S&P: As Oil & Gas Rebounds, US Distress Ratio Sinks to Lowest Level Since 2014

The U.S. distress ratio has dropped to its lowest level since September 2014, tightening to 6.5% in January, from 7.4%, amid strengthening commodity prices, according to S&P Global Fixed Income Research.

distress ratio“The oil and gas sector continued to improve throughout 2017 as hydrocarbon prices recovered and stabilized,” noted Diane Vazza, head of the S&P Global Fixed Income Research group, in a Feb. 1 report titled “Distressed Debt Monitor: Strengthening Commodities Sectors Compress The Distress Ratio To Its Lowest Level Since 2014.”

“Accordingly, since their highs in February 2016, the distress ratios for the oil and gas and metals, mining and steel sectors have steadily decreased,” Vazza said.

Moreover, the oil and gas sector accounted for the highest month-over-month decrease in the number of distressed credits, moving to 15, from 23. As such, the oil and gas sector’s distress ratio decreased to 7.9% as of Jan. 15, from 88.5% as of Feb. 16, 2016.

The outlook for the oil and gas sector in 2018 is generally stable, reflecting a continued flattening of oil and natural gas pricing, but performance will depend heavily on potential OPEC production cuts and price volatility, S&P Global says.

The distress ratio for the metals, mining and steel sector decreased to 5.6%, from 82.3% over the same roughly two-year period referenced above.

Distressed credits are speculative-grade (rated BB+ and lower) issues with option-adjusted composite spreads of more than 1,000 basis points relative to U.S. Treasuries. The distress ratio (defined as the number of distressed credits divided by the total number of speculative-grade issues) indicates the level of risk the market has priced into bonds.

As of Jan. 15, the retail and restaurants sector had the highest distress ratio at 17%, followed by the telecommunications sector at 15.9%. — Rachelle Kakouris

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NRG Energy Scraps $870M High Yield Bond Deal

Electric power concern NRG Energy has pulled an offering for $870 million of 10.25-year (non-call five) notes, according to a company statement. The cancellation was “in response to broader market conditions.”

Citi, Credit Agricole CIB, and Deutsche Bank were bookrunners on the deal, which sources say saw initial price talk at 5.75%. Proceeds would have been used to finance a tender offer for its $869 million of 6.625% notes due 2023, which has also been withdrawn.

Risk-on sentiments have waned in the high-yield market as of late, with U.S. high yield funds recording an outflow of $622 million for the week ended Nov. 8, following last week’s $1.2 billion withdrawal. Another sign of weakening was reflected in the Nov. 9 reading of LCD’s flow-name high-yield bonds, which showed the average bid for the 15-name sample dipping 114 bps, to 97% of par, for a new year-to-date low.

NRG’s would-be bond sale is the first to be pulled since Charter Communications scrapped its offering in June. — Jakema Lewis

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Private Equity Companies Gamble on Oil and Gas Defaulters—S&P Global

Given the apparent bottoming out of the decline in oil prices, improving credit conditions in the oil and gas sector, and the favorable financing conditions across markets currently, many distressed oil and gas companies appear to be a high-return bet.

However, risks do exist, and adding more debt to these firms’ existing loads may prove costly if interest rates rise, if the larger U.S. or European economy dips into recession, or if oil prices once again decline, S&P Global Fixed Income Research warned in a report this week.

The drop in oil prices that began in the second half of 2014 was particularly hard felt among U.S.-based shale oil producers, as this relatively expensive extraction method proved unsustainable amid an approximate 80% drop in oil prices.

“The speculative-grade default rate has risen in recent years primarily due to disproportionate stress in the energy and natural resources sector, where oil and gas companies have been struggling with falling revenue due to lower oil prices,” said Diane Vazza, head of S&P Global Fixed Income Research.

Private equity defaulters story table 2 2017-07-11(1)Moreover, many recent defaulters in the oil and gas sector have gained extra funding sources via private equity companies taking out ownership.

