We have closely watched the spring borrowing-base redetermination period for US shale drillers because for many cash burning oil and gas companies it could mean the difference between survival and a quick death in bankruptcy court, as it represents the semi-annual event that determines if they have enough liquidity to sustain operations for the next few quarters or, alternatively, if they have to hand over keys to creditors.
As we previewed most recently on March 28, while many companies have already utilized the max of their revolver facility and are thus not immediately in danger of seeing their borrowing base yanked from underneath them (good luck to the banks who hope to see companies return funds following a net working capital redetermination without lots of legal costs) such as the names listed below...
... "the companies most at risk may actually be those with that currently have some of the most highly utilized borrowing bases, ranging anywhere from 62% for Contango to 94% for Vanguard. It is these companies that will suddenly find themselves with zero incremental sources of liquidity as the banks proceed to whack anywhere from 30 to 50% of their borrowing base, leaving them scrambling to preserve liquidity and ultimately leading to bankruptcy court, in no small part under the pressure of secured and soon to be DIP lenders (and in most cases, the post reorg equity) who will demand the least amount of Enterprise Value be wiped out in the months before bankruptcy. Here are the names."
Fast forward to this week when Reuters reports that "nearly two years into an epic oil rout, U.S. shale drillers that have upended global energy markets are finally feeling a credit squeeze as banks make their biggest cuts yet to their loans."
Every six months, oil and gas producers and their banks negotiate how much credit they should be given based on the value of their reserves in the ground. In previous reviews, banks were willing to offer borrowers some leeway, encouraged by producers' hedges against falling prices and their ability to keep cutting costs in step with crude's slide that began in mid-2014.
This time, with many companies' hedges largely gone and crude prices used in the reviews as much as 20 percent lower than six months earlier, banks are getting tough.
According to Reuters calculations, just a few weeks into the current round of talks and already more than a dozen companies have seen their loans cut by a total of $3.5 billion, equivalent to a fifth of available credit.
"At that rate, $10 billion more of bank credit will disappear as a remaining $50 billion or so of credit lines come under scrutiny in talks that stretch into May" Reuters concludes.
That $10 billion will also decide which cash-burning companies are next the bankruptcy block.
But it's not just the shale drillers who are in danger as they see their liquidity evaporate.
As the WSJ writes today, and as covered here since January, it is the lenders themselves whose unfunded revolver exposure may suddenly become funded and expose them to even greater risks from the energy sector should oil not rebound far more forcefully and put US oil and gas companies back in the black.
How big is the exposure? Very big: $147 billion.
According to the WSJ "when big banks announce earnings starting on Wednesday, all of these oil and gas companies have counterparties, i.e., lender banks, and in a few days the spotlight will be on massive energy loans that most investors didn’t know much about until recently. These unfunded loans have been promised to energy companies that haven’t yet tapped the money. Many banks historically haven’t disclosed these loans but have begun to recently following the extended slide in oil and gas prices."
It is the total size of these loans that banks are finally scrambling to collapse (following our report earlier this year in which the Dallas Fed and the OCC pushed banks to keep as big as possible) as per the Reuters story above, but in some cases it may be too late.
In the first quarter, a handful of energy borrowers announced more than $3 billion of drawdowns against these types of loans. Those commitments are expected to trickle down to bank earnings and saddle firms with more energy exposure at a time they are trying to pare it back. “Let’s not sugarcoat it, this is not necessarily a loan a bank wants to make at this point,” said Glenn Schorr, a bank analyst at Evercore ISI.
The other problem: even as oil spikes on one after another headline, it has to get far higher for banks to no longer lose sleep over unfunded exposure. "Oil prices have risen in recent weeks, with the U.S. benchmark settling a $40.36 a barrel on Monday, but analysts say the unfunded loans to the sector are still a headache for banks at that price."
“With oil at $60, it’s not that big of a deal. With oil at $40, it becomes more of a source of concern,” Barclays analyst Jason Goldberg said of the unfunded loans. “Will companies draw down in difficult times?”
As a result, banks in recent months have set aside billions of dollars to cover potential losses tied to energy companies, a trend likely to continue as more loans go bad. But nowhere near enough the maximum possible drawdowns.
Which banks are most exposed to unfunded liabilities? According to the chart below it is the usual suspects: Citi, BofA, Wells and JPM.
The $147 billion in unfunded loans have been disclosed by 10 of the largest U.S. banks, according to fourth-quarter data from Barclays PLC. The four-largest U.S. banks— J.P. Morgan Chase & Co., Bank of America Corp. , Citigroup Inc. and Wells Fargo & Co.—pledged the majority of this amount.
Smaller U.S. lenders and large international banks have made billions more of these loans.
And while we wait to see if i) the O&G companies rush to drawdown their available revolers and ii) they subsequently file, forcing banks to charge off the loan losses, later this week Fitch Ratings is expected to release a report saying that nearly 60% of unrated and below-investment-grade energy companies are likely to have loans labeled as “classified,” or in danger of default under regulatory guidelines. “It’s grim,” said Sharon Bonelli, senior director of leveraged finance at Fitch.
As the WSJ adds, lenders routinely offer these commercial lines of credit to industrial companies. But the energy loans, often promised before prices started their steep decline, face a unique set of pressures.
James Dimon, J.P. Morgan’s chief executive, said in February that the unfunded loans are “the most unpredictable part of our assumptions” about the bank’s energy exposure. Mr. Dimon also said he isn’t expecting a large percentage of the unfunded money to get drawn because most of those promised loans went to investment-grade companies that he thinks are unlikely to need access to additional cash.
Banks hold reserves against unfunded loans in addition to reserves for loans that have been taken out.
Meanwhile, as expected, companies on the cusip of insolvency are rushing to max out their untapped revolvers.
Denver-based firm Bonanza Creek Energy in March announced that it drew $209 million from its credit facility from a group of banks led by Cleveland-based KeyCorp. Bonanza Creek’s chief executive said in a news release that the move was “a risk management decision” and praised its “committed and supportive commercial bank syndicate.” A KeyCorp spokesman declined to comment.
Tidewater Inc., which provides vessels to the offshore drilling industry, in March said it took out the maximum $600 million from its credit facility led by Bank of America. The firm’s chief executive cited “the uncertainty surrounding the future direction in oil and gas prices,” in a news release announcing the withdrawal. A Bank of America spokesman declined to comment.
Amusingly, WSJ notes, in order to stem such withdrawals, some banks have negotiated “anti-cash-hoarding” provisions when energy firms have asked for amendments to their loans in recent months. These clauses require the companies to use extra cash to repay the balance on their credit lines in exchange, according to regulatory filings.
The problem with most of these companies is that they have zero extra cash as their burn rate is simply staggering and even a maximum drawdown on the revolver means just a few months of breathing room. And then there is also reality: for distressed firms facing bankruptcy that can contractually do so, “you’d seriously have to consider a game plan to draw down,” said Ian Peck, head of the bankruptcy practice at Haynes & Boone.
* * *
Finally, why is this headache "massive"? Because that's what the WSJ first dubbed it...
... at least until it got a tap on the shoulder from someone.