What next for UK stocks as banks collapse and interest rates rise?

March was a tough month for the stock market.

With only a few trading days left as I write, the FTSE 100 it is down 6%.

Shock events at several overseas banks, and unexpected news about inflation and interest rates at home, have rattled the market.

These developments have ramifications not only for UK banks, but also for London-listed companies in other sectors.

There are companies that have special characteristics (I will talk about this shortly) where the risk increases.

But, for many others, I don’t think much has changed. Except the stock is cheaper than last month!

Bank shock

Here’s a timeline of the shock event at the offshore bank:

• March 8 – US Silvergate Bank, lender of choice for cryptocurrency companies, goes into liquidation.
• March 10 – US technology lender Silicon Valley Bank (SVB) collapses (the second largest bank collapse in US history).
• March 12 – US Signature Bank, another banker in the crypto industry, also collapsed.
• March 19 – Swiss National Bank railroad UBS to take over Credit Suisse in an emergency rescue.

There is a risk that a bank failure or emergency could spread to other countries.

On the face of it, Britain’s biggest banks appear to be risk-averse. But things can get hairy for smaller banks, if many depositors send their money to the big banks they think are ‘safer’.

It’s not just about banks

British companies in other sectors were affected by the March event.

There after the collapse of the SVB, the London Stock ExchangeRegulatory news services are full of statements from FTSE companies (mainly small and mid-sized tech stocks) detailing their exposure (or lack thereof) to the US lender and/or its UK arm, SVB UK.

By the end of the day, more than 50 FTSE companies had issued statements.

Government intervention has seen SVB UK buy by HSBC for £1, and SVB parents buy by The first citizenTop 20 banks in the US.

However, the troubled banking sector has ongoing implications for businesses seeking loans.

Credit tightening

In times of stress, banks tend to reduce lending and try to increase deposit rates. In other words, strengthen the balance sheet against any adverse shocks.

Riskier businesses are generally the first victims when lenders tighten credit availability.

These businesses include companies that will make a loss or make little profit in the future. And struggling companies need funding to make changes that may take some time and may not be successful.

The situation was only exacerbated by the unexpected news about UK inflation and interest rates that I mentioned earlier.

interest rate

On March 22, there was a surprise revelation that, after three months of decline, British inflation had jumped to 10.4% in February.

The following day, the Bank of England – which, before the news of inflation, was expected to hold the interest rate – instead of increasing it for the 11th consecutive time (up to 4.25%).

Higher risk

In today’s climate of borrowing and interest rates, any company that has a weak balance sheet, and needs to be refinanced to continue as a going concern, is in a vulnerable position.

Clearly it will be more difficult for businesses that are making losses, low profits, or struggling to secure funding – and for those that are successful, loans will be more expensive.

This is what I mean when I say that there are companies with special characteristics where the risk increases. I’m afraid to see more of that business.

It’s not all bleak

On a brighter front, I’d also say that not much has changed for many companies – except for lower-priced stocks. I think greed may be the order of the day here.

For example, Intertek, a specialist in testing and certification, it really happened that I have seen it recently. They expect finance charges to rise to £40m-£45m in 2023 from £32m last year.

A 25%-40% increase in debt service costs can be crippling for the type of company I talked about above. However, EUROLAB has a strong balance sheet and generates sufficient free cash flow (£386m last year). It can easily absorb higher financing costs.

Basic stupidity

Even if banks give loans freely and cheaply (as they did decades ago), investors should check the company’s balance sheet and cash flow.

But all the more important when credit availability is tightened and higher interest rates make borrowing more expensive.