With oil trading just off its 52-week highs (at $46 WTI and $47 Brent) and with natural gas trading on its 52-week highs (at $2.76 NYMEX) I thought now would be an appropriate time to review five bond structures which I've either taken particular issue with or which I think could come under significant pressure in the immediate-term. Should commodities retrace lower, even just temporarily, the bond structures detailed within this note could see substantial pricing degradation. Should commodities retrace "lower for longer", the bond structures detailed could be permanently impaired.
While I do feel that a regular review of bond fundamentals is helpful to fixed income investors/traders I also believe that a regular review of a particular enterprises bond structure can help equity traders risk manage with greater accuracy. As stated in prior bond reviews, I truly believe that "credit leads equities"; after all, credit/debt traders are in fact trading less liquid vehicles, vehicles with wider bid/ask spreads (which makes active trading punitive - this isn't uniform across issues of course), and vehicles which usually require larger incremental capital exposure (i.e. bonds have minimum issue values which set a "floor" value that must be invested to take a position - bond traders don't have the option of buying "single shares"). Even if you're an "equity only" investor, knowing where and how an enterprise's bonds trade is paramount to risk management.
Chesapeake Energy (NYSE:CHK):
Above is a bird's eye view of the entire Chesapeake Energy GAAP-defined "Long-Term Debt" structure (i.e. this doesn't include convertible issues that are not structured as Notes, this doesn't include preferred issues, this doesn't include contractual obligations not GAAP-defined as "Long-Term Debt", etc.). It should also be noted that this data-visual doesn't include Chesapeake's Revolving Credit Facility. That said, this data-visual allows us some insight into the unique situation at the energy giant.
First, I highlighted Chesapeake's Second Lien Notes - which are currently next in line to the Revolving Credit Facility to claims on assets in any eventual restructuring (should a restructuring take place that is) - in an effort to make obvious the Second Lien Notes' unusual mid-pricing positioning within the total pricing structure. Why is this unusual? Well, being most senior to claims on assets in a worst case scenario (i.e. having the first "dibs" on recovery value to all the other issues presented within the data-visual) the Second Lien Notes should be pricing higher than all other issues. The only exceptions to this rule should be immediately maturing debt that has substantially zero duration risk.
However, we see this is clearly not the case. As detailed in prior analysis of Chesapeake, I believe this is because market participants realize that eventually, and for as long as it's able to do so, Chesapeake will have to swap debt for equity at whatever pricing is being demanded by debt holders. With Chesapeake being in a strictly dominated position (to bondholders) and with Chesapeake needing to deleverage at literally any and all costs, bondholders are bidding up the pricing of junior bonds despite having zero realistic claim to assets in any restructuring scenario. Bidders buying these unsecured, junior tranche bonds are banking on either selling them higher into any misled optimism regarding Chesapeake's long-term viability or on Chesapeake buying them back at near full-value. This dynamic is why I've highlighted Chesapeake's long-term debt structure within this note.
Should commodities retrace substantially lower, should Chesapeake issue a senior bond tranche (to the bonds junior to the Second Lien Notes; likely this would be a tranche junior to the Revolving Credit Facility but senior to the Second Lien Notes), and/or should Chesapeake's equity reprice lower to a point where the equity is no longer readily usable in debt/equity swaps - the entire long-term debt structure would come under serious pricing pressure. Literally every single issue within the data-visual above has serious risk weighting. In fact, if Chesapeake doesn't have perfect execution of its destressing strategy as well as several other low probability events take place - all but the Second Lien Notes above could be permanently impaired.
I believe only Chesapeake's Revolving Credit Facility, Chesapeake's Second Lien Notes, and Chesapeake's to come 1.5 Lien Notes have anything of recovery value.
California Resources Corp (NYSEMKT:CRC):
While California Resources offers us a more traditional pricing structure - one in which the most senior issue, the Second Lien Notes, trades at the highest part of the pricing structure - it offers one that is no less concerning than that presented by Chesapeake. None of California Resources' bonds (ex. the Second Lien Notes) trade above fifty cents on the dollar and its most senior issue - those Second Lien Notes highlighted - trades at just seventy-five cents on the dollar. As California Resources as an enterprise has come under significant stress, I believe its Second Lien Notes have traded in-line with expected recovery value in a restructuring scenario (i.e. a bankruptcy filing); this implies that the Second Lien Notes highlighted above don't expect to be made whole in a bankruptcy. That's not good for anybody but that's especially not good for junior bond issues and common stock holders. If the Second Lien Notes aren't (or don't expect to be) made whole in a bankruptcy filing this would mean zero recovery value would trickle down the cap structure to junior bonds and/or equity.