Recovery prospects
In terms of recovery prospects, bond prices for defaulting U.S.-based firms with private equity ownership do show some interesting distinctions among sectors. In the energy and natural resources sector, the average bond prices leading up to default were generally lower than those in other industries. But these same firms’ average bond prices were generally higher a month after default.

Generally, favorable recent bond prices for the oil and gas segment are in line with or slightly better than historical recovery rates.

The full report can be found here ($). — Rachelle Kakouris

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Oil Dive Hits California Resources, Other Energy Sector High Yield Bond Names

California Resources notes tumbled today as oil hit its lowest level in more than five weeks following a steep decline in crude prices triggered by a bearish U.S. inventories report that showed stronger than expected gains in gas stockpiles alongside a sluggish reduction in crude inventories.

Crude prices fell 3.6% in midday trading, to $44.78 a barrel, based on U.S. benchmark West Texas Intermediate, after a report by the Energy Information Administration (EIA) said gas inventories for the week ended June 9 climbed 2.1 million barrels and crude stockpiles fell by 1.7 million barrels. This compares with a Reuters poll forecasting a decline of 500,000 barrels in gas inventories and drop of 2.7 million barrels in crude stockpiles.

California Resources, whose ability to delever has long hinged on a crude recovery since its ill-timed split from Occidental Petroleum in 2014, saw its 8% 2022 senior secured second-lien notes drops 3.25 points, to 65.75, in afternoon trades.

Corporate and bond ratings are CCC+/Caa2 and CCC+/Caa3, with negative outlooks and a 4 recovery rating on the second-lien notes by S&P Global Ratings.

California Resources shares (NYSE:CRC) were down 8.5% to $10.82 in midday trading.

Other major decliners in the sector included EP Energy’s 9.375% 2020 notes and 8% 2025 notes, which fell 3.75 points and 2.75 points, respectively, according to MarketAxess, to 85 and 79. MEG Energy 7% 2024 notes were also changing hands at a steady clip, losing 1.25 points, to 82, while Whiting Petroleum 5.75% 2021 notes slumped 1.25 points in an active session, to 95.

Offshore drillers also took it on the chin, as Transocean 9% 2023 notes fell 1.312 points, to 104, according to MarketAxess, and Shelf Drilling 9.5% 2020 notes slid three-quarters of a point, to 98.75. — James Passeri

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Dynegy Notes Rise as PJM Capacity Auction Rattles Power Names

The long-awaited results of PJM Interconnection’s forward-capacity auction—the nation’s largest and a key benchmark in establishing the long-term rates among U.S. merchant power suppliers—were unveiled late Tuesday, sparking a sharp climb across a range of Dynegy’s unsecured bonds and rattling a slew of names in the sector.

Dynegy 8% notes due 2025 were among the most active in Wednesday trading, rising 2.5 points, to 96.25, according to MarketAxess, while the Houston-based generator’s 7.625% notes due 2024 and 7.375% notes due 2022 climbed 2.75 points and two points, respectively, to 96.25 and 98.

PJM Interconnection, the Valley Forge, Pa.–headquartered regional transmission organization (RTO), accounted for more than half of Dynegy’s roughly $1.25 billion in first-quarter sales, and made up 52% of the issuer’s 2016 wholesale power generation, according to a February filing with the Securities and Exchange Commission.

Although PJM’s banner numbers broadly missed analyst forecasts—primarily in the setting of a 2010–2011 payout rate to merchant suppliers of $76.5 rate per megawatt-day, down sharply from the roughly $100 rate for the previous period and a consensus range of forecasts of about $90–120—Dynegy was poised to gain in light of its unique position in regional markets, according to a Morgan Stanley report out Wednesday.

One zone in particular was the so-called DEOK zone, of which Dynegy is a majority owner, and which broke out for a positive performance for its first time, Morgan Stanley analysts added, underscoring their selection of Dynegy and NRG Energy as “top picks in merchant power.”

“Expectations were pretty low,” Cowen analyst Amer Tiwana noted of the PJM results in a Wednesday phone interview, noting that many merchant suppliers were benefited merely from the number of forecasters bracing for the worst, especially as the U.S. merchant power industry has been long pressured by an environment of low gas prices and a slate of new projects waiting to come on line.

