By Matt Jarzemsky 

Struggling oil and gas companies are maxing out revolving credit lines typically used to cover short-term funding gaps, raising fresh concerns about banks' exposure to the decline in energy prices.

Midstates Petroleum Co., Linn Energy LLC and SandRidge Energy Inc. in recent weeks drew down the full balance of their revolving credit lines, they said, collectively borrowing more than $1.5 billion to build up cash cushions as the oil slump heads into its second year.

Other producers also are weighing such a move, said bankers and lawyers who advise energy companies. Fully drawing down on a revolving loan can signal a company is building up its cash reserves ahead of a bankruptcy filing or that it is worried lenders may at some point cut off access to credit.

Some banks have started to explore selling revolving loans at a discount to distressed-debt funds, said people familiar with the matter, a sign they don't expect to get paid in full on the loans, typically seen as safe. Distressed-debt trading desks at Goldman Sachs Group Inc., J.P. Morgan Chase & Co., Bank of America Corp. and other banks have been quoting prices for some of the loans, though it is unclear if any have traded yet, the people said.

The shift represents another piece of bad news for bank stocks, which have been hammered lately on a number of worries, including the direction of interest rates and how exposed loan portfolios are to the energy sector. The KBW Nasdaq Bank Index is down 23% this year, more than twice as much as the S&P 500.

Revolving loans are typically considered unlikely to lead to losses because they are first in line for repayment in a bankruptcy. They essentially function like credit cards that companies use to cover small or infrequent expenses, such as equipment purchases. Companies typically carry little or no balance on the loans to avoid paying interest on borrowings they don't immediately need.

An increase in drawdowns of revolving loans could become problematic for banks because the drastic drop in oil and gas prices has left some companies with few assets valuable enough to fully cover the loans in bankruptcy.

"Lenders are concerned that as prices fall and liquidity is burned by operations and interest payments, at one point do the revolvers, in fact, become impaired?" said Damian Schaible, a partner in law firm Davis Polk & Wardwell LLP's bankruptcy group.

Bank executives have played down fears that energy loans are leading to severe losses, with many describing the situation as manageable. Still, in the final months of 2015, a number of those banks increased the reserves they hold in case their energy loans go bad.

Wells Fargo & Co. last month said that oil and gas borrowings accounted for 2% of its total loan book, and it said the vast majority--90%--of its problem oil-and-gas borrowers were current on their interest payments at the end of 2015.

The bank said it lost $118 million to defaults on loans to oil and gas companies during the fourth quarter, $90 million more than in the previous period. Citigroup Inc., meanwhile, has added $250 million to its reserves to account for soured loans to energy companies.

Standard & Poor's Ratings Services on Tuesday downgraded by one notch the credit ratings of four U.S. regional banks that have significant exposure to energy: BOK Financial Corp., Cullen/Frost Bankers Inc., Comerica Inc. and Texas Capital Bancshares Inc. The ratings firm said it believes debt restructurings in the energy industry will increase in the coming months and that banks broadly will have to boost their energy loan-loss reserves.

"We are in the early innings of the downturn, in our view, and we expect loan losses to rise over the next two years, even if energy prices rebound modestly from current levels," S&P said.

Oil-and-gas company defaults have reached 14.5%, compared with the broader high-yield default rate of 3.1%, according to Moody's Investors Service. As many as a third of American oil-and-gas producers could tip toward bankruptcy or restructuring in the current downturn, according to Wolfe Research.

In some energy bankruptcies, companies' assets weren't even worth enough to cover the highest-ranking debt. Quicksilver Resources Inc., for example, recently sold its assets for $245 million in a bankruptcy-court-supervised auction. The Texas producer owed $273 million on its revolving loan when it filed for chapter 11 protection in March 2015.

In the oil-and-gas industry, revolving loans often are secured by a producer's assets, and borrowing limits fluctuate with the value of its oil and gas reserves.

Banks are next due to reassess the value of those reserves in April.

If their value has fallen--a likelihood after a further decline in energy prices--companies that maxed out their credit lines may find themselves over their borrowing limits.

Midstates on Tuesday said it borrowed the remaining $249 million available under its $750 million credit facility, led by SunTrust Banks Inc. Linn last week borrowed the remaining $919 million on its $4 billion credit line, led by Wells Fargo, while SandRidge last month drew the $489 million available on its $1 billion revolver, led by Royal Bank of Canada.

All three companies have bonds that recently traded for less than 10 cents on the dollar, indicating that investors perceive a high risk of default.

Rachel Louise Ensign and Ryan Dezember contributed to this article.

Write to Matt Jarzemsky at matthew.jarzemsky@wsj.com

(END) Dow Jones Newswires

February 11, 2016 19:28 ET (00:28 GMT)