September 24, 2015

Regulators raise red flags over energy loan risk

Regulators and bankers have a Texas-sized difference of opinion on the quality of energy-sector loans, according to Wall Street Journal sources who witnessed a recent showdown between the two groups in a Houston conference room.

'Challenging times' for oil and gas
At issue was whether loans backed by energy reserves - oil and gas awaiting potential extraction - deserve the downgrades imposed by regulators.

Matt McCaroll, CEO of Fieldwood Energy LLC, said energy lenders don't appreciate the scrutiny just now given the widespread problems in oil and gas markets.

"We're concerned about it," McCaroll told the Wall Street Journal. "These are challenging times for our business … and to have additional pressure on the relationship between borrower and lender is going to be very problematic."

While consumers revel in cheap gas, the drastic price drops for oil are boding layoffs and hard times for energy companies. Oil was selling at less than $40 a barrel in August. That's a low not seen since before the Great Recession. And, depending on a particular oil company's efficiency level, it's a close call whether it even makes sense to keep rigs operating.

'We think their analysis is incorrect'
When regulators from the Federal Reserve, Federal Deposit Insurance Corp. and Office of the Comptroller of the Currency got into the same room with roughly 40 energy bankers, the sparks reportedly flew. Bankers disagreed with regulators' views about the risk level of reserve-backed loans.

The executive vice president of the Financial Services Roundtable put it this way to the Wall Street Journal:

"We disagree with the regulators. These are good loans," said Francis Creighton, "they have a history of performing … we think their analysis is incorrect on this."

Regulators weren't talking on the record, but an OCC review of perceived dangers to the banking system indicated federal watchdogs should "assess, monitor, and manage both direct and indirect exposures to the oil and gas sector, given the recent decline in oil prices and the potential for a protracted period of low or volatile prices."

Shared national credit probes to increase
Adding to the tense atmosphere between regulators and energy bankers is that it's shared national credit exam season. Results of the reviews, which affect loans of more than $20 million shared by three or more regulated banks, are already being made known to individual banks. National results should be released soon. Experts say that, for the first time in five years, a spike in troubled assets is in the offing. For 2016, the intensity of these probes doubles as they'll be made twice a year.

Underperformance expected for energy loans
Concern over energy sector loans has been building, according to American Banker. In spring, market talk was that loans for oil and gas drilling would underperform for 2015. Plummeting prices have led some companies along the Gulf Coast to sell off assets to private equity firms in efforts to keep current on their loans.

One effect of the expected poor performance of energy loans is that banks are trying to lower their loan portfolio exposure to the volatile sector. That's in the context of a wider skepticism among lenders about fossil fuels in general, according to American Banker. "Green lending" has begun to take hold in some bank board rooms. And while that certainly doesn't mean banks are getting out of the energy sector entirely, it does mean banks pushing back on the dirtiest extraction methods. PNC, for instance, no longer underwrites "mountaintop removal" operations.

"Ten years ago, senior bankers were climate skeptics," JP Morgan Chase's head of environmental affairs, Matt Arnold, told American Banker. "Today there are no climate change skeptics."

Evaluating loan portfolios, whether in the energy sector or elsewhere, can be a tricky business. Any questions or concerns can be discussed with loan sale advisory firm Garnet Capital Advisors.