By Rachel Koning Beals at MarketWatch
Energy-sector bond defaults—and for some producers, bankruptcy risks—are piling up, and coal liabilities aren’t the only culprit. Oil-and-gas producers, suffering with low crude prices after a shale revolution made the U.S. a viable energy producer, are smothered under their own junk bonds.
Small- and medium-size U.S.-based producers, especially those that expanded with the shale boom, are most vulnerable; any blip in oil prices may not be high enough or fast enough to protect all producers. And just this week, at least two more warned about their near-term future. It’s a climate that’s driven some of this sector’s high-yield paper to trade at 30 cents on the dollar or less.
Peabody Energy BTU, +11.87% said Wednesday it filed a “going concern” notice with regulators. Peabody has opted to exercise the 30-day grace period with respect to a $21.1 million interest payment due March 16 on its 6.50% notes due in September 2020, as well as a $50 million interest payment due March 16 on its 10% senior secured second lien notes due in March 2022. Costs and lost business to tougher coal regulation were cited.
But Linn Energy LINE, -9.35% —which on Tuesday filed its own “going concern” after missed interest payments now in a grace period—is primarily an oil-and-gas producer with shale interests in western U.S. states. If it files for bankruptcy protection, its $10 billion in debt would make it the largest U.S. oil company to do so since oil prices began their sharp decline in mid-2014.
In all, about 40 oil and gas producers had filed for bankruptcy protection globally since 2014, according to a February report from Deloitte. Crude traded to 12-year lows, below $30 a barrel, in February before their recent rebound toward $40 a barrel. Energy consulting firm Rystad Energy says smaller players typically need a minimum $50-a-barrel oil price to make a profit.
Last week, Fitch raised its 2016 forecast for U.S. high-yield bond defaults to 6% from 4.5%, and said it expects energy and materials issuers to default on $70 billion of debt this year, including $40 billion for energy alone. The new rate of default is the highest that Fitch has ever forecast during a non-recessionary period, beating the 5.1% it forecast for 2000.
Fitch is expecting the energy trailing 12-month default rate to end the year in a 30% to 35% range, while metals and mining are expected to climb to 20%. The coal subsector is expected to surge to 60%.
Eric Rosenthal, senior director of leveraged finance at Fitch, said his firm’s downbeat forecast takes into account the pile of outstanding debt and what’s been an accelerating clip of regulatory warnings from energy issuers. He acknowledges the likelihood that the default pace will only quicken as more interest payment due dates draw near. “We believe we’ve baked in the full risk of all looming defaults,” he said.
Rosenthal expects increased defaults because the energy sector can’t rely on distressed debt exchanges like they did up through late last year—many have already played that card. The main incentive behind such moves then wasn't only debt reduction, but an exchange of senior unsecured debt for smaller amounts of secured debt, which, if successful, lessens the probability of default for issuers.
Now, says Rosenthal, expect “going concern” and other regulatory warnings to be more prevalent.
Some energy price relief could allow firms with higher credit ratings to tap emergency borrowing. But anything other than a fast and furious rebound in oil prices—given a global supply glut, it isn’t likely—won’t be enough for some companies to turn the profit needed to stave off default, said Rosenthal. His outlook also takes into account a 2016 forecast for $35-a-barrel oil CLJ6, +4.11% about where crude trades now, which remains well below the profitable line for smaller exploration and production companies.
And more energy companies are staring down interest due dates on their IOUs. ZeroHedge searched all so-called U.S. 144A oil and gas bonds trading at 30 cents on the dollar or less and that have an interest payment due starting between April and September. It’s a hefty list of 141 companies that are due to pay that interest in what are expected to remain tough oil market conditions. See the list here.
The focus on energy raises some question of contagion for the broader high-yield market. Fitch’s Rosenthal sees little risk of this, noting his firm’s projection for a 1.5% to 2% default rate outside of energy. That’s below Fitch’s non-recessionary year average of 2.5%. “Retail and telecom default risk is on our watch list, but on a issuer-specific basis,” Rosenthal added.
Still, the high-yield market is turning into a tougher environment for capital-hungry companies. Two high-yield bond sales in February, one from The Manitowoc Co.MTW, +0.68% and one from Solera LLC, were only completed after the issuers tightened the covenants significantly, more evidence that the market has reached a turning point.
“This is an early sign that, as the high-yield credit market tightens, emboldened investors can demand and receive better covenant protections from lower-rated issuers,” said Danny Gao, associate analyst at Moody’s.
That’s challenging for energy producers and any lower-rated companies, but it’s giving the bond market the upper hand. For now.