The danger of stimulus-induced bubbles is starting to play out in the market for energy-company debt.
Since early 2010, energy producers have raised $550 billion of new bonds and loans as the Federal Reserve held borrowing costs near zero, according to Deutsche Bank AG. With oil prices plunging, investors are questioning the ability of some issuers to meet their debt obligations. Research firm CreditSights Inc. predicts the default rate for energy junk bonds will double to eight percent next year.
“Anything that becomes a mania — it ends badly,” said Tim Gramatovich, who helps manage more than $800 million as chief investment officer of Santa Barbara, California-based Peritus Asset Management. “And this is a mania.”
The Fed’s decision to keep benchmark interest rates at record lows for six years has encouraged investors to funnel cash into speculative-grade securities to generate returns, raising concern that risks were being overlooked. A report from Moody’s Investors Service this week found that investor protections in corporate debt are at an all-time low, while average yields on junk bonds were recently lower than what investment-grade companies were paying before the credit crisis.
Borrowing costs for energy companies have skyrocketed in the past six months as West Texas Intermediate crude, the U.S. benchmark, has dropped 44 percent to $60.46 a barrel since reaching this year’s peak of $107.26 in June.
Yields on junk-rated energy bonds climbed to a more-than-five-year high of 9.5 percent this week from 5.7 percent in June, according to Bank of America Merrill Lynch index data. At least three energy-related borrowers, including C&J Energy Services Inc. (CJES ▼ -3.13% 12.07), postponed financings this month as sentiment soured.
“It’s been super cheap” for energy companies to obtain financing over the past five years, said Brian Gibbons, a senior analyst for oil and gas at CreditSights in New York. Now, companies with ratings of B or below are “virtually shut out of the market” and will have to “rely on a combination of asset sales” and their credit lines, he said.
Companies rated Ba1 and lower by Moody’s and BB+ and below by Standard & Poor’s are considered speculative grade.
The Fed’s three rounds of bond buying were a gift to small companies in the capital-intensive energy industry that needed cheap borrowing costs to thrive, according to Chris Lafakis, a senior economist at Moody’s Analytics in West Chester, Pennsylvania.
Quantitative easing “has been one of the keys to the fast, breakneck pace of the growth in U.S. oil production which requires abundant capital,” Lafakis said.
One of those to take advantage was Energy XXI Ltd. (EXXI ▼ -1.39% 2.84), an oil and gas explorer, which has raised more than $2 billion in the bond market in the past four years.
The Houston-based company’s $750 million of 9.25 percent notes, issued in December 2010, have tumbled to 64 cents on the dollar from 106.3 cents in September, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. They yield 27.7 percent.
Energy XXI got its lenders in August to waive a potential violation of its credit agreement because its debt had risen relative to its earnings, according to a regulatory filing. In September, lenders agreed to increase the amount of leverage allowed.
“We think the sell-off has been a little over done,” said Greg Smith, a vice president in Energy XXI’s investor relations department. “People are trading us as though we’re distressed.”
The company has “plenty of liquidity,” Smith said. “Come January we’ll be free cash flow positive,” which is “a rarity in this business,” he said.
The debt rout is one of the latest examples of a boom and bust in U.S. markets as unprecedented Fed stimulus fuels a hunt for yield. The fallout has been limited so far, yet the longer the Fed holds its benchmark lending rate near zero, the greater the risk of more consequential bubbles, according to former Fed governor Jeremy Stein.
“To the extent that highly accommodative monetary policy courts risks to the economy further down the road, there is more of a live trade-off than there was at 8 percent unemployment” said Stein, now a Harvard University professor.
Joblessness of 5.8 percent in November was about half a percentage point away from the Fed’s estimate of full employment, or the lowest level of labor market slack the economy can sustain before companies bid up wages.
Employment in support services for oil and gas operations has surged 70 percent since the U.S. expansion began in June 2009, while oil and gas extraction payrolls have climbed 34 percent.
“There are distortions in multiple markets,” said Lawrence Goodman, president of the Center for Financial Stability, a monetary research group in New York. “It is like a Whac-A-Mole game: You don’t know where it is going to pop up next.”
