An increase in fixed-rate borrowing by small and medium-sized businesses (SMEs) may be due to businesses’ desire to avoid the impact of expected interest rate increases and ensure the availability of funding, says Hadrian’s Wall Capital (HWC), the London-based specialist debt adviser.
Fixed rate borrowing taken out by SMEs has increased 8%* over the last year to £28.7bn (year-end 31st December), up from £26.5bn in 2017. Meanwhile, floating rate borrowing by SMEs has fallen over the same period to £137.1bn, down from £138.9bn.
HWC says that although further interest rates increases are on hold in the UK for now, more are expected in the near future. The BOE Monetary Committee recently stated that “were the economy to develop broadly in line with [its] projections, an ongoing tightening of monetary policy over the forecast period, at a gradual pace and to a limited extent, would be appropriate.”
Swaps rates show markets imply that base rates would increase from 0.75% to 1% by the fourth quarter of this year**. Some of these expectations of interest rate increases come following the quantitative easing programs and the anticipated winding down of central bank bond purchases and related bond inventories that arose as a result of the global financial crisis.
HWC adds that there are signs that the global economy has entered the next phase of the credit cycle and interest rates are expected to increase. Six-month US dollar Libor interest rates have risen to over 2.6%, whereas GBP is still only about 0.95% which is well below the BOE inflation target of 2%.
Despite fixed rate borrowing taken out by SMEs increasing, 83% still remain exposed to future interest rate increases – fixed rate lending represents only 17% of all outstanding loans to SMEs. This reflects how difficult it can be for SMEs to obtain fixed-rate funding.
Fixed rate loans are generally for fixed periods of time, whereas floating rate finance is generally provided by banks and lenders who can often demand repayment early or not renew the loan facilities, which represents a considerable liquidity risk for SMEs.
HWC says that banks prefer floating rates, as they have less risk to rising rates and SMEs bear the increased risk to higher interest rates.
Fixed rate borrowing enables SMEs to more easily plan their spending, such as when to invest in fixed assets, as they know interest payments will remain the same.
HWC adds that many SMEs are, therefore, having to look to alternative finance providers to obtain the funding they need. For example, HWC has seen an uptick in demand for its fixed rate 5-year loan in recent months.
Marc Bajer, CEO at Hadrian’s Wall Capital, says: “With one eye on almost inevitable interest rate increases, many businesses are looking to lock in fixed rates now.”
“However, a vast number of businesses across the UK are struggling to obtain the fixed rate loans they need.”
“Banks much prefer lending on floating rates because they can increase how much they charge businesses as interest rates rise. As base rates are forecasted to rise again later this year, most banks will be reluctant to lend more on fixed rates.”
“Borrowing on a fixed rate provides SMEs with much needed flexibility in planning their spending and investment.
* Source: Bank of England. Year ended December 31st 2018
**Source: Bank of England Inflation Report 2019. Based on overnight index swap rates