American Oil and Gas Reporter - July 2020 - 38

Q:

What crucial factors are banks looking at when it comes
to deciding whether and how to restructure an operating
company's reserves-based debt? What can oil and gas companies
do to enhance their creditworthiness and strengthen their standing
with their existing banks?
MORRIS: Banks consider many factors when evaluating
options for a distressed borrower, including:
· Is there other debt (second lien, senior unsecured, etc.) in
the capital structure?
· Are there any midstream contracts that need to be restructured?
· Does the selling, general and administrative expense
burden need to be restructured?
· What is the fulcrum (natural equity owner based on value)
in the capital structure?
· Are there existing commodity hedges that should be terminated or restructured? Perhaps the banks will want to maintain
some or all of the hedges to underpin the cash flows after the
debt is restructured.
· How is the asset quality (location, reserves quality, drilling
economics relative to other areas, etc.)? Does the asset base have
good drilling economics with modest commodity price recovery,
or is it a candidate for a PDP blowdown? How marketable are the
assets now and in the future if commodity prices rebound?
· What is its assessment of the management team and the
general and administrative resources needed to operate the asset
base?
· What are the expected recoveries from restructuring the
debt (partial equitization, term-out of some RBL debt, etc.)
versus selling the assets versus blowing down the PDP reserves
and sweeping the cash flow to repay secured creditors? What
are the time frames for each option?
· Are the banks willing to own the assets?

I think the oil and gas companies that are weathering this oil
price volatility relatively well provide good examples of what
operators can do to bolster their creditworthiness and reassure
their banks. In short, those companies maintain strong liquidity,
operate with relatively low financial leverage, consistently hedge
a meaningful portion of anticipated production, and do not rely
on borrowing base availability to fund deficit spending plans.

Q:

For those companies with favorable balance sheets, what
do you expect in terms of how banks evaluate the creditworthiness and borrowing capacities of operators seeking to obtain
reserves-based financing? How might that impact the strategies of
companies looking to buy distressed assets in the coming months?
MORRIS: I don't expect dramatic changes to banks' underwriting methodologies for oil and gas RBLs. Instead, I think
banks will expect and negotiate for better collateral coverage
that is primarily reliant on PDP reserves (more mortgage
coverage), low debt leverage, prudent liquidity, a minimum
equity contribution in the case of acquisitions and some minimum
level of commodity hedge protection.
How low leverage needs to be and what constitutes prudent
liquidity will be based on the specific oil and gas properties
supporting the financing (conventional, unconventional, offshore,
etc.) and the borrower's development plan, among other things.
Aspiring buyers of distressed assets may be surprised by
banks' requirements for higher equity contributions to partially
fund acquisitions regardless of the value attributed to the target
properties by the banks, as well as minimum hedge protection
conditions that may be necessary to support borrowing bases
but limit equity investors' ability to capitalize on near-term
upside in commodity prices.

Private Equity Placements

Q:

In late March, as COVID-19 roiled global financial markets
and ground business activity to a standstill, Tailwater
Capital closed $1.1 billion in institutional capital commitments
to Tailwater Energy Fund IV and co-investments. Amid so much
uncertainty, and bucking a trend of declining private equity
placements in oil and gas, what was the secret to securing such
substantial investor support? Were the commitments primarily
from new or existing investors?
DOWNIE: It really comes down to the fact we have consistently
done what we said we were going to do and have been very disciplined in doing it, and therefore, were rewarded by our
investor base. We have been fortunate to have limited partners
that have serially reinvested with us over the years, and that
includes Energy Fund IV.
One of our commitments to investors is to continue to
execute a strategy focused on the midstream sector, where we
have expertise and a track record of success. Our goal is to pru38 THE AMERICAN OIL & GAS REPORTER

dently manage balance sheets and rates of return on a riskadjusted basis. We believe that prudent approach is important to
limited partners, because as we are seeing right now, having a
levered capital structure can be devastating in a down cycle.
A fundamental part of our business is that we do not
underwrite a midstream opportunity unless we have a solid perspective on the underlying rock. Everything we do starts with
the rock. Our technical team and dataset keep us dialed in with
respect to understanding the geology.
We also have deliberately kept fund sizes consistent. Our
portfolio goes beyond the traditional midstream, but the focus
is on primarily middle and lower-middle market fixed infrastructure
assets with contracted revenue streams. By staying in our niche
and sticking to our knitting, every fund we have raised to date
has had two or three opportunities already defined at first close.
That provides visibility into the portfolio early in the capital
raise, unlike with most private equity funds, in which limited
partners invest in a "blind pool."
American Oil and Gas Reporter - July 2020

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