The riskiest shale oil drillers and pipeline companies could enter a vicious cycle of losses for investors and increased borrowing costs.
Obligations of US oil and gas drillers noted in the trash were already exhausted before oil prices plunged unexpectedly this weekend, thanks to a surprise price war between Saudi Arabia and Russia. They looked set to take even bigger losses on Monday, as oil prices fell about 20% for the session.
The two largest exchange traded funds that follow the market lost about 4.5% at the start of the session, in line with their biggest drops since the financial crisis. The worst daily decline in the iShares iBoxx $ High Yield Bond index (ticker: HYG) was 8.1%, and the worst day
SPDR Bloomberg Barclays High Yield Bond ETF
(JNK) was a drop of almost 15%.
The liquidation of junk bonds is important for several reasons. First, it increases the likelihood of bankruptcies and job losses in the energy sector. A drilling company, Pioneer Energy, has already filed for bankruptcy this month – the company filed for Chapter 11 protection with a prepackaged reorganization plan on March 1. Deutsche Bank strategists predict a 15% default rate for energy companies this year.
“Weekend oil market developments could hardly have come at a worse time for the United States [high yield] market, “wrote Craig Nicol and Nick Burns, Deutsche credit strategists, in a note on Monday. “Defects are inevitable.”
Rated energy companies face pressure from two different market dynamics: low oil prices make it difficult to cover interest and principal payments, and bond sales increase the cost of refinancing debt once it is coming of age.
About $ 13 billion of high-yield energy bonds in the index mature by the end of 2021, or about 7.2% of the energy bonds in the ICE BofAML High Yield Bond index.
There is also another risk for mass selling: it could spread to the rest of the market because energy companies are, overall, the biggest borrowers in the index. Bonds by energy borrowers in the United States – largely shale drillers and pipeline companies – represent about 11% of the ICE BofAML High Yield Bond Index.
Investors withdrew $ 9.3 billion net of unwanted bond funds for the two weeks ending Wednesday, according to Lipper Refinitiv. About $ 5.1 billion of these withdrawals took place in the week ending Wednesday, one of the largest week-long outings on record.
If investors continue to draw liquidity from the market, companies in other sectors may face higher borrowing costs and increased financial pressure. As traders withdraw money from high-yield bond mutual funds and ETFs, these withdrawals force fund managers to sell other bonds to meet redemption requests.
“The big question, however, is contagion to [high yield] non-energy market. In our opinion, it is inevitable, “wrote the strategists of Deutsche Bank.
The market had already experienced one of its worst weeks since the financial crisis last week. Even before the producer price war broke out this weekend, oil prices had already been pushed down by fears of a slowdown in global demand linked to the Covid-19 coronavirus.
The market response to the pandemic and the price war seemed to have the potential to snowball in total panic on Monday morning. the
fell 7% at the start of the session, halting trading. The benchmark fell by 5.5% after the resumption of trade.
“Unwanted bonds are … abandoned and credit spreads are widening,” wrote Bob Schwartz, senior economist at Oxford Economics. “It could have a more damaging impact on the economy than a stock market correction.”
Write to Alexandra Scaggs at [email protected]