If you're at a commercial bank that's focused on the oil patch, you may well be counting your blessings. Loan growth in many other sectors of the economy has been tepid and drumming up new business a challenge. By contrast, the oil and gas space has been expanding—so much so that it is attracting new entrants to energy banking and spurring even sharper competition among capital providers.

And, of course, it is the unconventional resource plays, especially in oil, that are to be thanked for funds flowing into the sector.

“Capital for energy has never been any more abundant than it is today,” says Mark Fuqua, senior vice president of energy lending at Comerica Bank in Dallas, pointing to expanding capital availability, not just from commercial banking sources but also from private- and public-equity markets and the bond market.

“We have this incredible confluence of a tremendous resource base in the US—where we are arguably the largest oil and gas producer in the world and still growing—coupled with this abundance of cheap capital,” says Fuqua. “I've been through a lot of booms and busts, and I don't know exactly where this one [cycle] is going, but the fundamentals of it still feel pretty good to me right now.”

Fuqua is quick to note that such ready access to capital can be a double-edged sword. “In the long term, it is very, very beneficial; in the short term, it can be a little painful in that a lot of companies have paid down a lot of bank debt by raising high-yield bonds or equity in the markets. For example, we have seen our average utilization of our credit facilities decline since the beginning of 2013.”

The interplay between accessing different forms of capital is a theme struck by several bankers, who say that even as lending commitments have generally trended higher, funded loans may have contracted or held constant in the wake of rising capital market activity.

Carl Stutzman, executive vice president for oil and gas commercial lending at Union Bank in Dallas, says, “It's a crowded marketplace; there are a lot of capital providers out there. Our biggest challenge right now is in driving loan growth.”

The bank has been engaged in reserve-based lending to the oil and gas industry for 30 years, and currently has about $6 billion in loan commitments made to more than 150 clients. Large corporate and international lending to the energy sector is conducted through its parent, Mitsubishi UFJ Financial Group, with $1.4 trillion in assets.

Although energy may be viewed as a “hot sector” of late, broader capital markets have been highly accommodating as a result of the Federal Reserve Bank's recent low-interest-rate policy, leaving no lack of competing capital, Stutzman notes.

He cites a couple of main factors contributing to a drop in utilization of its loan portfolio over the past year.

“The high-yield market has been very receptive to the energy industry, with proceeds used primarily to reduce or retire revolving bank debt. We've seen a lot of that over this past year [2013], which has negatively impacted our loan balances,” he says.

“We've offset some of that through our investment-banking arm being a very active player in a lot of our clients' high-yield offerings. We've generated some nice fees, but it doesn't fully offset the drop in loans outstanding over the past 12 to 18 months.”

About 90% of the bank's loan portfolio is comprised of E&P companies, with the midstream and downstream sectors making up a growing portion of the remaining 10%. Clients typically carry sub-investment grade ratings. Historically, single B- or triple C-rated companies would have faced obstacles in accessing the high-yield market, Stutzman notes.

“But in the current low-interest-rate environment, and with an abundance of capital chasing yield, we're seeing even triple C-rated clients being able to access the high-yield market, and they can do so at surprisingly attractive rates,” he says.

A second factor contributing to lower utilization has been a lower level of loan demand related to acquisition and divestiture (A&D) activity, which for much of 2013 significantly lagged the pace of prior years. Here there were signs of a pickup in activity as the year closed.

“Over the summer it was extremely quiet,” Stutzman says. “And despite a reduced level of activity, there's still a fair amount of opportunistic divestiture activity within our portfolio companies, so you're running pretty fast just to stay even and replace the natural runoff of the portfolio. But the pipeline is looking better than it has in several months. It's really starting to pick up.”

Another bright spot has been the upswing in activity in the Permian Basin. For example, Union Bank has been well positioned to benefit from a longstanding relationship with fast-growing Concho Resources. Also of note is its role as an administrative agent for one of the most active E&Ps in the Wolfberry play, private operator CrownRock LP, which was expected to drill some 250 wells last year.

With energy performing well, banks have been expanding their exposure where possible. PNC Bank is an example.

Managing director Tom Byargeon heads up the energy lending team in Houston for PNC Bank. While its new Houston energy office opened in mid-2013, the Pittsburgh-based bank has a long history of funding commodity-based industries, including coal, steel and oil and gas. Having made acquisitions in the wake of the 2008-2009 financial crisis, PNC has grown to be the sixth-largest bank in the US, with total assets of more than $300 billion.

Given the latter growth in bank assets, PNC's energy component is “very significant, but still somewhat under-represented as a percent of the bank's overall business,” Byargeon says. “We have a strong desire to continue to expand in oil and gas. Obviously, what's going on in the Marcellus and Utica is driving some of this. But we're involved in the industry throughout the U.S.”

