The only way is up...what the Base Rate change means for corporate borrowers

Last week the Bank of England increased its Base Rate from 0.25% to 0.50%. This is the first such rate change since 2007, reversing the 0.25% cut that was made last summer following the Brexit referendum result.

For many the rate change comes as no surprise, particularly with inflation reaching 3% (the government target being 2%) and unemployment remaining low.  Commentators have been quick to flag the implications for individual borrowers and savers, but what does the rate change mean for corporate borrowers?

1. Fixed rate products

Borrowers with fixed rate products will continue to enjoy the same fixed rates until their fixed rate period ends. So for borrowers who benefit from fixed rate loans with long maturities, there may be little cause for immediate concern.

2. Floating rate products

Borrowers with floating rate products need to check if their interest rates track the Bank of England’s Base Rate or a different benchmark. For example, floating rates on loans to corporate borrowers are often set by reference to the London Interbank Offered Rate (LIBOR) for a specified tenor ranging from overnight to 12 months. That said, based upon the latest available LIBOR rate information as calculated and published by ICE Benchmark Administration, the Base Rate increase already appears to have been priced into LIBOR. For example, most UK corporate borrowers will pay interest based upon GBP 3-month or 6-month LIBOR, which each saw relatively minimal increases between Wednesday 1 November (the day preceding the Base Rate change) and the end of last week immediately following the Base Rate increase, as illustrated by the table below*.

* Source: https://www.theice.com

3. Other provisions affecting interest

Often the amount of interest corporate borrowers pay on a loan is not determined by reference to an interest rate benchmark alone, but by a combination of factors. Other points corporate borrowers need to keep in mind include the following:

1. Applicable Margin – this is the additional percentage added to a particular interest rate which allows a lender to make a profit on the loan. The margin will sometimes change depending upon certain factors, for example a borrower’s financial condition at a particular time.
2. Default rates – this is the extra interest charged on a loan where a borrower defaults on its obligations.
3. Bespoke provisions - occasionally, some loans allow a lender to increase the applicable interest rate simply where it foresees that a relevant benchmark rate may be subject to future increase. The Base Rate increase had been widely predicted, and some borrowers may already have been feeling the effect of this for some time where lenders have invoked such rights. As is often the case, the devil is always in the detail.

4. Covenant compliance

Borrowers will need to understand how any changes to their financial situation as a result of the rate rise may impact their ongoing compliance with any financial covenants. For example, borrowers who suffer a fall in earnings, or who find that their financing costs increase, may struggle to meet their debt service and interest cover ratios. Where there is insufficient headroom to accommodate any future such challenges, early dialogue with lenders with a view to taking remedial action is always to be encouraged. 

5. Interest rate swaps

It seems entirely possible that further increases in the Base Rate may follow, although the Bank of England has been quick to note that any such changes will be “at a gradual pace and to a limited extent”. Even so, corporate borrowers who have gone to the time and cost of putting loan-linked hedging in place previously may benefit from further protection against any future rate rises. Much will however depend upon the nature of the individual products in question.

The longer-term impact of the Base Rate rise on the wider UK economy and how it affects consumer confidence will only become clear over the coming months. What is clear is that the rate rise presents another challenge to the UK economy at a time when it is already feeling the effects of other difficulties, including the ongoing Brexit negotiations, currency devaluation and rising commodity prices. We expect most corporate borrowers to weather this particular change but many will be keeping a close eye on this development and how it affects their ability to comply with their existing finance arrangements going forwards.