The UK has entered a recession in all but name. The debate between economists now is about how long it will last, and how severe it will be. Of all the red lights flashing in the cockpit of the British economy, one is more persistent than most: the market for sterling-denominated corporate credit. If investors stop buying British companies’ debt, another credit crunch could prolong the pain.
High-yield debt, also known as “junk bonds”, is a particular area of concern. The term “junk bond” is unfair: it refers to bonds issued by borrowers whose credit ratings indicate they are “vulnerable to non-payment”, but that vulnerability is relative. In the US those borrowers include massive corporations such as Twitter and Tesla; in the UK they include retailers such as M&S, Asda and Iceland, and hospitality groups such as Pizza Express and Stonegate, the owners of Slug & Lettuce. These companies aren’t rated as highly as, say, a bank or a government, which are known as “investment grade” borrowers, but they probably won’t default on their loans any time soon. Because of the time periods of the borrowing – up to 100 years – agencies are ultra-cautious when determining their ratings.
Issuance of sterling-denominated junk bonds – borrowing in pounds, rather than euros or dollars – has plummeted in recent months, falling more than 50 per cent during the third quarter of the year, according to Refinitiv data reported by the Financial Times. The companies that are managing to borrow are paying dearly to do so: two weeks ago Northumbrian Water broke a six-week silence on the sterling-denominated high-yield market by borrowing £400m over a 12-year period; the yield on the bond – the interest the company will pay to the investor – was 6.585 per cent, well above the 2.375 per cent it paid for similar borrowing in 2017.
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Unsurprisingly, British companies are pessimistic about their ability to raise the funds they need to invest and expand. A recent survey by Deloitte indicated that 56 per cent of chief financial officers feel credit is now “costly”, the highest proportion in the regular survey since the aftermath of the financial crisis, in 2010.
Companies tend to use bonds to pay for planned investments, rather than for the day-to-day running of the business. Or, as in the case of Elon Musk and Twitter, they may use them to buy a company (known as a leveraged buyout, or LBO). In recent years, borrowing was cheap, investors looked for higher returns and companies had lots of buyers for their debt. When lending becomes riskier, investors tend to look to safer havens, such as government or investment-grade bonds, which inevitably means high-yield borrowers are left out in the cold. Less credit for those companies means less liquidity; less liquidity means less investment and, ultimately, fewer jobs. So it’s vital, if the government is as focused on growth as it purports to be, that these companies are able to borrow.
Some aspects of this phenomenon are global and are being felt across borrowing markets, caused by rising interest rates and central banks’ plans to stop their quantitative easing: according to the Refinitiv data, euro-denominated issuance of bonds also fell in the third quarter, although by a less dramatic 20 per cent, while a Bloomberg index of sterling-denominated investment-grade debt fell 9.6 per cent in September, the most since the index began.
Meanwhile, reports are circulating that the banks involved in Musk’s $44bn purchase of Twitter – the biggest leveraged buyout in history – have had such a hard time selling off the debt that they have decided just to keep it on their books until investors show more interest in it. That isn’t unprecedented – a similar thing happened when a group of private equity firms staged a $16.5bn leveraged buyout of the HR software maker Citrix in January – but it is highly unusual, particularly for a deal of that scale.
Analysts suggest that sterling borrowers may simply be pausing to reconsider their options while they wait to hear what the government’s plans will be. They are “holding off on any new projects until it becomes clearer how the new government is going to resolve the UK’s fiscal problems”, says the economist Tony Yates. There’s also a risk that, with investors looking for safer havens, not only will UK borrowers be buffeted by the same winds – namely, the end of cheap debt – as their rivals abroad, but if the new government fails to get the fiscal message right in its Autumn Statement this month, the continuing aftershocks of the mini-Budget could serve to make the UK’s recession even more unpleasant than feared.