Oil Assets Burning Cash Mean Risks Spread in Norway Junk Bonds

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Norway’s junk bonds face rising defaults and further declines as the plunge in crude squeezes the oil-service companies that have dominated issuance in the market, according to the country’s biggest bank.

DNB ASA has cut its outlook for the oil-related high-yield market to “negative” from “neutral” and the non-oil segment to “neutral” from “positive.”

“In rig and offshore supply there is a substantial risk for bond defaults going forward,” said Magnus Vie Sundal, a DNB credit analyst, by phone last week. “It’s hard to get new contracts and at the same time you have assets burning cash.”

Scandinavia’s biggest junk bond market has all but ground to halt this year as a plunge in oil prices has caused oil explorers to reduce investments, shutting down contracts for drillers and other service companies. Norway is facing the biggest decline in offshore investments since 2000. More than 22,000 job cuts have already been announced in the country, where the offshore industry accounts for about a fifth of gross domestic product, according to DNB.

Oil Squeeze

“The oil service companies will be squeezed by the oil companies,” Ottar Ertzeid, head of DNB Markets, said in an interview on Friday. “That will contribute to more consolidation over the next year.”

As contracts expire for oil-service companies they will be the first ones to run out of cash in the downturn. At the end of May, the annualized volume-based default rate for oil and offshore, including restructuring and maturity extensions, was about 15 percent, according to DNB.

“The fundamental supply/demand problems in the industry remain unchanged,” Vie Sundal said. “Many oil service companies will have to restructure their balance sheets, potentially raise equity, convert debt, extend maturities.”

Even so, as oil prices stabilized around $60 a barrel in the first half of the year, the market has recovered. The DNB High Yield Norway Total Return Hedged Index is up 6.5 percent from a low in February.

The recovery comes amid a dearth of new issues for oil service companies. Still, there is room for some. BW Offshore Ltd. issued a 900 million-krone five-year floating rate note in June, at a 425 basis points above the Norwegian interbank offered rate. In 2014, investors demanded 350 basis points above Nibor to buy a similar issue from BW.

Balance Sheet

“BW Offshore has long contracts and a strong balance sheet, which make it very suitable for bond financing,” said Roar Tveit, portfolio manager at Holberg Fondsforvaltning AS.

Tveit, who didn’t buy any of the BW bonds, said that yield spreads in the primary market offer little incentive since only the best companies can issue new debt. There’s better value in the secondary market, he said.

A total of 35.6 billion kroner has been issued in Norway this year, compared to 67.7 billion kroner for the same period in 2014 and 104.3 billion for all of last year, according to Nordea Bank AB. The high-yield segment accounted for 55 percent of corporate issuance so far, down from 62 percent in 2014.

“The high-yield market is more like the equity market, risk on, risk off,” said Ertzeid. “So volatility is negative for the high yield market and we saw that the last part of the second quarter with risk off in the high yield market.”

The concern is now that the general global turmoil will also shut the non-oil related market.

“In non-oil there is potential for credit spreads tightening but volatility in international markets, a potential Fed rate hike and spillover from oil service pull against” such a move, said Vie Sundal.