If forecasts from Barclays (LSE: BARC) (NYSE: BCS.US) are accurate — Brent crude down to $44 from $72 in 2015 — and oil prices stay low, several analysts may be forced to draft difference scenarios from which to derive the fair value of Barclays stock. Here’s why…
Oil Relationships & Barclays
Barclays is one of the most active lenders in the oil and resources sector. A strong player in the primary loan market, particularly in emerging markets, the bank is also marginally involved in the less liquid secondary market, where tranches of loans are sold and bought, trading just like any other security.
In the syndicated loan market, it’s not unusual to hear about “deals pulled”, as bankers say when a syndicated loan led by a group of banks — the bookrunners — can’t be sliced and sold to third parties, generally banks or institutional investors. Soon after 15 September 2008, when Lehman Brothers filed for bankruptcy, virtually all borrowers from Russia, Ukraine, Belarus, Latvia and other emerging market economies from the East had their deals pulled, as the market froze overnight.
Only Severneft and a couple of Gazprom-related entities still managed to raise a few billions from their relationship banks (again, the bookrunners), which negotiated higher fees and pricing, and could charge as much as they wanted on any maturity, but couldn’t find buyers in the primary market and had to share the risk among themselves.
Barclays has strong ties with oil producers both in Eastern Europe and in the Middle East, which is a great thing when the global economy runs at full throttle — but is more of a nuance when oil prices start plummeting as they have done since mid-2014.
Two Choices
When oil price plunge, lenders not only dictate the pricing of the debt to borrowers but also impose the overall structure of the loan, including size and tenor. It’s good to be a lender, but most of the exposure must be kept on the books.
If Barclays can’t find enough buyers in the marketplace now — potential lenders may not be able to take “country” or “name” risk if oil prices continue to remain low — it has two choices: a) it retains the client, keeping all the exposure on its books for some time, which may impact its earnings, given that the associated risk ranks higher than before; or b) it doesn’t lend any money at all to any such borrower, in which case it may lose all the additional ancillary business that usually comes with the loan, such as equity and advisory-related fees, bond refinancing and so forth — hence, lower earnings will come.
Either way, troubles may lie ahead. In late 2008, everybody wanted to know more about billions of exposure between banks and banks and borrowers, particularly those exposed to the leveraged loan market. Now, if oil prices remain low for a long period, banks will be asked more details about their exposure to the broader oil industry, you can bet on that!
“Banks including Barclays and Wells Fargo are facing potentially heavy losses on an $850m loan made to two oil and gas companies,” the Financial Times reported in November. That’s a tiny amount compared to the number of big oil clients in Barclays’s portfolio. Commodity-related business is risky, as proved this week when news emerged that Phibro, a commodity powerhouse founded more than 100 years ago, will be wound down by the end of March.
Analysts
So let’s hope Barclays is wrong about oil prices, at least for Barclays shareholders. Then, investors will just have to hope that Barclays will manage properly impairment and litigation risks, which pose a serious threat to earnings in the next few quarters.
The stock has been rising fast in recent weeks. It changes hands at almost 249p (its highest level for almost 10 months), and is getting closer to the average price target from brokers of 291p. But if Barclays is right, and oil prices remain subdued for long, most analysts will have to adjust their estimates to a fair value of 200p, which remains my suggested price target.
