“There is a significant increase in respondents who are looking to increase net debt this year, to the highest level in five years, despite the increase in borrowing costs”, according to a study by Herbert Smith Freehills (HSF) in conjunction with the Association of Corporate Treasurers (ACT).

Based on a survey of and follow-up interviews with treasury and finance professionals at 88 large UK listed corporates (primarily FTSE 100, FTSE 250 and equivalents) conducted between February and April 2023, the firm’s latest annual Corporate Debt and Treasury Report 2023 found that bank debt remains the mainstay of corporate debt financing.

Some of the key findings from the survey analysis include the following:

Macroeconomic events not to impact debt strategy

                  What is the expected impact of such events on your 2023 debt strategy?

Source: Corporate Debt and Treasury Report 2023 (Herbert Smith Freehills)

The survey findings highlight that 10% fewer respondents reported that recent geopolitical and macroeconomic events would have no bearing on their debt strategy this year, compared to the previous year’s findings. However, several treasury and finance professionals who were interviewed noted that the debt markets are becoming progressively more challenging for them to navigate.

Treasurers are grappling with ramifications of higher interest rates, further complicated by a reduced sense of certainty surrounding their preferred debt options, “Particularly with the perception that, with the collapse of Silicon Valley Bank, Signature Bank and First Republic and the emergency takeover of Credit Suisse, there is a risk of banks more systematically materially changing how they deploy capital”, the report explains.

For 19% of the survey participants (up from 15% of respondents last year), the focus has been on increasing net debt to finance elevated working capital expenses. Conversely, 8% of the respondents are exploring alternative strategies to raise capital, such as asset disposals, while another 10% of the respondents are opting to raise equity.

Treasurers are increasingly implementing comprehensive cash management strategies throughout their organizations, aiming to optimise the utilisation of debt and minimise interest expenses.

For some, this constitutes a significant undertaking, as it involves releasing cash reserves held by local teams across the globe and addressing occasionally intricate regulations concerning cash repatriation. Others are exploring avenues to expand their banking syndicates and further diversify their debt capital structures, even if it involves incurring tangible costs, all in an effort to mitigate the concentration risk associated with funding sources.

That said, it is worth noting that corporate treasury has remained resilient through tough and uncertain times, having "Already built robust processes and debt strategies off the back of a number of economic shocks over the last few years", the report further added. 

Rise in net debt amid climbing borrowing costs and polarised views on use of interest rate hedging

According to the study, “Inflation and supply chain issues, coupled with the varying abilities to pass on input costs to customers, has resulted in significant increases in working capital for many corporates and therefore a greater need for debt.”

Despite growing borrowing costs, there was a notable increase in respondents aiming to raise net debt this year to its highest level in five years.

                   Do you plan to increase your net debt this year?

 

Source: Corporate Debt and Treasury Report 2023 (Herbert Smith Freehills)

The current high-interest rate landscape is a novelty for many treasurers, marking a situation that they’ve never encountered previously. One respondent even remarked that navigating the challenges posed by rising interest rates demands “A complete change in mindset.”

Corporate debt financing remains heavily reliant on bank debt (46% of respondents favour bank debt for debt funding), an aspect a significant number of respondents cautioned against. This explains why corporate treasurers are weaning off excessive dependence on bank debt by undertaking debt diversification. Consequently, there has been a significant shift towards debt capital markets (DCM) issuance as a percentage of debt funding (34% of respondents obtain debt funding from DCM).

Private placement is another source of debt funding helping treasurers move away from bank debt. With 16% of respondents using private placement as a method of debt financing, it is now playing “A greater role in corporate debt strategies”, states the HSF report.

In terms of the need for corporates to consider their interest rate hedging strategy for 2023, “There is an interesting split in the increase in the number of respondents more likely to use interest rate hedging (which has increased by almost 10%, from 22% in 2022 to 31% in 2023), and respondents who do not use interest rate hedging (which has doubled from 18% in 2022 to 36% in 2023)”, the report further mentions.

The polarised views on the use of interest rate hedging perhaps reflect the fact that some treasurers hold the considered opinion that interest rates may have reached their peak, and so the opportunity to lock in rates at favourable prices may well have lapsed, as also the need to “Hedge against future rate raises has decreased.”

To conclude, while corporate treasury has remained resilient in the face of varied challenges over the past three years, the current economic uncertainty requires “Treasurers to be nimble in their debt strategy”, the report advocates. For now, core inflation has dropped in the UK, yet treasury and finance professionals remain cautious because of the cost of living crisis and rising borrowing costs putting sustained pressure on Britain’s economy.

To counter the impact of inflation, corporate treasurers and finance chiefs in the UK are taking a broad range of steps such as prepaying debt, prioritizing efficiency programmes, and embracing supply chain financing solutions that can effectively unlock trapped cash within the business’s working capital cycle, allowing it to be put to use elsewhere and ultimately contributing to reducing costs. Focusing on risk management processes and building larger liquidity buffers are other measures being deployed to adapt to unforeseen economic shocks.