MW: Falling oil prices add to high-yield bond marketâs long list of woes
Oil, natural gas, and other commodity prices are deteriorating once againâafter appearing to bottom in mid-Marchâjust in time to ensure a bumpy start to the second half of 2015 for high-yield bonds.
The renewed commodity weakness has affected the corporate bond market, which was already on shaky ground after a long winter of falling commodity prices, causing yield spreads in the energy sector to widen.
But analysts warned that the high-yield bond market is the sector that faces the biggest danger from what could turn out to be a perfect storm made up of falling commodity prices, shrinking liquidity and overheated prices.
Here is why:
Rising default risk
The high-yield bond market consists of low credit-quality companies, around 13-14% of which are energy companies.
Since last summer, energy firms have responded to the unexpected drop in oil prices with lowered near-term outlooks. In turn, âinvestors reacted through offloading positions in companies directly affected by these input prices,â explained Jody Lurie, corporate credit analyst at Janney, in a note.
âMany exposed firms have already been operating under âdamage controlâ mode and have less room to preserve cash against further commodities price declines,â Lurie said.
Last week, Fitch Ratings increased its 2015 U.S. high-yield default outlook to 2.5%-3% from 1.5%-2%, reflecting the impact that âlanguishing oil prices, weak coal demand and burdensome regulation have had on energy and metals/mining companies during the first half of the year.â
Already some energy firms have declared bankruptcy due to the challenging market environment. Energy and metals/mining accounted for 57% of the total of 35 high-yield bond issuersâ3.7% of the total marketâthat defaulted in the first half of 2015, according to Fitch.
The future looks even grimmer, as Fitch expects the default rate for high-yield energy companies to hit 6% to 7% in the current cycle.