Gridlock

by Oaktree Capital Management, 5/7/25

Private equity transaction volumes remain limited despite predictions for a boom in 2025. With interest rates remaining elevated and the economic backdrop increasingly uncertain, executing acquisitions and IPOs is proving a challenge, leading financial sponsors to hold portfolio companies for longer. This impasse has significant ramifications, not least for credit markets. The lack of fresh deals leads to an absence of new supply for the leveraged credit markets that generally provide funding for M&A and LBOs. Meanwhile, elevated yields have increased investor demand for credit, creating the supportive supply/demand dynamic that helps constrain spread widening. Even with the recent volatility relating to fluctuating global trade policy, that’s what we’ve seen in credit: relatively limited defaults, unremarkable spreads, but compelling coupon income.

An Absence of Deals

It’s no secret that M&A and LBO activity has struggled to recapture the heady days of 2021 when low interest rates and a flood of liquidity supported record deal levels – and the accompanying debt issuance. The post-pandemic deal boom came to a screeching halt in 2022 as central banks raised rates in an attempt to curtail rampant inflation. Private equity funds have since struggled to exit portfolio companies at their desired valuations and new deals have dwindled. Though we’ve seen some signs of recovery, predictions for a resurgence in 2025 appear to have been overly ambitious. (See Figure 1.)

Oaktree Deal Activity bar graph

All Roads Lead to Rates

In 2022-23, an increase of over 500 bps in the fed funds rate marked an end to the era of ultra-cheap leverage that commenced in the aftermath of the Global Financial Crisis. Private equity sponsors accustomed to getting seven turns of leverage for buyouts and paying a 4% coupon on their loans soon faced a new environment where that leverage level was largely unrealistic and their interest costs had doubled.1 While the rapid rate increases were designed to halt very apparent inflation, market participants have been caught off guard by how long it would take for rates to moderate again, with SOFR still well above 4%. (See Figure 2.) What’s caused this prolonged elevation? Chiefly, the surprising strength of the U.S. economy, led by a strong consumer benefitting in many cases from mortgage rates locked in at record-low levels. Rather than the anticipated economic slowdown as interest rates rose, strong jobs data and ongoing price increases have made it challenging for the U.S. Federal Reserve to make meaningful rate cuts. Whereas the Fed had latitude to become more accommodative during the Covid-19 crisis, now that prices of consumer goods have already risen significantly over the last few years, any policy change that fuels inflation may cause further struggle for lower/middle-income consumers.


Oaktree Base Rates graph

Capital Cost Mismatch

Crucially, higher interest rates impact the salability of private equity portfolio companies. With a drastically higher discount rate than that between 2009-21, the valuations portfolio managers believe their holdings are worth have been challenged: potential sellers refuse to compromise while potential buyers aren’t eager to increase their bid. Because of this deadlock, hold periods have increased, with almost 30% of portfolio companies in 2024 having been held for over seven years. (See Figure 3.)

Oaktree Portfolio Comp bar graph

What’s led to this impasse? Prospective sellers purchased companies at a much lower cost of capital than potential buyers now face to fund purchases of the same assets, leading to a mismatch. Notably, over 60% of buyout deal returns in the low-interest-rate era were attributable to broad market multiple expansion and leverage.2 With these levers challenged, a private equity manager may need to sell to a buyer with a lower cost of funding to achieve their desired exit multiple: a situation that might not be forthcoming. Private equity managers can’t get the exits they want and could face a renewed lack of buyers as uncertainty over trade policy pushes potential buyers to the sidelines.