Energy Lending Presentation Texas RMA Spring Conference. Tony Ross April 9, 2015

Transcription

1 Energy Lending Presentation Texas RMA Spring Conference Tony Ross April 9,

2 Energy Lending Presentation / Agenda Agenda I. Energy Industry Overview Upstream Shale Video Midstream Downstream Refining Petrochemicals II. Energy Lending Upstream (Reserve-Based Loan) Lending Overview Loan Structure Loan Documentation Factors Impacting Borrowing Base Engineering Due Diligence Midstream For internal IBKC use only; not for distribution. 2

3 Energy Lending Presentation / Agenda Agenda (continued) III. Energy Lending Risks Upstream Risks Commodity Risk Bank Price Survey Operational Risk Financial Risk Midstream Risks IV. Portfolio Management V. Oil Field Service Lending 3

4 Energy Lending Presentation / Agenda Agenda I. Energy Industry Overview Upstream Shale Video Midstream Downstream Refining Petrochemicals II. Energy Lending Upstream (Reserve-Based Loan) Lending Overview Loan Structure Loan Documentation Factors Impacting Borrowing Base Engineering Due Diligence Energy Lending PD/LGD Risk Rating System Midstream 4 For internal IBKC use only; not for distribution.

5 Energy Lending Presentation / Energy Industry Overview Energy Industry Overview Oilfield Services Service, Supply & Manufacturing Seismic Drilling Marketing Drilling Contracts Typically a dedicated line of business Energy Group lends to Upstream and Midstream companies Oilfield Services companies are typically handled on a local market or specialty group basis. 5

6 Energy Lending Presentation / Agenda Agenda I. Energy Industry Overview Upstream Shale Video Midstream Downstream Refining Petrochemicals II. Energy Lending Upstream (Reserve-Based Loan) Lending Overview Loan Structure Loan Documentation Factors Impacting Borrowing Base Engineering Due Diligence Midstream For internal IBKC use only; not for distribution. 6

7 Energy Lending Presentation / Energy Industry Overview - Upstream Upstream The successful development in the U.S. of "disruptive technologies" like horizontal drilling and multi-stage fracturing of wells are "game changer" events that have transformed the global energy outlook by opening up vast new supplies that could not be produced using conventional drilling technology. The size of the resource is reducing oil and gas prices, expanding basis differentials, driving a reconfiguration of long-haul oil and natural gas infrastructure, negatively impacting coal prices and impacting NGL/petrochemicals markets worldwide. Increased natural gas production has reduced natural gas prices to a level that results in gas-fired power generation being both cheaper and cleaner than coal-fired plants and much cheaper than power from both solar and wind. The scale of shale plays require substantial capital to acquire large acreage positions, technical expertise on horizontal drilling / completion methods and significant capital to both drill enough wells across a wide enough area to identify sweet spots and experiment with different techniques to determine the best method to maximize resource recovery and economics. Shale Drilling Video Time-lapse Video 7

8 Energy Lending Presentation / Energy Industry Overview - Upstream 8

9 The revolution is real. 9

10 But commodity cycles have not been repealed 10

11 History doesn't repeat itself, but it does rhyme. Best summed up as déjà vu all over again New discoveries creating oversupply and price collapses; scarcity creating price spikes, technological advances, export then import then no don t; move to suburbs; no move to the city, muscle cars are back. VUCA Final irony is Pennsylvania is back and exporting natural gas to Texas!! 11

12 Energy Lending Presentation / Energy Industry Overview - Upstream 12

13 Energy Lending Presentation / Energy Industry Overview - Upstream 6,000,000 Oil Production by Play 5,000,000 Barrels/day 4,000,000 3,000,000 2,000,000 Utica Permian Niobrara Marcellus Haynesville Eagle Ford Bakken 1,000,000 - * Source - EIA.gov * Actual data through August 22,

14 Energy Lending Presentation / Energy Industry Overview - Upstream Rig Count Trend 14

15 Energy Lending Presentation / Agenda Agenda I. Energy Industry Overview Upstream Shale Video Midstream Downstream Refining Petrochemicals II. Energy Lending Upstream (Reserve-Based Loan) Lending Overview Loan Structure Loan Documentation Factors Impacting Borrowing Base Engineering Due Diligence Energy Lending PD/LGD Risk Rating System Midstream 15 For internal IBKC use only; not for distribution.

16 Energy Lending Presentation / Energy Industry Overview - Midstream Midstream Industry Overview UPSTREAM DOWNSTREAM 16

17 Energy Lending Presentation / Energy Industry Overview - Midstream Oil Pipeline Map 17

18 Energy Lending Presentation / Energy Industry Overview - Midstream Natural Gas Pipeline Map 18

19 Energy Lending Presentation / Energy Industry Overview - Midstream Refineries 19

20 Energy Lending Presentation / Energy Industry Overview - Midstream New Oil Pipelines 20

21 Energy Lending Presentation / Energy Industry Overview - Midstream Midstream Outlook depends on location (proximity of resource to end-user markets), exposure to the type of commodity (natural gas, natural gas liquids ( NGLs ) or oil) and the level of drilling activity which is associated economics of the oil or gas reserves. Huge opportunities for "green field" expansion in shale plays with attractive upstream economics and lack of existing infrastructure to transport new supplies to established end-user markets. Infrastructure associated with lower-cost supplies that are closest to end-user markets have a competitive advantage over higher-cost supplies that have to be transported longer distances. Declining volumes in older gathering or interstate pipelines tied to conventional natural gas to connect historical production areas (e.g., TX/LA Gulf Coast, Rockies Express Pipeline) to major end-user markets (Northeast) or in more recent higher-cost dry natural gas shale plays that are not economic based on current prices (Haynesville, Barnett, Fayetteville) which are seeing reduced drilling activity. Some existing infrastructure is being reversed to move excess domestic supplies to enduser markets. Value and revenue for natural gas storage facilities has decreased due to increased 21 production, flatter futures curve and reduced price volatility.

