Thinking about new borrowing?

Posted: 6th March 2024 Gill Bloomfield, Director of Treasury

While the global political and economic backdrop remains uncertain, UK inflation has fallen, creating a potentially more stable interest rate environment. Many sectors are revisiting investment plans, and we now expect to see new borrowing activity tick up. Previous borrowing may have been under very different conditions but the key routes to funding remain largely unchanged.

Bank funding

Banks tell us they are open for business and keen to lend. Shorter tenors continue to be favoured, usually in the form of revolving credit facilities. Some lenders are edging back towards longer-term debt (7-10 years), and some less traditional lenders are offering smaller size loans with tenors of up to 25 years.

The step change in interest rates has seen existing borrowers with floating rate debt facing significantly higher costs. The good news is that market rates suggest that we are now at the peak, with a gradual fall anticipated, although no return to recent historic lows is expected.

Is it better to keep with variable rates and enjoy costs falling as rates come down, or is it better to lock in that expectation with a fixed rate? Depending on an organisation’s appetite for interest rate risk, there may be a preference for variable, in the expectation that markets have called the peak of the cycle correctly, and to retain maximum flexibility. Where there is a preference for cost certainty, fixed rates are still available, although many lenders now provide these via ISDA agreements rather than embedded in the loan.

Capital markets

Where larger levels of debt are under consideration, borrowers may be considering accessing funding from the capital markets to access long-term fixed rate debt.  Investors continue to show strong appetite with universities, housing and utilities seen as a key source of supply at the longer end of the curve.

It may feel uncomfortable to lock in fixed rates at the levels we are currently seeing, especially compared to remarkably low coupons that were achieved up to early 2022. There is a risk that rates fall faster than the market expects leaving this debt looking expensive and with high exit costs, especially compared to bank debt. However, for investments with a long payback period, the certainty can stabilise long-term plans and may even see lower costs in the early years while short-term rates are yet to fall.

Private placement or public issue?

Both private placements (bonds sold directly to investors) and public issue (bonds sold and traded on a stock exchange) are priced at a spread over gilts, but they differ in several significant areas.

A private placement is a more bilateral relationship. Typically, investors also seek covenants similar to those required by banks. Spreads for a private placement will also be higher than for a public issue.

On the plus side, investors may offer greater flexibility such as smaller sizes of debt and delayed drawdowns.

Another significant advantage is that a public credit rating is not required, and the borrower is not subject to market regulations applied to a publicly traded issue.

Public bond issues

A public bond issue brings with it an ongoing commitment to a public credit rating and market regulations, and this should not be underestimated. These obligations need to be well-understood and embedded throughout an organisation. The plus side here is that covenant requirements can be significantly lighter and pricing significantly cheaper.

Sustainability

No discussion of funding is complete without mentioning sustainability. This is a whole subject in itself and we will release more articles on this in the coming months. Watch this space.

To have a conversation about how Altair can assist you with our suite of Corporate Finance and Treasury services, please contact:

Gill Bloomfield
Director of Treasury
gill.bloomfield@altairltd.co.uk

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