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Capital Markets
Oil plunge sparks US credit market fears
From the Financial Times of Tue, 16 Dec 2014 16:29:47 GMT
Oil groups’ varied debt levels and the diverse location and quality of their assets adds up to a diverse outlook within the sector©Bloomberg

Investors in securitised packages of loans are scrambling to determine how much the complex products are exposed to plunging oil prices as turmoil in the US credit markets spreads.

The price of oil has sunk almost 50 per cent since June with West Texas Intermediate crude slipping below $60 a barrel last week and Brent falling below the same level on Tuesday.

While the crude price has had a pronounced effect on the prices of corporate bonds sold by junk-rated companies, and to a lesser degree the investment-grade bonds issued by firms with stronger balance sheets, there are signs that it is beginning to slip into more esoteric corners of the credit market.

Investors have been rushing to analyse their holdings of collateralised loan obligations. CLOs are a type of bond that bundles together cash flows from loans made to highly indebted companies and then slices them according to risk.

Commercial mortgage-backed securities, which pool loans secured by commercial properties such as offices and industrial facilities, are also under scrutiny. Some 25 CMBS deals worth $251m have loans on properties in the Bakken formation of North Dakota — where shale drillers have been scaling back — according to Morgan Stanley estimates.

Pressure to identify and potentially offload energy-exposed debt is likely to intensify as the end of the year approaches and asset managers prepare portfolios for review by investors — a process known as window-dressing.

Oil and gas loans make up 4.5 per cent of the S&P LCD Loan index by amount outstanding — a proxy for exposure that may be embedded in CLOs. Energy loans make up 4.1 per cent of JPMorgan Chase’s loan index. “While small on a relative basis, [that] energy share of our loan index is still enough to worry CLO investors,” JPMorgan Chase analysts said in a research note.

In some CLOs energy exposure was as much as 15 per cent of their portfolios, with loans to Ocean Rig UDW, SeaDrill, MEG Energy, Sheridan and Fieldwood Energy accounting for a big chunk. “Energy-related angst among CLO investors is certainly warranted, particularly among subordinated debt and equity investors,” the analysts said, referring to the riskiest slices of CLO deals.

“But at the moment we don’t think the exposure is broad enough to cause serious alarm for senior and most mezzanine tranches.”

Richard Hill at Morgan Stanley said that, while some CMBS deals might be overly exposed to the energy sector, the falling price of oil could benefit the wider commercial real estate universe, which includes retail properties such as shopping malls and hotels.

“Thus far the decline in oil is probably more bullish than bearish for commercial real estate, particularly for retail properties. The question is how far does oil fall and how long does it stay at a low level.”

Meanwhile, the slumping price of crude continues to weigh on corporate bonds. Marty Fridson, chief investment officer at Lehmann, Livian, Fridson Advisors, said a third of the bonds in the BofA Merrill Lynch US high-yield energy index were distressed — up from 18 per cent two years ago — implying a default rate of
6.6 per cent over the next 12 months.

“That is a rate ordinarily observed just a year before the cyclical default rate peak, which typically occurs in conjunction with a recession,” he said in research published by S&P Capital IQ LCD this week. “In effect the market is predicting an oil patch recession in 2016.”

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