Private equity wrestles with higher interest rates 

This is an audio transcript of the FT News Briefing podcast episode: ‘Private equity wrestles with higher interest rates’

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Joanna Kao
Good morning from the Financial Times. Today is Monday, November 6th, and this is your FT News Briefing.

Former US president Donald Trump takes the witness stand in New York today. And the prime minister of Japan is betting on a big stimulus plan to help address higher costs of living. Plus, higher interest rates are hitting the private equity industry hard.

Antoine Gara
The idea that private equity is gonna die is probably a little bit extreme, but it’s gonna be sort of a reset and a washout.

Joanna Kao
I’m Joanna Kao, in for Marc Filippino, and here’s the news you need to start your day.

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Donald Trump is set to testify in a Manhattan court today. He’s going to be grilled over his finances and business empire in a civil fraud case. A judge in the case has already determined that the former president committed fraud. Trump allegedly inflated his net worth in order to get his organisation better terms for bank loans and insurance policies. A lot is on the line in this case. The former president could be forced to pay crippling penalties, and he and his two adult sons might lose the ability to operate a business in New York. That would be a big blow for Trump who has staked his political career on being a savvy businessman.

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Japan’s prime minister Fumio Kishida is in a tough spot. He’s facing record-low approval ratings and pressure for a snap election. He’s trying to turn things around with a stimulus package to address the pain of inflation. But it could complicate the Bank of Japan’s move to unwind loose monetary policy. I’m joined now by the FT’s Kana Inagaki. Hi, Kana.

Kana Inagaki
Hi there.

Joanna Kao
So why are Kishida’s approval ratings so low?

Kana Inagaki
So the prime minister got a slight boost in popularity right after the Group of Seven summit in May in Hiroshima. But after that, it’s really been on a constant downward trend. There’s been quite a lot of dissatisfaction within the public about how the government has been dealing with the rise in prices. And because of the sharply weaker yen, the imported costs of energy have risen quite significantly. So that’s probably one of the biggest reasons why his approval rating had fallen so much over the past year.

Joanna Kao
What can you tell us about this plan?

Kana Inagaki
The prime minister surprised both the public and the economists as well when he suddenly announced that the stimulus is going to include temporary cuts to income and residential taxes, as well as cash handouts to low-earning households. The government has announced a big boost in defence spending and also Prime Minister Kishida has announced that he’s going to increase childcare benefits. And so much of the focus has been on how Japan is going to finance these extra costs. And so both the public and, you know, the economists are slightly caught off-guard when he suddenly said that instead of increasing taxes, he’s gonna lower them.

Joanna Kao
So this announcement happened a few days after the Bank of Japan took a big step to end its policy of capping long-term interest rates. And that basically sets the stage for gradually tightening monetary policy. How could this stimulus package complicate that process?

Kana Inagaki
So as you mentioned, the Bank of Japan is trying to basically normalise decades of its ultra-loose monetary policy. And so by rolling out this big stimulus package and doing these tax cuts, a lot of economists are concerned that the government will complicate the BoJ’s exit from its monetary policy. The BoJ is trying to unwind this policy without causing too much market turmoil. But if the bond market feels that with the stimulus, the Japanese government is being lax on fiscal discipline, then you know it might cause a rise in government bond yields and that would really make it difficult for the BoJ to exit from its policy.

Joanna Kao
What does this mean then for Kishida’s political future?

Kana Inagaki
You know, his popularity has been declining over the past year. And if this economic stimulus package does not help to boost that, there are serious concerns about what he can do as a new measure to help his approval rating improve.

So his term as the head of the ruling Liberal Democratic party runs through September. There’s a lot of speculation about when he might call a snap election, and if his approval rating does not improve, then he’ll probably does not have an opportunity to call it and he could wait until September. But obviously, there will be concerns about whether factions within the party would try to remove him if he proves to be too unpopular with the public.

Joanna Kao
Kana Inagaki is the FT’s Tokyo bureau chief. Thanks, Kana. 

Kana Inagaki
Great. Thank you.

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Joanna Kao
Private equity firms have become titans of the financial sector over the past decade and a half. They used that period of low interest rates and essentially free money to snap up one company after another. Then they turned them around and sold them a few years later for big profits. But now that debt isn’t so free-flowing and cheap, private equity is in a bit of a bind. Here to explain is Antoine Gara. He’s the FT’s US private and institutional capital correspondent. Hi, Antoine.

Antoine Gara
Hi. How are you?

Joanna Kao
Doing good. So can you give us a sense of scale — how is private equity doing compared to a couple of years ago?

Antoine Gara
The industry is really seeing its volumes hit new lows in terms of being able to sell assets. Also, we’ve seen a number of large firms really disappoint on the amount of money they can raise from investors. And the real peak was 2021 where the money was really flowing in this industry. So it’s been a pretty sharp reversal and it’s all really due to the fact that interest rates have gone much higher, much quicker than anyone expected. And that just means the cost of buying companies using leverage has gone way up. It’s just become more and more problematic for dealmakers, mostly because they’re sitting on so many investments that were made when rates were zero and prices were higher. And so what it did was it caused firms to not be able to sell assets, return money to investors and give those investors cash that they might then again invest in new private equity funds.

Joanna Kao
So in this era of high rates and how PE is getting hit really hard, what are PE firms doing now to overcome these challenges?

Antoine Gara
For months we’ve really been reporting on a lot of different financial engineering tactics. There are not a lot of deals happening. The cash isn’t really moving around. So we’ve been reporting about these things called NAV loans, which are loans against an entire fund’s assets. And what firms are doing are either using that cash to pay dividends back to their investors without actually having to sell the assets . . . but it is not free money. It’s very expensive. It’s north of 10 per cent. It can be, depending on the structure, as high as 18 per cent.

Joanna Kao
So are these strategies working?

Antoine Gara
In the interim, they are. But we’ve, you know, been worried that it’s cross-collateralising assets. The whole beauty of private equity was, you buy a company, you put debt on the company. It’s in a fund that’s locked up for 12 years. You sell it. But if you start taking loans against the fund, now you can have an entire portfolio put at risk versus just one company. So these are actually fairly controversial. Some of the trade groups that represent the large investors in private equity funds have grown increasingly alarmed about these loans. And they’re starting to come up with sort of formal guidance and rules of the road for these loans.

Joanna Kao
Is this just a storm that private equity has to weather or are there going to be lasting consequences?

Antoine Gara
You know, the idea that private equity is gonna die is probably a little bit extreme, but it’s gonna be sort of a reset and a washout. And there are gonna be firms that sink and there are gonna be firms that swim. And for some, you know, they’ll be, have maybe overinvested in recent years or done deals that were aggressive and those might get exposed now. And then there are others that, you know, if they have the patience and they have the stability, there could be enormous opportunities on the other side.

Joanna Kao
Antoine Gara is the FT’s US private and institutional capital correspondent. Thanks, Antoine.

Antoine Gara
Thank you for having me.

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Joanna Kao
Warren Buffett’s Berkshire Hathaway released its earnings results on Saturday, and the company is sitting on a lot of cash — $157bn worth — a record for Berkshire. Buffett sold stakes in publicly traded companies last quarter. It was a signal that he just didn’t see a lot of appealing investments out there. Fund managers and even the public closely watch Buffett’s investment moves for clues on where the so-called Oracle of Omaha sees attractive returns. But recently, he’s been putting a lot of the money he made from stock sales into Treasury bills, taking advantage of the returns from higher US interest rates.

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You can read more on all of these stories at FT.com for free when you click the links in our show notes. This has been your daily FT News Briefing. Make sure you check back tomorrow for the latest business news.

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