?As has been well documented, declining home prices and the related credit deterioration across a range of mortgage-related assets have put considerable pressure on the banking sector, leading banks to become more selective in extending credit to corporate clients.


As a result, some energy issuers have had difficulty rolling over all of their commitments on bank revolvers under existing terms, according to a report by Mark Sadeghian, an analyst in the Chicago office of credit-rating agency Fitch Ratings Ltd.


“While we believe the difficulty in extending revolver commitments among selective issuers in the energy sector says more about the state of the banks extending the credit than it does about their corporate clients, it nonetheless underscores how problems in the credit and capital markets ripple through the financial system and can potentially affect the liquidity of corporate issuers,” he says.


He notes recent trends in bank-line renewals in the energy sector, which, by virtue of runaway oil and gas prices, has one of the most robust cash flows among corporations, and which, by extension, should generally carry relatively few credit concerns for banks.

Revolver reductions
The credit crunch, combined with major banks’ reserve-building and focus on their own liquidity cushions, appears to have reduced their appetite to extend credit to corporate clients—particularly credit facilities that would have been sold onward to third-party investors this time last year.


The result has been a trend of selective reductions in revolver commitments in the energy sector in the first half of the year. Although the reductions remain somewhat anecdotal in nature, a few tentative patterns are beginning to emerge.


First, reductions generally appear to be taking place among investment-grade rather than high-yield energy credits, possibly because the risk-reward balance may have skewed toward high-yield.


Second, in line with this, reductions are generally taking place among unsecured rather than secured revolvers.


Third, expansions have taken place at a number of high-yield refiners, possibly aided by banks’ comfort with the value of their security packages, which generally include crude and products inventories—significantly more valuable in a high-oil-price environment.
One common denominator among these companies is their investment-grade rating, ranging from Hess Corp. (BBB/Stable) to Occidental Petroleum Corp. and Apache Corp. (both A/Stable).


While it is somewhat counterintuitive that banks would fail to roll over full commitments in energy, given the industry’s strong cash flows and credit-protection metrics, the cost of bank capital created by the ongoing wave of write-downs may have forced lenders to tighten their returns-based capital allocations nonetheless.


“Given the widening spreads between high-yield and investment-grade issuances, high yield may have a more attractive risk-reward ratio at this point,” says Sadeghian. “For example, as of the end of September, U.S. corporate bond spreads for BBB-rated industrials were quoted at 309 basis points over Treasuries, versus 626 basis points for BB-rated industrials, a spread of 317 basis points. The spread difference last July was just 76 basis points.”

Expansions in high yield
In contrast, a number of non-investment-grade names in energy have seen credit expansions. The high-yield refining subsector is one that has seen significant credit-line expansions. Examples of recent expansions include Frontier Oil Corp., Holly Corp., Alon USA Energy and Delek U.S. Holdings.


“A feature shared by revolvers across the group is a strong security package, which in most cases includes inventories of crude oil and/or finished products, as well as other assets. Crude and product inventories are particularly well suited as revolver security, given the fact that inventories are both liquid and their value tends to rise in a bullish oil market. This is, in turn, when refiners tend to experience expanded working-capital requirements and related short-term borrowing needs,” he says.


Another theme among the group is the high level of recent M&A. For example, Alon, which has four secured revolvers, has undergone a flurry of deals over the past two years, including the $514-million acquisition of Paramount Petroleum Corp. in August 2006; the $93-million acquisition of Edgington Oil Co. in September 2006; the $70-million acquisition of 102 Texas retail outlets in June 2007; and most recently, in July, the purchase of Valero Energy Corp.’s 85,000-barrel-per-day Krotz Springs, Louisiana, refinery for $333 million plus a $140-million working-capital adjustment. Similarly, Delek has made a significant number of acquisitions to grow its downstream business.

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Energy sector risk
“To be sure, we do not believe that the failure to roll over full commitments on existing revolvers constitutes a near-term liquidity issue for the energy sector, because curtailed commitments to date have generally been small and many bank lines have five-year terms,” says Sadeghian. “However, the risk for the sector lies in the fact that if the trend continues, borrowers may have difficulty finding new syndicate members to replace existing ones on current terms, or be forced to renegotiate new credit at more expensive levels.”

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