Banks are boosting their reserves in preparation for a potential wave of defaults in the U.S. energy sector as a plunge in oil prices pushes shale producers to the brink.
The price of oil has fallen over 70 percent from its 2014 peak, adding tremendous pressure to the sector, and increasingly forcing oil and gas companies into bankruptcy.
Now, two large U.S. shale oil producers — with a combined debt of $7.6 billion — could be the next victims forced into bankruptcy in March as they failed to pay interest on their bonds last week, Bloomberg reported on Wednesday.
Energy XXI, which owes $3.4 billion, said it missed an $8.8 million interest payment on its bonds last week, and SandRidge, which owes $4.2 billion, said it missed a $21.7 million payment.
The two firms have until the middle of March to pay the interest, work out a deal with creditors, or face a default that could tip them into bankruptcy.
In addition to selling high-yield bonds, which lost 24 percent last year for the energy sector as a whole, the biggest fall since 2008, these firms have borrowed money from banks including Royal Bank of Scotland Group Plc, UBS Group AG and BNP Paribas SA, Barclays Plc, Royal Bank of Canada and Morgan Stanley.
Investors are now demanding bond yields of 19.3 percent in order to hold U.S. junk-rated energy bonds, Bloomberg said, after borrowing costs for these companies exceeded 20 percent for the first time ever this month, according to Bank of America Merrill Lynch.
The U.S. shale boom has been fueled by junk debt as drillers have piled up a whopping $237 billion in borrowings as of the end of September 2015, according to data compiled Bloomberg.
Since the start of 2015, 48 North American oil and gas producers have fallen into bankruptcy, with a combined total of $17.3 billion in debt, according to law firm Haynes and Boone.
Could this be the start of the next wave of defaults in the U.S. energy sector?
SandRidge is likely to file for bankruptcy, KDP Investment Advisors wrote in a report last week. In a separate report, S&P said that Energy XXI was also likely file for bankruptcy.
“We are at the very beginning of the next wave of energy defaults,” Paul Halpern, chief investment officer at Versa Capital Management, told Bloomberg.
According to a report published by Moody’s Investors Service earlier this month, the number of U.S. firms that have the highest risk of defaulting on their debt is nearing a peak that has not been seen since the height of the financial crisis, and 28 percent of those at risk, 74 borrowers, are from the oil and gas sector.
The U.S. shale industry’s debt is mostly in the form of bonds. Of the total $197 billion of securities, $101 billion is junk-rated, according to Bloomberg.
“We’re just beginning to see how bad 2016 is going to be,” said Becky Roof, managing director AlixPartners told Bloomberg.
The risk of defaults has led banks to boost their reserves to protect against potential loan losses. On Tuesday JP Morgan said it boosted its reserves to $1.3 billion to protect against loan losses in the oil and gas sector in the first quarter of 2016.
“The additional reserves bring the amount that J.P. Morgan has set aside to cover losses in the battered energy space to $1.3 billion, after reporting more than $800 million in oil-and-gas loan-loss reserves at the end of 2015. The bank also said that nearly 40 percent of its loan exposure in the sector is to energy and production companies,” Marketwatch reported.
Standard & Poor’s Ratings Services estimates that credit lines to energy firms could be cut by 30 percent by April, which with thus further put a strain on the sector and lead to more bankruptcies.