Trouble in the energy sector was one of the themes of the first quarter for the big US banks, where provisions for loan losses leapt an average 61 per cent from the same period a year earlier, according to DBRS, the credit rating agency.
Now, with many banks deep into the twice-annual process of resetting borrowing limits for their energy customers, they say they are cutting facilities by between 20 and 25 per cent — a deeper contraction than the 15 to 20 per cent cuts in the second half of last year.
The squeeze comes despite a recovery in the price of oil, which has risen more than 60 per cent from its February lows. It is likely to mean that more cash-strapped borrowers tip into bankruptcy.
“At the margin, the higher spot price has helped, but it has definitely not fixed companies with too much leverage in their capital structure,” said one senior Texas-based banker, speaking on condition of anonymity. Another banker at a rival bank noted that, unlike late last year, most customers no longer had the option of refinancing via equity markets or high-yield bond markets.
“It’s a little trickier this spring,” he said. “The market is running out of places to go for money.”
April was the heaviest month for energy company bankruptcies since the oil price started to turn in late 2014, according to Haynes and Boone, a Dallas-based law firm. Eleven companies filed for Chapter 11 protection during the month with total debts of $14.9bn — a significant increase from March, which saw seven collapses with total debts of $1.9bn.
On Monday Chaparral Energy, an Oklahoma-based oil producer, became the latest US independent to file for bankruptcy, filing for Chapter 11 protection with debts that were about $1.6bn at the end of last year.
It followed Chapter 11 filings last month from other midsized US independents, including Ultra Petroleum, a Houston-based gas producer that has debts of $3.9bn, and Midstates Petroleum, an Oklahoma-based oil producer that owes $2bn.
The largest North American oil producer to go bust in this downturn has been Pacific Exploration & Production, which is Toronto-based but operates in Colombia and elsewhere in South America. It filed for bankruptcy at the end of April, owing $5.3bn
Companies that have entered Chapter 11 are typically unable to raise enough money from asset sales to cover their debts because of the depressed market for oil and gas reserves.
Osage Exploration and Development, a California-based oil and gas producer, filed for bankruptcy in February owing about $43m. In April the court approved the sale of its assets for just $8.4m.
Analysts said energy exposures were likely to weigh on the big banks’ earnings throughout the year, in some cases offsetting improvements in credit quality in other corners of their loan portfolios. At Bank of America, which is still boosting profits by releasing reserves for losses in parts of its consumer banking business, net releases during the period came to just $71m, down from $429m a year earlier, as the bank built up reserves in its energy book.
“It is difficult to call ‘peak provision’ on an individual bank basis, as charge-offs accelerate into the back half of the year,” said Ken Usdin, analyst at Jefferies in New York. He noted that regulators including the Office of the Comptroller of the Currency have been urging lenders to take a more comprehensive look at borrowers’ indebtedness — including junior liens and unsecured debt — when assessing their own positions.
Fitch, the rating agency, calculated recently that 67 per cent of its sample of US exploration and production companies had balance sheet leverage ratios in line with levels that the OCC considers higher risk.
In the latest round of redeterminations of borrowing limits, the outcomes have varied widely.
Chesapeake Energy’s banks last month agreed to keep its borrowing limit at $4bn, although they required additional assets as collateral. However, Denbury Resources had its limit cut 30 per cent to $1.05bn.
Calgary-based Lightstream Resources had its borrowing base cut from C$550m to C$250m, less than the C$371m it had outstanding. It said on May 2 it had 90 days to repay the difference, or it would have to default on its debts.
Buddy Clark, a partner at Haynes and Boone, noted that if banks reset companies’ borrowing bases lower than the value of their outstanding debts, then the companies typically had five months to make up the difference. If they failed to do so, they defaulted. Avoiding that fate can be difficult, he said, if the companies had suspended capital expenditure or cut production to conserve cash.
“If you’re not drilling new wells, if you’re not replacing collateral, it can become a death spiral,” he said.
Banks and other investors in bank loans are turning to specialist law firms to maximise their recoveries. Zach Rosenbaum is the New York-based chair of the capital markets litigation group at Lowenstein Sandler, which focuses on helping lenders claw back proceeds from bust companies. He says his firm has recently “pivoted” from mortgage-related claims to oil.
“There’s usually a delay between market effects and this type of distress, but in the last six months I’ve seen more activity,” Mr Rosenbaum said. “For the moment, the recovery in the price of oil has not changed that.”
Bankers and analysts said equipment manufacturers were in a particularly tight spot, as big projects got mothballed with little prospect of revival. But all stressed that defaults were set to tick up elsewhere.
“It’ll get a lot worse before it gets better,” said Ramanan Krishnamoorti, chemistry professor at the University of Houston, adding that the current oil price in the mid-40s was not high enough to make companies’ reserves viable.
“Even at $60 a barrel oil, we’d be seeing a significant retrenchment and bankruptcies across the board.”
