Speaker 1: Hello, and welcome to The Credit Edge, a weekly markets podcast.
Speaker 1: My name is James Crombie. I'm a senior editor at Bloomberg.
Speaker 1: Today's guests are Eliza Ronaldshannon, who covers distressed debt and
Speaker 1: bankruptcy for Bloomberg News in Atlanta. We're delighted to have
Speaker 1: you on the show. Good to be here. We're also
Speaker 1: very pleased to welcome Spencer Cutter, who covers energy for
Speaker 1: Bloomberg Intelligence in Seattle. Thanks for having me on. Companies
Speaker 1: in the energy sector are highly exposed to the tightening
Speaker 1: in financial conditions that's happening as we speak. We'll be
Speaker 1: getting his insight a bit later on in the show,
Speaker 1: but before we do. Eliza Ronaldshannon, with Bloomberg News, you've
Speaker 1: been all over the biggest distressed debt stories for as
Speaker 1: long as I can remember. How is the global banking
Speaker 1: crisis affecting the troubled companies that you cover well so far?
Speaker 1: It's it's interesting. It's a bit of a double edged sword.
Speaker 1: On one hand, these companies have already been creeping into
Speaker 1: further tightness in terms of their ability to obtain new financing.
Speaker 1: The rise in rates has been increasing the amount of
Speaker 1: distress that that's out there really reducing their options in
Speaker 1: terms of financing themselves. So that has meant a lot
Speaker 1: of turning to you know, private debt funding, these specialized
Speaker 1: firms that will lend to them at quite high rates,
Speaker 1: which creates only a snowball effect of further burden on
Speaker 1: the companies. But the interesting side of this is that
Speaker 1: it's possible, you know, given that the backdrop is already
Speaker 1: tough and one of you know, the outlook being a
Speaker 1: lot of more distressed now that things have reached a
Speaker 1: real crescendo in one regard, a lot of a lot
Speaker 1: of market participants are hopeful that this will slow down
Speaker 1: the fed's rate hikes, in which case the struggling and
Speaker 1: the and the overindebted companies will benefit. So can I
Speaker 1: ask you about the funding cust I mean, they have
Speaker 1: increased across the board. But but if you're going to
Speaker 1: the private market, how much more are you're gonna have
Speaker 1: to pay? You're gonna have to pay? I mean, it's
Speaker 1: interesting because you're it's it's more about it's it's it's
Speaker 1: like you're gonna have to pay more. But it's more
Speaker 1: than the option being nothing at all. So I mean
Speaker 1: it'll be at three percentage points more in terms of
Speaker 1: the yield on a loan um. We're looking at some
Speaker 1: of the loans that we see recently in for instance,
Speaker 1: bankruptcy financing, which is only one step beyond um distressed financing.
Speaker 1: Some of these loans are going for fifteen percent um.
Speaker 1: I think there was one company that recently took out
Speaker 1: a small loan at twenty percent to avoid bankruptcy. So
Speaker 1: that becomes a really onerous It doesn't sound sustainable to me.
Speaker 1: I mean, these companies just running themselves like they're giving
Speaker 1: themselves short term lifelines, but they're not long term sustainable,
Speaker 1: are they right. It's a lot of short term lifelines.
Speaker 1: It's a lot of the companies hoping and praying that
Speaker 1: they will have a experience an operational turnaround in the meantime.
Speaker 1: So sometimes these will be pretty short term loans and
Speaker 1: they're thinking, our whole business model is going to be
Speaker 1: different and amazing in two years, so if we can
Speaker 1: only get through this tough time will be smooth sailing.
Speaker 1: And of course sometimes that is true. Sometimes they need
Speaker 1: to take on you know, you have to kind of
Speaker 1: dig yourself out of the hole and that means throwing
Speaker 1: good money after bad but it can work out in
Speaker 1: the end. It's hard to know in the moment which
Speaker 1: outcome you're going to have. But of course for executives
Speaker 1: that are in the positions, better to buy some time
Speaker 1: and not have to be the one who sank the ship. Yeah,
Speaker 1: absolutely right, So you talked about the double edged sword.
