Over the past several weeks, courtesy of the jump in oil prices from 13 years lows, the narrowly reopened window granting some companies the chance to sell equity and in some cases debt (and promptly use the proceeds to repay their secured lenders), and the various last-ditch extensions afforded to near-default oil and gas companies, the dire reality of the default wave about to be unleashed in the shale patch has been swept under the rug, if only briefly.
That is about to change.
In a recent interview with Bloomberg, Fitch's Eric Rosenthal paints a very disturbing picture: the rating agency senior director predicts that about $40 billion worth of energy debt will likely default in 2016.
Here are some of the highlights behind his forecast of a 6% default rate, the highest non-recessionary rate since 2000.
The increase in the overall default rate to 6 percent from 4.5 percent relates purely to the challenges of low commodity prices in the energy and metals/mining sectors. A false dawn in prices last spring allowed many energy companies to access the capital markets. As a result, the sector accounts for more outstanding debt in the high yield bond universe than any other — 19 percent. When combined with metals/mining, the two most distressed sectors account for 25 percent of the high-yield bond universe. Energy, rightfully, received much attention last year. With $13 billion of defaults already tallied this year, compared to $17.5 billion for all of 2015, it shows no signs of slowing down. E&P and coal companies are the most prone to default this year, with expected default rates of 30 percent to 35 percent and 60 percent, respectively. As these companies work through their last lifelines, like distressed debt exchanges, there is an expectation that we will see more filings.
On the ongoing liquidity concerns resulting from what remains mostly a shut high yield issuance window:
Currently, $63 billion of energy and metals/mining bond issues are bid below 40 cents. While there is definitely noise around names that are bid in the 60-to-80-cents region, the majority of issues trading at deep discounts are near-term default candidates. The high-yield market has bounced back nicely over the past few weeks, highlighted by a record $5 billion in mutual fund inflows, but the energy troubles aren’t getting resolved with crude oil prices still under $40. Liquidity is definitely a concern.
Is the recent bounce in oil prices enough to delay the day of reckoning?
While crude oil prices have gained more than $11 from a Feb. 11 low, the levels are still well below what is required to break even. Most energy companies need the WTI to be north of $50 and quickly. If this happens, the capital markets could thaw a bit and asset sales might get done, enabling these companies to keep going. However, several of these companies are already in a precarious position and will be tested further by semiannual interest payments due next month. Many have already used lifelines like distressed debt exchanges and hired restructuring advisers, so absent that fast rise in WTI, some defaults will be inevitable. We estimate about $40 billion of additional outstanding energy bond debt will likely default this year.
Finally, on a topic very dear to us, recovery rates and what to expect if there is a 20% cumulative default rate in the energy sector.
The 30-day post-default energy price over the past 12 months is 23 percent and that figure is unlikely to rise considering current secondary levels. It doesn’t bode well for recoveries. In the worst cases, investors could be looking at cents on the dollar.
In short, it looks like we may be in the eye of the hurricane, and it is only a matter of time before the pent up avalanche of energy defaults is unleashed.
But how long; what are the specifics? For those who enjoy combing through forward calendars, we have conducted a quick search of all U.S. 144A oil and gas bonds trading at 30 cents on the dollar or less, and which have an interest payment over the next six month, starting in April through September. As can be seen from the 141 individual bonds that satisfy these criteria, the eye of the hurricane is set to leave and unleash some very strong wind.