?In today’s high-priced environment, it makes a lot of sense to invest money on infrastructure, says Bo Conrad, executive vice president of the energy-lending division for Park Cities Bank.

?The leveraged loan market in the U.S., robust and flourishing only a year ago, is in a deep freeze that may not thaw for some time. Even favored industry sectors such as oil and gas can’t help but feel the chill, according to credit-rating firm Standard & Poor’s Ratings Services.


“The ability to syndicate large loans is difficult right now,” says Chris Donnelly, vice president of Standard & Poor’s leveraged commentary and data unit. “Indeed, we may be seeing a generational shift in this marketplace.”


Lagging demand for leveraged loans means that any new offerings must now be priced with a significant premium to be successful. Competition with loans in the secondary market that offer attractive yields makes that difficult.


“Anecdotally, we’re hearing that, for big borrowers in oil and gas, there is a 25-basis-point premium, with smaller companies seeing a 50-basis-point rise,” Donnelly says. Until demand for leveraged loans picks up, oil and gas companies may find greater incentive to tap the speculative-grade bond market.


Meanwhile, in May, the Federal Open Market Committee pushed its target federal funds rate down to 2%, its lowest level since late 2004 and a seventh consecutive rate cut. The cuts should mean lower borrowing costs for qualified parties, but many banks, particularly large ones, aren’t issuing as many loans as in the past, while they are sorting out their own liquidity issues.


So where do oil and gas companies go for commercial debt? In many cases, regional, boutique firms such as Park Cities Bank, Western National Bank and Citizens Bank remain fully open for business.


Park Cities Bank, based in Dallas and with offices in Fort Worth, is historically a real estate bank, says Bo Conrad, executive vice president, energy-lending division. “In the past, we had an energy division but the people in charge left the bank, so that division had to be rebuilt.”


Rebuild it Park Cities did, giving the bank an energy division with both a regional and national focus on upstream oil and gas. “We are dedicated to providing capital to small independent oil and gas companies that may have been underbanked in the past. We define the small and midsize oil and gas operators as those with $2- to $5 million in total reserve base, and somewhat upwards of that.


“But we can go wherever the business is. We will follow our clients anywhere.”


The credit market is still very solid for E&P companies, says Conrad. Energy is one of the few sectors in banking that has continued to do very well. He sees very little credit weakness in the energy sector, particularly in the single-bank market.


“It has been a little tougher in the broadly syndicated facilities, but that’s not what we are doing. Our sector still has very competitive terms and is still very borrower-friendly in the independent, small-bank community market. For reserve-based deals, the market is still very liquid. It’s one of our strongest performing sectors,” he says.


The bank is aggressively trying to grow the energy portion of its portfolio, to double it $150 million within the next 10 months. Its focus is to help E&Ps lever existing production to buy new, incremental production by drilling new wells or rehabilitating older fields.


Specifically, the bank lends to E&Ps for new leasehold acquisitions or to rework or enhance existing production. Its clients’ assets are predominately onshore the U.S.


“Every play has its nuances. We are very interested in upstream companies, relationships and assets, but we are also very interested in the midstream business,” says Conrad.


Park Cities’ model is biased toward proved developed producing (PDP) reserves, although its bankers consider proved developed nonproducing (PDNP) and proved undeveloped (PUD) reserves. There is no bias on the type of reserves, oil or gas, resource or conventional, as long as it makes sense for the bank’s underwriting parameters. Park Cities lends for secondary and tertiary enhanced oil production as well as primary.


Lending for alternative-energy sources, such as wind, biofuel or solar, is not on the bank’s radar. “As much as anything, that reflects our strategy to grow the E&P segment of our portfolio first. Once we build out a reasonable portfolio on the more traditional reserve-based and midstream side of the business, we could potentially look at alternatives, if that market matures.”


The bank is also planning to increase its lending to infrastructure expansion. “There are a lot of areas where, in the past, there hasn’t been good infrastructure. There are good potential areas in which to drill, but in the past, they weren’t drilled because the infrastructure wasn’t there to get it to market.


“In today’s high-priced environment, it makes a lot of sense to invest money on infrastructure in those areas. In some cases, though, midstream infrastructure tends to require more capital than most community banks can provide,” he says.

Permian-based
Western National Bank has long ties to the oil industry. Chartered in 1977, the bank is based in Midland, Texas, with offices in Odessa, Dallas and San Antonio. The bank staffs a dedicated oil and gas lending team, which includes bankers, petroleum engineers, lease analysts and technical assistants, and claims the largest and most experienced engineering staff in the Permian Basin.


Western makes reserve-based financings for acquisitions or the development of existing properties, looking at factors such as personal net worth and liquidity, beyond the traditional net present value of the energy properties.
As of first-quarter 2008, oil and gas commitments made up some 40% of the bank’s total loan portfolio of $832 million, $570 million of which has been funded.


“We have about $100- to $150 million per year available to the energy industry. Some of our E&P relationships go back 20 years. It’s what we know best,” says Mark McKinney, senior vice president of energy lending. “We focus on regional customers so we have relationships with managements, rather than just seeking transactions.


