How Does the Low Price of Oil Affect Banks?

Banks with high exposure to the energy sector are in the cross hairs of investors right now, and for good reason. Lower energy prices are putting pressure on their loan portfolios, which could result in heavy losses at banks that aren't adequately prepared for a sustained period of low oil prices. How can investors identify the banks that are most at risk for this? Motley Fool analysts Gaby Lapera and John Maxfield dig into the subject in the video below.

A transcript follows the video.

This podcast was recorded on Feb. 2, 2016. 

Gaby Lapera: Basically a combination of two questions, which essentially is asking, what's going to happen to banks with a lot of oil exposure? So, the basic thing to understand here is, certain things are exposed a lot more to oil than others. And the type of bank and the size of that bank is going to matter a lot. For example, JPMorgan, yes -- it has energy exposure, but it's huge, and it has a hugely diversified portfolio. It's going to hurt, but it's not going to take the bank out of business.

Now, let's go to Texas to a small community bank that has energy exposure both in its portfolio and also to the people that it's lending to. For example, say you have a guy who works out on an oil field and he has a mortgage with that bank, and he gets laid off because they're not making enough money, and suddenly he can't pay his mortgage anymore -- it's going to hurt a bank like that a lot more than it's going to hurt one of your big banks of the world.

John Maxfield: Yeah. If you listen to the conference calls of these big banks, you're talking about 1% of their loan portfolios are energy-related. And in those portfolios, a lot of these banks are marking this down, they're taking reserves on those, assuming that oil stays at $30 a barrel. So, they're being pretty aggressive about it. But the big point -- and this is exactly what Gaby is saying -- it's the banks that have a large amount of exposure relative to their overall loan portfolio to either the energy market or other markets that would be affected -- like real estate markets in Texas, things like that.

And let me just give you a quick example of how bad it can get: in the 1970s, we had a couple of oil crises, and that caused oil prices to shoot. And in the 1980s, oil prices fell just as fast. When they fell that fast, basically every single major bank in Texas failed because they were overexposed to energy. Now, I don't think we're going to see that this time. We may, I doubt it, but we may. But the point being, those banks that are in the oil patch, highly exposed to it, are going to, most likely, take larger losses than your big, well-diversified banks.

Lapera: Yeah. Something that I've actually been seeing in a lot of 10Qs this quarter is, banks, where they normally wouldn't have said anything at all, devote at least two or three sentences explaining what their exposure to the energy industry is, and what they've done in terms of reserves for that. Obviously, like I said, some are super-duper exposed. I think the banks that I've seen the most ... I can't remember which one it was, but--

Maxfield: I think it was Cullen/Frost, maybe.

Lapera: Was it around ... I can't remember, something like 80% of its portfolio was energy-related in some way, shape, or form?

Maxfield: Oh, I don't know who that is.

Lapera: I can't remember who it was. I read a lot of articles every day, since I'm also an editor. So, it's lost somewhere in the haze of editing. But, that's a massive exposure. And it was a fairly small bank, as I recall. So, they're probably in a lot of trouble. And as I recall, they raised their reserves quite a bit. But, eh, I don't know.

Maxfield: And here's the thing, Gaby -- let's say you look at that bank, and you look back 30 or 40 years, and they've made it through all those other cycles, there's a very good possibility that they know exactly what they're doing going into this thing, and they know exactly what they're doing to get out of it.

Lapera: That's true.

Maxfield: It's a very, very, very fact-specific situation.

Lapera: That's definitely true.

Maxfield: But there are instances ... Cullen/Frost has been around, I can't remember, like 100 years. They're an oil-patch bank, and they've made it through a whole bunch of different crises. So, it seems to me that they know how to get through these things, whereas maybe, a bank that's newer, that hasn't been through all this stuff that's facing the oil patch now, your confidence in them should probably not be very high.

Lapera: Right. So, I think, ultimately, what we're saying to our two listeners who both asked about this is, one, it depends on the bank. It depends on the size, it depends where it is, it depends on what its portfolio looks like. Two, it depends on what the bank is doing. And three, it depends on the bank's history. So, it's just the same as any other company that we look at The Motley Fool. We're looking at its fundamentals and its history. And although that's never a guarantee that a company is going to pull through and succeed, it's certainly a good indicator of whether or not it's going to be OK.