It’s clear that the Pandemic has loomed over just about everything since 2020, but even before that the oil patch’s financial model had begun to change. Jeremy Bishop, president of Midland’s First Capital Bank of Texas, noted that equity financiers have changed their model from what he called a “build and flip” to an operate-within-cash-flow model.
“I think operating within cash flow would really be a constraint on capex, but with elevated commodity prices that cash flow should allow for some capex,” he continued. But that inflow will be much less than the reserve-building dollar flood of 2010-2019. “I think those days are over,” Bishop said.
Overall, people in the Permian are cautiously optimistic in his view because, “The energy industry is really resilient. We can go from $90 a barrel down to $20 and we still survive. We can find a way to make things work.” Even with a hostile administration and the additional constraints of ESG concerns, both of which may tighten supply, the upside for Bishop is that, “With less supply that’ll mean higher prices, so I think it all in the end will work out.”
Much of the bank’s loan opportunities have centered on mergers and acquisitions among E&P companies in recent months. Equity market money is still available for producers operating in the cash flow model. “We’re seeing more M&A deals to put more cash-flowing assets on the books to increase the cash flow” so the E&P can use the cash flow to fund capex projects, Bishop explained. Sometimes an M&A deal in that vein requires leveraging the new asset with a small amount of debt.
“We’ve also seen some growth in capex lines of credit for drilling and working over,” he said. The oil price uptick, especially into the $80 range, has provided opportunities to fund maintenance that was delayed during $30-$40 days in 2020 and early 2021.
First Capital is a regional bank whose clients are mostly small-to-mid size producers. They also lend to some service companies, a sector for which Bishop is more concerned. “They are doing better because of the commodity prices, but I really fear that competition is still going to keep their margins low. There’s been so many service companies pop up over the years because it’s been so good for so long—now they’re all trying to survive, so they’re all slashing prices and trying to win business.”
Pandemic-related oil price drops had limited effect on the bank’s loan clients. The bank worked to restructure loans as applicable. Also he called the bank’s loan policies “fairly conservative,” making sure clients have adequate equity, as well as commodity hedging, and ensuring that other factors are in line before making the loan in the first place.
Those who went into default generally “were trying to grow too fast, they got a little bit over their skis, maybe they made some risky decisions.” As a regional bank Bishop says they’re able to work closely with borrowers, being familiar with them and their business, and work with them as needed when downturns happen.
Factoring is a Factor
Small to midsize service companies, especially startups, often turn to an option known as factoring for short term money. This option is based on the fact that many producers pay invoices on a 60-90 day schedule, so factoring companies like TXP Capital loan the owed party the money, then are paid back by the payor, extracting a small fee for the service.
Because this loan is short term and is backed by the presence of a payable invoice, factoring is often a more available cash option for startups than getting a bank loan would be.
Ryan Curry, president and CEO of TXP Capital, does factoring and asset-based loans. The latter are defined as “based on the value of the asset as opposed to the financial strength of the company or the owners of the company.”
Factoring times are challenged by the fact that the need for that kind of capital has been relatively low over the last 18 months, Curry said. That’s because during the pandemic, “a lot of companies received a great deal of government money, from a multitude of the programs that were out there to keep people afloat.” Additional programs offering tax cuts or credits to maintain staffing levels also kept companies afloat without loans.
There’s an uptick on the horizon, however. As 2022 starts its trek across the calendar, Curry sees his clients’ biggest need is for working capital in order to get new projects started for their clients. Staffing up and sometimes acquiring equipment or supplies to do the job has to precede receiving payment from operators. If a service company can’t cash-flow such up-front expenditures, they look for a loan against the expected payments the job will generate.
Also, maintenance and upkeep often suffered during the pandemic, so money is needed for tires, oil changes, new batteries, and other repairs before the fleet can be redeployed. Factoring helps there as well.
On the other hand, “You don’t see a ton of companies looking to borrow money for new equipment purchases,” Curry observed. “We anticipate that that will come in the near term because the market seems primed for another significant boom,” as long as “God willing we don’t have COVID version 15 come out.”
Delayed payment systems are what give factoring a place in the world. Curry says, even at that, things move faster now than they did 10 years ago.
“When I first got in the business [TXP opened its doors in 2012], it was triplicates—you had the white copy, the yellow copy and the pink copy—and it had to go through 42 stages before it was approved.” The 60-90 days didn’t start until the invoice was approved for payment, which might be days or weeks after the service company sent it out.
As more companies across the board adopt computer driven back office systems for invoice handling, it’s sped the approval process for at least some, Curry noted.
American Momentum Bank
While Omicron has been sweeping the country, most E&Ps’ capex decisions for 2022 are based on price expectations instead of shutdown concerns, said Jarod Thomas, West Texas president of American Momentum Bank. “Their capex decisions look to be based on the commodity price, the hedge position, their acreage positions, lease requirements, and cash flow, as well as the desire for growth and their reserve base.”
Prices are expected to remain in the $80-$100 per barrel range through the year, giving E&Ps confidence they can get a good return on investment—which can require capital from lenders.
As Bishop noted above, Thomas believes those prices will let producers fund both investor returns and expansion of drilling programs. In addition to increased drilling activity, companies are poised to spend more on M&A activity, efficiency software, and more.
Some of the additional cash flow will justify paying back new loans aimed at new drilling activity, and some of those loans will be very large, Thomas said. Some of those bigger loans will exceed loan limits of any one regional bank similar to American Momentum, so the originating bank will look to syndication. This lets them get the loan while spreading the risk.
Thomas explained that in syndication “you’ve got a lead bank, they drive it, but they reach out to other banks to come in and participate and take a portion of the loan, a certain tranche of it.” The list could include up to five total banks, to spread the risk.
“It’s a way for banks to gain loan production without having to be the lead bank, to diversify their portfolio and get into a production lending platform without having to be an ‘oil and gas lead bank.’” This is especially true for non-energy banks wanting to add oil and gas to their portfolio without having to acquire the expertise required to initiate loans in that sector. He added that syndication is mostly used on loans above $50 million.
A conservative approach to lending served the bank well during the downturn. What Thomas called a “middle-of-the-road” approach—not too conservative but not too aggressive—allowed them to escape the 2020 collapse relatively unscathed.
Banks with extensive oil and gas interests have an opportunity for new loans as a result of the current ESG climate. Almost every day there are headlines about a new lender deciding to stop making energy loans to satisfy ESG demands. This, as he called it, “vacuum of lenders” leaves “any company with the capital, lending talent, and the experience, foresight, and willingness to recognize that, to take advantage of a huge opportunity,” Thomas observed.
Balancing risk and reward in the oil patch is always a challenge, and financial institutions that survive must keep re-tweaking their see saw, as these three have done, to stay alive.
By: Paul Wiseman