Sure, commodity prices have rebounded since last fall. And the acquisition-and-divestiture market is beginning to heat up. And yes, in a dormant public equity market, operators are looking more to banks for credit to fuel their stepped-up plans for asset purchases and drilling. But let the borrower beware. The U.S. energy lending landscape is changing. With recent banking consolidation, there are fewer oil and gas lenders around today. Indeed, by one estimate, the universe of energy lenders during the past five years has shrunk from 50 banks to just 26. And as one credit-market observer points out, "When you combine two banks into one, the appetite of the merged bank doesn't double." Despite low interest rates, the cost of capital is rising. Loan-pricing spreads have risen sharply of late, as much as 30% since last December for investment-grade credits. The reason? During the past year, several investment-grade energy credits-besides Enron-have either been downgraded to junk status or filed for bankruptcy. Also, in the wake of the Enron debacle, wary banks, seeking to lessen their credit-risk exposure, have reduced their hold position in syndicated credits. Another sign of the times: many traditional energy banks, looking to prop up their returns on credit relationships, are trying to carve out more of a share of the lucrative, fee-based investment-banking business by tying lending to that business. Wells Fargo "We have the ability to underwrite public equity and debt offerings, but it's not something we push," says Tim Murray, executive vice president and manager of Wells Fargo's energy group in Houston. "That's because just about everyone else in town is pushing it. The fact is, not everyone in the banking industry can be successful with that strategy-unless you think all those investment bankers in New York City are just going to give up and go home. Instead, we see ourselves more as an old-fashioned, traditional lending institution." Wells Fargo & Co., with assets of $308 billion, has energy loan commitments totaling nearly $4 billion and corresponding outstandings of $1.3 billion. The target range of its middle-market loans: $1 million to $50 million. Also, through Wells Fargo Energy Capital, which Murray heads up, it provides higher-risk, higher-return nonrecourse project financings, in the $1- to $20-million range. "Even though the syndicated loan market is tightening and credit is becoming more expensive, we expect to be a lot busier this year, especially on the oilfield-service side, since there are very few banks active in that sector," says Murray. "Also, deal volume on the E&P side will increase as the majors and large independents divest more assets. Just recently, our asset-and-divestitures group sold a large package of South Texas assets for Burlington Resources." Among its recent deals, the bank closed a $3.7-million, three-year revolving term loan for Proton Energy, a private Houston producer. "The pricing on the loan was pretty aggressive for a company this size," explains the banker. "That's because Natural Gas Partners owns a major stake in Proton." Last December, Wells Fargo's energy group also advised Proton on a $5-million acquisition of South Louisiana properties which was that operator's largest acquisition to date. In addition, the bank made $500,000 of credit available to the producer for hedging, which the company recently used. Says Murray, "Hedging requirements by banks are becoming more prevalent today, and it makes a lot of sense. Producers have well-blowout insurance; this is [commodity] price-blowout insurance." Recently, the bank also put together a two-tiered financing for CamWest, a private Dallas operator, that allowed its management to complete the $30-million buyout of the limited partnership from Stephens Inc. The way the financing was structured, Wells Fargo itself agented a $25-million, three-year term loan, priced 250 basis points above Libor, and brought Union Bank of California into the credit. At the same time, Wells Fargo Energy Capital, which can take more risk than its parent, provided a four-year, $8-million subordinated facility that carried a fixed interest rate of 10%, in addition to a 1% up-front facility fee. This gave CamWest's management an additional $3 million of working capital after the buyout. On the oilfield-service side, when Houston's Oceaneering International wanted to build a mobile offshore production unit (MOPU), but not touch its $80-million, five-year revolver with the bank to do it, the lender suggested a 5.5-year, delayed-draw, $50-million term loan, priced 75 basis points above Libor. "With this facility, which closed in March 2000, Oceaneering was able to draw down on the $50 million during the 18-month period of the MOPU's construction-but didn't have to start paying back on the loan until after that period," explains Murray. More recently, this past December the bank provided for T-3 Energy Services, a publicly traded Houston oilfield products and services manufacturer owned by First Reserve Corp. Fund VIII, a trio of financings. This included