Why You Shouldn't Write Off Citigroup's Energy-Loan Troubles Just Yet
JPMorgan Chase (JPM) - Get Report , Citigroup (C) - Get Report and other U.S. banks that got relief from the recent rally in oil prices could see a resurgence of loan losses as global energy demand slumps following Britain's vote to exit the European Union.
The two lenders and Bank of America (BAC) - Get Report said during the past week that oil's rally in recent months to around $45 a barrel, from a 13-year low around $26 in February, has reduced pressure to set aside money to cover losses on loans to energy companies. Partly as a result, the banks posted profits that topped analysts' estimates.
The losses could quickly return, some analysts say, as both the U.S. Energy Information Administration and Credit Suisse warn that oil prices may easily tumble to $35 or lower by the end of the year. The so-called Brexit vote on June 23 prompted many investors and economists to reassess their outlook for global economic growth, and that may indicate lower energy demand from consumers and industry.
"It's too early to say that the oil risk is over," said Mike Mayo, an analyst at the brokerage firm CLSA.
Early this year, as oil prices foundered, bank investors were so concerned about the rising potential for energy-loan losses that executives at the firms scrambled to tally their exposures and handicap the extent of the problem.
In February, analysts at the Wall Street firm Morgan Stanley (MS) - Get Report published a 21-page report detailing more than $110 billion of energy-loan exposure at 25 large and medium-size banks. JPMorgan CEO Jamie Dimon warned that his bank, the largest in the U.S., might need to set aside an additional $1.5 billion of loan-loss reserves if oil prices stayed mired in the $25-a-barrel range.
Those alarms seem all but forgotten now, as analysts who dialed into second-quarter conference calls in the past week drilled instead into topics like mortgage underwriting, charge-card customers' credit-bureau scores, trading conditions and the impact of lower-for-longer interest rates. Energy losses barely registered.
According to Citigroup, some of the improvement lies not just in the oil-price rally to around $45 a barrel, but in the gradual improvement over the past few months in bond markets. Energy companies that were squeezed for cash were able to borrow money from investors to delay any reckoning, Citigroup CFO John Gerspach said.
"Certain energy clients were able to access the capital markets as the market environment became more favorable," Gerspach said. "This allowed these clients to improve liquidity, resulting in either pay-downs or improvement in the credit quality of our exposures."
The New York-based bank, which added $573 million to loan-loss reserves in the previous two quarters in its institutional division, was able to release $26 million from reserves during the second quarter. That's partly because charge-offs due to loans that went bad during the second quarter already were covered by existing loss reserves, Gerspach said.
The bank now expects full-year loan losses in its institutional division of $800 million to $1 billion. As recently as early June, executives had predicted the figure would be about $1.2 billion.
Even so, Gerspach acknowledged on a conference call with reporters that a renewed bout of weak energy prices could drive bad-loan costs back up. In the second quarter, soured corporate loans in Europe, the Middle East and Africa jumped by 62% to $762 million, primarily owing to two energy-related clients, according to Gerspach.
"I don't say that energy is completely over," Gerspach said.
JPMorgan's bad-loan costs in its investment-banking division fell to $235 million, down by about half from the first quarter.
Despite the improvement, "the oil and gas sector remained stressed, and reserves will continue to be idiosyncratic," JPMorgan CFO Marianne Lake said.
Bank of America's bad-loan costs declined to $976 million in the second quarter from $997 million in the first.
"Commercial portfolios saw lower net charge-offs and lower energy-related losses," the bank said in a presentation on its website.
At San Francisco-based Wells Fargo (WFC) - Get Report , which has more exposure to higher-risk energy loans than its peers, net charge-offs on oil and gas loans rose 29% to $263 million in the three months through June, but total high-risk loans in the portfolio narrowed and executives believe the worst of the defaults are over.
The bank has extended $39.1 billion in oil and gas loans, according to a presentation, about $17.1 billion of which has already been drawn by borrowers.
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Oil-price analysts at Credit Suisse wrote last week that Brexit probably took a toll on worldwide demand. The firm cut its forecast for 2017 demand growth to 0.9% from about 1.3%, driven partly by reductions in northwestern Europe. Under a bearish scenario, oil prices could fall back to about $30 a barrel early next year, the firm said.
The Energy Information Administration this month cut its forecast for 2016 oil-demand growth to 1.44 million barrels a day, from 1.45 million just a month ago. It's well within the realm of possibility that prices could fall to $35 a barrel by October, the administration said.
Corporate debt defaults, already at the highest level since the financial crisis, should continue along the current trend, ratings firm Standard & Poor's wrote in a July 14 report.
The ratings firm expects "stress on many U.S. oil and gas companies to persist, with continued low oil prices, ongoing cash-flow deficits as a result of declining prices, more limited debt-funding sources (including credit facilities and bank lending), and potentially limited benefits from plans to further cut capital expenditures," according to the report.
Exxon Mobil (XOM) - Get Report , the largest U.S. oil company, lost its AAA rating from Standard & Poor's -- the highest available -- during the past quarter.
Indeed, the oil market is still so weak, compared with the $100-plus levels when many loans were underwritten, that JPMorgan might require higher prices before the it begins to release loan-loss reserves for the energy industry, according to CFO Lake.
"What we would need to see is continued firming of sentiment in the sector, continued access to capital markets to allow companies to repair their balance sheets and continued stabilization, if not improvement, in oil and gas prices," Lake said.