Because of its “extreme capital intensity,” the industry needs to tap capital “from every available source,” Byargeon says. PNC is active in the capital markets, and its clients' greater reliance on the bond market over the past couple of years has taken away some of the bank's loan business, where loan utilization in general is “down a bit.”

“But you can't totally ignore the disparity between short-term interest rates and long-term rates, especially when you see how the yield curve has steepened,” Byargeon says. “What we've seen from many of our clients is that they like to manage their interest-rate exposure by having a relative balance between fixed-rate debt in the bond market and floating-rate debt in the bank market.”

In addition to customers in E&P, PNC has significant exposure to the midstream sector, an area in which it sees plenty of growth opportunities. In E&P, Byargeon favors clients with diversified reserves, and notes that most historically gas-levered clients “have done a really good job at getting oil and natural gas liquids into their portfolios.”

With pre-heating season prices for natural gas trading in a range of $3.50 to $4 per thousand cubic feet (Mcf), dry-gas activity generally has been limited to prolific areas that are the “exception rather than the rule,” such as in the Marcellus shale. However, Byargeon notes that some master limited partnerships can have an appetite for gas properties if acquisitions are accretive and production can be hedged out three to five years.

“If they can buy gas reserves that are accretive with current strip prices, they'll go ahead and pull the trigger on a deal,” he says.

Portfolio shifts

Comerica's Fuqua says E&Ps make up roughly 70% of the bank's energy loan portfolio, while loans to midstream and oilfield service players account for the remaining 30%. Over the past three to four years, he has seen the portfolio shift from a split of about 60:40 in favor of natural gas to now 60:40 in favor of crude oil and liquids, as a focus on resource plays like the Bakken and Eagle Ford have expanded to include the Niobrara, Utica and—with much enthusiasm—new zones to develop in the Permian.

On the gas side, Fuqua says optimism has been scarce due to the prolonged price weakness since gas prices spiked briefly at the beginning of the 2012-2013 heating season. Looking ahead to rising demand for gas in coming years—from gas-fired power generation, industrial/petrochemical demand, exports to Mexico and, eventually, liquefied natural gas (LNG)—he thinks the key issue is at what price incremental gas supply can be brought to market to meet demand growth.

“If in three to five years that amounts to, say, another 10 billion cubic feet per day, is the supply readily there at $3.50 to $4 per Mcf?” he asks. ” I'm not sure it is.”

Given greater liquids-focused activity accompanied by greater use of pad drilling on the part of their E&P clients, banks have been more willing to offer second-lien or stretch facilities, assuming operators have some underlying cash flow and success with prior pads, says Fuqua. In addition, lending can be more aggressive if some private-equity or mezzanine backing has been secured to help fund drilling. Advance rates of 60% to 65% against a reserve base can in some cases be moved up to 90%- to 100% with a second lien or stretch facility.

For diversity of customer base, few can offer the global reach of Citibank, which counts many of the major domestic and international oil companies among its clients. The upstream sector accounts for the greater part of its energy loan book, while midstream is substantial—25% to 30%—with oilfield service and refiners making up about 10% and 5%, respectively.

Citibank has invested heavily in developing its energy division. And with numerous new E&Ps starting up, as well as private-equity sponsors backing management teams in new ventures, the bank has seen not only increasing loan commitments but also recent signs of growth in its funded loans.

“I think we may have hit an inflection point at which some companies will start using more of their bank commitments,”says Phil Ballard, who heads up Citibank's corporate-banking and reserve-based-lending (RBL) group in Houston.

This would represent an uptick from some banks' recent experience of increasing loan commitments but decreasing levels of funded loans, due to competing capital-market activity. Funded RBL loans at Citibank have recently been running “about flat relative to a year earlier,” Ballard says.

With Citibank offering an extensive suite of products and services in addition to commercial banking, head of global energy investment banking Steve Trauber offers an overview of the firm's energy group activity.

“The industry is not only growing, it's growing rapidly, driven by the unconventional revolution in the US,” says Trauber. “Our energy business, in particular, is growing very rapidly. The amount of capital required by the energy industry is substantial and, obviously, banks are flush with capital. Absolutely, bank capital is required. But it may not always be the optimal capital; at a certain point, clients need to be comfortable using the public markets, too.”

Trauber says having a commercial-banking relationship with a client is viewed as a prerequisite for winning business in other areas, including investment banking. “Companies look at the banks in their credit facilities, and if you're not there, they're going to have a hard time giving you other business.”

How competitive are terms being offered by banks playing in the wholesale banking market? “The reality is that, because of the amount of capital out there, the bank market is fairly aggressive. They're giving loans and credit facilities out to companies at rates that don't earn an adequate rate of return on a standalone basis,” says Trauber. “Instead, they rely upon the other businesses in order to get the rates of return they need on their capital.”

Ballard agrees. “It's a very competitive market,” he echoes. “Some recent deals have probably been a little more aggressive than they historically have been in terms of covenants and borrowing-base amounts. And because there are so many new banks coming in, if someone doesn't like it, someone else will step right in to take its place.”

