The Three Financing Trends to Watch in 2025

02.18.2025

As we look ahead to 2025, several macroeconomic and financial trends are set to influence how companies structure transactions, manage financing, and plan for long-term growth. From the impact of tariffs on company valuations to the challenges of persistent high interest rates, innovative hedging tools, and strategic capital optimization, understanding these trends is essential for making well-informed decisions. Here’s an in-depth look at each trend and its implications for the leveraged finance and M&A landscape.

Trend No. 1:  Tariff Troubles: Impact of Trade Policies on Credit Risk

Tariffs are proving to be a significant factor in shaping the economic landscape, not only influencing company valuations but also affecting credit risk profiles. As new trade policies impose higher costs on imported raw materials and components, businesses face increased financial pressure that can compromise their ability to meet debt obligations.

Rising Operating Costs and Cash Flow Pressures:
Tariffs directly increase the cost of essential inputs, thereby compressing profit margins and straining cash flows. Companies that rely on international supply chains may experience reduced liquidity, making it more challenging to service existing debt. For financial advisors and legal professionals involved in structuring deals, this necessitates a careful reassessment of the credit profiles of potential investments or transactions.

Heightened Vulnerability in Key Sectors:
Industries such as manufacturing, consumer goods, and export-dependent sectors are particularly susceptible to the adverse effects of tariffs. In these sectors, increased operational expenses can lead to deteriorating creditworthiness. As credit risk escalates, lenders may become more cautious, potentially demanding stricter covenants or higher risk premiums. This scenario underscores the importance of sector-specific due diligence to understand the full impact of trade policy on a company’s financial stability.

Adjustments in Lending Standards and Risk Premiums:
In response to the uncertainties introduced by tariff policies, financial institutions are likely to adjust their underwriting practices. Lenders may tighten credit standards and reprice debt to reflect the elevated risk. This means that companies affected by tariffs might face higher borrowing costs and less favorable terms when seeking new financing or refinancing existing obligations. For business professionals and legal advisors, incorporating these factors into transaction models is essential to ensure that financing structures adequately account for increased credit risk.

Implications for Credit Risk Management:
The interplay between tariff-induced cost pressures and credit risk requires a strategic approach to risk management. Decision-makers must integrate rigorous financial analysis and scenario planning into their due diligence processes. By understanding the potential impact of evolving trade policies on cash flow and debt servicing capacity, stakeholders can better negotiate transaction terms and structure deals that mitigate the risk of financial distress.

Strategies for Client Success

Refinancing: We are working with PE borrowers with tariff exposure to refinance to reduce debt service obligations and improve financial flexibility.

Asset Based Loans: We are working with smaller borrowers to finance their M&A transactions with ABL financing — securing financing against tangible collateral rather than relying solely on unpredictable cash flow metrics. Inflationary concerns may also lead PE firms and other borrowers to opt for ABL financing in lieu of loans that are based on cash flows.

Trend No. 2:  Banking Innovations for Managing Rate Exposure

To address the challenges of a persistently high-interest rate environment, banks are developing innovative interest rate hedge products to help borrowers manage financing costs more effectively.

Introduction of Tailored Hedge Products:
New hedging instruments are emerging that enable companies to lock in or cap interest rates on private credit arrangements. These products provide a level of predictability in debt servicing costs, offering a strategic tool to mitigate the risks associated with persistent high interest rates. Integrating these hedges into private financing strategies can enhance the stability of cash flow projections and support long-term planning.

Enhanced Risk Management:
By employing these innovative hedge solutions, companies can more effectively manage their interest rate exposure. Improved risk management not only stabilizes operating margins but also contributes to more reliable financial planning, which is critical in an environment where borrowing costs remain relatively high.

A Major Departure from Past Practices:
Traditionally, banks preferred to provide both the loan and the hedge to manage their risk exposure comprehensively. However, as private credit markets have expanded, banks have become more willing to offer standalone hedging products for borrowers with loans from private lenders. A borrower needs to obtain an interest rate hedge from a bank because private lenders typically do not offer direct hedging solutions, as their focus is on providing capital rather than risk management products.

Flexibility in Deal Structuring:
The availability of these hedge products adds a layer of flexibility when structuring financing transactions. They can be tailored to meet the specific needs of a company’s debt portfolio, allowing for more sophisticated and adaptive deal designs. This flexibility is particularly advantageous in complex transactions where risk mitigation is a priority.

Strategies for Client Success

Banks Hedging Private Credit Rate Exposure: We are working with private credit borrowers to put rate hedges in place with banks. The private lenders typically need to approve the hedge and in some cases, the loan documents must be amended to permit the bank’s hedge.

Zero Premium Collars: We are also working with borrowers to reduce exposure to rate volatility through bank hedges by simultaneously purchasing an interest rate cap and selling an interest rate floor, with the premiums offsetting each other to create a no-cost hedge.

Trend No. 3: Reevaluating Capital Stacks

As interest rates are expected to begin a measured decline in 2025, businesses are reassessing their capital structures to optimize financing costs and improve financial flexibility. While recent years have been defined by higher borrowing, the expectation of lower rates is driving a shift in how companies approach debt reduction, equity redemptions, and capital allocation.

Deleveraging and Refinancing for Efficiency

With interest rates expected to decline, borrowers are reconsidering their debt reduction strategies. While deleveraging remains a priority for companies that took on expensive debt during the high-rate environment, some are now opting to refinance rather than aggressively pay down debt. As lower-cost financing becomes available, firms are seeking to replace existing high-interest loans with longer-term, lower-rate debt, allowing them to maintain liquidity while reducing overall borrowing costs.

Redeeming Preferred Equity to Lower Capital Costs

As rates ease, the cost of capital is shifting, making preferred equity redemptions a more attractive strategy. Many companies issued preferred stock or structured equity at high yields when debt financing was costly. Now, with traditional debt financing becoming more affordable, firms are looking to redeem expensive preferred equity and replace it with lower-cost debt or common equity issuances. This shift allows businesses to reduce their weighted average cost of capital and improve profitability without overleveraging their balance sheets.

Strategies for Client Success

Preferred Equity Redemptions: We are working with private credit clients to redeem expensive private equity capital, substituting a smaller amount of lower cost senior debt in its place.

Shorter Loan Terms: We are working with several clients to take out loans (or extend existing loans) for shorter terms, between 1 and 4 years. These clients expect to refinance these loans at lower rate, or fully repay the loans off with cash, in the next 1 to 2 years.

Dividend Recap Pivot: We have also had clients reduce or postpone planned dividend recaps amid concerns regarding persistent inflation and expectations of lower rates in the months ahead.

Hirschler attorneys can provide strategic legal guidance regarding the above. Please contact a member of our Financing and Private Capital Formation Team for consultation and support.