When the government shut all non-essential retail stores in March many businesses were forced to increase borrowing to simply stay afloat. But are these levels of debt unsustainable? Retail Week looks at whether retail is facing a ticking liquidity time bomb.

  • Enforced closures and dampened consumer demand have seen many retailers forced to take on extra debt 
  • Asset-based loans are becoming increasingly common with retailers struggling to stay afloat
  • Fashion CFO predicts that autumn will see many businesses tested to the limit on their liquidity

Since the UK was plunged into a nationwide lockdown, the retail sector has been scrambling to keep afloat. 

With stores shut for nearly three months and homebound shoppers not spending, many retailers have seen sales plummet. To get through this unprecedented time, many were forced to go to new and existing lenders to secure additional credit in order to pay the bills.

As the government pushes to reopen the economy and wean businesses off state funding, some retailers are facing the prospect of having to pay back large loans on top of existing debts – all while footfall levels wallow at a historic low and consumer confidence remains stagnant.

Could this mixture of excess debt and stagnant sales lead to a retail credit crunch?

Money, money, money

The government has strived to make funds available to help businesses get through these turbulent times, but fundamentally these are loans that need to be paid back.

The main measures unveiled by chancellor Rishi Sunak in late March were two separate state-backed loan schemes: the Coronavirus Business Interruption Loan Scheme (CBILS) for businesses with turnovers of less than £45m and the Coronavirus Large Business Interruption Loan Scheme (CLBILS) for businesses with turnovers of more than £45m. 

These schemes were joined in late April by the Bounce Back Loan Scheme (BBLS) for smaller businesses, with loans ranging from £2,000 up to 25% of turnover, with a maximum of £50,000. 

No interest will be incurred by businesses taking any of these loans for the first year. 

Lauded at the time as one of the more generous government responses anywhere in the world, the limitations of the CBILS, CLBILS and BBLS schemes are becoming increasingly clear. 

“I’m working with about a dozen retail clients. And it could easily be between 30% and 50% above what their normal funding levels would be” 

Alistair Lee, Argyll Partners

As the chief financial officer of one mid-market fashion retailer explains, the schemes do leave some businesses without cover – including internationally owned retailers or those considered to be in danger of failing.

A notable example was French Connection, which last week said it had been forced to raise £15m in working capital investment from Hilco after it was refused access to government support. 

As a result, many retailers in this “funding no man’s land” have had no other recourse than to either raise cash through share buybacks or additional funding from owners or new investors – or, failing that, go cap-in-hand to banks. 

This has led to a huge increase in the overall amount of debt that retailers have taken on, on top of existing loans and borrowing. While a true figure is impossible to calculate, Alistair Lee, partner at financial advisory firm Argyll Partners, offers an example. 

“I’m currently working with about a dozen retail clients,” he says. “And it could easily be between 30% and 50% above what their normal funding levels would be.” 

Another banker agrees with this figure, and says that a mixture of concern for existing clients and external governmental pressure to prop up the sector has seen traditional lending norms go out the window. 

Lending is calculated against a business’ EBITDA. The banker explains that, prior to the pandemic, it would never lend more than two or three times a retailer’s EBITDA. However, due to the effect the virus and store closures have had on sales, banks are now effectively taking a leap of faith and lending at eight, nine and even 10 times current EBITDA levels. 

financial crash

“In many cases, businesses that are ‘undertaking in difficulty’ [businesses either unable to pay debt or whose incomings are less than outgoings] and can’t access these loans, we’ve ended up lending them money anyway, because they are fundamentally good businesses and we believe in them,” he says.

Lee says most of his retail clients, even those with robust balance sheets, have increased their overdrafts or revolving credit facilities.

However, credit isn’t available to all businesses. The banker says that retailers with severely reduced revenues are being forced into asset-based loans (ABLs) – effectively borrowing against the paper value of their stock. 