Fed Chair Janet Yellen said in a July 2 speech in Washington that she saw “pockets of increased risk-taking,” including in the corporate debt markets.
Midstates Petroleum Co. (MPO ▼ -11.56% 1.30) is spending about $1.15 drilling for every dollar earned selling oil and gas. Outspending cash flow is the norm for many companies in the U.S. shale boom.
The Houston-based company’s $700 million of 9.25 percent notes due in June 2021 have plummeted to 53.5 cents from 108 cents at the beginning of September, according to Trace. The debt is rated Caa1 by Moody’s and B- by S&P.
Representatives of Midstates didn’t respond to phone calls and e-mails seeking comment.
Some borrowers are under pressure just a few months after selling new debt. Sanchez Energy Corp.’s $1.15 billion of 6.125 percent notes maturing in January 2023, issued this year, have tumbled to 77 cents from 101 cents in September, according to Trace. Proceeds from the bonds were partly used to fund a purchase of Eagle Ford shale assets from Royal Dutch Shell Plc. (RDSA ▲ 0.78% 25.97)
“The company has planned for and is poised to rapidly adapt to a changing commodity price environment,” Tony Sanchez, III, chief executive officer of Sanchez Energy, said in a statement yesterday.
The Houston-based company expects to fully fund its 2015 capital program from operating cash flow and cash on hand without drawing on its revolving credit line, the statement said.
Sanchez Energy has never had positive free cash flow. Michael Long, chief financial officer, didn’t return a call seeking comment.
“Oil companies that have high funding costs in the Eagle Ford and the Bakken shale plays are the ones that are most exposed right now due to lower crude prices,” Gary C. Evans, chief executive officer of Magnum Hunter Resources (MHR ▼ -4.16% 3.46) Corp., said in a phone interview.
Magnum Hunter’s $600 million of 9.75 percent debt due in 2020 has tumbled to 84.5 cents from 109 cents in September, Trace data show. The notes are rated CCC by S&P and yield 13.9 percent.
Evans said Houston-based Magnum Hunter sold almost all of its oil properties over the last year and a half and is now predominantly a gas company.
“We’ve insulated ourselves,” Evans said. For other energy borrowers at risk, “the liquidity squeeze” will probably occur in March or April when banks re-calculate have much they may borrow under their credit lines based on the value of their oil reserves.
Deutsche Bank analysts predicted in a Dec. 8 report that about a third of companies rated B or CCC may be unable to meet their obligations should oil prices drop to $55 a barrel.
“If you keep oil prices low enough for long enough, there is a pretty good case that some of the weakest issuers in the high-yield space will run into cash-flow issues,” Oleg Melentyev, a New York-based credit strategist at Deutsche Bank, said in a telephone interview.
For Related News and Information: Junk Fervor Cools as Oil Rout Upends Energy Debt: Credit Markets Junk Backing Shale Boom Faces $11.6 Billion Loss: Credit Markets Shale Boom’s Allure to Wall Street Tested by Drop in Oil Prices Oil Slump Heaps Bond Losses in $50 Billion Glut: Credit Markets Drillers Piling Up More Debt Than Oil Hunting Fortunes in Shale
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- By ALAN ZIBEL
andANDREW R. JOHNSON WSJ
WASHINGTON — A U.S. financial regulator is growing worried about increasingly risky practices in the auto-lending market, an area of growth for banks.
The Office of the Comptroller of the Currency, in a report released Wednesday, singled out concerns in the “indirect” auto lending market, in which banks buy up loans originated by car dealers. The regulator said it’s concerned about signs of loosening lending standards, including more loans to borrowers with weaker credit.
“These early signs of easing terms and increasing risk are noteworthy,” the banking regulator said.
Banks saw auto lending grow nearly 13% compared with a year earlier in the fourth quarter of last year and the OCC said it’s worried about growing losses in the industry. Average losses per vehicle have “risen substantially in the past two years.”
Auto lending has been a big area of growth for banks as demand for credit cards and other consumer loans has remained tepid.
U.S. Bancorp USB +0.14%, the largest U.S. regional bank by assets, has been “moving more aggressively in auto loans,” Chief Executive Richard Davis said during an investor conference earlier this month.
