On the eve of first-quarter earnings, BDC investors are anxious to see whether the energy sector will inflict more pain on loan portfolios.
An analysis of the portfolios of 45 BDCs tracked by LCD shows that 31 energy-related companies with outstanding debt were in distressed territory at the end of 2014, in this case valued at 80 or less, which is a widely used definition of distressed debt. Of these, the average weighted fair value at year-end was 64 cents on the dollar.
Prior to last year’s oil price declines, there were just 10 energy-related companies with debt in distressed territory, at a weighted average of 38.5, an analysis by LCD of public filings of the BDCs showed.
First-quarter results for BDCs began to trickle in last week, and many more are expected this week. While oil prices have yet to recover fully, prices are off lows, and the outlook is relatively stable for the short term.
“While the energy exposure is still a concern, we are not expecting an influx of energy non-accruals in the quarter,” KBW analyst Troy Ward said in an April 27 research note. But if oil remains depressed, KBW expects to see an increase in loans booked as non-accrual in the second half of 2015.
Of all the distressed debt within BDC portfolios, energy accounts for about a quarter of the total. Distressed energy debt totaled $500 million of principal within BDC portfolios tracked by LCD, counted across various tranches of debt, at the end of the fourth quarter. That’s 23% of $2.2 billion by principal amount in total distressed assets.
Similarly, energy is the most concentrated sector of distressed assets across other measures of distress in the credit markets.
For example, the Oil & Gas sector accounted for 37.2% of the loans in the distressed ratio of the S&P/LSTA Loan Index. The distressed ratio tracks the percent of performing Index loans trading at a yield of L+1,000 or higher. Oil & Gas-related loans account for 4.7% of the overall Index.
Of all loans in the Index, Oil & Gas-related loans account for 4.7% as of April. Despite two defaults that totaled $1.7 billion –Walter Energy and Sabine Oil & Gas’ second-lien loan – the lagging default rate of the S&P/LSTA Loan Index by principal amount dropped to 1.26% in April, a one-year low, from 3.79% in March.
In another measure of distress in credit markets, S&P Capital IQ’s Distressed Debt Monitor, the ratio of U.S. distressed debt was steady, at 11.5% in April. Again, distressed credits are defined here as speculative-grade issues with option-adjusted composite spreads in excess of 1,000 bps over Treasuries.
The Oil & Gas sector had the highest proportion of debt trading at distressed levels, at 38%, and the highest share of distressed issues by count, at 72, and one of the largest by distressed amount, at 29.9%, as of April 15, according to Distressed Debt Monitor, which is published by S&P Capital IQ.
In a sign of stabilization in the sector, the Oil & Gas sector experienced the largest decline in the proportion of distressed issues, falling 3.9% in April, month over month, the Distressed Debt Monitor showed.
Within the BDC portfolios, energy debt accounts for 5.8% of all debt investments, or $60.7 billion (in outstanding principal).
“It’s not that things have dramatically improved, but the volatility has subsided for now. It’s reasonable to think that they are at a floor level now,” said Merrill Ross, an equity analyst at Wunderlich Securities.
Energy sector allocations vary between BDCs. Some have no exposure to the sector. At year end, CM Finance, PennantPark, Gladstone, Main Street, Apollo Investment, Blackrock Capital, TPG Specialty, and White Horse Finance had 10% or more exposure in oil-related energy, including equity investments, according to KBW research. The weighted-average fair value for energy debt across these eight lenders ranges between 86.5 and 97.9.
Fair values vary across portfolios and can be difficult to assess among small private companies. Sometimes differences across the same investment can be attributed to different cost-basis levels for each provider. The timing of changes in fair value also can vary.
Below are some examples of distressed Oil & Gas holdings as of Dec. 31, 2014.The implied bids are based on fair value to cost:
The 7.5% second-lien debt due Nov. 1, 2018 for Bennu Oil & Gas is marked at 83% of cost at Sierra Income Fund, whereas CM Finance and PennantPark mark it at 76 and 75, respectively.
The 8.75% senior secured loan due April 15, 2020 for exploration-and-production company Caelus Energy is marked at 93 at CM Finance, and 91 by WhiteHorse Finance.
The 12% mezzanine financing due Nov. 15, 2019 for New Gulf Resources was marked at 56 by Blackrock Capital Investment at the end of 2014, while PennantPark Investment marks the debt at 52. However, Blackrock Capital on April 30 reported first-quarter earnings, showing the 12% mezzanine loan now marked at 67.
A $7.5 million, 9.5% subordinated loan due 2020 to Comstock Resources was marked at $5.1 million at year-end by FS Investment, or 70 to cost. Comstock Resources, based in Frisco, Texas, is an oil-and-gas exploration-and-production company that trades on NYSE under the ticker symbol CRK.
Other distressed debt holdings in energy within BDC portfolios are of larger companies whose financial woes are well publicized.
Apollo Investment Corp. holds Venoco 8.875% notes due 2019 and had them marked at 55 as of Dec. 31, 2014. In early April, Standard & Poor’s cut the notes to D, from CCC+, and the corporate rating was lowered to SD, after the company announced the results of a below-par debt swap.
On April 22, Standard & Poor’s raised Venoco’s corporate rating to CCC+, and the senior unsecured notes were raised to CCC-, after the release of 2014 earnings and taking into account the significant loss of principal on the unsecured notes after the exchange.
In another closely tracked credit, some distressed energy sector debt in BDC portfolios is that of Sabine Oil & Gas, which defaulted on debt last month after skipping a $15 million interest payment on its second-lien term loan. Corporate Capital Trust holds 8.75% Sabine debt due 2018 and marked it at 78 in its 2014 fourth-quarter portfolio.
FS Investment (FSIC) showed a $6.3 million holding in SandRidge Energy subordinated debt due 2020, marked at 81. SandRidge Energy unsecured notes are trading in the high 60s, according to sources and trade data.
One distressed energy credit, Halcón Resources, will better weather the slump in oil prices due to the sale of $700 million of 8.625% second-lien notes due 2020 on April 21. The exploration-and-production company operating in North Dakota and eastern Texas intends to use proceeds to repay revolver debt and to fund general corporate purposes.
Main Street Capital has a holding of existing Halcón Resources bonds, the 9.75% unsecured debt due 2020, marked at 82, and HMS Income fund debt has a holding of the same debt marked at 87 (When marked to principal amount, the debt is marked at 75 at both BDCs.). – Kelly Thompson/Abby Latour
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