In 2009, America teetered on the brink of the worst financial crisis since the Great Depression. Commercial lending nearly ground to a halt. No industry escaped unscathed, including energy.
In its recent report, the Federal Reserve Board reported that loan balances at commercial banks had fallen by their fastest rate in 25 years. In fact, the 22 banks receiving the lion’s share of bailout funds had cut their small-business loan balances during the past six months.
By year’s end, the parent of at least one major energy capital provider, CIT Group Inc., had filed for Chapter 11 bankruptcy protection. (By January 2010, the firm’s restructuring plan, supported by bondholders, enabled it to emerge from bankruptcy in just 40 days, after eliminating $10.5 billion in debt. CIT’s Houston energy office remains open for business under managing director Peter Gaw.)
“From my perspective, the volume of oil and gas lending transactions in the market during 2009 was at the lowest level I can remember, and I have been doing this for a long time,” says Carl Stutzman, Dallas-based senior vice president for Union Bank of California. “Merger and acquisition transactions, which are a huge driver of loan demand in this sector, were virtually nonexistent in 2009.”
Much of the credit crisis and economic collapse happened just as President Obama assumed office. Taking a stance of “not on my watch,” he quickly moved to shore up shaky banks and rescue the U.S. financial system. He also quickly took to task executives at the largest banks to ensure that irresponsible lending practices and impossibly tangled debt derivatives would not go unchallenged in the future.
One bone of contention: bank executives’ high salaries and bonuses. Obama vowed to cap Wall Street salaries, worrying some bankers. Stutzman is concerned that “the Obama administration’s decision to have a say in how bankers are compensated may have a negative impact on our ability to attract and retain senior talent.”
By the end of 2009, the president, Federal Reserve chairman Ben Bernanke and Treasury secretary Timothy Geithner had begun to draft strict financial reforms to support economic recovery and to prevent the next big financial crisis. HR 4173, sponsored by Rep. Barney Frank and entitled the Wall Street Reform and Consumer Protection Act of 2009, passed by a vote of 223 to 202 on December 11.
Although it is unclear what form the Senate version will take, the banking community cannot be sure that the new legislation will plug loopholes and ensure accountability and safeguards without uprooting the green shoots of recovery.
In December, President Obama met with top executives of some of the nation’s largest financial institutions, including energy-lenders Bank of America, Capital One, Citigroup, JPMorgan Chase, Morgan Stanley and Wells Fargo. After the meeting, Obama reportedly declared his reforms a “common-sense change” in the way government interacts with Wall Street and Main Street.
Much of the proposed legislation is intended to require more oversight and stronger capital cushions for the largest banks and Wall Street firms. For example, HR 4173 calls for the formation of an emergency fund, capitalized by the largest banks (a total of $150 billion), to be tapped when a failing bank must be taken over or broken up.
The House bill also establishes a Consumer Financial Protection Agency and requires greater transparency from investment advisors, financial brokers and hedge funds. Other provisions allow lawmakers to strengthen oversight and aggressively pursue financial fraud, conflicts of interest and manipulation of financial accounting systems.
New Treasury power
New capitalization requirements, rigorous standards and vigorous supervision are meant to ensure that no single financial institution is capable of bringing down the economy, but many aspects of the law appear somewhat punitive.
Shortly after the bill passed, House Speaker Nancy Pelosi stated her intention to send a clear message to Wall Street that “the party is over.” She condemned what she called reckless behavior “on the part of the few that threatened the fiscal stability of the country.”
Some Street insiders worry that, had such measures been in place prior to the credit freeze, the bailouts of several of the largest commercial banks not only would have been impossible, they would have been illegal. Even delaying the bailout for too long could have caused a cascading collapse of the nation’s banking industry.
Others, even some Democrats, fear problems from the proposed concentration of power. Under the legislation, a new council, in which the Federal Reserve would play a major role, would be formed to oversee the largest financial firms. The Treasury secretary would chair the council and his approval would be needed before the government could take over a failing financial giant or make loans to troubled assets.
Rep. Brad Sherman (D-California) weighed in on the bill, telling the press that “passing good regulation is not an excuse for passing permanent, unlimited bailout authority.” He believes regulators should continue to seek Congressional approval for bailout money. Other Capitol insiders voiced concern that regulators susceptible to lobbying could favor some creditors over others when unwinding a failed bank.
Referring to the executive branch’s proposed expanded powers, Rep. Paul Kanjorski (D-Pennsylvania) said, “I’m not a man that fears this administration. But I do fear the accumulation of power exercised by someone in the future that can be extraordinary.”
