[When times are good, the capital-intensive oil business is a banker’s dream. From new wells dug in North Dakota and Texas to the oil patch of Alberta, oil producers have turned to Wall Street and local banks to help them sell billions of dollars in bonds, raise equity and arrange lines of credit.]
By Michael Corkery and Peter Eavis
Tumbling oil prices are dimming one of the few big bright spots
that banks have enjoyed since the financial crisis.
Banks have been lending hand over fist to companies in the
nation’s energy industry, underwriting bonds, advising on mergers, even
financing the building of homes for oil workers. All of this has provided a
boon to banks that have been struggling to find more companies and consumers
wanting to borrow.
Yet with the price of crude oil falling below levels sufficient
for some energy companies to service their huge debts, strains are being felt
and defaults are likely. While it may take some time for the crunch in the oil
industry to translate into losses, one thing already seems clear: The energy
banking boom is over.
“At the least, you are talking about a slowdown in loan growth
for the banks in the energy-producing states,” said Charles Peabody, a banking
specialist at Portales Partners. “That, we feel pretty strongly about.”
Mr. Peabody covered Texas banks in the 1980s, when a slump in
the energy business helped cause large losses at the lenders, and banks to
collapse or be rescued. He says he expects the current problems for energy
companies to lead to losses, too.
“We do believe that you will start to see some defaults,” he
said.
This week, as many of the largest banks report their earnings
for the final three months of 2014, investors will press the banks for answers
on how a sudden slump in the once-roaring oil and gas industry may hurt their
bottom lines.
The expected slowdown comes as banks, both big and small, have
finally dug out from the wreckage of the financial crisis and have been looking
for new ways to bolster their revenues.
When times are good, the capital-intensive oil business is a
banker’s dream. From new wells dug in North Dakota and Texas to the oil patch
of Alberta, oil producers have turned to Wall Street and local banks to help
them sell billions of dollars in bonds, raise equity and arrange lines of
credit.
“It’s been a hot industry, probably a little too hot,” said Dick
Evans, chief executive of Cullen/Frost Bankers of Texas, which has a relatively
sizable energy practice. “But it is not time to panic. We have been in the game
a long time. I am comfortable with what we have been doing.”
There is a flip side to lower oil prices that helps the banks,
or at least those with large consumer businesses. The less cash consumers have
to spend filling up their gas tanks or heating their homes, the more emboldened
they may feel to sign up for a credit card or take out a mortgage.
“As consumers have more money in their pocket, surely that helps Wells Fargo,” the chief executive of that
bank, John G. Stumpf, said at a financial services conference last month. “I
would say net-net this is a good thing for the country.”
Still, if oil prices remain near $50 a barrel for long,
economists and industry analysts expect a sharp deceleration in production this
year, idling energy bankers and cutting into their lucrative fees.
Two of the banks that may be the hardest hit by lower investment-banking fees are among the biggest. Wells Fargo derived about 15 percent of its investment banking fee revenue last year from the oil and gas industry, while at Citigroup, the business accounted for roughly 12 percent, according to the data provider Dealogic.
At some of the larger banks in Canada, a slowdown in fees could
be even more pronounced. At Scotiabank, about 35 percent of its investment
banking revenue came from oil and gas companies last year.
And Wall Street firms that financed energy deals may now have
trouble offloading some of the debt, as they had originally planned.
Morgan
Stanley, for instance, led a group of banks that made $850 million
of loans to Vine Oil and Gas, an affiliate of Blackstone, a private
equity firm. Morgan
Stanley is still trying to sell the debt, according to a person briefed on the
transaction. Similarly,Goldman
Sachs and UBS led a $220 million loan last year to
the private equity firm Apollo Global Management to buy Express Energy
Services. Not all the debt has been sold to other investors, according to
people briefed on the transaction.
A precipitous drop in oil prices can quickly turn loans that
once seemed safe and conservatively underwritten into risky assets.
The collateral underpinning many energy loans, for example, is
oil that was valued at $80 a barrel at the time the loans were made. As oil has
dropped well below that price in recent months, the value of the banks’ collateral
has sunk.
Many oil companies have bought hedges on oil prices, which are
providing lenders with additional cushion. But when those hedges expire, and if
oil prices remain low, the banks may need to reserve money against the loans.
“At $50 a barrel, things can get a bit testy,” said Christopher
Mutascio, a banking analyst with Keefe, Bruyette & Woods.
Some of the greater risks may be the loans the banks have
extended to the many kinds of services companies that work in and around the
oil industry. Some of these services companies, lured by the boom, may have
short track records, analysts say.
Low oil prices can have ripple effects that many banks may not
anticipate, particularly in states such as North Dakota and Oklahoma where
energy is a large driver of the economy.
When oil prices crashed in the 1980s, many Texas banks failed
not because of loans to oil producers, but because of loans to local real
estate developers who had been caught in the energy bust.
Just over 20 percent of the loans at MidSouth
Bank, based in Lafayette, La., are to oil and gas companies, a high
proportion relative to its peers. But Rusty Cloutier, MidSouth’s chief
executive, said the bank had focused its lending on services companies with
seasoned management that were most likely prepared for a dip in activity.
“Our companies understand that they ride the crest, the up and
the down,” Mr. Cloutier said. “We are not panicking.”
Mr. Stumpf of Wells Fargo also expressed confidence in his
bank’s ability to weather a downturn. Energy loans make up about 2 percent of
the bank’s loans.
“Some marginal producers will get challenged in this, but this
is not something new to them,” he said last month. “Cycles like this happen, so
industry will be able to work through this.”
Investors in the junk bond market — of which energy companies
account for an estimated 18 percent, according to JPMorgan Chase— are not so optimistic.
Junk bonds issued by energy companies are signaling a jarring
jump in the number of defaults in the coming months. Martin S. Fridson, chief
investment officer at Lehmann Livian Fridson Advisors, said the yields on
energy junk bonds appeared to be predicting that 6 percent of the bonds would
default this year, and even more in 2016.
“As far as the high-yield market is concerned, the energy sector
is in a recession,” Mr. Fridson said.