Dynegy bonds have most recently been in the spotlight amid reports that Vistra Energy could be in the hunt with a takeover offer, with bonds climbing on the heels of a Wall Street Journal report last week that the two issuers have entered into preliminary discussions over a potential tie-up that would create one of the country’s biggest independent power generators.

Morgan Stanley noted in a separate Wednesday report that such a tie-up supports its Overweight thesis for Dynegy, especially in light of the benefits of regional diversity and the likelihood of cash flows significantly improving through expected annual cost savings of about $250–300 million.

“We see the strategic rationale for both companies of such a deal, and if a transaction was announced, we would expect it to be structured as a stock-for-stock basis due to change of control considerations on Dynegy’s debt,” the analysts noted.

Houston-based Dynegy’s corporate and bond ratings are B+/B2 and B+/B3, respectively, with a 3 recovery rating on the unsecured notes by S&P Global Ratings. — James Passeri

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Chesapeake Energy Eyes High Yield Bond Market for $750M Offering

Chesapeake Energy’s proposed $750 million offering of 10-year (non-call five) senior notes is talked at 8–8.25%, according to sources. Books are expected to close at 3 p.m. EDT with pricing to follow via joint bookrunners Citi, Credit Agricole, and J.P. Morgan.

Proceeds will be used to finance a concurrent tender offer for up to $750 million of Chesapeake’s outstanding debt, and for general corporate purposes. The issuer is looking to tender for its 8% senior second-lien notes due 2022, 6.625% senior notes due 2020, 6.875% senior notes due 2020, 6.125% senior notes due 2021, and 5.375% senior notes due 2021.

Chesapeake was last in the market in December when it placed $1 billion of 8% notes due January 2025, also to refinance existing notes. Those notes traded up to 102.25 this morning, yielding around 7.5%, from 99.75 Friday afternoon, trade data shows.

Existing issue ratings are CCC/Caa3. Corporate ratings are B–/Caa1, with positive outlooks on both sides.

Chesapeake Energy (NYSE: CHK) engages in the acquisition, exploration, and development of properties for the production of oil, natural gas, and natural-gas liquids (NGL) from underground reservoirs in the U.S. — Jon Hemingway/Nina Flitman

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GenOn Energy launches $540M of 1st-lien notes to redeem 2017s

GenOn Energy has launched $540 million of five-year (non-call three) secured first-lien notes. Goldman Sachs is sole bookrunner.

Proceeds from the 144A-for-life paper will be used on the consummation of the SPV merger, and together with cash on hand, to redeem or discharge the borrower’s $691.2 million of 7.875% notes due 2017. The bonds are subject to the make-whole call, which is roughly 100.2, according to trade data. The bonds closed last night at 71.5, according to S&P Global Market Intelligence.

The new bonds extend the borrower’s cash curve beyond the 9.5% notes due 2018 and 9.875% notes due 2020, which closed last night at 63.5 and 62, respectively.

The call schedule is non-market standard — note the longer-than-typical three years for a five-year term, and that the call premium drops from 50% in year one, straight to par in year two.

The 2017 maturity has been looming for some time. As reported, last year bondholders’ hopes were raised after the company announced it was selling a natural gas power plant for $365 million, and was to use capital to support general corporate purposes. As the maturity date has drawn closer the bonds have been downgraded numerous times, and are currently at CCC/Caa3.

