With low oil prices lasting longer than many expected, banks in the energy-rich 11th Federal Reserve District saw loan growth and profitability decline in 2015, according to a new report from the Federal Reserve Bank of Dallas (Fed).

Banks in the 11th District -- which includes Texas, Northern Louisiana and Southern New Mexico -- saw “sharply lower loan growth” in 2015 resulting from low energy prices that slowed economic expansion and impacted banks’ commercial and industrial (C&I) portfolios, according to the Fed report.

Many banks in the district saw provision expenses rise as they set aside more money to guard against potential loan losses. “Half of district institutions -- 275 in all -- increased provision expense last year, up from 42%, or 240, in 2014,” the report said.

“...District institutions also reported an increase in the percent of loans that are noncurrent, those that are past due 90 days or more or no longer accruing interest. At year-end, 0.93% of loan portfolios at district banks were noncurrent,” below the national average of 1.53% but an increase over 0.85% at year-end 2014. The Fed report attributed this increase to commodity price weakness, as C&I loans, which include oil and gas companies, accounted for a larger share -- 32% -- of noncurrent loans in 2015, compared with 19% in 2014 and 13% in 2013.

“Rising energy-related provisioning reflects increased chances of loan losses -- a trend likely to continue through 2016,” the report said.

As lower for longer oil prices have weakened hedging portfolios and reduced reserve values, “regional banks with high energy concentrations have been the hardest hit,” according to the Fed report, which noted credit downgrades earlier this year for several energy-exposed banks in the district (see Shale Daily, Feb. 10).

“At the same time, regional banks increased their energy-related provisions and accelerated the pace of previously announced provisions. This combination of ratings agency actions and bank public statements sends a signal that losses are building faster than previously anticipated,” the report said.

The federal Office of the Comptroller of Currency has since issued regulatory guidelines for managing risks posed by the commodity price slump, and banks now must evaluate exploration and production loans based on repayment capacity without factoring in collateral, the report said.

“Eliminating the value of the collateral backing the loans tightens the loan grading methodology, making it more likely that a loan will be downgraded and a bank will be forced to provision against future losses,” the report said. “Market participants view the guidance as regulatory tightening. However, this perception more likely stems from the extended oil price decline’s erosion of energy loan performance and the resulting regulatory response.”

District banks now appear to be adjusting to an extended oil price downturn that they thought would be shorter-lived, the Fed wrote.

“The original assessment was that the decline would be transitory, with borrowers and lenders well-positioned to weather the storm. Even a relatively sharp decline was expected to cause only limited damage, provided it was a shorter-term event,” the report said. Early in 2015, energy companies were still able to access debt markets despite declines in the values of their reserves, and “banks also benefited from their customers’ use of hedges that shielded borrowers from falling oil prices.

“The impact of the 2008-2009 oil price decline -- a 65% drop -- provided the basis for the consensus initial expectations...A year ago, district banks appeared to have a heightened resiliency to lower oil prices due to better risk management, a more diverse economy and an improved regulatory environment,” the Fed wrote.

“But as the oil price decline...has lingered into 2016, its impact on some banks has become more pronounced.”

Moving forward, the price slump presents “district-specific” risks for banks in energy-intensive regions, as the downturn spills over into other sectors. “Even banks with minimal direct exposure to energy could be adversely affected due to the broader importance of energy in localized markets,” the report said.