Last week we traveled to Texas with a group of investors to meet with management teams from 15 different banks (14 are publicly traded). With the exception of six banks, all are headquartered in Texas, and all but one has notable energy exposure in their loan portfolios (Oklahoma, Mississippi, Arkansas, and Louisiana banks also participated). The stocks of most of these banks have dropped over the past 12 months in unison with the massive decline in energy prices, with average declines of 8% and 19% in 2015 and YTD, respectively. As oil is still hovering in the low $30 price range and with the banks having just reported, these meetings were quite timely.


Attractive yield
  • Large, Diverse Economy: Texas is home to a massive energy sector, but other industries including healthcare, tourism, construction, and technology contribute to its GDP of ~US$1.6 tln
  • Diversification Driving Job Creation: Although increasing, management teams noted that Texas still has a lower unemployment rate than the U.S. national level, and is expected to create over 100k jobs in 2016
  • Low Oil Prices Leading to Increased Provisions: Banks in Texas, and some neighbouring states, are feeling the pressure from low oil prices as clients’ revenues decline and businesses shut down
  • Proactive Approach to Credit Management: Significant push on customers to increase loan collateral; Most executives not anticipating oil prices to move much higher in 2016
  • M&A on Hold, Buybacks a Priority: Most CEOs not expecting additional bank M&A driven by the drop in energy; Buybacks have become a priority for some banks due to the depressed / attractive valuations
  • Economy Different Than it was During Last Downturn: Diversification of Texas economy and job market leaving executives confident in resilience
  • First Signs of Weakness in Commercial Real Estate: Investors worried about indirect impact of oil shocks; Seeing first signs of softness in the Houston CRE market
  • Opportunity to Increase Exposure: Differences in strategy on oil and gas loan exposure, with some executives using the retrenchment of competitors to increase energy loans

Summary Facts about Texas

Texas has a population of ~27 million[1] and a GDP of over US$1.6 trillion[2] (comparable to Canada). Due to the pro-business / growth regulatory and tax policies, hundreds of companies have moved their headquarters to Texas since 2004 (many in sectors other than energy). Texas is now home to 54 Fortune 500 companies, 2nd in number only to New York. Although the unemployment rate in Texas has increased over the past year, it is currently at 4.7%, still lower than the national rate. Even with the downturn in energy prices, executives pointed out that Texas is expected to create 132k new jobs in 2016[3]. The state is home to the Permian Basin, the largest petroleum producing basin the U.S., but participating bank CEOs noted that it is also quite diversified, with prominent healthcare (Houston is home to the Texas Medical Centre, the world largest medical complex), construction, and technology industries, among others.

Key Takeaways from the Trip

Banks and Clients Feeling the Impact from Low Oil

Most bank executives with whom we met are not expecting oil to go much higher in 2016, and expect the performances of their loan portfolios to reflect that (i.e., migration to classified and in some cases non-performing, additional provisions and charge-offs). The energy exposure for participating banks averages 6.9% of loans (low of 0%, high of 21%). Multiple banks on the tour took large provisions for oil and gas loans in the fourth quarter, anticipating that the negative pressures on loan performance will continue.

Many oil field service companies have gone out of business already and most executives expect that trend will continue, in particular for the smaller, newer, and more leveraged firms (e.g., service companies supporting new drilling operations are some of the first to suffer). Revenues for some of these borrowers have declined by 50% year-over-year, but companies which are able to provide services to other industries are able to better manage the loss of business from the oil and gas sector.

Proactive Approach to Loan Quality Deterioration

The borrowing bases of many energy companies have been significantly lowered from the decline in oil, as many these customers on the production side were using their reserves as collateral. Multiple banks stated that they are stress testing their energy loan portfolios using estimates much lower than the futures curve for WTI, in efforts to be conservative and use “worst-case scenarios”. Banks are analyzing exposure going loan by loan, and if necessary, pushing customers to put up more collateral. This usually entails the customers raising equity or pledging additional assets, which include homes, ranches / summer homes, etc. In some cases, the borrowers have significant personal wealth and are putting additional equity into these companies using personal funds.

