As Rachel Emerson, Partner of Kreston Reeves notes the Bank of England has lifted the cost of borrowing 14 times in a row with its base rate hitting a near five-year high of 5.25%
Sparked by bursting inflation rates not seen for over four decades, it has increased the cost of borrowing, adding further stresses for businesses.
Whilst inflation is expected to fall, the increased cost of borrowing is causing businesses concern. Business owners need to understand how rising interest rates will impact their ability to secure borrowing, how lenders are responding, and what impact default rate changes may have.
It will sound obvious, but business owners should always be aware of their current borrowing, when credit facilities expire, and what covenants are linked to that borrowing. If further borrowing is required, acting early to gain certainty is often advisable.
At the same time, the need to understand borrowing covenants and the headroom in those covenants is vital. It should be remembered that a covenant’s purpose is to protect both the borrower and lender, set at a level that allows variance in the business performance over the term of the facility.
If forecasts suggest that those covenants might be broken, perhaps because of increased overheads such as higher wages, or exchange rate fluctuations, business owners should take proactive steps and explain to lenders how the position will be resolved. That may require the renegotiation of current borrowing or seeking a capital repayment holiday.
Lenders have always stress-tested borrowers’ ability to cope with an increase in the base rate, but with base rate rises well above lenders’ expectations, any future increases are likely to force a rethink of those stress tests and the rates applied. That may well lead to a tightening of available credit, emphasising the need for businesses to look ahead and plan for future borrowing requirements.
Lenders, however, remain open for business. They will still expect to see a well-structured proposal backed up by balanced forecasts that set out best and worst-case scenarios. However, do expect lenders to seek a personal guarantee and possibly a charge over personal assets – something that does not always sit comfortably with business owners.
What can business owners do?
The increased cost of borrowing will have a detrimental impact on cashflow. With many businesses already having increased prices and squeezed suppliers, what other options are open to them to ease cashflow in the short term?
Businesses may wish to consider the following:
• Repayment holidays. Bounce Back Loans and CBILS include the option for a lending holiday and now might be the right time to explore the opportunity. All lenders should be receptive to considering requests for short term capital holidays including those offering asset finance facilities.
• Extend borrowing terms. Extending the loan term will reduce monthly repayments. Those with Bounce Back Loans have the right to extend from six to ten years, and those with a CBIL can request an extension. See further detail below.
• Recovery Loan Scheme. The RLS is now in its third iteration and is designed to help businesses weather the uncertainties caused by the COVID pandemic and subsequent economic challenges. Many businesses do not realise that it is still open for new borrowers.
• VAT loans. VAT is often an issuing of timing, and specialist short term loans are available to meet and spread the cost of VAT bills.
• Value in assets. Is there an opportunity to refinance plant and machinery where there is hidden value?
• Value in debtors. Invoice financing is a type of finance that can release cash locked up in the balance sheet that can help ease cashflow demands.
Bounce Back Loans and CBILS – extend the term to improve cashflow
Many businesses will have a Bounce Back Loan with a repayment term of six years. There is a right to extend the loan term from six to ten years. With Bounce Back Loan rates fixed at 2.5%, compared to borrowing rates now exceeding 10%, this continues to look good value.
Borrowers will of course pay more in interest by extending the term, but monthly repayments could fall by as much as 50% providing a boost to cash flow.
CBILS also offer the ability to extend the loan term from six to ten years but at the discretion of the lender. This extension is available if the borrower is in difficulty and the lender believes that the extension will help the borrower repay the loan. Businesses that wish to extend the loan term to ease cash flow will need to factor in additional interest paid.
Businesses are reminded to take independent advice before borrowing or making changes to their existing borrowing.
If you have any questions related to this update or would like further information or guidance, please contact Rachel Emmerson:
Call: 0330 124 1399