In terms of adapting to the more statistical nature of some resource plays, as well as operators' increasing use of pad drilling, Ballard

“I think we may have hit an inflection point at which some companies will start using more of their bank commitments.” Phil Ballard, Citibank notes that some banks have been more aggressive in how they apply advance rates against proved reserves. For example, advance rates for well-capitalized companies could move up to 70% from 60%, with the underpinning for the loan staying tied to proved reserves. Likewise, a limit on proved undeveloped (PUD) reserves at 25% might be moved up to a maximum of 45%.

Excess liquidity

Scotiabank is part of a group of banks occupying a middle position between the bulge-bracket banks (JP Morgan, Credit Suisse, Citibank, etc.) and the regional banks (Comerica Bank, etc.). Heading up its energy industry activities in the U.S. is managing director Mark Ammerman, who also oversees much of the Toronto-based bank's international energy operations, including Latin America, Europe and Asia Pacific. He is a 32-year industry veteran, 26 of those with Scotiabank.

Ammerman does not shy away from discussing challenges he sees on the horizon, even as he describes 2013 as a “very positive” year in which funded loans again grew. Latin America and the bank's recently acquired European operations significantly exceeded expectations, its North America business grew—albeit more slowly than in recent years—and the bank's energy loan portfolio was “pin clean.”

In Europe, where Scotiabank brought on board the ex-Lloyds Bank energy team in 2012, the new UK team made its mark when it co-underwrote a $1.2-billion credit facility for North Sea producer EnQuest. And Scotiabank's recently acquired Howard Weil team is on an upswing, says Ammerman, while its commodity business put in another year of solid growth.

Why is he cautious in his outlook, given these positives? He points to two main factors.

First, the commercial-banking sector is moving into a period of “unparalleled excess liquidity,” along with a lack of business demand. “We need a rebound in the economy to suck up some of this liquidity,” he says. Second, a deep freeze in merger and acquisition (M&A) activity is also affecting commercial loan demand to finance energy transactions. With M&A transactions totaling $123 billion in 2012, but running at only about $38 billion—or less than one-third of the prior-year level—in late 2013, “everyone's M & A platform has been hit on the chin due to the overall market drop. That's a big whack affecting debt underwriting, equity issuance, hedging, not to mention M & A banking.”

Ammerman characterizes current banking conditions as “frothy,” as mainly regional banks enter the space at a time of sluggish deal flow. This is good for the client, of course, but reduces pricing and stretches terms and conditions. Also, while a regional bank will want to participate in a deal as long as there is drawn debt, it stands to have the loan paid down if the client goes on to issue bonds. One-time fees are earned, but the lion's share goes to the lead banks on the bond deal.

In addition, Ammerman questions the favor-ability of timing for new entrants to the sector, given that “the long end of the commodity curves for oil is worrisome.” Acknowledging that he is prone to raising red flags—and sometimes is the only one to do so—“if Brent goes to $80 per barrel and West Texas Intermediate to whatever, three to four years out, how do these deals look then?” he asks. “We have a strong technical bench of engineers and geologists, and we know how to handle declining commodity prices and how they affect lending values. It's something you just have to experience to know how to survive.”

In M & A, Ammerman says he expects “more reasonableness” on the part of both buyers and sellers to be a potential catalyst for a positive 2014. This follows a “capitulation” in 2013 by both sides in trying to find an agreed-upon middle ground for forward commodity price assumptions and, consequently, expectations for transaction prices. This in turn led to “the highest failure rate in M & A transactions in the industry that we've ever seen,” he says. However, parties to potential transactions “are now signaling to us they understand where the real market exists between a willing buyer and seller.”

Does this also signal a strengthening commercial loan market?

“I'm not forecasting a significant drawdown on my clients' lending facilities—not until we see some A & D activity. We'll have to wait and see,” Ammerman says.

So what is the product of these varying trends in commercial banking? Demand for capital is being driven by a remarkable US energy renaissance but remains tempered by competing capital sources and no shortage of liquidity. Is the market tempo too fast?

“All the capital-market activity has probably driven down the cost of the bank facility somewhat,” says Comerica's Fuqua. “But most of the deals I see are still reasonably structured. Maybe there's more pressure on pricing.”

PNC's Byargeon says, “If things get too far off kilter from a return or a risk standpoint, then you may see people start to back off a little bit. But I am not seeing that yet.”

Citibank's Ballard points to the tough competition between major banks for lead and agency roles. “They're showing the client the market. It's free enterprise,” he says. “But you're probably not getting paid for as much risk as you were in the past.”

“It sounds funny to say,” Ammerman says, “but you really don't make much money lending money any more, certainly not in as challenging a market as we have with today's liquidity and increasing regulatory capital. You really make your money selling other products and services.”

For more on commercial banking and capital access, see OilandGasInvestor.com.