Oil companies typically come into favor in mid-December and remain so until late April or early May ...
Oil Rally Won't Save Banks but We Unlock Hidden Value
05/12/2016 9:44 am EST
The International Energy Agency (IEA) released updated supply and demand data that said a rebalancing toward equilibrium in global oil markets is starting to become evident.
The report said that demand has been resilient and the global surplus should start to shrink later this year.
Report Highlights an Improving Global Position
The monthly report released by the IEA was very bullish and it should serve as a catalyst to oil prices as well as the stocks levered to the price of oil.
The April report contained a number of positive statements:
- Global supply increased to 96.2 million barrels a day as higher OPEC output more than offset deepening non-OPEC declines
- Global output increased by 50,000 barrels a day, remarkably lower than the gain of 3.5+ million barrels a day a year ago
- 2016 non-OPEC supply is expected to fall to 56.8 million barrels a day, a decrease of 800,000 barrels per day
- Iranian supply rose to 3.56 million barrels a day, a level last hit in November 2011 before sanctions were tightened
- Global inventory is now expected to decrease by 200,000 barrels a day in the back half of 2016 after a build of 1.3 million barrels a day during the first half of the year
Leading Indicators Are Bearish for Banks
Spillover risk represents one of the largest risks faced by the economy and this is what banks and lenders face 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.
Preparing for a Rough Quarters Ahead
Although oil prices have soared more than 60% off of its 2016 lows, it has done little to improve the prospects of overstretched borrowers, which has increased the possibility of defaults and bankruptcies for companies and their lenders in the months ahead.
According to Haynes and Boone, April was the heaviest month for energy company bankruptcies. During the month, eleven companies filed for Chapter 11 protection with $14.9 billion in total debt. During March, 7 companies filed for Chapter 11 protection with $1.9 billion in total debt.
Companies that file for Chapter 11 protection typically are unable to raise enough money from asset sales to cover their debts because of the depressed market for oil and gas reserves.
First Quarter Bank Earnings Show Weakness
The first quarter is typically the best for Wall Street banks, but 2016 has been a different story. According to credit rating agency DBRS, provisions for loan losses increased by an average of 61% from the same period a year earlier.
Earlier this year, several of the largest domestic banks like Citigroup, Inc. (C), Wells Fargo & Company (WFC) and JPMorgan Chase & Co. (JPM), warned about the ripple effects caused by weak oil prices.
Many analysts have said that a bank’s energy exposure would likely weigh on earnings throughout the year, and in some cases, offset improvements in credit quality in other parts of their loan portfolios.
Regional Banks More at Risk
Banks have started to reset borrowing limits for its energy clients, which are even lower than the cuts made during the same period last year.
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.
Oil Stocks to Watch
Even after its recent rally, the current risk/reward profile for Tesoro Logistics LP (TLLP) is very attractive. If fact, we see upside from current levels even if current crude oil headwinds persist. We view TLLP as one of the highest-quality growth stories in the MLP industry and expect to see the company’s cash distribution grow by at least 15% annually in each of the next three years.
Concho Resources, Inc. (CXO) is our favorite exploration and production energy stock due to 1) its premier asset base in the Permian basin, 2) its positioning for another beat-and-raise performance during 2016, 3) its balance sheet offers capital flexibility, and 4) its valuation has improved as CXO has fallen more than 4% from its post-earnings high.
Occidental Petroleum Corporation (OXY) has rallied approximately 13% during 2016 and we are favorable due the company’s high, but safe dividend, its leading position in the Permian Basin, and potential asset monetization. While Occidental incorporates the superior capital discipline of more conservative energy stocks, we like its high degree of leverage to the upcoming oil price recovery.
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