Canada's big banks brace for higher loan losses amid oil slump

This week has given us the first peek at how Canada's big banks are faring in the world of low oil prices. Losses so far have been modest. But banks know that deeper losses are likely in the future.

So far, the credit issues have been manageable. Will they stay that way?

The big concern among bank watchers is that a prolonged slump in the energy sector could develop into a wider problem with delinquent consumer mortgages and loans, especially in Alberta. (Larry MacDougal/Canadian Press)

This week has given us the first peek at how Canada's big banks are faring in the world of low oil prices.

With five of the Big Six reporting first-quarter results (Scotiabank reports next Tuesday), the banks have shown they are already feeling the effects of the plunge in energy prices.

So far, the credit issues have been manageable, even as several banks boosted their loan loss provisions to reflect a rising level of difficulty in the oil and gas sector. But several bank executives also acknowledged that those provisions could grow in the coming quarters.

This week's earnings reports also show that the banks, whatever problems they are experiencing or are expecting because of the weakened environment around low oil, are steady profit machines and will likely remain so.

Three of them — TD, RBC and CIBC — were confident enough this week to boost their quarterly dividends.

Data from Bloomberg show that the loans made by Canadian banks to energy companies are a relatively small percentage of their total loan book — topping out at 3.5 per cent at Scotiabank.  

But the big concern among bank watchers is that a prolonged slump in the energy sector could spread into a wider problem with delinquent consumer mortgages and loans, especially in Alberta.

Profits under pressure

Moody's Investor Services warned on Monday — just before the banks started releasing their financial reports — that falling oil prices would "strain the profitability" of the big banks. That's under Moody's "moderate distress" scenario.

Under a less likely "severe stress" scenario, Moody's said the banks might even need to cut dividends or issue more shares to raise money.

So what have the banks revealed so far? Only two — BMO and RBC — have substantially boosted their energy loan loss provisions.

The losses we see here today stand as a warning of what is to come for the sector as a whole.– Meny Grauman, Cormack Securities

Royal Bank doubled its provision for credit losses in the oil and gas sector to $310 million from the previous quarter's $156 million.

"There's no question that the persistently low oil prices are tough for clients in the affected regions and are driving an increase in credit provisions in our portfolio," RBC chief executive David McKay said Wednesday.

BMO said impaired energy loans rose almost 60 per cent from the previous quarter to $162 million. 

Modest deterioration 

But as a proportion of the banks' total loan portfolios, those amounts are negligible. The question is: will they stay that way?

"We think that, if anything, Royal Bank is a bellwether, and that the losses we see here today stand as a warning of what is to come for the sector as a whole," wrote Cormack Securities analyst Meny Grauman in a note to clients.

The banks themselves are acknowledging that they're hardly out of the woods, as far as potential loan losses from the energy sector are concerned.
The five Canadian banks that have reported Q1 financial results so far say they made $6.983 billion in profits, up 1.8 per cent from the same quarter last year. (Adrien Veczan/Canadian Press)

CIBC, which reported only a slight quarter-over-quarter increase in gross impaired energy loans, said the problem is likely to grow.

"We are seeing this quarter … a lot of downgrades in the oil and gas space, an increase in delinquencies," CIBC chief risk officer Laura Dottori-Attanasio said Thursday in a conference call with analysts. "Our expectation would be to see increased loan loss provisions on a go-forward basis," she said.

A difficult year 

Barclays financial services analyst John Aiken thinks it will be difficult for the banks to report profit growth this year.

"While we admit that the full impact of the energy decline will take time to be felt by the Canadian economy and even longer to fully impact the banks' credit quality, it is hard to ignore the fact that the outlook for 2016 is shaping up to be even more difficult than 2015," he said in a note to clients last week. He substantially lowered his price targets on the six largest Canadian banks by an average of almost 20 per cent.

Investors seem to be wary, too. In the last three months, the S&P/TSX bank index has underperformed the broader TSX market by more than three percentage points. 

The consensus recommendation of analysts surveyed by Thomson Reuters First Call is a "hold" for shares of most of the Big Six, with only RBC and TD rated as a "buy."  

But Canadian banks have shown through the years that they have many ways of making money, even when the economic skies turn cloudy. The total first-quarter net earnings at the five banks that have reported so far were up 1.8 per cent from a year ago, to $6.983 billion.  


In the meantime, the banks say they haven't been idly watching as economic conditions deteriorated.

They're busy stress-testing how their loan books are likely to fare if oil goes as low as $25 a barrel and stays there. 

"We constantly adjust our underwriting criteria based on where we see the economic situation in every market, and Alberta is not different," BMO chief risk officer Surjit Rajpal said in a conference call this week. "We actually have already made changes to how we underwrite in Alberta."

The oil and gas industry, of course, has also made painful moves to shore up capital — thousands of layoffs and major spending reductions.

"I think they've been quicker to take actions than they had in past cycles," Rajpal said.

"I think the only unknown right now is how long will it last." 

With files from Reuters and The Canadian Press


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