With the Bank of England (BoE) having quashed the last hope of interest rates reverting to the sub 1% level, the final remnants of an easy money era have been unceremoniously swept off the ballroom floor. Back when money was cheap to borrow, debt was easy to take on; refinancing came at a token cost. Those days are gone, probably for good.
How did we get here?
It is easy to overlook the significance of 16 December 2021. On that day in history, the BoE raised its base rate to 0.25%, which, in hindsight, was a wake-up call for companies to review their refinancing options. It was to be the first of 14 consecutive rate rises. Several months later base rate hit 1% for the first time since 2009.
The period from March 2009 to May 2022 was a golden era for cheap debt and easy money, as interest rates remained at the sub-1 % level for the duration. After 13 years of low rates intended to stimulate the economy, businesses now had a debt funding conundrum. Bonds, guilts, bank loans and bounce-back loans are maturing at a time when the cost of replenishing that borrowing is up to five times more expensive. Put simply, the economy is not growing fast enough for businesses to offset higher interest rates and inflation. That is why the number of insolvencies has reached its highest level for over a decade. There are tools for managing the burden of corporate debt, but no option is without compromise.
What are the options?
Debt refinancing is the settling of one loan by taking out another. The principal is similar to switching mortgage providers for a cheaper deal or using a loan to pay off a credit card. Debt consolidation works on the same principle, except the company takes out a single loan to clear multiple liabilities. Both refinancing and consolidation can extend the payment term or reduce the interest rate being paid, thereby freeing up capital.
Debt restructuring (also known as a Workout) focuses on reducing the principal amounts owed through formal or informal negotiation. A Company Voluntary Arrangement (CVA) provides a legally binding framework to clear debts over an extended period, often at a reduced amount. Restructuring can also involve bondholders (and even banks) accepting shares in lieu of repayment. Similarly, the business might turn to selling shares to raise capital (Equity Financing). There is a balance to be had here between taking on debt and surrendering control to shareholders. Corporate restructuring is a broad term and can include a change in business ownership, rightsizing of headcount and real estate, and the reorganisation of operational divisions through demerger or cessation. The goal of restructuring is to reduce losses and preserve enough of the business so it can continue trading.
Debt refinancing and consolidation are seen as proactive measures, whereas restructuring is reactive and in response to financial distress.
The London Approach
The options of today are a nod to the London Approach introduced by the BoE in the 1970s. The London Approach places an onus on banks to remain supportive, act in the best interests of all creditors, and base decisions on reliable information. Although banks still can play their get-out-of-jail-free card (that of calling in a guarantee or cashing out by selling the debt), it is not in keeping with the London Approach.
Who is missing easy money?
To survive the pandemic, aerospace group Rolls-Royce took on several billion pounds of debt. Fresh in as CEO in 2023, Tufan Erginbilgic described the business as a ‘burning platform’ and warned dramatic changes were needed to save it. Rolls-Royce is now undergoing extensive restructuring to clear down debt, reduce overheads, streamline operations and ensure long-term survival. Those measures appear to be working with debt now sub £3bn from a peak of £5.2bn.
Before collapsing in 2023, Wilko had been undergoing restructuring, including a £40m loan and the sale and leaseback of a distribution centre. Disappointing levels of trade scuppered the turnaround. Wilko had tried to defer creditor payments which in turn reduced stock levels because suppliers could not increase credit limits. This reduced stock levels and turnover, compounding the retailer’s cashflow troubles. Liquidators cited inflationary pressures and rents as key factors in Wilko’s demise. Year-end 2022 accounts have proved controversial, showing £5.25m being paid out in dividends on the back of a £31.9m loss, taking the shareholder’s haul to £77m over the last decade.
Upon privatisation in 1989, Thames Water was debt-free. Today, it is indebted to the tune of £14bn, amounting to 80% of the water company’s net worth. That debt is now even more expensive to service. According to regulator Ofwat, Thames is one of the worst performing providers when measured against leaks and pollution and requires significant investment to improve. To avoid being placed in special administration, the embattled business secured £750m from shareholders in 2023 and warned it may need to tap them for an extra £2.5bn by 2030.
Upon rescuing beleaguered car maker Aston Martin from impending doom in 2020, billionaire Lawrence Stroll set about returning the business to profitability. Measures to date include renegotiating bonds to a lower interest rate, refinancing £210m of high-interest debt, and equity financing. James Bond’s favourite marque has been both shaken and stirred back into shape.
Other companies undergoing refinancing are clothing retailer New Look and supermarket Morrisons. New Look is on track to exit a CVA in 2024, having, amongst other debt restructuring measures, renegotiated some rents from a fixed amount to a sum based on store turnover. The deal to delist Morrisons from the London Stock Exchange in 2021 was fuelled by adding another £6.1bn of debt onto the supermarket’s balance sheet. Last year, Morrisons made a £200m profit and spent £400m on servicing debt. Refinancing is underway, including the sale of its 340 petrol stations, which is expected to raise £2.5bn.
On the money
In the Bank of England’s 330-year history, its base rate has only ever dropped below 1% in the period 2009-2022. Even the most optimistic (bordering on doolally) economist will struggle to claim with a straight face that sub 1% times are coming back. As we see every day at Advocate Commercial Debt Recovery, debt is only easy when you are cashflow positive. It only takes an increase in costs or reduced demand to make debt difficult, caressing the debtor into the clutches of Advocate to expedite payment for conscientious clients!