Bank of England warns on corporate default risk

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British companies face a higher risk of corporate defaults, posing a threat to investment and employment, as a result of rising interest rates, the Bank of England warned on Tuesday.

The share of non-financial UK companies experiencing debt-servicing stress — those with a low ratio of earnings to interest expenses — will rise to 50 per cent by the end of the year, from 45 per cent in 2022, according to an analysis published on the BoE’s blog.

The proportion rose to 70 per cent for medium-sized companies, those with an annual turnover between £10mn and £500mn. Under this scenario, corporate debt stress would hit its highest level since the 2008-09 financial crisis.

“Higher interest rates are putting pressure on indebted corporates through higher debt servicing costs,” said the analysis. “Such pressure increases the likelihood of defaults on corporates’ debt and may lead some firms to reduce investment and employment sharply.”

The UK interest rate has risen from a record low of 0.1 per cent in November 2021 to its current 5.25 per cent. The BoE analysis used market expectations that the rate will climb to 6.1 per cent.

David Bharier, head of research at the British Chambers of Commerce, said: the BoE’s analysis was consistent with what it had heard from thousands of small and medium-sized companies (SMEs).

“Rising borrowing costs are putting significant pressure on many smaller businesses, who after three years of economic shocks, are unable to absorb the increases,” said Bharier. “Many . . . will be concerned the real pain is yet to come.”

Martin McTague, national chair of the Federation of Small Businesses, said the analysis had mainly focused on bigger firms and “so doesn’t show the whole picture, with small businesses far more exposed to rising interest rates than their medium-sized and large peers”.

One in five small businesses reported financing as a main cause of increased business costs, according to FSB data from the second quarter of 2023, which was the highest proportion to date.

The BoE said that companies with low-interest coverage were more likely to experience difficulties in managing their debt, and warned that defaults could threaten financial stability in the economy by reducing lenders’ resilience.

Sharp reductions in corporate investment and employment — which happens when defaults rise — could indirectly make future economic downturns more severe, it warned.

Ruth Gregory, analyst at Capital Economics, said corporate insolvencies were expected to rise “sharply” in the months ahead as a result of surging borrowing costs, a largely stagnant economy and high inflation.

Separate data from the Insolvency Service, a government agency that deals with bankruptcies and companies in liquidation, last month showed there were 6,342 registered company insolvencies in England and Wales in the three months to June — the highest figure since the second quarter of 2009.

The BoE also forecast that the share of companies in distress will stay below the peaks reached during the financial crisis and the dotcom crash of 2000.

This was because many SMEs, which are typically more dependent on bank lending than larger companies, took out fixed-rate loans at a rate of 2.5 per cent cent over a term of six-10 years during the Covid pandemic, according to Gregory.