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North American Shale Producers Drove 1Q Downgrades, Says Fitch

The oil and natural gas sector accounted for the most downgrades in the first quarter at 28%, driven by the decline in oil prices that most impacted North American shale producers, according to Fitch Ratings.

"Weak oil prices have significantly reduced the rating headroom for many oil and gas companies that went into the slump with stretched credit profiles," said analysts on Wednesday. "This is particularly true among speculative-grade entities that have a concentrated risk and/or small operating base.

"Negative rating actions, including those for investment-grade entities, have reflected limited headroom in the prior ratings. For speculative-grade issuers, downgrades have also reflected their vulnerability in the current cycle, such as liquidity or stretched credit profiles."

Oil prices should remain low versus June 2014 levels "over the next three years," analysts said. Fitch reduced base West Texas Intermediate price assumptions in early 2015 to $50/bbl in 2015, $60/bbl in 2016 and $75/bbl in 2017.

"Continued negative rating actions will be driven by company actions in response to weak prices, and the risk that the recovery in the oil price is slower than Fitch anticipates. Upgrades will probably be limited over the next 12 months."

In response to the commodity price slump, exploration and production companies, along with the service providers, have made significant reductions to planned capital expenditures (capex) because the economics of the new projects are less attractive.

"The biggest cuts have been made by North American shale producers, which typically have high financial and operating leverage and low ratings," said Fitch analysts. "Capex cuts have been smaller among global integrated oil and gas companies with higher ratings" because of the "need to continue investing through the cycle.

"The expected decline in drilling and services costs in the current downcycle will be a partial offset to low oil prices for exploration and production companies. While the benefit is global, it is especially concentrated in onshore North American shale companies."

Fitch noted that energy sector defaults hit the institutional leveraged loan market in March for the first time since December 2013. At the end of March, the energy trailing 12-month (TTM) sector institutional leveraged loan default rate stood at 1.7%, higher than its 1% long-term average.

Analysts cited Chapter 11 bankruptcy filings by U.S.-based onshore operator Quicksilver Resources Inc. (see Shale DailyMarch 18), as well as marine contractor Cal Dive International Inc., "which serve as bellwethers..." Houston-based explorer Dune Energy Inc. also sought bankruptcy protection in March (see Daily GPI, March 9; March 4). The default rate is "expected to rise further on Shoreline Energy's early April bankruptcy filing and Sabine Oil and Gas' April 21 missed interest payment" and "Samson Investment is also engaged in restructuring discussions" (see Shale DailyApril 2).

The energy sector is seen as "an outlier for leveraged loan defaults while it navigates the current rough patch," said Fitch's Eric Rosenthal, senior director of leveraged finance.

The overall TTM leveraged loan default rate fell to 3.6% in March from 3.9% in February. Average coverage improved to 3.4 times at year-end 2014 from three times one year earlier, while revenue and earnings also increased over the same timeframe. Average leverage declined 10% over the past year to five times to five-and-a-half times.

"Despite the increased energy default rate, the industry comprises just 5% of outstanding institutional leveraged loans compared with 18% of the high yield bond market," Rosenthal noted. "At 14%, services and miscellaneous is the largest sector, followed by computers and electronics, and healthcare and pharmaceutical."

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