If investors are nervous about how Canadian banks will navigate a rough domestic economy driven by depressed oil prices, they might get some comfort from a relatively upbeat Fitch Ratings review that reaffirmed the banks' solid fundamentals and consistent performance – for now.
On Monday, Fitch affirmed the default ratings of the Big Six. However, it cautioned that the banks nonetheless are vulnerable to credit deterioration in their domestic loan portfolios, high levels of consumer indebtedness, a housing market that is overvalued by more than 25 per cent and an economy that is being pressured by depressed commodities.
"For now, these risks have been manageable given the steady unemployment rate, low interest rate environment, and low inflation," Fitch said in its review. "However, should the rapid decline in global oil and gas prices pressure the broader economy in Canada that leads to a sharp rise in unemployment, Fitch believes credit deterioration could be hastened."
The ratings agency added that the banks' direct exposure to oil and gas lending looked manageable compared to their total loans – which is something the banks have stressed in their recent quarterly earnings calls with equity analysts – but that losses would rise if prices failed to recover.
John Aiken, an analyst at Barclays Capital, made a similar point in a research note on Monday, when the price of oil returned below $30 (U.S.) a barrel – once used as a worst-case scenario by the bank in their internal stress tests.
But in his "base case" scenario, Mr. Aiken estimated that Canadian bank profits in 2016 would only affect about 1 per cent of consensus expectations for 2016 bank profits. Under a particularly gloomy "bear case" scenario, he believes the hit to profits would rise to 6 per cent.
"While we believe that the banks will be able to manage their exposures, oil and gas represents another headwind to earnings that will likely add to the downward pressure we anticipate that 2016 consensus earnings will face," he said in his note.
In addition to sticking with its default ratings, Fitch maintained a "stable" outlook for Bank of Montreal, Bank of Nova Scotia, Canadian Imperial Bank of Commerce, Toronto-Dominion Bank and National Bank of Canada.
The outlook, Fitch said, is supported by its view "that Canadian banks have solid fundamentals evidenced by their consistent performance through various downturns and global shocks. Further, the banks have good funding profile with strong access to wholesale funding and solid capital positions."
However, Fitch revised its outlook for Royal Bank of Canada to "negative" from "stable," making RBC the outlier among the Big Six, because it expects RBC's profits will be more volatile than its domestic peers.
"Fitch believes this will be driven by higher provisioning in Canadian Banking and capital markets (primarily the wholesale businesses), as well as some increased volatility in overall results from capital markets revenues," Fitch said.
David Berman