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.
Well, while Valeant proudly announced it had obtained a covenant waiver from its lenders late last week, it appears not everyone was onboard with the plan, and as a result moments ago Valeant stock crashed (below $30) after hours as major bond investor Centerbridge has notified the company that it intends to call a default event, presumably on annual report delays breaking covenants, and potentially forcing Valeant to repay its bonds early. That could trigger default notices in other pieces of Valeant's roughly $30 billion in debt, analysts have said, and become a major additional headache, not to mention be a huge cash demand and perhaps force Valeant to sell even more assets, which however its recent agreement with secured lenders prhibits.
It is clear that the creditors are breaking ranks as Centerbridge seeks first mover/hedger advantage (with CDS near record highs) in calling the technical default.
Three weeks ago, the catalyst that pushed Valeant CDS to record wide levels implying a 55% probability of default over 5 years, while sending the company's stock plunging, was news that Valeant was scrambling to engage its lenders to obtain a default waiver to its bank credit agreement to eliminate a technical default that arose when it didn’t file its 10-K before March 15.
As we reported then, "in anticipation of those meetings, owners of Valeant's senior bank loans are reaching out to investment banks, including Barclays, who will help mediate the negotiations, the sources said. Barclays did not immediately respond for comment."
As was explicitly warned, the lenders' demands include higher interest payments and a pledge to pay a larger amount of the bank loans from the proceeds of any Valeant asset sales.
Since then the stock bounced modestly because apparently the algos forgot that when lenders smell blood and a potential default from a debtor without any other recourse, they will demand a pound of flesh. Or maybe two.
It appears one creditor is moving away from the group, and the result...
Chesapeake Takes Out "McClendon Suicide"-Squeeze Rally Highs, Soars 35%
In the second massive short-squeeze of the year for Chesapeake 'speculators', the company of the verge of bankruptcy has exploded 35% higher today, perfectly tagging (to the penny) the 200-day-moving-average. Breaking above the McClendon probe/suicide "squeeze" rally highs, at $6.13, CHK is at 5-month highs... as 'modeled' CDS spreads collapse after the management was forced to pledge the entire company to maintain existing credit lines.
As we concluded yesterday, while the stock may be delighted at this latest "can kicking", the unpleasant reality remains, namely that unless something dramatically changes in the company's income statement, Chesapeake has merely bought itself a few quarters of time while in the process stripping unsecured bondholders of any potential recoveries if and when it files for bankruptcy.
Chief Executive Officer Doug Lawler has employed a combination of debt exchanges, asset sales and open-market purchases of Chesapeake’s cut-rate bonds to reduce leverage and cope with falling gas prices. Chesapeake’s main focus is 2017 and 2018 “maturity management,” Lawler said in a presentation to analysts last month. In other words, without a dramatic rebound in commodity prices, CHK has about a year before it hits a refi wall at which point it will have to replace its current cheap debt with far more expensive funding, which will likely hand over major equity stakes to the existing bondholders, unless of course the company does not file Chapter 11 (or 7) long before.
And here is the punchline: the company lost about $40 million a day in 2015 and is expected to end this year in the red as well, based on the average estimate of 14 analysts in a Bloomberg survey.
The daily cash burn will only increase as Chesapeake is layered with even more debt and has to fund even more interest expense, which for the time being is manageable due to the existing low blended cost of its debt, but which will spike over the coming two years.
The banks however, don't care: they now are assured full control of all the company's assets when the hammer hits. As for the bondholders, there is always prayer and hope that soon the same "production freeze" headlines that push oil higher on a daily basis will finally shift over to natural gas.
Someone else who won't care if the company he built from scratch is handed over to the lenders: Aubrey McClendon who may have had a sense all of this was coming long ago.
