Texas Oil Boom Starting to Worry Regulators

WASHINGTON — A recent oil and gas boom in Texas that has captivated banks' attention is also drawing the eye of regulators as they become concerned how far institutions will go to win loans and hire specialists within the energy industry.

Regulators are pleased to see banks restore earnings after the financial crisis, but are becoming increasingly worried about the possibility of another boom-and-bust cycle like the kind seen during the oil crisis of the mid-1980s.

"The economy really presents equal part challenge and opportunity for our banks during this boom period and that will also be true when the boom ends and we move into the bust cycle," said Amy Klein, assistant deputy comptroller in Lubbock, Texas, for the Office of the Comptroller of the Currency. "And so we want to make sure that we're more vigilant this time than we were last time … Certainly it could have as much of an impact this time as it did last time in the mid-80s when the boom was over and the bust started."

To be sure, regulators said they do not yet see any signs of a bust in the near future. Indeed, regulators and bankers said in areas like Midland and Odessa, energy companies are bringing in so much business that it's spurred new restaurants, housing and temporary schools to support families who've moved nearby to work for energy companies.

"I've seen pictures in areas like Eagle Ford of the so-called 'man camps' where they have to put people in trailers because they don't have enough housing," said Mine Yucel, director of research and specialist in energy economics for the Federal Reserve Bank of Dallas. "The fast growth in these areas strains the infrastructure of the local economies. And until supply catches up, the prices will go up for labor and housing, and many local services."

While this means loan and deposit growth for banks, it also adds pressure to fight aggressively with other banks and even energy companies in order to find and retain experienced personnel with the energy industry.

Many bankers said recruiters for energy companies will easily offer six figures to snag someone from their bank with experience. And because oil and gas lending is a specialized niche, banks often need the same sort of talent such as petroleum engineers and analysts in order to do larger loan deals.

"Staffing is one of the challenges that I hear most from our bankers in that [Midland] area and in the surrounding areas. The oil companies are attracting whoever they want with very top dollar offers," Klein said. "Especially for some of the specialty-type individuals, some of our banks have had to go outside of the immediate area to find those individuals, which is not something that has happened in the past several years."

Klein also said outside firms are just as aggressively going after tellers, accounting and technology personnel as they are energy experts.

"We saw that in Houston where accounting was impacted because they can make more money at an energy company," said David Zalman, senior chairman and chief executive of $18.9 billion-asset Prosperity Bancshares in Houston. "But what we try to convey is if you've been around long enough yes, you can make it, but when the industry goes down, they cut as fast as they hire."

Employee retention has been a huge focus — and risk — for many of the bankers in Texas. Executives at Texas Capital Bank in Dallas, which targets larger loans for oil producers, said they often spend two years courting select bankers to add to their energy team. But having an experienced team also means they are constantly being sought after.

"For many years a number of recruiters have told me, 'We tried to hire your people for years and have not been able to get them,' " said Keith Cargill, president and chief executive of the $12.1 billion-asset Texas Capital Bancshares. "But I promise you, they haven't given up so we are constantly re-recruiting and promoting our people."

Chris Cowan, executive vice president of energy lending at Texas Capital, said this also means challenges for their business clients as well.

"The examiners are focusing on these issues today but we focus on them every single day," he said. "The biggest challenge for clients is where they are going to find their own people."

To put the activity coming out of Texas into a global perspective, the Dallas Fed's Yucel said the state produced 2.9 million barrels per day in February, which was more than the amount of oil produced in places like Mexico, Venezuela and Norway.

"Since 2010, we have added about 1.5 million barrels per day to our output. So in the last four years, we have added another Norway, essentially," she said.

This also means significant loan growth for banks, whether they are lending "upstream" to the oil exploration companies or "downstream" to the businesses that service and distribute the oil. Among the nine states that make up the OCC's southern district, Texas and Oklahoma had the highest average loan growth with some areas reaching up to 11% growth in 2013 compared to 4% across the entire district, the OCC said in an analysis released April 22. Oil and gas lending was the primary contributor to that growth, the report said.

This has also made regulators cautious of what Klein calls "slippage" in underwriting standards in order for a bank to win the business.

Regulators are watching for warning signs include longer amortization periods or releasing guarantors on a loan. Last month, the OCC issued guidelines for oil and gas lending, which had not been updated since the mid-1980s.

Though the OCC's Klein said she has not yet seen the kind of underwriting deterioration they saw in the commercial real estate or housing market, competition in the energy sector has heated up enough for them to be on guard.

"If I have to have them compete, I'd rather have them compete on price than anything else because they're not going to price it below what would be a reasonable profit margin," Klein said. "But what we're really looking at is competing more on terms. Certainly longer amortizations would be a warning sign."

In interviews with a handful of bankers, most said they do not extend the term of a loan in the servicing area — such as equipment financing — past five years.

Zalman of Prosperity Bancshares said he's seen instances in the past year where a bank would offer a seven-year or 10-year fixed amortization to win the deal.

"People are trying anything they can to put loans on books and extending the terms and conditions rates are one way to do that," he said. "The economy, to me, doesn't feel overheated. What feels overheated is the competition for business."

Several bankers said most of their direct peers stay in line with each other in terms of underwriting but that foreign and nonbank lenders often have the ability to undercut for a deal.

"It's surprising to me how quickly memory fades when everyone around them is growing," Cargill said. "It's imperative that you put quality first, not growth. It's imperative that you're selecting clients, not collecting clients."

Jim Outlaw, president and chief-operating officer of the Houston market for Trustmark Corp., a $12 billion-asset bank based in Mississippi, agreed that competition has increased partly due to foreign banks and private equity firms who have the resources to take greater risks.

"The bottom line is there's a lot of liquidity out there and desire to be in a lucrative line of business," Outlaw said. "We haven't seen that needle rise yet" where deals are being poorly underwritten, "but right now we've been staying right down the middle."

Regulators and bankers also agree that there are significant differences between the oil boom now and the one in the early 1980s, partly because of technology upgrades. As a result, there's less speculative drilling, the state is less dependent on the energy sector and the nation is less dependent on foreign production.

"The Texas economy has diversified so I think we can withstand a bust much better than we did in the 1980s," said Yucel, who's projecting continued growth this year in the energy business.

While that has boosted confidence on the quality of the loans being made, many bankers acknowledged that the size of the loans is far larger than 30 years ago, which poses new challenges.

Some of these loans can be "$10 million to $12 million in order to frack or drill so it definitely is expensive," said Dick Evans, chairman and chief executive of Cullen/Frost Bankers, a $24 billion-asset bank in San Antonio. "It will separate the men from the boys pretty quick."

Banks also face another issue: what to do with a sudden and unexpected influx of large deposits from customers who have benefited from the oil boom. Klein said examiners have seen large enough surges that have thrown off the capital ratios of a bank, particularly smaller institutions.

She cites an example where a farmer who sold mineral rights to a drilling company placed $15 million into a deposit account. Typically, a bank would deploy such deposits into loans or other investments, but the deposit surge ebbs and flows too quickly, making it difficult to manage. Some banks have effectively found their leverage capital ratio decrease within a matter of days.

These bankers "never can tell when [surge deposits] are going to come or they don't know when they're going to leave" and "it's really hard for them to figure out how to deploy that money profitably and to make sure they have enough capital for when that big deposit comes in," Klein said. Because of this, "bankers are being very conservative with those deposits and they're offsetting liquidity on the asset side of the balance sheet so that when they have fluctuations, they have liquid funds available to take care of those."