Banks are beginning to worry about their loans tied to oil and gas industry as they predict widespread defaults in repayments. Midstates Petroleum Company Inc (OTCMKTS:MPOY), Linn Energy LLC (NASDAQ:LINE) and SandRidge Energy Inc. (OTCMKTS:SDOC) are some of the energy companies already strained to the point of exhausting their existing revolving credit facilities. That portends disaster.

Drawing down credit facilities means that Linn Energy LLC (NASDAQ:LINE) and its peers could be more vulnerable if crude prices remain low or decline further. If energy borrowers go bankrupt, banks could be left with huge losses to deal with considering that some of the energy companies might not even have enough assets to cover their revolving loans. In times of bankruptcy, repayment of revolving credit is given first priority.

$1.5 billion of credit line drawn

In the case of Linn Energy LLC (NASDAQ:LINE), Midstates Petroleum and SandRidge, the companies depleted their revolving credits in the recent weeks, drawing more than $1.5 billion. Linn borrowed $919 million that was remaining under its $4 billion credit facility backed by Wells Fargo and others. Midstates on its part draw all the $249 million that was left in its $750 million credit line led by SunTrust Banks. SandRidge on its part exhausted its $1 billion revolving credit line by drawing all the $489 million that was left in the facility.

How will they cover short-term funding gaps?

Revolving credit facilities are designed to cover short-term cash needs and they are typically looked at credit cards for companies. Therefore, if a company draws its full credit facility, it becomes difficult to cover urgent funding gaps, especially when the environment is hostile to negotiate for a fresh credit line without first repaying the previous one.

Value of assets held is shrinking

For banks, it is not just about companies exhausting their credit facilities, but the fact that falling oil means that the assets those companies hold aren’t enough to covert debts in case of a bankruptcy. For example, Quicksilver Resources’ asset sales only yielded $245 million yet the company owed $273 million under its revolving loan.

What next for banks

A number of banks are already boosting their energy loan reserves and others are warning of amounting loan losses if their energy borrowers default. Other banks are already contemplating selling their revolving credit loans to distressed-debt funds to at least hedge against the looming losses.