The tangle of loose lending to tight oil
A few weeks ago, a big hedge fund manager in New York asked a major Wall Street bank what was happening to energy sector loans. The answer was sobering.
“They said that the covenants on 72 out of the 74 loans to the oil and gas sector had recently been modified,” this investor reports. Or to put this into plain English, this bank now realises that most of its energy sector borrowers are struggling — so it is quietly relaxing the borrowing conditions, to avoid the embarrassment of seeing loans it has made go into default.It is impossible to tell precisely how typical this is; bankers are pathologically secretive about loan modifications. But judging from the tone of US quarterly bank earning calls this week, I suspect the pattern is widespread — and points to an issue that investors need to watch closely this coming winter.Over the past year, the oil price has slid by more than 40 per cent, to trade below $50 a barrel. At that level many energy companies are almost unviable — particularly those small and midsized US explorers and producers that have ridden the shale boom.Yet this slump has caused remarkably few ripples in the wider financial world. True, the price of most energy sector bonds has tumbled, with many junk bonds now trading below par. But there have been few outright bond defaults and banks themselves have not been calling loans in; instead, it seems most have been “modifying” those covenants — and praying for an oil price rebound.
But this could soon change. One reason is that bankers are starting to accept that oil prices below $50 a barrel might be the new norm....MORE
For example Jamie Dimon, chief executive of JPMorgan, revealed that his bank is now conducting stress tests to see how its loan book would fare if oil fell to $30 a barrel. But he argued that even that scenario would only require another “$500m or $750m in reserves, which is just not something we worry a lot about”.