NEW YORK (Reuters) - U.S. banks are setting aside more money to cover bad loans to energy companies after oil prices plunged over the last year, raising the possibility that deteriorating loans could start to weigh on their earnings, some analysts said.
Loan credit quality for U.S. banks has been improving since the financial crisis. In the first quarter, 2.49 percent of loans on banks’ books were delinquent, the lowest level since the fourth quarter of 2007, according to the Federal Reserve, which hasn’t released second quarter data. The rate peaked at 7.4 percent in the first quarter of 2010.
Weakness among energy company loans could be a sign that overall credit quality among U.S. banks has little room to improve, analysts said. Executives from both JPMorgan Chase & Co. and Wells Fargo & Co. told investors last week, when posting earnings, that they were increasingly concerned about loans to oil and gas companies.
Texas bank Comerica Inc on Friday set aside about three times as much money to cover bad loans as analysts had expected, sending the regional bank‘s shares lower by more than 6 percent after the bank reported earnings Friday. Setting aside more money, known as “provisioning,” hurts earnings.
“The banks really have very low credit costs and those can go higher,” said Fred Cannon, who heads research at Keefe Bruyette & Woods. While “energy overall is not a life threatening issue for the banks, it is earnings threatening,” he said.
JPMorgan said on Tuesday it provisioned another $252 million to cover potentially bad wholesale business loans in the quarter, with $140 million of that related to oil and gas lending.
Oil prices rallied in March and April, but in recent weeks have fallen again on expectations that loosened sanctions against Iran create the potential for greater supplies. U.S. crude oil prices fell below $50 a barrel on Monday for the first time since April.
U.S. accounting rules require that banks set aside money to cover losses on loans only after the loan has shown visible signs of deteriorating, such as a borrower having missed an interest payment. The rules are subject to wide interpretation, however, so that such things as weaker oil and gas prices could potentially prompt some borrowers to increase their provisions.
The hit to earnings from banks’ higher provisioning could pour cold water on shares of a sector that has been on fire recently. Since the end of January, U.S. bank stocks have risen 18.7 percent, compared with a 6.6 percent gain for the broader Standard & Poor’s 500 index. Much of that optimism has come from investors preparing for the Federal Reserve to raise interest rates, boosting the rates at which banks can lend and therefore their profits.
Bank profits have been essentially stagnant in recent years, thanks to low rates and tepid economic growth.
JPMorgan CFO Marianne Lake said the bank “might expect” to add more reserves before this year is out. “It is possible we will be selectively downgrading some clients,” she said. She described the increases in reserves as “completely normal” in the business cycle. “We are still very happy,” Lake said.
CEO Jamie Dimon, interjecting as Lake spoke, said, “Those reserves do not mean we’re going to have losses.”
To be sure, credit quality is still good. Wells Fargo said that for its overall loan book, the balance of loans on which borrowers had stopped making interest payments declined $67 million in the second quarter, even though delinquencies rose among energy sector companies. Residential mortgage loans are performing better.
CFO John Shrewsberry predicted energy-related credit performance will remain weak.
“We’re still resolving these issues,” he said on a conference call with investors on Tuesday. “Some of them are just coming to light for certain borrowers, but it’s a very contained portion of our loan portfolio and the aggregate impact should not be material to Wells Fargo.”
Energy exposure accounts for just 2 percent of Wells Fargo’s loan portfolio. However, as KBW’s Cannon said, the total money the bank has provisioned for bad loans over time is even smaller— just about 1.2 percent. A Wells Fargo spokesman declined to comment.
Following an annual exam of loan credit quality, regulators are pressing banks to set aside more money to cover their energy loans, according to a report earlier this month from the Wall Street Journal.
Comerica CFO Karen Parkhill said in an interview that provisions could increase further if oil prices remain low, though this could be offset somewhat if borrowers begin paying down debt, as has occurred in past periods of weak oil prices.
As for why provisioning was so much larger than expected, Parkhill said, “we did always say that we would expect continued negative credit migration if oil prices remained low and that’s what has happened.”
Moody’s Investors Service flagged the issue in a report published Monday. Banks it singled out as having particularly high exposure to the energy sector by at least one measure were led by BOK Financial Corp., Hancock Holding Co, Texas Capital Bancshares Inc. and Cullen/Frost Bankers Inc. While noting “asset quality deterioration” in the energy loan portfolios of Wells Fargo and JPMorgan, Moody’s analyst Joseph Pucella wrote that the exposure of those banks is “comparatively small.”
BOK Financial investor relations director Joseph Crivelli responded to questions with a statement noting the bank forecasted loan loss provisions of $15 million to $20 million for 2015.
“We continue to believe that our energy portfolio is sound from a credit standpoint,” the statement read in part. “Stress tests on the portfolio conducted earlier this year reveal only a handful of customers who would demonstrate weakness in a highly stressed environment.”
Spokespeople for Hancock, Texas Capital Bancshares and Cullen/Frost declined to comment.
Reporting by Dan Freed, editing by Dan Wilchins and John Pickering