22 Energy Lending Presentation / Agenda Agenda I. Energy Industry Overview Upstream Shale Video Midstream Downstream Refining Petrochemicals II. Energy Lending Upstream (Reserve-Based Loan) Lending Overview Loan Structure Loan Documentation Factors Impacting Borrowing Base Engineering Due Diligence EneMidstream 22 For internal IBKC use only; not for distribution.

23 Energy Lending Presentation / Energy Industry Overview Downstream Refining Downstream/Refining On the macro level, the refining industry suffers from major headwinds - increased mileage standards; greater use of biofuels like ethanol and biodiesel; and fleet vehicles converting from gasoline/diesel to compressed natural gas. But on an individual refinery basis, profitability is tied to sources/prices of feedstock supply - Rockies/Midwest refiners (and to a lesser extent, Gulf Coast refineries) that can source cheaper Canadian/Mid-Continent supplies sources priced off of the West Texas Intermediate ("WTI") contract have lower feedstock costs. East Coast refineries that are not tied via pipeline to domestic supplies import crude tied to the Brent North Sea contract have higher feedstock costs but recent rail infrastructure in the Bakken Shale is now providing access to lower-cost domestic feedstock. Potential demand destruction due to high U.S. retail gasoline prices. U.S. gasoline demand is expected to be flat-to-declining according to the EIA. A number of major integrated oil companies (like Marathon and Conoco) have decided to spin-off their refining businesses. Major refiners with access to domestic discounted crudes are exploiting lower feedstock costs to export refined products that can be made more cheaply than refined products made from higherpriced, supply-constrained global crudes. The reversal of existing oil pipeline infrastructure (e.g., Seaway) and the building of new oil pipelines (e.g., Keystone XL) will alleviate the bottleneck for inland crude and reduce the Brent/WTI differential in the next couple of years. The delivery of more crude from the Canadian oil sands, the Bakken Shale and the Permian Basin will reduce the need for imports. 23

24 Energy Lending Presentation / Energy Industry Overview Downstream Refining * Source EIA.gov 24

25 Energy Lending Presentation / Energy Industry Overview Downstream Petrochemicals Downstream/Petrochemicals Lower U.S. natural gas prices reduce operating costs and declining natural gas liquids prices (relative to crude) are reducing feedstock costs for U.S. petrochemical companies. Many companies, mostly with existing plants along the Gulf Coast, are expanding petrochemical production capacity to exploit these cost advantages which translate into superior economic returns compared to their international competitors. Most of U.S. ethylene crackers depend on ethane (a natural gas liquid) for their feedstock whereas most overseas ethylene crackers utilize naptha (product derived from refining crude oil). 25

26 Energy Lending Presentation / Agenda Agenda I. Energy Industry Overview Upstream Shale Video Midstream Downstream Refining Petrochemicals II. Energy Lending Upstream (Reserve-Based Loan) Lending Overview Loan Structure Loan Documentation Factors Impacting Borrowing Base Engineering Due Diligence Midstream 26 For internal IBKC use only; not for distribution.

27 Energy Lending Presentation / Energy Lending Energy Lending Business Model Energy lending is a specialty lending group that handles loans across the entire footprint of a bank so it is different from the general market-based model used for all other types of lending in the bank. Energy lending group includes companies in the upstream and midstream sectors of the energy industry; lending to oilfield services companies is not in the energy group and is handled on a local market basis like other commercial & industrial customers. Banks use internal and/or external third-party engineering consultants for petroleum engineering to prepare an engineering evaluation on the reserves that will serve as collateral for borrowing base revolving credit facilities. 27

28 Energy Lending Presentation / Agenda Agenda I. Energy Industry Overview Upstream Shale Video Midstream Downstream Refining Petrochemicals II. Energy Lending Upstream (Reserve-Based Loan) Lending Overview Loan Structure Loan Documentation Factors Impacting Borrowing Base Engineering Due Diligence Midstream 28 For internal IBKC use only; not for distribution.

29 Energy Lending Presentation / Energy Lending - Upstream Where Does a Reserve Based Loan fit into a Company s Capital Structure? The upstream oil and gas business is capital intensive and companies rely on all forms of debt and equity capital to finance their exploration, development and acquisitions activities. Banks are key capital providers to the upstream sector: Banks generally focus on the lower end of the reserve risk spectrum (Senior Debt). 29

30 Energy Lending Presentation / Energy Lending - Upstream LOWER RISK HIGHER RISK LOWER RISK HIGHER RISK 30

31 Energy Lending Presentation / Energy Lending - Upstream Reserve - Based Lending Overview Reserve based loans are based on lower-risk proved reserves with the majority of the value based on proved developed producing reserves. The reserve based loan amount is calculated based on collateral values based on a bank s price deck which typically includes a discount to the futures strip. Bank engineer will review the company s independent third party reserve report to review estimates of operating costs, expected ultimate recovery of reserves, production rates, capital expenditures needed to convert reserves into the PDP category and make technical adjustments based on their professional judgment. Bank engineer will provide engineering runs based on the bank s price deck that conform with the bank s energy lending policy with respect to risking, concentration and reserve splits. 31

32 Energy Lending Presentation / Energy Lending - Upstream Reserve - Based Lending Overview Energy lending policies require reserve values to be haircut for risking (to reflect exploration risk, mechanical/operating risk and timing issues); concentration (to avoid too much value being derived from any single well or field); and reserve splits (to make sure loan value is based primarily on properties with PDP reserves with current production/cash flow with lower limits for higher-risk PDNP/PUD reserves). Engineering runs are used to develop financial projections that test for compliance with energy lending policy parameters including base case and sensitivity case advance rates; reserve tail tests (based on economic half-life of the reserves or remaining cash flow after projected loan payout); and annual cash flow coverage tests. Cash flow projections must demonstrate the ability to cover projected G&A expenses, scheduled principal and interest payments on other unsecured or subordinated (e.g. 2nd lien) debt, and debt service assuming a full draw of the borrowing base with an adequate reserve tail as cushion. 32

