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Banks' energy reserve-building could extend well beyond Q1

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Banks' energy reserve-building could extend well beyond Q1

Any opinions expressed in thispiece are those of the authors and do not necessarily represent the views of S&PGlobal Market Intelligence. Follow on Twitter @NWStovall.

Bankslikely will build their energy-related allowance for loan losses considerably inthe first quarter, but more reserve-building could come later in 2016 and 2017,as the impact of job cuts at oil and gas companies begins to wear on certain markets.

Bankshave steadily built theirenergy-related provisions in recent quarters as oil prices have remained depressed.Several banks have preannouncedfirst-quarter results and indicated that further building of energy-related reserveswill occur, but investors are waiting to see if contagion could spread to otherlending segments in oil-rich areas.

At leastone regional bank, Hancock HoldingCo., has indicated that some of the recent reserve-building has comeat the behest of regulators following the annual shared national credit review.Analysts expect banksthat have not yet preannounced results will follow the moves of their peers whenreporting first-quarterresults over the next few weeks.

Hancock'sdisclosure marked its second quarterin a row where the company preannounced earnings. The Gulfport, Miss.-basedcompany had boosted itsallowance for energy loan losses in the 2015 fourth quarter, and analysts hopedHancock was taking the opportunityto "kitchen sink" its energy exposure by building reserves to protectagainst anticipated losses for the entire cycle. But, just a few months later, Hancockincreased its expected provision for credit losses in the first quarter by $45 million,attributing the increase to risk-rating downgrades on energy credits and the resultsof the shared national credit review.

The Hancockreserve build prompted a number of analysts to view many banks in oil-rich areaswith greater caution. Hovde analyst Kevin Fitzsimmons said in a late March reportreviewing the Hancock disclosure that he was not surprised by the pace of negativerisk-rating migration following regulators' shared national credit review and thespring redetermination process. The latter is a regular process where lenders updatethe price decks used in their underwriting assumptions. However, Fitzsimmons believedthat Hancock management would have anticipated some of the migration when preannouncing2015 fourth-quarter results.

"Thisseems to suggest that either the credit conditions of the borrowers in question(or the related collateral values) deteriorated very quickly, regulators increasedtheir level of scrutiny in the SNC review process, and/or HBHC simply misjudgedhow regulators would approach energy credits in the SNC review (or perhaps somecombination of all three of these)," Fitzsimmons wrote in the report.

Followingthe Hancock announcement, Fitzsimmons lowered earnings estimates on other bankslike Texas Capital Bancshares Inc.and Independent Bank Group Inc.due to the higher assumed energy provisioning. Other analysts followed suit, expectingthat provisioning would be higher in the first quarter for banks with energy exposures.

Somemembers of the investment community we have spoken with have expressed concern thatpain in the energy sector could lead to pain in other segments such as commercialreal estate and consumer lending. Energy companies have already made significantheadcount reductions,particularly in the area of the drilling oil and gas wells subsector, which reporteda 38.4% year-over-year decline in jobs through September 2015, according to theBureau of Labor Statistics. In support activities for oil and gas, jobs were 22.3%lower year over year in September 2015, and the oil and gas extraction categorysaw a 4.6% decline.

Thosejob reductions came during a 12-month period when oil prices fell close to 50%.Prices fell even lower in the months that followed and remain near the $40 level.The weakness in oil prices is expected to present challenges for a number of energycompanies, and at the very least, cause lenders to reduce borrowing bases for explorationand production companies during the ongoing spring redetermination period.

RaymondJames analyst Kevin Smith estimated in a March 21 report that the majority of E&Pcompanies will see their borrowing bases reduced by 20% to 30% in the latest redeterminationperiod. The analyst said this redetermination period would mark the third consecutivereduction in credit facilities for the broader E&P group. Smith said a significantnumber of E&P companies are still largely cut off from the equity and high-yielddebt markets, and argued that the spring redetermination period could "pushsome companies over the financial cliff and into bankruptcy or some form of corporaterestructuring."

If thoseevents occurred, they would almost certainly not only result in some pain for directenergy lenders, but likely would also spur further job cuts in the energy sector.

Someenergy companies are already forecasting headcount declines in 2016. The FederalReserve Bank of Kansas City recently said oil-and-gas firms in its district — whichcovers Kansas, Colorado, Nebraska, Oklahoma and Wyoming; the western third of Missouri;and the northern half of New Mexico — expectto reduce headcount by 22% on average in 2016.

Giventhe prospect of further job cuts, there is a growing fear that stress in the energysector could spill over to other lending segments if laid-off workers struggle togain new employment. That seems like a reasonable possibility in certain energy-centricareas, and could eventually cause consumer and commercial real estate delinquenciesto rise. If contagion spreads, borrowers likely would burn through what savingsthey have before defaulting. But it would mean banks will once again deal with energy-relatedheadwinds through 2016, or even in 2017.