Refinancing and resilience: key takeaways from the Bank of England's Financial Stability Report

The Bank of England (the Bank) published the latest edition of its biannual Financial Stability Report (the Report) on 27 June, analysing the Financial Policy Committee's findings on the stability of the UK financial system. The Report identified a number of market participants and instruments of interest, with particular focus on the private equity sector. Here are some key takeaways:

• Refinancing pressure for UK corporates – approximately 30% of high yield bonds and 40% of leveraged loans currently issued to UK corporates will mature within the next 2 to 3 years, putting pressure on these borrowers to refinance in an environment with significantly higher interest rates than those that were available at issue. The impact to date for borrowers will not have been uniform – those with floating rate debt characteristic of the leveraged space will already have felt the effect of higher rates, and may feel the cost of refinancing less acutely. Conversely, those with fixed-rate offerings by way of corporate bond issuances or interest rate hedges may soon feel the squeeze.
   
• Round 1 results for the “System-Wide Exploratory Scenario” (SWES) – the SWES is currently being tested with a number of Non-Banking Financial Institutions (NBFIs), in order to determine how "severe, but plausible" shocks to rates and asset prices might impact these entities. Participants anticipated "significant liquidity needs" arising mostly from margin calls, but expected to be able to meet these with existing financial resources. The Bank found that the SWES conditions would create "significant selling pressure" on UK corporate bonds as NBFIs would seek to offload large volumes of these instruments to raise cash, coupled with "limited" appetite from banks to make markets in this scenario. Round 2 will examine what the effect of this on the corporate bond market may be, with results published by the end of the year.
   
• The significance of private equity to the UK economy – Bank data estimates that 5% of private sector revenues in the UK can now be attributed to private equity-backed corporates, with such entities also comprising 10% of UK private sector employment and 15% of UK corporate debt. This is giving rise to closer scrutiny by the Bank and other regulatory bodies – the Report notes in particular the Prudential Regulation Authority's April 2024 letter to major banks which encouraged greater scrutiny by banks' risk management functions of their private equity exposure.
   
• Creative solutions for funds' financing needs are on the rise - the private equity sector has thus far been resilient in the face of the higher interest rate environment. The rise of NAV financings; a market currently estimated to have a US$100 billion value globally, was highlighted, noting that this market is expected to increase in the coming years. Similar noted trends include the use of amend-and-extend and payment in kind transactions, both aimed at finding a solution for portfolio companies and lenders alike providing for greater runway for the former and a premium on returns (plus, in some cases, tighter financial controls) for the latter.