Corporate debt defaults in the first half of 2020 already surpassed the total number of defaults reported in all of last year. In the second quarter, 54 defaults occurred, nearly three times the total for the first quarter of this year.
Moody’s Investors Service reported the data Friday in its second-quarter U.S. Corporate Default Monitor. Nearly a third (30%) of second-quarter defaults came in the oil and gas sector. The oil patch was responsible for nine bankruptcies, six distressed exchanges and one missed interest payment. The one missed interest payment also resulted in a Chapter 11 filing by California Resources in mid-July.
Other notable oil and gas bankruptcies were Chesapeake Energy, Whiting Petroleum and Diamond Offshore Drilling. Moody’s noted that 38% of the oil and gas defaulters had either executed distressed exchanges or filed for bankruptcy protection before last quarter.
Only six of the non-energy sector defaulters filed for bankruptcy protection, according to Moody’s. More than half (58%) of these defaulters were owned by private equity firms that prefer out-of-court debt restructurings that allow them to preserve equity and avert bankruptcy. Moody’s expects more distressed exchanges in the near term, given private equity’s ownership of speculation-grade companies.
The dollar value of the defaulted debt in the second quarter reached nearly $100 billion, almost equal to the peak during the 2008 to 2009 financial crisis. The default rate at the end of June was 7.3%, the highest in a decade, and the worst is yet to come. Moody’s baseline forecast indicates that defaults will peak at 12.4% in the first quarter of next year before dropping to 10.5% in June 2021.
Of the 54 second-quarter defaulters, 21 had more than $1 billion in rated debt. The oil and gas patch led with eight billion-dollar-plus defaults, trailed by the retail sector with three and the services and telecom sectors with two each.
The outlook going into 2021 is particularly grim for smaller, highly leveraged oil and gas firms. Low prices for crude will lead to lower cash flows, from which follows lower liquidity and, finally, more leverage. These companies will be forced to curtail operating costs by cutting production leading to even lower cash flow unless crude prices jump, an eventuality that appears increasingly remote.
At the moment, Moody’s has a negative outlook on every industry sector, the first time that has happened since the firm began tracking that data in 2008. The ratings agency released its first-ever negative outlook on the oil and gas midstream (pipeline) sector back in June.
Moody’s list of companies with probability of default ratings of Caa (speculative, with very high credit risk) or worse increased by more than 30% in the second quarter from 103 at the end of the first quarter to 135. Nearly two-thirds (65%) of these firms are owned by private equity and, according to Moody’s, “are facing governance risk associated with private equity ownership given the aggressive financial strategies employed by these owners.”
Since March 2020, Moody’s reports, the number of rating downgrades mainly affecting lower-rated speculation-grade debtors has led to a near doubling of Caa and lower population, and the overall B3 and below ranks grew to 45% by the end of June. The longer the COVID-19-driven economic downturn lasts, the more companies will see their credit ratings fall to Caa levels or worse.
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