Speaker 1: Rates are going up, but that you know also at
Speaker 1: the same time, because the banking crisis, the FED may
Speaker 1: have to take its foot off the accelerator. But that's
Speaker 1: not good for these companies, right, If the economy is
Speaker 1: getting worse, right, that's net worse for them for you know,
Speaker 1: more distress, Right, it is, it's net worse for them, certainly.
Speaker 1: I mean, the the hope is that it will at
Speaker 1: least tame inflation. So the the real entrenched fear is
Speaker 1: for a stagflation a sustains stagflation situation where inflation is
Speaker 1: high and even a recession doesn't um tame it. So
Speaker 1: to some extent, you know, people are hopeful, I mean,
Speaker 1: the markets are, especially for high yield debt or always
Speaker 1: suspiciously hopeful about everything. But um, you know, it's it's
Speaker 1: a little bit of a this might hasten the cycle
Speaker 1: and at least let us come back out of it
Speaker 1: a little faster, but it's not good for corporate growth
Speaker 1: and it's not good for the company's actual operational outlook.
Speaker 1: There any particular sectors that are in trouble companies specifically,
Speaker 1: it's really not a sector specific at this point. The companies,
Speaker 1: it's just going to be the companies that have had
Speaker 1: to or had to or have just taken on a
Speaker 1: lot of debt in order to finance themselves, you know,
Speaker 1: in sunnier times when rates were really low. So that's
Speaker 1: going to be a lot of private equity owned companies
Speaker 1: that were acquired through leveraged buyouts. It also can be
Speaker 1: companies like Carvana, which is not private equity owned, but
Speaker 1: it took on almost five billion dollars worth of debt
Speaker 1: during the pandemic in order to fuel its massive growth goals.
Speaker 1: And now it was one of those companies that didn't
Speaker 1: have a lot of revenue or it wasn't profitable at
Speaker 1: the time, And of course that's you know, not unheard
Speaker 1: of for a company to really focus on growth over profits.
Speaker 1: But the worst case scenario is for that that era
Speaker 1: to lead into an environment where there's no turning back
Speaker 1: and you have really put a lot of burden on
Speaker 1: the company, and the economy is not in a place
Speaker 1: where it will become profitable. So it just sounds like
Speaker 1: a really depressing outic I'm to see on the credit guy,
Speaker 1: so I'm always looking on the dark side. But in
Speaker 1: terms of like the the actual trade, somebody is making
Speaker 1: money here right now. Everyone is unhappy. So who's who's
Speaker 1: who's rolling in the in the big bus on someone
Speaker 1: else's paying here. Well, one place you're seeing funds try
Speaker 1: to make money, and it's a little bit too soon
Speaker 1: to know who's really going to cash out on some
Speaker 1: of these bets because they involve products that you know
Speaker 1: don't immediately turn over. But um, there's a lot of
Speaker 1: activity relatively speaking, in the market for credit default swaps,
Speaker 1: and that is a product that allows investors to bet
Speaker 1: against companies, and so that became a snowball issue during
Speaker 1: the financial crisis. But there's a lot more regulation involved
Speaker 1: now and the markets are smaller, But that is one
Speaker 1: place where hedge funds and particularly macro funds can kind
Speaker 1: of pile onto the negative sentiment and they can bet
Speaker 1: against companies where the market psychology seems to already be
Speaker 1: that everyone is in fear and there's a little bit
Speaker 1: of panic going on, and then once those bets are
Speaker 1: noticed and recorded, it exacerbates things often. So that's one
Speaker 1: place where there will be profits taken. You talked to
Speaker 1: one of the biggest guys that you know. He makes
Speaker 1: his money at moments like this, Bill as Weinstein. He
Speaker 1: always catches in at this point. He smells blood in
