Garnet Capital Advisors Blog

Lower oil prices have certainly been tough on big banks across the US.

While consumers are enjoying cheaper gas at the pumps thanks to tumbling oil prices, the country's energy lenders are being hit hard.

Since the financial crisis rocked the nation back in 2008, banks have been zealous about lending to companies in the energy sector. As these energy firms continued to thrive, so did banks' loan portfolios.

As of March 23, oil dropped back to under $40 a barrel, continuing the slump that has left energy lenders in a bind. The loans that energy companies have taken out with banks get riskier as it becomes increasingly challenging to service these massive debts. The energy banking realm certainly isn't showing much promise in performance or in the origination of new loans.

The energy slump has certainly created a massive slowdown in loan growth for many banks, and a worrisome downturn in performance, particularly those in energy-producing states.

Sharp drops in oil prices can turn profitable loans into potentially risky assets. When many energy loans were made, oil was priced well over the $80 per-barrel mark. And as oil prices plummet, the collateral backing these loans is becoming increasingly insufficient.

Padding Reserve Funds to Protect Against Further Price Declines

In the short term at the very least, financing oil projects have become unattractive to lenders. An extended period of low oil prices is beginning to seriously affect banks across the US. The fourth quarter of 2015 saw a number of big banks take a hit on energy loans gone bad.

Over the fourth quarter of 2015, Wells Fargo experienced $90 million in higher losses in its oil and gas loan portfolio, and reacted to such losses by pouring more into its commercial-loan reserves.

U.S. Bancorp announced that the drops in energy prices have caused some weakening of part of its commercial loans to energy clients. While such effects weren't dire for the bank in 2015, any further decreases could put the bank in a more risky position.


Banks like Citigroup have been adding to its reserves to hedge against bad energy loans.

And many lenders are continuing to pour capital into reserve funds to hedge against the potential for more energy loans to default. Citigroup says it increased its loan-loss reserves by $250 million in Q4 to protect against risks in its energy loan portfolio. This marks the first time that Citigroup has added to its reserves for bad loans instead of releasing them since 2009.

Other banks have followed suit, with JP Morgan Chase adding $124 million to its loan-loss reserves as a result of energy borrowers' struggles, and possibly more to be added.

The oil price debacle has eclipsed the beginning of US banks' earnings season, even though energy loans account for 3.4 percent or less of the big banks' loan portfolios.

The turbulence in oil prices has cut back market expectations on what the Federal Reserve will do as far as increasing interest rates this year, which would boost bank profits. Revenue growth has been somewhat muted for many US banks. Those that have managed to turn a net profit so far have done so as a result of cutting costs.

The Up Side to Cheap Oil Prices

There is a potential positive side to lower oil prices that can help the banks that are serving a large consumer base. With less money needed to fill up gas tanks and heat households, consumers have more disposable income to finance large purchases. With more money in their wallets, consumers are more likely to take out auto loans, mortgages, and apply for credit cards.

Such activity would surely be a good thing for banks that are looking to increase their consumer lending practices.

Oil Prices Won't Stay Down Forever

Oil prices might seem down and out right now, but they won't stay that way indefinitely. The US Energy Information Administration anticipates that crude oil prices will increase 25 percent from 2016 to 2017. Eventually, prices will make their way back.

In the meantime, it's more important than ever for banks to be extremely diligent in managing their loan portfolios. Throughout this energy price decline, many banks may be tempted to reduce their loan portfolio exposure to this unsettled sector.

But evaluating loan portfolios is a complex and intricate practice, and one that necessitates careful consideration. Before making any decisions on the classification of loan portfolios, discussing options with a loan sale advisory team like Garnet Capital is advised. Browse our white papers to find out more.