33 Energy Lending Presentation / Energy Lending - Upstream Borrowing Base Loan Structure Risk associated with the volatility in commodity prices/market values for o&g collateral is mitigated by the flexibility in a reserve-based loan with borrowing base provisions. Semi-annual borrowing base redeterminations with at least one based on an independent third party petroleum engineering consultant; the second one can be an internally-prepared update incorporating changes since the last independent third party report. Both Lender and Borrower typically will have one wildcard option to call for an interim borrowing base redetermination at their discretion. Documentation includes a built in remedy to address any borrowing base deficiency (defined as the amount by which loan utilization exceeds the borrowing base amount); Borrower typically has 30 days to make their first payment (typically 1/3 rd to 1/6 th of the deficiency amount) with additional monthly payments over the following two to five months. 33

34 Energy Lending Presentation / Energy Lending - Upstream Borrowing Base Loan Structure Loans are almost always structured as a revolver or a reducing revolver where commitments reduce by a fixed amount each month to account for depletion. On smaller deals, 100% Lender approval is needed to increase, affirm, or decrease the borrowing base. On larger deals, 100% Lender approval is needed to approve or increase the borrowing base with a lower threshold (typically 67%) to affirm or reduce the borrowing base. Typically include a liquidity test that requires Day 1 liquidity at closing to be 10% of the borrowing base amount. 34

35 Energy Lending Presentation / Energy Lending - Upstream Reserve - Based Loan Documentation Documentation typically includes standard provisions such as financial covenants (leverage/liquidity); restrictions or prohibitions on additional indebtedness and distributions; and a borrowing base deficiency provision. The borrowing base deficiency can be cured by the borrower adding additional oil and gas properties to the collateral base or the bank can establish monthly commitment reductions to reduce debt to a level that will bring the loan back into compliance with energy lending policy or covenant compliance. Borrowing base credit facilities allow debt levels/amortization to be either increased or decreased to levels that maintain loan-to-value and cash flow coverage ratios that take into consideration changes in cash flow caused by acquisition/divestitures, changes in commodity prices, drilling activity since the last redetermination and production performance that impact decline curves or expected ultimate recoveries of reserves. Bank legal counsel will review/evaluate the Borrower s title to its oil & gas properties to make sure it matches the net revenue interest reflected in the one-line engineering report and prepares mortgages/ 1st lien deed of trust; typically a bank requires at least 80% of the initial collateral value to be covered by a perfected security interest and to have clear/acceptable title. 35

36 Energy Lending Presentation / Energy Lending - Upstream Factors Impacting Borrowing Base Loan Amount Borrowing Base Decrease Lower prices / price deck Unwinding existing hedges with strike prices above price deck Borrowing Base Increase Higher prices / price deck Additional hedges at prices above price deck Reserve divesture (with material PDP component) Reserve acquisition (with material PDP component) Producing existing PDP reserves and not replacing them through drilling or acquisitions Converting PUD or unproven reserves into PDP category through drilling of development or exploratory wells Increased operating costs, G&A expenses, production taxes, drilling / completion CAPEX Converting PDP reserves to PDNP category because of weather and/or (hurricane, freezing temperatures) mechanical/operational problems (requiring well maintenance or repair of pipeline/processing facilities) Negative reserve revisions (performance was less than expected) resulting in fewer reserves being recovered Reducing operating costs, G&A expenses, production taxes, drilling / completion CAPEX Converting PDNP reserves to PDP category, recompletion of additional behind pipe zones Positive reserve revisions (performance was better than expected) resulting in more reserves being recovered Risk associated with the volatility of commodity prices/market values for oil and gas properties is mitigated by the flexibility in a reserved-based loan with standard borrowing base provisions. Borrowers can manage risk through commodity hedging, maintaining adequate liquidity, taking prudent exploration risks, and not over-leveraging the balance sheet. 36

37 Energy Lending Presentation / Agenda Agenda I. Energy Industry Overview Upstream Shale Video Midstream Downstream Refining Petrochemicals II. Energy Lending Upstream (Reserve-Based Loan) Lending Overview Loan Structure Loan Documentation Factors Impacting Borrowing Base Engineering Due Diligence Midstream 37 For internal IBKC use only; not for distribution.

38 Energy Lending Presentation / Energy Lending / Engineering Due Diligence Petroleum Engineering & Legal Due Diligence for E&P Loans Independent petroleum engineer is engaged by bank to perform oil and gas evaluation (if in-house engineer, they generally report to credit): Evaluates both reserve/production volumes and lease operating expenses; Includes any capital expenses necessary to convert non-producing reserves to producing; Employs bank s oil and gas price assumptions reset quarterly (or more often if deemed necessary due to market conditions) 70% 85% of forward strip for base case unhedged volumes and includes hedge prices on hedge volumes; sensitivity case pricing typically set at 80% of base case pricing; Calculates the present value of projected cash flow stream using a discount factor PV X%; 38

39 Banks employ parameters: Energy Lending Presentation / Energy Lending / Engineering Due Diligence Petroleum Engineering & Legal Due Diligence for E&P Loans Collateral comprised of no less than X% PDP properties (no more than X% from PDNP PUD combined with maximum of X% PUD); exceptions to PDP/non PDP reserve slits are allowed up to a limit particularly in cases where there are high quality behind-pipe reserves and the borrower has capacity to fund capex needed to covert these reserves to PDP status; Risk factors on non-pdp reserves; risk factors on individual wells may be higher or lower based on independent engineers assessment (5% - 10% on new PDP wells with limited production history, 20% - 25% on PDNP reserves, and 50% on PUD reserves though it can be as low as 30% in de-risked core of wellestablished resource play with drilling success rate of ~100%; No single PDNP or PUD well > X% of the risked PV8% value; Reserve values that become uneconomic (because of of price deck and risking parameters) are removed from the evaluation. Maximum advance rate against PV X% is generally 65% (using base case pricing) and 100% (using sensitivity case pricing). 39

