Local banks flee energy amidst mounting regulatory and internal pressure – Middle Market Memo

21 June 2017
Comerica is now just over a decade removed from moving its headquarters to Dallas from Detroit in order to chase business in the oil patch. Predictably, its massive buildup in energy loans took a turn for the worse as it upped reserves for bad loans by three times in 3Q15 triggering a massive drop in its stock.

Management brought in Boston Consulting Group to evaluate cost-cutting measures and streamline its credit process in 1Q16, and said they’re open to a sale if it was “realistic.” At the time, Comerica’s soured energy loans was at USD 1.8bn, or 46% of total criticized loans. The numbers went down to approximately USD 1bn, or 38% of total criticized loans, according to the company’s 1Q17 earnings.

Behind Comerica, smaller banks are now putting its energy loans on the block as newer regulatory standards implemented by the Office of the Comptroller Currency (OCC) are forcing the issue. In recent months, Houston bank Green Bank wrapped up the sale of its assets at a really steep discount, while Louisiana bank Origin Bank is in process. Another local bank, MidSouth Bank, might also have to put its energy assets on the block soon with 10% of its energy loans on non-accrual, said sources familiar with the situation. With distressed assets on the block, there was a willing universe of credit funds willing to put money to work, said those sources.

The selldown was a result of stricter standards implemented by the OCC, which asks banks to assess repayment for reserve-based loans based on a company’s total debt rather than the RBL alone. The new OCC categories—which range from pass to loss—are key as banks have to set aside more reserves for loans with weaker credit ratings.

In an analysis of 150 public E&P companies, Chiron Financial estimated that 86% do not pass the new regulatory standards, which totaled approximately USD 75bn of bank debt. After removing companies with investment-grade debt ratings that are well-positioned for refinancing in public markets, there’s still USD 48bn of bank debt that’s substandard or worse, Scott Johnson, managing director for Chiron Financial told Debtwire.

“I’ve heard anecdotally that regulators have been pushing banks to mark their loans down beyond what they might have on record. So, there’s a lot of pressure from regulators to trim energy exposure for sure,” a second industry banker said.

Get out, fast

Smaller banks knee-deep in upstream loans and oilfield services (OFS) loans have been vulnerable to the selloff. Banks became less enthusiastic in lending to OFS and less patient in extending forbearances, according to a third industry banker, a bank lender and an industry executive.

MidSouth might be next as its OFS exposure has resulted in some management shakeups, the third industry banker and bank lender said.

Its energy-related loan portfolio totaled USD 232m, or 18.2% of total loans, according to 1Q17 filings. Of that, 27m of the loans are non-accrual. Management said it’s unlikely to repay dividends in the near term until its energy credit pressures ease. The stock for MidSouth, highly concentrated in OFS lending, trades at USD 11.50 per share for a market capitalization of USD 183m, well off 52-week highs of USD 16.60 per share.  

As reported, fellow Lafayette-based bank Origin enlisted Chiron to market five of its energy loans totaling USD 44m in debt outstanding. Executive Vice President and Chief Risk Officer Cary Davis said it was an internal decision, as the oil and gas industry is too volatile for their taste. Bids are due next week, when borrowing base is generally evaluated.
“I don’t see a mass exodus but lots of them are willing to sell assets and take a haircut,” the third industry banker said.
Houston-based Green Bank certainly exited its energy portfolio at steep discount. Some of its energy loans cleared as low as 10 cents on a dollar, as reported by Debtwire.  It has reduced its energy exposure to 3.1% of the portfolio in 1Q17 from 8.8% in 1Q16, and is left with only one pass-rated E&P loan.

With oil prices slipping into bear territory, banks are unlikely going to see the loan upgrades and paydowns as they hoped, which could affect their ability to release more energy reserves. On that same 1Q17 earnings call, Comerica’s management couldn’t provide the cumulative loss in the bank’s portfolio since prices crashed, nor clarified their target of the size of energy book for 2017.
“If oil prices stay where they are or in this range, if rig counts stay high, the net portfolio will start to level off here at some point in 2017,” Comerica President Curtis Farmer said on the call.

Oil prices were trading above USD 50 a barrel at that time, but as publicly reported, had slid to below USD 44 per barrel as of Wednesday morning.

MidSouth and Comerica did not return calls seeking comment.