Falling oil price threatens junk energy bonds

FT: “A sharp drop in energy bond prices has pushed yields to their highest level in more than one year, casting a shadow on the outlook for the broad US junk bond market and highlighting the risks to investors who flocked to the debt in recent years.”
“Low-rated energy bonds have sold off in the past month amid a slump in oil prices, which have dropped more than 25 per cent since June.
The shale boom that has created a surge in US oil and gas production has been financed in part through a steep increase in sales of low-rated debt in the past decade. Energy bonds now account for 15.7 per cent of the $1.3tn junk bond market, according to Barclays data, having accounted for just 4.3 per cent of that market in 2004. “No one can avoid the energy sector,” said Sabur Moini, a high-yield fund manager at Payden & Rygel. “Every high-yield manager has a lot of energy bonds.”
Junk bond investors are now facing a double blow. A further drop in oil prices could put pressure on the highly indebted companies in the sector and potentially trigger a wave of debt restructurings, which has not been seen since the depths of the financial crisis.
The second risk is the extent of the sell-off for junk-rated energy bonds. The bonds have been the worst performing group in the market for high-yield corporate debt, with negative returns of 1.3 per cent in the past month, according to Barclays indices.
A further drop in bond prices raises the odds of a broader spill-off at a time when trading volatility has increased in riskier assets. “Energy was considered a fairly defensive sector and the whole renaissance of US shale made it a good story,” said Mr Moini. “Now everybody is paying very close attention to what may happen to some of those companies if conditions become truly unfriendly.”
Junk bond managers are also mindful that the Federal Reserve is no longer providing a tailwind for asset prices as the central bank has wrapped up its large-scale bond purchases.
Fed policy helped drive global investors into the riskiest corners of the US debt capital markets
, and investors are primed for selling down their portfolios should interest rates normalise in the coming months. The drop in prices has pushed yields to 6.9 per cent at the start of the month, the highest level since July 2013, according to Barclays.”