“Not only do we want to lend them money but we also want to have their deposits, and offer ancillary services like treasury management. We have a private-client services department to accommodate E&P owners who have money to invest.”
In the first quarter of 2008, Western National’s growth has been “fairly nominal compared with what it was during the past 12 months,” he says. But the deal size, on average, is the same.


The deal terms haven’t changed much, either, he says, because the Dallas market is fairly competitive. “Western National has somewhat strong credit standards that we try to abide by, but in this competitive market it is harder to get everything that we are used to getting. We may have to give up a little on the rates.”


As far as the borrowing base, the bank still requires 70% PDP reserves and up to 25% PUD, and hasn’t deviated from that standard. It looks for companies that have strong balance sheets and good cash flow. “Finding them is probably more of a challenge for us than any change in transaction terms,” he says.


For the past three years, McKinney has seen more requests for capital for unconventional energy or non-traditional facilities like ethanol plants in the Midwest, but does not pursue that market because the bank lacks experience in that segment.


“We do have an affiliate through which we do some mezzanine transactions. That gives us the ability to do some stretch pieces and things, but we found out, over a four-year period, that senior debt is what we are best at.


“From the past, we may have developed a reputation for looking at unconventional things because of our mezzanine unit. And I think that that is probably not a bad thing. But the deals that we have done are mostly traditional senior debt financings. We would still consider doing a term-B note or some other form of subordinated debt on a deal if we think the reserve base and the cash flow is sufficient to support it.”


Two-thirds of Western’s energy portfolio is in production-based credits and the rest is in service and supply or midstream operations. Most of its business is from $1- to $15 million. “We have one E&P credit that has a $30-million borrowing base. And we have a couple of service-related syndicated deals that are larger than that.”


Western started a Dallas office last summer. “We hired a team of people for this office that have a long history in the area and they brought in some new business.


One of those opportunities was for a Dallas-based E&P with very active drilling programs in East Texas, he says.


The E&P had a borrowing base with Western National for some $24 million and was seeking an increase. When Western’s energy-lending team left it to pursue other opportunities, in March 2008, that request had not yet been activated.


“Still, within four days, we were able to get them an increase to $26 million. The E&P wanted a larger increase, but had been waiting for some third-party reservoir engineering statements that weren’t forthcoming in a timely manner.


“Because we have two full-time staff engineers, two engineering techs, a title analyst and a contract engineer, we put them to work and were able to increase the base even further, to $30 million, fairly quickly, which enhanced our responsiveness to the customer.”

Capital from Kilgore
Citizens Bank, based in Kilgore, Texas, is a small, regional bank with a dozen branches that serve mostly small, privately held independents from Lafayette, Louisiana, to Denver. Those are, for the most part, sole proprietors or private partnerships.


“We have oilfield-service clients, such as in tubulars, saltwater disposal and pumping services. We also lend to used-equipment sellers,” says Charles Spradlin, senior vice president of the oil and gas division.


“We will lend up to about $12 million, but we can go above that with syndicated loans. We have never had to foreclose on a loan in our 20 years of lending. Our average size deal is from $500,000 to $3 million.”


The credit crunch has had no effect on Citizens Bank’s deal flow, says Spradlin. “We are completely isolated from the troubles of the big banks. We’re not seeing any effects. The only new trend is that, over the years, we have extended our amortization.


“We have only limited exposure in the drilling-rig segment. There has never been a time in my years in the business that they didn’t overbuild in that end of the business. But it could be a different story now.


Higher global energy prices are here to stay, he says. “But I still think that we are going to see a surplus of rigs again, which may already be happening. In any event, we are not into the rig-lending business in any serious way.”


The bank usually requires borrowers to personally guarantee a portion of their note. “It’s sort of a commitment in the form of an eggs-and-bacon scenario. The chicken is involved, but the pig is fully committed. With any transaction, once you have a personal guarantee, the buyer is pretty well committed.”


Some of Citizens’ clients have been with the bank for more than 15 years. In fact, many of its customers have done so well that they have sold their E&P businesses and retired. Others are plowing money back into their companies to grow, using capital for well workovers, returning wells to production, buying and enhancing stripper production and drilling in-field wells. The bank loans to E&Ps operating in North Dakota’s Bakken play, East Texas’ Cotton Valley trend and in plays in north-central Texas.


Credit revolvers are in high demand. “That gives the customers the best of both worlds. If he needs money immediately available, he has it, and then can use his surplus cash to pay down the line of debt to keep interest to a minimum. So the open-end line of credit with collateral backing is a very useful vehicle to many of our customers,” says Spradlin.


The bank prefers to lend primarily on PDP reserves. “However, in today’s higher commodity-price market, we keep increasing the amount of PDNP and PDP. While those have to be appraised very carefully, they are useful as backing for lending.”


The bank also provides a letter-in-lieu-of-bond, on behalf of its clients, to regulatory parties, such as the Texas Railroad Commission. “That seems to be very popular with many operators. If they have to put up a bond with the Railroad Commission, that’s money that could be used for development purposes.


“For example, an operator with more than 100 wells might have to put up a bond of about $250,000. To these operators, that is a sizable amount. We provide that for them so they can get back to business.”