The impact of lower energy prices on banks
Banks operating in oil and gas intensive areas of the U.S. have experienced a significant increase in nonperforming commercial and industrial loans, but not in other types of loans – at least so far, according to a recent study by Federal Reserve researchers.
“Our evidence seems to back up the view that to date, the banking sector has successfully weathered the storm of low energy prices,” said researchers in the Federal Reserve Bank of New York’s Research and Statistics Group.
Analysts examined banks with at least 25 percent of deposits held in oil- and gas-dependent counties in order to investigate the impact of direct lending to local oil and gas firms and indirect lending to companies servicing the sector. They also wanted to try to assess the impact of any consumer or mortgage defaults tied to higher unemployment or lower home prices in areas affected by the lower energy prices. Using data from quarterly Call Reports going back to 2013, analysts compared the performance of “energy-sensitive banks” with that of similar banks that aren’t located in energy-dependent regions.
The data found “no evidence of widespread bank losses or failures in these regions,” the report published on the Fed’s “Liberty Street Economics” blog said. “Lower energy prices have had only a modest effect on banks’ profitability and capital adequacy.”
Earlier this year, the Office of the Comptroller of the Currency said its supervisors would be monitoring banks’ ability to stress test loans affected by low oil prices. And participants at Sageworks’ 2016 Risk Management Summit had an opportunity to discuss with peers their institutions’ challenges and best practices related to oil and gas loan concentrations.
Some differences in loan portfolios
However, nonperforming loan ratios, a good measure of the health of a bank’s loan portfolio, for commercial and industrial loans began to deteriorate at energy-sensitive banks in mid-2014 once the oil slump began, especially relative to two comparison-bank groups. “By the second quarter of 2016, the nonperforming loan share is more than fifty percent higher for banks located in oil and gas regions,” the researchers wrote. Nonperforming loans were those classified as nonaccrual or those 90 days or more past due.
“We find that banks in the ‘oil patch’ have experienced a significant rise in delinquencies on commercial and industrial loans,” the report said. “There are also hints of spillovers to the performance of other types of loans, although the effects seem smaller than for C&I loans.”
Nonperforming loan ratios for residential real estate, consumer loans and other loans have increased for oil- and gas-sensitive banks relative to one of the comparison groups, the study found. The difference for nonperforming loan ratios for commercial real estate has stayed roughly constant throughout the study period. In any case, “the level of nonperforming loans still isn’t much higher for the energy-sensitive banks, in any category,” the researchers said.
Possible causes
Why might that be the case? Federal Reserve analysts noted that banks might have reduced exposure to the local economy by securitizing mortgages or selling loans to other parties outside the region, or it may take time for the lower employment tied to oil and gas industries to affect consumers or property prices. Other industries in the local economies might also have offset the effects or borrowers might have adjusted in other ways to avoid defaulting, such as by moving for employment in other areas.
In general, banks sensitive to the oil and gas industries were significantly more profitable than comparison groups before the drop in oil prices, probably reflecting the benefit of high energy prices and the growth in fracking, the study said. However, the oil- and gas-sensitive banks’ return on assets has converged toward the comparison groups since mid-2014.
The energy-sensitive banks appear to be better capitalized than either comparison group (based on regulatory measures of capital), and only five banks have failed so far in 2016, on top of eight failures in 2015. This failure rate is significantly below historical averages, the study noted.
Summary of findings
Researchers summarized the study’s results:
“While small banks located in oil- and gas-intensive regions of the United States are indeed experiencing a rise in nonperforming loans to businesses, so far there is little evidence of a widespread effect on bank performance or a repeat of the 1980s-era wave of bank failures linked to low oil prices. One important change since then is that our banking system is now much more geographically diversified, owing to the removal of restrictions against interstate banking and branching. Recent research finds that geographic diversification across states does make banks safer, reducing their exposure to sector-specific shocks—such as those from the energy sector. Even so, further analysis and continued monitoring of the effect of lower oil and gas prices on the banking system is warranted going forward.”
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Image credit: Clinton Steeds, Flickr CC
