Crude oil plunge challenges renewed faith in ‘junk’ bonds

0
109


The plunge in energy prices this week could expose the frailty of a rebound among bonds sold by the most indebted companies in the U.S., buoyed by the prospects of help from the Federal Reserve.

Pain from a sharp drop in crude oil futures this week is expected to spill over into the debt of American shale oil companies that are rated below sub-investment grade, or “junk”-rated firms.

Even though many oil companies have looked to raise cash and curtail production, many will struggle to survive if oil continues to trade at these depressed levels, said market participants.

“The market is vastly oversupplied and demand destruction is far too great to be corrected by supply cuts,” said John McClain, a high-yield portfolio manager at Diamond Hill, in e-mailed comments.

The troubles of energy company bonds has the potential to weigh on returns for the more than $1 trillion junk bond market as their debt represents around 12% of the benchmark index for the performance of below-investment grade bonds.

The iShares iBoxx $ High Yield Corporate Bond exchange-traded fund
HYG,
-1.86%

is down more than 3% this week, but positive for the month, FactSet data show.

Yet before this week, the perception of a Federal Reserve backstop for corporate bonds helped to revive sentiment in the market after the central bank deployed emergency lending facilities that could see the Fed acquire junk bonds.

See: Fed’s souped-up lending programs extends aid to ‘junk’ bonds

Navistar
NAV,
+3.04%

and Seaworld
SEAS,
+5.57%

are among the sub-investment grade companies that have sold new debt on Tuesday as inflows make their way back into funds holding junk debt.

Investors say energy debt have booked the biggest gains in the rally as the most beaten-down bonds were the sharpest to bounce back.

The yield for a basket of high-yield bonds tracked by Bank of America traded at a yield of 8.05% as of Monday, down from a recent peak of 11.41% on March 20. For energy issuers, the average yield fell to 16.42%, down from a high of 23.05%.

But the renewed selloff in crude oil is challenging the thesis for snapping up debt from energy companies.

“Those assets are permanently impaired and we will need to reduce production domestically. Marginal producers and marginal assets will go away,” said McClain.

May futures for West Texas Intermediate crude
CLM20,
-33.82%

settled at around $10 a barrel on Tuesday, following a brief foray into negative territory the day before.

“Because it’s a spot contract, it’s signalling how bad things really are,” said Lale Topcuoglu, senior fund manager at J.O. Hambro Capital Management, in an interview.

In that environment, investors are likely to focus less on the viability of a driller’s operations and how cheaply it could unearth oil. Instead, money managers would look to assess if a company’s finances were resilient enough to stay afloat during the current economic downturn.

“Oil is so low right now, you couldn’t survive anyway” from pumping out crude, said Topcuoglu.

Fund managers, however, may not see much of an additional hit from the reaccelerating slump in crude values as junk-rated oil companies, even with the recent rebound, were still trading at distressed levels before this week amid concerns that drillers and producers in the shale patch would not survive the precipitous drop in global demand for commodities.

One widely used definition of a distressed bond refers to any debt trading below 80 cents on the dollar.

Plus, the actual share of energy debt held by bond mutual funds is likely to be lower as money managers have steered clear of the energy sector, said analysts.

Still, low energy prices could portend trouble for the high-yield corporate bond market because such highly leveraged companies are the first to go underwater when revenues shrink and cash flow narrows to a trickle.



Source : MTV