As many as half of all US energy debt issuers will be forced into some form of restructuring over the next two years, according to T. Rowe Price as it warns investors to hold off re-entering the sector.
The worst pain for issuers and investors will come over the next six months as bank lenders seek to reassess the value of their oil reserves – the collateral underpinning many loans to oil and gas producers – and credit quality.
T. Rowe Price high yield credit analyst Andrew Jamieson explains with bank loans sitting highest in the capital structure, much subordinated debt would immediately present a higher risk and is urging investors to avoid energy debt.
He says: “Many lenders are already under pressure from regulators to reduce exposure to low-quality borrowers, so any further declines in collateral values would likely lead them to call in lines of credit.
“Given bank loans sit highest in the capital structure, subordinated debt would immediately be at increased risk of default.”
Jamieson draws the parallel with the oil bust of the 1980s where around one-third of US energy firms failed, saying that today’s higher levels of leverage and weaker balance sheets indicate as many as half may have to restructure their debt.
While $30 a barrel or lower may be necessary to redress the supply/demand dynamic, such a level would be temporary.
He adds that the faster the bottom is reached, the sooner the recovery can begin.
Jamieson says: “With yields on high yield energy issues averaging almost 600 basis points higher than the broad market at the end of 2015, much bad news clearly has been built into valuations.
“At some point, this yield pickup will become too attractive for high yield investors to ignore, especially as the sector is cleansed of weaker credits and absorbs relatively high quality issuers to have fallen out of the investment grade market.
“That time, however, has not yet arrived, in our view. With credit fundamentals still deteriorating, and liquidity conditions fragile at best, caution is warranted.
“We expect 2016 to be a year of volatility and bottom testing, offering select bargains, but also considerable risks.”