The decade of 2010 opened to a “black gold rush” built upon horizontal drilling and hydraulic fracturing, drawing in a flood of investment money of all kinds. Investors dreamed of funding an unlimited Christmas list for producers and service companies alike, asking only that the list be used to expand the company so it could be sold at a major profit in 3-7 years.
Almost none of those investors ever wanted to be “stuck” in the oil business long term and to actually operate them for perpetuity, nor even for a matter of years. Through various busts and contangos, that’s exactly the situation some have found themselves in at the start of the next decade.
With the market collapse of March, 2020, oil patch companies in every sector who over-leveraged to fund explosive growth find themselves in great danger.
Local banks, on the other hand, like Southwest Bank and what is now American Momentum Bank, did lend money into that scenario but with different rules and expectations. President of the Energy Division for American Momentum Bank, Bobby Norman has 43 years in banking, mostly in energy loans. He sees the 2020 crisis as a teaching opportunity.
“You ask what’s the market teaching us right now—I think it’s two or three things,” he said. “One is, even in the oil and gas industry, most companies historically have not focused on liquidity as much.” This is particularly true with smaller companies. “I think one of the things the market would teach us right now is that liquidity is critical to protect against the extreme volatility we’ve seen. That volatility can come from a variety of sources.”
A company with ample cash reserves has more choices in a downturn than one that is leveraged to the max. “If you don’t have any liquidity, then someone else has those choices.”
A second lesson is controlling growth. While growth was king in the 2010 decade, Norman points out that methodical, organic growth was more financially prudent than spending all of one’s cash and borrowing heavily against an idea that exponential expansion could pay for itself over 5-10 years.
Momentum Bank’s clients stretch across the spectrum from E&Ps to service companies, now including Paycheck Protection Plan (PPP) loans tied to COVID-19 relief. Understandably, the commodity price crash has affected the loan market, with PPP loans taking great precedence over standard ones.
“I think loan requests are fewer today, but that would be excluding PPP loans,” he said. E&P loans in particular are down, although the loans that are in play are for amounts that would have been typical before the crisis.
There are two main reasons for the decline. “One [is] the oil and gas markets [collapse], but number two, obviously, the COVID situation has had people working remotely and contact with clients has been more difficult and probably less as they kind of retreat.” Some re-situate out of the area to a second home or distant family. This has reduced personal contact to the point that even if new business is available, opportunities are harder to encounter by phone or Zoom meeting.
Many are taking a pause, waiting to see how and when commodity prices return to a profitable level before expanding or taking on debt—this being a situation that, in all the booms and busts of history, has not exactly come around before.
Regarding the bank’s loan criteria, Norman said nothing has changed because they maintained their borrowing standards all along. “In any lending environment, the question is always cash flow—what cash is available on a monthly or quarterly basis to repay the debt,” he pointed out.
“Obviously that gets impacted when you have a 60 percent drop in the commodity price, but most of us have built-in margins in that cash flow or collateral scenario.” If anything might be different, it would be how the pandemic has affected a client’s work environment. Some are working remotely, some cycling workers in 20 percentile groups, and “That’s a new twist that we’ve never had to deal with before.”
Taking out a loan, no matter the size, involves a calculated risk that the loan will provide resources to more than pay itself back. As a lending institution, he noted, the bank’s job in any economic climate is to help its borrowers manage that risk.
For existing notes, the fact that oil prices quickly bounced back into the mid-$30-range has helped borrowers stay current. As stated, those with cash reserves can survive at least short-term crises more easily.
“We’ve had some clients ask for some payment relief such as going to an interest-only scenario for 60-90 days to get them through the worst part of the commodity price decline,” Norman said, adding, “That’s not unreasonable in this environment.”
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Paul Wiseman is a Midland, Texas-based freelance writer.