Fed Rate Cuts Contribute to Increasingly Sunny Outlook for Behavioral Health

Behavioral health has had a series of small but laudable wins in the last few weeks.

The Biden administration finalized new parity rules. Drug overdose deaths are on the decline. The Federal Reserve cut interest rates. And Fed observers are predicting additional rate cuts, too.

Be still my nerdy behavioral health industry-observer heart: That’s quite the slate of good news.

As I stave off the “well, what bad thing is coming now?” thoughts for a few minutes, I can’t help but dwell on the rate cut news. In the few years into the post-COVID era, we’ve seen interest rates get added to the list of things to happen that were historic. In particular, the Federal Reserve has raised interest rates at the fastest pace in recent memory.

This was painful, to put it simply. For more than a decade before the pandemic, the Federal Reserve set zero and near-zero percent interest rates in the wake of the Great Recession. All at once, behavioral health businesses had to deal with the ground shifting under their feet again. On top of inflation raising the prices of everything they had to pay for, the Fed made debt much more expensive almost overnight.

So, getting a break, even with something as small as half of a percentage point, can do a lot for the industry. But that “a lot” isn’t going to show up all at once. Like many major trends, it takes time for impacts to manifest themselves.

I share my thoughts on the above as part of this week’s exclusive, members-only BHB+ Update. Among the points I cover:

— What I think the immediate and most important (at least for the moment) impact of the rate cuts will be

— The potential impacts on dealmaking

— What the future looks like

The immediate (and maybe most important) impact

I was struck by something when I got into this job. Unlike other generalized business publications, journalists at Behavioral Health Business and its sister publications are intimately connected to the industries they cover. That gives you a much better opportunity to see business truths at play in real time.

While I knew it at some vague level, I realized that the comings and goings of many segments of the American economy are based heavily in — as the kids say — vibes. This is true behavioral health. I’ve seen it here strikingly for the first time, and now I see it everywhere. Is the stock market up or down? A reflection of traders’ vibes. Is it a good or a bad time to buy or sell a house? Depends on the vibes of the real estate agents in your market. The fact that the rate cut came in such a dramatic fashion and relief was hoped for for so long maximizes the impact on the vibes (or the mood of the market, if you’d rather call it that).

Kevin Taggart, the co-founder and managing partner of the M&A firm Mertz Taggart, told me it’s hard to specify how this works. But it’s something that definitely can be seen and felt in a market place.

“When rates are lower, people are more optimistic,” Taggart said. “But overall, I think it has a positive effect on people’s psyche when it comes to doing deals.”

Better vibes or a better collective mood can mean a lot, especially considering just how important relationships are to any business. Given the smallness and the peculiarity of the behavioral health industry, the importance of relationships is magnified.

While ephemeral, the rate cut and the cumulative impact of the developments I mentioned at the open are likely to have a meaningful impact on the industry and its vibes.

The Rate Cut’s Impact on dealmaking

As American songstress Amy Grant once said, “It takes a little time sometimes to get the Titanic turned back around.” Don’t expect the cork to pop on dealmaking volumes. The impact of this rate cut, and the rate cuts that Fed watchers predict, will likely have an incremental impact, but in a good way, like with the parity rules.

“I’m hopeful that it makes deals a little easier to get done,” Taggart told me. “Deals have just gotten harder to get done because of the environment. … It’s taking longer than I think everybody would like, and a lot of that’s being driven by the lenders.”

As we’ve observed before, those that finance behavioral health deals are much more savvy about the space. They are also much more judicious than in the pre-COVID era. It took time for that demanding stance to develop; it will take time for it to abate.

Still, as Taggart and others have noted, the rate cut will make it easier for buyers to get into – and, for some, back into – the game. This is especially true for private equity firms and their platform companies, which are behind most deals in behavioral health, according to The Braff Group. About 60% of all behavioral health deals in the last few years involved private equity. Despite being the driving force, private equity deal making has led to a tiny minority of addiction treatment and mental health sites of service under this type of ownership.

Other dealmakers have told us that the demand for behavioral health assets remains very high. But the dealmaking environment is inspiring a cautious approach. With better vibes, it would be reasonable to expect that to change in 2025.

My guess is that the rate cut is the signal that a relatively small handful of especially eager buyers and sellers need to get back into the game. These folks will likely seek to get ahead of a time of higher volumes when more done deals could adjust expectations for valuations, which many tell BHB remain relatively high today.

There is some expectation that the greater volume of dealmakers that will come in the coming months will rationalize their valuations. They will be looking to make up for lost time during the dealmaking pause of the last few years. Plus, if more deals are done in the not-so-near term, companies that were distressed for the last three years or so could sell at lower valuations, pull them down for everyone else.

Jeff Crisan, co-founder and managing partner of the PE firm Silversmith Capital Partners, told Axios: “I think we’re seeing some sellers start to look and say: ‘I know my asset isn’t perfect, so maybe I take a little bit less.'”

Silversmith is one of the PE firms behind the creation of Lifestance Health Group Inc. (Nasdaq: LFST). Crisan is still a member of its board. Lifestance is an extreme example. However, it is an example of a platform company that could arise in a less restrictive monetary environment. Who knows? Maybe we’ll see the next Lifestance come out of this.   

The future

There are good reasons to expect that good will come from this one rate cut. Multiple Fed observers have said the half-percentage-point cut was higher than many predicted.

Here’s how PitchBook put it: “The decision to lower rates by half a percentage point instead of a quarter-point cut indicates that the Federal Reserve is taking a relatively dramatic approach in its easing campaign.”

Similar monetary policy measures have been instituted in Europe, leading to a 17% pop in the cumulative value of deals done in the second quarter of 2024, according to PitchBook. The data firm suggests that IPOs might become more relevant for more mature investments and otherwise make it easier for private equity firms’ investors to get their money back.

The Associated Press reports that the Fed has signaled additional rate cuts: an additional half-percentage point by year’s end, four more cuts in 2025 and two more in 2026. Much of that depends on major economic indicators like unemployment and inflation. Already, the rate cut suggests that the Fed and its various bodies are pleased with its previous work and are now trying to achieve the so-called “soft landing,” an intervention in an overheated economy without kicking off a recession. 

If unemployment picks up or prices fall off too quickly, the Fed may accelerate its rate cut measures.

It was a low-interest rate environment, in part, that enabled the M&A feeding frenzy in the venture capital and private equity worlds in 2021. Cheap debt meant more capital to sling around. While there are several rate cuts on the horizon, there is no reason to expect near-zero interest rates from the Fed. Federal Reserve Chairman Jerome Powell shot that idea down.

“My own sense is that we’re not going back to that, but honestly, we’re going to find out,” Powell said at a press conference on Sept. 18, the day the rate cut was announced.

He added that the ideal interest rate that helps balance inflation and encourage job creation is much higher relative to what was coming out of the Great Recession.

Given that we are likely not going back to post-recession- or COVID-era rates, I wouldn’t predict that we will see record-setting levels of activity. But it’s an easy bet to see an elevated floor for dealmaking volumes in the years to come. There is likely pent-up demand that will make the next few years look very active.

It’s going to be key to take this sunny outlook without losing realism.