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Sterling HY and retail: keep your receipt


The US high yield bond market’s vulnerability to the price of oil is a perfect example of how heavy dependence on a single industry can hit a whole market. Now, the sterling bond market faces a similar test from the retail sector.

Data unveiled this week by the Centre for Retail Research will have sent chills up the spine of holders of UK retail industry bonds. Because it is the largest sector of the market, anyone with exposure to sterling high yield will also have felt the shivers.

Some 28 UK retail companies had failed by the end of August this year. That is higher or in line with figures for the entire years of 2015 and 2016, which were 25 and 30 respectively, and more than half 2017’s 44 failures.

In recent weeks, bonds issued by retail credits have taken the top five slots in a list of worst performing sterling high yield bonds. Last week, it was Matalan, Twinkle Pizza and New Look, with negative returns ranging from 0.81%-5.77%, according to CreditSights data.

When oil prices plunged to a 10 year low of $26.50 for a barrel of WTO Crude on January 10, 2016, it slapped the US high yield market hard. US high yield issuers with direct links to the oil industry represent 15% of the borrower base, according to Bank of America Merrill Lynch’s US high yield index, a market of $1.5tr in size.

The sterling high yield market may only be £100bn ($129bn), but retail represents 15.7% of the volume.

An industry with such big grip on a market can shake it and even shock it when things get tough, with long-lasting effects.  

In 2016, average high yield spreads in the US shot up from 300bp to more than 600bp. It took more than 18 months for spreads to tighten to 300bp again, according to data compiled by the asset manager M&G.

During this period, the US high yield market suffered bouts of volatility from different industries, including telecoms and retail, but the weakness of the oil sector exacerbated the damage and turned it into a more inhospitable place.

After oil prices plummeted, US high yield borrowers started to look for a way into the euro high yield market. US issuers printed some €8bn of new bonds in the euro high yield market in the first half 2017. According to Dealogic data, this figure was more than double the €3bn sold in the same period the year before.

The sterling high yield market has yet to show signs of real damage despite the perils the retail industry is facing. Spreads have widened 83bp since January to 460bp, similar to the euro high yield index’s widening 88bp to 367bp.

The average sterling high yield spread for retail credits is above 600bp, the third largest in the index, and retail sector bonds trade at an average cash price of 95.20, the lowest bid price for any of the sectors represented.

Retail is the only sector that has generated distressed events so far this year, according to Credit Suisse data. According to Moody’s, consumer and retail are set to be the main source of high yield defaults in the next 12 months.

If you are going to be buying this sector, make sure you keep the receipt.