Grant Thornton, together with economics consultancy Retail Economics, have produced The Cut Back Economy – a detailed look at the impact of the UK cost-of-living crisis on the retail and consumer industries.
The report shows that UK retail and consumer industries are at risk of losing out on £24.9 billion of spending this financial year as nine in 10 UK consumers will be forced to reduce their spending to help cover essentials.
This has huge ramifications for speciality small and medium-sized enterprises (SME) lenders who finance small businesses in the UK retail, leisure and consumer space. In turn, it also has significant implications for larger banks, private equity (PE) firms and debt funds who finance these speciality SME lenders.
Small and medium-sized enterprises face pressure on multiple fronts. Cash reserves are being eroded by sharply rising input costs, including wage inflation and increasing supply chain costs – SMEs will be bearing the brunt of significant pressure being applied further up the supply chain. Having weathered the pandemic, SMEs now have higher debt service costs as they make repayments on government-backed loans issued during the pandemic.
There are also growing concerns that a combination of tighter monetary policy and fallout from geopolitical tensions could tip the UK into recession. Many economists expect the economy to slow rapidly in the upcoming quarters. The OECD has cut its UK growth forecast for 2023 to zero – the lowest in the G20, except Russia.
Against this backdrop, speciality SME lenders – together with the banks, PE firms and debt funds that finance them – must consider the effect of consumer cutbacks on SMEs. Will SMEs ability to service their debt be affected? Will there be an increase in defaults? Anecdotally, we're seeing an uptick in defaults from the SME sector. Speciality SME lenders need to aware of this, and their own financiers need to understand the knock-on effect in their own portfolio.
The Financial Conduct Authority (FCA) has recently expressed disappointment as to how SMEs are being treated by lenders, citing repeated instances of poor customer outcomes. On 12 July, the regulator wrote to lenders with SME customers saying they must treat small business customers fairly when collecting and recovery debts.
Will there be more requests for forbearance, and what effect will this have on the liquidity and capital position of the speciality SME lenders?
Almost nine in 10 (86%) of consumers plan to cut back their spending over the next 12 months due to the rising cost of living. The average household is set to cut back £887 of their discretionary spending through to April 2023. The least affluent are projected to cut back close to 10% of their annual household spending, compared with 8.1% for the average household. Even the most affluent – the top 20% wealthiest households – are expected to cut back 7.6% of their spending, equating to a £2,654 reduction in absolute terms per year.
Collectively, the overall impact of the cost-of-living crisis is set to wipe out a potential £24.9 billion of discretionary spending across retail, leisure and consumer industries in the 12 months to April 2023. Speciality SME lenders should take time to understand these trends, and what the consequences will be for their portfolio. Equally, lenders to the speciality lenders themselves need to be mindful of these risks.
Our research highlights behaviours which consumers are adopting in order to seek value for money: substitution, scaling back and shopping around.
Substitution is the most common strategy adopted by consumers, with around one in two consumers actively switching to cheaper brands, retailers or service operators to combat cost pressures.
In response to the cost-of-living crisis, 43% of consumers plan to go shopping less frequently. This has obvious implications for footfall. Retailers and leisure operators will need to provide stronger incentives for consumers to visit their stores or pay for their services.
Two in five shoppers (39%) intend to do more research, compare prices and shop around for deals before committing to a purchase in the inflationary environment.
Speciality SME lenders should review their portfolio companies to understand how vulnerable they are to reduced consumer spending in 2022 and 2023. Financiers to the SME lenders should also understand what the knock-on effect will be should there be an increase in forbearance requests or defaults.
The recent intervention from the FCA also highlights the combined operational and regulatory challenges SME lenders will face when attempting to manage financial distress in their borrower base. They'll need to manage the desire and need to be proactive in managing their customers while also being mindful of the customer journey and ensuring they are treating those customers fairly.
It remains to be seen how this forecast change in customer behaviour will impact lenders to the SME sector. We're already starting to see signs of stress among SMEs, however, and those levels of stress are likely to increase.
SME lenders will, in those circumstances, be updating their own probability of default (PD) assumptions. This will ultimately feed through to provisioning levels and that could impair their own balance sheets. Liquidity for such lenders may become a lot tighter and the combined impact may be greater stress or distress for those lenders – which in turn will provide challenges to their owners and lenders.