In the days leading up to the announcement of COVID-19 pandemic-related stay-at-home orders, many Americans bought abnormally large quantities of toilet paper, among other necessities. This universal hoarding trend may have come as no surprise to veterans of oil and gas reserve-based lending, who have likely seen other examples of how anticipated scarcity breeds hoarding behavior. When the price of oil craters to levels that make production uneconomical, many producers with reserve-based credit facilities are incentivized to draw down as much cash as they can under their credit facilities in an attempt to shore up their liquidity. As grocery stores impose per-customer quotas to curb the hoarding of toilet paper and other essentials, lenders are turning to a trusted strategy to limit the hoarding of cash by oil and gas borrowers.
Cash hoarding, and the anti-cash hoarding provisions that seek to counteract it, are recurring phenomena in reserve-based lending facilities (facilities where credit availability is tied to the value of a borrower’s oil and gas reserves, expressed as a “borrowing base” amount). Prior to the COVID-19 pandemic and the related collapse in demand for oil worldwide, the most recent surge in popularity of anti-cash hoarding provisions occurred during 2015 and 2016. When a severe (and/or prolonged) downturn in commodity prices appears, biannual borrowing base redeterminations – typically conducted by lenders in the spring and fall – threaten to shrink borrowers’ access to available credit at precisely the time they need it most in order to withstand the downturn. Reduced cash flows incentivize borrowers to draw down their revolving line of credit as much as possible to protect against a potential liquidity crunch. Lenders use the borrowing base redetermination process to limit such actions by borrowers, offering a bargain: amend your credit agreement to add anti-cash hoarding provisions, often along with a number of other concessions to the lender group, such as increased interest rate margins and tighter financial covenants, and, in return, the lenders will either maintain the borrowing base at its current level or agree to less of a reduction based on the underlying value of the borrowing base assets. This trend is currently playing out on a daily basis in the public filings of oil and gas companies disclosing their spring borrowing base redeterminations, along with concurrent amendments to their credit facilities that include the addition of anti-cash hoarding provisions.[i]
The current round of anti-cash hoarding amendments seems to have been partially touched off by the bankruptcy filing of Whiting Petroleum, announced on April 1, 2020. Whiting has reported that at the time of the bankruptcy filing, it held $585 million in cash. Since most reserve-based credit facilities are now generally secured by all of the borrower’s assets, including its cash, Whiting’s lenders likely have lien priority with respect to this $585 million. But it seems probable that restricting Whiting’s ability to draw down the full amount of its revolver would have been preferred by its senior lenders as compared to holding a secured claim in the bankruptcy.
Anti-Cash Hoarding Provisions: A Primer
Anti-cash hoarding provisions in credit agreements typically have three main components: (1) a condition precedent to future advances of loan funds, (2) a mandatory prepayment, and (3) a “cash balance” or “excess cash” definition that is used in the first two components.
The first component – the condition precedent to future advances – prevents borrowers from obtaining loan funds if it would result in the borrower’s cash balance exceeding a designated threshold. The threshold is set well below the amount of the borrowing base that would otherwise limit the availability of loan funds. In effect, a portion of the borrowing base becomes available only for purposes other than sitting on the borrower’s balance sheet.
The second component – the mandatory prepayment – caps the amount of cash that can be held on the borrower’s balance sheet, with any excess over that cap being required to go toward paying down the borrower’s outstanding loans. Unlike the first component, which only interferes with the borrower’s use of loan proceeds, the mandatory prepayment provision reaches cash that the borrower may have separately obtained from its operations or other sources. The prepayment threshold is tested frequently, as often as daily, to keep a tight leash on cash hoarding. The limitation on the borrower’s cash balance is sometimes structured as a flat dollar cap, sometimes as a percentage of the borrowing base or aggregate lender commitments, or sometimes as a hybrid of both concepts. Sometimes the mandatory prepayment only applies when a revolver utilization threshold is exceeded.
The third component is the defined term used to measure the borrower’s cash balance, which typically carves out a number of categories of cash that are exempt from the foregoing tests. The “cash balance” definition is where borrowers subject to anti-cash hoarding provisions have the opportunity to create flexibility for their anticipated cash management needs. Common carve-outs, often subject to durational limits, include:
- cash restricted or set aside for the purpose of meeting royalty obligations, taxes, payroll, or employee benefit payments;
- proceeds of permitted debt offerings that will be used to redeem other debt;
- refundable purchase price deposits held in escrow under purchase and sale agreements; and
- amounts subject to issued checks, initiated wires, or ACH transfers.
Beyond these three main components, anti-cash hoarding provisions may also include other variations, such as additional reporting obligations or negative covenants that flatly prohibit a borrower’s cash balance from exceeding a designated threshold at any time.
Additional Considerations for Borrowers
a. Lender voting. Reserve-based credit agreements are typically syndicated among a group of bank lenders, and typically provide that certain types of amendments to the credit agreement require 100% consent of all the lenders, while other types of amendments require only a majority or two-thirds vote. Amendments that are minor or that benefit the lenders usually require a majority vote, while amendments that are more material or that may negatively impact a lender’s economic interests usually require a 100% vote. Consistent with this principle, an amendment adding strictly anti-cash hoarding provisions should only require a majority lender vote.
Given the boom-and-bust nature of the oil and gas industry, many borrowers presently accepting the addition of anti-cash hoarding provisions to their credit agreements will also be looking to the future as to what it will require, from a lender voting perspective, to get rid of those same anti-cash hoarding provisions in the future. Borrowers should be aware that, while adding anti-cash hoarding provisions now may only require a majority lender vote, subtracting them in the future is likely to require a 100% lender vote because the removal would be taking away an economic benefit from the lenders. This means that a single holdout vote in the lender group could block the borrower from returning to an unrestricted cash management environment after commodity prices have improved. The holdout lender(s) may have motivations for blocking the removal of anti-cash hoarding provisions that have nothing to do with the borrower’s finances. While “yank a bank” provisions (whereby the borrower can replace a non-consenting lender with a new, consenting lender so long as the new, consenting lender pays off the non-consenting lender) are designed to provide a work-around in this context, they require a willing substitute lender in order to be useful, and they may involve the payment of additional fees or expenses.
b. “Cash balance” carve-outs. When negotiating anti-cash hoarding provisions, borrowers should consider all of the contexts in which they may need to hold cash on their balance sheet during the loan term – including any such contexts that may be unique to their particular business and thus not accounted for in publicly available anti-cash hoarding precedents – and should seek carve-outs from their “cash balance” definition to exempt those contexts from the new cash hoarding tests. For example, if a borrower has a large contingent obligation – such as a surety bond indemnity obligation – for which it needs to set aside cash without actually paying that obligation within a short period of time, it may need a specific carve-out for that purpose. If a borrower plans to refinance other indebtedness during the loan term, it should consider whether the exemptions from the “cash balance” definition provide enough flexibility to accommodate the possible timing and funds flow of such a transaction.
Anti-cash hoarding provisions in reserve-based credit agreements, like per-customer quotas for essential products, will hopefully go away soon. The provisions added during the 2015–2016 period were eventually taken out. Until then, borrowers should understand market practice and the trade-offs involved in adding these provisions to their credit agreements.
[i] Two examples of this trend can be accessed at the following links: