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Weak Energy Sector Continues to Hurt Banks' Asset Quality

One of key issues that dominated the Q1 earning season for the banks was the impact of the sustained volatility in oil prices on the quarterly results, given their exposure in the energy sector. Profitability of major companies including JPMorgan Chase & Co. JPM, Wells Fargo & Company WFC and Bank of America Corporation BAC was hurt because of the high provisions to cover the soured loans of the energy companies.

Deterioration in credit quality of the loans made to the energy companies continues to be a major headwind.  In its latest quarterly filing, Wells Fargo revealed that the “criticized” loans in its commercial and industrial portfolio increased a whopping 62% to $29.9 billion, driven by the energy related loans.  Criticized loans are those that exhibit weakness or undue risks. Significant losses may occur when these loans become uncollectible. As of Mar 31, 2016 Wells Fargo's oil and gas loan portfolio totaled $17.8 billion, representing 2% of total outstanding loans.

While Wells Fargo did not mention the amount of loans criticized in oil and gas, per JPMorgan’s filing, the company’s criticized loans to the oil and gas industry increased significantly to $9.7 billion as of Mar 31, 2016, from $4.5 billion at the end of Dec 2015. Notably, the New York-based company’s total criticized loans (excluding loans held-for-sale and loans at fair value), was $21.2 billion, increasing 45% year over year, “driven by downgrades, including within the Oil & Gas and Natural Gas Pipelines portfolios, and in the Metals & Mining portfolio.”

Also, Bank of America noted in its filing that of the total energy-related utilized exposure to the higher risk sub-sectors, 56% was criticized as of Mar 31, 2016. Notably BofA’s energy-related committed exposure was $43.5 billion at the end of Mar 31, 2016 while utilized exposure was $21.8 billion.

Energy companies are struggling hard to sustain amid the low prices by undertaking several measures including cut in capital spending and layoffs.  However, oil prices in the near term are not expected to shoot up given the absence of production cuts from OPEC, the resilience of North American shale suppliers to keep pumping despite plunge in prices, a weak European economy and slowing growth in China.

Banks, which have extended credit to troubled energy firms in order to avoid large amounts of defaults, are however tightening their funding pipeline to these companies. Several banks continue to increase reserves while closely monitoring the loan portfolio and working with borrowers to address issues. Though many of the banks claim exposures to be manageable, risk grade migration within the energy portfolio may lead to higher provisions in the near term, consequently hitting the overall asset quality.

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JPMORGAN CHASE (JPM): Free Stock Analysis Report
WELLS FARGO-NEW (WFC): Free Stock Analysis Report
BANK OF AMER CP (BAC): Free Stock Analysis Report
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