Selling billions of dollars worth of insurance on things that turn out to, on occasion, exhibit extraordinary volatility can be a dangerous thing — just ask AIG which was sucked dry by collateral calls from a certain vampire squid when the M2M value of the MBS the company so foolishly insured cratered in 2008 and Goldman came banging on the door for its money. And while the value of the price hedges (i.e. insurance contracts) the US banking sector has sold to the country’s now beleaguered shale drillers may not be large enough to present an imminent systemic risk, as Bloomberg [21] notes, “$26 billion is still $26 billion”:
For U.S. shale drillers, the crash in oil prices came with a $26 billion safety net. That’s how much they stand to get paid on insurance they bought to protect themselves against a bear market -- as long as prices stay low…
The fair value of hedges held by 57 U.S. companies in the Bloomberg Intelligence North America Independent Explorers and Producers index rose to $26 billion as of Dec. 31, a fivefold increase from the end of September, according to data compiled by Bloomberg.
Though it’s difficult to determine who will ultimately lose money on the trades and how much, a handful of drillers do reveal the names of their counterparties, offering a glimpse of how the risk of falling oil prices moved through the financial system.
More than a dozen energy companies say they buy hedges from their lenders, including JPMorgan, Wells Fargo, Citigroup and Bank of America…
At the end of 2014, JPMorgan had about $671.5 million worth of derivatives exposure to five energy companies, including Pioneer Natural Resources Co., Concho
Resources Inc., PDC Energy Inc. and Antero Resources Corp., according to company records. That’s the amount JPMorgan would have owed if the contracts were settled Dec. 31, not including any offsetting trades the bank made.
It’s a similar story for Wells Fargo, which was on the hook for $460.9 million worth of oil and natural gas derivatives for companies including Carrizo Oil & Gas Inc., Pioneer, Antero, Concho and PDC, according to regulatory filings.
Of course, as Bloomberg goes on to point out, these are the same banks which helped to finance the shale bonanza in the first place and as we recently saw with Standard Chartered [22], collapsing crude prices can spell trouble if you’re in the commodities loans business.
Those who sold the price hedges now have to make good. At the top of the list are the same Wall Street banks that financed the biggest energy boom in U.S. history, including JPMorgan Chase & Co., Bank of America Corp., Citigroup Inc. and Wells Fargo & Co.
That list is particularly interesting because as the following graphic shows, these banks are the first, second, third, and sixth largest bookrunners for leveraged oil & gas loans over the past three years:
[23]
Here’s The Telegraph [24] with more...
A lengthy period of cheap crude is likely to trigger widespread defaults and many oil and gas loans are now changing hands for well below their face value as investors fear they will not get their money back.
Banks will offload many of the loans and hedge their losses, and some will have stricter lending standards for high-yield loans than others.
Losses will also depend on how long the oil price stays low, so it is unclear precisely how exposed the banks are to the energy industry’s woes...
Chirantan Barua, an analyst at Bernstein Research, has estimated that the combined losses of Barclays, RBS, HSBC and Standard Chartered from falling oil prices could amount to $3.4bn.
“Someone is feeling the pain,” said Mr Barua. “When you see [this much] high-yield issuance in a sector that has been levering up across the supply chain, any shocks in the underlying business will have risk ripples across the financial system...”
According to Dealogic’s data, RBS has arranged $14.3bn of leveraged oil and gas loans in the past four years, making it the biggest UK player in the high-yield space.
This compares to $10.5bn for Barclays and $4.7bn for HSBC, but is far less than the biggest Wall Street players. Wells Fargo and JP Morgan have both been bookrunners on almost $100bn since the start of 2011.
...and a bit more color from NY Times [25]:
Two of the banks that may be the hardest hit by lower investment-banking fees are among the biggest. Wells Fargo derived about 15 percent of its investment banking fee revenue last year from the oil and gas industry, while at Citigroup, the business accounted for roughly 12 percent, according to the data provider Dealogic…
And Wall Street firms that financed energy deals may now have trouble offloading some of the debt, as they had originally planned.
Morgan Stanley, for instance, led a group of banks that made $850 million of loans to Vine Oil and Gas, an affiliate of Blackstone, aprivate equity firm. Morgan Stanley is still trying to sell the debt, according to a person briefed on the transaction.
Similarly,Goldman Sachs and UBS led a $220 million loan last year to the private equity firm Apollo Global Management to buy Express Energy Services. Not all the debt has been sold to other investors, according to people briefed on the transaction.
A precipitous drop in oil prices can quickly turn loans that once seemed safe and conservatively underwritten into risky assets.
The collateral underpinning many energy loans, for example, is oil that was valued at $80 a barrel at the time the loans were made. As oil has dropped well below that price in recent months, the value of the banks’ collateral has sunk.
[26]
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So it certainly looks like a lot is riding on the degree to which large US banks have been successful at offloading their exposure to the sector (which, thanks to falling crude prices and mounting bankruptcies is likely getting more difficult by the week) and on how well they have been able to hedge the hedges they sold to shale drillers. Any way you slice it, it's difficult to see how this turns out particularly well, for if Barclays, RBS, HSBC, and Standard Chartered may be facing a combined $3.4 billion in losses and they represent a small portion of the market compared to Wall Street's largest firms, and if these same US banks are facing $26 billion in exposure on hedges they sold, well, "someone is feeling the pain," as the Bernstein analyst told The Telegraph. As for the likelihood that most of the risk has been transferred to outside investors or otherwise hedged, we'll leave you with the following quote from an analyst who spoke to Bloomberg on the matter:
"The banks always tell us that they try to lay off the risk [but] I know from history and practice that it’s great in concept, but it’s hard to do in reality.”
