Capital markets activity continues to accelerate, as the likelihood of rising interest rates looms in the near future, which means now is the ideal time for borrowers to explore interest rate hedges. These insights and others are shared by Neil Wessan, Group Head and Managing Director of CIT Capital Markets, a division of CIT Group Inc. in “Capital Markets Prepare for an Interest Rate Hike,” the latest piece of market intelligence in the CIT Executive Insights series.

“The U.S. capital markets are very liquid, with many investors looking to participate in the market, especially the middle market,” said Wessan. “The market is even more open for business than it was last year. The pricing environment is increasingly aggressive as capital bids for fewer deals and Collateralized Loan Obligations (CLOs) are dipping down into the middle-market to gain yield.”

At the same time, Wessan sees an increase in interest rates ahead, saying, “I believe that the Federal Reserve will act to raise interest rates within the next twelve months... The yield curve also indicates that the market expects such a move. As such, we’re strongly advising our clients to look at hedging a portion of their floating-rate obligations to protect themselves against interest rate moves while they can do so in a cost-effective manner.”

Additional trends noted by Wessan include:

• A Push to Avoid Riskier Assets: Leverage levels have gone up since last year, but the new federal leveraged lending guidelines have had an effect on curbing bank lenders’ appetites for maximizing leverage. This is creating space for non-banks, such as Business Development Companies (BDCs), to lead highly leveraged transactions, resulting in a certain amount of disintermediation between banks and non-banks.
• Economic Outlook is Hot or Cold by Sector: Energy, healthcare and transportation have remained the most active sectors for lending activity in the middle market. In particular, oil field services and helicopters stand out as sub-sectors with a lot of deal flow. Looking ahead, the U.S. economy should continue to produce slow growth, even if there is an increase in interest rates.
• Middle Market M&A to Remain Stable at Low Level: Middle market M&A activity hasn’t grown year over year, with at least another year before it returns to historical levels. There is a divergence between the broad market, where large, transformational acquisitions are getting done, and the middle market, where sponsors are still exercising discipline.
•  Regulatory Uncertainty Takes a Toll: One of the biggest challenges facing businesses is regulatory uncertainty, which manifests itself as companies being unwilling to invest in expansion or acquisition and acts as a dampener on economic activity. The recent midterm elections could help bring clarity to the likely course of legislative and regulatory action.

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