Banks can handle potential energy losses, but face risks if larger economic crisis triggered by coronavirus unfolds

Canada’s big banks can absorb potential losses on loans to energy companies after years of trimming exposure to the sector, but a larger economic crisis triggered by the COVID-19 virus could still cause significant damage to loan books, analysts warned Monday.

In the wake of Monday’s oil price crash, Canadian and U.S. energy producers face pressure on profit margins, making it harder for them to service loan payments and refinance debt.

That’s bad news for roughly $60-billion worth of loans to energy companies held by Canada’s Big Six banks. Moves in recent years to limit lending to the energy industry, however, mean the overall impact on provisions for credit losses for large Canadian banks will be muted, analysts say.

Canada’s Big Six have been reducing exposure to the oil and gas sector since 2014, when a collapse in oil prices led to widespread insolvencies in Alberta’s oil patch, causing significant pain for lenders. Loans to energy companies now account for around 2 per cent of total loans held by the Big Six, with Bank of Montreal the most exposed, at 2.8 per cent of its loan book, and Royal Bank of Canada the least exposed, with 1.2 per cent of its total loan book, according to Cormark Securities.

That’s down from an average of between 5 per cent to 10 per cent of total loans going to energy companies prior to the 2014 price crash, said Rob Colangelo, senior vice-president of the global financial institution group at ratings agency DBRS Morningstar.

If prices stay low, it “certainly could result in some higher impairments, which would lead to higher provisions for credit losses, but again, it’s very manageable, considering how low their exposure is to the oil and gas sector,” Mr. Colangelo said.

Not only have Canadian banks tempered overall loans to the energy industry, but they’ve also changed the lending mix to focus more on oil and gas producers, rather than on companies servicing the energy industry, which tend to have more volatile earnings, said David Beattie, senior vice-president in the financial institutions group at Moody’s.

“There was also some consolidation in the industry where some of the weaker players were acquired by the stronger players, and that took some of the more troublesome exposures out of play for the Canadian banks,” Mr. Beattie said.

Still, some loan books are more vulnerable than others, particularly those with significant exposure to the U.S. shale oil industry, where loan losses were on the rise even before coronavirus hit global oil prices. BMO has the greatest exposure to U.S. energy loans, followed by CIBC, according to John Aiken, director of global research for Canadian financials at Barclays Capital.

By itself, the impact of an oil price drop on Canadian banks is not overly concerning, Mr. Aiken wrote in a note to clients published Monday. The last time the price of a barrel of West Texas Intermediate (WTI) fell below US$40, Canadian banks saw provisions for credit losses rise by between 20 and 50 basis points, and most losses were recorded in a single quarter, he wrote. (One hundred basis points equal one percentage point.)

The bigger concern is that the decline in oil prices is a bellwether for wider economic damage, he wrote.

“We are in the early days of the economic impact of COVID-19 and the drop in WTI is symptomatic of larger issues, not simply supply and demand issues surrounding oil. Consequently, there is the risk of prolonged dampened pricing for oil, if not additional declines. At its worst, energy could be the ‘canary in the coal mine’ for broader economic weakness and sustainably higher credit losses,” Mr. Aiken wrote.