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Major Banks Shrug Off Concerns Of Bad Energy Debt

The latest survey by the Federal Reserve among senior loan officers has revealed a pessimistic picture. Banks operating in the U.S. are still skeptical about the ability of their energy industry clients to pay back their loans, and they are taking a variety of steps now to minimize the damage.

Last month, the Wall Street Journal quoted data from Barclays that showed American banks are saddled with over $140 billion in unfunded loans to E&Ps in oil and gas. They cautioned this will very likely weigh down on banks’ first-quarter earnings and plunge them even deeper into the abyss of unfunded, non-repayable debt.

Fortunately for the lenders, their first-quarter results largely beat expectations, which were understandably low in light of this degree of exposure to an industry in distress.

Citigroup, for instance, booked a healthy $3.5 billion in net earnings, which although lower than the result for Q1 2015 was still good, especially given that its exposure to the energy industry is close to $60 billion. Related: Germany About To Make Big Changes To Its Renewables Policy

Bank of America actually reported an increase in both revenues and earnings on an annual basis, despite over $40 billion of exposure to energy industry loans, both funded and unfunded. JPMorgan’s net earnings were slightly down on the year at $5.5 billion versus $5.9 billion, but still above analyst expectations.

For Morgan Stanley, the dip in earnings was more substantial and yet it too beat expectations, at $0.55 per share versus $0.46 expected by analysts. Wells Fargo, which has the same size exposure to energy as BofA’s, reported a net income of $5.46 billion, down from $5.8 billion for Q1 2015. The average rate of exposure to oil and gas loans of the U.S. banks is 5 percent, the report noted.

What all these figures show is that, although they are significantly exposed to energy via a load of loans that will not all be repaid, the banks are doing quite well. Related: Beleaguered Chesapeake to Sell Off More Assets to Reduce $9B Debt

And this is what the Fed’s report listed among the measures they have taken so far to manage the situation: lending policy tightening, requiring additional collateral, restructuring outstanding loans, and boosting their own loan-loss cushions.

Basically, the lenders are doing whatever they can to sustain potential losses, apparently having learned a valuable lesson from the Great Recession.

However, there is more cause for worry, because, “[o]n balance, banks indicated a spillover from the energy sector onto credit quality of loans made to businesses and households located in energy-sector-dependent regions,” the report also found. The spillage is for now in the form of car, credit card, and other household loans, and loans to businesses “somewhat deteriorating” over the past 12 months. “Somewhat” is not too bad, for now. Related:Why Oil Prices Will Likely Drop Below $40 Soon

Yet further deterioration in loan quality may very well lie in the near future because of banks tightening their lending policies. Enter the vicious circle of energy firms unable to sustain their operations without further loans, unable to take out these loans because of tightened bank policies, forced to lay off more people or just succumb to the effects of low oil prices, leaving their debts to the banks unpaid.

Grim as this scenario is, it may very well become a reality for a lot of smaller energy companies. As for banks, chances are they won’t get hurt too badly. As long as oil prices don’t plunge again, the larger players’ should be able to keep paying their debts.

By Charles Kennedy of Oilprice.com

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