Why were oil and gas firms major issuers of high-yield debt?

Oil and gas firms were major issuers

Overseas geopolitical and credit risks, coupled with jitters in the U.S. about the near-historical low yields on junk-rated debt, took their toll on the market environment last week. New issue volumes in the U.S. high-yield (HYG) primary market slumped by ~61% week-over-week, to $2.15 billion in the week ending August 8. The number of deals was also lower with eight transactions compared to 14 in the previous week. Last week brought the total year-to-date (or YTD) issuance to $211 billion—about 2% higher than the $206 billion issued in the comparative period of 2013.

Market sentiment was affected by debt woes in Argentina and Portugal. Heightened geopolitical risks coming from the Middle East and Russia-Ukraine also preyed upon market sentiment. Recent comments on credit risks voiced by a number of Fed officials, including Fed Chair Janet Yellen, also played a role. These factors affected high-yield debt (SJNK) issuance.

Why were oil and gas firms major issuers of high-yield debt?

Purpose of issuance

Out of the eight deals to hit the primary market last week, there were two deals each for financing leveraged buyouts (or LBOs) and acquisitions. Financing from the remaining transactions was earmarked for refinancing older debt, dividend payments or recapitalization, project financing, and general corporate purposes.

Why will issuers continue to seek recourse to the high-yield debt market?

Yields in the high-yield space are still attractive enough for small and mid-cap firms to pursue buyouts and acquisitions. Compared to historical data, yields still remain low due to the Fed’s accommodative monetary policy. Recent economic data showing low wage growth, labor market slack, and inflation short of the Fed’s target, are likely to keep rates low going into 2015. These factors are creating a favorable environment for issuers. The remainder of 2014 may see a rush of merger and acquisition (or M&A) deals in a final scramble to complete transactions before the rate tightening cycle commences.

Refinancing deals, which involves retiring older and costlier debt by issuing new debt at more favorable terms, would also see increased activity.

However, investors would likely demand higher yields as new issue volumes gather sufficient traction because they’re already beginning to price in higher risks associated with junk-rated (JNK) debt.

Issuance by sector

Smaller oil and gas (UNG) sector firms were major issuers last week. When the economy is gaining momentum, oil and gas sector (USO) firms generally tend to do well as energy demand spikes. Energy firms are also good hedges against inflation, which often accompanies economic growth.

Two exchange-traded funds (or ETFs) that invest in the energy sector include the United States Oil Fund LP (USO) and the United States Natural Gas Fund LP (UNG).

You can read about the major issues last week in the following section.