Oil Plunge Sets Stage for Energy Defaults: Credit MarketsSridhar Natarajan
Bond investors, already stung by the biggest losses from U.S. energy company debt in six years, are facing more pain as the plunge in oil leads analysts to predict defaults may more than double.
While bond prices suggest traders see defaults rising to 5 percent to 6 percent, UBS AG said it may actually end up being as high 10 percent if prices of West Texas Intermediate crude approach $50 a barrel and stay there. Debt research firm CreditSights Inc. predicts a jump to 8 percent from 4 percent.
A borrowing binge by energy companies in recent years to finance new sources of oil has pushed a measure of leverage among the lowest-rated firms above its 2009 peak, according to CreditSights. The $203 billion of bonds outstanding have lost 16 percent this quarter and are poised for their worst performance since the end of 2008, Bank of America Merrill Lynch index data show. More than $40 billion of value already has been wiped out, Bloomberg index data show.
“The bid for yield caused a lack of discrimination across credits and sectors and people were buying whatever was available,” UBS AG credit strategist Matthew Mish said in a telephone interview from New York. “When you transform from a low-default regime to high default, the re-pricing of risk can be pretty aggressive.”
Energy-sector bonds have delivered 16 percent losses to investors this quarter and are on track for the worst performance since the three months ended December 2008, Bank of America Merrill Lynch index data show.
The decline in the debt, which makes up 15 percent of the U.S. high-yield bond market, has pushed yields among all junk issues to 7.4 percent, up from a June low of 5.69 percent and the most in more than two years, the data show.
The yield premium investors demand to hold energy company debt rather than government securities has surged to 10.5 percentage points on average, past the 10-point limit considered distressed, according to data compiled by Bloomberg. About $300 billion of securities linked to 512 bonds across all industries trade as distressed, compared with about 150 six months ago.
Distressed bonds tracked by Bloomberg include securities that have traded at a yield of at least 10 percentage points above the benchmark government debt in the last five business days on Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. High-yield bonds are those rated below Baa by Moody’s Investors Service and BBB- at Standard & Poor’s.
The CreditSights forecast of an 8 percent default rate next year equates to about 14 companies, according to the report. That alone could lift the broad speculative-grade default rate in the U.S. to about 3 percent from 1.8 percent, analysts Kai Gilkes and Brian Gibbons wrote.
Market leverage, a function of total liabilities and stock price, for energy companies rated CCC or lower has jumped to 76 percent, compared with a 2009 peak of 66 percent. A level above 60 percent indicates great concern, Gilkes said in a telephone interview.
The data includes real-time insight from the stock market, which takes into account the 39 percent decline in oil to $56 a barrel in this quarter, a factor not captured in the latest corporate cash-flow statistics.
“The market leverage metric is a forward-looking indicator to where actual financial leverage could end up,” Gilkes said. “The equity market is anticipating a deterioration in earnings.”
The analysts flagged Quicksilver Resources Inc. and Connacher Oil & Gas Ltd. among companies with the greatest risk of default. The two explorers combined have more than $3 billion of debt.
Quicksilver’s $298 million of 9.125 percent bonds due in August 2019 have tumbled to 30.5 cents on the dollar from 102 cents in January, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. Its stock has plummeted 90 percent to 31 cents this year.
Other vulnerable companies include American Eagle Energy Corp., Goodrich Petroleum Corp. and Midstates Petroleum Co.
Gas distribution companies such as Access Midstream Partners LP, MarkWest Energy Partners LP and Gibson Energy Inc. have the lowest risk of default over the next year in the sector, according to CreditSights.
With the average trading price of high-yield energy company debt at more than a 15-cent discount to par, some investors are sensing an opportunity.
“We’ve been getting very interested in the debt securities of oil companies,” Wilbur Ross, who runs WL Ross & Co., said in a Bloomberg Television interview. “Many of those issues have been smacked to where they are yielding in the teens. That’s the segment of the market where there’s best value right now.”
Oaktree Capital Group LLC, the world’s biggest distressed-debt investor, is using the declines to purchase energy obligations, according to its co-chairman Howard Marks.
“In some corners we are seeing panic,” Marks said in a Bloomberg Television interview. “When that happens we go from being extremely reticent to being aggressive. When panic takes over, and markets stop being discerning, that’s the time for the bargain hunter to get active.”
West Texas Intermediate oil, the U.S. benchmark, dropped to more than 50 percent below its 2014 peak, falling as low as $53.60 per barrel on Dec. 16. The growth in U.S. oil production, aided by producers tapping the debt market to finance capital expenditures, has pushed domestic output to more than 9 million barrels a day for the first time in at least 30 years.
Lower oil prices pose a threat to profitability of these companies as they contend with the expensive cost of new drilling technologies that paved the way for burgeoning supply. Many U.S. producers bought derivatives that protect them against declining prices, shielding them for some time.
“These companies are battening down the hatches to protect their balance sheets and are going to be cutting capex to get through this downturn,” Gibbons of CreditSights said. “But some of them will still not be able to make it.”