Falling Oil Prices: Good For Drivers, Bad For Banks

Transcript

SCOTT SIMON, HOST:

This is WEEKEND EDITION from NPR News. I'm Scott Simon.

JOSEPH JEAN-BAPTISTE: I'm Joseph Jean-Baptiste from Miami, Florida. Gas prices have been beautiful. I've been putting Supreme - 93 - because prices are so low.

ANGIE CHISLEY: Angie Chisley, Waldorf, Maryland. I have three kids, so cheaper gas is better because it pays for the bills and gets more stuff for my children. And yeah, I save a lot of money in gas, a lot.

SIMON: Falling oil prices are great for a family budget, but they are not so great for other segments of the economy, especially banks. Lending money to energy companies is usually a pretty profitable business. But if the price of oil drops low enough, the threat of default becomes real. Indeed, it's happened before, in the 1980s. And bank defaults are not good for anyone. Charles Peabody, a banking analyst at Portales Partners, joins us from our studios in New York.

Thanks very for much for being with us.

CHARLES PEABODY: My pleasure.

SIMON: Explain to us how this relationship works out, that ties the banks to energy companies.

PEABODY: Well, there are several exposures and potential ripple effects. The first is, as energy companies cut their capital expenditure budgets, you're going to see less demands for loans. And so we expect a significant slow-down in corporate loans in the first half of 2015. Beyond that, if energy prices remain depressed, there will be problems created in the credits and potential write-offs in 2016 and beyond.

SIMON: And this creates a ripple effect in the economy?

PEABODY: It does. You know, what we saw in the '80s and what the banks underestimated was that ripple effect to Main Street. So your local Caterpillar or Deere dealer may suffer. Your local shopping mall may be hurt. Your local Main Street mom-and-pop shops may be hurt.

SIMON: What do you think bankers learned during the 1980s slow-down that might change the kind of evaluations they make today?

PEABODY: Very little. I think, you know, bankers continue to make the same mistakes decade after decade and cycle after cycle.

SIMON: Well, like what?

PEABODY: Underestimating the risk and, you know, their exposure to certain sectors. I think, in terms of the exposure to the energy industry, the banking industry has done a better job of confining that exposure. Most banks have low to mid-single-digit exposure as a percentage of their long portfolio to energy. But I think they'll underestimate the ripple effect and the volatility that we see in price corrections in various asset classes, and energy's just a symptom of that process.

SIMON: I think a lot of people remember what happened in the 1980s with falling oil prices. They saw businesses go under in unemployment. What would you project might be on the horizon this time?

PEABODY: It's going to start with a slow-down in growth, in particularly, areas like Texas, Oklahoma, Montana, North Dakota et cetera, the energy producing states. It's going to spill over into Main Street and you're going to see an increase in non-performing assets in the banking system. And most of that will start the second half of this year. And then you'll start to see significant write-offs and loan losses recording in 2016.

SIMON: There's been no secret that over the past generation, or more at this point, a lot of people in the United States are interested in making the United States, you know the phrase - energy independent.

PEABODY: Correct, and as a part of that, there's the assumption that asset prices will always rise. And the assumption is you continue to drill more, you know, holes. So what caught the bankers this time and every time is, when you get very violent corrections and asset prices, which will change collateral values, and you get very significant changes in the assumption of growth.

SIMON: And a lot of that hasn't registered yet?

PEABODY: No, there are long lead and lag times between the event and the fallout of that event.

SIMON: Charles Peabody. He is director in charge of research at Portales Partners.

Thank you so much for joining us.

PEABODY: My pleasure. Transcript provided by NPR, Copyright NPR.