RBC braces for losses tied to oil sector woes

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Royal Bank of Canada has set aside significantly more money to cover potential energy-related losses as concern grows over how a deteriorating economy will affect the operations of Canada's Big Six lenders.

Canada's largest bank raised its provision for credit losses to $410-million in its fiscal first quarter – up more than 50 per cent from last year largely as a result of four unnamed energy companies and one utility – as low oil prices hammer the energy sector and drag down economic activity.

"There's no question that the persistently low oil prices are tough for clients in the affected regions and are driving an increase in credit provisions in our portfolio," Dave McKay, RBC's chief executive officer, said during a conference call with analysts.

The price of crude oil has fallen about 50 per cent since the summer, increasing concerns about whether energy companies will be able to repay their loans and raising the question of whether consumers associated with the energy sector will have trouble paying off credit-card balances, auto loans and mortgages.

These issues have weighed on bank stocks for most of the past year, but RBC's disclosure on Wednesday had a particularly big impact. RBC shares fell as much as 6 per cent in mid-morning trading, dragging down other bank stocks.

The shares ended the day at $67.81, down 2.61 per cent.

However, RBC executives offered assurances that its exposure to the energy sector was manageable, pointing out that loans to the oil and gas sector accounted for just 1.6 per cent of its total loans and any spillover from the energy sector would be limited.

"In Canada, we continue to believe that pressure from low oil prices will be largely contained to oil-exposed regions, and that strength in other regions will support modest GDP growth this year," Mr. McKay said. "In fact, we started to see the economic benefits of low oil prices and a weaker Canadian dollar on manufacturing and export activity."

In an effort to head off skepticism to its upbeat outlook, RBC outlined what its loan losses would look like under gloomy scenarios, concluding that it would emerge relatively unscathed.

Mark Hughes, RBC's chief risk officer, said that if oil remains at $30 (U.S.) a barrel through 2016, the bank's provision for credit losses (PCLs) would range between 0.3 per cent and 0.35 per cent of its total loans, which is only slightly higher than the bank's PCL of 0.31 per cent in the first quarter.

If conditions get noticeably worse – oil falls to a 14-year low of $25 a barrel, the Canadian economy slips into recession and nationwide housing prices plunge 25 per cent – money set aside for losses would rise as high as 0.5 per cent of total loans, or 50 basis points.

Mr. Hughes said that, even this elevated level "is within our historic average through a cycle."

However, some analysts sounded less than convinced about these assurances from RBC and other banks this week.

"So how do we reconcile that guidance with a historic record where occasionally we did see that ratio well above 50 basis points?" said Peter Routledge, an analyst at National Bank Financial. "How should we think about that?"

Mr. Hughes responded: "Well, all we're trying to do with the stress test is to give you information as to what could happen if the variables that we put into the stress test occur.

"Obviously, if any of those variables are different, then the numbers and the output would also be different. So it could be less, it could be higher."

RBC is the third bank to report its quarterly results this week. It said that its profit during the first quarter was $2.4-billion, almost unchanged from last year but down 6 per cent from the fourth quarter.

Profit from RBC's personal and commercial banking division rose to nearly $1.3-billion, up just 3 per cent from a year earlier, reflecting the challenging environment of slowing loan growth, low interest rates and a weak domestic economy. Net income from capital markets fell 4 per cent, to $570-million, reflecting a slowdown in investment banking.

RBC raised its quarterly dividend to 81 cents a share, up 2 cents.