Oil Loans Burden Banks

FBN oil pipe drilling rig

The $147 billion question for banks: Will energy companies max out their credit lines?

When big banks announce earnings starting Wednesday, the spotlight will be on vast energy loans that most investors didn't know much about until recently.

These unfunded loans have been promised to energy companies, which haven't yet tapped the money. Many banks historically haven't disclosed these loans, but began doing so recently following the extended slide in prices for oil and gas.

In the first quarter, a handful of energy borrowers announced more than $3 billion of drawdowns against these types of loans. Those commitments are expected to trickle down to bank earnings and saddle firms with more energy exposure just as they are trying to pare it back.

"Let's not sugarcoat it. This is not necessarily a loan a bank wants to make at this point," said Glenn Schorr, a bank analyst at Evercore ISI.

Oil prices have risen in recent weeks, with the U.S. benchmark settling at $42.17 a barrel on Tuesday, but analysts say the unfunded loans to the sector still are a headache for banks at that price.

Banks in recent months have set aside billions of dollars to cover potential losses tied to energy companies, a trend likely to continue as more loans go bad.

Fitch Ratings  released a report Tuesday that said that nearly 60% of unrated and below-investment-grade energy companies are likely to have loans labeled as "classified," or in danger of default under regulatory guidelines. "It's grim," said Sharon Bonelli, senior director of leveraged finance at Fitch.

Banks often use a company's proven energy reserves as collateral for loans and typically reset the value of these reserves twice a year, usually in spring and fall.

The draws made so far were done ahead of the spring redetermination process, in which banks are expected to cut the credit lines of energy firms by an average of more than 30%, according to a survey from law firm Haynes & Boone LLP.

Ms. Bonelli and other analysts say bank loans are increasingly vital lifelines for energy companies, because other funding sources have dried up.

The $147 billion in unfunded loans have been disclosed by 10 of the largest U.S. banks, according to fourth-quarter data from Barclays. The four largest U.S. banks -- J.P. Morgan Chase, Bank of America, Citigroup and Wells Fargo -- pledged the majority of this amount.

Smaller U.S. lenders and large international banks have made billions more of these loans.

"With oil at $60, it's not that big of a deal. With oil at $40, it becomes more of a source of concern," Barclays analyst Jason Goldberg said of the unfunded loans. "Will companies draw down in difficult times?"

Lenders routinely offer these commercial lines of credit to industrial companies. But the energy loans, often promised before prices started their steep decline, face a unique set of pressures.

James Dimon, J.P. Morgan's chief executive, said in February that the unfunded loans are "the most unpredictable part of our assumptions" about the bank's energy exposure.

Mr. Dimon also said he isn't expecting a large percentage of the unfunded money to get drawn because most of those promised loans went to investment-grade companies that he thinks are unlikely to need access to additional cash.

Banks hold reserves against unfunded loans in addition to reserves for loans that have been taken out.

A mounting number of troubled energy firms have tapped their unfunded loans.

Denver-based oil-and-gas firm Bonanza Creek Energy, for instance, said in March that it drew $209 million from its credit facility from a group of banks led by Cleveland-based KeyCorp. Bonanza Creek's chief executive said in a news release that the move was "a risk-management decision" and praised its "committed and supportive commercial bank syndicate." A KeyCorp spokesman declined to comment.

Tidewater, which provides vessels to the offshore drilling industry, said in March it took out the maximum $600 million from its credit facility led by Bank of America. The firm's chief executive cited "the uncertainty surrounding the future direction in oil and gas prices," in a news release announcing the withdrawal. A Bank of America spokesman declined to comment.

To stem such withdrawals, some banks have negotiated what are known as anti-cash-hoarding provisions when energy firms have asked for amendments to their loans in recent months.

These clauses require the companies to use extra cash to repay the balance on their credit lines in exchange, according to regulatory filings.

But for distressed firms facing bankruptcy that can contractually do so, "you'd seriously have to consider a game plan to draw down," said Ian Peck, head of the bankruptcy practice at Haynes & Boone.

Write to Rachel Louise Ensign at rachel.ensign@wsj.com