Refiners May Violate Loan Terms as Fuel Demand Stalls

Oct. 1 (Bloomberg) -- U.S. refiners may fail to meet financial requirements of their credit agreements later this year as slumping fuel demand erodes the profitability of making gasoline and diesel.

Independent refiners, which don’t have oil and natural-gas wells to fall back on, are being pushed to the brink of violating performance covenants of their loans, said Scott Van Bergh at Bank of America Merrill Lynch in New York. Van Bergh, the bank’s energy banking chief for the Americas, declined to comment on specific companies. Bankers and analysts say Western Refining Inc., Tesoro Corp. and Alon USA Energy Inc. are among the fuel makers at risk of failing to meet debt terms.

Violations of covenants, which often include ratios related to earnings in the past 12 months, could lead to higher fees or collateral requirements, according to Standard & Poor’s. So- called crack spreads, the gap between oil costs and fuel prices, are narrowing as the recession cuts demand. Third-quarter profits at independent U.S. refiners dropped 85 percent from a year earlier, analyst estimates compiled by Bloomberg showed.

“I think there are certainly refiners in the sector that have had, and may continue to have, covenant issues in a stressed crack-spread environment,” Van Bergh said. “We will continue to work with companies on a case-by-case basis to get them through this period of time.”

Covenant Modifications

Bank of America’s stance may be typical. Lenders will probably modify covenants to help refiners comply, said Paul Harvey, an analyst at Standard & Poor’s in New York. He said he doesn’t expect banks to close credit lines, cutting off access to the cash refiners need to feed their plants with crude oil.

Banks may impose more restrictions on credit for those purchases, said Darin Schmalz, a director at Fitch Ratings in Chicago. Banks may later force borrowers to use cash to cut debt rather than for other purposes, he said.

Western, Tesoro and Alon shares are trading more than 75 percent below 2007 highs -- 91 percent in Western’s case -- on the New York Stock Exchange. Western fell 37 cents, or 5.7 percent, to $6.08 today, and Tesoro slid 72 cents to $14.26. Alon dropped 40 cents to $9.53.

Tesoro has 14 hold and 5 sell ratings from analysts. None rates the shares a buy. Western has 1 buy, 5 hold and 2 sell ratings. Alon has 3 holds and 3 sells.

Western ‘Very Comfortable’

Tesoro and Western notes are trading at or above 94 cents on the dollar, up from 85 cents as recently as July, rising amid a jump in prices for bonds rated below investment grade.

El Paso, Texas-based Western said its lenders amended its credit facilities in June 2008, eliminating covenant requirements for one quarter. In this year’s second quarter, Western renegotiated its covenants and issued 14 million shares of stock and $700 million in bonds.

Western is “very comfortable with where we are and will continue to be opportunistic in further increasing our flexibility as it makes sense,” according to an e-mailed statement by the refiner. Bank of America, which serves as agent for Western’s term loan, declined to comment on the credit agreement.

Western posted losses in two of the past three quarters. When it reports results for the current period, its second-most profitable quarter on record will no longer be included in its results for the past 12 months.

Tesoro, Alon

“As we roll through into the second half of this year and lose those strong quarters is where the issue is,” said Ann Kohler, an analyst at Caris & Co. in New York. “Based on my current analysis of their earnings on the balance of this year and into early next, they will breach their debt covenants in the first quarter.”

San Antonio-based Tesoro and Alon, based in Dallas, also had two of their best quarters in last year’s second half. That means they will lose the results propping up their 12-month earnings by early next year, said Jim Byrne, an analyst at BMO Capital Markets in Calgary.

Alon said it’s paying down debt to remain in compliance with terms of a loan it took out to acquire a plant in 2008. “We’re still de-levering,” Alon CEO Jeff Morris said in an interview.

The company has twice amended its $400 million revolving credit facility, used to purchase crude at its Krotz Springs, Louisiana, refinery. The second time, in April, parent Alon Israel Oil Co. provided a $25 million letter of credit, according to a company filing.

Credit Requirements

Bank of America is lead arranger for Alon’s credit line. Bank spokesman John Yiannacopoulos declined to comment on the matter.

Tesoro, which operates refineries in the Western U.S., has two key covenants on its $1.81 billion revolving credit facility, according to company filings. One stipulates that the company must keep a minimum level of net worth. The other requires the company to keep a level of earnings that exceeds a measure of financing expenses.

Lynn Westfall, Tesoro’s chief economist and spokesman, declined to comment on loan covenants.

Tesoro and its lenders modified the credit line earlier this year, according to a filing with the U.S. Securities and Exchange Commission. “They’re increasing debt limits, so that gives them more breathing room,” said Mark Sadeghian, another Fitch Ratings director in Chicago.

Justin Perras, a spokesman for JPMorgan Chase & Co., agent for Tesoro’s credit line, declined to comment.

Harvey, the Standard & Poor’s analyst, said banks are working with refiners rather than demanding immediate payment of their loans.

“Banks have been willing to grant amendments or waivers to covenants, understanding that margins are extremely volatile right now,” Harvey said. “If the banks really wanted to play hardball, they could require them to repay loans.”