The company is a subsidiary of NRG Energy, engaged in the ownership and operation of power-generation facilities. — Luke Millar

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Amerigas Sets $525M High Yield Bond Deal Backing M&A

AmeriGas Partners today placed a $525 million offering of 10.25-year bullet notes at the wide end of talk, sources said. Bookrunners for the SEC-registered deal were J.P. Morgan, Wells Fargo, Bank of America Merrill Lynch, and Citigroup. Proceed will be used to back a tender offer for the company’s 7% notes due 2022. In December, the company printed $700 million of 5.5% notes due 2025, also to back the redemption of the 7% notes due 2022. King of Prussia, Pa.–based AmeriGas (NYSE: APU) distributes propane and related equipment and supplies in the U.S. Terms:

Issuer AmeriGas Partners
Ratings Ba3/BB (Moody’s/Fitch)
Amount $525 million
Issue Senior (SEC-registered)
Coupon 5.75%
Price 100
Yield 5.75%
Spread T+336
Maturity May 20, 2025
Call non-callable for life
Trade Feb. 6, 2017
Settle Feb. 13, 2017
Sole bookrunner JPM/WFS/BAML/C
Price talk 5.5–5.75%

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Fridson: Rise in Credit Quality does not Explain Crude Oil Price/High Yield Spread Decoupling

Synopsis: We disprove the assertion that the crude oil price and the high-yield spread decoupled in July because the credit quality of high-yield energy companies improved. Investors should expect the high-yield spread to blow out again if crude enters a sustained downturn and if greed gives way to fear among investors.

The lead topic of our recent analysis, “Oil and high-yield decouple; month-end recap” (available to LCD News subscribers), has generated a vigorous debate during the last two weeks. As we explained in that piece, there was no particular correlation between crude oil prices and the high-yield option-adjusted spread (OAS) up until mid-2014.

Once crude oil began its sharp descent, however, the BofA Merrill Lynch US High Yield Energy Index started swinging violently in conjunction with oil’s ups and downs. As the largest industry subindex, Energy strongly influenced the overall BofA Merrill Lynch US High Yield Index, which was consequently transformed into a barometer of the crude price.

It was therefore a sharp departure from recent experience when the BAML High Yield Index and, to a lesser extent, the BAML High Yield Energy Index tightened versus Treasuries in July despite a sharp decline in the crude price.

A recent Barron’s article did an excellent job of summarizing the explanations that have been advanced for July’s decoupling. The arguments can be summed up as follows: 

Group A. Improvements in the quality of the high-yield energy universe

  1. The weakest energy credits—a quarter of all the speculative-grade energy names—have already defaulted over the past year. What remains is a less default-prone energy universe.
  2. Further reducing the expected high-yield energy default rate, the rating agencies have downgraded billions of dollars of formerly investment-grade energy debt to the upper end of the speculative-grade category. These issues are less likely to default than the surviving lower-tier names.
  3. The survivors have deleveraged through asset sales or equity offerings. As one sell-side strategist commented, “The energy companies in high-yield today are not the same companies we had two years ago. Those that remain are somewhat stronger.”

Group B. Changes in investor attitudes

  1. Investors do not think the July drop in crude prices will turn into a sustained decline. 
  2. Investors who sold high-yield when oil bottomed, then sat out the rebound, do not want to repeat the experience.

Group A’s explanations for July’s decoupling, if correct, are quite bullish for high-yield bonds. They suggest that even if the attitudinal changes listed in Group B give way to more pessimistic feelings, high-yield can withstand a new downturn in crude prices, thanks to reduced risk that cheaper oil will trigger defaults.

We reject this optimistic interpretation.

It is true that to a not inconsequential extent, fallen angels have displaced original issue high-yield bonds within the high-yield energy universe. Nevertheless, the ratings mix within energy is worse than it was two years ago, implying increased, rather than decreased, default risk.

Moreover, there has been no material improvement in the energy sector’s credit quality since Feb. 11, 2016, when renewed slippage in the crude price drove the OAS on the BAML High Yield index to an astronomical 1,984 bps, up from an interim low of 994 bps on Nov. 4, 2015. 

If the high-yield energy universe’s credit quality did not materially improve after February, then the BAML High Yield Energy Index should have widened dramatically versus Treasuries when the crude price fell in July, unless the spread-widening was in truth explained by the attitudinal factors listed in Group B.

Carrying the logic one step further, if credit quality improvement did not explain the July decoupling, then investors should expect both the energy and the overall high-yield spreads to blow out once again if:

  • crude drops on a sustained basis and
  • investors become less worried about selling at the bottom and more worried about failing to sell before the bottom is reached.

