New York — The twice-a-year evaluation of energy borrowers’ reserve-based loans has taken on more significance than ever as banks seek to cut their exposure to oil and gas companies amid the global Covid-19 pandemic that has caused demand for oil to plummet and a price war between Russia and Saudi Arabia that has flooded the market with crude.
Lenders are grappling with how best to cut energy companies’ borrowing bases while ensuring they still have some access to capital. Some estimates say borrowing bases could be lowered by 30% or more in the first half of 2020.
“In a recovery, banks want to get back 100% of the money they lend out,” said John Kempf, a senior director at Fitch Ratings. “This go around they will probably be a bit tougher on (oil exploration and production) companies in determining their borrowing bases.”
Oil and gas companies are feeling the pressure as a result of the historic turmoil in the oil markets.
“There has been a huge decline in demand – no one is driving cars, no one is commuting to work, no one is flying. We need to cut supply to synchronize with demand,” Kempf said. “We are starting to see production come down, not as fast as it needs to, but we are starting to see it come down.”
Fitch expects the energy loan default rate to rise to 18% by the end of the year.
The average bid of US oil and gas loans tracked by Refinitiv LPC fell to as low as 71.95 cents on the dollar on March 24, almost 25% down since the start of the year. It had rebounded to 75.15 cents on Wednesday. That trajectory followed the overall market – the LPC 100, a cohort of the 100 most liquid loans in the US, fell more than 21% this year to an almost 11-year low of 77.87 cents on March 23 before rebounding.
TIGHTENING BORROWING BASES
Twice a year banks conduct a redetermination of oil and gas companies’ RBL borrowing bases, reworking the amount of debt borrowers can draw upon. The adjustments take into account oil and gas prices and forecasts, as well as current and projected production.
Centennial Resource Development said on Thursday that its agent bank recommended the oil producer’s borrowing base be cut by almost 42%.
Earthstone Energy, which develops oil and gas properties, said its borrowing base was cut by 15% – to US$275m from US$325m. It had US$152m outstanding as of March 31.
“We did go a bit earlier in the cycle and we did that because we saw some signs of volatility,” said Mark Lumpkin, chief financial officer at Earthstone. “I think going earlier was absolutely to our advantage.”
Oil and natural gas producer Chaparral Energy said it had a borrowing base of US$325m with US$160m outstanding as of March 31. On April 2 it notified its lenders it wanted to borrow US$90m to increase its cash position. Later that day, Chaparral’s lenders made an interim redetermination of the borrowing base, decreasing it to US$175m, creating a “borrowing base deficiency” of US$75m.
Deficiencies are often required to be remedied within six months.
Banks are also using this redetermination period to tighten covenants in credit agreements, increase the interest rate they charge and include so-called “anti-cash hoarding” provisions, which stop companies from drawing the full amount of their revolvers and holding it as cash.
“Banks are very focused on putting anti-cash hoarding language back into credit facilities,” said Kraig Grahmann, head of the energy finance practice at law firm Haynes and Boone.
Exploration and production company Ultra Petroleum Corp said that in addition to its borrowing base being reduced, its anti-cash hoarding amount was also cut to US$15m from US$25m for all times there are borrowings outstanding under the revolving credit agreement.
But banks must walk a fine line because while they seek to reduce their risk, they do not want to push companies into default and hurt recoveries if there is a chance borrowers’ health may improve.
“Banks are going to take any kind of default seriously,” Grahmann said. “Their goal is really just to achieve the outcome that maximizes recovery rather than looking for full control of the borrower.”
Decreased demand for oil due to the coronavirus and stressed oil prices will continue to affect what can be done in the RBL market, said Earthstone’s Lumpkin.
“ are no doubt creating a lot of stress at the banks on their loan portfolios and the bar to get internal approval of any type of borrowing base is exceptionally high and at some banks just a non-starter,” he said.