Credit Crunch Time In The Shale Patch


Banks are clashing with regulators over loan reviews that could crimp the flow of new credit to the oil patch.

The dispute is focused on the relatively narrow issue of loans secured by oil and gas companies’ reserves, but it highlights the much broader point of how postcrisis regulation of the financial industry is affecting sectors far from Wall Street.

On one side are the bankers who have been grappling with the plunge in oil prices and the need to shore up billions of dollars in credit extended to the energy industry. On the other are regulators eager to prevent another financial crisis while not knowing what it might be.

Caught in the middle are the small- and medium-size exploration and production companies that rely on credit lines that use their energy reserves as collateral. Banks are now beginning their fall reviews of the quality of that collateral and worry regulators could ding them for making loans the banks think are prudent. “We’re concerned about it,” said Matt McCaroll, chief executive of Houston-based Fieldwood Energy LLC. “These are challenging times for our business…and to have additional pressure on the relationship between borrower and lender is going to be very problematic.”

The oil and gas exploration company has about $1.75 billion of reserve-based loans with 23 banks. Mr. McCaroll said he has voiced his concerns with congressmen.

The issue came to a head this month when a dozen regulators from the Office of the Comptroller of the Currency, Federal Reserve and Federal Deposit Insurance Corp. flew to Houston to meet with about 40 energy bankers from J.P. Morgan Chase & Co., Wells Fargo & Co.,Bank of America Corp.,Citigroup Inc. and Royal Bank of Canada. In the spring and fall, regulators conduct a review of large corporate loans shared by multiple banks.

Several industry officials said the meeting, held at Wells Fargo’s offices in downtown Houston, was the first of its kind. The bankers and regulators sat around tables in a large room with a screen displaying the OCC’s agenda that largely focused on examining and rating the loans, people familiar with the meeting said.

The banks were concerned because a review of their loans by regulators this spring left many reserve-based loans rated as riskier than the banks had considered them to be. They spent much of the meeting explaining why reserve-based loans are similar to lower-risk, asset-based loans, some of these people said. The bankers also questioned why the OCC considers an energy company’s total debt when assessing reserve-based loans, which generally get paid off ahead of other debt in the event of a restructuring.

“We disagree with the regulators,” said Francis Creighton, executive vice president of government affairs at the Financial Services Roundtable, an industry trade group. “These are good loans, they have a history of performing…we think their analysis is incorrect on this.”

So far, the regulators’ approach is winning out. Those biggest U.S. banks, Comerica Inc. and Capital One Financial Corp. collectively filed a record number of appeals to the spring review, arguing that reserve-based loans have a long history of low default rates. Late this summer, most of those appeals were rejected, according to people familiar with the matter. Some banks had all of their appeals denied, the people said.

The regulators didn’t make any concessions at the meeting in Houston, which was described by several participants as a fact-finding mission.

Regulators declined to discuss specific conversations with banks. The OCC has said it is concerned about energy lending exposure. In a June report on lending risks, it said OCC examiners would be focused on “banks’ actions to assess, monitor, and manage both direct and indirect exposures to the oil and gas sector, given the recent decline in oil prices and the potential for a protracted period of low or volatile prices.”

Oil prices fell below $40 a barrel last month for the first time since the financial crisis. On Wednesday, oil for November delivery dropped $1.88, or 4.1%, to $44.48, on the New York Mercantile Exchange and has declined 52% in the past year. Previous energy busts, like the one in the 1980s, have resulted in major losses at banks, with painful ripples through the broader economy.

The OCC regulates the national-bank units that make many of the energy loans at big firms like J.P. Morgan, Wells Fargo, Bank of America and Citigroup. It reviewed energy loans at about 10 banks it oversees in 2013 and 2014 but didn’t find any significant problems at that time, according to a person familiar with the matter.

Yet in a semiannual report on emerging risks published in June, the OCC said the “significant decline in oil prices in 2014 could put pressure on loan portfolios” going forward.

Any pressure from regulators will only amplify the cuts to borrowing already affecting the small- and medium-size energy companies. They are the producers that have helped sharply boost U.S. oil output in recent years, helping create the supply glut that is now weighing on prices.

According to a recent Citigroup report, banks will reduce the amount of money they could lend to energy firms by as much as 15%. If banks were to make cuts of that magnitude, some $10 billion of credit could dry up, according to a Wall Street Journal analysis of securities filings by 75 exploration and production companies.

“It all flows downhill,” said Steve Moss, a bank analyst at Evercore ISI. “If the regulators are going to be tougher on the banks, expect the banks to be tougher on the borrowers.”

San Antonio-based Cullen/Frost Bankers Inc. recently cut a number of customers’ borrowing capacity as energy prices fell, reducing the value of their reserves as collateral.

“It comes down to a basic in lending,” Chief Executive Dick Evanssaid. About 15% of his bank’s loans are energy related, one of the highest levels among banks. He said he couldn’t forecast how tougher regulatory scrutiny might affect the industry.

“We just have to live through this,” he said.

Source: Energy Lending Caught in a Squeeze – WSJ