A dramatic increase in expected energy-related loan losses at Canadian Western Bank has reignited concerns that the effects of the energy downturn are just beginning to be felt by the country’s biggest lenders.
In a pre-announcement before second quarter financial results are released later this month, the Edmonton-based bank said it will record $33 million of provisions for credit losses on its oil and gas production portfolio, owing to the weak oil price environment and borrowing base redeterminations.
In addition to the updated credit losses for the quarter, the bank sharply increased its full-year loan loss guidance to 35 to 45 basis points from 18 to 23 basis points.
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“Notwithstanding the recovery in the oil price from its lows … the oil-related credit cycle has only just begun after a prolonged lag period that saw credit provisions remain near trough levels,” Rob Sedran, an analyst at CIBC World Markets Inc., wrote in a note distributed to clients Tuesday.
“This announcement confirms that all of the banks are hardly out the other side,” the analyst wrote.
However, he noted that Canadian Western Bank’s geographic exposure to provinces including Alberta renders it “proportionately more exposed.”
Canadian Western Bank’s oil and gas production portfolio was $329 million at the end of the first quarter, suggesting a 10 per cent loss rate, Sedran said. The oil and gas production portfolio represents two per cent of the bank’s total loan portfolio.
Sedran said he does not expect book value erosion or other balance sheet issues to emerge as the credit cycle plays out.
“We do, however, expect the pressure on the income statement to remain,” the analyst wrote as he downgraded Canadian Western Bank to “sector underperformer” and reined in his earnings expectations.
Canada’s banking regulator, the Office of the Superintendent of Financial Institutions, is keeping close tabs on the banks’ exposure to the energy sector, a spokesperson told the Financial Post Tuesday.
“Given the prolonged low oil price environment, OSFI continues to pay close attention to the adequacy of risk identification,” Annik Faucher said. “We focus on banks’ ability to identify and manage their risks and believe they generally have prudent practices in place to monitor and manage these concentrations.”
Canada’s big banks are in a “quiet period” that precedes quarterly earnings reports, and, for the most part, either declined to comment or did not respond to queries about energy exposure. A spokesperson for Bank of Nova Scotia, which earlier this week disclosed plans to take an unrelated restructuring charge in the second quarter, said there are no plans to pre-release any other details.
Stephen Kerr, a partner in the financial institutions group at law firm Fasken Martineau DuMoulin LLP in Toronto, said the impact of the oil price downturn is an additional “headwind” the banks must deal with as they face new compliance and regulatory capital requirements.
“The more immediate market impact will be on profits and share prices rather than on significant changes to capital as the Big Six banks are extremely well capitalized,” he said.
Kerr said the focus at OSFI is likely on the potential for “contagion” beyond direct energy-related losses.
Broader economic fallout such as job losses can lead to problems in other loan categories, such as mortgages, auto loans, and credit card debt.
“The question the regulator will be assessing is the meaning of ‘energy related exposure,’” Kerr said.
John Aiken, a financial services analyst at Barclays Capital, characterized Tuesday’s oil-related financial news as “another negative data point” for those keeping tabs on bank energy exposure.
In a note to clients, he said low oil prices have hit credit at Canadian Western Bank with a “thud.” Expected provisions for consolidated credit losses at the Alberta-based bank — at $40 million — are four times what he had forecast for the second quarter.
In a related note, Aiken looked at first quarter results from HSBC Canada for insights into what can be expected when Canada’s largest banks report financials later this month, beginning with Bank of Montreal on May 25.
While there were some positives at HSBC Canada, including stronger trading revenue, this was offset by an uptick in energy provisions and margin pressure, he said.
“On the credit front, provisions were more than four times higher than a year ago, largely due to weakness in the energy portfolio,” he wrote, cautioning that direct comparison with other banks is difficult because the fiscal quarters don’t line up.