The free-falling price of crude oil has walloped North American energy companies, and the Canadian banks that lend to them are being hit almost as hard. But the bank sell-off may be overdone, offering a good buying opportunity – and dividend yields that now average 5.7 per cent.
In what is essentially a rerun of the 2014-16 oil price collapse, analysts are now picking through the loan books of the Big Six banks to determine their exposure to energy companies and estimating the downside risk to bank profits if some of these energy loans go bad.
On Monday, the price of West Texas intermediate oil fell about 25 per cent, for its worst one-day plunge in about three decades.
It rebounded around 11 per cent on Tuesday afternoon, to US$34.36 a barrel. But the price remains well below US$60 a barrel at the start of the year, and still threatens the ability of some energy companies to service their debts.
“We estimate that stressed loss rates in oil and gas portfolios would reduce [bank] sector earnings per share by 2 to 6 per cent," National Bank Financial analyst Gabriel Dechaine said in a note, using the prior oil downturn as a template.
"However, with [bank] stocks trading down about 12 per cent [on Monday], the market is clearly pricing in additional downside,” he added.
Concerns about the financial health of energy loans are raised at a time when investors are already nervous about how the banks will navigate through deteriorating global economic activity and falling interest rates amid the spread of the novel coronavirus.
The good news: The Big Six exposure to the North American oil and gas sector has fallen to about 2 per cent of their overall loans from more than 5 per cent prior to 2014.
The bad news: In dollar terms, total exposure is a massive $60-billion, according to analysts.
Mr. Dechaine at National Bank ranked the Big Six based on oil and gas loans as a percentage of their total loans.
Four banks are clustered together. Bank of Montreal is the most exposed by a slim margin, with oil and gas loans accounting for 2.8 per cent of its total. Bank of Nova Scotia and National Bank of Canada are close behind, with 2.7-per-cent exposure each. Canadian Imperial Bank of Commerce has an exposure of 2.3 per cent.
The biggest banks, though, have less exposure relative to their gargantuan loan books. Toronto-Dominion Bank’s loans to the oil and gas sector account for just 1.3 per cent of its total loans, followed by Royal Bank of Canada at 1.2 per cent.
The geographic breakdown is split almost evenly between the United States and Canada for all but one bank: National Bank’s energy loans are confined to Canada.
Mr. Dechaine further examined the loan books by breaking down the banks’ exposure to two higher-risk types of borrowers: exploration and production companies, whose revenue streams are largely tied to commodity prices, and oil and gas services firms, whose business models depend on their E&P customers.
Based on this measure, Royal Bank is the most exposed. Its E&P and services loans account for 89 per cent of the bank’s oil and gas loans. BMO is next, with an exposure of 73 per cent. National Bank’s exposure is 60 per cent, followed by TD at 57 per cent, CIBC at 51 per cent and lastly Scotiabank at 50 per cent.
Mr. Dechaine said that the banks’ energy loan books are already reflecting deteriorating credit metrics: The ratio of impaired oil and gas loans recently stood at 1.84 per cent for the Big Six, on average. That’s well above the sector-wide average loan loss ratio of just 0.53 per cent.
But the sell-off of bank stocks looks worse than the backdrop – and this is where the buying opportunity comes in.
Mr. Dechaine said that current valuations imply an ugly environment for the Big Six, including 2020 profits falling 14 per cent shy of his already lacklustre estimates and dividend increases put on hold.
“To state the obvious, this figure is much more than what we estimate in terms of the EPS impact of a repeat of the 2015-16 oil and gas downturn,” he said.
After that downturn ended in early 2016, bank stocks rallied an average of more than 40 per cent within 12 months. And yes, those dividends continued to increase.