Two headline economic markers that have long seemed unattainable – a falling unemployment rate and a growth in GDP – prompted a burst of speculation earlier this year that interest rate rises are becoming a possibility.
In January, the ONS announced that GDP growth hit 0.7% for the fourth quarter of 2013, making the overall growth rate for the year 1.9%, the UK economy’s strongest result for six years. And, following the Bank of England’s announcement that unemployment would have to fall to 7% before rate rises could be countenanced (which at the time the Bank anticipated would perhaps occur around 2016) unemployment fell to 7.1%, with the expectation of further falls.
The prospect of interest rate rises, as indicated by the Bank of England’s forward guidance, was quickly dampened by governor Mark Carney speaking at the World Economic Forum in Davos. Britain’s economy was well short of “escape velocity”, he said. He has since said that markers other than unemployment will be used to decide when interest rates will rise.
Carney may have put aside the possibility of increases for a time, nevertheless ordinary mortgage holders and business people who are used to historically low rates have now at least to grapple with the prospect of rising interest levels. The impact on households and businesses within an economy that is still highly indebted needs to be evaluated as a medium-term possibility. And of course, increased interest rates stand to impact on accountants personally as well as professionally.
The UK is, says independent economist Frances Coppola, particularly sensitive to interest rate rises. “With many more mortgage holders than, say Germany, and many more on fluctuating rates compared to the US where fixed rate mortgages are more prevalent, we could see really large amounts of mortgage distress and defaults.
With many more mortgage holders than, say Germany, and many more on fluctuating rates compared to the US where fixed rate mortgages are more prevalent, we could see really large amounts of mortgage distress and defaults
“These would occur not because people borrowed recklessly but because of relative falls in wages. That in turn hits the banking sector. There is a huge amount of debt still in the economy.”
Interest rate rises are “a bit of trap” for banks, she says. On the one hand they may make more profit, but on the other they stand to lose as debt becomes less affordable.
The small business sector is also in a precarious position. “Looking at small businesses, one argument is that lending rates are already too high,” says Coppola. “Banks have been asked to price their rates properly, and often the only way to secure lending is to put your house on the line. Among SMEs, with some facing potentially crippling borrowing rates, a policy rate rise could be the difference between life and death. We have to consider if this is a good idea when the recovery is so feeble.”
Good idea or not, assessing the impact of rate rises on clients’ personal and business finances must be moving up the to-do list of many practitioners. Paul Tooth, managing director of the Accountants Division at Sage, says he has seen a lot of focus on this among accountants with an SME client base. They are reviewing clients’ debt levels, medium and long-term cashflow as well as investments, he says.
While interest rates are still low, bringing any debt-backed asset purchases forward is one possibility accountants are looking at, says Tooth, as is refinancing debt across property portfolios as the yields that buy to let portfolios have garnered stand to be eroded by rate rises.
Rebecca McNeil, head of business lending at Barclays Business Banking, says businesses need to remember to assess fees and charges on borrowing arrangements alongside calculating the impact of rate rises.
Businesses should review whether existing borrowing arrangements still meet their requirements, she says, particularly if circumstances change. Above all they need to ensure they maintain a dialogue and assess their requirements ahead of any meetings with their bank business manager. “Ask yourself some questions ahead of the meeting – understand your appetite for risk and what you are looking to do with the finance. This will help you get the best from the conversation,” she says.
Concerns remain that constraints within the banking sector will continue to limit the capacity of banks to lend. However, while current growth in credit is anaemic, evidence suggests that the situation is gradually easing.
The Bank of England’s latest Credit Conditions Survey shows UK banks are making more credit available to households and businesses. The overall availability of credit to the corporate sector increased significantly in the last quarter of 2013, according to the Bank, with a further increase anticipated for the first quarter of this year. Lenders reported availability of credit increasing for small businesses and large private businesses alike.
Whether interest rate rises are imminent or not, whether businesses are heavily indebted or not, planning and reviewing finances and operations now can only be a good strategy.
Lynette Lackey of Greenside Solutions advises international businesses and high net worth individuals. She suggests advisers look at a range of issues and evaluate how the interest rate rises might incline clients to change tack, including the structure of the entity group and whether it remains the right one in a potentially tougher environment.
Where inter-group loans are a feature of the business it will be worth reviewing to ensure whether the structure remains commercially efficient, or whether the loans are fixed at a sensible rate if you expect interest rates to rise, she says. And given the recent changes to LLPs, it may be worth considering any transactions with any of these vehicles in the group to ensure transactions and profit flows remain commercially viable and tax efficient.
When it comes to the people in the business, interest rate rises may provide an opportunity to review incentives or revise succession planning. For a cash-rich business looking to incentivise staff, an offer of employee loans that beat rising high street interest rates may be helpful.
In organisations where founders are planning to exit or key individuals are coming up to retirement, it may be worth considering any plans for deferred interest bearing payments to ensure the rate and timing remain effective. “If a founder or director is planning an exit route, they should consider whether there are elements in the company’s arrangements with them that can take advantage of low interest rates now,” she says.
On the product and supply chain side, it may be worth encouraging clients to review their current arrangements and the financing of those arrangements. Stocking up to take advantage of low interest rates in the short term should be weighed up against the costs of holding the extra stock. Suppliers might look favourably on companies that want to buy in advance at a discount, while taking the delivery later.
The flipside of this is customers and their payment habits. “It may be that companies should think about charging interest to customers who habitually pay late as a means of deterring that late payment. The key point is efficient financing and to maintain sufficient cash within the business.”
On the marketing side, advisers should encourage their clients to assess whether their sales pricing reflects the full cost of any interest rate rise, just as they would any added cost to the business. Reviewing key markets and customers to refocus attention on the most profitable areas would be well advised.
“On the positive side, we are seeing businesses exploring new export markets and international trade relationships now to ensure a wider spread of customers and suppliers,” says Lackey.
For healthy, buoyant businesses a little good housekeeping will go a long way. However, many professionals are concerned about the sheer number of businesses that are struggling on the margins. According to insolvency and recovery body R3, there are some 200,000 such businesses in the UK economy, negotiating with creditors or struggling with current debt levels.
“Some owner-managers have survived by cutting their own benefits rather than close,” says Paul Tooth. “That’s not sustainable. Accountants are saying that often there is very little else to take out of the business. Roll that forward a year and the business isn’t viable,” he says.
It’s for this group of companies that an interest rate rise will prove most onerous and leave advisers most hard-pressed to offer strategies that could pull them through. The impact of rate increases on business confidence, currently riding its highest level for years according to the ICAEW’s Business Confidence Monitor (BCM), is likely to be severe.
Stephen Ibbotson, ICAEW director of business and head of the Finance & Management Faculty, says this has to be a concern. “Rate increases could be a real dampener on recovery,” he says. “Evidence shows that a lot more companies go out of business at the start of a recovery than during recession.” He points out that the combination of a potential housing bubble and a predicted shortfall in export growth against government targets (according to the BCM), means current growth may not be robust enough to warrant interest rate rises.
Advising clients against this tough economic backdrop is no easy matter. “But that is the role of accountants in the current business environment,” he says.