Wells Fargo WFC +0.21% & Co., the fourth-largest U.S. bank by assets, has expanded its auto-lending business significantly. The San Francisco-based bank’s auto-loan portfolio increased 11.3% in the first quarter to $52.6 billion.
Wells Fargo has improved its credit quality in the auto-lending business in recent years, Thomas Wolfe, executive vice president of consumer credit solutions for the bank, said during an investor presentation in May. “We have moved upstream slightly,” he said, adding that the bank does “a lot more prime financing than we do non-prime or subprime financing.”
Total outstanding U.S. auto loans have risen to $875 billion in the first quarter of 2014, the highest level in more than a decade, according to Federal Reserve Bank of New York data.
Earlier this month, General Motors Financial Co. sold off its largest bond backed by subprime auto loans since 2007, garnering the lowest yields in more than a year compared with an interest rate benchmark.
Bond investors have gravitated to auto loans because delinquencies are low and the bond deals weathered the financial crisis with few rating downgrades, a stark difference from bonds backed by home mortgages.
The auto-lending market faces regulatory inquiries as well, The Justice Department and Consumer Financial Protection Bureau have been investigating whether lenders’ practices have led to discrimination against women and minorities.
- By VIPAL MONGA
Senior Editor WSJ
Lenders beware: junk-rated companies that borrow with few strings attached are defaulting at higher-than-average rates.
Analysts at Moody’s Investors Service MCO -0.22% studied 423 U.S. companies that borrowed money on easy terms between 2005 through the first quarter of 2014. By tracking their default rates over three-year intervals, the analysts discovered that the average default rate totaled 18.8%, compared with a 13.4% rate for all high-yield loan borrowers.
More companies are getting access to those so-called covenant-lite loans. More than half of loans in the $750 billion junk loan market lacked financial covenants, according to a recent analysis by S&P Capital IQ.
Recently, pest-control and cleaning company Servicemaster Global Holdings Inc., borrowed $1.83 billion in a covenant-lite loan. Other recent borrowers included designer fashion house Kate Spade & Co. and nut specialist Diamond Foods Inc.DMND +0.29%
Covenants are triggers that could force borrowers to shore up their financial health. Those triggers usually involve periodic tests of overall debt levels and cash flow to cover scheduled interest payments.
Moody’s study also found that the covenant-lite loans are becoming a larger part of companies’ capital structures.
“It’s a worrisome trend,” said Moody’s analyst Julia Chursin. She noted that a smaller debt cushion means that lenders will take bigger losses in a default, because there are fewer lenders behind them in the capital structure to absorb losses.
Moody’s analysts found that covenant-lite lenders recovered less: 79 cents on the dollar versus 82 cents for all lenders in their database.
The growth in riskier loans is starting to concern regulators. The Office of the Comptroller of the Currency released a report on Wednesday, which cited the growth of risky high-yielding loans with looser underwriting standards as an area of “supervisory concern.”
Auto Lending Standards Plunge: New Car Loans Average 110% LTV; Used Car Loans 133% LTV with 55% Subprime! Repossessions Up Sharply
U.S. car sales are up. It’s easy to explain why: car buyers borrow more as standards loosen
The average loan on a new car climbed to $26,719 in the third quarter, up by $756 from a year earlier, and the most in at least five years, according to data collected by Experian Plc.
Despite borrowing so much more, average monthly payments on new car loans rose only $6 to $458. That is because banks and finance companies were willing to lend at lower rates and grant borrowers more time to repay.
Lenders made 26.04 percent of their loans on new cars to buyers with subprime credit scores, up from 24.84 percent a year earlier, said Experian, which collects car title and financing information to compile its reports. For loans on used cars, the portion to subprime borrowers rose to 54.95 percent from 54.43 percent.
As the lenders made bigger loans, they also extended credit further beyond the value of the vehicles. The average loan-to-value on new cars rose to 110.6 percent, up by 1.17 percentage points. On used cars it rose to 133.2 percent, up by 2.18 percentage points.
Auto lenders often provide loans that exceed the value of cars they are financing because borrowers want cash to pay sales taxes and fees.
Extra-long loans are becoming more common. Some 19 percent of new car loans were made for more than six years, up from 16.4 percent a year earlier.
