Private Equity Emerges as Last Resort Energy Lender

U.S. energy companies facing a likely cut in their bank loans are seeking a costly alternative - borrowing from private equity firms at hefty interest rates to stay alive for longer.

In a sign of the times, U.S. oil and gas producer Clayton Williams Energy Inc said this month it was borrowing $350 million from private equity firm Ares Management LP to replace an equivalent loan from a group of banks.

The loan from Ares is the first publicly-known deal of its kind, and does not come cheap.

Ares will charge interest rates more than triple that collected by banks, win the rights to buy up to 18.5 percent of outstanding Clayton shares and can appoint two directors to Clayton's board. Crucially, it could also give Ares control over Clayton's assets if it should fall into bankruptcy.

Clayton and Ares declined to comment when reached.

But like other cash-strapped energy firms, Clayton does not have a choice. Tens of billions worth of loans are expected to be downsized - or "re-determined" - across the energy sector this spring as banks pare their exposure to the battered industry, a Reuters calculation showed.

Desperate to hang on to their sources of financing, energy companies are likely to accept stringent deal terms they may not have accepted in normal times. Indeed, some are also restructuring their debt with bondholders.

"The deal here for Ares gives them an opportunity to win in almost every situation," said John Sirico, an analyst at independent credit research firm Covenant Review.

More of such deals could be struck this spring as loans get renegotiated, he said, and private equity firms with big credit arms such as Blackstone Group LP, Apollo Global Management LLC and Oaktree Capital Management are likely to take the lead.

Blackstone, Apollo and Oaktree declined to comment.

The worst energy slump in 12 years that has seen oil prices tumble 65 percent since mid-2014 has cost tens of thousands of jobs and triggered dozens of bankruptcies.

With oil prices widely expected to hover around $40 this year, many analysts expect many more companies to fall into bankruptcy in coming months.

U.S. banks have been increasing the amount of money they set aside to cover energy-related losses and some have been looking to sell blocks of distressed energy loans to private equity firms, to remove the risk from their balance sheet.

LOAN-TO-OWN
Before the collapse in oil prices, banks were prepared to disburse "revolver" loans to energy companies based on the value of their energy reserves. The loans allowed borrowers to use the cash when they needed to, much like a credit card.

Often priced at a couple of percentage points above benchmark rates, revolvers were the cheapest form of financing for energy producers and were considered mostly risk-free by banks.

But as oil prices plunged, banks, under pressure by regulators to shed risky business, started slashing loans to energy businesses since October. U.S. oil and gas producers Energy XXI Ltd and Rex Energy Corp said on Tuesday their credit lines had been cut by banks, regulatory filings showed.

Some banks are even selling their energy revolver loans to private equity firms at deep discounts.

Indeed, Clayton's financing may have shrunk if not for Ares.

Previously, Clayton had a revolver worth $450 million from banks. It is not clear who backed Clayton's most recent credit facility but banks including JPMorgan, Wells Fargo & Co , Union Bank and Frost National Bank have done so previously. The banks declined to comment.

A senior JPMorgan banker had warned in February that lenders could cut credit lines by 15 percent to 20 percent in the upcoming negotiation season.

Under the new arrangement, Clayton would borrow $350 million from Ares for five years, and get the remaining $100 million in a revolver loan from a consortium of 16 banks that include JPMorgan, a regulatory filing showed.

Ares, which manages about $94 billion worth of assets, will charge Clayton an annual interest rate of 12.5 percent for its loan. That is much higher than the approximate 3.1 percent that Clayton would pay for its $100 million revolver loan, filings showed.

Should Clayton slip into bankruptcy, Ares could stand to benefit as well. Its loan ranks behind that of the banks in terms of repayment among creditors, possibly leaving Ares with much of Clayton's equity during a bankruptcy. That would allow Ares to control Clayton's assets, a "loan-to-own" strategy favored by private equity houses.

"If the loan does not perform, then the private equity firm may be in the driver's seat to potentially own the company after a bankruptcy," Sirico said.

Reporting by Koh Gui Qing