3 minute read
Ross Walker, Co-Head of Global Economics & Chief UK Economist, looks at how the debt profile of UK companies has evolved as a result of the coronavirus crisis.
The unprecedented nature of the coronavirus crisis has prompted an equally unprecedented policy response in the UK. It’s been successful in terms of reducing the short-term damage, but how might problems emerge further down the road due to the increased amount of debt that UK companies have taken on?
Unprecedented crisis, unprecedented policy response
The lockdown triggered by the coronavirus pandemic has been without precedent in terms of the breadth and depth of its impact on the UK economy. The Bank of England and Treasury quickly implemented various measures to forestall a corporate insolvency crisis: these included cutting the Bank Rate, additional quantitative easing measures (including purchases of corporate bonds as well as Gilts) and various lending-support mechanisms. The chart below shows the support that companies have received in the form of a surge in funding to private non-financial corporations (PNFCs) since March.
This availability of funding is in stark contrast to what we saw during the global financial crisis of 2008–09, and has clearly been of benefit. The downside, of course, is that firms will need to repay what they’ve borrowed, and that’s inevitably going to hit their capital expenditure and hiring down the line.
Companies’ balance sheets have expanded
UK firms’ debt levels had been falling in the years before the coronavirus crisis, but in Q1 their debt increased by £33.2bn and by another £37.6bn in Q2. Although the amount of debt they’re taking on is moderating, it still seems reasonable to assume that UK firms will have an extra £100bn of debt by the time the crisis is over.
The big question is how fast they burn through this cash.
The reality of the ongoing restrictions in capacity is that firms in some sectors are going to use it more quickly than others. Companies in the accommodation, travel, restaurant, arts & leisure and services sectors will probably spend the money they receive most rapidly.
Coronavirus isn’t likely to cause an immediate corporate debt crisis because aggregate debt levels aren’t that high. The concern is that the distribution of this debt, against a backdrop of sluggish economic growth and ongoing capacity constraints, represents a risk for particular sectors of the economy and firms with more limited financing options (such as small- and medium-sized enterprises).
Corporate profitability and investment under pressure
Corporate profitability had been falling even before coronavirus came about, as we can see in the chart below.
But even though profitability growth had been slowing down, the Bank of England had noted that UK firms’ average profit margin was big enough to absorb a 16% drop in turnover while still paying labour costs in full.
Along similar lines, capex had also been falling before coronavirus – probably due to Brexit concerns, which have by no means gone away – although hiring remained buoyant. Coronavirus is going to have a major negative impact in the near term, and probably a lasting drag.
Insolvencies may be trouble ahead
Corporate insolvency data have remained benign so far, with the number of insolvencies actually falling in recent quarters. More ominously, survey data are pointing to expectations of higher insolvency levels over the coming quarters, although HMRC is reportedly pursuing “reduced enforcement” of some winding-up petitions. Once again, we see polarisation in the market: at one end of the scale, 35% of firms are reporting that they have cash reserves of six months or more; at the other, 4% have either no reserves at all or only enough to last one month.
Even if there’s relatively little “scarring” of the UK economy in the form of large-scale insolvencies, there’s likely to be “bruising” in the form of debt weighing on firms’ appetite for investment and hiring. Either way, it’s hard to envisage the UK corporate sector leading an investment-based economic recovery any time soon.