The percentage of loans 30-days delinquent was down in the third quarter to 2.58 percent from 2.67 percent a year earlier, Experian said.
However, the average loss on loans gone bad jumped to $7,770 in the third quarter from $7,026 a year earlier and repossessions increased sharply, particularly for subprime borrowers.
Used Car Loans 133% LTV with 55% Subprime?!
Excuse me for asking, but didn’t we try “lower-and-lower lending standards” once before? How did it work out? Can anyone tell me why it will be different this time?
Repossessions are up sharply, but who cares about that? No doubt the loans are sliced, diced, tranched, and securitized to make them appear as AAA. Pension funds are probably dumping gold to load up on them.
Auto lending, like housing in 2006, appears to be a no-lose proposition.
After all, the Fed is in complete control. Isn’t it?
Mike “Mish” Shedlock
Americans have been holding on to their wobbly washing machines and sagging sofas even longer than their grandparents did 50 years ago, setting the stage for a rebound in consumer spending as old household goods wear out.
The average age of consumer durable goods — long-lasting items such as furniture, appliances and computers — is the highest since 1962, according to data from the Bureau of Economic Analysis dating to 1925. Among things Americans are keeping for the longest time: jewelry and wristwatches and home and garden tools like lawnmowers.
Replacement purchases, overdue after the worst recession since the Great Depression, would boost the consumer spending that accounts for 70 percent of the economy. Automobilesales are headed for their best year since 2007, showing Americans have the financial security to buy more expensive items, and economists say that means household-goods sales will pick up.
Such purchases are “postpone-able for only so long,” said John Silvia, chief economist for Wells Fargo Securities LLC in Charlotte, North Carolina, the biggest U.S. mortgage lender. Increases in home values, along with gains in consumer confidence, incomes and employment from recessionary lows, make “people sense it’s worth putting money back into that house” with purchases such as appliances, he said.
Cars and luggage were the only two of 17 categories the BEA tracks that saw a decrease in average age in 2012, according to the data released Nov. 14. The average age of jewelry was 5.3 years, the oldest since 1942, while that of home and garden tools was 5.1 years, the highest since 1961. The categories include products that typically last at least three years.
The data show a replacement cycle that started in the post-World War II era as people moved to the suburbs and made purchases to set up their households, said Neil Dutta, head of U.S. economics at Renaissance Macro Research LLC in New York.
The average age of goods rises during an economic downturn, and “towards the middle of an expansion, you tend to see these numbers start to come down, and that means people are buying more stuff,” said Dutta, who projects durables purchases will pick up next year.
Appliance maker Whirlpool Corp. of Benton Harbor, Michigan, expects bigger gains in 2014 from people replacing aging goods, Bob Bergeth, the company’s general manager of national contract builder sales, said in a telephone interview. “There is quite a bit of pent-up demand,” he said.
“People who have lived with one burner or two burners on their stove that have been working now feel more secure in their job outlook and employment and even wage increases,” Bergeth said. “They’re increasingly coming back into the market and replacing that range.”
Manufacturing in the U.S. accelerated in November at the fastest pace in more than two years as companies boosted production to keep up with growing orders, figures from the Institute for Supply Management showed yesterday.
Steven Orlikowski, a software developer in Houston, said he’s ready to replace the five-year-old computer he’s been getting along with since he “rediscovered thrift” after losing his job in 2009.
The 36-year-old, who has since found a new job, said he’s shopping this week to take advantage of holiday discounting.
“I’ve got to replace it, because that one is pretty much dead in the water,” he said. “I’m in a good position right now” to make more expensive purchases.
A jump in household durable-goods demand would help lift U.S. growth that is little changed from last year’s 2 percent average annualized rate. Gross domestic product expanded at a 2.1 percent rate so far in 2013 and 2.3 percent since the recession ended in June 2009.
Consumer spending in the three months ended September rose at the slowest pace since 2011. That reflected the weakest gain in four years in expenditures for services such as haircuts or consulting and doesn’t mean Americans aren’t willing to make lasting purchases, Dutta said.
There is “an emerging willingness among consumers to finally replace items that are worn or outdated or to make significant enhancements to their homes,” Gregory Bridgeford, chief customer officer at the second-largest U.S. home-improvement retailer, said on a Nov. 20 earnings call.
