The Cost Of Oil Investments To Banks – Not As High As Thought?

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The Cost Of Oil Investments To Banks – Not As High As Thought?

Richard X. Bove, Vice President Equity Research at Rafferty Capital Markets, highlights the cost of oil investments that banking companies are facing.

The Cost Of Oil Investments To Banks – Not As High As Thought

A few days ago, David Fanger, Moody’s Financial Institutions executive released a report indicating that banking companies face a risk of losing $9 billion on their oil investments. This loss was a worst case assumption and it would be taken over a multi quarter period. It was Mr. Fanger’s belief that this could be costly but that the banks could handle the expense.

Today, the Wall Street Journal published an article entitled Banks Face New Headache on Oil Loans. The Journal’s take is that banks have commitments to make an additional $147 billion in loans to the energy sector and this represents a major problem for the banking industry. The Journal does not refer to Moody’s work but is relying on information provided by Fitch.

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So who is right? Obviously, I am biased toward Moody’s results but why?

There are a series of reasons.

  • The commitment to lend is not a loan. It is true that it works like a home equity loan in that the entity paying the fee for the commitment can simply draw down the money promised at will.
    • If the commitment is written properly, however, should there be a material change in the borrowers financial condition the commitment terms can be changed.
    • Generally speaking commitments are obtained by companies with enough money to pay for them – i.e.; they tend to be investment grade companies and not high risk organizations.
  • Banks are working with their clients to re-categorize the nature of the commitments. They are ignoring certain loan indentures in return for:
    • Reductions in the size of the commitments
    • Faster payback of outstanding loans
    • Higher rates
    • More collateral
  • The price of oil appears to have stabilized at a higher price than was used in the reference pricing that takes place twice a year.
  • Write-offs, when they occur, are spread out over long periods when the loans are collateralized.

Fortunately, in the next couple of days we shall see what the initial results are as banks report their earnings.

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