40 Energy Lending Presentation / Energy Lending / Engineering Due Diligence Petroleum Engineering & Legal Due Diligence for E&P Loans Cash flow projections must demonstrate the ability to cover projected G&A expenses, scheduled principal and interest payments on other unsecured or subordinated (e.g. 2 nd lien) debt, and debt service assuming a full draw of the borrowing base with an adequate reserve tail as cushion (defined as within one year of the economic half-life). Outside oil & gas legal counsel engaged by bank: Reviews and evaluates the Borrower s title to its oil & gas properties; Matches title resulting with ownership percentage as used in engineering evaluation; Prepares all other documentation to achieve a first lien deed of trust on at least 80% of the collateral value and clear title on at least 80% of the collateral value. 40

41 Energy Lending Presentation / Energy Lending / Engineering Due Diligence Customers provide technical information like seismic interpretations and well logs to support their reserve estimates Prospect 41

42 Energy Lending Presentation / Energy Lending / Engineering Due Diligence Engineering Evaluation Cases 42

43 Energy Lending Presentation / Energy Lending / Engineering Due Diligence Total Proved Unrisked Case Engineering Evaluation LOE FNR PV9% value 43

44 Energy Lending Presentation / Energy Lending / Engineering Due Diligence Total Proved Base Case Engineering Evaluation LOE FNR PV9% value 44

45 Energy Lending Presentation / Energy Lending / Engineering Due Diligence Engineering Evaluation Total Proved Roll Forward Case LOE FNR PV9% value 45

46 Energy Lending Presentation / Energy Lending / Engineering Due Diligence Engineering Evaluation Total Proved Sensitivity Case LOE FNR PV9% value 46

47 Energy Lending Presentation / Energy Lending / Engineering Due Diligence Commodity Price Impact on Reserves Commodity prices impact the amount of reserves The value of the collateral is based on a present value of future cash flows with an assumption that reserves will not be produced at a loss Net Volumes NYMEX Strip Case Risked Reserves Base Case Risked Reserves Sensitivity Case Risked Reserves Total Net Oil/Cond. (Mbbls) Total Net Gas (MMcf) Total NGL (Mbbls) Net Oil Hedge Volumes (Mbbls) 25, , , , , , , , , ,183.4

48 Energy Lending Presentation / Energy Lending / Engineering Due Diligence Cash Flow Model Once the engineering runs are received, they are checked to make sure the price deck, effective date and reserve splits are correct. Often there s talk and s to get some color on the quality/quantity of technical information received and get a feel for the magnitude of any adjustments made to lease operating expenses, recoverable reserves and decline curves (which are subsequently summarized in an engineering memo). If significant adjustments are made, these observations are shared with the client to see if they have additional technical information they can provide to support their estimate. An effort is made to reduce any differences in the estimates to a difference of professional opinion. Individual differences should narrow over time as actual results will provide additional information that both the client and bank engineer will take into consideration in their updated estimate at the next redetermination. Once final engineering runs are received, we use a standardized model to project cash flow to test for debt capacity and compliance with energy lending policy with respect to advance rates and reserve tail. This can be an iterative process to determine the maximum debt capacity that results in no or few exceptions that are not too severe. 48

49 Energy Lending Presentation / Energy Lending / Engineering Due Diligence Reserve Tail / Annual Cash Flow Coverage Exhibit 49

50 Energy Lending Presentation / Energy Lending / Engineering Due Diligence Historical / Projected Financial Summary 50

51 $300, $250, $200, Energy Lending Presentation / Energy Lending / Engineering Due Diligence Reserve-Based Loan Engineering Cases Unrisked FNR at Futures Strip Unrisked FNR at Base Pricing (72.5% of Futures Strip) Base Case Pricing Risked Undiscounted FNR Base Case Pricing Risked FNR Discounted PV9% Sensitivity Case Pricing Risked Discounted 9% FNR Borrowing Base $150, $100, Note FNR, Future Net Revenue, is defined as the net revenue after the deduction of lease operating expenses, production taxes and capex associated with converting nonproducing reserves into the proved developed producing category. $50, $

52 Energy Lending Presentation / Energy Lending / Engineering Due Diligence Reserve-Based Loan Determining Borrowing Base $90, $80, $70, $60, $50, Day 1 Advance Rate of 62.0% with collateral value of $80.6 million. Six-Month Roll-Forward Advance Rate of 64.6% with collateral value of $77.4 million. Future Date of Projected Loan Payout Base Case Pricing Risked FNR Discounted PV9% Sensitivity Case Pricing Risked Discounted 9% FNR Borrowing Base Future Net Revenue Future Net Revenue of 48% after payout. $40, $30, $20, $10, Reserve Tail $ Initial Borrowing Base = Lower of 65% Day-1 or 6-Month Roll-Forward Base Case & 100% of the Sensitivity Case. 52

53 Energy Lending Presentation / Energy Lending / Engineering Due Diligence $90, $80, $70, Reserve-Based Loan Equity Cushion Base Case Pricing Risked FNR Discounted PV9% Sensitivity Case Pricing Risked Discounted 9% FNR Borrowing Base $60, $50, $40, $30, $20, $10, Equity Cushion $ Focus on Advance Rates and Adequate Reserve Tail results in equity cushion and acceptable collateral over the life of the loan. 53

