excellent article reprint from WolfStreet.com
Liquidity Stress Spikes to Worst Level since Financial Crisis
by Wolf Richter •
Moody’s blamed oil and the collapse of commodity prices. Earlier in August, it blamed the financial turmoil around the globe and the implosion of the stock market bubble in China. Earlier, it blamed the debt crisis in Greece. Because month after month, it has been getting worse.
But it should have blamed investors and banks. They’re licking their wounds from hefty losses on these deals. More losses are on the horizon. Folks began to look at these deals more closely. And now they don’t want them anymore, not at these low yields.
So Moody’s reported today that its Liquidity Stress Index, which rises when corporate liquidity weakens, spiked to 5.1% in August, from 4.1% in July. The worst level since December 2010.
The biggest contributor? The energy LSI. It spiked to 12.7% in August, from 10.5% in July, the worst level since January 2010, at the depth of the Great Recession.
More oil-and-gas companies fell into liquidity purgatory, as Moody’s downgraded them to its lowest liquidity rating, SGL-4. Energy companies account for a little over half of the denizens of SGL-4 purgatory.
Downgrades and defaults marked August – but not all in energy. Of the 11 downgrades to SGL-4, seven were energy companies. One of them, Pioneer Energy Services, saw its liquidity rating knocked down two notches. And after seven defaults in August, the trailing-12-month speculative-grade corporate default rate rose to 2.4%, the worst in two years.
But the word is that the liquidity crisis tearing up the energy sector is not yet spilling over into other sectors. John Puchalla, a Senior VP at Moody’s:
“Excluding energy from the LSI paints a different and more benign picture of speculative-grade liquidity – showing that underlying credit conditions remain supportive and weakness in energy is not spreading broadly to other sectors.”
At least not “broadly.” And not yet. But these things always spill over eventually. That’s why Moody’s is watching it. Two week ago, he’s said that “liquidity pressures are not widespread outside of energy as steady cash flows, the slowly improving economy, and ready access to credit markets continue to provide fundamental support for US speculative-grade company liquidity.”
Junk-rated energy companies are in the grip of a liquidity death spiral. Many of them will have to be restructured, either in bankruptcy court or outside. But the non-energy junk-rated companies hope they won’t be affected, that investors will continue to buy their bonds as if nothing had happened.
So what has happened?
It’s more difficult for junk-rated companies, especially in the energy sector, to sell new bonds. Without new bonds, they can’t pay off their maturing debt, and they can’t service their bank loans and make interest payments on existing bonds. Without a constant flow of ever increasing, cheap, new credit, the fruits of the credit bubble turn toxic.
Early this year, junk bond issuance in the US still ran ahead of last year. But June was bad; only $21.2 billion in junk bonds were issued. It sent shivers down Wall Street’s spine. They blamed the Greek debt crisis. And July was terrible. China’s stock market bubble was imploding. Frazzled investors lost their appetite for risk; and only $10 billion in junk bonds were issued. August was no better at $10.2 billion, according toS&P Capital IQ’s LCD. Year-to-date, $205.8 billion of junk bonds were issued, down 1.4% from the same period last year.
It didn’t help that oil and commodity prices re-collapsed after a false-hope rally, even as the Fed stubbornly refuses to categorically and forever back away from raising rates.
Trying times for bond investors. They’ve been spoiled by a bull market that, aside from a few panics, lasted for over three decades. For companies that had to issue bonds in August no matter what, it got a lot more difficult and expensive:
Already, several of the 19 deals that priced in August had to come with healthy concessions as investors pushed back amid tough conditions. As seen in June and July, the bulk of issuance came from time-sensitive M&A and LBO issuers, to represent 39% of total volume for the month, although dividend and recapitalization/stock repurchase use of proceeds both grew as compared to previous months.
These are the spill-over effects that are still being denied. And note: junk-rated energy companies were excluded.
Energy companies borrow from banks to drill this money into the ground. These loans – usually lines of credit – are secured by oil and gas reserves. Then companies issue bonds, often unsecured, to pay off the bank loans and have some operating cash. The cycle works, until it doesn’t.
And now it doesn’t.
The value of the collateral has plunged by more than half with the price of the hydrocarbons they’re estimated to contain. Twice a year, in April and October, banks look at this collateral to determine how much they want to lend on it. So during the re-determination next month, banks are going to cut back their loans by 10% to 15% on average, according to Bloomberg, thus wiping out $15 billion in sorely needed credit.
It sets off the liquidity death spiral. Companies will have to issue new bonds or leveraged loans to pay down these credit lines. But this time, investors won’t be lining up to buy them. They’ve learned their lesson. Bloomberg:
About $7 billion of junk bonds issued by oil and gas producers in the first quarter to refinance debt have since lost 17%….
