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After a risky bet on the oil industry went the wrong way last month, Capital One Financial Corporation sought relief from regulators, a step that raised eyebrows among public watchdogs and Wall Street analysts.
But on Friday the bank told MarketWatch that it intends to withdraw the request, saying it is not needed.
At issue are derivatives, contracts between financial institutions that are based on the value of other assets.
Capital One COF, -3.77% entered into such contracts with oil and gas production companies to whom it had made loans in 2018 and 2019. As is typical, the bank also entered into derivatives contracts with other parties to offset the risk from the first set of agreements.
But when the price of crude oil plunged by more than half in the last few months after a global price war between Saudi Arabia and Russia, the value of those derivatives changed sharply.
In March, Capital One asked the Commodities Futures Trading Commission, which regulates derivatives, for a waiver that would allow it to avoid registering as a “Major Swap Participant.”
The “Major Swap Participant” category applies to any financial institution with swaps worth at least $1 billion in daily average exposure.
“We asked the CFTC for temporary relief from the designation of Major Swap Participant because commodity price volatility could temporarily cause us to reach the threshold triggering MSP registration,” a Capital One spokesperson told MarketWatch in a statement.
“We are not an MSP. To alleviate confusion, we are withdrawing our waiver request and will register as derivative volumes require.”
Reuters was the first to identify the bank, after the CFTC granted that request anonymously on March 20.
The flurry of press attention around that decision is a signal to broader financial markets that Capital One was dabbling in business lines it’s not known for, said Chris Whalen, a long-time independent banking analyst.
“This is a bank that’s in consumer finance but doesn’t have a Main Street banking presence,” Whalen said.
Third-party estimates of the bank’s officially-stated exposure to commercial and industrial loans to the energy sector are only about 1.4% of its book. Capital One did mention the derivatives in a footnote in its 10-K in 2018 and 2019.
| We enter into those derivatives with our customers primarily to help them manage their interest rate risks, hedge their energy and other commodities exposures, and manage foreign currency fluctuations. We then enter into offsetting derivative contracts with Counterparties to economically hedge the majority of our subsequent exposures. |
“If they do have other sources of risk, it adds complexity to understanding the stock,” Whalen said. We all understand consumer finance, but this… this is in the territory of a big investment bank like Goldman Sachs or Morgan Stanley.”
Capital One’s statement also said, “Our Commercial Bank does no speculative trading. Since 2015, our commercial bank has provided commodity price hedges as a service to some of our oil & gas customers. When we enter into these hedges with our clients, we simultaneously enter into hedges with investment banks to reduce our exposure to commodity risk to essentially zero, and we are subject to no outstanding margin calls. There has been no change to this normal hedging activity, which is described in our quarterly 10Qs and 10K.”
The CFTC’s decision to anonymously grant registration relief was a first, and a troubling precedent, said Tyson Slocum, energy program director for watchdog group Public Citizen. Slocum is also a member of an advisory committee to the CFTC, and publicly protested the March 20 decision.
“It’s not the job of the CFTC to bail out the oil and gas sector, it’s to protect against systemic financial risks,” Slocum told MarketWatch. Derivatives were the same financial instruments that brought the financial system to its knees in 2008, and the Dodd-Frank regulation passed a few years later charged the CFTC with making sure nothing like that happened again, he pointed out.
Slocum was particularly troubled by the decision to keep the identity of the bank anonymous. “There is abundant public interest in identifying the recipient of such relief.”
In response to a request for comment, a CFTC spokesman said, “Commission rules prohibit the agency from publishing any portion of a request letter or the agency’s response to the request, which would separately disclose the business transactions or market positions of any person or trade secrets or names of customers. In the case of this matter, naming the entity would have in effect done that. To call it a bailout is misleading, as we are not providing anyone with taxpayer dollars. This is temporary, targeted regulatory relief.”
Slocum called that “nonsense.” If the regulator can waive its rules to allow a bank not to register, it should waive them to make public the identity of a potentially troubled financial institution, he said.
Given the unprecedented nature of the CFTC request, as well as the unsettled energy markets, it’s unclear what will happen next. Capital One is scheduled to report its first-quarter earnings on April 28, according to FactSet.
