Last year, after a long run of robust energy prices and plentiful investment, it became increasingly clear that the financial industry was ailing. By September, the credit-crash virus that had begun in the mortgage sector had spread throughout the entire banking industry, leaving anxiety and uncertainty in its wake.

Enter Dr. Obama, who injected the financial sector with a bailout package (the $700-billion Troubled Asset Relief Program) and a stimulus plan. Although not a perfect cure, the emergency care slowed panic fever and gave banks a fighting chance. Other countries’ governments quickly followed suit.

But not all endorsed the plan. Said one banking executive, “If the host governments had not bailed out the remaining over-levered institutions, there would have been more transactions.” Translation: Big banks wanted a clear shot at snapping up little banks.

Yet in May, when 19 of the largest banks underwent an FDIC-mandated stress test, most of them were given a clean bill of health.

In fact, JP Morgan Chase & Co. repaid US$25 billion of preferred-stock investment it had accepted through TARP and paid the U.S. Treasury $795 million in dividends on the preferred, including dividends that had accrued through the redemption date. In July, the bank reported a 36% jump in second quarter profits.

Defending the government’s decision to inject cash into struggling financial institutions rather than purchase toxic assets, former Treasury Secretary Henry Paulson said his actions, “were not perfect,” but “saved this nation from great peril.”

This month, on the one-year anniversary of the crisis that crippled such giants as Bear Stearns, Lehman Brothers, Merrill Lynch and AIG, there are signs that the worst is over. Demand for the Federal Reserve’s emergency short-term lending program (kicked off in March 2008) has slacked off.

Christopher Shebby, managing director and co-head of energy and natural resources for Stifel Nicolaus & Co. said, “The energy investment-banking sector is increasingly showing signs of life. After being absolutely flat on its back in the fourth quarter of 2008, and for most of the first quarter of 2009, the second quarter saw encouraging levels of activity.”

He notes that the factors driving recent activity in the energy sector are very different from those in 2008. Recent follow-on equity offerings have been defensive, largely meant to reduce debt and improve liquidity as opposed to funding acquisitions or growth.

“The primary aim of recent transactions has been to position the balance sheet to withstand a protracted downcycle and future commodity price weakness in an environment where less credit is expected to be available, particularly after borrowing base redeterminations are completed this fall,” Shebby said.

As a group, investment bankers said they are closing both equity and debt deals that, for the most part, have been well received by the market. The oftentimes ludicrously high interest rates have come down. Oil and gas asset valuations can once again be quantified with some sense of certitude.

Greg Pipkin, managing director, Barclays Capital in Houston, has worked in energy finance for 25 years. “The investment banking world went through an epic change the week of September 15, 2008,” he said. “We had 10 years’ worth of consolidation that week.”

A bought deal cure

Meanwhile, M&A advisory fees are “way down,” said Pipkin, but Barclays has not been sitting on its laurels. So far this year the investment bank has acted as book-runner on several major upstream equity deals, including those by Anadarko Petroleum Corp., Plains Exploration & Production Co., Petrohawk Energy Corp. and Stone Energy Corp.

Shebby echoes the slowdown lament. “M&A activity remains very weak and IPO activity is nonexistent. Capital raising assignments remain heavily focused on delevering and improving liquidity.”

To overcome shaky faith in the equity market, investment banks have developed a cure: the bought deal. Jason T. Meek, managing director for RBC Capital Markets in Houston, explained that true bought deals, where the underwriter takes title to the stock prior to announcement, are “an excellent way for companies to avoid market risk when seeking equity capital.”

This year, RBC acted as joint book-running manager for a $66.5 million bought deal for Penn Virginia Corp. It purchased shares at an 8% discount to the last trade and had them placed with investors prior to the market’s opening the next day.

Jim Warren, managing director of energy investment banking for SunTrust Robinson Humphrey, said, “We’ve seen 20 follow-on equity raises this year, with about five or six bought-deal transactions used to avoid market volatility and the erosion that can occur. As a rule, most of these raises were defensive in nature, meant to replenish balance sheet liquidity and enhance borrowing base availability, as opposed to supporting acquisitions.”

But not every overnight deal is a bought deal, Meek said. In fact, not all companies are eligible for a bought deal. General criteria for determining whether a bought deal is suitable include the company’s overall historical performance, its size, the size of issue as compared to float, the quality of institutional holders, trading liquidity and use of proceeds.

“While elimination of market risk is clearly the greatest benefit, the largest drawback is the inability to tell the story of the company. Some companies will benefit greatly by taking their pitch directly to the institutions,” said Meek.

Shebby agreed, but said, “If there’s no significant strategic story to tell in support of a capital raise, there’s really no reason to use a full marketing effort that includes a road show. Recent data has shown that fully marketed deals have priced at much deeper discounts that those deals that employ some form of an accelerated marketing approach.”

