'Brexit' risk raises the cost of sterling credit

By Laura Benitez

LONDON, Feb 25 (IFR) - The risk of 'Brexit' has increasedthe cost of sterling funding for UK corporates by 50bp,according to JP Morgan, delivering a further setback to a sectorstruggling to compete with the more cost-effective euro market.

Sterling investment-grade credit spreads - around 275bp -are pricing in a 52% probability of Brexit, according to a JPMorgan model. Things could get a lot worse with the US bankpredicting spreads will rocket to 325bp - 2009 crisis levels -if the UK decides to leave the European Union.

With the referendum due on June 23, analysts say UKcorporates have put their spending plans on hold. Sterlingcredit issuance is expected to be limited over the next fewmonths and just two UK corporates have tapped the European bondmarket this year. Only one, EasyJet, has contemplated issuing inits home currency.

The airline met investors in January with a euro or sterlingdeal in mind, according to its mandate announcement, buteventually issued in the single currency only.

Vodofone went straight for euros for a jumbo 6bn deal thisweek following last year's pulled dollar transaction wheninvestors demanded stronger covenants.

Those seeking funds can do so more cheaply in euros, wherenegative deposit rates are keeping yields around 100-150bp loweracross the curve. Even adjusting for the rates differential,issuance in euros is around 40bp cheaper when swapped back intosterling.

JP Morgan's estimates are based on a model comparing assetswap spreads on the iBoxx sterling benchmark index with severalmacro variables, including UK GDP growth and global equityvolatility.

STERLING ILLIQUID

However, Nicolas Trindade, senior credit portfolio managerat AXA Investment Managers, said that spreads across the euro,US dollar and sterling market have all widened since the startof the year due to general volatility.

Sterling, he said, has taken the biggest hit partly due toilliquidity, and not solely on 'Brexit' worries.

"The challenging liquidity of the sterling market will makeany moves more exaggerated, so Brexit concerns may look moredrastic than they actually are."

UK corporates with short-term funding plans will continue tofavour euro-denominated bond issuance, market participants say.

"Looking at volumes so far this year ['Brexit' concerns]shouldn't disrupt funding too much. If UK companies need to theycan issue in euros. It's not a huge change from what's happeningalready," said Trindade.

(Reporting By Laura Benitez; editing by Alex Chambers, IanEdmondson)