Many businesses struggling with their cashflow due to the pandemic could soon face increased interest rates causing them to default on their loans, risking bankruptcy. As interest rates increase the risk is that the threshold required to be generated from operating cashflows over and above the interest becomes too low, meaning the loan covenants are breached and the loan can be recalled by the bank immediately. If not managed carefully, or without a supportive lender, this could result in the company failing.
Many modern loans include a requirement for operating cashflows to exceed interest payments by a certain threshold. Those operating cashflows are in many cases already depleted by the impact of Covid-19, with the further impact of rising inflation to come. Increasing interest rates is a mechanism for the Bank of England to control inflation. However, businesses with interest rate covenants need to be extremely careful.
Thousands of companies have taken on more debt during the pandemic in a bid to preserve jobs and maintain working capital levels. Rising interest rates increase the cost of servicing these higher levels of debt, reducing cash available for other purposes, and putting a strain on a small company.
Business owners should look to forecast their cashflows and covenant calculations for at least the next year to make an informed assessment as to whether the risk of default is significant and if so, hold pre-emptive discussions with their lender in advance of the covenant being breached.
This allows time to agree a refinancing package, or revised covenants, without the pressure of the loan having already defaulted. Other business owners, who are more confident about their ability to repay interest but are concerned about the unpredictability of amounts due caused by rising interest rates could look at hedging their loans through interest rate swaps to fix the interest rates at an agreed percentage.
Would you like to know more?
If you would like to discuss the above or how it may affect you, please get in touch with your usual Blick Rothenberg contact or David Hough using the details on this page.
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