Lower Oil Prices Drag Down Profits, Drive Up Loans

May 5, 2016

By HV

Not only do the lower oil and energy prices take their toll on oil companies, they spill over to banks, drive up their problematic loans, and even put an end to oil-related R&D projects.

Banks are suffering

Wells Fargo reports a 62% increase in potential problematic loans, or criticized loans, from $18.5 billion to nearly $30 billion for the first three months of 2016.

JPMorgan sees a 45% increase in criticized loans, from $14.6 billion to $21.2 billion, over the same period.

banks

Criticized loans are used to classify those with weaknesses to worthless ones that should no longer count as assets on bank balances sheets.

The oil and energy companies are having a hard time paying their debts due to plummeting oil prices. Back in March, the Oil & Gas Liquidity Stress Index deteriorated to the worst level ever following the downgrade of 19 energy companies. The index jumped to a record high of 27.2%, meaning 27.2% of the oil and gas sector faces credit problems.

It forces the banks to increase their reserves for possible loan losses. Bank of America and Wells Fargo had to set aside $997 million and $1.1 billion, respectively, to cover bad loans to oil and energy companies.

But doing so causes their profits to plummet in return. Bank of America reported a 13% drop in its net income, and Wells Fargo’s net income fell 5.9%. Comerica marked more than half of its energy loans as criticized, resulting in the bank’s profits falling more than half.

R&D projects on the wayside

In a desperate attempt to cut cost, the oil industry has vanquished $270 billion in projects since the crash of crude prices two years ago. They were high-tech projects aiming to sustain the global energy supplies, but reduced to a relic of a time where big energy companies spared no expense to push into new frontiers.

oil

According to IHS Inc, an information and analytics firm based in Colorado, the oil-and-gas industry spent 15% less on R&D in 2015 compared with 2014. And the focus of R&D has shifted to reducing costs and improving efficiency.

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