OREANDA-NEWS. Weak commodity prices could continue to raise the subordination risk for natural resource fallen angels, according to Fitch Ratings. Additionally, while lien limitations provide a line of subordination defense, the lack of explicit guarantee language and, in some cases, lax lien carve-out provisions can provide fallen angels with additional subordination opportunities.

The commodity downcycle has created a need for companies in the natural resource sector to preserve and generate liquidity. The traditional playbook has been some combination of operating cost cuts, capex reductions, asset sales and secured/unsecured debt and equity issuances. However, Fitch has more recently observed an ability and a willingness by some fallen angels in the natural resources sector to use provisions within the terms of their unsecured bond indentures to issue subsidiary-guaranteed debt. This structure has involved material operating subsidiaries providing guarantees directly to debt issued by the parent company, which structurally subordinates existing unsecured debtholders.

Four natural resource fallen angels have issued subordinating debt with three using subsidiary-guaranteed debt. The move to issue subsidiary guaranteed debt was kick started by two bank-related transactions executed by Weatherford International plc (rated B+/Negative by Fitch) and Teck Resources Ltd (rated B+/Negative by Fitch) in May 2016. Many banks seem to have seized on credit facility renegotiations as an opportunity to push for priority and sometimes to reduce their lending exposure. Liquidity and maturity management appears to be the focus of these transactions, which should enhance natural resource fallen angels' ability to bridge through the cycle.

Fitch believes subordinating transaction candidates are likely companies with credit facilities maturing in 2017 and 2018, sizable maturity profiles and/or exposure to a prolonged downcycle. Another consideration is the fallen angel's susceptibility to lien limitation contraction, which is typically limited to a percentage of consolidated net tangible assets. In a downcycle, this secured debt capacity may contract as reported asset values shrink due to lower activity, underinvestment and/or impairments. Expectations of lower asset values may encourage some fallen angels to issue secured debt sooner rather than later.