British companies are issuing bonds again after the shock triggered by the “mini” budget, but deals are sparse and investors are demanding high yields – a worrying sign for the country’s more indebted borrowers.
Northumbrian Water broke a six-week lull in UK corporate bond markets at the end of October. But even this stable, reliable power company had to pay a yield of 6.585 per cent on its 12-year £400m bond – well above the 2.375 per cent rate the North East utility paid on 10-year debt in 2017. A later deal, for Northern Ireland Electricity Networks, came with a similar scale and return.
An Ice Data Services index of UK corporate bonds outside the financial sector fell 14 percent in the third quarter, compared with 3 percent for a gauge of euro-denominated bonds. While demand remains high for strong corporate debt at the right price, investors say sterling debt markets are likely to remain unwelcoming to riskier borrowers.
“It would take someone braver than me to go out and buy a low-rated clothing company or whatever it might be,” said Ben Lord, a portfolio manager at M&G who bought Northumbrian Water’s bond.
The amount of corporate bonds issued in the UK fell by more than 50 percent in the third quarter, compared with 2021, with former prime minister Liz Truss’s disastrous “mini” budget and a darkening economic outlook contributing to the decline in the sterling corporate bond market. Issues in euro-denominated markets fared better, falling 20 percent in the third quarter, according to Refinitiv data.
Over the past two weeks, UK government and corporate bond yields have fallen back. A new prime minister and chancellor have already torn up the previous fiscal plans and are preparing to announce a new party.
“The messages coming out of the government are positive for bondholders,” said Paola Binns, chief investment officer at Royal London Asset Management. “But it takes a while for things to return to reality.”
Much will depend on how deep spending cuts are under new Prime Minister Rishi Sunak. “If the result of austerity is a longer recession in the UK, as a credit investor you want quality debt, not high yield debt,” said Barnaby Martin, credit strategist at Bank of America.
Many of the highest-yielding bonds in sterling come from retail and leisure companies, such as discounter Iceland Foods and restaurant chain Stonegate Pubs, whose 300 bars include the Slug and Lettuce chain.
These companies borrowed heavily when interest rates were low and have no impending repayment dates. But analysts warn that costs could remain high well into 2023 and 2024 when these riskier borrowers will return to the markets.
Iceland Foods issued a £550 million bond in 2017 with a coupon of 4.625 percent. The bond matures in 2025 and yields almost 16 percent, one of the highest yields in the market, in a sign that its bonds are not loved by investors.
Refinancing at this rate would weigh on profit margins just as the UK enters an economic slowdown.
Like many companies, Iceland is feeling the effects of inflation, while competition keeps margins thin. Running freezers is also expensive given high gas prices.
Iceland did not respond to requests for comment on its bonds but a spokesman said it was trading “exceptionally well and liquidity remains strong”.
Research firm CreditSights expects Iceland’s earnings to fall in the year to March 2023 and net leverage to increase from five to seven times. Companies normally refinance debts at least one year before they become due.
“[March] is less than two years from the refinancing. I think that’s then the real downside in the bonds that we’ve seen so far [comes in]said Amarveer Singh, analyst at CreditSights.
Paying more to service debt would prompt businesses to cut back on spending further, while the Bank of England has predicted a prolonged recession that would weigh on consumer-focused names. Other policy decisions, such as reducing energy bill support, are also likely to weigh on customer spending, adding further concern to borrowers such as Iceland.
“Fiscal restraint is what the markets want to hear but . . . austerity has a negative impact on growth,” Martin said.
For some, business credit in sterling is no longer attractive. It’s a relatively small and lumpy market, and some fund managers have let their stakes dwindle and are looking for better returns elsewhere.
Several investors said they could find better returns in other sectors, such as emerging market debt. Sabrina Jacobs, a portfolio manager at Pictet Asset Management said it was “a disservice to actual EM economies” to compare the UK to an emerging market, saying “in some respects less developed countries are proving to be a relative haven of stability – not least in corporate bond market”.
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