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You Brexit, You (Don't) Buy It

June 24, 2016 - It happened. Defying the complacence on the street, yesterday (June 23rd) the UK voted to leave the EU.

The fallout was immediate, harsh – possibly a market overreaction – and predictable. The impact when the markets opened was brutal: As the WSJ published at 4 am ET, 9 am GMT, the FTSE 100 and Stoxx Europe 600 both tumbled over 8%, the S&P futures pointed toward an opening down as much as 5%, the daily limit, Greece was down 13%, Spain and Italy were down 11%. The British pound fell as low as $1.32, a level last seen in 1985. The top five British banks saw their share prices fall by an average of 21%, Reuters reported. S&P said that Britain would likely lose its AAA rating. And, of course, let’s not forget that Britain fell into a constitutional crisis as Prime Minister Cameron pledged to resign after the vote, and Scotland’s first minister said that a second referendum on independence was likely, the FT noted. As the Rolling Stones say, Shattered.

But that may be an over-reaction – for markets, if not for the geopolitical world. By 7:30 ET, the FTSE had recovered to “only” 4.5% down, while the pound rebounded to $1.37. And the WSJ offered the cold comfort that Brexit was no Lehman.

Though credit markets tend to be more subdued, there was volatility closer to home as well. As the LSTA Chart of the Week illustrates, CDS indexes – iTraxx Crossover in Europe, CDX HY in US – had widened several weeks ago as the “Leave” vote gained ground, and then recovered as folks thought (erroneously) that Remain would win. Then, when the “Leave” camp won, iTraxx Crossover widened 130 bps – some 40% - before coming in to the 400 bps context, LCD reported. TR-LPC/IFR wrote that European HY tumbled on Friday morning, but there was no panic selling and the blow was cushioned by some buyers looking for bargains.  On the secondary loan front, LCD added that loans were marked 2-3 points lower across the board at the open, but had recovered to 1-1.5 points down by 11 am GMT/6 am ET.  On this side of the pond, the DJIA dropped 500 points on the open, the LCDX HY fell nearly two points to 101.8 and loan prices started to trend 50 to 100 bps lower, with cyclical sectors seeing larger price variances.

So where do we go now? LCD writes that a raft of potential opportunistic European deals that were lined up to be launched have already been shelved – but also that European bankers are stoic.  They point out that while today’s uncertainty certainly doesn’t help, they will get a full view of the prospects for new issue and investor appetite in the coming weeks, and are hopeful that the European leveraged loan market will remain stable in the longer term.

Law firms and trade associations are, of course, analyzing the situation to determine the impact on the loan market in Europe and the US. From a higher level perspective, Shearman & Sterling published an advisory, “Brexit: What Does the Vote Mean For Business?” while Davis Polk focused on the “Legal Implications of Brexit”.  In the loan space, the LSTA is reprising the crack Allen & Overy team that presented on Brexit in April. Please join us on Tuesday, for a webcast on “Brexiters Win: UK Will Leave EU”, which will cover macro issues like post-Brexit relations and London’s future, but also will drill into implications for the US loan market, lenders to UK borrowers, and financial institutions active in the UK and the EU. (Click here to register, and for a preview, here are the April Brexit webinar slides. Slides 19 & 20 flag high level implications for the UK and US loan markets.)

Meanwhile, the LMA emailed out a missive, noting that while the vote will have a major impact on the financial landscape of UK and Europe,” in the vast majority of cases it does not bring about any immediate legal or contractual change.”   ISDA, in turn, described the vote as a “momentous decision” that “will have significant implications for financial markets” but stressed that the vote to leave “will not have an immediate impact on the legal certainty of existing contracts, nor will it require any immediate contractual change or action from counterparties.”  They also linked to their detailed analysis of the contractual implications of Brexit, available here.

In the CLO space, Citi pointed out this morning that, from a credit perspective, CLOs may not be dramatically impacted. UK borrowers make up just 11% of the typical European CLO portfolio. Nonetheless, the secondary might be choppy. Some investors may feel the need to reduce their risk profile, and with dealer balance sheets likely to be constrained, selling may not be smooth. On the other hand – if not the bright side – risk aversion will likely slow/stop the European CLO flow for a time. While European CLO issuance - at more than €7 billion – had been running almost even with last year’s levels, LCD previously wrote that a Brexit vote would turn off the spigot in the near term – and possibly in the longer term as managers figure out the way forward (and the city in which they go forward). On the flip side, an article in Monday’s Bloomberg Brief Leveraged Capital – well before the vote – wondered where one might ride out Brexit. Skybridge Capital argued that US CLOs and CMBS could be a safe haven. Being more sensitive to the US economy, these assets might be more insulated from Brexit risk. The coming weeks will tell.

Of course, the LSTA will continue to focus on Brexit, holding webcasts and publishing on the issue in the coming weeks.

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