Oil Prices and the Effect on Banks: An Earnings Preview

04/12/2016 9:20 am EST

Focus: STOCKS

Michael Berger

President & Founder, Technical420.com

Although the risks are prevalent in the banking industry if oil prices remain weak, Michael Berger Associate Editor of MoneyShow.com, continues to see value in owning the smaller acquirers—such as these names—which are not heavily levered to the energy sector.

As JPMorgan Chase & Co. (JPM) prepares to lead off earnings season for the financial industry, energy loans have come back in to focus.

Given the duration of the weakness in oil prices, bank stocks with energy exposure have remained in focus as credit risk concerns increase.

Last year, after bank examiners marked many energy loans with tougher ratings than lenders expected, banks had to downgrade loans and set aside more cash to cover losses.

Just the Beginning? We Hope Not

Spillover risk represents one of the largest risks faced by the economy and this is all because of the weak oil price environment.

Since late 2014, domestic oil companies have cut more than 100,000 jobs, and states like Oklahoma and Texas are already seeing an increase in credit-card delinquencies and auto-loan defaults.

The spillover risk coupled with these leading indicators have banks closely monitoring the housing market and commercial real estate in those states for signs of cracks in larger parts of their loan portfolios.

Banks Set Aside Cash for Potential Losses

Earlier this year, several of the largest domestic banks warned the market about the ripple effects caused by weak oil prices.

Wells Fargo & Company (WFC) has downgraded 38% of its energy loans and set aside $1.2 billion to cover potential losses, according to company filings. Even though these loans only make up 2% of the bank’s portfolio, they have come under scrutiny from regulators and investors.

Although JPMorgan’s energy loan composition is only 1.8% and its energy portfolio makes up a small portion of its balance sheet, the bank allocated $124 million to cover potential losses from its oil and gas loans. JPMorgan said this amount could increase to $750 million if oil prices remain low for the next 18 months.

Citigroup, Inc. (C) expects oil prices to remain lower for longer and increased its loan loss reserves by $300 million.

Regional Banks More at Risk

Although banks like Wells Fargo, JPMorgan, and Citigroup are setting aside hundreds of millions of dollars for potential loan losses, the risks are not as great because their energy portfolios make up a small portion of their respective balance sheets.

Regional banks are more at risk because they tend to have a much higher energy loan composition. For example, BOK Financial Corporation (BOKF), Cullen/Frost Bankers, Inc. (CFR), and Texas Capital Bancshares, Inc. (TCBI) have a 19.4%, 15.3% and 10.2% energy loan composition, respectively.

We continue to see value in owning the smaller acquirers that are not heavily levered to the energy sector. Our top picks in the banking industry include Meta Financial Group, Inc. (CASH), BofI Holding, Inc. (BOFI), and Bank of the Ozarks, Inc. (OZRK).

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