effective Fund Rate by 2017.Assuming this is correct, the Fed wouldmove rates much closer the historicalaverage rate for the internet era of 2.73%.
Whilst rate normalization would force mid-market firms to mitigate the impact of astronger dollar, clear policy direction willallow mid-market firms with effective capitalmanagement mechanisms to gain a tangibleadvantage over their peers.
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