Speaker 1: the water. What's what's his view now on the bank bonds? Well,
Speaker 1: he is he saw the displacement in the market. He
Speaker 1: thought that the um and thinks still that there's a
Speaker 1: little bit too much selling and that there's been some
Speaker 1: forced selling on the part of counterparties, you know, other
Speaker 1: banks that need to just effectively manage their risk and
Speaker 1: just our buying protection in a way to hedge their
Speaker 1: exposure and just stay within some reasonable limits in terms
Speaker 1: of their the risk that's on their books. Um So,
Speaker 1: the demand surging when and when a bunch of banks
Speaker 1: have to do that at the same time, gives sellers
Speaker 1: of CDs, which could be any any fund or that
Speaker 1: that decides to write up a contract they can really
Speaker 1: sell them at over Arguably inflated prices, and so then
Speaker 1: you're getting you know, you're you're selling a product that
Speaker 1: is higher than its market value might be. It does
Speaker 1: he think the route is over? Does he think that
Speaker 1: the unions has further to full or is it? Is
Speaker 1: it stabilizing that well, it's it's tough to know because
Speaker 1: the market is so a liquid that it changes every day.
Speaker 1: Um what's more interesting in the horizon for people like
Speaker 1: Weinstein and UM funds pursuing these kind of bets is
Speaker 1: that the same phenomenon of hedging exposure and that creating
Speaker 1: a lot of demand for CDs is now expanding into
Speaker 1: other industries. So first it was just banks. Now you're
Speaker 1: seeing it in the insurance companies. UH, their CDs is
Speaker 1: being traded very heavily. There's a lot of demand for it,
Speaker 1: and that's because insurance companies themselves have a lot of
Speaker 1: exposure to bank debt. They have that debt on their
Speaker 1: own balance sheets where they manage their assets. And that
Speaker 1: was because it was supposed to be quite safe debt,
Speaker 1: and so that's that's what they to invest in so
Speaker 1: that they have a decent return without a lot of risk.
Speaker 1: But now that it's suddenly become risky, people are betting
Speaker 1: against those insurance companies. Very interesting. So before we talk
Speaker 1: to Spencer Cutter at Bloomberg Intelligence about the energy setor
Speaker 1: what's the next big story to watch here, Eliza, I
Speaker 1: think it might be how the interest in CDs and
Speaker 1: how the rush to hedge or bet against the credit
Speaker 1: of various companies expands even beyond insurance. So does this
Speaker 1: trickle down to a lot of trading activity in other
Speaker 1: CDs indexes or in single name CDs. Thank you, Eliza
Speaker 1: Ronolds Hanon for Bloomberg News, Thanks so much for joining us.
Speaker 1: Thanks we look forward to reading all your scoops on
Speaker 1: the Bloomberg terminal and of course at Bloomberg dot com. So,
Speaker 1: as I said earlier, we're very fortunate to have Spencer
Speaker 1: Cutter here from Bloomberg Intelligence. Thank you very much for
Speaker 1: joining us. Spencer, thanks for having me. The companies that
Speaker 1: you look at, um, you know, I just remember a
Speaker 1: whole well of paying there as well. I mean, we've
Speaker 1: been talking for years about the problems in the energy sector.
Speaker 1: They borrow a way too much money and they can't
Speaker 1: pay it back. How are they affected by what's going
Speaker 1: on in the banking set to what's what's you know,
Speaker 1: roiling them in terms of like the global termoil was
Speaker 1: seeing they are they all falling apart as well? Uh No,
Speaker 1: actually quite to the contrary, and I think some of
Speaker 1: the troubles that we've talked about over the past several
Speaker 1: years have helped put the energy sector into a much
Speaker 1: stronger position today, which could leave them in a really,
Speaker 1: relatively speaking to other sectors, a good position if we
Speaker 1: do see a sort of another financial dislocation or banking crisis.