Many bank executives and their clients have been through cycles before. Although still difficult, previous experience has made it easier for borrowers to implement the business changes necessary to maintain debt servicing ratios, including cutting wages, then employees, and then if necessary, liquidating assets. As previously mentioned, bank executives believe the highly levered service companies will go out of business, but the mature firms will come out of this intact. In fact, some clients are viewing the downturn as an opportunity to buy the assets of failing competitors at deeply discounted prices (e.g., some auctions now at 60 cents on the dollar for equipment).

Over the past year, many banks forced their borrowers to put on hedges, which in hindsight turned out to be an excellent idea. Unfortunately for investors, the disclosure on hedging is inconsistent across banks’ reporting, and given this, some bank executives admitted that it may not be helpful in assessing the risk from a high level (e.g., useful on a loan by loan basis for the banks to stress test, but aggregate numbers may not be helpful for investors given differences in production costs by borrower).

M&A and Buybacks

Tour participants noted the problems with acquiring a struggling competitor right now. Analysts and investors would likely punish them for taking on more energy exposure, especially if it’s as a result of buying a bank with issues. Although most acknowledged that the downturn in energy prices and accompanying weakness in Houston will not likely lead to more M&A, multiple executives thought that regulatory costs would continue to drive banks to sell themselves (see M&A Insight where we describe the regulatory environment’s impact on U.S. bank M&A).

Some banks have increased their buybacks as their stocks prices have declined towards tangible book value (in some cases below). One bank executive noted that he strongly dislikes doing buybacks, but with his stock falling like it has, it’s hard to argue against it, and if he could, he would buy the entire bank himself at these prices. He was not alone in his confidence in the resilience of Texas banks, as multiple participants noted the unique opportunity to buy these banks at such a steep discount. As one executive stated, “the market has overreacted when it comes to Texas banks”.

Economic Diversification Leading to Confidence

Multiple bank executives noted the differences in the current Texas economy, specifically its diversification, when compared to the downturn in the 1980’s[4]. The banks in Dallas, although not as upbeat on the Houston market as those based in that city, were still generally positive on the Texas economy. Many on the trip cited the fact that Houston was still a net job creator in 2015 as evidence of the city’s diversification, with Texas as a whole creating 168k new jobs over the same period. In fact, multiple bank executives stated that they are more worried about Oklahoma than they are about Texas, given the former’s larger dependence on the energy industry for the state as a whole.

The Ripple Effect in Houston; First Signs of Weakness

One tour participant lamented that his stock price had the “Houston Discount”, and he was being punished, unfairly in his mind, for his location and loan issues that haven’t materialized. That stated, a few bank executives expect there to be further softening the Houston commercial real estate market. They are worried, in particular, on the higher-end multi-family and office properties, and noted that they were surprised that we haven’t seen more of an impact yet from the decline in energy prices. There have been some companies offering incentives to get people into high-rise apartment buildings, offering the first two months of rent off of a 14-month lease. This is evidence of the market slowing down, as office vacancies increased 2.6% from Q4 2014 to Q4 2015, although prices have yet to drop materially. One bank CEO noted that people are still spending money in Houston, but he admitted that the downturn may drive consumers to cut back on larger expenses in 2016.

Time to Double-Down?

Although most banks on the trip have been decreasing their exposure to energy in recent years, this has not been the universal business strategy amongst tour participants. One bank executive noted that he believes this is the time to increase exposure to the energy industry, stating that this is an opportunity to acquire “once-in-a-lifetime” customers, as other banks retrench and cut off funding. He also noted that the decline in liquidity from competitors has allowed him to dictate better terms and conditions, something not easily accomplished during the boom times when competition for loan growth in this sector was higher.


[1] Source: U.S. Census Bureau, 2014 estimate.
[2] Source: Federal Reserve Bank of St. Louis, 2014.
[3] Source: Federal Reserve Bank of Dallas.
[4] There were 425 commercial bank failures in Texas from 1980 to 1989, which included 9 of the 10 largest banks. The sharp increase in oil prices and subsequent decline, in addition to regulatory change, contributed to an overbuilding and collapse of commercial real estate in Texas, which ultimately led to widespread bank failure.

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