54 Energy Lending Presentation / Energy Lending / Engineering Due Diligence Example Customer moving from Natural Gas to Oil/Liquids $300, Temporary loss of production / reduction in commodity prices Increase in commodity prices / reserve base Move towards wet gas operations Curtail drilling for natural gas until markets improve / Continue to develop wet gas reserves $250, $200, Production back online / Joint Venture established $150, $100, Unrisked Base Sens Borrowing Base $50, $0.00 Mar-10 Apr-10 May-10 Jun-10 Jul-10 Aug-10 Sep-10 Oct-10 Nov-10 Dec-10 Jan-11 Feb-11 Mar-11 Apr-11 May-11 Jun-11 Jul-11 Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 Jan-12 Feb-12 Mar-12 Apr-12 May-12 Jun-12 Jul-12 Aug-12 Sep

55 Energy Lending Presentation / Energy Lending / Engineering Due Diligence Example Offshore Customer Growing Via Acquisition $1,400, Reaffirm Borrowing Base / JV agreement Move towards oily production / added additional rigs to enhance drilling program in the GOM Acquired sizeable GOM shelf oil and natural gas interest $1,200, Bolt on Acquisition $1,000, $800, $600, Unrisked Base Case FNR Base Case FNR Sensitivity Case FNR Borrowing Base $400, $200, $0.00 Jan-11 Feb-11 Mar-11 Apr-11 May-11 Jun-11 Jul-11 Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 Jan-12 Feb-12 Mar-12 Apr-12 May-12 Jun-12 Jul-12 Aug-12 Sep-12 Oct

56 Energy Lending Presentation / Energy Lending / Engineering Due Diligence $0 $150,000 $300,000 $450,000 $600,000 $750,000 $900,000 $1,050,000 $1,200,000 $1,350,000 NYMEX Strip Case unrisked Unrisked Base case NYMEX Strip Case Risked Sensitivity Case Risked Base Case RF Base Case *Borrowing Base is currently at $150MM

57 Energy Lending Presentation / Energy Lending / Engineering Due Diligence $0 $150,000 $300,000 $450,000 $600,000 $750,000 $900,000 $1,050,000 NYMEX Strip Case unrisked* Unrisked Base case* NYMEX Strip Case Risked* Base Case no splits* Base Case no splits Sensitivity Case no splits Sensitivity Case* Sensitivity Case no splits* Hedge Downgrade - Sens Base Case - 10% Capex incr. RF Base Case* Base Case - 10% LOE incr. Base Case 5% production Base Case 5% production Base Case - 10% Capex incr.* Risked Base Case* Hedge Downgrade - Base Base Case - 10% LOE incr.* Base Case 10% Differ. Decl. Base Case 10% Differ. Decl.* Sensitivity Case - No Hedges Sensitivity Case - No Hedges* Base Case - No hedges Base Case Cumulative case Base Case Cumulative case* Base Case - No hedges* Borrowing Base Range *Assumes 10% increase in cash G&A expense and issuance of $150MM of high yield debt. ** Borrowing Base is currently at $150MM

58 Energy Lending Presentation / Energy Lending / Engineering Due Diligence

59 Energy Lending Presentation / Agenda Agenda I. Energy Industry Overview Upstream Shale Video Midstream Downstream Refining Petrochemicals II. Energy Lending Upstream (Reserve-Based Loan) Lending Overview Loan Structure Loan Documentation Factors Impacting Borrowing Base Engineering Due Diligence Midstream 59 For internal IBKC use only; not for distribution.

60 Energy Conference / Energy Lending Risks - Midstream Midstream Loans to companies in the midstream sector of the energy industry include loans to companies engaged in the gathering, treating, processing, compression, transportation and storage of oil, natural gas, natural gas liquids and refined products. The loan structure for any particular loan should be based on historical or projected cash flows associated with volumes to be handled and incorporate the fees payable under the contracts with producers. Loans to start-up or nondiversified midstream companies may require independent third party consulting reports including: A petroleum engineering report to assess the volume of projected production flowing through the system; and A midstream consulting firm to conduct an assessment of the competitive position of a company's assets, as well as a contract review to assess the reasonableness of projections. 60

61 Energy Conference / Energy Lending Risks - Midstream Midstream (Continued) For loans to companies involved in the natural gas processing business, it is important to distinguish the percentage of cash flow that comes from the three basic types of contracts which include: Fee-based contracts where there is essentially a fixed fee for processing volumes (low commodity price risk); Percent-of-proceeds contracts where revenue is tied to the sale of an agreed upon percentage of the end products (typically natural gas liquids and/or natural gas) - these contracts have moderate commodity price risk which can be mitigated through the use of commodity hedges or contracts; and 61

62 Energy Conference / Energy Lending Risks - Midstream Midstream (Continued) Make-whole contracts where the revenue is based on the sale of natural gas liquids extracted from the processing of "wet" gas and an obligation to reimburse the producer by "making them whole" on the MMBTUs associated with the NGLs extracted by purchasing/providing them with an equivalent MMBTU of "dry" gas - these contracts have high commodity price risk since a high natural gas/low natural gas liquid price environment could result in a negative margin. Loans to processing companies with significant fee-based contracts or percent-ofproceeds contracts where the commodity risk is mitigated by commodity price hedges are preferable and exposure to make-whole processing contracts should be avoided. 62

63 Energy Lending Presentation / Agenda Agenda (continued) III. Energy Lending Risks Upstream Risks Commodity Risk Bank Price Survey Operational Risk Financial Risk Midstream Risks IV. Portfolio Management 63

64 Managing Risk Energy Lending Presentation / Energy Lending Risks Centralized Specialized Expertise: Reserve-based lending requires industry specific knowledge, a consistency of approach and evaluation to assure portfolio quality. Manage portfolio risk by centralization of relationship management, credit underwriting and credit approval for all "non-guarantor reliant" upstream and midstream energy loans. Conservative Pricing Assumptions: The Energy Product Pricing Guidelines used for underwriting reserve-based loans should be approved by the Energy Credit Committee on a quarterly basis. The goal in setting price is to target the average of prudent energy lenders to ensure one remains competitive, but avoid closing higher-risk loans simply because you have more aggressive commodity price assumptions. Engineering Evaluation: Engage an independent third party engineering consultant to perform an evaluation of the company s reserve report using the bank price deck and making adjustments for energy lending policy (reserve 64 risking/splits/concentration).

