HOUSTON ─ Reserve-based lending (RBL) practices should be adapted to the lower commodity price environment, David Lazarus told the Houston Energy Finance Group recently. That means bankers will return to more traditional deal structures and tougher terms than were prevalent during the shale frenzy that demanded so much capital.

“Borrowing bases should be for liquidity and short-term needs, and more permanent RBL capital should be for longer terms and match the asset profile,” said Lazarus, a New York-based Morgan Stanley managing director.

Many energy lending banks have been reluctant to cut off their customers so far this year, so they have been relaxing covenants during the downturn and maintaining an accommodative stance. “But I think most now realize there will have to be some changes” in the lending marketplace.

“A lot of people had been kicking the can down the road,” Lazarus said, by extending E&P clients’ borrowing bases another six months even as low oil prices stubbornly linger.

However, Lazarus said he expects a return to the use of more conservative mechanisms that were the norm a few years ago. That means tougher terms, more term debt, lower advance rates on reserves, more hedging required─and often, higher costs of capital.

E&P companies that are largely unhedged going into 2016 will be challenged, which also may create additional loan problems, Lazarus said.

Bankers today confront a number of problems when lending against oil and gas reserves, whether making traditional loans or those with stretch structures such as second liens. (One E&P recently obtained a third-lien debt deal.) “There’s a tremendous amount of pressure on both reserve values and leverage ratios. This in turn may limit how much a banker can do for the E&P client,” he said.

“One of the biggest problems I’ve seen is the lack of amortization, and we see the market potentially beginning to use the six-month reserve roll-forward mechanism again. I think it would be more appropriate to keep borrowing bases better in line with the decline profile of the assets. A borrowing base today is really just six-month capital, and I’d ask, is that really the right capital for these assets?”

In time the weighted average cost of capital will be going up, even if interest rates do not rise, he said. “Clients have gotten very used to receiving loose terms and benign waivers recently, although it does seem that the market is moving away from recent structures and back to historical norms.”

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