A boom in lending to energy companies in the United States has the country's banking regulator worried that the meteoric rise will lead to loose underwriting standards.
Because the U.S. energy sector has exploded in recent years, driven by shale oil and gas production, banks are piling into the market. Heavyweights such as Bank of America Corp. and JPMorgan Chase & Co. have long lent to energy companies, and now their rivals are bulking up, with Associated Banc-Corp more than doubling its oil and gas portfolio in 2013 and Wells Fargo & Co. buying BNP Paribas SA's energy lending business in 2012.
The energy sector's rapid growth also looks much more lucrative now that mortgage lending is cooling – as proven by JPMorgan and Citigroup's latest earnings results – and competition in auto lending is becoming incredibly fierce, forcing some banks to target riskier borrowers to drive growth.
Before the market gets ahead of itself, the Office of the Comptroller of the Currency, the U.S. banking watchdog, has laid out some new ground rules because "increased competition leads to more aggressive underwriting and potential problems," rating agency Moody's Investors Service wrote in a recent report.
To start, the OCC released its first Oil and Gas Production Lending Handbook, which underscores the risks inherent in oil and gas production lending, details proper loan examination procedures and outlines the regulator's risk management expectations.
The new guidelines should help to improve poor disclosure of energy loans, which U.S. banks typically do not break out in their filings with regulators and communications with investors. Their Canadian counterparts, by contrast, outline their commercial lending exposures by sector – including Bank of Nova Scotia, which has a sizeable U.S. energy lending portfolio.
Moody's, which rates the banks' credit-worthiness, admits to having trouble tracking their exposures to energy. "Currently, regulatory filings do not require detailed information on sector exposure and details are minimal in banks' 10-Ks and 10-Qs," the agency said. "Often, most information about a bank's energy lending initiatives is in press releases, investor presentations and earnings call transcripts, where detail is lacking."
Until now, the agency – and investors – have simply had to rely on high-level figures and other updates, such as JPMorgan increasing its credit exposure to energy by 10 per cent in 2013 and Fifth Third Bank forming an energy banking team in 2012.
"The OCC's regulatory focus should temper this aggressiveness and lead to better disclosure of banks' energy exposure," Moody's noted.