Markets

Lisa Abramowicz is a Bloomberg Gadfly columnist covering the debt markets. She has written about debt markets for Bloomberg News since 2010.

A lot of companies view revolving credit lines the way some rock climbers view harnesses and ropes: They would rather not use them, but they're glad to have them when trouble strikes. 

So it's worth paying attention when a corporation starts withdrawing a substantial amount of money under these prearranged agreements with banks. This can signal a significant problem.

For example, consider last fall, when more than 20 energy companies had borrowed more than two-thirds of their limit on their credit lines, according to Spencer Cutter, a senior credit analyst with Bloomberg Intelligence. More than four of those have since filed for bankruptcy. The degree of distress last year wasn't surprising given the sharp plunge in oil prices that started in 2014. A mounting number of energy companies were forced to sell assets, restructure or file for bankruptcy.

Down to Earth
Energy junk-bond yields surged as oil prices fell, but have since come back down
Source: Bloomberg

But now that oil prices have rebounded and borrowing costs for riskier junk-rated oil companies have dropped, it makes sense to think that the worst companies have largely been washed out.

This is not the case. For evidence, just look at the relatively high number of companies relying on revolving loans for their financing needs. At least 11 oil and gas producers are using 70 percent or more of their borrowing-base credit lines, according to Cutter. That includes smaller companies such as Trinity River Energy, Yuma Energy and Mid-Con Energy, and some larger ones such as Sanchez Production Partners and California Resources.

Maxed Out
Some energy companies have withdrawn substantial amounts from their credit lines
Source: Bloomberg Intelligence

Meanwhile, banks are often less inclined to extend credit lines to companies that use them. Going back to the rock-climbing metaphor, someone who keeps slipping and hanging by their rope should probably try scaling easier peaks.

Similarly, banks could cut lines of energy companies for failing to have a more sustainable capital structure, forcing them to scramble for financing when investors are still somewhat skeptical about their future. About 24 percent of exploration and production companies will likely have the base size of their revolving credit lines cut in the upcoming round of redeterminations, according to a Haynes and Boone survey.

Fallen Fortunes
While oil values have risen since the recent nadir in 2016, they're still relatively low
Source: Bloomberg

To be clear, this is a better outlook than six or seven months ago, when oil prices were lower and OPEC members hadn't yet agreed to curb production. But in an odd twist, banks may be more willing to allow smaller, less-important energy companies to fail now than they were a year ago. That's because the largest banks have already cut their exposure to the asset class and are less at risk of losses should these borrowers go belly up. Wall Street's biggest banks just lived through a significant scare after helping oil and gas companies lever up, only to watch them suffer amid plunging crude values. It's logical these lenders would continue to cut their potential losses now, during a relatively sanguine period, by limiting their loans to the weakest companies.

Over the next few weeks, companies will start announcing their new revolving credit agreements. Investors shouldn't be surprised at some bad news for smaller energy companies that still haven't fortified their balance sheets. Just because oil prices have stabilized and even marginally increased doesn't mean that there won't be additional rounds of energy-related bankruptcies and restructurings in the near future.

-- Liam Denning assisted with valuable insight.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Lisa Abramowicz in New York at labramowicz@bloomberg.net

To contact the editor responsible for this story:
Daniel Niemi at dniemi1@bloomberg.net