It is difficult for Alberta residents not to be caught up in the “challenges” facing our currently depressed economy. Whether you are a social worker addressing crises stemming from the wildfires or recent unemployment of clients to a young entrepreneur struggling to make inroads into craft brewing, it is difficult to step outside one’s immediate “space-time continuum.”
So this column is going to take the quarterly reports from seven banks’ most recent quarterly reports (31 July 2016), summarizing the comments about “Alberta,” “energy,” and “oil and gas.” One of the banks is Canadian Western Bank and it is not surprising that considerably more attention was paid to these terms than by the Big 6 banks. For those readers wishing more detail, the link below extracts the key sections of these quarterly reports while highlighting key passages. It is important to stress that financial reports are only a snapshot in time and problem loans can deteriorate or improve rather quickly. No oil-induced recession is alike to previous recessions as individuals and institutions (hopefully) learn from past experience.
Canadian Western Bank
Until quite recently, CWB’s activities were primarily confined to western Canada. Virtually no business of significance was conducted east of the Manitoba-Ontario border. That is changing with various niche acquisitions undertaken by the bank in an effort to lessen its geographic concentration risk. The bank had for many years been a leader in managing credit losses through strict underwriting criteria, selectivity and specialization in its lending activities, and vigilant account management practices. Historically, CWB’s provision for credit losses would be about 20 basis points which had been consistent for nearly two decades.
The current economic environment in western Canada put CWB’s enviable record under strain. According to its Third quarter report, the outlook is dominated by “the impact of persistent low oil prices. Credit quality “reflects strain within CWB’s small portfolio of oil and gas production loans, and the level of provisioning remains elevated compared to our historical experience. Outside of the oil and gas portfolio, credit quality has remained stable.”
A key question for the bank’s investors, board, and senior management is how the knock-on effects of low oil prices will infect other parts of the bank’s books. CWB stresses in its report that the level of provisioning of its oil and gas loans are “elevated compared to our historical experience.” A further question will be how much, if any, of these oil and gas loans will be written off. (Moody’s Investor Services recent report [see Bankruptcies] on defaulting energy loans finds write-offs might be higher than historical experience. “Write-offs,” as opposed to “provisions” are when the final accounting for the loan account takes place, that is after the realization of security.)
Until recently, a key strength of the Bank has been its exposure to western Canadian and the growth opportunity this market gave vis-a-vis its bigger competitors. In the last quarter loan balances in Alberta fell by three per cent and growth is occurring in non oil-producing provinces. CWB is closely watching for “second and third order effects” from the downturn and are monitoring carefully the residential housing sector “and with a particular focus on markets where a combination of rapid price escalation and regulatory change could impact pricing and the level of future activity.” This sounds like code for Vancouver where recent media reports have highlighted speculation in the property markets and ethical and regulatory problems in some real estate firms. Further troubling are reports of weak compliance with FINTRAC rules by realtors along with questionable lending by Canadian banks to foreign buyers in the Vancouver area.
CWB characterizes the Alberta and Saskatchewan economies to be in “recession” and anticipates housing prices and housing activity in these provinces to be weak relative to other Canadian jurisdictions. Gross impaired loans (GIL) in Alberta actually fell from $80.4 million at the end of April to $42.4 million at the end of July. The GIL within the oil and gas production lending portfolio totaled $17.2 million at July 31, 2016, compared to $53.8 million last quarter- a stunning improvement.This seems counter-intuitive unless the temporary surge in oil prices above U.S. $50/barrel led to reductions in the GIL based on adjusted oil “price decks” used by the credit department.
The bank’s management is closely monitoring the first and second order effects (e.g. rising delinquencies in housing and credit card markets) but “no material impact has been evident.” Given the precedent of the 1980s when Alberta’s credit unions were restructured, several trust companies failed, and two small, Alberta-based banks were liquidated. CWB reported on the results of stress tests carried out to simulate “severe economic conditions in Alberta and Saskatchewan, in combination with very challenging economic conditions throughout the rest of CWB’s geographic footprint over a multi-year timeframe.” The test concluded that the loss rate under this simulation would be 65 basis points per year which on a loan book of about $21 billion is around $135 million per year or less than half the bank’s pre -tax annual income.
Like most of the other banks (except National Bank), mention was made of the Fort McMurray wildfires, as a facet of the continuing economic weakness in Alberta.
Royal Bank of Canada (RBC)
RBC acknowledged that the contraction of the Canadian economy was caused principally by the Fort McMurray wildfire’s reduction of bitumen production. This fact underlines the importance of the oilsands to the whole Canadian economy and especially its balance of payments. “The Canadian economy is expected to rebound in the second half of 2016 as oil production returns to normal levels, reconstruction related to the Fort McMurray wildfires begins, and government stimulus spending picks up.” The report contrasted falling unemployment in B.C. and Ontario against the rise of the unemployment rate to 8.6 per cent in Alberta.
