American Oil and Gas Reporter - October 2024 - 61

SpecialReport: Financial Perspectives
For the most part, banks active in
RBL have between 2% and 5% of their
total loan portfolios in that segment, Kennedy
estimates. In years gone by, it was
not unknown for a bank to have as much
as 10% of its total loan portfolio in RBL,
but that level now seems imprudent to
lenders and unnecessary to operators.
" Many producers are operating with a
lot less debt in relation to their earnings
before interest, taxes, depreciation and
amortization, " Kennedy notes. " That means
they are not hanging on the borrowingbase
redeterminations twice a year. "
Most public independents used to
have enterprise values of 6.0x-8.0x their
EBITDA, Kennedy recalls. " Many banks
would be happy to lend at half that
level, so 3.5x debt to EBITDA, with a
covenant limit of 4.0x. That is for companies
with an enterprise value
below $3 billion.
" Today, those same companies
trade at 3.5x to 4.5x
EBITDA, " he contrasts. " These
numbers require a lower covenant
limit, which is currently
being set at 3.0x, but banks are
not actually comfortable with
borrowers close to that. Instead,
the preferred limit is closer to
2.0x-and in practice, the ratio must be
below 2.0x to enable the borrower to
make cash distributions. "
The focus on cash flow is a testament
less common than they were only a few
years ago, Kennedy reports. " Reservebased
lenders generally dislike second
liens, because they have lost real money
to second liens in previous down cycles, "
he says.
as a replacement for RBL, " Kennedy allows.
" An exception is when ABS provides
debt for special-purpose entities that are
subsidiaries of a parent company, and
the parent has separate assets pledged
under an RBL. "
As lenders have gotten more experience
with unconventional plays, Kennedy says
they have become more conservative.
" Initially, producers and debt engineers
severely overestimated unconventional
wells' production because they did not
yet understand interference between wells
and how horizontal fracs degrade over
time, " Kennedy says. " It took a while to
appreciate those effects and begin accounting
for them. "
Eager Lenders
" Many producers are operating with a lot less
debt in relation to their EBITDA. That means
they are not hanging on the borrowing-base
redeterminations twice a year. "
Steve Kennedy
Managing Director
Opportune
to investors' power. " There is not a lot of
argument about those levels from industry, "
Kennedy remarks. " Investors have put
cash-distribution discipline on industry,
so now, we usually see debt-to-EBIDTA
ratios of 1.50x-1.75x. "
Implications for A&D
The emphasis on financial discipline
encourages companies to make acquisitions
without taking on much debt,
Kennedy observes. He suggests that this
may slow post-acquisition divestitures,
as acquirers can hold on to noncore assets
rather than urgently marketing them to
reduce debt.
There are many ways for producers to
manage capital, but second liens are much
Such losses occur even though second
liens are subordinate. " In a bankruptcy, the
second lien can hold the first lien hostage
by threatening to cause trouble, " Kennedy
explains. " There have been situations where
the second lien gets paid 5%-10% even
when the first lien was at a loss. "
Even when there is no bankruptcy,
Kennedy continues, second liens can increase
the amount of capital a lender has
to hold. " Since 2016, the Office of the
Controller of the Currency has specified
how all secured debt, first and second, is
graded. If the first lien is well covered,
but the second is not, they are both downgraded,
forcing the bank to hold more
capital against a loss, " he clarifies. " That
is true even if the lender of the first lien
does not hold the second. "
It also is unusual for other forms of
debt to be combined with RBL. " In many
cases, asset-backed securities (ABS) act
While banks are taking a more conservative
approach to structuring
RBLs than they once were, they
are seeking opportunities to lend,
says Cristina Stellar, senior vice
president and managing director
of BOK Financial Securities.
" Energy lenders continue to
be hungry for origination, as
nearly all banks have been given
budget directives targeting asset
and/or loan growth in 2024, "
she reports. " Growth has been difficult
for lenders to achieve because of continued
portfolio attrition associated with
consolidation in the sector. 2023 was a
record year for corporate consolidation. "
This trend, along with moderation
of drilling budgets, has contributed to
relatively low loan volumes. In fact,
LSEG Refinitiv's upstream issuance
data through the second quarter of this
year, the latest period for which data is
available, puts loan volume at its lowest
level since 2020.
" We are starting to see rationalization
transpiring in the market with more deals, "
says Stellar. " As consolidators' noncore
assets continue to hit the market, the expectation
is to have a fairly active fourth
quarter of 2024 and first quarter of 2025.
In the past, the last quarter of the year has
been a challenging time for lenders to
raise new capital on the bank debt side. "
OCTOBER 2024 61
American Oil and Gas Reporter - October 2024

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