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The Defaults Are Coming In HY Energy, UBS Warns
As we’ve discussed on quite a few occasions, voracious appetite for HY issuance (which hit $90 billion in Q1) coupled with artificially low borrowing costs has allowed otherwise insolvent oil producers to keep drilling in the face of the global commodities downturn contributing not only to depressed oil prices, but also to an increase in the amount of risk that’s embedded in US HY credit markets. Consider the following graphics which tell the story quite nicely:
Despite the obvious risks that go along with throwing money at highly leveraged shale companies ahead of Q1 results which will invariably include huge writedowns as E&Ps are forced to calculate PV-10 based on prices that bear a stronger resemblance to market prices than they did at the end of last quarter, “investors” have continued to chase double-digit yields seemingly undeterred by the fact that even in a world where credit markets have been stripped by central banks of their ability to price risk, an 11% coupon still spells trouble. For their part, UBS sees a “correction” just around the corner. Here’s more:
We have maintained an underweight on the US high yield (HY) energy sector (ex-gas pipelines) since the fall of last year. In recent months, that view has been the wrong one. Why are we sticking with our view? First, the rally in energy sector bonds has coincided with not only the stabilization and modest recovery in oil prices but also a constructive backdrop supported by dovish central bank actions and solid HY fund inflows. With HY market valuations entering expensive territory versus our model forecast, we are growing concerned that HY market valuations will correct and energy will underperform with higher beta credit…
Second, valuations in the HY energy sector look rich under most reasonable default rate scenarios. Put differently, an oil price recovery towards the 60s and 70s this year and next is already reflected in current bond prices. The energy sector currently trades at a yield of 7.8% and spread of 661bp; in comparison, the overall market ex-energy trades at a yield of 5.5% and spread of 447bp (Figure 1). For the weaker sub-sectors, secondary E&P and oil service bonds yield 8.7% translating to spreads of 765bp and 733bp, respectively. In short, energy and the lower quality segments trade at spread discounts of 214bp and c300bp versus the market. And the bulk of the excess spread can be found in the oil service and triple C sub-segments (Figures 2 & 3). We continue to believe default rates could reach 10 – 15% for HY energy as a whole by mid-2016, which would translate into 15-20% for the weaker sectors. Our prior analysis suggests energy sector spreads could be 300 – 600bp wider than the current index if oil prices remain low for longer. Investors are simply not being rewarded for the incremental risk.
And as for the defaults well, they’re on their way UBS thinks, as evidenced by recent events such as American Eagle Energy’s “Movie Gallery” moment:
Where are the defaults? They're coming: we've seen Quicksilver Resources and Dune Energy, are likely to see American Eagle Energy, RAAM Global Energy, Venoco and thereafter perhaps Connacher Oil & Gas, Samson and Sabine Oil & Gas. Most E&P firms had hedges in place for 2015; defaults typically lag by about 12 months and the clock started ticking late last year.
We'll close with the following from "Is The Stage Set For A High Yield Meltdown?":
We’ve talked a lot lately about HY in general and about the HY energy space more specifically. Recapping, periods of QE in the US saw US HY supply surge 50% above normal levels as issuers sought to take advantage of lower borrowing costs and investors clamored for the relatively higher yields they could get by taking on more credit risk. More recently, struggling oil producers have tapped the market in an effort to stave off insolvency as crude prices plummet, leading directly to a situation where outstanding HY energy bonds account for a disproportionate share of all outstanding debt in the space. With rates set to rise later this year, with crude prices likely to stay depressed for the foreseeable future, and with suppressed liquidity in the secondary market for corporate credit poised to bring heightened volatility, the stage may be set for a high yield meltdown.
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A few HY defaults should propel the S&P to fresh highs.
Yes, it's hard to imagine a situation where energy, the stuff required for ANY economy, would be defaulting and new index highs in the NASDAQ. lol hell, why not.
If you give an oil man money he's going to stick a hole in the ground. If you force interest rates down, investors are going to search for more yield and put thier money in riskier investments. If the fed is faced with a collapse the are going to lower interest rates, start QE and similar programs.
None of these are the root cause for the bust in the oil patch, THIS IS.
Please stop shilling your website on ZH.
Everyone puts their thoughts on here. At least you can choose to click on more of my thoughts instead of having to deal with a novel in the comments section. Its even worse on mobile.
Not to mention we have to put up with your thoughts like:
"Clearly being manipulated lower. Someone is also propping up gold as it hasn't fallen further."
