Investor aversion to the slumping energy industry is so strong that even some debt of TransCanada Pipelines Ltd., the highest-rated Canadian pipeline business, is being shunned.
A TransCanada investment-grade bond is trading with an 18-per-cent yield to call that's in line with companies rated in the lowest portion of junk, which usually signals that credit raters are expecting a default.
The bond's movement tracks the nearly 60-per-cent decline in the U.S. benchmark West Texas intermediate oil price from 2014's high. Record levels of production along with decreased global demand have driven investor concerns that oil and gas companies may not be able to shore up their balance sheets any time soon.
"There's uncertainty around the financial health of the producers and their ability to operate through this price environment," said Peter Molica, a New York-based pipelines analyst at Fitch Ratings, which doesn't rate TransCanada. "There is concern that will weigh on the midstream" part of the business, including pipeline operators.
Mark Cooper, a spokesman for TransCanada, said the company doesn't comment on trading activity or the price of its securities.
TransCanada, which is lobbying the U.S. government to build the controversial Keystone XL pipeline linking Alberta's oil fields to U.S. refineries on the Gulf Coast, has investment-grade ratings from Standard & Poor's and Moody's Investors Service and in July reported second-quarter profit that beat analysts' estimates. Still, some of its debt is being treated like that of a company on the financial ropes.
The TransCanada bond trading at distressed levels is rated BBB, two steps above junk, with a 6.35-per-cent coupon and a 2067 maturity. It is a hybrid, in the sense that the debt is tied to issuing new equity under certain circumstances.
Companies began issuing hybrids prior to the 2008 financial crisis because they let borrowers defer interest and principal payments and don't affect the company's credit rating. About 1 per cent of actively traded corporate bonds are hybrids, according to data compiled by Bloomberg.
Since the downturn, bondholders have been selling off their hybrids because the relatively lower rank of the security means that investors get paid out after holders of higher-ranked bonds. That helps make a junior hybrid bond more volatile than its senior peers, said Phil Adams, an analyst at debt researcher Gimme Credit.
"When the going gets tough, you can't get a bid on them," Mr. Adams said by phone from Chicago.
TransCanada isn't the only investment-grade energy company with a bond trading at a distressed level. NextEra Energy Capital Holdings Inc. has a BBB-rated bond with a 6.65-per-cent coupon maturing in 2067, trading with an 18-per-cent yield, according to data compiled by Bloomberg.
A bond's yield to call measures how much it pays out assuming the debt is paid back at the earliest possible date. The yield to call on TransCanada's 2067 hybrid bond started spiking two months ago as oil prices collapsed, sending borrowing costs for all oil companies higher and making it less likely the company will take advantage of its May, 2017, call date. After the bond's call date, the 6.35 coupon automatically goes lower to a floating rate of three-month Libor plus 2.21 per cent, or about 2.5 per cent at current rates.
"It's pretty cheap debt for them at that coupon," said Jack Flaherty, a fund manager at GAM USA Inc. "Nobody believes it will be called."
The picture looked a lot different for investors when the bond was announced in 2007, with oil at $65 (U.S.) a barrel and heading toward a record high of $145.29 the following year. The 2067 bond was trading above its $99.82 issue price with a yield around 5 per cent in June, 2014, before the oil drop accelerated.
TransCanada is in better shape than many energy companies, with its bonds – excluding hybrids – rated investment grade. Still, bondholders are going to want to know the company is protecting its balance sheet and credit rating through the oil price volatility before interest in the hybrid revives, said Gimme Credit's Mr. Adams.
Even better news would be an improvement in the price of crude or approval of the $8-billion Keystone XL project from U.S. President Barack Obama.
"If these things happen and happy days are here again, then people will buy them," Mr. Adams said.
For now, the languishing price of oil will keep people away, said Mr. Flaherty of GAM USA.
"Now people are looking at things on a much less optimistic, more pessimistic scenario."