By Pam Martens and Russ Martens: February 24, 2016
The same phenomenon that’s been playing out for months took center stage yesterday with one notable twist: oil prices dove, the broader stock market swooned, but the mega Wall Street banks took a worse beating than the broader stock market averages. The Dow Jones Industrial Average lost 1.14 percent yesterday while Bank of America, Citigroup and Morgan Stanley were off by more than 3 percent. In an unusual twist, JPMorgan Chase, the bank that analyst Mike Mayo has preposterously called the Lebron James of banking, performed the worst among its peers yesterday, down 4.18 percent.
What knocked the wind out of JPMorgan’s sails yesterday is at the heart of why the banks keep tanking when oil prices swoon. In a nutshell, the market doesn’t think these banks are coming clean about their exposure to oil – whether it’s in loans to beleaguered oil companies or whether it’s derivatives it sold to its corporate clients and hedge funds to make wagers on the declining price of oil. In addition, the market thinks these banks have not taken adequate reserves to cover their potential losses and that they are waiting until the last possible moment in order for executives to boost their own pay and bonuses.
Where would the market get such cynical ideas? This is precisely how many of these banks behaved with the subprime debt crisis in the leadup to the 2008 financial crash.
JPMorgan Chase poured some gasoline on the fire of these suspicions yesterday when it held its annual investor day and announced that it will be beefing up its reserves to cover potential losses in the energy sector to $1.3 billion by the end of this quarter. The bank noted further that if oil stays in the $25 range for over a year, it would have to put aside an additional $1.5 billion.
JPMorgan Chase has owned up to $44 billion in exposure (loans and commitments) to the energy sector with $19 billion of that being rated below investment grade. A reserve of $1.3 billion represents just 3 percent of total exposure. That amount of reserves stands in contrast to data provided by the Federal Reserve on November 5, 2015 from the findings of the Shared National Credit Program (SNC), an annual review conducted by bank regulators to examine syndicated loans of $20 million or more that are shared between three or more banks.
According to the SNC, “Oil and gas commitments to the exploration and production sector and the services sector totaled $276.5 billion, or 7.1 percent, of the SNC portfolio. Classified commitments — a credit rated as substandard, doubtful, or loss — among oil and gas borrowers totaled $34.2 billion, or 15.0 percent, of total classified commitments, compared with $6.9 billion, or 3.6 percent, in 2014.”
In other words, if 15 percent of syndicated loans to the oil and gas sector are rated substandard, doubtful or a loss, why aren’t the banks reserving at a rate closer to 15 percent instead of the low single digits? Not to put too fine a point on it, but these are the same banks that received the largest taxpayer bailout in the history of finance just eight years ago.
The scariest part of the SNC review resides in this one sentence: “Results are based on analyses prepared in the second quarter of 2015, using data provided by the institutions as of December 31, 2014, and March 31, 2015.” Oil prices have declined by almost half since March 31, 2015, meaning impaired debt should have grown commensurately.
Another serious problem, according to the SNC review, is that the banks that syndicated these loans “continued to refinance and modify loan agreements to extend maturities. These transactions had the effect of relieving near-term refinancing risk, but may not improve borrowers’ ability to repay their debts in the longer term.” The SNC warned that “Bank management should ensure such loan modification strategies are not substituted for realistic debt repayment or to avoid recognizing problem loans.”
This is another big angst in the market: are the banks extending and pretending that the losses aren’t real, hoping for a miraculous spike in the price of crude to bail out the bad loans?
According to a February 12, 2016 article by Christopher Helman at Forbes, other major banks have the following estimated energy sector exposure (loans and commitments): Wells Fargo $42 billion; Citigroup $58 billion; Bank of America $43.8 billion; Morgan Stanley $16 billion.
What no one seems to be talking about is what the derivatives exposure is on the part of the banks to the energy sector. The price action of the bank stocks on down days for oil is sending a crystal clear message that we may be in for a lot of negative surprises in that arena.
Stock price action represents the composite wisdom of all participants in the market, including those with long memories. The market remembers that the London Whale derivatives fiasco at JPMorgan was first characterized by CEO Jamie Dimon as a “tempest in a teapot” until it became $6.2 billion in bank depositor losses. Then there was Citigroup telling investors that it had $13 billion in subprime debt exposure when it was actually $50 billion. No one went to jail in either of these matters, sending a clear message to Wall Street that manipulating the truth is an accepted form of earnings management.