For a while there in January and early February investors started to get truly nervous about the energy sector. Everyone knows the energy industry itself is in trouble, but earlier this year there was increased concern about energy woes spilling over into the broader economy as China and the EU added their own troubles to the mix. Those fears have been alleviated in part due to the limited rebound oil prices have seen in the last few weeks. It’s too soon to tell if the worst is truly behind us, but for energy companies any salvation may already be too little too late.
The best indication of just how dire the situation is for energy companies is the state of their bank loans. For all of the breadth and debt of U.S. capital markets, bank loans still form a critical part of the capital structure of many companies, including oil firms. But at this point it’s starting to look like there may be more bad loans in the market than good ones. In other words, more than half of all bank loans to energy companies are likely to wind up being at least partially written off.
Importantly, this reality does not mean that banks are in trouble. For the vast majority of banks out there, energy loans are a very tiny part of their overall portfolio. In addition, banks have already set aside significant amounts of cash reserves to cover bad debts for loans they are on the hook for. Many of these loans were advanced on the basis of the security derived from untapped reserves owned by O&G firms – yet these untapped reserves were often of questionable economic value even in good times. The case for significant value from untapped reserves at present is even more dubious.
Over 50 O&G firms have declared bankruptcy since the start of 2015 and there are 175 more firms at risk of busting their loan covenants according to Deloitte. Even with oil prices having rebounded from the mid-$20s, most oil companies are not going to be able to make ends meet with oil at $40 a barrel.
Given that, the biannual redeterminations held in the fall and spring of each year will likely result in most firms having their revolvers cut by around 30%. In an effort to shed more exposure to the sector, many banks are selling loans to private equity firms and hedge funds generally at discounts ranging from 65 to 90 cents on the dollar. New loans for O&G firms—again mainly from hedge funds and private equity funds—are commanding rates of 10-15% and often include substantial equity warrants. A loan to Clayton Williams by Ares Management a few weeks ago awarded warrants for 2.25 million shares to Ares along with an interest rate on the debt of 12.5%.
The situation should make for interesting opportunities for investors in private equity firms like Blackstone (bx), Apollo, and KKR (kkr). Most investors are ill-equipped to extract the kind of beneficial arrangements from their investments that Blackstone and its peers are.
More from Oilprice.com:
• How Oil Can Be Used to Defeat ISIS
• Rockefeller Family Fund Blasts ExxonMobil, Pledges Divestment From Fossil Fuels
• Israel’s Game Changing Gas Discovery Dealt Another Blow
Yet Blackstone and other private equity firms are trading at deep discounts as investors worry about their ability to monetize investments and the close of the IPO markets. However, in the longer-term, most major private equity firms should benefit from the current turmoil greatly just as they did in the years following the Financial Crisis.
This article originally appeared on Oilprice.com.