March has undoubtedly been a “mensis horribilis” for the UK retail sector.
Moss Bros posted an 8% fall in sales in the period since December. Its chief executive officer echoed many of his peers at other companies, citing an increasingly competitive environment, cost pressures and a cautious UK consumer. In a similar vein, children’s clothing and toy retailer Mothercare, which is in the midst of a store closure programme, noted “profound pressures on the retail sector”.
Next’s CEO, Simon Wolfson, described the environment on Britain’s high streets as “the most challenging in a quarter of a century”. This is saying something, particularly when one reflects on some of the problems the UK economy has weathered over the last 25 years, and also given that Simon Wolfson’s team ranks among the most sure-footed in the sector over that period.
However, perhaps one of the most interesting statements emanated from Carpetright. It, too, issued comments confirming the ubiquitous gloom surrounding the retail sector. However, it also provided details of a shareholder loan – one which showed very clearly how the price of money can escalate if other sources of finance are no longer open.
The troubled flooring and bed seller, short of working capital, approached one of its larger shareholders to tide it over until longer-term sources of (probably equity) funding become available. Meditor agreed to lend Carpetright £12.5m to assist with working capital requirements, with a short-term loan repayable at the end of August. For this, Meditor will charge an interest rate of 3% per annum – but with an arrangement fee of £1.9m, the bulk of which will be in the form of new equity in the company, representing almost 5% of Carpetright’s share capital. In effect, this is five-month money at a price in excess of 17%.
[If] Carpetright struggles to raise further finance, an eye-watering 17% may indeed be the correct rate.
This is an unsecured loan. If the bricks-and-mortar retail sector continues on its downward trajectory, and Carpetright struggles to raise further finance, an eye-watering 17% may indeed be the correct rate. In the event that Carpetright fails, the secured creditors will be at the front of the queue – and I suspect that there may not be much left on the table for those queueing near the back. Meditor is therefore undoubtedly taking a risk – but is being paid well to do so. We’ll see soon enough whether it is being paid enough.
From a broader perspective, cheap money continues to wash round the system, and junk credits can borrow as cheaply and with poorer covenants than they have ever done. The European High Yield market as a whole yields roughly 3% - low from a historical perspective, but nonetheless a fair premium to the meagre returns available from government bond markets. “Covenant-lite” loans, where bondholder protections are withdrawn, have been popular for some time in North America. Now, they are increasingly common in Europe. In an environment of synchronised economic growth, this is perhaps nothing to worry about. However, if that growth should falter, the lack of bondholder protection could well give cause for concern.
But regardless of the economic outlook, or the wisdom (or otherwise) of covenant-lite lending, Carpetright’s capital-raising exercise serves provides a useful illustration. It shows us how high the price of money can climb, in the event that the bank manager is unavailable and the bond markets are shut. For distressed corporate borrowers, it is not a pretty picture.