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John Reed's LDC and Hancock's energy reserve build

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John Reed's LDC and Hancock's energy reserve build

Jeff Davis, CFA, is a veteranbank analyst and S&P Global Market Intelligence contributor. The views andopinions expressed in this piece are those of the author and do not necessarilyrepresent the views of S&P Global Market Intelligence or Mercer Capital,where he is the managing director of the financial institutions group.

haspreannounced two quarters back-to-back for about $87 million of reserve-building for its$1.6 billion energy-related loanportfolio. As of April 8, its shares had fallen 26% over the pastyear. Hancock has plenty of company among banks in what used to be called theoil-patch (Louisiana, Oklahoma and Texas). BOK Financial Corp., Cullen/Frost Bankers Inc., and havefallen 15% to 28%. Houston-based Green Bancorp Inc. closed at $7.03 on April 8, down 38%over the past year and more than 50% from its well-timed price of $15.00 pershare.

Absenta cataclysmic event Hancock's oil & gas saga is not going to merit anasterisk in banking history even if the 2016 first-quarter $45 million reservebuild proves to be the second in a series of installments. Hancock and its2011 survived the1980s downturn and went on to prosper in the 1990s. More notable is the broadernarrative of the disappointing performance of Hancock since it merged withWhitney, but I digress.

Theenergy story among lenders, so far, is a slow-moving story that appears to be a long way from acathartic cleansing. Thus far, it has been about incremental reserve building.Moody's did not make a case for a wash-out in a report it released . Moody's estimated that in aworst-case scenario the combined losses of JPMorgan Chase & Co., , , and would require anadditional $9 billion of provisioning. The combined pretax, preprovision netrevenues of the three universal banks were $91 billion in 2015. Goldman's andMorgan Stanley's combined 2015 pretax income was $17 billion. Moody's mathseems manageable for the five, although the absence of lush underwriting feesfor leverage loans, high-yield bonds and equities for many energy clients are asecondary casualty.

Themath could be more problematic for the regional banks based in Louisiana, Texasand Oklahoma. Further the tertiary impact the longer the downturn lingers willincrease as CRE and other areas of the portfolio are impacted. I have no ideahow bad the downturn will be. If oil pricesare poised to move back to $50 per barrel and $2.50 per BTU for natural gas,maybe the cycle peak in provisioning is at hand, though I doubt it. Citigroup'sand other money center banks' experience in the lesser developed country (LDC)crisis of the 1980s may be instructive in terms of benchmarking expectations.

Citibankand other banks (some of which are legacy institutions that form JPMorgantoday) were conduits for petrodollars that were deposited by OPEC and otheroil-producing nations that reaped a windfall from the sharp move higher in oilprices during the 1970s. The banks lent the funds to Latin America and otherdeveloping economies that required capital and had limited access to capitalmarkets.

Iassume the profits were great, as was the case with the lending boom to theenergy sector the past decade. Rapid loan growth and few loan losses can beintoxicating for bankers and investors, at least initially. Credit bubbleseventually pop. The tipping point was Paul Volcker and a mandate to bringinflation down. Short-term rates were pushed to unimaginable levels, the dollarrose, oil prices tanked, and the LDCs were broke. Actually, they probably werebroke well before Mexico raised its hand in August 1982, and said no more debtservice.

TheFederal Reserve's history of the era notes that regulators provided forbearanceto avoid full provisioning and loss recognition (and implicitly build capital)while negotiations occurred. Citibank CEO John Reed proved to be the nexttipping point and perhaps signaled the beginning of the end to the crisis whenhe surprised the market by making a $3.3 billion provision in 1987.Others followed. A couple of years later, then-Treasury Secretary NicholasBrady developed a novel approach to bring closure to the crisis in which LDCborrowers swapped commercial bank loans for "Brady Bonds." Theborrowers obtained a haircut on what was owed, the banks got a tradable bondthat was usually backed by a U.S. Treasury.

Whatmight be a comparable event — on a small scale — to Reed's dramaticannouncement? A move by one of the banks to sell unsalvageable positions thatis then followed by others. Apparently after Reed recognized the obvious, LDCdebt prices fell as more supply hit the market. However, the recognition of theobvious set the stage for the market to clear, which was further aided byBrady's plan.

Maybemy analogy to the LDC saga is a bit of a reach. Latin American LDC debtrepresented 176% of capital among the larger U.S. lenders then, while all LDCdebt represented 290%, according to a Fedretrospective look at the era. Hancock's $1.6 billion energy-relatedportfolio represented 74% of subsidiary Whitney Bank's (i.e., where the loansreside) year-end Tier1 capital and loan loss reserves.

Absenta sustained rebound in the price oil, such a move might prove to be amarket-clearing event both for borrowers and lenders. The logical buyers areprivate equity firms and better-capitalized energy companies that will convertdebt to equity and merge weaker companies into stronger ones. As for bankinvestors, Hancock and other oil patch banks appear to be inexpensive basedupon 2016 earnings estimates and tangible book value; however, valuation is nota catalyst. A rip-the-band-aide-off scenario could set the stage for aresumption of EPS growth and a sustained rebound in their shares. I think thatcase is harder to make under an installment approach to reserve-building.