Oil is less than $10 per barrel away from a level where it could begin wreaking havoc across the high-yield bond market.
When crude drops below $35 a barrel, the debt-to-enterprise value ratios of high-yield energy companies typically climb above 55 percent, according to Deutsche Bank AG strategists including Oleg Malentyev. That would increase risk premiums and affect the wider high-yield market, they said.
“Oil weakness to this point is problematic directly to energy valuations but is not yet a cause for credit-loss concerns in energy or the broader high-yield market,” the strategists said in a research note. “We are getting closer to the point where this narrative could begin to change.”
Junk-bond investors are on the lookout for any signs of contagion from oil’s latest foray into a bear market after a plunge in the commodity last year sent yields to the highest level in more than four years. The average yield on the Bloomberg Barclays Global High Yield Index advanced 14 basis points to 5.33 percent last week, while WTI crude’s drop below $43 a barrel caused at least three companies to scrap bond and loan sales.
Yields on sub-investment energy bonds could add another 50 to 75 basis points to their advance of one percentage point in the past month, according to the Deutsche Bank strategists, who have an underweight recommendation on the sector. If debt-enterprise value ratios stay below 55 percent, a major spillover into the broader high-yield space is unlikely, they said.
Oil recovered some of its losses on Tuesday, with WTI futures adding 0.8 percent to $43.73 a barrel on estimates that U.S. crude inventories continued their decline from record levels seen earlier this year.
“We would become mindful of implications for the broader high-yield market if oil were to drop under $40, and particularly if it were to head toward $35,” they said.
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