65 Managing Risk Energy Lending Presentation / Energy Lending Risks Prudent Underwriting Policy: Have an energy lending policy that is consistent with prudent and experienced energy lenders and includes guidelines designed to limit energy loan portfolio risk. Financial Projections: Prepare projections based on the engineering runs and include other expenses such as G&A expenses and debt service to assess if the cash flow from the collateral properties can repay the loan assuming a full draw of the loan while leaving an adequate cushion after payout of the loan. Loan Structures Provide Flexibility to Ensure Adequate Coverage: All reservebased loans have semi-annual borrowing base redetermination provisions that allow the bank to reset the loan amount/amortization every six months based on the price deck and energy lending policy..essentially a 6-month rolling demand note that gives us the ability to sweep cash to reduce the loan. Borrowing base change voting provisions are normally subject to a 100% lender approval to increase the borrowing base and usually 67% to affirm/decrease the borrowing base (for larger deals) so participant banks have a lot more control than is normally the case in a syndicated non-reserve based shared national credit. 65

66 Energy Lending Presentation / Agenda Agenda (continued) III. Energy Lending Risks Upstream Risks Commodity Risk Bank Price Survey Operational Risk Financial Risk Midstream Risks IV. Portfolio Management 66

67 Energy Lending Presentation / Energy Lending Risks - Upstream What are the Key Risks of a Reserve Based Loan? There are key risks to consider in reserve based lending: Reserve Risk Commodity Risk Operational Risk Financial Risk 67

68 Mitigating Reserve Risks Perform thorough engineering evaluation of reserves, Energy Lending Presentation / Energy Lending Risks - Upstream Focus on proved producing reserves (PDP), Diversity of reserves i.e. number of wells and fields, Favor reserves with a higher Reserves to Production Ratio (RP Ratio), and structure the repayment accordingly, Semi-annual borrowing base reviews. Concentration of any single producing well must be 20%.. 68

69 Energy Lending Presentation / Energy Lending Risks - Upstream Mitigating Commodity Risks Use Bank approved price forecast that is adjusted quarterly, Encourage companies to hedge the commodity price, Prohibit speculative hedging; Limit hedging volumes (typically 80% projected PDP) Limit tenor of hedges (typically not longer than 3-4 years) Seasonal hedging limitations for customers who are susceptible to hurricane disruptions Semi-annual borrowing base reviews. 69

70 Energy Lending Presentation / Energy Lending Risks - Upstream Bank Price Survey 3rd Q 2014 Macquarie Tristone Price Survey: Mean of 39 Participating Banks $ $8.00 Dollars per Barrel $ $90.00 $80.00 $70.00 $60.00 $50.00 $40.00 $7.00 $6.00 $5.00 $4.00 $3.00 Dollars per MCF $ Oil (Base) $81.00 $79.29 $77.65 $76.83 $76.75 Oil (NYMEX) $98.47 $90.69 $84.98 $81.82 $80.81 Oil (Sen) $64.24 $62.96 $61.64 $61.19 $61.28 Gas (Base) $3.68 $3.74 $3.86 $3.96 $4.08 Gas (Nymex) $4.45 $4.20 $4.15 $4.25 $4.36 Gas (Sen) $2.84 $2.95 $3.08 $3.16 $3.23 $2.00 Banks generally reset their oil and gas price forecast every quarter. Base case price forecast are generally below the NYMEX futures pricing (70% - 95%). Banks generally always have a sensitivity case which is 80% of the base case price 70

71 Energy Lending Presentation / Energy Lending Risks - Upstream Mitigating Operational Risk Understand cost structure of the Company s Operations, Experienced management team, Understand operational risks (e.g. hurricane disruptions) and their liability/insurance policies which help mitigate this risk 71

72 Energy Lending Presentation / Energy Lending Risks - Upstream Mitigating Financial Risk Understand leverage position, debt profile, and available liquidity Analyze financial data in order to understand trends in operating costs, G&A expenses, production taxes, and drilling and completion CAPEX Production analysis to analyze whether the customer is a high or low cost producer (cost of LOE, G&A, depreciation, production tax per unit of production) Run sensitized models on customer s projections (commodity price, production, drilling, etc.) Adequate capital structure Ability to gain additional financing through debt / equity markets or private equity sponsor 72

73 Energy Lending Presentation / Agenda Agenda (continued) III. Energy Lending Risks Upstream Risks Commodity Risk Bank Price Survey Operational Risk Financial Risk Midstream Risks IV. Portfolio Management Appendix: Energy Lending Policy Overview Key Underwriting Standards Energy Lending Portfolio as of 06/30/14 Reserve Definitions 3Q2014 Price Deck Memo Moody s and S&P Reserve-Based Loan Articles 73

74 Energy Conference / Energy Lending Risks - Midstream Energy Lending Risks - Midstream The credit application should address relevant risk issues including: The diversity of the collateral (exposure to multiple supply basins or enduser markets); The economic viability and historical/projected drilling activity of the reserves; Summary details of the contracts with producers including fees to be paid, the different services to be provided, tenor of the contracts and any other important terms such as acreage dedications or minimum volume commitments which are lower risk than a month-to-month contract where the borrower is exposed to customers moving to a competitor with short notice); and An assessment of contract counterparty credit risk (with a preference for multiple contracts with high-quality producers with no significant concentration to a single counterparty). 74

75 Energy Lending Presentation / Agenda Agenda (continued) III. Energy Lending Risks Upstream Risks Commodity Risk Bank Price Survey Operational Risk Financial Risk Midstream Risks IV. Portfolio Management Appendix: Energy Lending Policy Overview Key Underwriting Standards Energy Lending Portfolio as of 06/30/14 Reserve Definitions 3Q2014 Price Deck Memo Moody s and S&P Reserve-Based Loan Articles 75

