Former British Prime Minister Harold Wilson’s observation that ‘a week is a long time in politics’ will ring depressingly true for those UK corporates looking to raise funds over the coming weeks and months.
There may have only been days between the announcement of the abolition of the 45p tax rate and the decision to reinstate it,but the damage was already done – concerns over the credibility of UK economic policy prompted investors to sell UK corporate bonds at a rate not seen since the 1990s.
Despite the Bank of England’s decision to restart its long-dated UK government bond (gilts) purchasing programme, average yields in sterling corporate bond markets are still running more than three times higher than they were at the end of last year and UK corporates face higher fundraising costs than their counterparts in the euro zone or the US.
According to digital asset manager Collidr, UK corporate bonds shed more than 13% of their value in the first six months of 2022, while gilts fell even further over the same period.
This is clearly a problem in light of J.P. Morgan’s observation last week that while the current wild swings in rates and swap spreads (making it all but impossible to pinpoint pricing for new deals) could make issuers more cautious, there is still pent-up supply out there with corporates facing both dwindling cash balances and the necessity to shore up liquidity ahead of the upcoming squeeze to margins as they tackle elevated input prices.
Sue Noffke, Head of UK Equities at Schroders observes that not only has the cost of refinancing increased materially – there is less of it to go around. This is obviously a major issue for companies with high levels of debt (especially if it needs to be refinanced over the next 12 months) and can be material in sectors such as retail, hospitality and transport.
She explains that if a company looks weak already, any refinancing and increase in interest and/or lease costs could potentially trigger a breach of debt covenants.
To this end, Noffke notes that higher borrowing costs should favour companies with strong balance sheets as well as those with a significant proportion of their debt at fixed rates, rather than floating ones.
However, Ian Stewart, Deloitte’s Chief Economist in the UK points out that about three quarters of the stock of corporate bank debt is at variable rates and that most corporate borrowers have seen an increase in the cost of servicing existing and raising new finance from banks.
He also points out that yields on UK investment-grade corporate bonds are close to levels last seen after the global financial crisis.
Overall corporate balance sheets look in reasonable shape says Stewart. But he acknowledges that this high level generalisation conceals the fact that debt is spread unevenly across the corporate sector and that while the slowdown in economic activity has been driven by high inflation to date, rising interest rates are likely to add an increasing drag to activity from here.
In addition, the reversal of the planned cancellation of corporate tax increases due to start in April 2023 means UK GDP will miss out on an uplift from earnings upgrades for companies which don’t have borrowing or currency related input cost issues. However, this would probably have excluded retail and property companies due to the effect of the falling pound in the case of the former and rising interest rates in the latter.
