Scarce capital and banker caution continue to be troublesome issues for the energy industry, says Kyle Hranicky, executive vice president and manager of Wells Fargo Energy Group. And, the market window for new issues of public debt and equity will be volatile, opening and closing for periods of time.


“Even after the recovery, yields and spreads are likely to be above historical averages when the market opens more fully to new issuances,” he told the Houston Energy Finance Group recently.


As a result of credit losses, capital is at a premium and banks are limiting its availability. “Getting brand new deals done in this market is really difficult. We are still in the correction.


“Of the 28 energy-lending banks we spoke to, only 16 are in the market for new deals, and of those 16 all are being more selective…and generally committing at lower levels than previously.”


Hranicky said early indications are that, based on low commodity prices alone, the borrowing bases for E&P companies will decrease 15% to 30% this spring.


“Some companies will be hit more than others. Some companies can deal with this but others can’t. Clearly, the short-life property sets are under significant pressure right now.”


The slowdown is affecting nearly all forms of capital. The primary or senior loan syndication market is still weak, he said. Second-lien and mezzanine opportunities have been significantly reduced as hedge funds and other institutions pull out of the market.


While private equity firms have several billion dollars ready to deploy, they too, are sitting on the sidelines, waiting to see what the liquidity crunch does to the market and what kind of opportunities fall from that.


First-half 2008 oil and gas debt issuance—before the market turmoil—was already down 26% from the prior year, compared with a 56% drop in the overall market. Activity is expected to drop further in 2009.


Existing issuers of high-yield debt that have higher debt ratings and stronger assets are taking advantage of the current market window after that market had been shut down in second-half 2008.


“The tone of this market has improved so far in 2009,” Hranicky said. “Energy issues have dominated this sector, making up 44% or $4.4 billion of new volume year-to-date.” Petrohawk Energy Corp., Forest Oil Corp. and Plains Exploration & Production Co. have issued this kind of debt since January.


The public high-grade or investment-grade bond market continues to be the largest source of long-term capital in the world. Issuance year to date is up 33% across all industries, to $288 billion.
“The high-grade market has been phenomenal,” he said.


Weatherford, BP, Chevron, Devon Energy and Anadarko Petroleum are some of the energy companies that have accessed this market since January.

?The devastation in the banking sector has been severe. As of January 2007, the 22 largest banks had an aggregate market cap of $1.94 trillion. By February 6, 2009, those banks had consolidated to 16, with a market cap of just $459 billion.


Commercial banks’ response is to conserve capital, favor existing clients rather than reach out to new ones, and tighten deal terms. They are reducing targeted commitment amounts and favoring loans with maturities of three years or less. Pricing and fees have risen across all sectors.


“Deal structure needs to be in the middle of the fairway,” Hranicky said. “Stretch loans are difficult to do.”


Companies with more levered borrowing bases have been told that the low price deck at present could severely limit their credit availability this year. Since last September, bank price decks for oil are down 42% and for natural gas, down 38%.


Bankers are beginning to see signs of expected loan-covenant breaches for the second and third quarters.


Hranicky advised borrowers to be proactive and to approach their bankers before a covenant is breached.


Interest rates have risen, but higher loan pricing alone will not necessarily guarantee success, Hranicky said. Capital decisions are being made in the context of the overall bank-client relationship. Banks prefer that borrowers also give them ancillary business such as treasury management, deposits and interest-rate swaps.


Wells Fargo Energy Group has $19 billion in commitments to the energy sector, with about $7.5 billion of that dedicated to E&P firms and $4.6 billion to oilfield services.