Quantifying the energy sector’s alleged quality improvement
As detailed in the chart below, fallen angels currently represent a larger portion (25.3%) of the BAML High Yield Energy Index’s face value than in mid-2014. At that date, just before the crude price began to plummet, fallen angels accounted for just 5.5% of the face amount. The proportion has even risen significantly since the Feb. 11, 2016, wide point in the high-yield spread, when 14% of the face amount of the high-yield universe consisted of fallen angels.

Fridson pie chart 2016-08-17

The past two years’ ongoing shift toward fallen angels, however, does not correspond directly to the trend in default risk. In the table below, we stratify the BAML High Yield Energy Index by rating, in percentage-of-issuers terms, on the same three dates depicted in the preceding breakdown between fallen angels and original issue high-yield bonds.

Fridson table 2016-08-17

As the bulls maintain, today’s high-yield energy universe is not the universe of two years ago. They are exactly wrong, however, about the direction of the change in credit quality.

Credit quality is lower by this important measure than it was in mid-2014. The CCC-C component, the source of most defaults that occur within one year of the measurement date, is twice as large as it was on Jun. 30, 2014 (40.00% versus 20.00%). Downgrades from BB or B have more than offset any credit quality improvement resulting from addition of comparatively high-quality fallen angels. The BB component has shrunk from 28.82% to 23.87% of energy issuers.

True, the CCC-C component has declined since Feb. 11, 2016, but only from 40.99% to 40.00%. No one, we trust, will seriously argue that the BAML High Yield Energy Index’s OAS tightened (from 831 to 823 bps) in July 2016, instead of widening by almost 1,000 bps, as it did between Nov. 14, 2015, and Feb. 11, 2016, because the CCC-C component declined by not quite one percentage point in the interim.

Another way of expressing the change in riskiness of the speculative-grade energy universe over the past two years is to calculate average expected one-year default rates for each measurement date, based on the ratings mixes shown in the preceding graphs.

To generate these numbers, we use average annual default rates per rating category for the period 1970–2015, as reported by Moody’s. The chart below shows that in an average year, the June 30, 2014 energy universe would have been expected to suffer a 3.09% default rate. That rate jumped to 5.89% on Feb. 11, 2016, a material change to be sure.

Since then, however, the expected one-year default rate has declined only negligibly, to 5.82% (this analysis is less than 100% precise due to data constraints). It beggars belief, however, that the energy sector’s dramatic change in response to declining oil prices between February and July of this year resulted from as minor a reduction in credit risk as that which occurred in the last month.

Fridson bar chart 2016-08-17

Incidentally, let us dispose of the knee-jerk reaction of some high-yield promoters who say that ratings are wrong and irrelevant.

We do not contend that every single rating of S&P Global Ratings, Moody’s, and Fitch Ratings exactly captures its expected default probability, down to the second decimal point. In aggregate, though, the ratings do a pretty good job, as evidenced by Moody’s data for the years 1970–2015 showing that over every interval from 1–20 years, the Caa-C cumulative default rate exceeded the B rate, which in turn exceeded the Ba rate.

Furthermore, the market—which rating agency bashers claim is smarter than the raters—by and large agrees with the ratings. The chart below shows that even at the more granular, alphanumeric level, today’s median option-adjusted spreads within the energy sector increase in a nearly monotonic fashion with each step down the rating scale.

Fridson energy spreads by rating chart 2016-08-17

Bottom line: Improvement in credit quality does not explain why, in a radical departure from its behavior of the preceding two years, the high-yield energy sector tightened in July in the face of a sharp drop in the crude oil price.

A more credible explanation
Judging by the evidence presented above, the conclusion seems inescapable that July’s decoupling reflected attitudinal changes of the kind listed above in Group B. Investors must be aware that reversals in such attitudes are routine occurrences in the securities markets.

Yes, investors do not currently expect oil prices to fall on a sustained basis, but that was undoubtedly true for many market participants when the crude price initially ticked lower in the second half of 2014. Yes, selling out at the bottom in crude prices and missing the rebound is currently a bigger worry for high-yield investors than riding the market to an even lower level, but lurches from greed to fear are proverbial in financial markets. 

