Texas banks brace against oil defaults

Efforts to diversify after last bust to be tested

WASHINGTON — Five years ago, after taking big losses during the last oil bust, banks across Texas moved to insulate themselves from a future crash in crude prices, shifting loans away from energy companies to less risky industries.

Now with the coronavirus pandemic pushing crude prices to historic lows, those moves are being put to the test with a wave of oil sector defaults and bankruptcies on the horizon.

So far, credit ratings agencies maintain the banks are adequately capitalized to withstand the shock. But almost 35 years after Texas’ banking industry was nearly wiped out by the 1980s crude and real estate crash, missed loan payments and write offs are in

creasing. Unease about a repeat is growing.

“I think a lot of these banks are overextended, particularly the ones that backed the shale players,” said Lamar Roemer, the owner of Roemer Oil in Houston. “A lot of the banks required a hedge (against low oil prices), so they’re probably OK through the end of the year. But at some point, those will run out.”

In just the first three months of the year, before the pandemic fully took hold in the United States, Cullen/Frost Banks in San Antonio saw uncollected loan payments increase more than 15-fold from the same period a year ago to $173 million. The bank cited a combination of the oil crash, economic losses related to the coronavirus and new accounting rules.

Comerica Bank in Dallas wrote off $84 million in loans they believe unlikely to be recovered, a more than six-fold rise, with 80 percent of that increase involving energy companies.

“A lot of the banks required a hedge (against low oil prices), so they’re probably OK through the end of the year. But at some point, those will run out.”

Lamar Roemer, owner of Roemer Oil

Reduced exposure

So far, banks maintain they have healthy reserves that make them well-prepared for a downturn. But they acknowledge the combination of the oil crash and shutdown orders to limit the spread of the coronavirus have left local economies reeling.

“Compared to the late 1980s, banks are more diversified and better capitalized,” said John Healy, general counsel for the Texas Banking Association, a trade group representing regional banks. “That said, the banking industry, especially in the oil patch, is being hit very hard. It’s very difficult to have large parts of Texas running when oil is under $20 (a barrel).”

In early March, as oil prices first began falling, credit rating agency Moody’s issued a report stating that most U.S. banks “had reduced their energy exposure” after the 2015 oil price crash, pointing to energy-focused regional banks such as Cullen/Frost, Texas Capital Bancshares in Dallas and BOK Financial Corp. in Oklahoma City as having reduced their loans to energy companies in recent years.

Even as crude prices have continued to plummet since that report, with U.S. benchmark West Texas Intermediate turning negative last month, regional banks in Texas have largely seen their credit ratings hold up, a Moody’s spokesman said.

But the move away from direct lending to oil companies won’t shield Texas banks entirely from an oil shock, experts say.

The economic hit to oil in regions from Houston to West Texas to South Texas means not just failing energy companies but laid off workers not able to make mortgage payments, restaurants and shops going out of business and motels with empty rooms, said James Weston, a finance professor at Rice University.

“The risk isn’t just loaning money to a bunch of wildcatters in the Permian,” he said. “There’s a trickle-down effect, a multiplier effect when there’s a big shock to the regional economy, even if the loan portfolio appears diversified.”

How severely Texas banks are hurt by the oil downturn is unclear. Typically, banks won’t report an increase in loan defaults until they report their quarterly earnings, and those for the second quarter won’t be out for a few months.

National banks including JPMorgan Chase, Wells Fargo and Bank of America are already making preparations for rising loan defaults, setting up independent companies to operate any oil and gas assets on which they might have to foreclose, Reuters reported last month.

But regional banks don’t have those same resources. Healy, of the Texas Banking Association, said he wasn’t aware of similar efforts by regional banks in Texas.

‘A careful dance’

So, when it comes time this fall to decide whether to extend credit to oil companies already on their books, Texas bankers will be forced to decide between giving oil companies some leeway or taking over assets that would likely sell at a loss.

“Unless they want to be the one to hold the assets, they don’t want to be the reason the company has to file (for bankruptcy),” said Rachael Lichman, a Houston finance attorney at the law firm Baker Botts. “There’s a careful dance that has to be done.”

But if oil prices don’t improve, banks eventually will be forced to cut their losses and sell their borrowers’ oil and gas fields for whatever they can get, if only to assuage regulators and investors.

For some in the oil sector like Roemer, who said he’s debt free and starting to think about buying oil assets, it’s just a matter of waiting.

“The banks will want people to start paying back their notes, which will cause a lot of people to go into bankruptcy,” he said. “It’s starting to happen, but it’s going to take a while.”