Brexit Adds to U.K. Credit Market Stress as Oxbridge Bonds Soar

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Growing Brexit risks are magnifying stresses for U.K. credit investors -- hurting bank bonds, sending investors scurrying for safety and slamming the door on new debt sales.

Brexit’s been a headwind through the year but in recent weeks it’s been joined by a sudden repricing of credit across Europe and the U.S., triggered by tighter monetary conditions. Borrowing costs have soared and there’s been a wave of sell-offs of riskier company debt.

Some of these bond-price drops have been endured by U.K. companies. Debt securities of Thomas Cook Group Plc and PizzaExpress Ltd. are among those trading at record lows.

Brexit headlines this week are a reminder the outlook for the U.K. is difficult to forecast, particularly in the political arena. Here are some of the main issues being monitored by investors in the U.K. credit market:

No Deals

There hasn’t been a sterling bond sale in the corporate market since TSB Bank canceled a covered bond on Nov. 15. Three U.K.-focused leveraged-finance transactions were canceled in the past couple of weeks.

Given the high level of uncertainty in sterling bonds, “portfolio managers are reluctant to participate in the primary market,” said Nicolas Trindade, a portfolio manager at Axa Investment Managers U.K. Ltd. in London. “In order to come to the market now, a corporate will have to offer a high premium, so some treasurers would prefer to wait.”

Larger borrowers are likely to be able to ride out a prolonged sterling market shutdown because they have already locked in funding or can shift to another currency. However, smaller or higher-risk companies more reliant on the U.K. may be less flexible or unable to find investors.

Even some large companies may encounter difficulties. S&P Global Ratings cited the risk of a ‘no deal’ Brexit hurting Jaguar Land Rover when it downgraded parent Tata Motors Ltd. this month. The luxury-car unit has a $700 million bond maturing in the next few days.

Politics

Brexit is a big event risk for the market, but it’s not the only one. Today’s no confidence vote in Theresa May reminds us of the parlous state of the government, which has survived without a parliamentary majority since June 2017.

Sterling credit will start the year with a large Brexit premium and so any kind of exit deal would likely reduce that, Mark Holman, chief executive of TwentyFour Asset Management, wrote this week. This might mean sterling outperforming other major credit markets, though Holman said the asset manager is wary of risk surrounding opposition party leader Jeremy Corbyn grabbing power. Should there be a general election, and should Labour win, “we will face a set of circumstances here in the U.K. that our financial markets are quite likely to panic about.”

Long Bonds

Sterling investors have been fleeing short-dated riskier debt and shifting into longer-maturity, low-risk debt. That’s boosted 30-year U.K. government bonds and other multi-decade securities. Cambridge University’s 300 million-pound ($376 million) 50-year CPI-linked bond has gained nearly 12 percent this month. Oxford University’s 750 million-pound 100-year bond has rebounded during December to claw back about half of this year’s losses.

TwentyFour AM’s Holman wonders if the flight to long-dated gilts could reverse if Corbyn’s Labour take power. However, his base case is for gilt yields to only creep higher.

Dollar Hedging

Hedging costs for companies reliant on dollar funding are rising. U.K. investors seeking to buy dollar assets have seen the cost of hedging their exposure about double over the course of 2018. The chart below shows the cost to a pound-based investor of hedging dollar assets back into sterling on a rolling three-month basis.

Bank CoCos

Bank bonds have been at the sharp end of this year’s sell-off in U.K. credit. Additional Tier 1 notes -- the riskiest form of bank debt -- have seen the biggest moves.

The value of AT1s issued by Barclays Plc and Lloyds Banking Group Plc dropped sharply last month, not helped by the Bank of England identifying the two lenders as potentially having to convert some AT1s into shares to boost capital under a stress test scenario. Still, all seven U.K. lenders assessed in the test passed, and the Bank of England said it was reassured the sector had sufficient liquidity.

Leveraged Consumers

Credit investors are getting nervous about the borrowing habits of the U.K. consumer amid concerns about job losses, higher inflation or even recession in the event of no-deal Brexit. The cost of insuring debt issued by retail bellwether Marks & Spencer Plc has surged more than 40 percent since June. Other investments related to consumers may also get squeezed, such as asset-backed securities tied to credit-card debt or consumer loans.

Regulatory Risks

The U.K. leaving the European Union without a deal could harm bonds that have benefited from Europe-wide regulatory alignment. U.K. covered bonds, for instance, could suffer if European banks can no longer use them in some liquidity coverage ratio calculations. European investors will also want reassurance of their ability to collect coupons or trade bonds listed in London once the U.K. leaves the Single Market.

However, there’s always the chance of a bounceback if there’s greater clarity over Brexit. Analysts at ABN Amro Group NV wrote on Monday that covered bonds rallied in the aftermath of the June 2016 Brexit vote, and could do so again.

--With assistance from Andrew Burke and John Glover.

To contact the reporters on this story: Hannah Benjamin in London at hbenjamin1@bloomberg.net;Tasos Vossos in London at tvossos@bloomberg.net

To contact the editors responsible for this story: Tom Freke at tfreke@bloomberg.net, Neil Denslow

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