“As companies get more distressed, they go down the ABL route,” he says. “There’s a lot more of that. Remember, banks are also investors. You’re protecting your loan by lending them more money because if you don’t, they’ll go bust. If you lend them more, there’s at least a chance of recovery.”

While ABL loans are far more prevalent in the US, they have historically been seen as a last resort for struggling retailers in the UK and developed a stigma due to their association with high-profile collapses, such as Woolworths in 2008.  

In the wake of the pandemic, however, the banker says there has been an explosion in asset-based lending, which in turn has seen American banks like Wells Fargo enter the UK retail market as “ABLs are their bread and butter”.   

“The banks we deal with have been more flexible and creative when it comes to loans” 

Chief financial officer, fashion retailer 

Given the increased volatility across the retail sector, are lenders applying more strenuous terms to cover themselves should a retailer collapse?

The banker claims not. Many banks have agreed to increase existing loans or add new ones based on pre-coronavirus metrics, such as the company’s revenue expectations, he says.

“We’re not charging crazy interest rates at all. Most companies are on the same interest rates to what they were on before,” he explains.

The fashion CFO backs this up. “The banks we deal with have been more flexible and creative when it comes to loans,” he says, confirming that the retailer’s lenders have agreed extra facilities based on pre-coronavirus revenue levels.

Despite existing lenders offering support, Lee admits that the retail sector isn’t exactly top of many banks’ new client wish lists.

“If you had a traffic-light approach to different sectors and whether you’d want to lend money to them, I think it’s fair to say there wouldn’t be a green light on retail. It’d be probably amber, at best,” he says. 

As the banker points out, it’s been the mid-market apparel and footwear brands that have suffered the most due to the crisis – both in terms of collapsing sales and in struggling to open up fresh lines of credit with banks. 

Looming credit crunch? 

With banks suspending normal lending rules and many retailers borrowing money against old revenue forecasts, which may be unachievable in this new world, the situation looks increasingly perilous. 

The fashion CFO says he does not expect in-store sales to return to even 80% of pre-coronavirus levels until the second half of next year.

“Having all these old, tired brands fail is taking the industry forward quicker. They would have failed anyway, but this has just accelerated that process”

Banker

If sales continue to lag and generous interest rates and loan agreements expire, the banker believes a number of retailers could default on existing loans, or find themselves unable to access new ones. 

He tries to see this as a positive, however. “Having all these old, tired brands fail is taking the industry forward quicker. They would have failed anyway, but this has just accelerated that process.”

And while banks are happy to lend right now, will this be the case later in the year when retailers are struggling to keep up with repayment? Could banks that have been hit with bad debt from retailers failing simply switch off the taps to the wider sector? The fashion CFO worries this could be in the offing.

”We’ve come together really through the crisis, but how that pans out as things get more ‘normal’ and get more tested is the worry,” he says.

As those support schemes, such as furlough pay and business rates holidays, taper off at the back end of the year, the CFO predicts issues will come to a head. 

“We’re currently not paying for a lot of liabilities, which are being stacked up to pay back in the future,” he says. 

“As these things unwind, you’re almost certainly going to see a second hit where the liquidity point could really be tested. That could come October or November time, where liquidity could be seriously challenged again if stores sales don’t pick up significantly.

“A lot of retailers won’t have headroom and will need new facilities. I think they may face more challenging conversations with banks at that point.”

Lee agrees and sums up the situation: “There’s a lot of retail businesses, particularly the ones that have high street exposure, that will come out of this with more debt than they had going in, and not all will be able to cope with that debt going forward.”

Ultimately, whether or not retail is heading for a gargantuan credit crunch depends on two things: how quickly sales normalise to pre-Covid levels and whether the government extends existing support packages or unveils fresh fiscal stimulus measures.

Whatever happens, this coming golden quarter could well be the most important in the history of retail. A happy Christmas will see many retailers be able to pay off their debts, while a poor one could be fatal.