Firm sees E&P borrowing on the rebound – failure rate will improve from a dismal 91% in 2016 to 26% in 2019

In March 2016, the Office of Comptroller of the Currency (OCC) issued the “Oil and Gas Exploration and Production” booklet of the Comptroller’s Handbook. The 2016 edition updates and replaces the guidelines issued in the OCC’s April 2014 version.

Revision highlights

  • Expands descriptions of the oil and gas business, types of oil and gas reserves, and lending structures
  • Expands descriptions of prudent risk management for this line of business
  • Expands and clarifies regulatory rating characteristics and factors that examiners should consider when evaluating oil and gas exploration and production loans, including application of accrual accounting guidelines
  • Clarifies the differences between traditional asset-based lending and oil and gas reserve-based lending
  • Expands the discussion of the allowance for loan and lease losses

What a difference a year makes.

Cimarex CEO Tom Jorden hit the nail on the head back at the EnerCom conference in August 2015—nine months after OPEC’s Thanksgiving Day 2014 announcement pushed crude oil prices into a nosedive from three-years at $100 and higher to values less than half of that for all the work that goes into producing a barrel of oil.

“The challenge to the companies in our space is to figure out how you get your business sustainable,” Jorden told Oil & Gas 360® in 2015. “Don’t be a shipwreck victim. The rescue ship is not coming.”

Jorden was right. The 50% cut in commodity values took the value of company reserves and collateral down with it through 2015 and most of 2016, and banks who had huge exposure to E&Ps felt the pain along with the E&Ps who were fighting to stay alive and out of Chapter 11.

2016: the vast majority of the oil and gas industry is non-bankable

According to U.S. energy powerhouse attorneys Haynes and Boone, the revised 2016 guidelines resulted in a majority of E&P borrowers being categorized as “classified” or as “non-passing credits.” This “failing” categorization requires banks to increase the amount of reserves held against investments.

In Aug. 2016, Haynes and Boone released a report that analyzed 58 E&P companies using publicly available data. Haynes and Boone determined that 53 of them, more than 91%, would fail the OCC’s leverage test in 2016. The report said, “The OCC has deemed the vast majority of the oil and gas industry as non-bankable.”

Good news in 2017: more E&P companies will be able to pass OCC leverage tests thanks chiefly to use of alternative funding sources to banks—capital markets, private equity, farmouts, JVs

In Oct. 2017, Haynes and Boone and The Mitchell Group updated the Aug. 2016 analysis with publicly available data from 55 E&P companies. 62% of the companies would fail the OCC’s leverage test in 2017, an improvement of 31% from the 91% failure rate for the prior year. In 2018 the fail rate should decline to about 42% and 26% in 2019, according to the firms’ updated analysis.

One analyst from the study said, “E&P companies are faring better because they have raised capital through means other than the banks, including from a robust capital market last year and from private equity firms that refinanced debt or used non-debt ways to finance these companies, such as farmouts or joint ventures. In addition, the price of oil has risen modestly in the past year, which helps with collateral values.”

Another analyst commented that it remains to be seen whether or not banks would reengage E&P companies after stepping back from the oil and gas lending market. However, bank familiarity with the revised guidelines, combined with more E&Ps passing the OCC’s leverage test, should encourage lenders to again open their coffers to the oil and gas industry.

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