Speaker 1: We had two waves of bankruptcies in the last five
Speaker 1: or six years, the first one in twenty sixteen when
Speaker 1: oil prices fell below thirty dollars a barrel, and then
Speaker 1: again in twenty twenty when oil basually went to zero briefly,
Speaker 1: and as a product as a result of that, you
Speaker 1: had a lot of the weaker companies wiped out take
Speaker 1: you know, go to bankruptcy, wipe out a bunch of debt,
Speaker 1: and either go away or re emerge with very little
Speaker 1: debt on their balance sheets. And the ones that survived,
Speaker 1: you know, they had a couple of near death experiences
Speaker 1: and they got religion, and they started using free cash
Speaker 1: flow and asset sale proceeds to pay down debt. So
Speaker 1: the overall health of the high yield energy sector, and
Speaker 1: I primarily cover high yield, but this applies to investment
Speaker 1: grade as well. I believe you know, the overall health
Speaker 1: of the sector from a credit standpoint is probably the
Speaker 1: strongest it's been in decades. So you'll see if you're
Speaker 1: trying to tell me that the high yield junk junk
Speaker 1: energy issues are a safe haven in all of this mess, well,
Speaker 1: if you if you want to go back to two
Speaker 1: thousand and eight, and not that we are going to
Speaker 1: have a repeat of two thousand and eight, but that's
Speaker 1: obviously sort of the benchmark that a lot of people
Speaker 1: go by. Oil prices plunged from about one hundred and
Speaker 1: forty five dollars a barrel down to around thirty four,
Speaker 1: and as a result, credit spreads in the energy sector
Speaker 1: did jump by quite a bit. That said, the sector
Speaker 1: then was the spreads were still three hundred, three hundred
Speaker 1: and fifty basis points tighter than the overall market despite
Speaker 1: that sort of dislocation. And one thing to point out
Speaker 1: is in two thousand and eight, the midstream sector was
Speaker 1: actually not part of the Bloomberg high yield Energy Index,
Speaker 1: and I'm looking at the index overall index spreads here,
Speaker 1: and the midstream sector is moved in and I think
Speaker 1: it was twenty fourteen out of utilities, and that's by
Speaker 1: far the safest sector within energy, and so that would
Speaker 1: account if we have another repeat today, I would think
Speaker 1: that would help keep overall energy spreads down. But if
Speaker 1: you look at leverage ratios today and free cash flow
Speaker 1: expectations today, even after we've seen natural gas prices fall
Speaker 1: to two dollars per thousand cubic feet from north and
Speaker 1: nine dollars just in August, you know, the overall the
Speaker 1: top ten high yield independent energy debt issuers, they're expected
Speaker 1: to have an average leverage ratio this year at the
Speaker 1: end of this year of less than one and a
Speaker 1: half times, and all but one of them is expected
Speaker 1: to still generate positive free cash flow. So not to
Speaker 1: say there won't be some dislocation, not to say the
Speaker 1: high yeld energy sector won't suffer somewhat. And I do
Speaker 1: think if if we do have another you know, big
Speaker 1: recession or another financial lending crisis similar to or in
Speaker 1: the spectrum of two thousand and eight, yeah, sure, it's
Speaker 1: gonna it's gonna impact energy, but I do feel like
Speaker 1: the sector's well positioned. And also keep in mind where
Speaker 1: we're coming from and how energy relates to the rest
Speaker 1: of the world today. When you do have a lending crisis,
Speaker 1: a credit crisis, and banks are pulling back, concreditors are
Speaker 1: pulling back, they really start to look for companies that
Speaker 1: have hard assets, that have a long track record of
Speaker 1: generating cash flow that can be monetized. And that's energy.
