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U.S. Banks Growing Hesitant To Loan Money To Energy Firms

U.S. Banks Growing Hesitant To Loan Money To Energy Firms

BNP Paribas, France’s largest bank, announced that it would no longer lend money to struggling oil and gas companies in the United States. "Given the current environment in the oil and gas markets and the short to medium term outlook, BNP Paribas has decided to halt the redevelopment of its reserve-based lending business," BNP said in a statement. The bank will continue to work with its existing borrowers, but won’t lend to new ones.

The French bank was concerned that default rates among energy companies would rise, sources told Reuters. It was the second time that the bank pulled out of lending to energy companies in the U.S. – it sold a unit to Wells Fargo in 2012 before reentering the space in 2014 when oil prices shot into triple-digit territory.

It isn’t that BNP Paribas was a large lender to shale companies – it wasn’t. But the move illustrates the increasingly grisly landscape in the energy sector for borrowers and lenders alike. Related: Oil Glut Compounded By Cracks In Global Economy

The Wall Street Journal reported that three oil and gas drillers maxed out their credit lines in recent weeks. Midstates Petroleum Co., Linn Energy LLC and SandRidge Energy Inc., collectively tapped $1.5 billion in new borrowing, the full extent of their credit lines. Maxing out a credit line is a worrying sign that a driller has now exhausted all of its options, and as the WSJ puts it, the company could be “building up its cash reserves ahead of a bankruptcy filing or that it is worried lenders may at some point cut off access to credit.”

The prospect of default, in turn, could end up burning a lot of banks. “Lenders are concerned that as prices fall and liquidity is burned by operations and interest payments, at one point do the revolvers, in fact, become impaired?” Damian Schaible, a partner at Davis Polk & Wardwell LLP, told the WSJ.

For now, large banks are not concerned because energy represents a small share of their whole loan portfolio. Wells Fargo says the energy industry only represents about 2 percent of its loans. Still, Wells Fargo, JP Morgan Chase, and Citigroup are building up cash reserves in order to protect themselves against bad loans. Together, the three banks have “set aside” $2 billion to cover for their energy losses. Wells Fargo says it has about $17 billion in outstanding energy debt that could be at risk. Bank of America admitted that over $8 billion of its $21 billion in energy loans are to high-risk companies.

Related: OPEC-Russia Rumors Persist After Comments From Rosneft Chief

Smaller banks could be hurt worse. S&P downgraded four regional U.S. banks because of their exposure to bad energy debt.

A big turning point could be the credit redetermination period in April, which could present another blow to struggling oil and gas companies. Lenders make periodic reassessments of the creditworthiness of drillers, adjusting the credit lines to borrowers based on their specific circumstances, oil prices, and economic viability of the assets companies are sitting on. As oil and gas reserves become uneconomical as oil prices drop, credit lines based on the shrinking recoverability of those reserves get cut. In October, the credit lines for the oil and gas industry were slashed 10 to 20 percent. Another cut will likely take place in April, with analysts expecting a reduction of a similar amount.

On the flip side, pulling the plug on drillers could end up doing more damage, endangering any chance that the bank has of getting repaid. Pushing a company into bankruptcy could cut into production, reducing cash flows. Moreover, selling off assets – another avenue of repayment – is not an appetizing endeavor right now in the depressed marketplace. Related: ISIS Forced To Cut Wages As Oil Revenues Tank

Over the past year and a half since the oil price crash began, lenders have tried to work with their energy clients to ensure that they keep the lights on, if for no other reason than to ensure they get repaid. Banks were generally lenient during the credit redetermination period last year.

“It’s a bit of a catch-22 situation,” Harry Tchilinguirian, the head of commodity markets strategy at BNP Paribas in London, told the FT in January. “If you limit finance to a US [exploration and production] sector that is living beyond its cash flow, then you run the risk that production will fall and companies will fail to meet their financial obligations.”

However, oil is now down below $30 per barrel, more than 30 percent lower than where prices were during the last credit redetermination period in October. Even the most lenient bank may not be able to help the most indebted oil and gas companies.

By Nick Cunningham of Oilprice.com

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