Borrower-friendly terms over the past few years have helped boost M&A totals—and a number of factors suggest the financing will not change dramatically in 2022
Flexible and attractively priced financing has been a driving force of the M&A market for a number of years now, a trend that even the pandemic did not reverse. Persistently low interest rates have helped keep borrowing costs low, but rising inflation has prompted concerns that the US Federal Reserve may undertake measures to tighten monetary policy on a faster basis than previously projected.
The US consumer price index rose by 7.0 percent in 2021—the largest annual increase since 1982—with many sectors, including gas, food and shelter, registering substantial jumps. Even before the release of these figures, the Fed had already indicated that it would accelerate the tapering process for its quantitative easing program and that interest rates may rise sooner than it had anticipated earlier in the year.
Despite those headwinds, we see a number of factors that should underpin a continued robust finance market for M&A dealmaking. Although consumer price inflation is at a four-decade high, there remain reasons to believe it is unlikely to continue at this pace through 2022. For one, US savings rates are trending down (they were 7.3 percent in October 2021, substantially lower than the 10.6 percent seen in July 2021), which suggests that wage inflation should stem as people feel pressure to return to the labor market.
There are also significant structural factors that will continue to drive strong deal lending volumes. Globally, private debt funds were sitting on US$364 billion of dry powder as of July 2021, according to Preqin figures, and the number of funds continues to increase—there were more than 651 funds in the market, targeting US$295 billion, more than double the totals seen in January 2017. Coupled with the firepower of private equity, this will lead to enduring high levels of competition for deals, which should keep pricing and terms competitive. Additionally, private equity sponsors' continued focus on buy-and-build transactions to generate value will likely translate into a continuation of strong demand for incremental debt to finance the growth of existing platforms.
While higher inflation and burgeoning labor costs may yet put pressure on borrowers' balance sheets, sponsor-backed businesses have generally thus far been successful in passing these costs on to customers. Another mitigating factor is that we are now seeing longer maturities on financing arrangements, as borrowers seek to lock in attractive terms and pricing—three- to five-year tenors are now being pushed to up to six or even seven years.
Overall, we are cautiously optimistic that—absent a major shock—the financing market will continue to be highly active, at least through H1 2022 and possibly beyond.
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