January 18, 2016 / 6:18 PM / in 2 years

Oil shock seen hitting Canadian bank profits in 2016

TORONTO (Reuters) - The knock-on effect of sinking oil prices is expected to take a bigger bite out of Canadian bank profits in 2016, as more corporate loans sour, oil and gas capital raising dries up and job losses take a toll on banks’ consumer arms.

Canada’s big six lenders reported profit growth of 6 percent on average last year, even as falling oil triggered a shallow recession. International operations and aggressive cost cuts underpinned results.

Bank executives have emphasized that their direct exposure to loan losses in the energy patch is minimal.

But analysts and investors see a high risk the oil price rout will have a broader ripple effect on the banks’ other businesses, as struggling customers in Western and Atlantic Canada default on more mortgages, auto loans and credit card debt.

“They’re all making pretty bold statements about how their portfolios are positioned. They could be wrong,” said Edward Jones analyst James Shanahan.

Macquarie analyst Jason Bilodeau expects just 1.3 percent earnings growth this year.

Banks will also confront declining revenue from underwriting and capital markets activities as their oil and gas clients cut spending, according to Moody’s analyst David Beattie.

These concerns pushed CIBC analyst Robert Sedran to cut his price targets on the six Canadian banks. He warned earnings in the banks’ Canadian personal and commercial segments could slide 11 percent on average in fiscal 2016.

“The fallout from the rapid and deep oil price decline was always going to take time to work through the system,” wrote Sedran, pointing to a recent spike in consumer bankruptcy filings.

The most recent data indicates that consumer bankruptcy proceedings in Newfoundland and Labrador rose 21.4 percent in the third quarter of 2015 from a year earlier. In their fellow oil-producing provinces of Saskatchewan and Alberta, these filings rose 10.7 percent and 25.8 percent, respectively.

Canada’s big six lenders are Royal Bank of Canada (RY.TO), Toronto-Dominion Bank (TD.TO), Bank of Nova Scotia (BNS.TO), Bank of Montreal (BMO.TO), Canadian Imperial Bank of Commerce (CM.TO) and National Bank of Canada (NA.TO).

WORST-CASE SCENARIO

“When oil was at $60, less than a year ago, the banks would say their severe stress would be, ‘What if it goes to $30?’ Well, guess where we are?” said Chris Wolfe, managing director for North American banks at Fitch. “In many cases, the stress case has become the base case.”

U.S. crude oil Clc1 hit its lowest level since 2003 on Monday. [O/R]

Bank executives have acknowledged the risks of prolonged oil weakness.

“We would expect our portfolio to be more challenged over the coming year than in 2015,” RBC CEO David McKay said at a Jan. 12 conference.

Canadian financial shares fell 6.7 percent last year and another 8.3 percent so far in 2016.

“The banks can go lower. Everything can go lower. Nothing should surprise anyone at this point, but their exposure should be manageable relative to what we saw in 2008,” said Ryan Bushell, a portfolio manager with Leon Frazer, which has roughly C$250 million ($172.22 million) invested in four of the six banks.

“I see maybe 10 percent downside on the bank share prices from here,” he said, adding that capital flows back into Canada could lift the banks and that their dividend yields also create a floor.

Still, for outside investors looking at Canada, there is not much attraction in the banks right now, said Kevin Headland at Manulife Asset Management.

“Banks are much better in a stronger economic cycle and in a rising rate environment. We don’t see either one of those in Canada.”

($1 = 1.4516 Canadian dollars)

Editing by Jeffrey Hodgson and Matthew Lewis

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