Low interest rates have been a blessing to U.S. mergers and acquisitions deals, with 2015 a record year in terms of the total transaction value.
Last year, there were 12,272 M&A deals in the United States, with a transaction value of $2.38 billion.
In December, the Federal Reserve raised rates for the first time in almost a decade after rates went to zero in 2008. Even though the Great Recession officially ended in mid-2009, steps to revive the economy through appropriate monetary policy was needed at that time.
So what happened in 2009?
M&A activity was adversely affected by the the recession and loss of corporate confidence. But M&A activity picked up in 2012 due to low rates and most importantly, improved economic conditions.
Since the 1980s the United States has seen seven merger waves, with the seventh wave starting in 2012. Since 2000, the industry that saw the largest number of merger transactions was technology.
An increase in the federal funds rate increases the cost of borrowing and hence affects the value of merger deals, especially if a large portion of a deal is being financed through loans. If the company is highly leveraged and the cost of debt goes up, the internal rate of return is affected, lowering the valuation of the company.
Interestingly, companies with lower valuations may sometimes activate the M&A deals as potential and strategic buyers find them more affordable.
Strategic companies have huge cash reserves, which makes them immune to rate hikes, according to a KPMG 2015 report on M&A activity.
"Credit markets are very healthy, and even the increase in interest rates is unlikely to have a significant impact on borrowing because rates are at historic lows," according to the report.
Hence, an acquirer with a strong balance sheet and liquidity with little debt financing will remain unaffected by a rate hike.
Amid historically low rates, for a merger deal to be significantly affected, the Fed's Federal Open Market Committee would have to either decide at its two-day meeting that starts Tuesday on a successive increase in rates or decide on a sudden increase in basis points.
Of the two, the latter is highly unlikely to happen because Fed Chief Janet Yellen made it clear in a recent speech that the rate increase will be a gradual process.
"I continue to think that the federal funds rate will probably need to rise gradually over time to ensure price stability and maximum sustainable employment in the longer run," she said.
The Fed must be cautious about the timing of its next rate increase because of uncertainties, including the weak May jobs report and the United Kingdom's June 23 referendum on membership in the European Union.
Meanwhile, cross-border merger deals are affected by a number of factors such as country risk, the growth rate of the countries involved, political stability and tax considerations. But they can also be affected the Fed's decision on rates.
According to Merger Market, James Epstein, a partner at law firm Pepper Hamilton, in the case of multi-jurisdictional operations, "the cost of capital is viewed differently from the vantage points of financing and ongoing working capital requirements in each jurisdiction."
He added that in such circumstances the prevailing rates in foreign jurisdictions "become important to the overall success of the investment because that is where the firm is financing the business' growth. And even if the company is using a U.S.-based credit facility, the repatriation of funds back into the U.S. has to be carefully considered in servicing the debt."
This article is commentary by an independent contributor.