Low oil prices are great for consumers but will soon begin to cause trouble for banks that extended too much credit to the energy industry.
The big banks seem to be relatively well insulated, with Citigroup, JPMorgan Chase, Bank of America, and Wells Fargo all reassuring investors on their latest conference calls about their limited exposure to the industry.
But the same cannot be said about smaller banks based in energy-dependent states like Texas and Oklahoma. Not only will these lenders face higher loan losses in their energy portfolios, but the lower energy prices could weigh on real estate values in the states as well, thus bleeding into other areas of their operations.
What banks are likely to be hit the hardest? While this is difficult to answer with precision, as it depends on how well individual banks have managed their credit risk, data collated by Marketwatch.com at the end of last year lists the following 10 banks with the greatest exposure relative to their overall loan portfolios:
Just to be clear, some, if not many, of these banks could come through the downturn in the energy market unscathed. As BOK Financial's (NASDAQ:BOKF) chief credit officer Stacy Kymes noted on its fourth-quarter conference call, the recent drop in energy prices is far from unusual.
Oil prices dropped by 53% from peak to trough immediately after the turn of the century. And during the financial crisis of 2008-2009, they fell by 77%. By contrast, at the time of BOK Financial's call, oil prices had fallen by 55% from their peak in the middle of last year.
It's also worth noting that banks in these geographic areas have decades of experience managing the ups and downs of the energy market. In BOK Financial's case, energy lending has been a "core competency for over 100 years." To mitigate losses, it not only capped the collateral value of oil at $85 per barrel, but it also shied away from the energy services sector, which has demonstrated a tendency over the years to be much more vulnerable to the vicissitudes of the market.
Of course, all of this could change if oil prices stay depressed for a long time. "If commodity prices take a year to return to a normalized level, we will see some credit migrate to problem loans, but few if any material losses in the portfolio," said Kymes. But if the downturn lasts longer, then loan losses are likely to rise, and the spillover effect into other areas of the economy will be greater.
In sum, the issue for heavily energy-dependent banks and their investors boils down to time. That may not be reassuring, but it's nevertheless a tangible mark that investors can keep their eyes on.