a $41.5-million, three-year revolver, priced on a grid from 225 to 300 basis points above Libor; a $16.5-million, three-year term loan with similar pricing; and a $12-million, four-year subordinated loan from Wells Fargo Energy Capital Services that carried a fixed interest rate of 9% and a 2% facility fee. "The $41.5-million revolver is tied to the company's current assets; the $16.5-million credit is predicated on the cash flow of the company longer term," says Murray. "The subordinated debt is strictly higher-risk money that will be funded for a longer period and have less collateral coverage. What we've tried to do is keep the blended cost of capital as low as possible for the company." Although it's not pushing capital markets activities, the bank is active in providing many ancillary, fee-generating services for its energy clients, beyond the lending product. It administers, for instance, Oceaneering's 401(k) plan. It also provides treasury management services for T-3 Energy and has recently done an interest-rate hedge for that company. Says Murray, "Increasingly, banks are focused on returns." Credit Lyonnais Paris-based Credit Lyonnais, with about $200 billion in assets, also sees an increase in its U.S. energy lending activities in 2002, spurred by a confluence of factors. "The maturity dates on a lot of energy credits are coming up this year, and many borrowers will need to refinance those loans," says Dennis Petito, senior vice president and head of the bank's U.S. energy, power and pipelines group in Houston. "Also, there are changes in U.S. accounting laws that will cause some energy clients to refinance their structured-finance transactions." Petito observes that besides the need for this compliance, energy companies are beginning to recognize that in the post-Enron environment, the market may view with a jaundiced eye any structured deal where it believes the only objective of the transaction is to move debt off a balance sheet. The bank, which has energy commitments of $6.5 billion in the U.S. alone and corresponding outstandings of $3.5- to $4 billion, cites other reasons for a likely rise in its energy lending levels this year. "On the producer side, we're going to see heightened M&A activity, particularly as more asset divestitures from larger operators and energy conglomerates come on the market," says John M. Falbo, first vice president and manager, independent producer group, in Houston. "In addition, much stronger industry fundamentals and better natural gas pricing versus year-end 2001 should drive higher capital spending in the upstream." But there are yet other factors at work, within the banking industry itself, that will require adjustments by producers and oilfield-service companies alike. "The total universe of banks lending to those sectors is much smaller than it was two or three years ago," says Petito. "Also, many banks are saying that, by policy, their hold position within any credit can't be more than 10%; two years ago, those same lenders would have held 50% of a credit for an extended period and not blink. In addition, with returns marginal at best on energy credits, more and more banks are requiring additional fee-based business from borrowers, such as being included in public debt and equity underwritings." One of the banks seeking a share of the capital-markets pie is Credit Lyonnais itself-and with good reason, says Petito. "Unlike many investment banks, we're using our balance sheet, putting capital to work in our relationships." Translation: if the bank lends $100 million to a company, it has to maintain at least an 8% level of equity capital in that loan, and the same rule applies to 50% of the unused portion of a lending commitment. "Also, we now provide quality equity research coverage for producers, service companies, energy conglomerates and utilities through analysts Brad Beago, Karen David-Green, Gordon Howald and Samir Nangia, respectively. So it's anachronistic for any energy client, during the life of a relationship, to view us as simply a commercial lender. That kind of customer doesn't interest us." Among recent credit facilities on the oilfield-service side, the bank this May was the sole bookrunner on a $450-million syndicated credit for driller Pride International. The term of the loan: three to five years, with institutional investors picking up $200 million of the longer-term portion of the credit. Also this May, the lender agented a $125-million, three-year term credit facility for Willbros Group, the Houston engineering and pipeline construction firm. In addition to agenting this loan, priced 175 to 200 basis points above Libor, Credit Lyonnais was the co-lead on a $65-million public equity offering for Willbros that same month. On the E&P side, the bank this May was elevated to a syndicate agent on a credit refinancing for Range Resources Corp., a publicly traded Fort Worth-based producer. The new $135-million, three-year term loan, priced 200 basis points above Libor, can increase to $145 million if the company continues to retire subordinated debt. "Our