May 20, 2016 / 3:28 PM / in 2 years

Canada's banks to set aside more funds to cover toxic oil loans

* Provisions expected to increase in second quarter

* Expected losses to reflect recent redeterminations

* Two banks have hiked provisions ahead of results

By Matt Scuffham

TORONTO, May 20 (Reuters) - Canada’s biggest banks are expected to set aside more funds to cover bad loans to the oil and gas sector, eating into their profits when they announce second quarter results next week, analysts say.

Royal Bank of Canada, Bank of Nova Scotia, Bank of Montreal and Canadian Imperial Bank of Commerce all reported an increase in losses from oil sector loans that turned sour in the first quarter.

Although oil prices have improved since February, the banks’ second-quarter results will show the impact of credit lines to oil firms being tightened to reflect lower oil prices, a move that could lead some to default on their loans, analysts say.

The situation is likely to have been exacerbated by the impact of the Alberta wildfires, which has led to several producers being unable to fulfill supply contracts.

“We believe that provisions are going to increase in the second quarter for the Canadian banks. I think it’s likely going to reflect the redeterminations that just took place,” said Fitch Senior Director Doriana Gamboa.

Energy companies across Canada and the United States have met with their banks in recent weeks to determine how much debt they can continue to hold as part of a bi-annual process and senior bankers have told Reuters credit lines have been cut by around 15-20 percent.

Two mid-sized Canadian banks already have increased provisions ahead of announcing their results.

National Bank of Canada estimated it would set aside C$250 million in the quarter ended April to cover bad loans to the oil and gas industry, much higher than the C$17 million it set aside in the first quarter. Alberta-based Canadian Western Bank said it had set aside another C$33 million.

Barclays analyst John Aiken said those warnings had “re-ignited” energy credit concerns for Canadian banks.

Scotiabank has the highest exposure to the oil and gas sector of any major Canadian bank, equivalent to 3.6 percent of its total loan book, followed by Royal Bank of Canada.

In addition to direct losses from bad loans to oil and gas firms, banks also face a secondary impact from the knock-on effect on consumers affected by the oil slump. Defaults on consumer loans in oil-producing regions such as Alberta, which has been hit by rising unemployment, have already hiked, and analysts say the situation could deteriorate further. (Reporting by Matt Scuffham; Editing by Bill Trott)

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