Seasoned commercial energy lenders and well-respected newcomers are still keeping in step with an E&P industry that refuses to slow down. But high commodity prices and producers' inclination to keep cash in the coffers have created a mighty high hurdle for the energy-banking group to get over. The hunt is for prospects, not funding, and the energy lenders bent on growth are realizing that a hefty bag of E&P capital is no longer a unique lure for producers. As one energy executive put it, a creative energy-company management team will "find strategic partners that can do more than just bring the money." Not to be left in the dust, many commercial lenders have responded to producers' desire for more lending diversity. To avoid slumps in loan demand, energy bankers are increasing their portfolio of lending vehicles, preparing to originate more upstream transactions, hiring teams that know the E&P industry and beefing up their customer service with every client they work with, no matter how small the deal is. Three banks that have put these approaches to work are Germany-based WestLB AG in Houston, the Houston-based lending group of DZ Bank and San Francisco-based Bank of the West in Denver. WestLB AG Bank The energy practice of one of Germany's largest commercial banks, WestLB AG, has been in full swing since the inception of the bank's Houston office in 1987, although it has originated upstream deals and participated in syndication groups since 1976. Ron Ormand, managing director and head of the North American oil and gas group, says, "Philosophically, we want to be a 'full capital provider and advisor to our clients,' meaning we'll provide capital on the right side of the balance sheet from debt, mezzanine and equity funding. But we'll also support clients with other services, including advisory, capital markets and commodity hedging. "We do not lead any transactions where we don't put our own capital to work, and we don't act just as an agent-we act as principal and agent in everything we do. That's a bit of a distinction between some of the investment banks that don't want to have capital on the balance sheet." In 2005 the group was lead, sole arranger for a $150-million dollar A/B transaction for a U.S. independent that consisted of a $55-million A-borrowing base and a $95-million B. The funding provided growth capital to exploit reserves. West LB took all of the A-piece and had a partner on the B-piece. Adam Dexter, executive director, says, "We also arranged and co-led a US$170-million senior borrowing base facility for a Canadian income trust. These kinds of deals are representative of what we'd like to keep doing in the future." In another Canadian deal, the bank is sole, lead arranger for another income trust. The deal is a crossborder transaction that supports the trust's acquisition of certain U.S. properties, Ormand says. West LB is advising the trust and providing structured bridge financing. It's also leading a U.S. tranche to support the trust's acquisitions. Additionally, the bank is advising a private U.S. independent on a $300-million merger, which should close this quarter. In 2006, the lender is looking to expand its E&P portfolio. Ormand says, "Our total lending portfolio is roughly $1 billion, and we'd like to see that double in the next couple of years. Right now it's about 20% E&P, but that could grow to a third or more." He adds, "We put our capital to work in each of our transactions, so we've got to make sure that we're backing the right clients. We want to find the premier players with the growth potential that we can back and then bring our ability to the table to help them grow." As the financing needs of the E&P industry have changed, West LB has changed with it. Dexter says, "We've been able to step out with our project-finance expertise and hit the various segments. As [the segments] developed we had to grow too, be it rigs, oil services, upstream financing or midstream MLPs [master limited partnerships]. We've been able to effectively provide capital solutions for each segment of the energy industry through this evolution." The bank has added staff with experience in the upstream space. "We're also very entrepreneurial in the ways that we'll look at transactions and our ability to execute them. We have a competitive price deck and a very favorable view of the oil and gas sector. Beyond the senior lending, we bring advisory, capital-markets insight, commodity hedging and other services to support clients going forward." With the surge in commodity prices, Dexter says he's seen many energy players look to gather capital to finance expansion plans and develop exploitation programs, and West LB's lending has focused on meeting those needs. According to Ormand, the lender's risks have remained fairly stable in today's borrower's market. "There are some higher-risk opportunities but within the senior spectrum it is still generally confined to what's been traditionally there. But we are stepping out into other risk products. One of the things we're doing is looking to expand from traditional senior into mezzanine and even all the way down into equity." Being able to cover the risk spectrum is especially attractive to clients, as is providing capital in large amounts in an efficient manner, Dexter adds. The pair expects future global investment trends to include a move back toward large infrastructure projects done under the old, project-finance-type structures. Producers are going to have to buckle down in their area of expertise and make those strategic proved undeveloped or proved developed nonproducing plays to maintain their growth curve, Dexter adds. "We have clients that are doing that and we're moving forward with them. You're also going to see growth with the MLPs taking over a larger space in the midstream. Globally, you'll see people investing in nontraditional plays and the entities that pursue them will be looking for capital, advice and value-added services." Ormand adds, "Domestically, in the upstream area, we're seeing the majors reinvesting in the onshore business. That activity level is going to drive up prices on the property sales, M&A activity and services. "On the upstream side there will be a continuation of things we've already seen. Consolidation will likely continue but it will be selective. You'll see the smaller independents continue to be sold out to the large guys and new companies will be formed by the management of these companies." DZ Bank Headquartered in Frankfurt, Germany, DZ Bank entered the energy sector in 1998 when it hired a project-finance team from New Jersey-based lender AT&T Capital Corp. Since then, DZ has been the lead or co-lead bank in about 15 energy-related transactions, and has provided underwritings and participations for several dozen more. The bank has successfully committed more than $3.5 billion on behalf of energy clients during the past seven years. It entered the oil and gas marketplace in 2003 and the current energy group is comprised of 12 professionals in Houston and New York. Scott Lamoreaux, vice president and head of the Houston office, says, "During the past several years the team [began] an initiative to expand its lending activities