One very important task in connection with any oil and gas loan is to determine a loan value and structure the terms in such a way that the property supporting the loan provides an adequate coverage to assure a payout for the lender. After the lender has completed the analysis or appraisal of the reserves and prepared a revised projection based on the lender's own assumptions, most banks use that revised projection as a basis for computing various coverage projection as a basis for computing various coverage ratios and tests in order to determine whether the property is adequate collateral for the loan. This property is adequate collateral for the loan. This paper shall examine on an anonymous basis a sample paper shall examine on an anonymous basis a sample of 15 oil and gas loans that have been made within the last two years in an attempt to provide insite into what the current standards are for this type of loan.

For the purposes of this analysis eight different commonly used ratios and other tests have been computed for each of these 15 sample loans and the results of these computations have been summarized on Tables I and II. All of the loans chosen for this sample have been syndicated among a banking group, and in each loan the banks have assumed the project or reserve risk. In the computation of these ratios, no attempt has been made to revise the projections that have been furnished by the borrower (in the Information Memorandum) for each of these loans except that all interest computations and present values have been determined at a rate of 14% per annum. As a result, the comparisons shown on Tables I and II may be distorted to some extent by any variation in the assumptions that have been made in the preparation of the economic projections for each of these 15 sample loans. However, later in the conclusion section of this paper there is a discussion of the sample loans in order to point out any assumptions that differ in a significant way from the normal criteria that most banks require in connection with this type of loan.

In the next section there is a definition of the way that each of these ratios has been computed.

Definition Of Each Ratio

A. TABLE I - Each ratio in Table I which is computed based on a projection of cash flow from the oil and gas property has been determined from the maximum cash flow (before interest) available for application against the loan. Therefore, if the documents provide for the dedication of a specific percentage of revenue against the loan with percentage of revenue against the loan with escalation above that percentage (under certain circumstances), then the maximum escalated percentage has been used as the cash flow to percentage has been used as the cash flow to compute the ratio. However, if the escalated percentage (for any loan) exceeds projected percentage (for any loan) exceeds projected future net revenue (before non cash charges and interest expense) and there is a question as to the ability of the owner of the property to pay operating costs out of other sources of income, then the ratio has been computed for the loan based on the assumption that only future net revenue is available for application against the loan. An example of such an exception would be a case where up to 100% of gross revenue has been dedicated, but the property in question represents all of the owner's assets. In this type of a situation, only future net revenue has been used as cash flow. If the information memorandum contains more than one projection of cash flow, then the ratio has been computed using the most conservative forecast.

The total amount of the commitment has been used as the principal amount of the loan in the computation of these ratios in all cases except if (based on the economic projection used for the computation of the ratio) the borrower would not be permitted to borrow the full amount of the commitment because of certain coverage tests which are preconditions of borrowing under the documents. In such an exception, the principal amount of the loan for the purposes of each ratio computation would be assumed to be only the maximum amount that could be borrowed under the commitment.

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