Low oil prices are rattling global markets and destabilizing economies around the world. They are also posing one of the first big tests to the U.S. banking system since the financial crisis.
Banks of all sizes are marking down the value of loans and setting aside reserves to absorb additional losses as oil producers struggle to pay their debts.
On Tuesday, Bank of America said provisions for credit losses increased $264 million in the fourth quarter, driven by the downturn in the energy sector. Citigroup, Wells Fargo and JPMorgan Chase reported last week that oil issues also weighed on fourth-quarter earnings.
While the energy downturn is cutting into profits, it is not threatening the big banks’ capital cushions — a testament, analysts say, to the rigorous regulations put in place to protect the financial system after the collapse of the mortgage market in 2008.
Still, the worst pain for the banks may lie ahead. While many banks have reduced credit lines to oil producers, some lenders are loath to cut off financing entirely for fear of forcing energy companies into bankruptcy, according to energy lawyers and consultants.
The banks — and their regulators — are also trying to determine loan values and forecast future losses amid great uncertainty about the direction of oil prices, which have dipped below $30 a barrel. Some analysts and energy executives say prices could rebound in a few months if the global oil glut eases. Others say it could take years for prices to rise again as the global economy slows and new supply comes online from countries like Iran.
“The natural bias will be to keep these things on life support for as long as you can,” said Dennis Cassidy, a co-head of the oil, gas and chemical practice at AlixPartners, a consulting firm.
“The question becomes how much of that waiting can you endure before you get to the point where you say ‘It is never going to turn around,'” he added.
There are other factors that may be putting off a reckoning for oil companies and their lenders, even as the slump in oil prices enters its second year.
When times were booming and oil was selling for more than $100 a barrel, many banks required energy companies to hedge, or protect against price drops. As a result of those deals, some companies are still receiving as much as $80 a barrel. But those hedges are supposed to expire early this year — dealing a big blow to some companies’ cash flow and their ability to make debt payments.
“A lot of these energy companies are still enjoying some handsome hedges,” said Brady Gailey, an analyst at the investment bank Keefe Bruyette & Woods, who covers regional banks in the oil-producing regions of the Southwest.
Executives at the largest banks have stressed in recent days that oil and gas exposure does not make up a big percentage of overall loans. But that confidence is also prompting questions from some analysts about whether the banks are socking away adequate reserves in light of the prolonged oil slump.
Shares of bank stocks have been hammered since the start of the year when the stock market turned volatile in the face of the collapse in oil prices and concern about China’s slowing economy. Bank of America’s shares, for example, are down more than 15 percent since the start of the year, while the broader market has fallen more than 8 percent.
Loans to oil and gas companies make up less than 2 percent of the loans at Bank of America and Wells Fargo — a far cry from the residential mortgage exposure at some large banks, which was as high as 25 percent leading up to 2008.
There is always risk, analysts say, that declining oil prices could lead to additional energy losses from trading positions or hedges that go against the banks. But it is not likely to equal the vast array of the derivatives like collateralized debt obligations and other mortgage related investments that clogged the bank’s balance sheets and nearly brought them down.
“You could easily write off every dollar in oil and energy loans and have more capital than before that last crisis,” said Mike Mayo, a banking analyst at CLSA. “Banks have enough cushion.”
For years, North America’s expanding oil production — particularly in the shale fields of North Dakota and parts of Texas — was a boon to the nation’s biggest banks. During the last five years, oil and gas companies in the United States and Canada have issued bonds and taken out loans that are together worth more than $1.3 trillion, according to data provider Dealogic.
In good times, the financing boom provided banks with billions in fees and interest incomes. The banks financed nearly every facet of the industry, from drilling operations to the service companies providing the drill bits. In the downturn, the risks are becoming clearer.
Bank of America said Tuesday that $8.3 billion of its $21 billion in energy exposure was in the “high risk” activities of exploration and production and oil field services. The bank has classified about one third of that debt as problematic.
“We feel like we have a very good handle on our energy portfolio,” the bank’s chief financial officer, Paul Donofrio, said in a conference call Tuesday morning.
Wells Fargo said most of its $17 billion in energy exposure was to noninvestment grade companies, which are at higher risk of default. Citigroup said 32 percent of its energy loans went to below investment grade borrowers.
For regional banks, where energy exposure makes up as much as 1 in 5 of the bank’s loans, the pain is more acute.
Last week, BOK Financial, which includes banks in Oklahoma and Texas, updated investors ahead of its scheduled earnings release to say that its credit loss provisions in the fourth quarter would total $22.5 million, not the $3.5 million to $8.5 million that it had previously forecast. A bank official said “a single borrower reported steeper than expected production declines.”
Gailey, the banking analyst, was blunt in his prediction: “These oil patch banks have a tough road ahead in 2016.”