Even so, “it’s a slow build,” he said.
One reason: Consumers are reluctant to take on more debt after the recession forced them to clean up their finances.
Household debt as a share of income was 92.2 percent last quarter, a decade low and down from its peak of 114 percent in 2009. The debt-service ratio, which measures how much income is devoted to paying off obligations, has also steadied after dropping last year to a record low.
Thirty-six percent of consumers listed keeping current on bills as their top financial priority, according to a Bankrate.com survey conducted Nov. 7-10. Twenty percent prioritized paying down debt and 18 percent said they were most concerned with saving money.
Revolving debt, which includes credit-card spending, shrank by $2.1 billion in September, the fourth straight month of declines and the longest such stretch in almost three years, according to Federal Reserve data. Non-revolving credit, which includes financing for college tuition and autos, increased $15.8 billion.
Those figures show consumers are less likely to run up credit-card balances with casual expenditures such as movie tickets or restaurant meals, Silvia said. That doesn’t mean they’ll continue to put off major purchases, he said.
“A number of people will have to come back and say OK, I’ve postponed this now for three to five years, we really need to get it done,” Silvia said.
If so, they may find financing more readily available as banks ease standards for consumer loans. Among 70 banks polled for the Federal Reserve’s quarterly senior loan officers’ surveyin October, all said credit standards for consumer loan approvals were either unchanged or had eased somewhat. All 65 banks who responded specifically about approving auto loans also said the standards had stayed the same or loosened.
Cars and light trucks sold at a 15.2 million annualized rate in October, the 12th consecutive month above the 15-million mark for the longest streak since February 2008. The rise has supported companies such as Fort Lauderdale, Florida-based AutoNation Inc., the largest U.S. retailer of cars and trucks.
“The auto-credit environment remains strong,” Chief Executive Officer Michael J. Jackson said on an Oct. 24 earnings call. Further sales gains are “dependent upon the fundamental strength of the economic recovery in the U.S. and whether the employment picture has significantly improved from what it is today.”
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November sales figures for Detroit’s “big three” automakers are out, and like last month, they’re looking good:
- Ford has its best November since 2004, selling more than 190,000 vehicles, up 7% from last year.
- GM’s sales surged by 16%, the best November for the company since 2007.
- Chrysler’s sales were also up 16% compared to a year ago, its strongest November in six years.
It’s a good sign for the US economy, given that automakers are both a huge employer and a major customer for other industries. It’s also further vindication for the Obama Administration’s 2009 bailout of the sector.
But as we’ve previously discussed, there’s good reason to be at least slightly concerned: The boom in auto sales coincides with a massive increase in cheap auto loans, many of which are subprime. These loans are packaged together and sold on to increasingly yield-hungry investors. Issuance of securities backed by subprime auto loans have more than doubled since 2010 to $17 billion this year, but remain below their 2005 peak, Businessweek reports, citing Deutsche Bank.
What’s more, a recent survey of auto dealers by UBS found that lending standards for financing auto purchases have been easing since mid-year. The chart below shows the percentage of auto dealers who think lending standards are getting tighter versus more lenient:
Neither Wall Street or Main Street seems all that concerned. UBS is forecasting arecord year for GM in 2014, with its North American profit to increase by some $2 billion, up 27% from this year. Auto dealers, according to the UBS survey, expect industrywide car sales to increase by 2.6% in 2014.
Of course, surging auto debt comes at a time when falling credit card debt has been falling sharply. Slate’s Matt Yglesias has argued that credit card lending standards have tightened far more than auto lending standards have since the financial crisis. He puts this down to the greater strength of the car lobby relative to the banking lobby. The UBS survey supports this notion. Most dealers say warnings from the Consumer Financial Protection Bureau have had no impact on lending practices this year, as shown in the chart below.
The pressing question these numbers raise is whether consumers are shifting their spending and debts from credit cards to auto loans. The New York Fed’s latesthousehold debt and credit report shows that while housing debt has fallen since 2008, non-housing debt, which includes credit cards and car loans, is actually back at pre-crisis highs. If consumers are piling up on auto loans, the economy may have moved on to its next bubble.