higher position in the credit recognizes our advice on structuring and pricing the loan, and our long-standing relationship with Range's chairman, Tom Edelman," says Falbo. Last year, the bank agented a $60-million credit for Elysium Energy, a 50% owned subsidiary of Denver's Patina Oil & Gas-another Edelman-run company. Most recently, the lender proposed a 10% participation in a $250-million syndicated credit for Quicksilver Resources, also a Fort Worth-based producer. "We're looking for companies with compelling strategies that we can understand, that recognize they need a balanced capital structure to grow, and are willing to let us provide them the resources to do that," says Falbo. "We're not looking to bank a company that's always going to be a $15- or $20-million credit relationship." Comerica Bank Comerica Bank, with assets of $50 billion, isn't tying energy lending to a borrower's expected use of investment-banking services. "We're a North American bank primarily focused on the loan product across all industries, including energy," says Mark Fuqua, senior vice president and manager of energy banking in Dallas. This isn't to say that Comerica, with energy commitments of more than $1 billion and outstandings in that sector of $600 million, doesn't have an appetite for providing additional services beyond the lending product. "We do," says Fuqua. "But it's more in the form of traditional banking services, such as deposits, treasury management, short-term cash investments, foreign-currency exchange and interest-rate swaps." With $600 million of commitments to the E&P side alone-covering about 40 private and publicly traded producers-the bank is aggressively attempting to expand its credit exposure in the upstream sector. During the past two years, it has stepped up its calling efforts, out of both its Dallas and Houston offices, into the U.S. Rocky Mountain region and Canada. "Given the bright outlook for natural gas in North America, producers in these regions are going to be an increasingly important source of supply for that commodity-yet they haven't been marketed to by banks as much as operators in Texas and the Southwest," says Fuqua. "So we've pursued this opportunity." The result: during the past 24 months, Comerica has established $100 million in commitments with four small- and mid-cap Denver-based producers. Also, late last year, it set up a US$20-million commitment with an intermediate-size oil and gas operator in Calgary. "The target companies for our upstream credits-where we would be the agent-are those with asset sizes or market caps under $500 million, that have borrowing needs of at least $5 million," says Fuqua. "However, we also participate in credits with much bigger producers where we're not the agent." An example of the bank's typical E&P credit relationship is Matador Petroleum Corp., a private Dallas-based producer focused on drilling for oil and gas, primarily in the Permian Basin and East Texas. The relationship began nine years ago with the lender providing a $5-million loan for the operator. But within the past few years, Matador has stepped up its development drilling activity, and with that has come the need for more funding. To address that, Comerica recently brought in additional banks and agented a $95-million, four-year term, customized credit facility for the producer. Its pricing? The bank says that credits for small-cap producers like Matador are typically priced 125 to 250 basis points above Libor, depending on how much of the commitment an operator uses. Seeking to take advantage of lending opportunities in the oilfield-service arena, the bank this past February hired Mona Foch from JPMorgan Chase to start an energy-services lending group in its Houston office. Says Fuqua, "Prior to Foch joining us, the bank had some oilfield-service clients, but we were seeing so many more lending opportunities in the Gulf Coast area that it became apparent we needed someone dedicated solely to this sector." Comerica is also expanding its lending exposure in the midstream sector, looking for more credit opportunities among pipeliners, gas gatherers, processors and storage companies. "There was some contraction of appetite on the part of banks to make energy loans when commodity prices were spiraling downward late last year-and the problems with Enron made lenders even more nervous," admits Fuqua. "But commodity prices are now strong-we're using $20 oil and $3 gas price decks for 2002-and the markets have pretty well absorbed the impact of Enron. So bankers are now getting more aggressive with respect to energy lending, particularly amid the outlook for an improving economy." Also, the bigger oil and gas companies that made acquisitions in recent years are now beginning to divest their noncore assets; that, in turn, is creating buying opportunities for smaller companies-as well as the need for more capital to develop those acquired assets, he says. "With the public equity markets not all that open at the moment, the demand for oil and gas loans should be much greater this year than last."