Dealmaking is looking up as companies stop waiting out the Fed

Morgan Stanley CEO Ted Pick said ‘corporate boardrooms have been quiet for three, four years, and that is not sustainable.’ (Bloomberg)
Morgan Stanley CEO Ted Pick said ‘corporate boardrooms have been quiet for three, four years, and that is not sustainable.’ (Bloomberg)

Summary

Borrowers are getting on with things as rates are set to remain high for longer.

Bankers’ advice for dealmaking clients who have been sidelined by the high cost of funding boils down to this: Get used to it.

Wall Street investment banks in the first quarter have finally started to report a pickup in activity following a long slowdown. Revenue from arranging sales of stocks and debt, and for advising on mergers and acquisitions, was collectively up 27% at the five largest Wall Street banks from a year earlier, to the highest level since the first quarter of 2022, when the Federal Reserve began raising interest rates.

Many deals were put on hold as the Fed rapidly raised rates, then began to signal cuts at the end of 2023, only to have to rein in market expectations for this year from as many as six cuts to perhaps two or even none now. That kind of whipsawing isn’t conducive to placing multibillion-dollar bets on a company’s future.

But with some clarity emerging that rates aren’t likely to fall dramatically in the near future, banks are reporting signs of capitulation among their clients.

Morgan Stanley Chief Executive Ted Pick told analysts on Tuesday that “corporate boardrooms have been quiet for three, four years, and that is not sustainable, they need to move," noting that the challenge of fast-rising rates followed on the heels of the global pandemic. Now, he said, “Those higher rates seem to be well absorbed."

As borrowing by highly indebted companies picks up, these offerings make the “cost of capital much more observable" to private-equity dealmakers, Goldman Sachs Chief Financial Officer Denis Coleman told analysts on Monday. “That should unlock their ability to start to price and put together transactions." A buoyant leveraged-finance market is a key to seeing more private-equity deals.

Of course, it serves investment banks’ interests to convince clients it is a good time to make a deal. But there is history to what they are saying, as the current level of interest rates hasn’t always by itself been a barrier to dealmaking.

Before the zero-interest rate era, prior U.S. merger-and-acquisition dollar volume peaks came in 2000 and 2007, which were years when the average federal-funds effective rate was over 6% and 5%, respectively, according to Dealogic and Fed data.

A jump in activity in the market for financing highly leveraged companies in the first quarter mostly wasn’t related to new deals. Yet it is a sign that borrowers are getting comfortable with the present rates on offer, which might just represent the best they will get for a while. 

Nearly 90% of the over $350 billion of leveraged loans priced in 2024 have been opportunistic, for things like refinancing or repricing, data from LevFin Insights shows.

This was aided by attractive pricing, as measured by a narrowing spread between borrowing costs and benchmark rates. This is a sign that debt investors are hungry to buy and aren’t overly worried about credit risk, reflecting the same strong economic data that may keep interest rates elevated. 

In March, average spreads on new loans from issuers rated single-B were roughly 1.5 percentage points lower than they were at the same time last year, according to LevFin Insights.

With more of their existing deals refinanced, private-equity firms might now be in a position to start to deploy more capital into new deals. Certainly the urgency for deals is there: With share prices of potential buyout targets rising, and many of their funds getting long in the tooth, private equity’s need to deploy capital and start generating more fees could alone be a powerful motivator this year.

Investors will hear quarterly updates from private-equity fund managers in the coming days. But the fact that Goldman Sachs and Morgan Stanley—both closely identified with deal activity—have seen their share prices perform the best among the big five Wall Street banks since reporting earnings suggests that investors see more deals coming.

Just because everyone is telling you to do something doesn’t mean it is a good idea. But companies, like people, often move in tandem.

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