When good loans go bad among junior energy companies

This is shaping up to be a deeply unpleasant autumn for junior energy companies and the banks thatlent them hundreds of millions of dollars.

Everyonegot hall passes until the fall, butthe principal is going to be standing in the hall wanting his passes back.- Bruce Edgelow, ATB Financial

Bankstypically review their loans twice a year, but the last review took place in the springwhenit looked as though oil prices might be poised to makea recovery.There areno such illusions now.

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"Everyonegot hall passes until the fall," said Bruce Edgelow, head of energy banking at ATB Financial."Butthe notion is that the principal is going to be standing in the hall wanting his passes back."

Looking for the exit

The investment bankCanaccordGenuitysuggested that Canada's banks are going to be looking to reduce their exposure to oil and gas loans by 15 to 20 per cent, simplybecause lending to energy has become too risky.

This has come as a shock to some juniors.The relationship between banker and corporate borrower tends to be pretty jolly when times are good, with money on tap for growth plans and parties during the Calgary Stampede. Butwhen those loans become troubled, they are passed to another group, whose job it is to collect or otherwise getthedebtoff the books.

It's a little less friendly.

"When you move files to the special loans teams, in most of the eastern banks, they are managed by the eastern-based special loans guys and their sole mandate is to get off the position," said Edgelow. "Not necessarily to restructure and return it to health."

All of the major banks have increased the money set aside for bad loans to the energy sector. A year ago, the Royal Bank set aside just $5 million for potential bad loans in oil and gas. In the most recent summer quarter, that increased to $183 million.

ATB Financial, which is owned by Alberta's government increased its loan loss provision by nearly 500 per cent in the spring quarter to $57 million.

Collateral damage

Loans to energycompaniesare largely secured by the value of oil and natural gasreserves in the ground. With oil prices down so sharply, many of thosereservesare worth around half of what they were a year ago.That is the driving force behind re-evaluating the loans.

Edgelow said ATB in the spring told its clients who were stretched that it was time to raise some cash. Many companies tried to sell oil and gas assets, but there was a widespread difference between the asking price and the offer.

"Some of the bids won't clear the bank debt," said Edgelow. "Sothe borrowers are having a hard time figuring out what to do."

Canaccord Genuity said in its report this week that it expects corporatelines of credit to be cut by 15 to20 per cent in the fall and thatthe loan re-evaluationwill probably lead to a wave of merger and acquisition activity in which companies that have managed their debt and have cash on hand will be ableto pick off companies that are struggling.

Hedge funds circling

There is another option. For months now, hedge funds thatbuy debt have been circling all the banks, looking to buy distressed loans, although not at full price. Selling thoseloans might be a quick way to get them off thebooks, but can also hurt long-term relationships in the sector.

Finally, there's insolvency. Edgelow says only around a dozen juniors have been pushed into receivership since the downturn began last fall, three of which are clients of ATB. Once in receivership, the assets are sold off, the banks are paid back and investors are typically left with little or nothing.

Edgelow said there's a reluctance to take that step, but that sometimes it's necessary.

"We will be less likely to push the receivership,if we don't have to," said Edgelow. "And we will be more patient,as long as we don't think our collateral will be eroded."