76 Energy Lending Presentation / Portfolio Management Credit Approval Process Credit Approval Process HOUSTON ENERGY LENDING UNDERWRITING CHAIN OF APPROVAL Energy Lending Manager Underwriters Texas State President ORIGINATION PORTFOLIO MANAGEMENT Senior Credit Officer Relationship Managers Portfolio Managers Executive Credit Officer / Chief Credit Officer Chief Operating Officer Chief Executive Officer 76

77 Energy Lending Presentation / Portfolio Management Energy Lending Portfolio Overview A summary of energy lending policy criteria and statistics are as follows: Sector Exposure: Upstream commitments increased Midstream commitments increased Other commitments remained the same at Reserve Split very low drill bit risk exposure to PUDs: Based on Commitment: % PDP; % PDNP; % PUD Based on Outstandings: % PDP; % PDNP; % PUD Balanced Reserve Mix reserve mix becoming more oily as non-pdp gas reserves reduce as they become uneconomic after risking and companies cut gas-directed capex and shift capex to oil-directed drilling: Based on Commitment: % Natural Gas; % Oil (was %/% at 3/31/14 and % /57% at 12/31/13) Based on Outstandings: % Natural Gas; % Oil (was %/% at 3/31/14 and %/54% at 12/31/13) Reserve Location offshore companies have lower utilization than onshore companies: Based on Commitment: % Onshore / % Offshore (was %/% at 3/31/14 and %/% at 12/31/13) Based on Outstandings: % Onshore / % Offshore (was %/% at 3/31/14 and %/% at 12/31/13) Loan Utilization: Outstanding as a percentage of loan commitments slightly decreased in the 2Q 14 from % at 3/31/14 to % at 6/30/14. Outstandings have been updated to include both loans and letters of credit. Advance Rates: Advance rates as a percentage of commitments slightly increased from % at 3/31/14 to % at 6/30/14 77

78 Energy Lending Presentation / Portfolio Management Oil Commodity Exposure Summary Total Reserve-Based Loan Commitments: $million Reserve-Based Loan Commitments to oil oriented companies ( 60%) $million Reserve-Based Loan Commitments to oil oriented companies ( 60%) and have ( 40%) Total Cost Reserve-Based Loan Commitments to oil oriented companies ( 60%) and have ( 40%) Total Cost and unhedged $million $million 78

79 Energy Lending Presentation / Portfolio Management Natural Gas Commodity Exposure Summary Total Reserve-Based Loan Commitments: $million Reserve-Based Loan Commitments to gas oriented companies ( 60%) $million Reserve-Based Loan Commitments to gas oriented companies ( 60%) and have ( 40%) Total Cost Reserve-Based Loan Commitments to gas oriented companies ( 60%) and have ( 40%) Total Cost and unhedged $million $million 79

80 Energy Lending Presentation / Portfolio Management Tracking Exceptions The Houston Energy Lending Group maintains and continuously updates a database that tracks exceptions to our energy lending loan policy on all upstream loans booked in the Houston Energy Lending Group. This is provided to Loan Review and Executive Management on a quarterly basis. The objective is to monitor the portfolio to identify changes in the frequency and/or severity of exceptions in order to identify portfolio migration trends and potential problem loans, as well as making appropriate risk grade rating changes. 80

81 Energy Lending Presentation / Portfolio Management Energy Lending Policy Tracking Database Example 81

82 Questions? 82

83 Energy Lending Presentation / Agenda Agenda (continued) III. Energy Lending Risks Upstream Risks Commodity Risk Bank Price Survey Operational Risk Financial Risk Midstream Risks IV. Portfolio Management V. Oil Field Service Lending 83

84 Oil Field Services Multiple drivers of risk S&P Criteria Corporates General: Key Credit Factors: Global Criteria for Rating Oilfield Services and Equipment Companies July 30,

85 Part I-Business Risk Analysis Oilfield Services Sector Categories Equipment Drillbits Drillpipes, casing, and tubing Fluids Compressors and artificial lifts Rig equipment (mud pumps, draw works, top drives, etc.) Downhole products and tools (packers, liners, hangers, etc.) Wellhead equipment (valves, trees, blowout preventers, etc.) Services Wireline services Directional drilling, rotary steerable technology, logging while drilling, and underbalanced drilling Pressure pumping; cementing and stimulation (acidizing and fracing) Plugging and abandonment services Workovers Seismic data acquisition and processing Marine support vessels and helicopter transportation Subsea equipment (manifolds, subsea trees, marine risers, remotely operated vehicles, etc.) 85

86 Part I-Business Risk Analysis Category One Key Credit Factor: Degree Of Geographic And Product-Line Diversity An oilfield services company that warrants a favorable assessment of geographic and product diversity is characterized by: Geographic diversity of operations and cash-flows, with the majority of services being of significant scale and in relatively low-risk countries/regions; and Participation in multiple product lines mitigating a firm's exposure to the risks of a single market. An oilfield services company that warrants an unfavorable assessment of geographic and product diversity is characterized by: High degree of geographical concentration and/or significant exposure to high-risk countries; and A narrow product base. 86

87 Part I-Business Risk Analysis Category One Key Credit Factor: Technological Complexity An oilfield services company that warrants a favorable assessment of technological complexity is characterized by: High-technology-content products and services, to help customers tackle more challenging projects, while affording barriers to entry and pricing power; and A good track record of developing successful new products as a result of R&D. An oilfield services company that warrants an unfavorable assessment of technological sophistication is characterized by: Commodity-type, low-value-added products and services; and Does not contribute materially to improving E&P producers' success rates and production costs. 87

