Even James Bond might find it difficult to get out of this tricky situation but then again, he isn’t laden with debt!
Much has been in the news recently about the hike in interest rates and the steep curve acceleration due to the mishandling of the mini-budget and lack of fiscal confidence in the Government. This has obviously hit the consumer credit markets as well as the cost to the Government of funding their debt, but no one seems to be looking at the long term debt of the corporate markets and what lies in store for them.
Like the rest of the world, Corporates had been enjoying historically low interest rates for nearly 10 years (Chart 1 below), which has allowed them to fund their business activities and growth plans with minimal cost.
Chart 1 - Interest rates and Bank Rate | Bank of England
But those chickens are now coming home to roost as maturing cheap bond and debt issuance of the past is maturing and will need to be rolled over but with a poor economic outlook, the specter of recession, higher forward rates, and an ever-growing credit crunch, this will make refinancing very expensive.
Corporates who are just about holding their own financially will very quickly see revenue’s decrease, with operating and profit margins beginning to diminish as financing costs continue to rise with very little relief over the next 3 years.
To give an example of what the cost to corporates may look like we looked at two large international corporates with debt issuance that runs out to 2035 and beyond.
We looked at their debt maturing between 2023 – 2025 and the average weighted cost of that debt. With maturing debt between 2Bln and 5Bln, over a 5–10-year period at an previous average rate of 1.75%. both corporates are now looking at a conservative increase in their previous rate by 3% (see below Chart 2&3 - rate changes).
Chart 2 - UK 10 year Gilt Bond, chart, prices - FT.com
Chart 3 - 5-Year Eurozone Central Government Bond Par Yield Curve (ycharts.com)
This would create a 3.2%-3.5% negative drain on operating profit. But that is only if corporate lending rates followed Government Bond rate spreads which is highly unlikely.
With a downturn in consumer confidence, lower GDP and continued higher inflation, due to higher energy, food prices and wages, etc., it would be more likely that corporate credit spreads would widen to reflect the additional risk most sectors would face. This could mean that the delta from previous debt could be between 4%-5% higher, creating far greater strain on net future profit.
Is this built into the current share prices and valuations? in some cases yes, but the Central Banks have been late to the table in raising rates to tackle inflation and although they are in an awkward position on how to balance what they do for the economy, they have very little else to work with as a panacea for the markets.
To make matters worse the OBR (Office for Budget Responsibility) have just warned the chancellor, Jeremy Hunt, that UK public borrowing will be about £70 Billion larger than expected. This will only add to a steepening of the debt curve making it more expensive for corporates to refinance and borrow.
Corporates need to begin looking at ways of negating these challenges and look more closely at alternative Working Capital Solutions that can help them counter these impacts while extending their working capital to help with longer term debt.
It's right in front of them, they only have to ask!
Kevin Hayden is an executive level professional with over 35 years of Fintech, Investment & Commercial banking, and software sales & services industry experience, managing key major business and transformation change teams. With an economics and banking background he is driven by challenge and excellence at all levels, he is committed to delivering a long-term partnership with clients that foster trust and build reputations, focused on the transformation of supply chain finance that helps and assists everyone along the journey.