Junk Oil Bonds Rely on Banks for Rescue
As oil prices have dropped as much as 49 percent in 2014, independent oil exploration and production companies are suffering. As their profits decline, those companies heavily are relying upon bank credit line to survive.
For now, the banks are doing their part to keep the companies afloat and the bond coupons paid. But the question is how long banks will be patient. Mutual fund managers who have invested in the bonds also are concerned.
U.S. mutual funds hold an estimated $30 billion in high-yield debt from a group of about two dozen energy-related companies whose bonds are considered highly distressed. 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.
Those independent energy companies rely heavily on the junk bond market to help fund their operations and to pay down their credit lines with banks. As a result, fund managers want 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 only will stretch so far. And, in the event of default, the banks are first in line to get paid, leaving bondholders with less to recover.
Funds run by Fidelity Investments, Franklin Templeton, Legg Mason and several other companies report getting hurt by falling junk-rated energy bond prices. 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.
At this point, fund managers have to decide whether 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 for less troubled issues.
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