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Crashing crude prices expected to hit Canada’s banks as earnings loom

ANALYSIS: It’s not a question of “if,” but “how much.”

How much oil-price weakness, that is, has seeped into the loan books of Canada’s big banks. We’ll find out between February 23 and March 1, when each of Canada’s big banks will report fiscal first-quarter results.

Investors will want to see whether further deterioration in oil prices caused loans losses to rise materially in the banks’ loan books. The last time the banks reported results (for the quarter that ended on October 31), the price of West Texas Intermediate crude oil averaged US$44.94 per barrel. This time, they will report results for the three months ended on January 31 – a period when WTI averaged US$37.43. And it’s only going to get worse. WTI averaged US$29.80 between January 31 and February 19.

What's more, the short interest in Canadian banks as soared to 5.9 percent, according to Scotia Capital. 

A couple of the banks noted elevated loan losses in their oil and gas books in the fourth-quarter results. It would be a big surprise if that trend doesn’t deepen and extend itself this time. The question is how material it will be to earnings per share growth.

“This quarter, we expect to see rising commercial oil and gas loan impairments,” wrote Gabriel Dechaine, an analyst at Canaccord Genuity, in a note to clients. Dechaine has “Buy” ratings on Bank of Montreal, Bank of Nova Scotia and Toronto-Dominion Bank. He has “Hold” ratings on the rest.

At Barclays, analyst John Aiken also sees it that way, telling clients on Wednesday that “rising provisions in 2016 are becoming harder to deny.” Aiken doesn’t have a single “Buy” rating among the banks right now, and has recently trimmed price targets on every Canadian bank stock.

Aside from the central issue of loans to the oil and gas sector, there are three more specific things to watch for.

First, will softness in loans to energy companies extend to consumer loans? We’ve seen lots of weak economic data from Alberta and Saskatchewan lately. On Friday, we learned retail sales in the province fell 5.5 percent in December. And earlier this week, credit monitoring agency TransUnion told us about a big spike in delinquent auto loans in Alberta and Saskatchewan. This is certain to show up in the bank results. Both Dechaine and Aiken expect to see it.

Second, will any of the banks take a loan loss allowance it attributes to the energy sector as a whole? This is something Dechaine is watching for. If it happens, it would be a clear signal that oil and gas loan losses are expected to ramp up meaningfully over the next year.

Third, will weakness begin to appear in the banks’ mortgage books? If it does appear, Aiken notes, the effects could be material. After all, Canada’s hot housing market is now the largest single contributor to gross domestic product. It will be important to hear what bank executives have to say about their real estate loans, and the housing market, when the conference calls take place. Those comments may shape the market’s view of the stocks for the rest of 2016.

Dividend increases have helped keep the banks’ share prices from shrinking further. This time around, Aiken expects Bank of Nova Scotia, Royal Bank of Canada and Toronto-Dominion Bank to raise their dividends. But if earnings growth is slowing down – and Aiken believes it is – these could be among the last dividend increases we see for a while.

The biggest bank-specific story to watch concerns National Bank of Canada, where capital ratios have become a big issue. National has now written off all of its 24.9 percent interest in Maple Bank of Germany, which has been shut down by regulators in Germany and here in Canada. It raised money in a common stock sale to protect its capital levels. When executives at National hold their conference call, you can expect lots of questions on that topic – a sign that not all of the hand-wringing is tied directly to the price of a barrel of crude oil. CTV Two CTV News CTV News Channel BNN - Business News Network CP24