Speaker 1: You've got that in spades in this sector. So people
Speaker 1: they stay you know, hey, you know, get me out
Speaker 1: of this latest fintech crypto vaporware company and let me
Speaker 1: buy some good old fashioned oil and gas stocks. But
Speaker 1: two things. One thing, you know, you mentioned the drop
Speaker 1: in gas oils drop from one hundred and twenty to seventy.
Speaker 1: Surely that's going to hurt. Yeah, it hurts. And so
Speaker 1: the free cash flow expectations have come down, but for
Speaker 1: most of these companies are still positive. What's happening is
Speaker 1: these companies are not are not ramping up production to
Speaker 1: sort of grab the you know, one hundred dollars plus
Speaker 1: barrel of oil opportunity to either saying I'm I'm going
Speaker 1: to focus on free cash flow and I'm gonna just
Speaker 1: spend as much as I need to spend to maintain production.
Speaker 1: So yes, the falling oil prices will hurt UM, but
Speaker 1: there's still in a really good position where like I said,
Speaker 1: we entered the year this year, I think in the
Speaker 1: strongest position from a credit standpoint in certainly in my memory,
Speaker 1: in many decades. But the other thing, the other thing
Speaker 1: I wanted to raise with the ESP crowd. I mean,
Speaker 1: you're destroying the planet with your fossil fuels. Come on,
Speaker 1: you know, Yeah, there there's a dichotomy there. There's a tuget,
Speaker 1: a push and pull. Um. ESG is certainly something that
Speaker 1: you're hearing a lot about, not only from the broader community,
Speaker 1: but every company I follow talks about it, and they're
Speaker 1: investing heavily in carbon capture and other ESG related ventures.
Speaker 1: You know, pipeline companies may benefit from this quite a
Speaker 1: bit because you had a huge build out of oil
Speaker 1: and natural gas and refined product pipelines. As sale the
Speaker 1: shale boom started, you started seeing more generation production come
Speaker 1: out of West whether it's West Texas or the Marcellus
Speaker 1: up in New England, or the northeast and the backing
Speaker 1: that's been largely built out, and you've seen the backlog
Speaker 1: of projects for the midstream companies come down dramatically, But
Speaker 1: now some of them are starting to come back up
Speaker 1: because all these producers are saying, well, I'm going to
Speaker 1: capture carbon and use it and inject the CO two
Speaker 1: into my well to help stimulate production, and I need
Speaker 1: a CO two pipeline for that, So they're building CO
Speaker 1: two carbon capture pipelines. So, just to drill down into
Speaker 1: one name in particular, Occidental Petroleum, Warren Buffett is buying
Speaker 1: shares in that company. What does that mean for bondholder
Speaker 1: is that's one of the biggest borrowers in our universe
Speaker 1: in terms of US credit markets. Yeah, Occidental is sort
Speaker 1: of the poster child for high yield own gas companies.
Speaker 1: They used to be investment grade and they levered up
Speaker 1: to buy Anadarko that didn't turn out too well. They
Speaker 1: lost their investment grade ratings and oil dropped to zero,
Speaker 1: and everybody thought they might go bankrupt. They've since paid
Speaker 1: off about twenty billion dollars a debt and are on
Speaker 1: the verge of moving back into the Bloomberg high you'ld
Speaker 1: or sorry the Bloomberg Investment Grade Index, and Berkshire Warren
Speaker 1: Buffett obviously is playing a big role there. He lent
Speaker 1: them a lot of money for the Anadarko acquisition, and
Speaker 1: he started buying a dish shares and keeps on buying
Speaker 1: and buying and buying. From a credit standpoint, at some
Speaker 1: point you've got to start thinking, does Oxidental become strategically
Speaker 1: important for Berkshire Hathaway and therefore get some sort of
Speaker 1: implicit credit support. You know, as Berkshire, do they own
Speaker 1: enough stock to have they invested enough in this business
Speaker 1: that if oil prices dropped back down to thirty dollars
Speaker 1: a barrel for an extended period, Well, Berkshire, which has
Speaker 1: billions and billions of cash, say we're not going to
Speaker 1: let this go under. We're going to stand behind them,
Speaker 1: We're going to lend them some money, or we're going
Speaker 1: to inject some capital into this company to help get
Speaker 1: them through this tough point. It's really hard to say
Speaker 1: where that line is crossed. Um. They believe Berkshire owns
Speaker 1: about twenty four percent of Occidental today, They have warrants
Speaker 1: to buy a lot more, and I think they have
Speaker 1: approval to get up to like fifty percent. So you know,
Speaker 1: fifty percent certainly seems like a line in the sand,
Speaker 1: but it may it's a fuzzy area. But that's something
Speaker 1: to consider, is when do you think that this becomes
Speaker 1: a strategically important investment for Berkshire and that they are
Speaker 1: going to back it up and help support Occidental if
Speaker 1: they should run into any sort of credit or financial trouble.
