Oil rout: worse pain lies ahead for US banks

New York

LOW oil prices are rattling global markets and destabilising economies around the world. They are also posing one of the first big tests to the US 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 US$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 US$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.

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 per cent since the start of the year, while the broader market has fallen more than 8 per cent.

Loans to oil and gas companies make up less than 2 per cent 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 per cent 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 collateralised 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 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 US$22.5 million, not the US$3.5 million to US$8.5 million that it had previously forecast. A bank official said "a single borrower reported steeper than expected production declines." Brady Gailey, an analyst at investment bank Keefe Bruyette & Woods, was blunt in his prediction: "These oil patch banks have a tough road ahead in 2016." NYT