Prolonged oil price slump throws problem loans into the spotlight

Global Publication March 2016

Challenging times for shipping and offshore energy companies

You would have had to be living on a remote desert island or perhaps under a rock for the past 18 months to have escaped the now daily analysis of the oil price. In this short space of time, we have witnessed crude oil prices take a tumble from trading at over US$100 per barrel down to the current lows of around US$30 per barrel. The fallout from this slump has been widespread, with the global shipping and offshore energy industries hit particularly hard, arguably even more so now than in the aftermath of the global financial crash in 2008.

In recent weeks, shipping sector giant AP Moeller-Maersk, widely viewed as a bellwether for global trade, has reported plunging profits and posted net income of US$791 million last year, against US$5.02 billion in 2014. Maersk’s performance was affected to a large extent by a US$2.6 billion write-down on the value of its oil assets. Whilst not necessarily on the same scale, this is a familiar story for a number of companies involved in the shipping industry. There are similar reports from companies engaged throughout the offshore energy industry, from producers to offshore support services. Last month saw UK producer First Oil Expro Ltd. enter into administration, unable to adapt to the fall in the oil price.

Lenders feeling the effects

A further inevitable fall-out from the sharp decline in oil prices is its impact on lenders to the shipping and offshore industries.

The longer the oil price stays low, the fewer options struggling companies operating in the shipping and oil and gas markets will have available to them. For much of last year, companies were able to negotiate extensions and amendments with their counterparts and their lenders, based on the assumption that prices would soon recover. Alternatively, some companies sold non-core assets, obtained capital from public or private markets or relied on their hedging arrangements. The prolonged oil price slump means that many of these measures are no longer available, which ultimately leaves these companies with no choice but to default on their finance obligations.

At the end of last year there was significant press coverage on the disclosures by US lenders regarding their oil and gas loan portfolios and the extent of the provisions they are making against non-performing corporate loans in the oil and gas sector. More recently, European banks are coming under scrutiny as investors grow increasingly anxious about the banks’ exposure to the oil industry. Banks in Asia are also feeling the strain as a number have sizeable oil and gas exposures, according to a recent report by Moody’s.

When a problem loan is a problem for too long

Whilst it is, of course, part of the normal course of business for lenders to have some non-performing loans on their books, they become more of a focal point and a concern when a particular issue envelops an entire industry, or, in the case of the oil price, multiple industries. As the percentage of non-performing loans on banks’ books creeps up, it becomes more likely that banks will take actions aimed at realising as much value as possible, it becomes more likely that banks will take actions aimed at realising as much value as possible from these loans.

There has already been a marked increase in shipping and oil and gas problem loan issues in the past 12 months. Many of these lenders have taken steps to review their recovery rights under transaction documents and send reservation of rights letters, which usually come as a pre-cursor to acceleration and enforcement action, including litigation and winding up proceedings.

Our experience tells us that many distressed loans can be, and are, restructured and repaid without the need for expensive and protracted litigation However, in recent months we have observed a gradual decrease in tolerance by lenders in response to defaulting borrowers. A recent example of this was a lender’s successful court application in Singapore against a shipowner, forcing the shipowner to sell its fleet of 11 bulkers under the supervision of a judicial manager. On the corporate side, in order to protect themselves against aggressive creditors, there has been an increase in the number of companies seeking court protection in various jurisdictions, Chapter 11 in the US being the most well-known. Whilst court protection offers companies an opportunity to restructure, it is not something entered into lightly, as it has the potential to become a very protracted and expensive process.

The outlook for the oil price and the shipping and offshore energy industries for the remainder of 2016 is poor, and beyond that there is much uncertainty. This can only mean greater stress for borrowers and more frequent action by lenders as the number of problem loans continues to tick upwards. We can expect to see even more restructuring, insolvency and enforcement in the coming months.

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