Business loan interest payments set to soar

Analysis by Altenburg shows that UK businesses with floating rate loans are currently paying £17bn annually in interest payments on their £381.1bn of floating rate debt, at an average interest rate that currently stands at 4.5%.

Following the latest increase in the Bank of England base rate on 22 September to 2.25%, the current market expectation is that the SONIA rate (which usually tracks closely with the BoE base rate) will increase by a further c.350bps to c.5.75% within the next 9 months. This would increase the value of loan repayments by businesses to £30.6bn, an increase of £13.6bn.

Interest rate rises mean that many businesses could be at risk of breaching their lending agreements. This is because loan covenants often state that a business’s borrowing costs cannot exceed a certain percentage of its profits before interest and tax. If a business breaches these agreements, the lender could demand immediate repayment of a loan or a contribution of additional equity in order to “cure” the breach of the covenant by partially repaying the loan.

Dan Barrett, partner at Altenburg, warns that some businesses may not be fully prepared for such a significant increase in their borrowing costs, with some only stress testing their business model against a further 1-2% increase in interest rates after the recent rapid increases in the base rate, rather than at (or ideally) over the further 3.5% increase the market is currently forecasting. With interest rates expected to rise well into next year, many businesses could struggle to meet their interest and principal debt service obligations if they don’t start planning now.”

“It’s more important than ever for businesses to understand how interest rates and inflation can affect their costs. If businesses think they are going to struggle to meet their loan repayments, they should consider options to reduce their payment obligations, which could include looking to refinance or at talking to their lenders about amending the term of their loans to reduce annual repayment obligations.”

Traditionally companies have taken out fixed rate loans or fixed the interest rate on variable rate loans using an interest rate swap to protect against future movements in the Bank of England base rate.

Other options include interest rate caps and collars, which lock in minimum and maximum levels for floating interest rates.

However, Barrett warns that if businesses don’t plan ahead now, they could find their options for mitigating rate rises limited given the continued volatility forecast for interest rates.

Barrett continued: “Further volatility in interest rates could make it harder for businesses to get fixed rate loans as those lending products are withdrawn by lenders. And/or if rates continue to increase quickly, it could also make other hedging options at interest rates that are viable for the business materially more expensive.”

“Traditional lenders are becoming more cautious in lending to companies and are performing more stringent stress testing of a business’s ability to withstand significant interest rate rises before offering funding. Whilst alternative lenders are also exercising a degree of caution, they remain keen to lend to good businesses that can demonstrate the ability to service debt under stress tested conditions.”

“To ensure they can still access affordable lending, businesses need to demonstrate how they can cope with rising costs and rising interest rates.”

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