Project Funding – After the Low interest Rate World

The uncertainty of the current high-inflation, high-interest environment has called into question the viability of some developments. Large projects within real estate, hospitality, and tourism that are heavily geared through debt are seeing unprecedented rises in repayments. In both the US and UK, mortgage repayments have gone from around 2.5% to almost 7%. And, for riskier projects, this figure is even higher.

The real shock isn’t just from a 4% increase in rates around much of the world, as a raise from 4% to 8% would result in less of a panic. The real shock is that money has gone from being almost free - where 20% of the global GDP had negative rates - to suddenly having to pay a serious price for borrowing. This change happened very quickly, and it’s putting question marks over many countries on whether they will default.

Some examples of this include US Series I Savings Bonds which are now 6.89% despite being around half of this heading into 2022, whilst junk yields have gone from 4.35% to 8.4% in a year.

The situation with inflation, which is predominantly caused by a sharp rise in energy costs, is what led to these rises in interest rates. But ironically, this creates a difficult environment for green energy and new technology to develop to help offer a sustainable replacement for Russian gas and oil. This is creating a situation where the government is more important than ever to provide subsidies, and almost China-like centralised capitalism to direct government spending at these important industries. Without it, innovation will suffer in such a difficult economy.

Riskier investing environment for large projects

It’s not just that large project funding is now more expensive, it’s that higher interest rates may discourage investment into riskier projects as investors demand higher returns to compensate. This may pose a serious threat to the blitz scaling that tech companies have been employing, which has been driven by cheap money despite some firms, like how Uber has hardly ever reported a profit. So far, many have been buying back their stock to boost share prices due to profitability concerns, though the outlook for other more tangible industries could be just as bad.

Of course, high interest also incentivises saving money over spending it, which is further perpetuated by the rising cost of living. So, the revenue for hospitality, tourism, and even being a residential landlord is under threat with customers having less money. Investment is down, consumption is down, and repayments are up.

A clear example of this is the scrapping of a 9,000-passenger cruise ship that is left unfinished and unwanted. Many blame the pandemic, but in truth, there are enough countries that are open enough to have a smooth holiday (particularly EU cruises). Furthermore, more people can tend to their jobs from afar. But no, cruise ships are essentially an expensive way to travel, and Europeans are struggling to afford their utility bills. Cruise companies are losing money even before considering rising debt costs. 13 cruise ships were sold for scrapping in 2022 as financing them becomes more difficult.

The interest rate rise also has an impact on the value of assets within these projects. Cruise ships themselves are falling in value because demand is falling. Another example is that property prices are forecast to fall considerably in the UK in 2023 (potentially by 20%), which can further make it difficult to secure funding. The threat of both negative equity and insolvency is high in 2023.

Bespoke refinancing for large projects

Whilst many large projects, particularly from £10 million upwards, are on hold, many will be turning to alternatives. First and foremost, a change in the capital structure towards more equity and less debt is an obvious one, but this can be done in a variety of ways.

With the newly expensive cost of debt, raising equity does become more attractive even if it means diluting. A more effective way to do this though might be to negotiate with the debt holders to exchange their debt for shares in the company as this directly cuts down debt repayments. Plus, the bonus here is that debt holders usually wouldn’t have agreed to the lending if they didn’t believe in the viability of the project.

Another option to help decrease repayments without changing the capital structure is to focus on getting better repayment terms. Increasing the collateral for more asset-based lending could be one way to decrease your risk profile, and thus interest terms.

If interest is believed to continue rising, then we may see projects locking in longer fixed-rate terms. Though, with inflation supposedly peaked already, it’s more likely to see people switching to a variable rate with the anticipation of interest rates falling towards the end of the year - in part to offset the anticipated recession. 2023 may be a year to refinance debt.

Concluding thoughts

Despite the GDP figures and global growth not being terrible in 2023, the UK braces for the slowest recovery in the G7. With both interest rates and high-risk projects losing favour to value investing - as seen with the FTSE 100 hitting a record high whilst the Nasdaq suffers - project funding is difficult.

Ultimately, project funding and refinancing depend heavily on circumstances. Bootstrapping is usually not an option, which is why bespoke solutions that deviate from relying on cheap debt are highly recommended.

Thomas Kelly Holdings has access to Project Funding with multiple lenders info@thomaskellyholdings.co.uk