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Fitch: OCC could mark high-yield exploration, production loans as substandard, doubtful

The OCC could start marking many high-yield exploration andproduction loans as substandard, doubtful or loss, Fitch Ratings said April 12.

The ratings agency performed an analysis in which 67% of itssample has balance sheet leverage ratios consistent with risk ratings ofclassified or special mention. The rating agency added that a number ofcompanies are already at risk of default, particularly those with high cashflow levels and balance sheet leverage, with cash flow leverage ratios expectedto continue to climb.

Higher funding costs, more difficult lender negotiations andreduced access to new loans may await firms that have their loans marked assubstandard, Fitch said. The rating agency also believes that — given recentreserve asset write-downs, declining production and low market prices — futurereserve-based loan borrowing base cuts could be harsher this time aroundcompared to cuts in the past.

The rating agency also projected that the trailing 12-monthdefault rate for the energy sector could increase to more than 20% this year,with many of the defaults coming from exploration and production firms. Banksare in turn expected to either reduce their exposure or either raise spreads orcharge fees on classified loans.

Fitch also noted that while a number of regional banks inproducing areas have a higher energy exposure, most banks have a "manageable"exposure to energy loans.