Oil Rally Sparks Surprise Drop in Bad Loans for Canadian Banks

  • Six banks had C$1.99 billion of provisions, below expectations
  • Pace of growth in impaired oil-and-gas loans eases since April

The oil-induced pain for Canadian banks is showing signs of easing.

The nation’s six biggest lenders set aside a combined C$1.99 billion ($1.52 billion) for bad loans in the most recent quarter, 11 percent below analysts’ expectations, as a rally in oil prices bolstered energy companies’ balance sheets. The provisions for credit losses were down from C$2.64 billion in the fiscal second quarter.

“Energy losses have stabilized, impaired loan formations have slowed and the banks are benefiting from recoveries," said Steve Belisle, a fund manager with Manulife Asset Management in Montreal, whose team oversees about C$3 billion. "It seems like the worst is behind us regarding energy-related credit losses."

Oil’s rebound to about $46 a barrel from $26 earlier this year allowed the banks to set aside less money for bad loans in the fiscal third quarter, leading to quarterly profits at all six banks that beat analysts’ estimates. The lenders posted combined net income of C$10.4 billion, even after Canada’s economy contracted the most since the financial crisis in the second quarter.

Provisions rose 25 percent from a year earlier though the pace of growth for impaired oil and gas loans is slowing. Concerns about bad loans may be dissipating as energy prices stabilize, investor David Baskin said.

“Oil prices showed some signs of life and a sustained recovery -- and certainly with oil at 45 bucks you’re not in anything like the situation you are at 30 bucks," said Baskin, who helps manage about C$1 billion for Baskin Wealth Management in Toronto. “The fact it has been steady now for six months allowed the banks to say, ‘Well maybe it’s not as dire as we thought’."

Energy Impact

Loans to energy companies account for about 2 percent of total loans, with Bank of Nova Scotia and Canadian Imperial Bank of Commerce the most exposed to the sector.

Royal Bank of Canada, the country’s largest lender by assets, set aside C$318 million for bad loans, 31 percent lower than the second quarter. Chief Executive Officer David McKay cited lower provisions in its oil-and-gas loan portfolio for improving credit quality. The bank also had a couple of recoveries, including one from an oil-and-gas company.

"Our portfolios benefited from stable economic conditions, a modest decline in Canada’s unemployment rate and a 28 percent increase in average oil prices" since the second quarter, Chief Risk Officer Mark Hughes said in an Aug. 24 conference call. He said the provision for credit loss ratio, which measures provisions on impaired loans as a percentage of overall loans, will fall within its historical range of 30 basis points to 35 basis points this year.

"We should see recoveries as the companies work their way through them,” Hughes said. “We’ve also sort of seen companies that went into bankruptcy earlier in the year have come out with much stronger balance sheets, and they’ve been able to continue to move forward."

TD Results 

Toronto-Dominion Bank, Canada’s second-largest, said provisions were C$556 million in the quarter ended July 31, down from C$584 million in the second quarter.

“What we were expecting in terms of what the potential impact of the oil-price reduction would be has not nearly played out as much as it could have,” Toronto-Dominion Chief Financial Officer Riaz Ahmed said in an Aug. 25 phone interview. “The oil-impacted areas are showing some weaknesses, but other parts of Canada are continuing to perform very well."

Scotiabank executives reiterated that energy losses peaked in the second quarter, after the lender posted provisions of C$571 million in the third quarter, a drop of 24 percent.

“We think the worst is behind us, for sure," CFO Sean McGuckin said in an Aug. 30 phone interview. “Going forward we expect much more moderated provisions for credit losses in this sector."

Not Blasé

Bank of Montreal was the only lender with higher provisions, primarily from two oil-and-gas companies and two accounts in other industries.

“We’re working through the impact of the lower commodity price on the sector. It’s happening, from our perspective, in a very orderly way," CFO Tom Flynn said in an Aug. 23 phone interview.

National Bank of Canada was the only bank to set aside less money from both a year earlier and the second quarter, when the Montreal-based lender took a C$250 million “sectoral provision” for its energy loans. Third-quarter provisions fell to C$45 million from C$317 million in the second quarter and C$56 million a year earlier.

CIBC, meanwhile said there is still a risk that provisions creep higher if oil prices decline again.

“Credit performance in this quarter was particularly good, but it may tick up a bit from here,” CFO Kevin Glass said in a phone interview. “We don’t want to be blasé about this: oil is certainly not back up to $100, so we need to keep an eye on it.”