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It seems like it was only yesterday – January, actually – when JPMorgan Chase (NYSE: JPM) said it would add up to $750 million to reserves for its energy loans if oil stayed around $30 a barrel.
But that has changed. At its annual investor presentation on Feb. 23, the nation’s largest bank upped the ante. JPMorgan said it would set aside an additional $500 million of reserves for oil and gas. That is on top of the $815 million already set aside for such loans.
Chairman and CEO Jamie Dimon added a caveat too. He said that if oil prices fell to $25 a barrel for 18 months, the bank would need to build reserves by another $1.5 billion.
Investors have wondered why stock indexes, and particularly big bank stocks, are in such lockstep with the oil price. JPMorgan Chase’s investor presentation pretty much answered that question.
Exposure to Energy
You see, much of the U.S. shale boom was built on the back of debt.
According to the Bank for International Settlements – the central banks’ banker – the global energy industry is drowning in debt. Between 2006 and 2014, the amount of energy bonds grew from $455 billion to $1.3 trillion. Syndicated loans to the sector soared from $600 billion to $1.6 trillion.
Of course, not all of that debt is U.S. shale debt. But you get the picture.
Heavy debt burdens are not good news. Especially when consultancy Alix Partners says many North American energy companies are losing $350 million dollars a day at current prices. The picture painted is one with lots of defaults and bankruptcies likely in the future.
Already, lenders in the fourth quarter of 2015 made $12 billion worth of provisions. That was up from $8.3 billion a year earlier. That was the largest such rise in six years.
To me, that translates to the numbers given by JPMorgan’s peers in January as being too small. As JPMorgan did, these numbers at other banks will likely be revised higher.
Here are what the major banks did reveal in January: Citigroup (NYSE: C) raised its energy loan loss reserves by $250 million; Bank of America (NYSE: BAC) upped its commercial (mainly energy) loan loss reserves by $2 billion; Goldman Sachs (NYSE: GS) said it had $10.3 billion of energy loan exposure; and Morgan Stanley (NYSE: MS) said it had $15.9 billion in oil company exposure.
Big Hang-Ups for Big Bank Stocks
What does this all add up to?
A study by RBC Capital Markets, Janney Montgomery Scott and Susquehanna International Group said that total exposure by U.S. big banks to energy is $123 billion.
Source: Bloomberg
Remember, this is only an estimate and the actual amount is probably higher.
It’s hard to pick out any winners from the energy loan mess. But one can glean losers just from what the banks are saying.
In February, Wells Fargo (NYSE: WFC) Chief Financial Officer John Shrewsberry gave a clue in his remarks at a conference. He said most of his bank’s oil and gas loans are to non-investment-grade companies. That’s not a good scenario for the largest equity holding in Warren Buffett’s portfolio.
Other firms have also offered clues. JPMorgan, Goldman Sachs, Morgan Stanley and Citigroup all have rather high exposure to non-investment-grade energy companies. These are all companies to be avoided. But at least Bank of America was smart enough to lend to higher-grade firms. That makes it the best pick in a bad neighborhood.
Right now, the reserves set aside by the large banks seem to be a manageable problem. But much rides on where oil prices are headed.
Fred Cannon, global director of research at investment bank Keefe, Bruyette & Woods, made an interesting comment to the Financial Times. He said, “If it (the downturn in oil) spills into the broader economy, and it starts looking like Texas in the 1980s, it could be a different story.”
That’s a scenario investors in bank stocks, and the rest of us, hope will not come to pass.
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