Small UK businesses exposed to higher risk of bankruptcy

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As economists are predicting the prospects of a recession looming ahead for the bearish British economy, the hike in interest rates is putting many UK businesses at risk of bankruptcy, The Telegraph reported on Sunday.

The situation is dire. Aston Martin Lagonda, one of the UK's most prestigious auto companies, is beginning to allow investors to buy shares as low as £103 in a bid to alleviate crippling debt costs. Morrisons which was acquired by Clayton, Dubilier & Rice in October 2021, doubled its debt from £3.2bn in January 2021 to £6.8bn a year later.

Although Moody's estimates that the company has enough finances to pull through the debt, a one percent increase in interest will cost Morrisons £30m a year in extra fees, which is likely to impact shares of the firm.

The Central Bank clearly knows things will get harder for companies that face high indebtedness and difficult capital markets.

"Those who need to refinance will be most at risk given the step-up in funding costs," said Richard Etheridge, Associate Managing Director at Moody’s.

A team of analysts at S&P Global Ratings said in the year 2022 alone, interest rates across the world have increased at a pace faster than at any time in the past four decades, adding that if central banks of the EU and the UK were to raise their interest rates and energy prices kept rising, it would "accelerate defaults quickly."

Analysts say that "zombie" companies, which are firms that survive debt by paying low-interest rates, will potentially have to face retribution as the main focus of rating agencies lies on bigger firms. 

Unlike smaller companies, bigger companies can issue bonds and stocks but the high cost of bank loans remains a matter of serious concern for smaller companies. 

Daryn Park, senior policy advisor at the Federation of Small Businesses, said, "If interest rates hit 6%, it will start to price out a lot of businesses."

According to a survey of FSB members, one in five small companies which applied for loans in Q3 failed to find an offer at an interest rate below 11%.

Consequences are even more severe for smaller businesses that depend on bank loans to invest in growth. "If we’re heading towards a tightening market, they are not going to be able to grow," Park said.

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According to Norman Chambers, managing director of the National Association of Commercial Finance Brokers, the coming six months are expected to increase "distressed borrowing" from companies in need of emergency funds, adding that brokers, which act as mediators between companies and banks, should "lengthen loan terms and consolidate where possible."

But the banking sector hasn't shown much concern over the matter.

UK Finance, the banking industry’s lobby group, said in September there persists a "high degree of financial headroom across SMEs, and lenders continue to stand ready to support businesses."

Katie Murray, finance boss at NatWest Group, said on Friday that "loan impairments remain extremely low," though the bank did recognize that it was foreseeing increased credit risk among its customers.

Stephen Pegge, managing director for commercial at UK Finance, acknowledged that there were tough times ahead for the UK economy but said the share of debtors is the same as it was prior to the pandemic.

"Banks have been stress-testing whether businesses can afford higher interest rates for some time," he said. "That gives me confidence that things could be OK."

In a report issued last year by the Central Bank of England, it was reported that an increase in borrowing costs of about four percent would "markedly increase the share of businesses with a high debt-servicing burden."

But these remarks were issued when the bank base rate stood at 0.1%.

Now that the rate has increased to 2.25%, with further increases anticipated, increases of four percentage points in borrowing costs are more possible than ever.

The study also suggested that the weight of the burdens would be containable if wages decreased but did not consider alternative scenarios in which sales would fall as interest rates soar.

Louise O’Sullivan, director at Interpath Advisory, a debt and restructuring consultancy, said the pace of interest rate rises had "taken a lot of people by surprise."

When interests were still at a low rate, businesses became laxed on protecting against interest rate risk.

But it is now clearly too late to take preventive measures.

Sandra Kylassam-Pillay, who is also a director at Interpath, said, "It’s not the increase in interest rates in isolation that is affecting corporates at the moment," adding that "it’s also inflation and the cost of living – all of that means businesses are under increased stress."

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