Penn Virginia, for example, one of the companies that Moody’s downgraded to SGL-4, had told investors during its July 30 earnings call that the bank would reduce the $425 million borrowing base on its credit line. Its shares became a penny stock. And the $775 million of bonds due in 2020 plummeted below 29 cents on the dollar, from 90 cents at the beginning of July. The company expects to have “sufficient liquidity” into 2016. But that’s only a few months. And it would try to raise capital as markets improve.
But raising capital will be tough. Oil markets might not improve anytime soon, given record quantities in storage in the US and internationally. And waiting for the junk bond market to improve, as the biggest credit bubble in history is beginning to deflate, is going to require a lot more patience.
Stock markets have been volatile recently, plunging and soaring sometimes the same day, and now folks that supply the juice to the startup ecosystem – VCs, pension funds, mutual funds, hedge funds even – are getting nervous.
OK, the debtors are broke and can’t pay the banks back (liquidity crisis) but what do we call it when the borrowers are broke and can’t afford to borrow at 0% (banks pushing on a string)?
Wise men do not invest in overcapacity. Shale/frack oil has always been a revenue skim.
To provide some history, my grandfather was a landman in the 40s and worked for Haroldson Lafayette. My old man was an auditor for the Railroad Commission in Texas. So I was encouraged to be a geologist as a kid (I am not) but along the way I got lots of hand-me-down advice, adages, stories, and so on … along with all the colorful colloquialisms and independence of the area where I grew up. Oh, and maybe some smart/crazy genes, but I digress.
One of the most impactful was a story about an offer on land/rights owned to share in profits of an oil exploration company in exchange for the mineral rights. The offer was refused, but the deal was offered, offered, and offered again, each time at a higher share/percentage. Eventually the offerer was told a share of REVENUE would be considered and to restructure the offer.
There was never a subsequent offer made.
The lesson here acutely describes the shale patch; they lived on borrowed money and never really wanted to give up REVENUE. The execs and such no doubt high roll and live with good benefits, options, bonuses, and all that, but they don’t have an interest in sharing REVENUE. They only want to share profit AFTER they have applied all their expenses. This has always been about insiders feeding on cheap money and insider status and ignorant land/rights owners and ignorant investors.
Let’s face it, if you opened up Bongo’s Nail Salon and borrowed all your revenue, wouldn’t you live high on the hog? Would you STOP after a year, or two, or three? Sure you are doing nails, but the continuous flow of capital INTO your business is required for dividends to go OUT (and more importantly your salary/bonus structure).
That is fracking in a nutshell.
Folks, here is a FACT. Shale/fracking is an EIGHTIES technology. It never had legs because of ECONOMICS. If you are tired of this EIGHTIES technology, lets talk about CO2 injection for tertiary recovery in old fields (really nice production rates for dead fields) … but it requires a HUGE source of CHEAP CO2. Come up with a huge supply of cheap CO2 and you can make money in the old Woodbine formation.
https://en.wikipedia.org/wiki/Woodbine_Formation
Maybe global warming will create a market for CO2 sequestration … in old oil fields … because government … like that is CO2 negative … but whatever. I don’t see how things hold together that long because the free money is gone and so are businesses that rely on free money (to enrich insiders).
Thus our current situation.
I have no doubt that that the “shale revolution” would have failed miserably if most land owners had had this same adage beat into their heads as small children. If they wanted revenue sharing, they (as landowners) wouldn’t have so much of a concern right now, as production is flowing and generating REVENUE. I suspect that most leased based on PROFIT, not revenue, so now they are screwed and/or not fairly compensated.
Back to my opening comment, demand is cratering because more debt doesn’t really fix anything and things are just rolling downhill and getting bigger. More QE isn’t going to fix anything, but that is what is coming. I giggle when folks say rates are going up – it implies we have a market.
We don’t.
Rates will go where the insiders want them to go – but that is a hell of a choice to make at this point.
Regards,
Cooter
Cooter. Well said. Prior to 1973, I couldn’t spell geologist, now I are one. A retired one, but of the petroleum vintage. The first thing I learned in the patch was to never use your own money. That is the cardinal rule. It is amazing what you can drill during a boom. Many wells that never should have been drilled included. So when you look at the amazing shale plays, thousands of wells that should never have been drilled now exist, with questionable future utility.
But don’t worry, the operators already have a new technology which is going to make shale oil that wasn’t economical to produce at $70/bbl economic at $50, or $40, or whatever you need. And if we hurry, we can probably still get in.
They expand with other people’s money while spending all the revenue on management. This was what gave us the big box store boom. All the money for expansion came from Wall St. and all the revenue was socialized by management. In South Florida even after the bust, all these stores were still open even with no business because the money they did produce was going into the pockets of management, while the expenses were being paid by investors.
See the chart: http://www.zerohedge.com/news/2015-08-21/oil-crash-result-excess-supply-or-plunging-demand-answer-one-chart
“Year-to-date, $205.8 billion of junk bonds were issued, down 1.4% from the same period last year.”
