Energy Slump Makes Strange Bedfellows of Banks, PE

The latest declines in the price of oil have renewed concerns about credit quality at energy lenders, but bank executives have found a reason to stay optimistic: private equity.

Banks and PE have alternated between friends and foes in recent years as they sometimes competed and PE firms' efforts to buy and turn around banks met with mixed success. But their interests have aligned when it comes to the energy slump.

Over the past few months cash-strapped borrowers have sold assets to private-equity firms, Gulf Coast bankers and industry observers said. That has been a boon for banks, as borrowers have used the fresh capital to pay down troubled loans. 

"One of the things that's different about this cycle — and this is the sixth energy cycle of my career — is that private equity has shown up in a big way," said Kevin Hanigan, chief executive at the $6.5 billion-asset LegacyTexas Bank in Plano, speaking to investors at a recent industry conference.

An analyst tracking banks' exposures to oil, gas and other energy firms agreed with Hanigan. "A lot of money has been raised to put to work in distressed energy deals," Brad Milsaps at Sandler O'Neill said. 

It is a silver lining for energy-focused banks in what has otherwise been a year-long saga of credit concerns and uncertainty.

Crude oil prices — which last summer hovered above $100 per barrel — have plummeted over the past year, reaching five-month lows of nearly $40 per barrel last week. Meanwhile, futures markets have indicated that prices could stay low for the coming year. 

Energy woes have also begun to weigh on the quality of syndicated loans. Banks have begun a wave of downgrades in their oil and gas books, after completing this year's shared national credit exam.

And adding to the anxiety is the belief that banks have yet to feel the full impact of the slump.

"The harder parts to quantify are the secondary and tertiary effects" that occur when [energy] companies cut budgets and lay off employees, Milsaps said. "The banks haven't seen any effects of that seeping into their loan books yet."

Still, banks in Texas and Oklahoma performed reasonably well in the second quarter, analysts said.

With the exception of the $69 billion-asset Comerica — which missed profit estimates on a larger-than-expected loss provision — energy lenders largely met industry expectations, Michael Rose, an analyst with Raymond James, said in a research note on energy lending. Dallas-based Comerica's 73 cents per share fell short of the average estimate of analysts polled by Bloomberg by 2 cents.

"While banks reported further negative migration and higher provisions related to their energy portfolios (as expected), Comerica's miss was about as bad as it got," Rose wrote.

During recent conference calls with investors, several executives — including at BOK Financial in Tulsa, Okla., and Texas Capital Bancshares in Dallas — pointed to the upside of having spurt of activity in the private-equity markets.

"There's no question the private-equity flow has really helped the health of the overall energy business over the last year," said Keith Cargill, CEO of the $17 billion-asset Texas Capital, noting he observed an increase in activity about six months ago, particularly among the bank's biggest borrowers.

"It will help the banks in some cases where they've got a customer that's upside down," Mickey Coats, manager for energy lending at the $30 billion-asset BOK Financial, said in a recent interview.

Estimates of the total amount of private equity angling for oil investments vary widely. They range from $10 billion to $75 billion, depending on whether investors focus on oil drilling or the more niche-oriented, services side of the business, according to industry sources.

For private-equity investors, an interest in oil is nothing new. Funds have been active in energy markets for more than a decade, said Thomas McCaffrey, an attorney at Akin Gump. "When prices are going up and everyone is fat and happy, most people aren't looking at who the buyer is."

Still, the dip in oil prices has spawned new opportunities for dealmaking, McCaffrey said, describing an "uptick" in deals over the past few months.

Most energy companies have responded to the slide in oil prices by cutting costs and laying off workers. But those in dire need of cash have sought out private-equity investments, or have sold land, mineral rights and other assets they cannot afford to develop, McCaffrey said. 

For example, OFS Energy Fund in Houston has built a portfolio of about $300 million, with investments in companies that provide pumping services, tank rental and drilling tools. The firm in April bought most of the assets of a west-Texas-based water transfer company, according to the fund's website.

The fund said in a press release announcing the acquisition that it bought the water-transfer equipment "at a deep discount to market value."

OFS is one of a number of PE firms making similar types of deals, according to managing director Bruce Ross.

"Going back to 2014, there were a number of private-equity funds that raised additional capital," Ross said.

The moves come at a time when banks have pulled back, said Ross, who is a former banker.

From "all of the banks in the Houston area, we're hearing the rule of thumb is caution and conservative structures, and movements to reduce debt," he said, noting that large commercial lenders are limiting their exposure to the struggling oil services business.

In the coming months, PE activity will likely help banks resolve problem credits before they result in steep losses, Hanigan said.

"I think the third quarter is going to be the quarter where we start seeing a pick-up in problem loan resolutions for the industry," he said, predicting that energy lenders will see a rise in pay downs on troubled credits.

Additionally, private-equity deals will likely play increasing role for many borrowers, as banks begin their fall reviews of energy credits, according to several bankers.

During the last round of reviews, which took place in the spring, most bankers in the industry had an overly optimistic view of oil prices, Coats said. But now they are realizing the slump may last a bit longer.

"[The industry] didn't draw the hard line. Maybe it's because in '08 and '09 the downturn [in oil prices] was very short-lived," Coats said. Bankers will likely apply more scrutiny to leverage ratios this time around.

Distressed borrowers will continue to turn to private-equity funds in the coming months to help pay down debt, particularly as oil companies see their borrowing bases curtailed Milsaps said.

"Any other industry where you lost 50% of your revenue would be pretty dire straits all over the place," Coats said. "This industry is adaptive and unique, and they will figure out a way to make it work."