Getting in on Lone Star comeback?

By Kevin Dobbs, SNL Financial staff writer

Prominent regional banking companies such as Comerica Inc. and Zions Bancorp. that are both asset sensitive and active in energy-heavy states like Texas say they are positioned to ride out an oil-price recession and could benefit handsomely from a confluence of an energy rebound and rising interest rates—should that develop in 2016.

But analysts are increasingly cautious.

How will oil and rate hike mix?

While an interest rate increase is widely anticipated when Federal Reserve policymakers meet next week—it would mark the first such increase since prior to the 2008 financial crisis—most observers look for a small bump at first followed by only a slow shift in the rate environment next year. And nobody has a firm grip on when oil prices will rebound.

[Editor’s note: Subsequent to the filing of this article, the Federal Reserve did indeed raise the fed funds rate from a range of 0% to 0.25% to a range of 0.25% to 0.5%—the first such hike in a decade.]

Concerns on the energy front deepened this week [week of Dec. 6] when U.S. crude oil benchmark prices dropped below $37 per barrel, touching a seven-year low amid a glut of global supply.

"As you get below 40 bucks, it can really start to trigger some issues" for banks' energy customers, Piper Jaffray analyst Brett Rabatin told SNL. "The math really gets worse at that point for them."

If oil stays this low for a substantial period—or fails to rebound in any significant way next year—cost-cutting, asset sales and other steps energy companies have taken to offset revenue declines could prove ineffective and loan defaults could follow, Rabatin said.

View from Comerica brass

Executives at Dallas-based Comerica said at a Goldman Sachs Group Inc. conference this week that energy lending continues to decline in the current quarter, as it has much of this year amid a pullback from its customers in Texas. Credit quality, however, is holding up, they said.

Chairman and CEO Ralph Babb Jr. said non-accrual oil-and-gas loans amounted to only 3% of the energy book. The energy portfolio accounts for about 7% of Comerica's overall loans. He said credit quality deterioration to date has been "isolated" and is "manageable."

"However," he added, "if prices remain low for longer, we expect to see continued negative credit migration and losses to emerge."

At the end of the third quarter, he said, 27% of the energy book consisted of criticized loans, or credits under close watch for potential trouble. At that same point, Comerica had reserves amounting to more than 3% of total energy and energy-related loans.

"We have increased our reserves for energy loans in each of the past four quarters as a result of an increase in criticized loans and sustained low energy prices," Babb said. "We are comfortable with our reserve."

How Zions sees road ahead

Salt Lake City-based Zions, which is active in several Texas markets, painted a similar picture. Zions Chairman and CEO Harris Simmons said at the Goldman conference this week that energy loan balances, which make up about 7% of total loans, have fallen this year and are expected to continue to decline.

"Energy is going to be a headwind," he said. "That's a portfolio that will continue to contract in this environment."

But he said credit quality issues are minor and are expected to prove manageable moving in to 2016. He said Zions has built a reserve of more than 4% of the bank's energy book.

Simmons added that any issues in the energy book have not spilled over into other portfolios. "We're just not seeing it appearing yet," he said. "We expect that as this persists that we will see some weakness, but we think that we've got enough… of [a] head start on this that this is going to be, again, very manageable."

“Love to see $50 a barrel again”

Piper Jaffray's Rabatin, however, said he is more cautious now than just a couple months ago about the specter of credit quality issues next year for banks in Texas.

Rabatin said conversations with smaller banks in the state provide reason for concern that not only large regionals in the state but also community lenders are vulnerable to emerging troubles in energy-related loans.

While many banks' energy-specific portfolios account for a relatively small percentage of their totals loans, as is the case with both Comerica and Zions, lenders in Texas and neighboring states work with a wide range of businesses and consumers that are at least partly dependent on the energy industry to prop up the broader economy. If oil prices remain below or even around $40 per for several more months to come, he said, a pullback on spending and employment levels by energy companies is likely to start hurting other sectors. And that could cut into banks' ability to weather this storm.

"You would see additional pressures," Rabatin said. Of oil prices, he added, "I think a lot of people would love to just see $50 per barrel again."

Terry McEvoy, a Stephens Inc. analyst, agreed. But he told SNL that, with the likes of Comerica and Zions, the interest rate picture could help offset low oil prices some.

"It's a situation where you have legitimate concerns about the health of the energy portfolios," he said. "But they also do stand to benefit from a rise in rates, which could start to happen as soon as next week."

Both Comerica and Zions say they are maintaining asset-sensitive positions. They have large bases of low-cost deposits, meaning that in a higher rate environment they anticipate they will be able to lift rates faster on loans than they will have to on deposits. As the spread between the two widens, their lending profitability would increase.

This article originally appeared on SNL Financial’s website under the title, "Regionals active in Texas await at intersection of oil prices and interest rates.” The original version contained speculation regarding rate hikes, which were answered by the Fed action referred to in the Editor’s note.

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