Canadian banks vulnerable to oil shock – Fitch

Fitch warns about banks’ exposure to oil field services, commercial loans tied to energy production

CIBC(one of largest Canadian banks) chief executive officer Victor Dodig

NEW YORK – Canada’s commodity-reliant economy will be facing challenges that pose new risks to Canada’s major banks if oil prices remain “lower for longer” and/or this creates a macroeconomic shock to the economy, according to Fitch Ratings.

“So far Canadian Banks have been resilient and the oil slump has appeared manageable but as falling commodity prices permeate the broader economy, banks will begin to feel pressures beyond direct energy loan exposure,” said Doriana Gamboa, senior director.

Oil production and allied sectors account for 10 per cent of GDP and the decline in prices has a significant impact on the broader economy and unemployment.

While Canadian banks’ direct exposures to energy companies may be manageable, Fitch warns there may be heightened weakness in areas such as oil field services or other commercial loans tied to energy production.

“Due to the stable Canadian economy over the last few decades, Canadian banks have taken little to no loan provisions over the years. As we move into an uncertain and ‘lower for longer’ oil price period, Fitch expects to see weakness in loan growth and a rise in provisions for credit losses,” said Gamboa.

She says that as the impact of the oil decline trickles through to other parts of the economy, potentially leading to a rise in unemployment, banks could face credit issues in their retail lending portfolios given high consumer indebtedness.

Household indebtedness is high at 165 per cent of disposable income, though low interest rates have minimized the debt service burden to date. Residential loans, which have been a growth area for Canadian banks as housing prices have skyrocketed, account for most consumer debt.

Fitch views housing markets nationally as overvalued in real terms by approximately 20 per cent. A housing market correction would negatively impact banks; however, a sizeable amount of this exposure is guaranteed by the Canadian Mortgage Housing Corporation (CMCH), a Crown corporation of the Government of Canada.

Bank profits will be challenging moving forward in 2016 and Canadian banks will likely report modest loan growth, higher credit costs and continued net interest margin pressures, says Gamboa.

As Canadian banking market shares are mature and relative stable, and as the Canadian economy has started to slow, many of the banks have started to expand into new markets and growth areas such as wealth management and capital markets businesses

This could, however, increase some of the banks’ risk profiles and potentially drive negative rating changes, according to Gamboa.

On Jan. 25 Fitch completed a peer review of the seven large Canadian financial institutions in its portfolio. Fitch affirmed with a Stable Outlook the ratings of Bank of Montreal (BMO), Bank of Nova Scotia (BNS), Canadian Imperial Bank of Commerce (CIBC), Caisse Centrale DesJardins (DESJ), National Bank of Canada (NBC), Royal Bank of Canada (RBC), and Toronto-Dominion Bank (TD).