OREANDA-NEWS. The majority of recent distressed debt exchanges (DDEs) in the energy space have provided limited interest relief to high-yield E&P companies, according to Fitch Ratings. In several cases, outside of the exchange transaction itself, additional secured debt was issued, increasing total cash interest costs. As the overall interest relief provided in these transactions was limited, in a lower-for-longer commodity price environment, further restructurings may be needed to right-size capital structures, highlighting continuing risks for unsecured bond holders. Exchanges to date have generally fallen into two types; exchanges that swap unsecured debt for higher priority secured claims or equity, with limited impact on overall liquidity, and exchanges where incremental second- or third-lien debt is issued, generating liquidity at the cost of higher interest expense.

Liquidity-neutral exchanges have primarily reduced unsecured principal balances without significant reductions in annual interest costs, lowering pro forma leverage metrics while not materially improving cost structures or interest coverage. An example includes Halcon Resources (HK) third-lien exchange in August, which lowered balance sheet debt by approximately \\$550 million on a base of \\$3.89 billion in debt at March 31, 2015, but produced pro forma annual interest savings of just \\$12 million, or less than \\$1 per barrel of oil equivalent (boe) based on run-rate production of 15.5 million boe per year.

Liquidity-enhancing transactions have created a cash buffer for several high-yield names, including Midstates Petroleum (MPO) and Sandridge Energy (SD). For example, MPO's debt exchange in May converted \\$630 million in unsecured notes into \\$504 million of third-lien notes (10% coupon with 2% PIK feature), resulting in annual interest savings to the company of \\$15 million assuming exercise of the PIK feature. Concurrently, MPO's second-lien issuance bolstered liquidity by adding cash to the balance sheet. However, when accounting for interest costs associated with the company's second-lien debt, total interest costs increased by \\$47 million per year, or approximately \\$2/boe. It is important to note that the capital markets window that allowed a number of the liquidity-enhancing second- and third-lien note deals to be done was open for a relatively brief period earlier this year when oil prices spiked up, but has since remained closed.

In these transactions, liquidity has come at the cost of higher interest costs per boe, decreasing the competitiveness of the company's cost structure in the short run. For companies making this trade-off, a return to higher oil and gas prices or additional reductions in operating costs may be necessary to overcome higher interest burdens. In general, interest costs of over \\$10/boe are indicative of aggressive capital structures and serve to lower competiveness, given the inability to lower these costs outside of restructuring activities or production growth, which is less likely in a commodity downcycle.