The rise in oil prices over the last few months is welcome news for the energy sector, but it doesn't mean that oil and gas firms — and the banks that lend to them — are out of the woods just yet.
Dozens of oil and gas firms have filed for bankruptcy protection since the start of the year and, with prices still hovering below the break-even point for many energy producers, industry experts say that the pace of bankruptcies is unlikely to slow anytime soon. That could mean more pain ahead for energy lenders, whose profits have been hammered in recent quarters by an increase in delinquencies tied to energy credits.
Banks with energy exposure have been steadily adding to their reserves in recent quarters and "they're going to have to wait until things are substantially better, or [there is] much higher visibility of being better, before they remove those funds from being classified for reserves," said Dallas Salazar, chief executive of Atlas Consulting in Austin, Texas.
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Banks reassess the borrowing capacity of oil exploration and production companies twice a year. The spring round of energy loan redeterminations is scheduled to begin in April. Will banks successfully use this process to de-risk?
March 9 -
Lenders repeatedly reassured skeptics that their credit risks from the energy slump were under control. But more oil and gas companies are filing for bankruptcy, and more of them are said to be drawing down their credit lines signaling that the worst may be yet to come.
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Bankers blamed regulators' new methodologies for rating certain energy loans and a new two-stage shared national credit review process for an increase in downgrades and loan-loss provisions. Regulators reportedly are reacting to an increase in second liens tied to exploration and production companies.
April 22
Steve Moss, a director at Evercore ISI, said it's "too soon to say" that the oil crisis might be over.
"At least we're out of the worst, and if oil stays at current prices, we're going to see some meaningful healing for bank balance sheets," he said. "But if you're a bank that's still … exposed significantly to oil and oil turns back south, it carries risk."
For many energy firms, the break-even point just for extracting oil and gas from the earth is the mid-50s. Factor in other overhead costs — salaries for executives and support staff and interest on debt, for example — and the break-even point could be $60 or $70, Salazar said. On Thursday, oil was priced at about $46 a barrel, up from about $32 in midwinter but down from roughly $50 just last week.
For lenders, a big concern is the threat of more bankruptcies. Through May, 39 North American oil and gas firms had filed for some form of bankruptcy this year, according to Haynes and Boone LLP, a Texas-based law firm that closely tracks bankruptcies in the energy sector. That nearly equaled the number of filings for all of 2015, when 42 firms sought bankruptcy protection.
This year's bankruptcies have been larger, too. The total secured and unsecured debt at oil and gas firms that have filed for bankruptcy protection through May 31 was $35.4 billion, more than twice last year's total, according to Haynes and Boone.
"Despite the modest recovery in energy prices, all indications suggest many more producer filings will occur during 2016," Haynes and Boone said in a May 31 report.
Falling oil prices have weighed on the entire banking sector. According to the Federal Deposit Insurance Corp., total industry profits in this year's first quarter
Still, some bankers see the recent uptick in prices as a sign that the energy sector is inching toward a recovery.
Joe Crivelli, the senior vice president of investor relations at BOK Financial in Tulsa, Okla., said that while the company will continue to increase its reserves for loan losses, he expects the amount it sets aside each quarter to stabilize later this year. The $31 billion-asset company set aside $35 million for loan losses in the first quarter, up from $22.5 million in the fourth quarter and $7.5 million in last year's third quarter.
"There's probably one more quarter of beefing up reserves," Crivelli said. After that, he added, "things should level off," if oil prices don't fall appreciably lower.
Tim Sloan, the chief operating officer at Wells Fargo, said the energy downturn has not diminished the bank's appetite for lending to oil and gas firms.
"We're very focused on providing credit to our customers," he said. "And the way to be successful in providing credit is to have a very long-term strategy ... which is, when times are good, you don't want to overlend. And when times are bad, you don't want to exit every one of your relationships and leave your customers without a bank. So you've got to be very consistent through all kinds of cycles."
But Evercore's Moss predicts that most lenders will be more cautious.
"Going forward I think it probably promotes tighter underwriting standards for energy loans," he said. "The amount a bank's going to commit to on a loan is going to be less, I think, and the rate the borrower's going to pay is going to be higher. So I think there will be more collateral for these loans and there's going to be less leverage."
Kristin Broughton contributed to this article.
