Interesting Turn of Events for Private Equity

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The United States is only now and still slowly emerging from the low-interest rate environment brought about by the Great Recession.

The central bank first raised the benchmark rate in December after keeping it at zero for nearly a decade to provide an economic stimulus. The Fed raised rates again in March, bringing us to the current range of 0.75 percent to 1 percent, with the possibility of another hike this month.

Low rates have had some obvious effects on the national economy, including a real estate boom across much of the country, with an acute effect in metropolitan areas such as Los Angeles. The median home price in Los Angeles County was $570,000 in April – an increase of 72 percent since 2010, when it was $330,500.

Now there are signs that many consumers could be falling into the same habits as they were before the crash – albeit on a smaller scale as the mortgage loan debacle, with credit cards and autos giving some troubling signals.

Credit bureau Transunion said in January that the subprime category’s share of the overall market for credit cards has reached its highest level since the end of 2010; the share for auto loans is now at its highest point since 2013. Those trends led Transunion to predict delinquency rates will rise in both categories this year.

So perhaps the Fed’s decision to tick up rates comes none too soon, notwithstanding the likely cooling of the real estate market as interest rates creep up.

Meanwhile, it will be interesting to see how higher rates will affect the private equity sector of the finance industry, where low interest rates have played into a trend among a number of firms, as noted in Henry Meier’s story on page 1. These shops have exploited the low-interest lending environment to load up their portfolio companies with high-yield corporate debt and take dividend payments on those loans.

These low rates have counteracted the effect of credit downgrades on those same portfolio companies – at least in terms of investor profits.

Whether or not this practice continues in the face of steadily increasing rates – and how it actually plays out – is something to gauge with some caution private equity adjusts to new market forces.

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