Bank investors confront a new fear: oil company defaults
After weeks of worrying that lower interest rates will squeeze bank profits, investors confronted a still more alarming possibility on Monday: that a collapse in oil prices could trigger a wave of defaults by borrowers.
By the end of the day, US bank shares had chalked up their worst single-session performance since 2009 and the industry was a big contributor to a global stock market rout.
The four biggest US banks, JPMorgan Chase, Bank of America, Citibank and Wells Fargo all fell between 12 and 16 per cent, destroying some $120bn of market value. The industry has now erased all of its stock market gains dating back to October 2016.
Banks’ shares had fallen steadily since late-February on fears that lower long-term interest rates would depress loan yields. Deposit costs are already near zero for many big lenders and can fall little further, robbing the industry of what traditionally would be an offsetting benefit at a time of falling rates.
The crash in oil prices has added worries that loan defaults, which have been hovering at historically low levels, may be set to rise. While the direct exposure of US banks to the oil industry is just 2 per cent, according to Autonomous Research, the indirect exposure to adjacent regions and sectors could be significant.
Investors sent the shares of regional banks in the shale-oil states of Texas and Oklahoma down between 20 and 30 per cent on the day.
There was “unmitigated selling if you have Texas in your name or energy in your portfolio”, said Piper Sandler analyst Brad Milsaps, as smaller banks such as Cadence Bancorp, Cullen/Frost Bankers, Texas Capital Bancshares and BOK Financial were hit with furious selling.
“With prices where they are, the [oil] drillers won’t generate enough cash flow, after covering their debt, for capital expenditure to drill new reserves. So the worry is they just declare bankruptcy and start over,” Mr Milsaps said. During the last oil price crash, in 2016, private equity and capital markets were wide open to oil drillers who needed to recapitalise, and that was no longer the case, he added.
Fear about banks’ profitability were also reflected in the spreads on credit default swaps, insurance-like derivatives that protect against the risk that they may fail to pay their debts. The spread on JPMorgan’s CDSs, for example, rose by 50 per cent on Monday, to 98, according to data from IHS Markit — meaning that insuring $10m in the bank’s bonds from default now costs about $98,000 a year, compared to $65,000 previously. Other large back CDS prices rose by similar amounts.
“We have a perfect storm” for the banks, said Mark Grant, chief global strategist at investment bank B Riley FBR.
Low rates are “substantially bad” for banks profit margins, and “there is no yield in Treasuries and agencies [mortgage-backed securities] and that’s not good either [so] you can’t make money in your trading operations”, Mr Grant said
The pain was shared at European banks, with the Euro Stoxx Banks Index falling 13 per cent. One of the hardest hit was France’s Natixis, which dropped 18 per cent. Domestic rivals Société Générale and Crédit Agricole also came under fire, with their shares falling 18 per cent and 17 per cent respectively.
“Within the French banks, Natixis and Crédit Agricole are more exposed to oil and gas with 5 to 6 per cent of group credit exposures,” said Kian Abouhossein, an analyst at JPMorgan.
“A price decline this large and quick brings more harm than good,” he said, because the turmoil could lower company spending, increase credit rating downgrades and defaults and depress emerging markets and commodity-linked currencies.
Italian lenders were also caught up in the sell-off after the government imposed a four-week lockdown of 16m people across 14 provinces in the north of the country in a an effort to stem the spread of coronavirus. Intesa Sanpaolo had also just launched an unsolicited bid for smaller rival UBI Banca SpA, which analysts said could now be in jeopardy.
UniCredit plunged 13 per cent and Intesa Sanpaolo lost 12 per cent in a fall that threatens to undermine their nascent recoveries from a decade of painful restructuring.
Despite the eye-watering drops, JPMorgan’s Mr Abouhossein said most global banks should be able to absorb any losses on their credit books without impeding their ability to lend and pay dividends.
On Monday, Saudi Arabia’s decision to start a price war with rival producers sent oil prices down 30 per cent to between $33 and $36 a barrel. Oil prices “are down to early 2016 levels, when the bottom was in the mid-$20s and European bank losses were manageable over that period,” Mr Abouhossein said.