In a landmark shift, JP Morgan ends financing of new coal mines
On Mar. 9, due in part to pressure from the Rainforest Action Network, major U.S. financial institution JP Morgan Chase & Co. (NYSE: JPM) vowed to curb financing to coal companies. The news did not get much attention at the time, but it nevertheless represents a watershed moment for the climate change movement. JP Morgan is the biggest bank in the country by assets, but to date has not placed significant investment in renewable energy investment.
This announcement speaks volumes about where the future of big banks and their fossil fuel investments could be headed.
A landmark collaboration
JP Morgan announced it would end financing of new coal mines, and also will stop financing new coal-fired power plants in developed countries. This fuels hope that JP Morgan will steer a greater portion of its corporate lending activities to renewable firms, many of which are still in the start-up phase of development, and need external financing to continue growing.
JP Morgan’s decision to reduce its exposure to the coal industry makes sense from a social standpoint, but more importantly, it also makes financial sense as well. The company’s credit portfolio has taken a big hit from losses in its oil and gas loans. Going forward, this could be the perfect opportunity to increase loans to the renewable sector, an area that is under-served by major financial institutions like JP Morgan.
While it’s important not to read too much into this one announcement, it could represent an important shift in strategy. This may finally be a meaningful reversal, because in recent years, JP Morgan’s broader fixed income strategy was to build up its investments in oil and gas loans. That decision made great sense when oil was at $100 per barrel, but is now hurting the company.
Energy loans take a toll
Before the renewable energy revolution, bank loans to the energy sector were almost exclusively made to fossil fuel companies. But as renewable energy companies become economically viable and begin to generate steady profits, attitudes are changing from lenders. Loans to the renewable industry are no longer as speculative as they once were. In fact, it’s the loans made to coal and oil companies that are hurting banks the most right now.
As oil prices have collapsed, from over $100 per barrel in 2014 to $27 per barrel at their 2016 lows, banks are taking on significant losses in their energy loan portfolios. JP Morgan is a best-of-breed financial institution, but it is not immune. Its loan portfolio bore the brunt of the carnage within the energy sector, as a result of extremely low oil and natural gas prices. Due mostly to losses in its oil and gas loan portfolio, JP Morgan set aside $1.8 billion for credit losses last quarter, nearly double the $959 million in the year-ago quarter.
JP Morgan’s oil and gas loans are serving as a huge weight on the company. As of Dec. 31, 2015, JP Morgan had a $42 billion loan exposure to the oil and gas industry, its seventh biggest out of 19 industry groups. Of that, only $24.3 billion was considered investment grade—meaning 43 percent of the company’s oil and gas loans are rated below-investment grade, or junk. In an environment of $40 oil or below, that is a major concern. Of its non-investment grade loans, the portion allocated to oil and gas has a higher level of what JP Morgan refers to as “criticized non-performing” loans, than any other industry within the company’s wholesale credit portfolio.
By comparison, JP Morgan has little in loan activity to the renewables space to speak of. Last year, JP Morgan underwrote more than $4 billion in green and sustainability-oriented bonds, and arranged $2 billion in capital for renewable energy projects in the United States. That seems great on the surface, but in the context of a $783 billion loan portfolio, it’s a relative pittance.
Some of this is due to a broader skepticism among financial institutions regarding the economic viability of renewables as a whole. Like other banks, JP Morgan classifies its alternative energy investments as Principal Investments, which are investments that the firm deems to have unique risks. Some of this investing is done largely for tax benefits, including its alternative energy investments. But considering the escalating losses in its oil and gas loan portfolio, it can be debated where the more significant risks really are.
More renewable energy focused companies are seeing more profit than ever before, but JP Morgan needs to do more to engage this industry. Otherwise, it risks missing out on an emerging industry revolution. JP Morgan is not a financial institution unwilling to lend—its credit facilities are wide open, and growing. Since 2011, JP Morgan’s commercial and industrial loan portfolio has grown at an 8 percent compound annual growth rate. It’s time to incorporate renewables more seriously into its loan portfolio.
But as the saying goes, it’s better late than never. As a result, the agreement to no longer extend financing for new coal mines and new coal-fired plants at least represents progress, and another step forward in what is hopefully a long journey toward renewable energy investing.
Companies to watch:
Wells Fargo & Co. (NYSE: WFC): It will be interesting to see if other banks follow in JP Morgan’s footsteps. Wells Fargo is one of the nation’s premier big banks, the third-largest by assets. Just like JP Morgan, it is also experiencing steep losses from oil and gas exposure. Net charge-offs were $886 million last quarter, up $178 million from the same quarter the previous year. Its provision for credit losses exceeded net charge-offs by $200 million last quarter. Wells Fargo is also hurting from the fallout in the oil and gas industry, and with JP Morgan’s announcement as a precedent, perhaps it will take a bold step itself to reduce lending to fossil fuel producers.
Bob Ciura is an independent equity analyst. Since 2012, his work has focused on fundamental investment analysis of publicly-traded companies in the energy, technology, and consumer goods industries. Bob has a Bachelor's degree in Finance and an MBA in Finance.