March has been a rocky month for the stock market.
With just a few trading days left as I write, the FTSE 100 is down 6%.
Shock events at several overseas banks, and unwelcome news on inflation and interest rates at home, have got the market jittery.
These developments have ramifications not only for UK banks, but also for London-listed companies in other sectors.
There are firms with particular characteristics (I’ll tell you about these shortly) where risk has ratcheted up.
However, for numerous others, I don’t think much has changed. Except their shares are cheaper than a month ago!
Bank shockwaves
Here’s a timeline of those shock events at overseas banks:
8 March — US Silvergate Bank, lender of choice to cryptocurrency firms, goes into liquidation.
10 March — US tech lender Silicon Valley Bank (SVB) collapses (the second-biggest bank collapse in US history).
12 March — US Signature Bank, another banker to the crypto industry, also collapses.
19 March — The Swiss National Bank railroads UBS into taking over Credit Suisse in an emergency rescue.
There’s a risk that bank failures or emergencies could spread to other countries.
On the face of it, the UK’s biggest banks don’t appear to be particularly at risk. But things could get hairy for smaller banks, if large numbers of depositors were to move money to perceived ‘safer’ big banks.
Not just about banks
UK companies in other sectors have been impacted by March’s events.
On the Monday after SVB’s collapse, the London Stock Exchange‘s regulatory news service was full of statements from FTSE firms (mainly small and mid-cap tech stocks) detailing their exposure (or lack of) to the US lender and/or its UK arm, SVB UK.
By the end of the day, more than 50 FTSE firms had issued statements.
Government intervention has seen SVB UK bought by HSBC for £1, and the parent SVB bought by First Citizens, a top 20 bank in the US.
Nevertheless, a worried banking sector has ongoing implications for businesses seeking loans.
Credit tightening
In times of stress, banks tend to reduce their lending and try to increase their levels of deposits. In other words, strengthen their balance sheets against any nasty shocks.
Riskier businesses are generally the first casualties when lenders tighten credit availability.
Such businesses include companies that will be loss-making or marginally profitable for the foreseeable future. And struggling companies in need of financing for a turnaround that could take some time and which may or may not be successful.
The situation has only been exacerbated by that unwelcome news on UK inflation and interest rates I mentioned earlier.
Interest rates
On 22 March, there was the surprise revelation that, after three months of declines, UK inflation had jumped to 10.4% in February.
The following day, the Bank of England — which, before the inflation news, had been expected to hold the interest rate — instead increased it for an 11th consecutive time (to 4.25%).
Higher risk
In the current lending and interest rate climate, any company with a weak balance sheet, and an urgent need to refinance in order to continue as a going concern, is in a vulnerable position.
It’s clearly going to get much more difficult for loss-making, marginally profitable, or struggling businesses to secure financing — and for those that succeed, loans are going to be a lot more expensive.
This is what I meant when I said there are companies with particular characteristics where risk has ratcheted up. I’m fearful of seeing an increase in the number of these businesses going under.
Not all gloom
On a brighter front, I also said I thought not much has changed for many companies — except their shares have got cheaper. I think greed could be the order of the day here.
For example, Intertek, a testing and certification specialist, is a firm I happen to have looked at recently. It expects its finance costs to rise to £40m-£45m in 2023 from £32m last year.
A 25%-40% increase in debt servicing costs could be crippling for the kind of companies I talked about above. However, Intertek has a strong balance sheet and generates substantial free cash flow (£386m last year). It can readily absorb the higher financing costs.
Foolish bottom line
Even when banks are lending freely and loans are cheap (as was the case last decade), investors should always check a company’s balance sheet and cash flows.
But it’s all the more important when credit availability is tightening and higher interest rates are making borrowing more expensive.
The post What next for UK stocks as banks collapse and interest rates rise? appeared first on The Motley Fool UK.
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HSBC Holdings is an advertising partner of The Ascent, a Motley Fool company. The Motley Fool UK has recommended HSBC Holdings and Intertek Group Plc. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.