In light of these realities, investors should be mindful of the following excerpt from the Barron’s article cited above:

“Still, don’t expect this disconnect between high-yield paper and oil to last if the price of crude keeps falling. ‘Long-term, high-yield has to reflect at least in part the fundamentals, and if fundamentals are that the price of oil is going to be lower for longer, high-yield has to eventually reflect that,’ warns Sean Coleman, chief credit officer at Franklin Square Capital Partners.”

Even one buy-side bull, who puts faith in the high-yield energy credit quality improvement that has resulted from cost-cutting by U.S. oil shale producers, acknowledges the limitations of that cushion. David Riley of BlueBay Asset Management says that persistence of the July decoupling depends on investors continuing to see the recent crude price drop as a mere technical move, rather than a reflection of global oil demand fundamentals. “Investors should carefully watch for any recoupling of oil prices and global financial markets,” he warns, “as the oil price moves below $40 a barrel.”

In a similar vein, sell-sider Brad Rogoff of Barclays Capital cautions that the energy sector “looks a little rich” and that a drop below $40 probably entails “some downside.” We regard those comments as understatements.

Keep in mind that even though the BAML High Yield Energy Index’s OAS contracted in July, the sector lost ground to the Non-Energy component during July. Between June 30 and July 31, Energy tightened by just eight basis points, versus 60 bps for Non-Energy, meaning that Energy widened by 52 bps versus the rest of the high-yield universe.

In short, investors did not truly ignore the crude price’s decline, blithely assuming that all of the weak energy credits had already defaulted. Rather, in their desperate quest for income, investors drove other high-yield bonds up so spectacularly that relative-value considerations prevented energy issues from managing to show an absolute decline.

There is no shortage of evidence or opinion to support our view that a push to an ever more overvalued state for corporate debt, rather than improvement in the energy sector’s credit risk, explains the July decoupling. According to J.P. Morgan Chase & Co., investor demand for bond funds is the highest since at least 2007 relative to demand for stock funds.  Valuation has naturally suffered. “I’d really question if you are being rewarded for the risk you are taking,” comments Duncan Sankey, head of credit research for Cheyne Capital, regarding the corporate market. For further insight into the risk-reward tradeoff, see the following section of this piece, which updates the FridsonVision Fair Value Model.

Another bottom line: The real reason for July’s decoupling between the crude oil price and high-yield spreads is investors’ desperate search for yield. If that pressure abates, there will be no solid basis for arguing that Energy—and by extension the high-yield asset class as a whole—cannot fall in response to a future drop in oil prices.

Marty Fridson, Chief Investment Officer of Lehmann Livian Fridson Advisors LLC, is a contributing analyst to S&P Global Market Intelligence. His weekly leveraged finance commentary appears exclusively on LCD, an offering of S&P Global Market Intelligence. Marty can be reached at [email protected].

Research assistance by Michael Li and Yanzhe Yang.

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Fallen Angel Transocean Prices $1.25B High Yield Bond Offering

Transocean priced a downsized offering of seven-year notes late Thursday via joint bookrunners Morgan Stanley and Goldman Sachs, according to sources. The $1.25 billion of paper priced tighter than talk, and the structure was revised to non-call four, from non-call three, sources added. Transocean will use the proceeds to fund tender offers for its 6.5% notes due 2020, 6.375% notes due 2021, and 3.8% notes due 2022, and for general corporate purposes. Terms:

Issuer Transocean
Ratings BB-/B1
Amount $1.25 billion
Issue unsecured (Rule 144A-for-life)
Coupon 9.000%
Price 97.50%
Yield 9.499%
Spread T+829
Maturity July 15, 2023
Call nc4 @ par+50% coupon
Trade July 7, 2016
Settle July 21, 2016 (T+10)
Joint bookrunners MS/GS
Price talk 9% at 98-99% OID
Notes The deal was scaled down from $1.5 billion; redemption was revised to non-call four, from non-call three.

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