Defaults on the bonds of energy, metals and mining companies are intensifying, as China’s decision to devalue the yuan added to a meltdown in energy and commodity prices and pushed the U.S. oil benchmark to a six-and-a-half-year low.
On Thursday, Fitch Ratings revised its corporate-default outlook to reflect an expectation of more defaults in the high-yield debt sector, where energy companies account for around 14% of the market and miners about 2%.
The metals-and-mining trailing 12-month default rate was raised to 10% on Thursday from 7.1% in July. Fitch said the default rate could jump to 15% by the end of August. The overall default rate rose 3%, up from 2.5% in July.
China is the world’s largest consumer of commodities and, when it comes to metals, is the largest producer of many as well. So it’s decision to devalue its currency on Tuesday, which followed a spate of economic data that showed slowing growth in Beijing, sent energy and mining sectors into a further slide.
China’s devaluation could hurt U.S. companies in the metals and mining sector in two ways:
On the consumption side, it makes metals more expensive for Chinese consumers, which means chinese imports would decline. On the production side, it “adds pressure to the cash flows of any company that has a dollar-based cost structure,” said Mark Sadeghian, Fitch’s oil-and-gas group head.
“A shortfall in Chinese demand would be particularly bad news for commodity-based industries,” Marty Fridson, chief investment officer of Lehmann Livian Fridson Advisors said in a research note for S&P Capital IQ.
The metals-and-mining sector ranked 26th out of 35 industries listed on the BofA Merrill Lynch U.S. High Yield Index, with negative returns of 0.967% in the first week of August, according to S&P Capital IQ. That was on top of a negative 13.5% return in the first seven months of 2015.
Investors fleeing energy bonds
Meanwhile, the default-rate outlook in the energy sector was also revised higher to 4% for August, up from 2.5% at the end of July and more than twice its 1.9% historic average, Fitch said.
The market has priced in a higher default rate, according to a Wednesday report by LPL Financial.
LPL says the market-implied default rate on the high-yield energy sector is 15% over a one-year time frame, according to the report.
To be sure, not everyone holds such a dour outlook for high-yield energy and metals bonds.
“We view such a big acceleration in defaults as unrealistic. The high-yield bond market has basically priced in a significantly negative outcome that may not materialize,” Anthony Valeri, LPL’s investment strategist, said in a note.
MarketWatch