more broadly in the oil and gas sector. We've added approximately $200 million of new commitments in the sector on behalf of eight clients. Commitments to four independent producers represent 56% of that, and the rest are credits associated with a natural gas pipeline, liquefied natural gas infrastructure and refinery upgrades." The bank participated in two reserve-based credit facilities in the second half of 2005 and is likely to participate in several more during the first half of this year. "Our goal for 2006 is to also develop opportunities where we can take a leading role in [upstream] transactions...We are very comfortable in our ability to leverage [our] underwriting and agenting skills in executing oil and gas transactions." The energy group and the bank wanted to show their commitment to the E&P community, so the Houston office was opened in August 2005. "This enables us to be more responsive to our existing customers, build new relationships at the ground level and work with other energy lenders on larger transactions." Although it does not have a long history as an E&P lender, it is counting its Houston presence and E&P experience among plusses. "We believe that our ability to understand our clients' fundamental operational activities in conjunction with helping them grow their business makes us an attractive source of capital," he says. In the E&P space, DZ's lending approach focuses on reserve-based transactions, usually senior-secured revolving credit facilities or volumetric production payments (VPPs) backed by proved-developed-producing (PDP) reserves and proven reserves. To help to diversify its energy-lending portfolio, the bank has already participated in a VPP, reserved-based revolving-credit facilities, and project financings for several energy projects, including gas storage, pipeline and terminals, and refineries. "Our objective is to help successful management teams grow their businesses. We recognize-collectively-our [E&P] clients will likely have operations in most onshore basins as well as the Gulf of Mexico. And because our clients range from small producers with experienced management teams that are backed by private-equity sponsors to the larger independents with substantial operations and balance sheets, we believe that we need to be responsive to the need for credit facilities that fit the customer. Therefore we will, on a case-by-case basis, consider transactions that include a stretch component." The lender recently committed $22.5 million to a senior secured credit facility that includes a stretch piece that allows the client, a Houston-based private-equity-sponsored management team, to complete an acquisition of producing properties. The client has well-defined proved undeveloped reserves that will help grow the operating cash flow and increase the PDP reserves tied to the transaction, Lamoreaux adds. In 2005 DZ also committed $25 million to a reserve-based credit facility for an independent that included producing reserves in West Texas and the Gulf of Mexico. "On the broader front, producers are aware of the level of competition in the energy-finance marketplace, and they're looking for lenders that offer the most attractive combination of loan terms and pricing." The result is a general downward trend in pricing and a movement towards more aggressive terms and conditions in loan structures and documentation, he adds. Looking ahead, Lamoreaux expects that robust commodity prices and economic fundamentals will continue to welcome new entrants and support the growth plans of established independents. "Independents are going to continue to invest in unconventional resource plays such as the Barnett, Fayetteville and New Albany shales. We also see companies maintaining substantial budgets for infield drilling as technology helps them unlock reservoirs like the Granite Wash in the Texas Panhandle and basin-centered, tight sands located in the Rockies. Given the current price environment, field-enhancement projects will yield attractive returns and will require substantial funds in aggregate." DZ plans to focus on growing its energy-lending relationships with Houston-based companies and building its business-development activities in Dallas, Denver, Oklahoma City and Tulsa. Bank of the West With more than 700 locations throughout the western U.S., San Francisco-based Bank of the West offers the depth of a super-regional player that stays focused on its relationships with E&P clients. "We are perhaps the last super-regional in our market that's truly relationship-driven," says Don McDonald, vice president and head of the Denver-based energy-lending team. "Our competitors continue to move up the market, but we want to provide a super-regional bank's depth of products with a relationship bank's service level to small and midsize E&P companies. It's important that companies right-size with banks focused on their segment of the market." The bank's clients are in-or have production within-its footprint, which currently covers 19 states, including California, Colorado, Wyoming, Utah, New Mexico, North Dakota, South Dakota, Nebraska, Kansas and Oklahoma. In addition to production-based lending, the bank underwrites service companies, gathering systems, processing plants, transmission lines, electric utilities and start-up operations. Bank of the West acquired Community First Bank in December 2004, expanding its service area into the Rockies. "As a super-regional, energy-lending bank we noticed that most of our peers continued to move up the market and become participant banks, and that can create problems. Over time, it's difficult for participant bankers-who are managing $30-million participation accounts-to be able to provide the same degree of attention to a $3- to $15-million relationship. "The second problem is, as the participant banks try to increase their loan portfolios on a nominal basis, they need increasingly larger facilities. This is especially true in our current environment where credit commitments are high but utilization is low." Bank of the West is a relative newcomer to the upstream-lending space, having started in March 2005. While most of the year was focused on putting the policy in place, Bank of the West was still able to book energy commitments of approximately $55 million with an average deal size of about $8 million. "In 2006, our bread-and-butter transaction will be $3- to $30-million oil and gas production facilities," McDonald says. "We're best suited for borrowers who like to establish a long-term relationship with a bank that has the ability to grow with them." Currently, the energy-lending division has grown its house account relationship to just above $50 million, and Bank of the West's commercial syndications group agents commercial facilities around $200 million. McDonald expects production, gathering, processing, transmission and utility operations to capture a large percentage of lenders' funds in 2006. His price decks are $50 oil and $7 gas. Over time, the lender expects to grow its portfolio into the $500-million range. "Our goal is to fill our E&P portfolio with one satisfied customer at a time, and we'll grow it as quickly and prudently as possible."