BANKRUPTCIES COULD FOLLOW HERCULES
Hercules Offshore, Inc.'s prepackaged bankruptcy filed may be a leading indicator of further bankruptcies among other challenged high yield (HY) offshore drillers, according to Fitch Ratings. Hercules' restructuring plan involves the conversion of over $1.2 billion in senior notes into 96.9% of the firm's new common equity and establishment of $450 million of new debt financing to fund the delivery of the company's contracted newbuild drilling rig, the Hercules Highlander, and provide liquidity. The plan also provides current equity holders with the remaining 3.1% of the new common equity despite the debtorasserted going concern enterprise value range of $535 million to $725 million being below full recovery. The plan is subject to court approval. Hercules' filing moves the energy trailing 12-month (TTM) default rate to 3%, up from 2.5% at the end of July. This and the expected bankruptcy of Samson Resources Corp. will push the energy TTM default rate to 4%, over twice the historical 1.9% mark. The recent oil price drop has compounded the effects of the offshore rig oversupply cycle, resulting in limited tenders, weak day rates and legacy fleet rationalization. Existing backlogs have generally insulated offshore drillers from lower market activity and day rates so far. However, backlog protections for offshore drillers are falling away at a fast clip - a significant portion roll- off within the next year - which will likely begin to pressure cash flows. Liquidity profiles are mixed, though larger, investment- grade offshore drillers tend to be better positioned to bridge the downcycle. Ultra- deepwater rigs have legacy contract dayrates generally in the high-$400,000 to $600,000 range, but a scarcity of tenders over the past several quarters has introduced uncertainty regarding market day rates. Fitch's best guess for short-run market day rates is around $325,000 for ultradeepwater rigs. This would probably represent a 'purge day rate' that disincentivizes uncontracted newbuild deliveries and facilitates legacy fleet rationalization, leading to an eventual inflection point currently anticipated to be late 2016/early 2017. Other rig types are anticipated to see similar day rate reductions with uncompetitive rigs being stacked or scrapped. Fitch expects HY offshore drillers to be at a contracting disadvantage, relative to larger, more established offshore drillers, due to their smaller size, limited customer history, and higher counterparty risk. Our view is that customers may, in most cases, prefer the highest quality assets, but are also giving careful consideration to an operator's size , staying power, geological familiarity, and historical operating performance. This assumed contracting disadvantage would greatly reduce HY offshore drillers' ability to build a future backlog in the current downturn, raising their probability of default. In this context, HY offshore driller recovery prospects and restructuring plans begin to come into focus in a hypothetical default scenario. Fitch recently reviewed three HY offshore drillers - Vantage Drilling Company, Pacific Drilling S. A., and Ocean Rig UDW Inc. - and determined that secured noteholder had above average (i.e. greater than 50%) recovery prospects, while unsecured noteholders had poor (i.e. 0%-10%) prospects.