The Impact of Oil Prices on Bank Lending or “Will the Tail Wag the Dog?”

The Federal Reserve Board recently released its survey of senior bank loan officers. The April 2015 Senior Loan Officer Opinion Survey on Bank Lending Practices (SLOOS) addressed changes in the standards and terms on, and demand for, bank loans to households and businesses and over the first quarter of 2015.

A previous post discussed a special question on bank approval of residential mortgage applications, but in addition to a special question related to household lending, the SLOOS also included special questions on business lending. One set of special questions on business lending addressed lending to firms in the oil and natural gas drilling or extraction sector. In response to the rapid decline in oil prices over the second half of 2014, the ability of firms in the oil and natural gas drilling or extraction sector to service their loan payments may have become impaired, thereby transferring financial stress to banks.

The results of these survey questions indicate that, on net, banks, both large and small, expect their loans made to firms in the oil and natural gas drilling or extraction sector to deteriorate. The net share is the difference between the percentage of banks reporting that these loans will improve and the portion responding that these loans will deteriorate. According to Figure 1, a net share of 56.8% of banks expect loans made to firms in the oil and natural gas drilling or extraction sector to deteriorate. While 2.0% of banks expect these loans to improve 58.8%, more than half of banks, expect these loans to deteriorate.

Both large and small banks have similar expectations for the loans that they respectively made to firms in the oil and natural gas drilling or extraction sector. As shown in Figure 1, a net proportion of 57.6% of large banks expect loans made to this sector of firms to deteriorate, no bank expects these loans to improve and 57.6%, or more than half, of all large banks expect the loans made to these firms to deteriorate. Meanwhile, a net percentage of 55.5% of smaller, regional banks expect loans made to these firms to deteriorate, 5.6% of these banks expect loans made to firms in the oil and natural gas drilling or extraction sector to improve, but 61.1%, or more than half, of smaller, regional banks expect these loans to deteriorate.

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In response to the expectation of loan deterioration, most banks consider restructuring outstanding loans to make them more robust to energy prices and also reducing the size of existing credit lines to firms in this sector to be an important step in mitigating the risks of loan losses from loans made to firms in the oil and natural gas drilling and extraction sector. To a somewhat lesser extent, banks consider tightening underwriting policies on new loans to firms in this sector and requiring additional collateral to better secure loans or lines of credit made to firms in this sector to also be important steps.

The SLOOS offers 6 possible responses to mitigate loan losses and, for all of these options, asks banks to identify which change is considered “not important”, “somewhat important”, or “very important”. At 82.3% and 80.4% respectively, restructuring outstanding loans to make them more robust to energy prices and reducing the size of existing credit lines to firms in this sector garnered the largest percentage of banks responding either “somewhat important” or “very important”. More than half of banks, 52.9% and 54.9% respectively, said these options were “somewhat important” and 29.4% and 25.5% respectively, said that these two options were “very important”.

An equal percentage, 70.6%, of banks mentioned that tightening underwriting policies on new loans made to firms in this sector was important, as is requiring additional collateral to better secure loans and lines of credit to firms in this sector. Among these two options, a larger proportion of banks considered requiring additional collateral as “somewhat important”, 54.9% versus 41.2%, but a higher share of banks believed that tightening underwriting policies on new loans to firms in this sector was “very important”, 29.4% versus 15.7%. Meanwhile, less than half of banks, 49.0%, considered enforcing material adverse change clauses to limit draws to be important and only 29.4% of banks have plans to tighten underwriting polices on new loans or credit lines made to firms in other sectors.

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Although the majority of banks, both large and smaller, expect loans to firms in the oil and natural gas drilling and extraction sector to deteriorate, these loans are not a large component of bank balance sheets. As a share of all Commercial and Industrial (C&I) loans held, loans to these firms does not exceed 30% at any bank, shown in Figure 3 below. When taken as a share of C&I loans, these loans make up less than 10% at a vast majority, 82.4%, of banks.

The steep decline in oil prices over the latter part of 2014 has been well documented. Members of the housing industry are, rightly, concerned about the impact of the oil price decline on homebuilding. One channel by which lower oil prices can impact homebuilding is through loans made to home builders. For example, a decrease in the performance of loans made to firms in the oil and natural gas drilling and extraction sector may lead banks to tighten their standards on loans made to home builders. However, the results of the SLOOS highlight two reasons why this is not likely to occur. The first reason is, for the vast majority of banks, these loans are a small portion of total C&I loans that they hold. Second, for the majority of banks, efforts to mitigate risks of loan losses from loans made to firms in the oil and natural gas drilling and extraction sector are not likely to include tightening underwriting policies on new loans or credit lines made to firms in other sectors.

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