Energy Lenders Brush Off Concerns Over Oil Price Drop

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Banks that have seen their fortunes lifted by the strong domestic energy sector don't think the good times are over just yet.

Energy lenders say improved extraction techniques, conservative underwriting and price hedging make the industry less vulnerable to boom-and-bust cycles than in previous decades. They say that credit issues remain distant even though the price of crude oil has dropped 25% in the last four months, to the lowest level since late 2011.

Opinions differ on why oil has fallen so sharply, but there's little question that global economic weakness is an important factor, one that some energy-industry analysts say could keep prices depressed long term.

That could mean trouble for banks in places like west Texas, the Gulf Coast and North Dakota, where local economies have been transformed in recent years by the energy boom. Regulators have expressed concern that energy lenders are setting themselves up for a hard fall when the party ends.

Yet bankers in these areas shrug off warnings aboutfalling oil prices.

"My family's been in the [energy-lending] business since 1958, and I've personally seen four or five slowdowns," said Rusty Cloutier, chief executive of MidSouth Bancorp in Lafayette, La. "The oil companies have never been more ready for a slowdown than they are now."

There are several reasons why bankers believe they can limit the damage from falling energy prices. Improvements in the technology of oil extraction have made the business more efficient, so firms can still make a profit even at a lower price per barrel. A barrel of crude oil is just under $82 a barrel as of Thursday, down from around $107 in June.

Ken Burgess, chairman of FirstCapital Bank of Texas in Midland, said the price would have to go lower than $70 a barrel, and stay there for months, before his customers have trouble breaking even. Cloutier, who said that nearly half of MidSouth's loan portfolio is tied to the energy sector, estimated that his customers' break-even point is below $60 a barrel.

One reason for the energy sector's resiliency is that many oil companies hedge their risk through futures contracts, so they're less affected by price shocks, bankers say.

Hedging makes the current dip in oil prices "completely different than prior ups and downs" and "gives us some runway to get through a temporary period of lower prices," Comerica Chief Credit Officer John Killian told analysts on a conference call last week. He said credit problems won't arise unless the price per barrel stays in the $60 range for several years.

Banks say they generally underwrite their loans with conservative oil-price assumptions. The loan-to-value ratio of loans to oil companies is generally around 55% to 60%, lower than the LTVs for many other types of lending, said Brady Gailey, an analyst at Keefe, Bruyette & Woods.

"There are multiple buffers in place, and it is probably correct that banks will not see a near-term impact from lower prices," Gailey said. "Oil would probably have to stay low for several years before it affects the credit quality of banks in Texas and Oklahoma."

If the oil industry is in for a long slump, however, the first to feel the pinch would most likely be the oil-servicing companies, Burgess said. Such companies provide services like testing oilfields, repairing machinery and transporting oil, but they don't produce the oil or own the fields.

"The ones that have been around for a while, that are not overleveraged, will be fine," Burgess said. "But those that are newer, that borrowed unwisely and are overleveraged, could be wiped out."

A slowdown would also hurt the local communities that have become dependent on oil revenue. "In Midland, the local economy is so specifically tied to oil and gas that if it went down, everybody would feel it," Burgess said. FirstCapital also has offices in Amarillo and Lubbock, areas that are less dependent on the oil economy, which mitigates the risk, he said.

In North Dakota, oil companies have invested so heavily and earn such high profit that a dip in oil prices will likely have a limited impact, said Dale Patten, president of McKenzie County Bank in Watford City, N.D. The most productive oil rigs in McKenzie County can break even with oil as low as $28 a barrel, he said.

"So much infrastructure has been built that each new barrel is not very expensive to be produced, and there's been so much invested that nobody's walking away," Patten said.

McKenzie County Bank is at the epicenter of the Bakken oil boom, which has completely remade North Dakota's economy over the past decade. The $150 million-asset bank generally lends to oil servicers and their employees, because the big oil-development companies have access to larger, out-of-state lenders.

"Every capital source that you can imagine is available here — from East Coast investment banks to private equity, private investors, investment companies, even all-cash financing," Patten said.

Lower oil profits could offer the hidden advantage of removing some of these competitors. Capital markets for oil-company debt have slowed over the past month, which could help loan demand. Furthermore, when oil is more expensive, producers have such strong cash flows that they don't need to borrow as much.

The "sweet spot" for banks is when oil is between $80 and $95 a barrel, Gailey said — low enough that energy companies need cash, but not so low that they reduce investment. Oil has been in this range since mid-August.

That may explain why bankers remain confident despite months of falling prices. Cloutier said his customers are more worried about domestic environmental policy, such as a rule proposed by the Environmental Protection Agency last June to sharply reduce emissions.

"My customers prepare for the worst every day and they can cut back if they need to," Cloutier said. "But they're terrified of Barack Obama and the EPA."

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