Banks are betting that pain in the oil patch is short-lived.
The twice-yearly process in which lenders assess certain energy exposures was unusually intense this fall. In the end, most lenders were relatively generous in setting credit lines, while also insisting on more protections, including holding more collateral against the loans, according to bankers and others familiar with the process.
Many energy executives expected banks would harshly cut credit lines after the fall redetermination process or—more severely—declare borrowers in breach of their debt terms, or covenants. But little of that has come to pass.
Banks were also optimistic in their projections for future oil prices, forecasting that the U.S. oil benchmark WTI would average $47.36 in 2016, according to a late-October survey of 32 banks from Macquarie Capital Inc. The banks predicted the price would continue rising in the following years.
That would mark a reversal of the trend through the last half of this year. On Tuesday, the U.S. crude benchmark rose $1.04 or 2.9% to $37.35 a barrel on the New York Mercantile Exchange. It has declined 33% in the past year.
While banks only review borrower reserves twice a year, the lenders tie the amount of money certain energy companies can borrow to price projections that can fluctuate more regularly. If so-called price decks are lower, that digs into available liquidity for clients relying on that borrowing. J.P. Morgan Chase & Co., Royal Bank of Canada and BB&T Corp. are among banks that have adjusted their price decks more frequently this year given the volatility of oil and natural gas prices, people familiar with the matter said.
Energy firms and their backers anticipated a 39% cut to borrowing capacity in the fall, according to an August survey from law firm Haynes and Boone LLP. But “only a portion of that cut came,” said Haynes and Boone partner Jeff Nichols, who is head of the firm’s energy-finance practice. “It’s definitely kicking the can down the road.”
Borrowing bases at public companies that disclosed a fall change were about 9% lower on average, according to an analysis by EnerCom Inc., a Denver-based oil and gas consulting firm. Individual banks have seen similar declines. At RBC, for instance, there was a 10% to 15% drop on average in borrowing bases in the fall, according to head of U.S. energy corporate banking Jim Allred.
Banks were hesitant to take harsh steps, because doing so could set off a chain reaction in which their borrowers ultimately fail and banks could end up owning the assets.
The banks “do not want to own this stuff,” said Jeffrey S. Muñoz, a partner in the Houston office of law firm Latham & Watkins LLP specializing in energy finance. The process of calculating reserves “is not an exact science. They gave a lot of benefit of the doubt.”
Still, sometimes foreclosure can’t be avoided. This week, Dallas-based Cubic Energy Inc. filed for bankruptcy protection and handed over control of the company to Wells Fargo and other debtholders. Wells Fargo declined to comment.
Previous energy busts, like the one in the 1980s, resulted in major losses at banks, with painful ripples through the broader economy. Experts say that seems unlikely to happen this time around, given that U.S. banks have ceded some of their share of the energy-lending market over the last decade to nonbanks and foreign banks, particularly to the riskiest companies.
“We don’t see it becoming really threatening to the solvency of banks this time through,” said Christopher D. Wolfe, a managing director at Fitch Ratings who focuses on U.S. banks.
The increased role of those nonbank investors is a comfort to many bankers, who say distressed firms are tapping such funds to pay off their bank loans.
“There’s a lot of capital available,” said Dick Evans, chief executive of San Antonio-based Cullen/Frost Bankers Inc. “Quite frankly, I sleep very well at night.”
Still, projections for losses on energy loans keep rising broadly—and some banks have started to increase their own forecasts for such losses. A November regulatory report said that the number of loans rated as “substandard, doubtful or loss” among oil and gas borrowers almost quintupled to $34.2 billion of total classified commitments, versus $6.9 billion in 2014.
Much of the risk to the financial system remains hidden for now, and may not be known until problems become severe. While larger producers have been able to withstand the pressure so far, energy consultancy IHS data shows more than a fifth of U.S. oil production comes from thousands of small, mostly private companies that do not file public disclosures about their finances—and rely heavily on bank credit for financing.
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