So far, the drop in oil prices has only had a limited impact on the Canadian banks, says Fitch Ratings. But, it cautions that the effects could intensify with a longer period of low prices.
In a new report, the rating agency says that most Canadian banks “have seen no impact to their earnings or asset quality from oil’s recent slide”. For now, Fitch says that the decline in oil prices has mostly created the risk of delayed or scrapped energy projects.
The ultimate impact on these banks of the slide in oil prices “will be determined by the length and severity of price declines, and spillovers to the broader economy,” it says. For example, it says that if prices were to come in at, or below, US$60 per barrel into the second half of 2015, it would expect “some weakness in loan growth and a potential rise in provisions for credit losses.”
Even at current levels, with prices of between US$60-US$65 for West Texas Intermediate (WTI) crude, Fitch says that this is below the long-term break-even levels for at least a portion of North American production. “These levels will also likely slow loan growth for both reserve-based projects and ancillary energy services-related businesses,” it suggests.
Fitch says that fourth-quarter earnings disclosure by Canada’s Big Six banks, “signaled tempered concern … mostly because the relative direct lending to the energy sector is modest within the context of their well-diversified loan books and good credit-quality measures.” Most of the large Canadian banks have under 10% of their total wholesale loans attributable to the energy sector, Fitch reports, although the actual exposure is higher, it says, due to businesses that support the energy industry.
“Canadian banks are also likely to see some impact in their commodities trading businesses due to oil’s decline; however, measuring the impact is challenging at this stage,” Fitch adds.
Overall, falling oil prices is a negative for the Canadian economy, Fitch says, given that energy accounts for 7.5% of GDP and nearly one-quarter of exports. ‘This impact on the broader Canadian economy could have a more significant influence on banks, beyond deterioration in its oil-related loan book,” it says.
Fitch also reiterates that high household leverage poses one of the biggest threats to Canada’s economy. And, it says that a slowdown in energy investment will affect local economies and housing markets in energy-dependent regions, such as Alberta. “To the extent that sustained declines in energy prices lead to weak economic activity or increases in unemployment, these factors could lead to broader asset-quality deterioration in much larger consumer-lending portfolios,” it says; adding that business investment and exports could be hindered by energy-sector pressures too, despite some weakening of the Canadian dollar.
Canadian banks have entered this period of declining oil prices “from a position of strong asset quality supported by formerly strong energy prices, low interest rates and robust housing demand,” Fitch says. “With energy prices weakening, we would expect some reversion in asset quality metrics and provision expense to potentially hasten.”