88 Category One Key Credit Factor: Market Position Part I-Business Risk Analysis An oilfield services company that warrants a favorable assessment of market position is characterized by: Strong market share in its main markets, products and services; Some degree of pricing power; Strong, long-term customer relationships; Good market reputation and brand recognition; A significant amount of business conducted under contracts with favorable provisions, including protective clauses to difficult the cancel of orders, etc.; and A substantial and diversified backlog that typically adds some predictability of cash-flows. An oilfield services company that warrants an unfavorable assessment of market position is characterized by: Low market share without pricing power; Little or unfavorable operating track-record; Low-value added product offering subject to very high competition; & Lack of or poor contractual revenue base or backlog, including a lack of long-term customer relationships. 88

89 Part I-Business Risk Analysis Category Two Key Credit Factor: Government Regulation Government regulations can affect technology used or techniques employed, because of potential effects on the environment. Regulations of the same activity may differ not only between countries, but also between states or other jurisdictions in a country--currently the case with hydraulic fracking regulations in the U.S. Governments can also restrict drilling activity and lead to punitive sanctions in the wake of oil spills, affecting not just the E&P company, but services companies found to be culpable as a result of government investigations and litigation remember Macondo 89

90 Part I-Business Risk Analysis Category Three Key Credit Factor: Operating Efficiency, Strategy, And Execution An oilfield services company that warrants a favorable assessment of operating efficiency, strategy, and execution is characterized by: A long-track record in executing contracts in accordance with specifications; An experienced operating management team A consistent strategy with organizational capabilities and market conditions; The ability to track, adjust, and control execution of strategy; and Low or controlled risk of manufacturing and assembling of equipment. An oilfield services company that warrants an unfavorable assessment of operating efficiency, strategy, and execution is characterized by: A poor track record in the industry; Inexperienced operating management; and An unclear strategy, or major shifts into new, unproven products or services. 90

91 Part II- Financial Risk Analysis Category One Factor: Financial Governance/Policies And Risk Tolerance Conservative debt levels and low fixed charges strengthen a company's operating flexibility during an industry downturn. A high proportion of variable costs, very low maintenance capital requirements, operational diversification, and the ability to squeeze working capital help large service companies better withstand attenuated demand troughs. A high degree of financial strength also means a strong capital structure and good liquidity to weather adverse factors as fluctuations in market conditions, changes in the customer base, and intensified competition is some product lines. 91

92 Part II- Financial Risk Analysis Category Two Factor: Cash Flow Adequacy Working-capital swings in cyclical industries also play a key role in cash-flow generation and its volatility. This has become a particular credit concern for small companies providing low-end equipment to bigger participants. In assessing cash-flow adequacy for oilfield services companies, it is especially important to understand ongoing capital expenditure requirements. Assess oilfield services companies' planned capital expenditures, to understand what portion stems from the need to maintain assets and equipment, what portion relates to growth initiatives, and how flexible the latter is under adverse industry conditions. Growth-related capital expenditures typically includes new equipment and or technology to support new businesses or contracts. 92

93 Part II- Financial Risk Analysis Category Three Factor: Capital Structure Evaluate the standard capital structure ratios, such as total adjusted debt to capitalization, particularly for companies with intermediate or better financial risk assessments. The capital structure review encompasses the level and mix of debt employed (i.e., fixed/variable rate, maturity, currency, secured/unsecured), and the hedging analysis. This helps determine a company's financial flexibility, and how leveraged it is. Companies with aggressive or highly leveraged financial risk profiles typically have debt to EBITDA of greater than 4x. From a credit standpoint, financial risks in such cases are exacerbated if combined with high principal refinancing risk and/or currency mismatch, which we view unfavorably. Significant movements in market rates could lead to covenant breaches and potential events of default for these entities. 93

94 Part II- Financial Risk Analysis Category Four Factor: Liquidity Must consider the industry's volatility by applying tougher standards than applied with more stable sectors. Adequate liquidity (factoring in maintenance capital, fixed charges, R&D, and operating costs) in the form of cash, cash equivalents, and borrowing capacity enhances financial flexibility during cyclical troughs. Most service companies have relatively low fixed costs, but when market activity is strong, working capital needs may be high. In a downturn, the ability to liquidate working capital can materially augment financial flexibility. The more volatile subsectors or oilfield services companies, such as those with unfavorable assessment of market position, consider tougher sourcesto-uses parameters. For example, higher DSC and lower leverage covenants. 94

95 Iberiabank OFS Screening Considerations Management Assessment Experience/Track Record Sponsor/Guarantor Backing up Room Stability of Cash Flow Contract vs. Spot Mix, Concentration, Volatility Projected Debt/Cap Stay well below 50% Type of Service Production is more stable 95 Funded Debt/EBITDA Stay under 2.0x Term Debt < 1.0x Area(s) of Activity Multi basin and mixed commodity is better Collateral Average Tenor Short; stay within the cycle Return to the Bank Get paid for the risk

96 Summary 96

97 Industry expertise is a must Reserve-based lending requires industry specific knowledge coupled with independent engineering evaluations and experienced legal counsel. Many RMs have geology or petroleum engineering degrees. Oil Field Service lending looks like C&I - but also requires industry specific knowledge. 97

98 Industry expertise is a must Midstream energy loans should be limited to RMs with experience in reserve-based lending and who are familiar with the risks associated with various sectors of the midstream business (including the commodity price risk associated with the different types of midstream contracts). Downstream energy loans should be limited to RMs with ABL and/or project finance experience. An organic chemistry degree is helpful. 98

99 Building and maintaining industry expertise Attending energy services conferences such as EnerCom, Johnson Rice, etc Reading daily research reports from energy investment banking firms such as Simmons & Company International and Tudor Pickering S&P and Moody s Subscribing to the Spears report Reviewing daily commodity reports on spot/futures pricing for oil and gas. International Energy Credit Association RMA Member Forum 99

100 Final Questions? 100

101 Conclusion When you combine ignorance and leverage, you get some pretty interesting results. - Warren Buffett 101