Really because there is a real physical over supply of oil. The only manipulators are those bringing product to market, not really what I would call manipulation. The reason the storage tanks are nearly full, as has been mentioned on zerohedge and countless other sites. How did your call on gold being propped up work out for you today. If anyone needs to keep their thoughts to themselves its you.
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Closed California Walmart Built On Former Military Industrial Complex Site
And municipal pension funds are no doubt "all-in" on energy HY credit.
It's a perfect time to invest in energy bonds since there are so many people who just want to sell their bonds, Chicago and CalPers should jump right in there while they can get such great deals......
no doubt
The Rekovery is getting Robuster:
Oilfield services company cuts nearly 5,500 jobsApr 22, 2015
Oilfield service giant Nabors Industries Ltd. (NYSE: NBR) has cut nearly 5,500 jobs since the end of last year, it revealed in its first-quarter earnings report.
http://www.bizjournals.com/houston/morning_call/2015/04/oilfield-service...
Waaaah!, they were my biggest customer. Overtaken by C&J, fracturing experts from Houston, so it should all turn out OK. I'll just deliver them a box of donuts at the OTC.
I wonder how many times they bought the same collateral this time ?
42 times was the record last time around on the RMBS fiasco.After the severe punishment
the bankers didn't get, there is no way its not far worse..
these folks were borrowing at over 8% to begin with. Going up to 10% plus isn't exactly a huge leap.
More good news to rally this market. Insanity is all over the place!
The did the same thing as predatory home loans to the shale industry... I guess since low interest rates can't be a benefit...... in the red at way to high of a sustainable price as yall showed last night. Wasn't it mostly gov done too?
And splat.....
The gov fad mandate crap does that shit.... Their mandated economies of us all being the same ain't sustainable fucking mommy dearest daddy big dick and big brother all up little sisters bedroom.... Mocking the family!
I guess they'd know, since UBS and Citi financed their share. As I've said before...
We'll see the transfer the well ownership from weak hands (US maxxed out entrepreneurs) to strong hands, by buying bankrupted assets for pennies on the Petrodollar, and use Citi (a Prime Dealer, of which they own a huge/controlling share) to do the financing.
And if you want to get really cynical, they'd also scoop up all the water rights possible, to sell drinkable water (that's left after fracking) for a fortune. I'd put nothing past these Wahabbi sociopaths, or their Wall St bumchums.
Come on guys, no one actually defaults anymore. They might "on paper", but the management and owners sure as hell don't lose any wealth in the deal. Employees are fired and then pay to keep the management and owners wealthy now. That's not a fucking default, that's fuedalism.
Meh, the fed will just moenetize the debt and own the oil fields too.
+1 Agree. Trivial result. Just like today's market action. ZH is going to really have to work hard explaning the breakout that is going to occur in a couple weeks (probably less), just like has happened in all the rest of the markets (DAX, HSI, SSEC, NIKK, etc.). I don't know how many more "Not since Lehman"s I can take.
anyone see PBS doc last eve about Mumbai terrorism and how NSA fumbled it ... (probably on purpose)
why the focus on the 5 Jews killed in "Chabad House" vs. other 160 dead Indians and tourists...
and every terrorism "expert" interviewed was a Jew...bar none
Buyers are all over the unrated auto junk bonds too ... the worst at a 7.8% yield. What can possibly go wrong ?
http://www.bloomberg.com/news/articles/2015-04-22/another-sign-that-the-subprime-auto-market-is-getting-hot
bullish!
IDK how the e-minis are only up half a percent on this news.
Clearly being manipulated lower. Someone is also propping up gold as it hasn't fallen further.
Oops! My bad. There goes gold...
Let's see, consumption is down. Will the government now pay us to put on the road what few unused clunkers may remain? That old wreck sure looks good to the gov't today....
Let me repeat if prices remain depressed oil produciton declines will continue rendering the glut mute...so what you continue no getting is that current prices nor $60 wont increase production period so how can prices remain depressed with overhang of huge decline rates? What is bound to happen is production will fall much faster as E&P are exaggerating production in late 2015 to boost stock prices and prices wont stay this low forever esp later in year or else u simply wont have enough oil to go around period.
Also Tyler go on peakoil.com and see the evidence that EIA is overstating current production and thus inventory builds....again your readers want to know why you continue to resist looking into this? The actual underlying data continues to show much steaper production declines via rail and ND vs what EIA is saying.....yet you ignore this while rant on trading spoof stuff....unreal