The largest oil and gas bought deal to date occurred in May, when Anadarko sold some 30 million shares of common stock at $45.50 each, for a gain of $1.37 billion. Barclays and Swiss bank UBS AG were joint book-runners on the overnight transaction.

Stephen M. Trauber, Houston-based global head of the energy investment-banking group, vice chairman of the investment-banking department and managing director for UBS, called the transaction a two-handed deal.

“UBS and Barclays bought the equity,” he says. “We took the risk that we would be able to resell it to the market. That was a successful transaction that illustrated the ability for quality E&P companies to access the equity market in a big way.”

Bought deals are just one example of accelerated marketing efforts undertaken in support of equity offerings. Others include overnights, one-day marketed transactions and wall-crossing deals.

Although investment banking has recovered substantially from last September, it is clearly not at the level of 16 months ago, and it favors debt over equity. In fact, for some E&Ps, going to the equity market is “a sign of weakness,” said Trauber.

“Any companies that are tapping into the equity markets now are paying for it in discounts, which can happen at any time from announcement to pricing. Discounts can be as high as 15% to 30%, depending on the nature of the company and how desperate they are for the capital,” he said.

Meanwhile, pipeline master limited partnerships (MLPs) are top dogs in the current market as the U.S. continues to build out infrastructure.

“We’ve led the market this year, having completed about 18 equity offerings in the midstream sector,” Trauber said. “To fund their organic growth, as well as their acquisitions, midstream companies need to tap into the equity market frequently. Retail investors, who tend to be more defensive in this market, like these securities because they pay.”

SunTrust’s Warren says although the overall market has been markedly off this year, due to lower asset and equity valuations, “We’ve seen the investment grade MLP universe actively access the bond market, which is very open to them.”

This year, SunTrust has been joint book-runner on several midstream debt issuances, including those for Magellan Midstream Partners ($300 million), Atmos Energy Corp. ($450 million), Oneok Partners LP ($500 million) and Enterprise Products Partners LP ($500 million).

But not all deals have been defensive. Warren noted there are acquisition opportunities for E&Ps having the wherewithal to buy assets from other independents, which are becoming more willing to divest, even if their noncore assets are worth less than in 2008.

Encore Energy Partners LP’s follow-on offering of 9,430,000 common units on June 29 provides an example. It priced the units at $14.30 each, raising $129.1 million to fund its acquisition of Rockies and Permian Basin properties from Encore Acquisition Co., and its acquisition of properties in the Midcontinent and East Texas from Exco Resources Inc. for $375 million in cash.

M&A malady

Despite the return of debt and equity deals, the M&A market remains somewhat stagnant, investment bankers said. The availability of capital is still low and it costs more than in previous years. More importantly, many E&Ps are trading at substantial discounts from 18 months ago, making it difficult for decision-makers to consider a sale.

Said RBC’s Meek, “For the first six months of 2009, E&P companies raised approximately $35 billion in debt and equity. During this same time period, the industry has traded only about $3 billion of assets. M&A and A&D were clearly not the drivers for the recent capital market activity.” Meek expects busy fall and winter seasons for both M&A and A&D.

For such deals, stock-trade transactions are favored when both sides of the deal are valued in depressed shares. Conversely, a cash sale is less favorable due to its absolute-value nature. Also, there is not a lot of conviction that the market will steadily improve.

“Both buyers and sellers don’t want to look foolish by undertaking a transaction now when the market might get stronger, which is beneficial for the seller, or weaker, which is beneficial for the buyer. I am seeing a period of relative stagnation in the market,” said Trauber.

Not surprisingly, when capital and commodity markets stabilize, shale plays are expected to draw the lion’s share of new investment.

“Shale plays are a growth story, and they require a lot of capital. Investors are drawn to them. But there is still opportunity in the conventional oil and gas plays,” said Trauber.

The same is not true for service companies, he said. “There will be a bifurcation between companies driven by international opportunities and those focused on the domestic market.” Large cap service companies with oil dominant customers outside the U.S. will draw more capital than domestic gas-concentrated firms, until prices pick up.

Meanwhile, some E&Ps have deliberately positioned themselves to weather the crisis, said Meek. The vast majority of capital market activity for the first half of 2009 involved seasoned issuers who wisely bolstered their balance sheets and delevered by terming out debt or raising equity in preparation for what could prove to be a challenging natural gas environment for the rest of 2009.

For those that undertook such strategies, it was “a no-lose situation,” he said. “If natural gas remains weak, they will be able to weather the storm. If natural gas improves, they will be well capitalized to take quick advantage of low service costs by accelerating their drilling activity or by acquiring assets when their lesser-capitalized competitors are out of the market.” – Jeannie Stell, from Hart’s Oil and Gas Investor