Will increased regulation and oversight cause megabanks to be so risk-averse that even tentative steps toward economic recovery will be stymied, just when bankers say energy deals are beginning to reappear?
Some lenders have found that bellying up to the Fed window to borrow money at nearly zero interest rates, then investing in risk-free, interest-bearing Treasury securities, creates safe-haven income for building capital cushions. But while big banks focus on such operations, very little lending is getting done. If it continues, the current shortage of new business loans will only magnify economic woes when Obama’s stimulus spending slows in 2010.
Signs of life
“All I can say is that I’m very glad that 2009 is over,” says Charles E. Hall, managing director of the natural resources group for ING Capital LLC in Houston. “There was a noticeable decline in the number of new-money upstream-related financings done last year.” Yet Hall says the decline likely resulted from “an almost-locked-down A&D market,” rather than from banks’ reluctance, unwillingness or inability to lend fresh dollars.
“For 2010, the market appears to be opening,” says Hall. “A number of sizeable acquisitions have been announced, public and private, and properties are beginning to change hands. In the transactions seen recently, there appears to be sufficient bank capital available to support an active market.”
Hall observes that, in a break from the recent past, loan terms and conditions “will tend to be more favorable to the banks,” but the trend will be “more in keeping with our new operating reality.” He predicts well-valued transactions will attract capital that is priced and structured competitively.
Mickey Coats, executive vice president of BOK Financial Corp., in Tulsa, agrees capital may be pricey this year. “All the energy banks have increased pricing on loans. And certainly that was due. Over the previous few years we have competed so hard for the universe of good deals that we cut our pricing down to the nubs. The banks are now beginning to earn their economics back to where they should be.”
Given that bankers are already raising costs of capital, new stringent government regulations that further constrain capital would only add to the cost for energy producers.
If commercial debt is expensive in 2010, energy executives—especially those with low-margin gas plays—could turn away from banks even if their lenders are willing. Producers might instead eye public and private debt and equity markets while risk-averse bankers watch their client bases shrink.
In fact, some bankers led their clients’ charge away from commercial debt during the crisis, giving them the best fiduciary care in hopes they would return once the credit crisis resolves.
“We led many of our clients to the public debt and equity markets, which resulted in paydowns on their loans,” says James McBride, executive vice president and managing director of energy banking for Capital One in Houston.
Yet, the bank did not experience shrinkage. “Overall, our 2009 outstanding-energy-loan balance sheet increased significantly relative to our 2008 energy-loan balance sheet, as we selectively added new clients and increased our commitments appropriately to existing clients.” Due to Capital One’s “proactive stance” during the credit freeze, the Obama administration’s proposed legislation has not changed the bank’s operations in any significant way, says McBride.
Chris Cowen, executive vice president for Texas Capital Bank, in Dallas, agrees. “The number of new relationships we added in 2009 wasn’t dissimilar from 2008, as we were cautious about higher commodity prices at that time.
“In 2009, we saw a greater number of opportunities, but a much lower percentage was bankable,” Cowen adds. “We’ve already seen an increase in activity as we booked as many new relationships in fourth-quarter 2009 as we did in the prior three quarters. That trend has continued, with three new relationships closed in January.”
One factor driving deal flow since the beginning of 2010 is higher oil prices. Oil kicked off the year by trading near $81 per barrel, almost double the price in first-quarter 2009. Although U.S. energy demand has not recovered to its pre-2008 level, commodity prices should get further support from persistent, record-setting cold weather sweeping across the Midwest and cutting deep into the South.
Higher commodity prices could renew corporate and asset acquisition deals, says Dorothy Marchand, Houston-based senior vice president and energy lending manager for Spain-based BBVA subsidiary, BBVA Compass Bank (which acquired failed Guaranty Bank in 2009). “We do expect a pickup in activity in 2010 as we see M&A activity heating up.”
One example of new activity is ExxonMobil Corp.’s plan to acquire XTO Energy Inc. in a stock-swap deal valued at $31 billion.
Union Bank’s Stutzman points to another recent transaction as a harbinger of renewed deal making. “The Denbury-Encore merger adds a little hope for improvement in M&A activity during 2010,” he says. In November, Dallas-based Denbury Resources Inc. announced its plan to acquire Forth Worth, Texas-based Encore Acquisition Co. for $2.6 billion in cash, stock and debt assumption.
Although energy bankers will continue to monitor new banking regulations and their effect on operations, they are also focused on new opportunities in 2010.