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Brexit risks take their toll on Britain's high-yield bond market

[LONDON] UK companies with speculative-grade ratings are increasingly shunning sterling bonds for their financing needs as investor unease over the outcome of Brexit makes for a more challenging marketplace.

"Headline risks around Brexit have driven pricing higher and in a market where liquidity is thinner, it can be a risk to issue sterling," said Steven Logan, who manages US$1.4 billion of bonds as the global head of high yield at Aberdeen Asset Management. "The sterling deals that came earlier in the year had to face higher pricing and a tougher investor base."

Bond sales in the sector have dropped by almost 60 per cent so far this year to £5.04 billion (S$9.01 billion), according to data compiled by Bloomberg. In a further sign of a shrinking market, the Bloomberg Barclays Index for sterling high-yield bonds has lost 18 per cent of its market value since the end of January.

Faced with potentially higher borrowing costs from sterling bonds, UK borrowers such as Jaguar Land Rover Automotive are instead opting to issue notes in euros while other funding routes such as the leverage loan market are seeing healthy levels of supply.

Tough Crowd

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An example of how challenging it can be for issuers is Leicester-based watchmaker and jewelry retailer Aurum Holdings which was forced to pay higher yields and strengthen creditor protection when it sold a £265 million bond in April.

"There's more room to push back on documentation and pricing, and this can create a real opportunity for investors," said Stefan Isaacs, deputy head of retail fixed income at M&G Investments, who manages £2.7 billion of assets. "But undoubtedly it's been a tougher market for borrowers with natural sterling needs."

To minimise such execution risks, some have opted to steer clear of the sterling bond market altogether. UK luxury automaker Jaguar Land Rover has avoided issuing debt denominated in pounds over the past two years and instead raised funds in euros due to investor diversification needs, according to a company spokeswoman.

The manufacturer of the Jaguar XJ and I-Pace models swapped proceeds from a 500 million euro (S$794.2 million)bond sale in September into pounds, the spokeswoman said. The shift in currency was not enough to ensure a smooth ride however and the company was forced to cut the size of the transaction after it failed to attract sufficient demand at the price it wanted.

On the same day that Jaguar Land Rover was said to have announced the bond sale, chief executive officer Ralf Speth told a conference in Birmingham that a bad Brexit deal could put tens of thousands of jobs at risk.

Investor Caution

"Since Brexit was announced high-yield spreads have widened to an 18 month high," said George Curtis, an analyst at TwentyFour Asset Management, which manages just over £13.9 billion of assets. "We want to safely extract the Brexit premium so where we have our sterling exposure is a very conscious decision."

Tougher market conditions for bonds are helping fuel supply in other asset classes, and high-yield syndicate officials have said that a number of sterling bond issuers have got deals away in the loan market of the same currency over the past year. In 2016 Jackpotjoy Plc (Intertain), for example, canceled a planned £200 million senior secured bond issue in favor of a sterling term loan package, according to a report by Moody's Investors Service.

Sterling issuance this year has been buoyant in the leveraged loan market because it can offer better terms and a more diversified buyer base, according to Aberdeen's Logan, whose high-yield fund holds around 15 per cent of sterling assets, much of which is short-dated defensive paper.

Institutional loans worth £6.9 billion have launched to date, closing in on the £7.2 billion full-year total for 2017, Bloomberg data show.

M&G's Isaacs said he has been reducing exposure to sterling assets in the last three to five years due to the growing need for portfolio diversification, and added that the amount of sterling-only bonds funds are dwindling.

Total returns in the sterling junk bond market so far this year stand at 1.96 per cent versus 0.07 per cent in euro high-yield, according to Bloomberg Barclays Index data.

That continues to provide an opportunity for some.

"We have technically slightly increased sterling exposure since the referendum, but this has primarily come from short dated financials in specific names that we know very well," TwentyFour's Curtis said. "On names where the premium is apparent but the Brexit risk is limited."


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