RBC’s gross impaired loans increased in its Capital Markets division by $1,011 million or more than 300 per cent from the previous year (31 July 2015). GIls in Capital Markets rose from about 14 per cent of total GILs to 36 per cent in the current quarter “primarily due to higher impaired loans in the oil & gas sector reflecting the lower oil price environment.”
Toronto Dominion Bank (TD)
Like RBC, TD distinguished between “healthy growth” in B.C. and Ontario, and oil-producing regions Newfoundland and Labrador and Alberta who “continue to struggled with the fallout from low oil prices- made worse for Alberta by this year’s wildfires.” The bank emphasized that its exposure to Alberta, Saskatchewan and Newfoundland of $62 billion in consumer and business loans, excluding real estate secured lending, was about two per cent of total gross loans and acceptances. The exclusion of real estate secured lending is significant as Calgary and Edmonton’s commercial real estate markets are expected to face difficulties with new supply coming on the market amid the depressed outlook.
TD noted that it carries out stress testing regularly and losses in the sector are expected to “be manageable given the Bank’s relatively small exposure to the oil and gas sector.”
Bank of Nova Scotia (Scotiabank)
Canada’s third largest bank by assets and profitability has the industry’s highest exposure to the oil and gas sector and consequently is closely watched by bank analysts. Scotiabank reported its exposure was $16.1 billion down from $16.3 billion at 30 April and $16.5 billion on 31 October 2015. Thus the bank has had some success in reducing its exposure to 3.3 per cent of its total loan portfolio. However, Scotiabank had “related undrawn energy loan commitments amounting to $11.9 billion as at July 31, 2016 (April 30,2016 – $11.4 billion; October 31, 2015 – $14.3 billion). The increase in undrawn loan commitments is associated with the midstream sub-sector. Exposure in the upstream and oil field services sub-sectors declined by $1.1 billion since April 30, 2016. Approximately 59% of the Bank’s outstanding energy loan exposure and associated undrawn commitments are investment grade, after taking into account the benefit of collateral and guarantees. As expected, retail delinquencies are tracking higher in Alberta. The outstanding loan exposures are primarily secured. The Bank continues to consider the impact of lower energy prices in its ongoing stress testing program. Results continue to be within our risk tolerance.
Provisioning for loan losses at Scotiabank fell, the majority of which is “consistent with our previously stated expectations that energy losses had peaked during the last quarter.” The bank also mentioned the “devastating wildfires” in the Fort McMurray area which would lead to rebuilding and the resumption of oil shipments.
The report also disclosed that its Global Banking and Markets division, the provision for credit losses was $210 million, up from $40 million due to higher provisions in the energy sector.
Bank of Montreal (BMO)
BMO expects that oil prices will improve encouraging a “partial recovery in Alberta” next year. Provision for loan losses increased by $23 million “primarily due to higher oil and gas provisions.” However, while growth in Canada should pick up, tempering the expansion will be “continued weakness in investment in the oil-producing regions, though this should improve as oil prices recover.” BMO mentions the boost to growth expected from rebuilding and resumption of oil production resulting from the Alberta wildfires. Consistent with the other major banks, BMO’s Capital Markets’ division saw its gross impaired loans rise due to problems in the oil and gas sector. The bank also reported that its loan exposure to oil and gas was about two per cent of total loans.
Canadian Imperial Bank of Commerce (CIBC)
CIBC also noted the impact of the wildfires in the Fort McMurray area. CIBC also provided the most detailed exposure on its affairs in Fort Mac stating “(O)ur drawn exposure to the Fort McMurray area is approximately $1.6 billion, with insured and uninsured mortgages accounting for $1.1 billion and $0.3 billion, respectively, of the total. We continue to monitor the related impact on our credit portfolio, and at this point, we do not anticipate any significant losses.” The bank also observed credit quality should remain healthy “despite an erosion in the energy-producing provinces.”
In commenting on its capital markets business, the CIBC management expected “continued strength in the issuance of government debt, in part to cover deficits in the energy-producing provinces.” CIBC reported lower provisions for loan losses in its Capital Markets division due to lower losses in the oil and gas sector.
National Bank of Canada
The Montreal-headquartered bank did not mention “Alberta” specifically in their report. The only mention of oil and gas related to a sectoral provision of $250 million ($183 million net of incomes taxes) taken for “producers and service companies in the oil and gas sector” for the nine-month period
In summary, the banks have flagged problems in their loan book and commitments to the energy sector, for their investors. They stress these loans are being actively managed. For national institutions, bank senior management emphasize the relatively minor nature of these loans compared with their full book of business. There is less mention of the effects to credit card, business, and personal loan markets from the fall-out in the oil price drop .