Jeff Nichols of Haynes & Boone, LLP reviews borrowing base redetermination information for public and non-public oil and gas companies.

The Practical Law review of actual results closely tracks the predicted results of the Haynes and Boone survey. In the January 2016 Haynes and Boone survey, lenders predicted an average of a 25% borrowing base decrease while borrowers predicted a 28% decrease. Practical Law's review showed a 28% decrease in the size of borrowing bases. As far as the scope of decreases, in the Haynes and Boone survey lenders predicted that 70% of all producers would experience a decrease and borrowers predicted that 67% would experience a decrease. Practical Law showed that 75% of these borrowers experienced a decrease.

The differences in the two surveys may reveal some insights. The Practical Law survey uses the actual results from publicly traded companies, whereas the Haynes and Boone survey is predictive and includes public and private companies. Public companies tend to be bigger with better credit capacity. Public companies may also choose to exclude some of their oil and gas properties from the borrowing base. They can, therefore, add more properties to manage the loss of value in reserves due to price swings. They may also scale their credit agreements to only include a small portion of the reserve value as collateral, whereas smaller, nonpublic companies tend to be less conservative and borrow as much as their reserves will allow.

In contrast to this past spring where the two surveys show similar results, in the fall, the Practical Law survey presented a much better picture than the predictions from the Haynes and Boone survey had indicated. This may be because of the differences in the pool of companies in the survey but also because, in our experience, many predicted borrowing base decreases never materialized. The redeterminations were delayed or bank groups simply reaffirmed borrowing bases that were way above their price decks.

Because much of the predicted decreases never came in the fall, the Haynes and Boone survey again predicted a significant decrease this past spring. The Practical Law study confirms that this decrease came, and it came to the public companies that appear to have run out of options to avoid it.

In September 2016, Haynes and Boone will publish its Fall survey. It will be interesting to see where things go from here.

The traditional driver of borrowing base decisions has been the bank’s “price deck” which is the bank’s vision of the prices for the hydrocarbon products these companies produce. The reserve report shows a projection of which products are produced at which times and the banks will use the price deck to estimate what revenue the borrower will earn based on the projected price for each period. The bank will use many other factors to compute the reserve value, including:

One phenomenon that is interesting to observe now and that is discussed in the Practical Law summary above is the influence of the OCC lending guidelines. One factor that weighs heavily now is the debt-to-EBITDAX ratio. This is having the effect of shifting oil and gas lending away from asset based lending towards cash flow lending. Whereas the EBITDAX is backward looking over the last twelve months, reserve reports look forward for the next several years. When prices start to recover, reserve values will grow, but companies will not be able to access the bank market to develop these reserves as they used to because the trailing twelve month EBITDAX will not pass the debt-to-EBITDAX test. Unless the lending guidelines change, the inevitable result will be that non-bank lenders will fill the gap. In fact, we are already seeing several bank facilities being refinanced by non-bank lenders.

Many bank lenders are looking to reduce their exposure to the sector, while non-bank lenders see an opportunity to increase exposure at the perceived bottom of the cycle. To preserve liquidity, many senior bank lenders are employing tactics normally used by “stretch” and “mezzanine” lenders by tightening covenants that restrict the borrower’s range of activities.

Specifically, covenants regarding the purchase, sale or development of oil and gas collateral are tightening up with more bank oversight on development plans. Some banks are forced to waive or amend financial covenants to accommodate the company’s situation.

Overall their ability to tighten covenants has to be balanced against the risk of throwing the company into default or bankruptcy.

In recent months prices have increased slightly and all companies have reduced costs at an amazing rate. For some companies, the result is that they have a new slice of collateral value to offer debt or equity investors. There are a small number of non-bank lenders that have come in to offer refinancings. Finally, several companies have entered into restructuring support agreements and proceeded through bankruptcy to reorganize and deleverage.

Some regional banks were very conservative and the lending guidelines may not affect them very much at all. There are a small number of regional banks that have made headlines because they hold some loans that were very aggressive and are likely to be paid back at less than par. These loans will need to be refinanced, and the new lending guidelines mean it's less likely that a bank will provide the financing.