Regarding plans to raise interest rates in the US - apart from the possibility that companies with a lot of debt would go insolvent or into restructuring,leading to more work in that area for lawyers - what other practice areas and types of clients would you say would be affected? Could the raise in interest rates lead to the value of global M&A going down (because it is much more expensive to borrow money)?
Hey Denisa!
To answer your second question first, yes - that’s something you could certainly argue. Cheap credit has helped M&A activity bounce back over the last few years, but as interest rates increase, companies could see their profits margins being eroded. So they may steer away from expansion plans.
That said, I'd suggest being prepared to argue the other side of the equation, especially for an interview. For example, if I were to play devil's advocate here, I could point to the fact that a lot of companies have cash reserves, so they're pretty resilient to a rise in interest rates. I could also argue that the economy is doing well (that's why interest rates are increasing in the first place), so companies may have more confidence in acquisitions. There could even be more opportunities as valuations fall or companies look to sell less profitable parts of their business.
You could also develop the argument by picking certain geographies (developed nations v emerging economies) or sectors (utility companies v tech companies).
Other practice areas impacted by interest rates rising:
Project Finance
For a very long time, cheap credit has helped companies to fund projects and service their debt. But, as it becomes more expensive to borrow, companies may suffer from cash flow problems. That's especially true if they haven't accurately priced a rise in interest rates to their projections. So as a result, law firms will need to advise companies on how to refinance their debt or they could even see a fall in projects work.
For new projects, companies will want to hedge the risk of rising interest rates. That's where derivatives teams could step in. You wouldn't need to understand this in much detail, but in short, companies can enter interest rate swaps (where they swap a floating rate of interest for a fixed rate) or forwards (where they pre-determine the rate of interest) to protect themselves.
On the lender-side, banks may scrutinise companies with a lot of existing debt. One way of doing this could be to have their lawyers negotiate stricter terms into the loan documents. For example, they could impose covenants that restrict levels of debt or require security (collateral to back up a loan).
Leveraged Finance
The leveraged finance market is really busy at the moment. For example, investors have recently flocked to leveraged loans - loans to companies that already have a lot of debt - in preparation for a rise in interest rates. Leveraged loans have floating rates of interest. That means if interest rates increase, the rate of interest they pay to investors will also increase. In 2017, these were used to refinance a lot of debt and investment banks made a lot of money underwriting these loans.
Structured Finance
One of the biggest buyers of these leveraged loans are collateralised loan obligations. These are loans that are pre-packaged into bonds and sold to investors. Thanks to their record levels of demand, structured finance teams have also been exceptionally busy advising issuers.
Private equity/corporate
For the last few years, PE firms have had a lot of negotiating power when it comes to borrowing money. Their lawyers have been able to push for 'cov-lite' loan agreements. These are loans with fewer protections for lenders. To give you a sense of how much it's grown - before 2007, about 30% of the leveraged loan market involved cov-lite deals, that figure is now around 70%. Thanks to these loose terms, PE firms have been able to pile debt onto companies. That could cause a lot of problems when interest rates increase.
