Investors in high-yield riskier bonds of U.S. shale firms have caught up with equity investors in showing impatience over the mounting debt that the shale patch has piled up to fund production growth at the expense of cash flow and profits.
Equity markets are largely ‘closed’ for smaller U.S. energy firms willing to raise funds, so the bond market has become their last chance to finance drilling operations. Investors in bonds, however, have become increasingly frustrated over the ‘growth for growth’s sake’ business model and the lack of cash flow generation.
This year, bond buyers are not flocking to the high-yield energy bond issues of companies rated below investment grade, or ‘junk’, while the rate of bond defaults has increased. Analysts and rating agencies expect the default pain to continue as the stubbornly low oil prices are not enough for many small drillers to clean up their debt-dominated balance sheets and meet all debt maturities.
So far this year, bond issues of high-yield energy firms have been half the amount they had sold at this time last year, while total bond issues by all junk rated companies have grown by 30 percent, data compiled by Bloomberg shows.
In the Bloomberg Barclays high-yield index, the energy bond issuance has been underperforming the other sectors. The energy sector itself represents the single largest portion of the high-yield bond market in the United States.
Persistently low oil prices and high corporate debt at the high-yield energy companies point to more pain and more defaults ahead, analysts say.
Signs have already started to emerge. Earlier this month, Halcon Resources Corporation filed for Chapter 11 bankruptcy proceedings, its second Chapter 11 this decade.
A few days later, Sanchez Energy also filed for reorganization under Chapter 11 following “an extensive review of strategic alternatives to align its capital structure with the continued low commodity price environment.”
In July, Fitch Ratings expected the energy sector to lead U.S. high yield default volume for the third consecutive month after Weatherford’s bankruptcy. The trailing 12 months (TTM) energy default rate stood at 4.1 percent in July, compared to 1.9 percent for the overall market, Fitch said.
The Halcon and Sanchez bankruptcies in August pushed the U.S. high yield energy default rate to 5.7 percent from 4.1 percent, marking the sixth consecutive month of an energy filing, Fitch Ratings said in a report last week.
Fitch sees a 5-percent energy default rate for year-end 2019 and 4 percent for year-end 2020, well above the expected 2-percent overall market rate for both years.
“The year-end 2019 energy rate could climb above seven percent if EP Energy LLC elects to file rather than do an out of court exchange for its nearer-term maturities,” Eric Rosenthal, Senior Director of Leveraged Finance at Fitch Ratings, said in a press release.
Last month, S&P Global Ratings said in a sector overview that the number of junk-rated energy companies going into default has started to increase and could lead to “a second reckoning” for some, as some survivors of the 2015-2016 wave of bankruptcies could be looking at Chapter 11 proceedings again.
Haynes and Boone’s latest Oil Patch Bankruptcy Monitor published last week showed that this year there has been an uptick in the number of bankruptcy filings, with 26 filings as of August 12, of which 20 since the beginning of May. To compare, the number of bankruptcy filings were just 24 for full-year 2017 and only 28 filings in the whole of 2018.
“It is clear that for certain financially troubled producers wounded by the crash in 2015, some stakeholders may have given up hope that resurgent commodity prices will bail everyone out,” Haynes and Boone said, adding:
“For these producers the game clock has run out of time to keep playing “kick the can” with their creditors and other stakeholders.”
By Tsvetana Paraskova for Oilprice.com
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