Energy Junk Bonds Deemed ‘Silo of Misery’ as Oil Resumes Plunge

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Once again, a slide in oil prices is bringing pain to the junk-bond market.

In just two weeks, speculative-grade energy securities have tumbled more than 3 percent, dragging down the entire U.S. market, according to Bank of America Merrill Lynch index data. Yields on the debt have climbed to an average 9.34 percent, the highest since February and approaching levels that indicate investors view the typical security at high risk of default.

Demand for the debt is evaporating as the latest slump in oil revives concern that high-yield energy companies will struggle to service the record $120 billion they borrowed in the past three years to finance production during the shale boom. Swift Energy Co., an oil and gas explorer, is struggling to find buyers for a $640 million loan, while investors who lapped up second-lien energy bonds earlier this year are now racing to dump them.

“The energy sector of the high-yield market continues to be a silo of misery,” Margie Patel, a money manager for Wells Capital Management in Boston, which manages $351 billion, said in a telephone interview. “If we stay near these levels, marginal high-cost producers won’t be able to survive.”

Crude has dropped to levels last seen in April, falling to $52.33 a barrel from $61.43 on June 10.

Bonds Fall

That’s caused losses for investors who just a few months ago bought bonds from energy companies that flooded the market to head off a squeeze from their lenders. Some of these securities have tumbled in the last 10 days, including debt from Energy XXI Ltd. and SandRidge Energy Inc.

Energy XXI’s $1.45 billion of 11 percent notes due in March 2020 have slumped 7.5 cents to 84.5 cents on the dollar to yield 15.8 percent, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. The notes for the Houston-based oil producer were issued at 96.3 cents in March, according to data compiled by Bloomberg.

SandRidge’s $1.25 billion of 8.75 percent notes maturing in June 2020 plunged 7.4 cents to 87.125 cents, according to Trace. The notes for the Oklahoma City-based oil-and-gas producer were sold at par in May.

‘Long Shot’

“The energy sector isn’t out of the woods by a long shot,” said Greg Hopper, head of global high-yield strategy at Aberdeen Asset Management Plc, which manages about $504 billion. “The market is going through a much-needed correction after coming back too strong. To win here you really have to sharpen your pencils and carefully troll through the weeds.”

Before the recent downturn, energy debt had gained 6 percent this year through June 23, according to Bank of America Merrill Lynch Index data.

Energy issuers such as Halcon Resources Corp., Veneco Inc. and Warren Resources Inc. are already carrying out “distressed exchanges to right size their capital structures,” UBS Group AG strategists Matthew Mish and Stephen Caprio, wrote in a July 7 report.

UBS predicts the global high-yield default rate will climb as high as 4.5 percent by the middle of next year, in part because of stress on energy firms. The default rate for speculative-grade debt in the U.S. rose to 2.1 percent in June, the highest since December 2013, when the measure reached 2.2 percent, according to Standard & Poor’s.

More Expensive

The extra yield investors demand to hold high-yield energy company debt rather than government securities rose to 8.6 percentage points on Tuesday, up from 7.6 percentage points a month ago, Bloomberg data show. That’s approaching the 10 percentage-point limit considered distressed.

Souring sentiment is making it difficult for companies that need cash to raise it. Investors are demanding more than the 10.5 percent Swift Energy is proposing on its five-year loan that will repay a credit line and boost liquidity, according to three people with knowledge of the matter, who asked not to be identified as the information isn’t public. Oil prices have plunged 12 percent since a June 29 deadline for lenders to commit to the financing.

“The market is realizing there is trouble ahead,” Wells Capital’s Patel said. “If energy prices don’t get better it will set up a rough 2016.”