Juicy Yields on Energy Bonds Attracting PE Firms

Crude price volatility may not have completely closed the funding doors for US high-yield energy companies as private equity firms and new funds prepare to snap up juicy yields on offer after a recent slump in the sector's bonds.

In a likely sign of things to come, GSO Capital Partners, the alternative asset manager owned by Blackstone, last week deployed cash by providing a large order for CrownRock's US$350m high-yield bond - the first such E&P offering in months.

The move came after Blackstone President Tony James said last month it has US$10bn in equity and debt capital available for energy investment opportunities.

GSO is now raising a new fund solely for energy, expected to be US$2bn, a source familiar with the matter said.

"We expect a number of transactions to happen in the next three months," said Dwight Scott, a senior partner at GSO who focuses on the energy sector. "And it's all about liquidity."

The same buyside investors burned by the sell-off in oil are now sifting through which companies they believe will outlast the slump in crude prices. And companies prepared to pay a premium are finding willing buyers.

"We do not see oil prices getting back to US$100 in the long-term, so for us the big question is about whether the capital returns work," Joe Lind, a portfolio manager at DDJ Capital Management, told IFR.

"Are the costs of the company low enough that they can still operate in a world with lower revenues?"

US crude prices have recovered from lows of US$43.5 just a couple of weeks back, inching back up to US$53. That has helped drive a 100bp rally in energy bond spreads in the past three weeks. But at 728bp over US government bonds, they still offer an extra 250bp spread to the broader high-yield sector, according to BAML.

The new CrownRock bond, for example, came with a coupon of 7.75% and yield of 8% - nearly 200bp better than the current 6.2% yield-to-worst on the Barclays High Yield Index.

PICKING THE RIGHT SPOTS

In another example, GSO this week joined up with Magnetar Capital to provide US$300m of secured commitments to Texas-based driller Jones Energy to help repay borrowings under its revolver.

The debt component, a US$250m eight-year bond, pays a hefty coupon of 9.25% - some 250bp higher than the 6.75% interest payment on a US$500m eight-year bond sold by the company in April 2014. The 2022 bonds have sunk to 91.75% of face value following the rout in energy names.

The swoop back into junk-rated energy bonds is expected to be a saving grace for a sector that is facing dwindling access to funds from traditional bank lenders.

The twice-yearly reset of revolvers and other loan agreements is always a fraught time for exploration and production companies, but this year will be trickier than most.

There are roughly US$250bn of revolvers outstanding for US E&P names, and some analysts expect that to be cut by at least US$25bn to US$37.5bn, or some 10% to 15%.

"It might be a bit premature yet, but the reset of revolvers in the spring will likely be a catalyst," said Jonathan Insull, a portfolio manager at Crescent Capital.

"There will definitely be opportunities."

A head of US credit trading desk, meanwhile, said early signs were that banks were not being very aggressive just yet.

"We've not seen many revolvers cut significantly, and in some cases they have even been increased," said the trader.

"The opportunities that funds are looking for are more likely to come in the fall, provided oil prices do not bounce back. Oil companies will have cut production more dramatically by then."

The US high-yield bond market remains virtually closed to all but the highest-quality borrowers - which leaves out the lion's share of riskier E&P names.

Most refinancings thus are likely to be in the guise of second-lien loans, and investors intend to demand on strict covenants which offer them better protections.

INSIDE TRACK

Joint ventures may also be on the horizon.

GSO will fund the entire costs associated with drilling new wells for Linn Energy in return for 85% of their cashflows, until it reaches a 15% internal rate of return.

"We provided dollars that sit outside of the capital structure," said GSO's Scott.

"It's good for the company as it doesn't increase their leverage, and good for us as we don't have to worry about the credit risk."

Other players are now looking at copycat trades.

"It was a great deal," said the trader.

"It gives GSO a great return on a first lien basis, and also provides them with a link to Linn down the road if they need further financing. A lot of people are looking to replicate that deal." (Reporting by Natalie Harrison; Editing by Marc Carnegie and Shankar Ramakrishnan)