Phones 4u Fallout Blindsides Junk Corporate Borrowers

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Fallout from the collapse of Phones 4u Ltd. has shaken investor confidence in the sterling high-yield debt market with bondholders in the U.K. retailer facing losses of as much as 275 million pounds ($450 million).

The average yield investors demanded to hold junk bonds in pounds climbed to 5.8 percent yesterday, approaching the record 6.1 percent in September last year, according to Bank of America Merrill Lynch index data. Phones 4u’s payment-in-kind and senior secured notes are the worst performing securities, the data show.

“Investors and market-makers who lost money on Phones 4u have less appetite for risk,” said Thomas Samson, a London-based money manager at Muzinich & Co., which oversees about $27 billion. “What happened to Phones 4u is specific to the company but it shows these things can happen.”

Investors were willing to accept the lowest rewards on record to hold junk bonds in pounds until May when Bank of England policy makers started focusing on the need for higher benchmark rates as U.K. economic growth accelerated. The jolt from the sudden collapse of Phones 4u acted as a further reminder of the dangers of holding speculative-grade debt.

The retailer shut its business and sought creditor protection on Sept. 15 after failing to renew contracts due in 2015 with mobile carriers Vodafone Group Plc and EE Ltd. It was almost a year to the day that the group sold 205 million pounds of payment-in-kind notes to help pay private-equity owner BC Partners Holdings Ltd. a 220 million-pound dividend, according to data compiled by Bloomberg.

PIK Collapse

The price of the PIK notes, issued by parent company Phosphorus Holdco Plc, collapsed to 1.625 pence on the pound today from 85 pence at the end of August, according to data compiled by Bloomberg. PIK notes allow borrowers to pay interest with more debt.

“This story once again highlights the need for investors to undertake intense due diligence in the high-yield sector, particularly when considering PIK notes,” Felipe Villarroel, a money manager at TwentyFour Asset Management LLP, wrote on the company’s website yesterday.

Investors in sterling high-yield bonds forfeited 1.4 percent this month, the biggest monthly loss this year, Bank of America Merrill Lynch’s data shows. They’re still making money this year with returns of 5.1 percent compared with 5.45 percent for junk bonds in euros.

Retailer Pain

The pain has mostly been felt by holders of junk bonds sold by retailers. Frozen food group Iceland Food Group Ltd.’s 400 million pounds of 6.25 percent notes dropped to a low of 91.4 pence on the pound Sept. 23 from 95.8 pence. The notes, rated B1 by Moody’s Investors Service, were issued at par by the Deeside, Wales-based company on July 10.

Clothing retailer Matalan Group Ltd.’s 8.875 percent notes were quoted at 94 pence today after they were issued at par in May, Bloomberg data show. The notes from the Skelmersdale, England-based company, are rated B2 by Moody’s and now yield 10.3 percent.

“Retail performance has been weak recently compared to other sectors,” said Jon Brager, a senior credit analyst at Hermes Fund Managers in London. “There’s going to be a persistent premium in sterling over what borrowers can get in euros.”

Virgin Media

Not all U.K. companies are having to pay up to borrow. Telecommunication provider Virgin Media Inc. sold 300 million pounds of notes due in 2024 this week paying 6.375 percent, according to data compiled by Bloomberg. The Hook, England-based company, rated B2 by Moody’s, issued 250 million euros ($329 million) of 2023 notes paying 7 percent in July 2013.

The environment for low interest rates in the U.K. may not last much longer because Bank of England policy makers were divided this month when they agreed to keep the key rate at a record low of 0.5 percent. By contrast, the European Central Bank cut benchmark borrowing costs to a record 0.05 percent.

“The retail sector hasn’t performed well recently and a constant stream of bad news has made people wary of sterling credits,” said Ky Van Tang, a senior credit analyst at Canaccord Financial Inc. in London.

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