As we head into the summer with the FTSE 100 reaching a record high and breaking 9,000 points for the first time in its 40 year history it’s easy to see how we could argue all is well with the British economy and there’s nothing to worry about.
However, what lies beneath the surface continues to show that the outlook remains more challenging than the headlines suggest, and that a disconnect exists between the globally skewed FTSE 100 and the heavily UK mid-market correlated private capital markets.
The list of challenges facing UK dominated mid-market businesses is getting longer by the month:
• Higher national insurance contributions continue to wash through the system, meaning inflation hasn’t died down, up again at 3.7% in the year to June 25
• The labour market remains soft, perhaps also a hangover from higher NI, with unemployment up to 4.7%, the highest since Covid lockdowns ended
• Sluggish GDP, shrinking 0.3% in April and a further 0.1% in May underline this backdrop, and explain why the UK government remains unable or unwilling to provide stimulus in the same way as in the US and Germany
• The trade deal with US was a relief for equity markets and the auto / aero sectors, but the blanket 10% tariff will likely weigh on wider export growth this year
• The continued sense that the Labour government has little room for manoeuvre – as evidenced by the climb down on benefits bills highlighting the political challenge they face to cut costs whilst facing elevated borrowing costs from self-inflicted gilt market volatility
Whilst debt markets by no means trade in tandem with equity markets, blink and you’d think so, with FTSE record highs being more or less matched by excellent conditions in the debt markets for borrowers.
However, similar to the equity market dichotomy between headline records and underlying weakness a similar bifurcation exists in debt markets. New deals, for the right credits, in a light market for deal volumes, are highly bid, oversubscribed, pricing tight. Underneath this, the UK heavy mid-market back book has more indigestion than most people want to openly discuss.
Sluggish UK growth and increased costs are weighing on businesses who raised debt at say 7% and face underlying interest rates up from near zero to over 4%. Certainly not widespread distress, but wider than advertised cash flow weakness / covenant weakness.
Luckily, the debt markets are strong, and in general optimism outweighs the media calls for the bubble to burst. At Newbrook we have been helping more and more borrowers readjust their balance sheets in the face of these headwinds – using strong market conditions to their advantage – for example (though by no means the only option), raising PIK debt to reduce cash pay debt both in absolute leverage terms and in meaningful rate terms, and by so doing improving cashflow and or resetting covenants / maturities. To a certain extent yes, it is the sign of quieter M&A markets that enable us to be creative in debt markets, but, and this is the key – it also makes a lot of sense for all parties….