Further drop in oil prices to $80 barrel coupled with slower shale oil production would have some negative consequences for banks in Texas regions, notes Sterne Agee.

Terry McEvoy and team at Sterne Agee in their research report dated October 14, 2014 titled: “Regional Banks and Falling Oil Prices” unravel answers to the question whether drop in oil prices would impact the regional banking sector.

Oil prices: Regional banks exposed to upstream operations

The Sterne Agee analysts note while historically universal and foreign banks have been the primary lenders to larger energy-related borrowers with a few U.S. regional banks also competing in that market. The following table captures energy-related loans at those banks with some degree of concentration. Interestingly, most of these banks have a Texas or Gulf Coast footprint:

Energy loan concentration Oil Prices

The Sterne Agee analysts point out that three major sectors or operational stages operated by the oil and gas industry are: upstream, midstream and downstream. They note a majority of energy loans made by the regional banks are to upstream operations and are predominantly reserve-based. The analysts highlight that since these loans are collateralized against specific proven oil and gas reserves and are based on the underlying cash flows of the project, they have proven more stable over time.

Besides the above three major sectors or operational stages, there is a fourth ‘services’ sector where lending would include drilling contractors, suppliers, pipeline services. The analysts note these have historically had a higher degree of credit losses and volatility as against collateral-backed reserve-based lending.

The analysts note in the event of oil prices continue to fall, any credit concerns would be on the oil servicing side.

Banks’ footprint in shale gas

With most of the financing behind the shale oil boom was done by the universal banks and the debt markets, the analysts note any prolonged depression in oil prices would have little direct downside to the regional banks outside those listed in the above table.

The following graph captures the major basins and shale gas plays in the U.S.

Drop In Oil Prices To Curtail Regional Banks' Lending?

Terry McEvoy and team at Sterne Agee point out that it would be premature to highlight any near-term risk to the banks in each respective region. However, they believe investors may start questioning the health of the local real estate markets and general economies if oil prices fail to rebound. The analysts point out that regional and local banks have benefited from the influx of energy companies into the shale regionals more on an ancillary level such as financing of new hotels, restaurants, and hotels / apartments.

The Sterne Agee analysts note several energy experts anticipate shale oil production would be trimmed in the event of oil prices continue to fall closer to $80 barrel. The analysts point out that in such a scenario, there could be some negative consequences for the banks in those regions.

The following table sets forth a breakdown of the loan portfolios for the banks, highlighting exposure to real estate lending:

Composition of loans Oil Prices