Downhill Slide for Oil Impacts Financials and Regional Economy

Rick Spencer, CFA, Fixed Income Trader
March 25, 2016

The decline in energy prices over the last two years has benefited American consumers through lower gasoline and utilities costs while holding down inflationary pressure.

Lower-income families can spend more than 20 percent of their incomes on energy, including both gasoline and electricity[1]. While many have benefited, the spillover effects of lower oil prices, such as increased risk and lower revenues, have hit business and government entities in Texas, Oklahoma and Louisiana.

Volatility was the story for oil prices in 2015, and it’s been a similar tale so far this year. In fact, oil has been on a roller coaster since mid-2014, dropping from $107 per barrel in July of that year to as low as $38.09 on Aug. 24, 2015. After a rally into November, the decline in crude steepened, eventually hitting the $26 level in January, and spillover effects became more evident in other markets.

 

Banks See Write-Downs and Lower Earnings

Changes in oil prices can dramatically affect other areas of the economy, such as regional banks that lend to energy companies. In the 1980s, the Texas economy saw a very strong banking industry reduced to rubble. An 80-percent drop in oil prices followed by a real estate decline caused loan default rates to skyrocket, driving the banks into failures or acquisitions at fire-sale prices by out-of-state banks. Of the top 10 banks based in Texas, only Cullen/Frost (CFR) survived without federal assistance or a forced merger with an out-ofstate institution.

Fast forward to late 2014, and a strong local economy and firm energy prices saw regional banks in Texas and Oklahoma like Cullen/ Frost (CFR), BOK Financial (BOKF), Texas Capital Bank (TCBI) and Prosperity Bank (PB) trading at or near all-time highs. Despite relatively low exposure of loan portfolios to energy, an examination of the price action over the last 15 months shows a strong correlation between oil prices and bank stock prices.

Business was good in the oil industry in November 2014, with West Texas Intermediate Crude (WTI) trading at around $77 per barrel. On Nov. 7, 2014, Cullen Frost (CFR) stock hit an all-time high of $81.13. As crude declined to below $40 in August 2015, regional bank stocks followed, with CFR dropping 24 percent from its November 2014 high to $59.40. In comparison, the S&P 500 Index was down less than 5 percent over the same period.

After a brief rally into November, the decline accelerated, with WTI dropping almost 45 percent in 10 weeks, hitting $26.55 on Jan. 20. CFR followed crude lower, hitting $42.55, down 42 percent from where it traded in November. Pain was evident on the balance sheet, as well, by the fourth quarter of 2015, with loan loss provisions increasing more than 600 percent from year to year and quarterly earnings per share coming in below the previous year despite an increase in revenues.

 

Municipal Finances Feel the Stress of Lower Oil Prices

As energy prices plunged to new lows, city and state governments were impacted, as well. Reduced production activity and employment in the energy business pushed revenues below budgeted projections. The state of Louisiana is projecting a $940-million deficit for the current fiscal year and a $2-billion gap for the fiscal year beginning July 1.

Governor John Bel Edwards is pushing for a higher sales tax and cuts to public services to narrow the budgetary gap. Unless action is taken quickly to reduce the deficit, it is possible that public health programs and some universities, including flagship institution Louisiana State University and its beloved football program, may be forced to close.

Louisiana municipal bonds have been affected by the budget pressures, with spreads rising relative to national peers. Bonds maturing in August 2024 recently traded at a yield of 1.83 percent, yielding 0.41 percent more than benchmark municipals. LSU bonds maturing in 2028 recently traded at yields close to 1 percent more than the average for AAA bonds of that maturity.

Across the border in Texas, finances look much better. Current projections are for a $4-billion budget surplus, though continued low oil prices could reduce that number. While more than 30,000 jobs have been lost in the energy sector over the last year, the state still logged an increase of 179,000 new jobs, many of them in the health care and hospitality industries.

 

Surveying for Opportunities

Though we are well below mid-2015 levels, we can take some comfort in the fact that energy prices have advanced some 45 percent from the bottom in early February. Energy equities and bonds have advanced, as well, as earnings prospects improve. The energy-sensitive banks have also seen their stock prices recover from the recent lows.

There is little doubt that energy prices will continue to be volatile over the coming year. It would be an excellent time to sit down with your advisor and ask: Does my asset allocation fit my objectives and risk tolerance? What is my exposure to energy and financials? How are my municipal bonds or funds performing?

Investors could possibly see better opportunities in 2016 than were available in recent years. Growth-oriented investors might see opportunity in regional bank stocks trading near 52-week lows. Income investors could be intrigued by the yields of the short- to intermediate-term bonds of the larger integrated energy firms. When considering these opportunities, it is always important that we stay within the bounds of what is appropriate for our investment strategies and situations.

 

[1] http://www.cnbc.com/2016/02/24/dont-need-new-supreme-court-justice-to-decide-war-on-coal.html

 

Disclosures:

All opinions expressed and data provided are subject to change without notice. Some of these opinions may not be appropriate to every investor.

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About the Author

Rick Spencer is a fixed income trader for the Capital Markets Group at 1st Global. In this role, he partners with affiliated advisors to apply his fixed income expertise to discover and create solutions that meet the clients’ needs.

 

About the Capital Markets Group

The Capital Markets Group at 1st Global is a team of professionals with backgrounds and experience from large banks and broker-dealers in the industry. These individuals have the capabilities, knowledge and market relationships to provide timely trading, research and consulting to enable our advisors to service and nurture their business relationships with their clients.