Employees torque a pipe at a wedge well at Christina Lake, a situ oil production facility half owned by Cenovus Energy Inc. and ConocoPhillips, in Conklin, Alberta, Canada, on Thursday, Aug. 15, 2013.Brent Lewin
Worries about Canadian lenders' ties to the struggling energy sector are on the rise again, despite a rebound in the price of crude oil over the past three months.
Canadian Western Bank on Tuesday said that it had quadrupled the amount of money it has set aside for bad loans to oil and gas companies, renewing concerns about banks' exposure to the sector just three weeks before the biggest lenders start to report their second-quarter results.
CWB's move shocked analysts, hammered the bank's share price and dragged down other bank stocks – mainly National Bank of Canada and Bank of Nova Scotia.
"Oil prices are up, but good times are still not here again for either the oil patch or anyone whose fortunes are tied up in the oil-producing regions of the country," Meny Grauman, an analyst at Cormark Securities, said in a note.
Edmonton-based CWB is not a big bank. But the surprising spike in loan provisions suggests that larger and more diversified banks will have to contend with another quarter of uncertainty over their lending to cash-strapped energy companies, especially after HSBC Bank Canada reported on Tuesday a fivefold increase in loan losses in its fiscal first quarter.
Concerns about the banking sector's exposure to energy companies come as the Big Six find themselves under pressure to find growth in a weak economy and respond to rapidly shifting consumer behaviour.
On the energy front, National Bank and Scotiabank face particular scrutiny given that they are more exposed than their peers: Oil and gas loans account for 3 per cent and 3.6 per cent of their total loans, respectively, versus a banking sector average of 2.2 per cent.
CWB, which has long been seen as particularly vulnerable to Alberta's reeling economy, set aside $40-million to cover bad loans, up from $8.9-million in the first quarter. About $33-million of that was tied specifically to the bank's oil and gas production portfolio, implying an alarming 10-per-cent loss rate on a portfolio of $329-million – or more than double the loss rate assumed by the bank in the first quarter.
"This unusual level of provisioning directly reflects the current impact of persistent low energy prices on our oil and gas production clients," said Chris Fowler, CWB's chief executive officer. "Our capital ratios are strong, and outside of this portfolio, credit quality is consistent with our prior expectations."
Still, the bank's shares fell as much as 11 per cent before closing down 6.9 per cent Tuesday on the Toronto Stock Exchange. National Bank dropped 4.1 per cent and Scotiabank shares lost 2.7 per cent. National Bank and Scotiabank declined to comment.
HSBC Bank Canada said Tuesday its first-quarter pretax profit fell 31.6 per cent year-over-year to $158-million, "mainly due to higher loan impairment charges due to credit deterioration on specific files in the energy portfolio."
Although the price of crude oil has rebounded above $40 (U.S.) a barrel in recent weeks from below $30 a barrel earlier this year, the price is still well off its highs.
Banks have been negotiating with energy companies and cutting borrowing limits as they attempt to reduce potential losses. Lightstream Resources Ltd. said this week that its borrowing limit had been cut in half. Twin Butte Energy Ltd. is negotiating with lenders to extend its deadline on a debt payment.
The big banks have also been setting aside more money to cover bad loans, while executives stress that potential losses, even under particularly gloomy scenarios for oil and the Canadian economy, remain manageable. In the first quarter, they raised their provisions for credit losses by an average of 25 per cent from the previous quarter, pushing provisions to 0.33 per cent of total loans.
By comparison, CWB expects that its provisions for loan losses will rise to as much as 0.45 per cent of total loans in 2016, up from 0.18 per cent in the first quarter.
"Do high loan losses continue? The short answer in our view is 'yes,'" Darko Mihelic, an analyst at RBC Dominion Securities, wrote in a note. "Magnitude and timing of losses are likely to be very erratic and could persist well into 2017, depending upon the price of oil and many other macroeconomic factors."
Analysts are now slashing their profit estimates. Mr. Mihelic cut his full-year profit estimate for CWB to $2.14 a share, down from $2.61 previously.
Robert Sedran, an analyst at CIBC World Markets, also cut his estimate and changed his recommendation on the stock to "sector underperformer" from "sector performer."
According to CWB's first-quarter report, about 2 per cent of the bank's outstanding loans are tied to its oil and gas production portfolio.
However, that's not where its exposure to the energy sector ends. Loans to energy service companies, which carry out much of the on-the-ground labour for oil and natural gas production companies – many of them no more than mom-and-pop operations – represent approximately 3 per cent of CWB's loans.
With files from reporters Kelly Cryderman and Jeff Lewis in Calgary
David Berman