An observation that many energy companies are in trouble is so passé—if that word is ever used to describe anything in private debt. The question now facing investors is what to do with their positions in oil and gas companies, a particular dilemma that some business development companies (BDCs) are facing.
The question looms over the industry as Franklin Square’s BDC, FS Investment Corporation and affiliates, stands poised to take a controlling stake in Warren Resources, a Denver-based business currently under bankruptcy protection.
The exploration and development company, which focuses on domestic onshore oil and gas reserves, is scheduled to seek approval on 25 July of a plan outline that would give FS Investment and its affiliates 82.5 percentof the new equity. If the company wins court approval of its plan outline, Warren Resources can begin rounding up creditor support to exit bankruptcy. FS held Warren Resources’ first-lien debt before the company filed its Chapter 11 petition on 2 June.
“Many BDCs are unloading or at least willing to unload (for the right price) their energy positions,” First Avenue Partners’ Ben Schryber, global head of credit at the placement agent, said in an email, noting that the debt is illiquid. While BDCs with underperforming energy loans may dump some of their holdings, BDCs with performing energy loans may still shed some positions if the managers want to reduce risk, he added.
Apollo Investment Corporation is among the BDCs with a heavy energy exposure. It has invested in several oil and gas companies that underwent a Chapter 11 bankruptcy proceeding, including Miller Energy Resources and Venoco Oil and Gas.
A source familiar with the matter said Apollo is working to exit some of its energy positions.
A May report from Wells Fargo BDC analyst Jonathan Bock noted that investments in energy “continue to weigh” on Apollo’s net asset value even though the price of oil has rebounded somewhat. In the first quarter, Apollo’s position in Venoco led to a $10 million markdown.
“When we looked at the BDC managers with the hardest-hit energy portfolios, we found that many of the teams making these loans did not possess energy investing skill-sets or experience,” Schryber said.
The energy market has seemingly burned even specialized BDCs. Shareholder returns from Franklin Square’s energy-focused BDC, FS Energy & Power Fund, was down 16 percent over the prior year through 31 March. Warren Resources is FS Energy’s fifth largest holding as a percentage of its portfolio.
FS Energy said in investor material released last fall that it saw opportunity amid the chaos.
“[FS] believes that market volatility will continue to disrupt the flow of credit from banks and the capital markets to energy companies, creating an attractive investment environment for our funds,” the BDC wrote in a case study it published.
The FS BDCs are sub-advised by Blackstone-owned GSO Capital Partners, which itself has a sizeable energy exposure (about 9 percent of assets). In prior conversations with GSO executives, they said they were committed to energy investing, though it’s unlikely they would raise the weighting at this point. They also said they’ve re-underwritten many of their energy positions, where the companies could remain healthy while oil trades at $40-$50 per barrel.
Other BDC managers with large energy books might not be as confident. “Some of the BDC managers we have spoken to admitted that they did not adequately stress test their loans to a collapse in commodity prices,” Schryber said. “The tricky thing about these poorly performing E&P credits is that they really just rely on commodity prices. [The energy market downturn] revealed that you have stick to what you know” when evaluating credits.
While oil prices are no longer hovering around $30 a barrel, the oil market crash still serves as a cautionary tale and it may be time to pare down those investments, if not exiting them completely.