Speaker 1: So overall credit energy sector, the big year for this
Speaker 1: particular pasit of credit is a moment for energy bonds.
Speaker 1: Uh well, energy bonds have they certainly did very well
Speaker 1: the last year, year and a half. And the problem
Speaker 1: run into is there is sort of a floor in
Speaker 1: terms of credit spreads, and I think we hit that
Speaker 1: floor last year. So not to say that spreads half
Speaker 1: to widen. And you've certainly seen credit spreads hold in
Speaker 1: even though oil and natural gas prices have fallen. I
Speaker 1: mean you see credit spreads for natural gas producers like
Speaker 1: Chesapeake Energy and Southwestern they're about the same place today,
Speaker 1: even though natural gas is two dollars per thousand cubic feet.
Speaker 1: Those credit spreads are still the same place today as
Speaker 1: they were back when natural gas was by fifty, so
Speaker 1: people are not hitting the panic button yet. That said,
Speaker 1: if oil goes back to one hundred and natural gas
Speaker 1: goes back to six seven seven dollars, it's hard to
Speaker 1: see that there's a lot of upside just because the upside,
Speaker 1: you know, the windfall from those higher prices, is being
Speaker 1: steered towards shareholders. All the companies have spent the last
Speaker 1: several years using they're free cash flow to pay down debt,
Speaker 1: and now they said, okay, we're kind of done with that,
Speaker 1: and maybe we'll pay down a little bit more, but
Speaker 1: we're really going to start using any free cash flow
Speaker 1: we generate to pay dividends or buy backstock. So for
Speaker 1: from a credit standpoint, there's not a whole lot more
Speaker 1: upside left, but not much downside either. Well, you know,
Speaker 1: there's always some downside in the credit world, and that's
Speaker 1: all we think about as credit analysts. But relative to
Speaker 1: a lot of the other industries out there, I feel
Speaker 1: pretty good like that the high old energy sector is
Speaker 1: pretty well positioned. If we should hit another financial storm
Speaker 1: in the near future, so and unlikely safe haven. Who'd
Speaker 1: have thought we'd be running for cover in junk energy
Speaker 1: bonds but Spencer Cutter from Bloomberg Intelligence, thank you so
Speaker 1: much for joining us. Thank you and do read all
Speaker 1: of Spencer's analysis on the Bloomberg Terminal and I look
Speaker 1: forward to catching up again very soon. Thanks again also
Speaker 1: to Eliza ronalds Hannon from Bloomberg News. Read all of
Speaker 1: her scoops on the Terminal and at Bloomberg dot Com.
Speaker 1: Definitely important to keep an eye on the distressed debt
Speaker 1: story right now, no matter what part of the market
Speaker 1: you're in, and Eliza and her team will continue to
Speaker 1: break a lot of news in that market over the
Speaker 1: coming months and weeks. I'm James Bromby. It's been a
Speaker 1: pleasure having you. See you next week on Credit Edge.