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Federal Reserve Bank of Dallas President Robert Kaplan told Yahoo Finance on Wednesday that plummeting oil prices will have to result in some bankruptcies and restructurings. But he clarified that the Fed will not step in to save insolvent companies that had pre-existing credit issues.
“There are a number of companies in this industry, either drillers or service providers, that went into this highly leveraged, and I think they're going to have to pursue other actions in order to restructure their debt,” Kaplan told Yahoo Finance’s “On The Move.”
Kaplan said creditworthy companies that pass lenders’ cash flow tests will be eligible for loans through the Fed’s forthcoming Main Street Lending facility.
Last Thursday the Fed expanded the scope of the program to offer low-cost, four-year loans to larger companies with as many as 15,000 employees or up to $5 billion in annual revenue. The loans would allow companies to pay down “mandatory and due” debt.
That facility could cover energy-exposed companies like those in Kaplan’s district, many of which are feeling immense cash flow pressure as they shut down rigs amid the sharp drop in oil demand.
“There will be a substantial number of bankruptcies, restructurings that are going to have to happen, because so much of production is being shut in,” Kaplan said.
[See also: Fed’s Harker: U.S. economy could contract by 5% in 2020]
But Kaplan said highly leveraged companies will not be able to access the Main Street Lending Program. The loans would have to meet existing standards in addition to an earnings test that limits the size of the loan to four- to six- times adjusted EBITDA, depending on the type of Main Street loan taken.
In late April, prices on WTI crude oil fell below zero as a lack of storage space for unused oil left sellers with no choice but to pay counterparties to get the contracts off of their hands.
But oil prices were under pressure since March, when Saudi Arabia slashed prices after negotiations on supply fell through among OPEC nations and Russia. As WTI prices fell below $30 per barrel, the Dallas Fed in late-March reported significant declines in business activity among oil and gas companies as capital expenditures and jobs were slashed.
Economic forecast
Kaplan, a voting member of the Fed’s policy-setting Federal Open Market Committee, offered rough estimates on the U.S. economy at large and predicted a 25% to 30% annualized contraction in U.S. GDP for the second quarter.
He said the unemployment rate could get as high as 20%, ending the year closer to 8% to 10%.