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zh<>BP debt to be rated as junk? Bond and derivatives market say yes.

Submitted by Cheeky Bastard on 06/10/2010 04:23 -0500

Some interesting tidbits coming from the credit markets about BP longterm debt prospects. As reported by Bloomberg, across-the-board downgrades of BP debt are almost imminent.

BP’s $3 billion of 5.25 percent notes due in 2013 fell as low as a record 89.94 cents yesterday, pushing the yield to 7.57 percentage points more than Treasuries. The spread compares with an average of 7.26 percentage points for junk bonds, Bank of America Merrill Lynch indexes show. The cost to protect $10 million of BP debt for a year with credit-default swaps almost doubled to $512,000, according to CMA DataVision. It was $29,000 on April 30.

My personal belief is that the market is pricing in the risk of cash reserve depletion due to the run up in costs of GoM spill service. Credit Suisse had this to say regarding BP debt:

Debt investors are losing confidence in London-based BP as the company fails to contain the oil leak in the Gulf of Mexico. BP said June 7 it has spent $1.25 billion so far, or about $27 million a day, related to the accident. Credit Suisse Group AG estimated the total cost may reach $37 billion.

Here is the ballance sheet [end of 2009] summarization of BPs assets and liabilities:





The alarming metric here is the rate of cash holding deterioration; which now runs at a whooping 15% of total cash and cash equivalent holdings as of end of 2009. And let us not forget that little has been achieved so far regarding the problem. Even if BPs estimates as to how much oil is now being recovered with their latest effort are true [I personally doubt any and all "official" figures]; there still exist the question of whether or not there is another, far bigger and more damaging leak located 5-6 miles from the acknowledged one.

Matt Simmons, one of the most regarded experts in the oil industry, says that yes; there is a much bigger, and more damaging leak:

http://www.zerohedge.com/article/bp-debt-be-rated-junk-bond-and-derivatives-market-say-yes?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+zerohedge%2Ffeed+%28zero+hedge+-+on+a+long+enough+timeline%2C+the+survival+rate+for+everyone+drops+to+zero%29

This means that if/when BP acknowledges the existence of this leak the costs to service the damage will not only exceed cash and cash equivalent holdings, but will require of BP to either resort to liquidation of some of its assets or to sell new debt [which will solely serve the purpose of financing the services required to dent the impact of the leak] in the open market.

That debt will surely be priced as junk since the current debt ratings are nowhere near as representative of the gravity of the situation as are the price movements in the derivatives and bond market.

Credit-default swaps on BP implied a Ba2 rating for the company as of June 8, nine steps lower than its actual Aa2 grade at Moody’s Investors Service, based on data from the ratings firm’s capital markets research group. The implied rating was as high as A3 on May 28, the data show. Junk bonds are rated below Baa3 by Moody’s and lower than BBB- by Standard & Poor’s.

As mentioned above; both derivatives and the bond market price BP debt as junk. Yields and spread signal that another wave of downgrades is but a certainty. These are the movements in BP CDS spread as of 8:30 am GMT:
Spread has widened to 538.23 bps for 5 year debt, or 152.31 basis points from yesterdays close which is an increase of 39.47%

We will monitor the situation closely all through the day. Market expects downgrades before weekend and those could happen today. If anything new emerges relevant to this situation during the day, you will be fully updated in the comments section.
OT: Worthy of a read is the article Tyler posted yesterday and in which he discusses potential counterparty risk regarding the OTC derivatives which reside on BPs balance sheet.