I believe only California Resources' Second Lien Notes to have anything of recovery value.
Stone Energy (NYSE:SGY):
Stone Energy is a really, really interesting enterprise from a capital markets standpoint. Because of some recent financial engineering Stone has an extremely tight trading-float (of equity) - this can, in some instances, cause extreme volatility. This has certainly been the case with Stone as of late with the E&P's underlying equity experiencing 15-20% daily moves on a regular basis; lately, these moves have been higher.
But don't mistake a low-float equity, which happens to be a current Social Finance darling, trading higher for long-term viability. I believe Stone to have none of the latter. Apparently, so too do Stone's debt vehicles.
Stone's bonds, which are both unsecured and are both well junior to its Revolving Credit Facility, both trade under fifty cents on the dollar. Both have also seen precipitous drops in pricing since the turn of the New Year - as it has become more and more obvious to debt traders than Stone is absent 1) long-term viability and 2) anything of meaningful recovery value for the issues.
I believe Stone to have zero equity value and to have minimal recovery value for either issue displayed in the data-visual above.
Rex Energy (NASDAQ:REXX):
Rex Energy is definitively the most stressed, as of the writing of this note, of the enterprises we've covered so far (although it won't be the most egregious in ultimate result). It should be noted that the above data-visual does NOT include Rex's recent 1%/8% Second Lien Notes - which only recently were registered for trading and have been excluded. It should also be noted that the issues comprising the data-visual above are extremely small in outstanding face value, the result of Rex executing a debt exchange and other financial engineering. Again though, as with Chesapeake, we can still take several key conclusions from the data-visual above.
Of the remaining face value of outstanding junior bond issues, again junior to the outstanding Second Lien Notes (not pictured above), no issue trades substantially above twenty-five cents on the dollar. As mentioned in prior enterprise analysis - this implies substantially zero recovery value in any eventual restructuring. With Rex's Second Lien Notes having to be issues with a variable tethered interest rate simply to provide Rex with anything of visibility into immediate-term survival it's no doubt the junior bonds trade at such low and obviously stressed pricing. While not wanting to reiterate concepts explained in the note above - if Rex's junior bonds aren't anticipating being made whole in a bankruptcy this would mean zero recovery value for equity holders.
I believe nothing but Rex Energy's Second Lien Notes to have anything of recovery value.
Bill Barrett Corp (NYSE:BBG):
Bill Barrett is the least stressed of the enterprises we've broken out within this note; which should be readily apparent given the seventy-five cents on the dollar (or higher) pricing of each issue in the data-visual. I also don't believe Bill Barrett to be at any imminent restructuring risk (i.e. I don't believe any sort of bankruptcy filing or other major event is of high visibility at this point). However, I did want to highlight Bill Barrett for a few reasons that I think readers might find interesting.
First, Bill Barrett has quite questionable IRR's for production - I've detailed these in prior analysis of the E&P. In that, and clearly exampled in the middle of the data-visual above (see the large "U" shape), Bill Barrett's entire cap structure (inclusive of equity) should be highly tethered to underlying commodity pricing; much more so than other names in the space. That, as it did in the middle of this data-visual, could and should leave Bill Barrett's bonds open to sizable downside pricing pressure if commodities have anything of a pullback. That's worth keeping in mind from the short side.
Second, if commodities don't pull back - let's say they move substantially higher - Bill Barrett has an untapped Revolving Credit Facility that it could lean on to fund aggressive growth development. If the E&P decides to do this, that would "dilute" its cap structure (speaking specifically of the debt instruments) and move the existing bond issues (which are junior to the Revolving Credit Facility) further "out of the money" if commodities ever retraced lower from our hypothetical higher pricing. That would create a lower-lows band (or level of pricing) for pricing of the junior issues and potentially sub-thirty cents on the dollar pricing in that environment; it should be noted that the bonds traded to thirty cents on the dollar in the middle portion of the data-visual above during the most recent commodity pullback (February 2016). So, don't think I'm exaggerating in any way.
Generally though, Bill Barrett's bonds are fairly stable and I'd be sure to have a macro-commodity opinion (bearish of course) prior to initiating anything directional here.
Good luck everybody.
Disclosure: I am/we are short CHK.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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