(Alliance News) - The Bank of England on Tuesday warned that rising interest is making it "difficult for some medium and large companies to repay debts".
Higher interest rates are heaping pressure on indebted firms due to the high costs of servicing debt, the central bank said.
"Such pressure increases the likelihood of defaults on corporates' debt and may lead some firms to reduce investment and employment sharply. Defaults can increase risks to financial stability directly through reducing lender resilience, while sharp reductions in investment and employment can indirectly affect financial stability by amplifying macroeconomic downturns," the BoE said in a website post.
However, it added that the share of medium and large companies that will find it difficult to repay debts due to interest payments rising relative to earnings is "expected to stay below historical peaks".
The BoE said a method of assessing a firm's debt-servicing ability is through their interest coverage ratio. This divides a company's earnings before interest and tax by interest expense.
"Companies with low ICRs are more likely to experience difficulties in making their debt payments," the BoE explained.
"In aggregate, the proportion of firms with low ICRs is projected to increase from 45% in 2022 to 50% at end-2023."
The central bank added that looking the proportion of firms that had low ICRs during the global financial crisis and even the dotcom crash in the year 2000 puts things into perspective slightly.
"It would take a further upward shock to borrowing costs of over 200 basis points and 800 basis points respectively – on top of the increases already expected – to reach GFC and dotcom shares of low ICR firms. A negative shock to corporate earnings relative to the May [monetary policy report] forecast could also increase the share of low ICR firms relative to the projection," the BoE added.
"It is notable that despite the severity of the GFC, the peak share of vulnerable corporates was relatively low. Unlike households, corporates did not, in aggregate, enter the GFC in a particularly leveraged position, although they did face credit supply constraints in its aftermath. Such credit constraints are less likely to occur now, as UK banks are significantly better capitalised than before the GFC, as demonstrated by the 2022/23 annual cyclical scenario results."
The BoE added that the ICR methodology can be "limited", however. It does not take into account self-help measures companies can turn to in order to reduce their exposure to rising rates. These can include deleveraging and debt restructuring measures.
"In fact, there is some evidence of corporate deleveraging in more timely aggregate data, which is not yet reflected in the more lagging corporate balance sheet data," the central bank added.
Earlier in August, the BoE lifted the benchmark bank rate to 5.25% from 5.00%. Threadneedle Street has dug deep with 515 basis points worth of hikes in the current cycle.
By Eric Cunha, Alliance News news editor
Comments and questions to firstname.lastname@example.org
Copyright 2023 Alliance News Ltd. All Rights Reserved.