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US SMEs face further borrowing pressure

By Jayne Jung

July 21, 2009 - Small and medium-sized energy companies' ability to raise capital is shrinking as banks consolidate their lending on established customers with large asset bases. (See related chart: Banks' shrinking market optimization ($ billion).)

SMEs can turn to mezzanine financiers, but even here the number of lenders has contracted, and the cost of borrowing has risen.

This is placing a large constraint on a traditionally dynamic sector that plays a key role in the energy sector's fortunes.

Despite talk of the "green shoots" of recovery, small to medium-sized enterprises are seeing their borrowing bases cut from under them.

And even with higher oil prices, oil and gas firms are no exception.

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"The market is way too tight. You look out there and you see many of your peers having their borrowing bases cut in half," says Scott Allen, chief financial officer of ReoStar Energy Corporation, a $6.5 million natural gas producer based in Fort Worth, Texas.

In October, his firm secured a $25 million credit facility. It is now weighing its options for raising additional capital.

Scott Johnson, Houston-based cofounder of mezzanine debt provider GasRock Capital, sees the same general trend.

He observes that banks are now very clearly focused on existing clients, and some companies are seeing their borrowing bases reduced, often to below the level of their outstanding bank debt, he says.

There are also whispers in the market that a large bank has recently limited its senior debt borrowing base transactions to firms with $100 million in assets or more, cutting out the SME sector all together.

While not consistent across the board, during the April-May redetermination period, when firms' lending arrangements are reviewed, commercial banks reduced the borrowing base of some smaller companies involved in exploration and production in the US by as much as 50%, several industry sources say.

All were in agreement that this redetermination period would be easier than the next.

Firms are likely to face more severe reductions with greater restrictions come October.

As a result, oil and gas companies will have to take on more junior debt, such as mezzanine, second lien or subordinated debt, in order to pay back their interest and principal to senior lenders.

They may also end up having to raise equity or sell assets.

They will certainly be limited in terms of new capital for investment.

According to Christopher Woodruff, an associate professor of economics at the University of California, San Diego, the smallest, fastest growing companies are likely to be hardest hit when there are limited resources.

During a crisis, banks often perceive the smallest companies as having the riskiest loans and will restrict them first, or they might require excessive over-collateralization, such as large amounts of real estate. (See related chart: iTraxx Europe - loan margins for BBB credits.)

An October 2008 Federal Reserve Board Senior Loan Officer Survey showed that three-quarters of US banks have tightened their lending standards on small business loans.

In the energy space, restrictions in lending are tempered by pricing pressures or expected price increases -- although those trends have been more difficult to forecast.

For natural gas, the consensus among lenders is that prices will remain suppressed, while oil prices are expected to increase.

Oil companies thus have an advantage over natural gas companies in their quest for capital.

Borrowing bases are determined by the price of the commodity multiplied by the volume of output less costs.

Derivative hedges to protect against falling prices are also factored in.

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