1.4% fewer junk bonds, issued over approximately 8 months, does not sound like a catastrophic downturn in junk bond creation.
“although dividend and recapitalization/stock repurchase use of proceeds both grew as compared to previous months.”
And there, folks, is the biggest bubble of all. It is these stock buybacks, that produce nothing (not even energy), that have driven stock prices. I had read that IBM, for instance, borrowed enough money for stock buy backs, over the last six years, to triple its debt load, while, during that same six year period, has seen little, if any, sales growth. Even apple, the gold standard of the stock market, is well along in the process of borrowing $130 billion, in order to pay dividends, pay off some of its bond debt, and execute its stock buybacks. How is this not a ponzi scheme? Tying executive pay to stock prices has been the driver of the stock price ponzi
This is not to say that fracking financing isn’t the most immediate ponzi. Back when oil was at $60 a barrel, David Einhorn called fracking:
“A business that burns cash and doesn’t grow isn’t worth anything,” Einhorn called Pioneer Natural Resources (PXD) the “mother fracker” of the industry.
If Einhorn is shorting, it’s hard to imagine that even someone like Carl Icahn is taking the other side of that trade.
The domino effect on derivatives will be the canary in the coal mine (fracking field):
“This ongoing credit, which in large part has fueled the bubble, will dry up as repayment will look increasing unlikely to lenders. Ultimately this dynamic will result in default on many of the ‘junk’ bonds triggering the the execution of credit default swaps (CDS or derivatives tied to defaults). This would be the toppling of the first domino, breaking the daisy chain of trust and likely causing a derivative ‘blood bath’ on all associated contracts and beyond.
Even more interesting is the move away from US Government credit instruments. Putin now working to pass legislation to eliminate the use of the U.S. dollar within the Federation. Chinese devaluation scheme was too effective and now China dumping US paper to support the Yuan.
When the recycling of US reserve currency stops flowing back into US markets, the shit will hit the fan. The U.S. Markets will no longer be larger than the rest of the world combined!
The days are numbered.
I am with you, fake markets, toilet paper for money, fake numbers. Let this shit pile blow. Please, someone pull the plug, I want to see the crap circle the toilet ring into the sewer.
Cooter: did you intentionally leave the “HUNT” off Haroldson Lafayette?? That’s quite a colorful family……They could have been the inspiration for the “Dallas” TV show back in the day.
Kind of how it was back then, at least that is how I heard it. Not sure what to make of that other than it is what it is.
The man ran a whore house for a corporate office. Times where very hard back then. My grandfather actually did a three sport scholarship to law school, graduated 3rd in his class, and played pro ball afterwards (leather helmet, 1/2 a pint of whiskey allowed on the bench per game, etc) and bounced bars for money in the depression. Oil saved his ass. He met my grandmother at his new law office (very late in life) and they had five children (Catholic family). My grandfather was very principled and refused repeatedly to be anywhere near it (he specialized in LA Napoleon land law – not like British common law). Eventually he was told he was going to move to Jackson Mississippi and was told they would pay his price – just name it.
He told them it would be cheaper to move Jackson to Shreveport.
End of story.
Regards,
Cooter
Cooter. I too enjoy old stories. Your grandfather sounds like some of the folks I met early in my career in the oil business. Men of respect. Men who did what they said they would do.
When I was in grad school, I was visiting a friend who was working for a company in Jackson, Ms. He was showing me around his office and introduced me to his boss who had come up through the majors where he started his career in the 1940s. He invited me into his office and we had a nice visit. He called me a few days later and told me that he had hoped to be in position to offer me a job, but was unable to at that time. He told me that he would offer me a position when he could. I was siting on an offer from Gulf Oil, but was not really wanting to move to Kilgore. I passed on Gulf and took a job with a local operator and did some consulting while working on my thesis. Two years later, the gentleman in Jackson called and asked if I remembered our last conservation. He offered me a position and I accepted with the caveat that I would report in three to six months after receiving my MS. During that time the company reorganized and the gentleman who had offered me the job was involuntarily retired. I forgot about it, until the man who replaced him called to find out when I was coming to work. I told them I wasn’t. He pressed the issue saying that I had a verbal agreement with the company. I told him that my agreement was with the gentleman he replaced and I wasn’t that crazy about how they treated their personnel. That was in the early 80s when a lot of things were getting more cut-throat. Fewer people could be counted on to follow up on anything that wasn’t in writing and the idea of following up on one’s word was all but gone.
Cooter, I love hearing the old stories; not only do they give one a feel for the times, they are a catalyst for change from ‘modern’ norms. Without the context they provide, the new normal proceeds apace without check or balance. But if the stories knock one person out of the rut and gets him or her thinking, the carefully crafted meme begins to fall apart. Or as my grandfather used to say, “I think the bobbin’s wound too tight.”