Boston - Independent oil exploration and production companies are leaning heavily on bank credit lines to survive plunging crude prices, making it a nervous time for U.S. funds holding their junk-rated debt.
“The question is, 'How long do the banks keep the heart beating?'“ said Francis Bradley III, a Greenberg Traurig attorney in Houston who specializes in energy company financing deals. “It's not an unlimited lifeline.”
U.S. mutual funds hold an estimated $30 billion in rapidly depreciating debt from a group of about two dozen energy-related companies whose bonds are considered highly distressed, according to Thomson Reuters data.
Fund managers need banks to keep extending credit so the energy companies don't collapse and default. But if the price of oil remains unprofitably low, the banks will only stretch so far. And in the event of default, the banks are first in line to get paid, leaving bondholders with less to recover.
“Usually when companies need them the most, the banks pull the credit lines in,” said Jonathan Stanley, a high-yield sector manager at Newfleet Asset Management in Hartford, Connecticut, which owns junk-rated energy bonds.
Since the end of 2009, the amount of energy debt has surged by 155 percent and currently accounts for 16 percent of the $1.38 trillion junk bond market, according to FitchRatings.
The Merrill Lynch US High Yield Energy Index is down almost 9 percent in December alone, and some of the bonds are selling at 30 cents to 40 cents on the dollar. By contrast, the broader Merrill Lynch US Energy Index is off only 2.1 percent this month.
Funds run by Fidelity Investments, Franklin Templeton, Legg Mason and several other companies report getting hurt by falling junk-rated energy bond prices.
Some of the companies' hardest hit funds over the past three months include the $94 billion Franklin Income Fund (down 6.83 percent), Fidelity's High Income Fund (off 4.04 percent) and Legg's Western Asset Global High Yield Bond Fund, down 7.34 percent, according to data from Morningstar Inc.
Fund managers now have to decide to sell their troubled bonds at deep discounts or hold out for a possible recovery. Most managers have been dumping the hardest hit bonds, even at fire-sale prices, but taking a wait and see approach to less troubled issues.
Ed Perks, manager of the Franklin Income Fund, said the sell-off in the junk-rated energy bond market has been indiscriminate in recent weeks because of investor skittishness.
“What we've had is a shoot first, ask questions second mentality,” Perks said. His fund is down 6.83 percent in the past three months as some of his bets on energy-related bonds have soured.
The $17 billion Fidelity Total Bond Fund has about 12 percent exposure to the junk bond market, but Ford O'Neil, who runs the fund, says he has largely avoided the names that have been crushed by oil's rapid descent.
He said it's almost impossible to forecast when banks will cut off credit to struggling energy producers. That's why managers have to bet on the companies with the best fundamentals in terms of liquidity and capital spending discipline. His fund is up 0.96 percent over the past three months.
Energy companies with distressed bonds include Quicksilver Resources Inc, Sanchez Energy Corp, Tervita Corp, Connacher Oil & Gas, Hercules Offshore, Goodrich Petroleum, Venoco Inc, Sandridge Energy Inc, Midstates Petroleum and Samson Investment.
Plunging oil prices have whipsawed these small energy companies' cash flow as they slash exploration plans for finding oil and gas in U.S. shale basins.
The independents, as they are called, relied heavily on the junk bond market to help fund their operations and to pay down their credit lines with Wall Street banks. But the bond market is largely closed down to them as their survival comes into question.
These companies are left with a dwindling amount of cash and whatever they can tap from their credit lines to get through what is emerging as a global oil price war. Some of these companies have gone back to ask forbearance from their banks.
For now, the banks are doing their part to keep the companies afloat and the coupons paid.
“It's never in the best interest of the banks or the bondholders for an exploration and production company to collapse,” Bradley said. “The banks are willing to cooperate.”
Last month for example, JPMorgan Chase & Co. allowed Fort Worth, Texas-based Quicksilver Resources to eliminate a covenant that required the company to meet the minimum coverage ratio on interest payments, U.S. regulatory filings show. The bank also agreed to allow Quicksilver, which has about $2 billion in long-term debt, to exclude exploration expenses when calculating its earnings for purposes of meeting the bank's minimum. JPMorgan bankers were not available for comment.
In another example, Houston-based Sanchez Energy recently negotiated a 79 percent increase in the borrowing base of its credit line to $650 million from a group of lenders including Royal Bank of Canada and Capital One. The company now says it has $1.2 billion in liquidity.
But Sanchez bondholders, including funds run by Franklin Templeton, AllianceBernstein LP and Legg Mason's Western Asset Management, are having a rough ride. The price of Sanchez Energy's $1.15 billion in debt due in 2023, for example, has dropped 25 percent since mid September, and the bonds now sell at 76 cents on the dollar.
The bonds' credit spread, or the extra yield investors demand to own the bonds over benchmark treasuries, has widened to about 850 basis points, or on the verge of becoming a highly distressed security.
For now, the question is how long will banks be patient. The decline in oil-dependent company profitability is recent, and for now fund managers are sitting on these bonds and not dumping them at fire-sale prices.
As recently as the third quarter, operating profits at 240 companies with “BB” or “B” ratings were showing improvement over the previous quarter, according to a Dec. 9 report from FitchRatings. Earlier this year, the independents were adept at issuing more bonds to pay down bank credit lines while pushing out pending maturities to give themselves more breathing room.
But that just means the fund managers have that many more worrisome bonds to tend.
“You don't know if the price of oil is a blip that last six months or if this becomes the norm for two or three years,” said Greenberg Traurig's Bradley. - Reuters