Effect Oil Prices Have on Banks

01/18/2016 9:41 am EST

Focus: FINANCIALS

Michael Berger

President & Founder, Technical420.com

Although the risks are prevalent in the banking industry if oil prices remain weak, Michael Berger, of Technical420.com, continues to see value in owning the smaller acquirers—such as these names—which are not heavily levered to the energy sector.

Since the beginning of 2015, continued deterioration in the energy sector has caused more than 40 North American oil companies to file for bankruptcy. Given the duration of the weakness in oil prices, bank stocks with energy exposure have remained in focus as credit risk concerns increase. Standard & Poor’s said that 50% of energy junk bonds are distressed and are at risk of default.

This situation will most likely get worse before it gets better after economic sanctions were lifted off of Iran on Sunday. The lifting of sanctions will make the global oil oversupply situation even worse as it ends a European oil embargo on Iran who already has 38 million barrels of oil ready to enter the market.

Banks Set Aside Cash for Potential Losses

Last week, three of the biggest banks in the United States warned the market about the ripple effects caused by weak oil prices. These warnings heightened concerns for already scared investors and now, investors want to know which banks have the most to lose if oil prices remain weak.

Wells Fargo & Company (WFC) has loaned more than $17 billion to the oil and gas sector. WFC said they allocated $1.2 billion to cover losses caused by continued weakness in the energy sector. JPMorgan Chase & Co. (JPM) allocated $124 million to cover potential losses from its oil and gas loans. JPM said this amount could increase to $750 million if oil prices stay at the $30 level for the next 18 months.

Citigroup, Inc. (C) said they expect oil prices to remain lower for longer and the company increased its loan loss reserves by $300 million. If oil prices remain around $30 a barrel, C is bracing for about $600 million of energy credit losses in the first half of 2016. If oil prices were to fall to and stay around $25 a barrel, the company said that figure could increase to $1.2 billion.

Smaller Banks Are More at Risk

While we expect to see oil prices rebound in the second half of 2016, the situation will likely get worse before it gets better as negative migration and continued provisioning impact earnings in the near-term. Despite this fact, we expect direct losses to be relatively benign in the near-term. We would not be surprised if long-time oil lenders begin to see energy balances bottom and potentially increase if oil prices begin to rebound.

CEO of JPMorgan Jamie Dimon said the energy portfolio makes up a small portion of JPM’s balance sheet and many of the loans are backed by physical assets. That means that the bank can sell off assets to recover money if a company defaults on its loans.

JPM’s energy loan composition is just 1.8% which is relatively minor when compared to many Texas-based banks. For example, Texas Capital Bancshares, Inc. (TCBI) and Green Bancorp, Inc. (GNBC) have a 9.5% and 10.7% energy loan composition.

Selectivity Is Key: Three Top Picks

Although the risks are prevalent in the banking industry, we expect to see increased consolidation during 2016. This theme will be most prevalent in banks with less than $1 billion in assets, by banks with less than $10 billion that fall under Dodd Frank/Durbin limits.

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).

Michael Berger, Founder and President, Technical420.com

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