A prolonged slump in oil prices will be negative for the Canadian banks, but should only have a limited impact on U.S. regional banks, says Moody’s Investors Service in a pair of new reports.
The rating agency says that a long-lasting period of low crude prices will have a negative impact on the profitability of the big Canadian banks, and a “limited effect” on the asset quality of the U.S. regional banks.
“For Canada’s major banks, the credit costs on energy-sector loans would rise if oil prices were to remain low for too long, which would hurt the banks’ profitability,” said David Beattie, a senior vice president at the firm. “Given the historical relationship between oil prices and the impairment rate for energy-related loans, we expect some mild erosion in these loans’ asset quality in the coming quarters.”
Additionally, Moody’s says that revenue from both underwriting and capital markets activities for the major banks could decline because of potential spending cuts by the banks’ corporate clients in the energy sector. And, it says that consumer credit costs could also rise due to a slowdown in the economies of the major oil-producing provinces, Alberta, Saskatchewan and Newfoundland.
Direct loan exposures to the oil and gas sector vary by bank, as does the overall exposure to the energy-rich provinces, Moody’s says, although it singles out Bank of Nova Scotia and Royal Bank of Canada as the banks that are particularly vulnerable to both the direct exposures and regional factors.
That said, the rating agency also notes that “the scale and diversity” of the banks’ businesses will act as a “shock absorber” against the likely rise in impaired energy loans and the decline in capital markets revenue. Moreover, the banks will also benefit from the depreciation of Canada’s currency, it says, noting that this has “so far functioned as a natural hedge by reducing costs in Canadian dollars and limiting the impact on the oil producers, whose production is sold based on US dollar benchmark pricing.”
For the U.S. regional banks, Moody’s says that direct energy-sector loans generally constitute only a small portion of bank portfolios, and these exposures tend to be diversified within the industry, so they would require only a slight increase in loan loss provisions at some banks.
“Declining energy costs could actually be positive for the U.S. banks’ operating environment, with a neutral to positive effect on their overall asset quality,” notes Allen Tischler, SVP at Moody’s. “In many cases, the U.S. banks with the highest exposures are also the most experienced in underwriting energy-sector loans.”
Although, it notes that, “if oil prices do remain depressed for long, credit risk will rise for even the most conservatively underwritten energy-related loans. For a handful of the smaller, more focused lenders among the Moody’s-rated banks with the most direct exposures, a lengthy slump in oil prices could lead to the need for higher loan loss provisions and to lower profitability.”