Junk Fervor Cools as Oil Rout Upends Energy Debt
We have discussed previously the vast expansion of high-yield (“junk”) debt, and the less transparent world of corporate leveraged loans. When high-yield spreads at record lows and the size of issuance of "covenant light” leveraged loan, not to mention overall issuance, this market becomes susceptible to market price shocks in commodities. This is occurring in the oil market thanks to a price decline that appears to have room to run…down.
“Prior to the start of oil’s slump, energy producers were the most prolific of junk issuers with about $50 billion of bond sales through October. Their share of the market has climbed to 13.8 percent, the most of any group, from 10.8 percent in 2008.”
The severe oil price decline impacts the credit markets both directly and indirectly. As the oil price declines, energy companies become less profitable, which impacts investor appetite. Some analysts are predicting that corporate earnings in the energy sector could decline as much as 15% in Q4 2014.
Investors, particularly retail, withdraw money from high yield mutual funds, and the mutual funds must sell the underlying bonds in order to provide cash for the investor. This causes a further decline in value and thereby an increase in junk bond yields. Yields are up from 5.7% to over 6.7% this year.
Rising rates then mean that the energy companies, now less profitable, will have to borrow at higher rates. The higher yields also cause companies to issue less bond debt or take a step down into the leveraged loan marketplace.
"New Atlas, a newly formed unit of oil and gas producer Atlas Energy Group, put on hold a $155 million loan it was seeking to refinance debt. EnTrans delayed a debt sale this week. More than half of Cleveland, Tennessee-based EnTrans’s revenue comes from equipment sales to the fracking industry.... Only one energy-related company has sold dollar-denominated junk bonds since Nov. 13, data compiled by Bloomberg show. MarkWest Energy Partners LP sold $500 million of 10-year, 4.875 percent notes Nov. 18.”
Expectations are that the default rate on energy-related junk debt could be double the default rate of all junk debt. And that presumes that the oil price does not fall further. With little hope of significant increases in global economic growth, we are unsure what could trigger a reversal in oil prices. And the struggle of the energy industry will affect other, non-energy industries that do business with them. Transportation in particular; low fuel prices mean little if there isn’t anything to transport.
