Corporate debt markets could become a secondary casualty of the Russia-Saudi oil price war.
If Saudi Arabia and Russia don’t resume negotiations to cut global oil production quickly, the U.S. oil patch faces calamity.
Stock and bond prices are tanking in the U.S. oil and gas sector—one of the biggest issuers of junk bond debt in the U.S. economy. Energy producers account for more than 15% of outstanding high-yield bonds in the market. Plummeting oil prices will hurt all producers, but the heavily indebted shale oil companies in the U.S.—which have made the country the top global energy producer—suddenly face potential bankruptcy.
Current conditions in the oil market look at least as bad as the 2015-2016 recession in the sector. Not only has the supply side of the equation collapsed with the split between OPEC and Russia, but there is still no clear picture of how big the impact on energy demand from the coronavirus outbreak will be. It could be dramatic, particularly in the transport sector as planes and trains empty and companies curtail all non-essential travel.
The prices of high-yield bonds have been falling along with stock prices. The yield of the ICE Bank of America Merrill Lynch High-Yield bond index (which moves inversely to bond prices) rose more than 1.25% to over 6.27% in the past two weeks and its spread over U.S. Treasury bonds jumped more than 2% to 5.64% as investors pile into the safety of U.S. Treasury bonds.
The yield is still below the brief spike over 8% at the end of 2018 and well below the more than 10% it reached in early 2016. The market rallied sharply after that 2016 spike largely because the price of oil and the outlook for the oil and gas sector did too. The question is whether the recession in the energy sector remains isolated as it was in 2015-2016. If a coronavirus-induced global recession does occur, borrowing rates will rise much further for a much wider swath of companies.
The immediate impact of recent volatility on corporate borrowers has not been significant. Most companies have taken advantage of very good financial markets to extend the maturities of low-interest debt out years and have lots of cash to weather a modest economic slump. Even the lowest rated investment-grade companies and junk bond issuers (below BBB-rated) have relatively good interest and debt coverage ratios. However, changes in consumer behavior because of coronavirus could change the picture rapidly.
With so much near-junk rated debt in the market (53% of outstanding investment-grade debt was rated BBB or lower last year, according to S&P Global), a recession and the credit downgrades that will accompany it may wreak havoc in the high-yield bond market.
The number of global potential “fallen angels”—investment-grade companies one notch above junk status with a negative outlook—was 44 at the end of January, according to S&P Global. If enough angels fall to earth, the flood of institutional investors selling will cause problems for all issuers in the high-yield market.
Some sectors are more vulnerable than others. Per S&P, the European automotive sector currently has four companies teetering on the brink: Renault S.A., GKN Holdings Ltd., IHO Verwaltungs GmbH and ZF Friedrichshafen AG, with billions in public debt between them. Ford Motor Co. is one downgrade by either S&P or Fitch away from falling to junk status. The more than $100 billion in debt it carries amounts to about eight percent of the total U.S. high-yield market.
