For the second time this week, a Canadian bank has dramatically raised its estimate of how much money it will lose because of soured loans to the struggling oil and gas sector, surprising analysts as the banks get ready to report their second-quarter financial results later this month.
National Bank of Canada on Thursday said it will set aside $250-million to cover bad loans in the second quarter, a fourfold increase from the previous quarter.
The increase will essentially cut the bank's quarterly profit in half, raising concerns about the Big Six banks' exposure to the energy sector despite efforts to frame these loans as a small part of their overall portfolios.
"Although all of the banks have continued to emphasize just how small these direct exposures are, we are now seeing clear evidence of how small exposures can lead to big spikes in loan losses," Meny Grauman, an analyst at Cormark Securities, said in a note.
The announcement from National Bank comes just two days after Canadian Western Bank (CWB) said it had set aside $40-million to cover bad loans – mostly associated with the energy sector – up from $8.9-million last quarter.
The moves landed amid considerable attention to the banking sector's exposure to the oil patch, as the rebounding price of oil has done little to improve the financial health of energy companies.
The price of oil has risen above $44 (U.S.) a barrel, but it is well below the $100 level seen less than two years ago, affecting the ability of many companies to repay their debts.
The big banks have been raising their provisions for credit losses in recent quarters, but have maintained that their exposure to the energy sector is manageable, even under particularly gloomy scenarios for oil prices and the Canadian economy.
"The credit performance of the overall loan portfolio, excluding the oil and gas producers and services loan portfolio, remains within expectations," National Bank said in a statement.
On average, bank loans to the energy sector represent about 2.2 per cent of all loans.
However, National Bank's exposure is higher at 3 per cent, putting the bank at the centre of attention while oil and gas companies struggle.
As well, just 40 per cent of the bank's loans are considered investment-grade. That's well below Bank of Nova Scotia, another bank being watched closely because of its relatively high exposure to the energy sector, where 60 per cent of energy loans are investment-grade.
National Bank's latest provisions for bad loans represent nearly 8 per cent of its $3.2-billion (Canadian) energy loan portfolio, or nearly 10 per cent after taking into account previous provisions, according to Darko Mihelic, an analyst at RBC Dominion Securities.
Big Six bank loans to the energy sector stood at nearly $50-billion in the first quarter, implying that the banks as a whole could be on the hook for $5-billion in bad loans to oil and gas companies if the 10-per-cent loss rate holds.
The losses can have a big impact on quarterly profits. National Bank estimates that its $250-million in provisions (or $183-million after taxes) will reduce its quarterly profit by 54 cents a share in the second quarter, or nearly half of the $1.13 in per-share profit that analysts had been expecting.
Robert Sedran, an analyst at CIBC World Markets, reduced his full-year profit estimate to $4.15 a share from $4.72 previously.
National Bank shares fell 0.8 per cent on Thursday, bringing the total decline to 5.2 per cent since CWB's announcement earlier in the week.
National Bank's provisions will also lower its common equity Tier 1 ratio – a measure of financial strength watched closely by regulators – by 0.16 percentage points. It expects the ratio will be 9.7 per cent at the end of the second quarter, which is lower than its Big Six peers.
The banks start to report their second-quarter results on May 25. National Bank will release its results on June 1.