Oil price drop threatens to reduce revenues at Canada's top banks

Oil prices that reached a five-year low on Friday are starting to take a bite out of profits at TD Bank and are raising concerns for the rest of the country's top lenders.

Canada's biggest banks earn up to 20 per cent of their revenues through providing investment and corporate banking services, with oil and gas companies an important part of that client base.

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But oil prices have tumbled roughly 35 per cent to under $70 a barrel from their mid-summer highs due to a strong U.S. dollar, low demand and a glut of global supply, and now TD Bank says it will have to look beyond the oilpatch to make up its investment banking revenue.

"With the current activity going on in oil pricing, it certainly is impacting activity levels in the business," Bob Dorrance, the head of TD's wholesale banking division, told investors during a conference call earlier this week after the bank reported its fourth quarter results.

"Things have slowed down."

Scotiabank was the last of Canada's five big banks to report its quarterly earnings this week, wrapping up a series of conference calls that were peppered with talk about falling oil prices.

Energy sector dragging down stocks

The energy sector — a major weight on the Toronto Stock Exchange — has taken a beating on the markets and has taken other stocks,  including those with indirect exposure to companies that produce crude, down with it.

While all of the country's top lenders reported substantial profits during the quarter, Canaccord Genuity analyst Gabriel Deschaine noted that lacklustre performance on the stock markets caused many of the banks to report weaker than expected revenues from their brokerage businesses.

Scotia Capital analyst Sumit Malhotra says roughly 30 per cent of the underwriting fees — fees from administering new issues on the stock markets — earned by Canada's six top banks this year came from the energy sector.

A drop in commodity prices could make resource companies less likely to make a public offering on the market, said Malhotra, pointing to Teine Energy as an example.

The Canadian oil and gas producer had been planning an initial public offering but a Bloomberg News report in October said the company delayed the debut due to the decline in oil prices.

"While we do not want to be too alarmist in this regard, it should be clear that the capital markets operations of the banks have played a key role in driving revenue and earnings growth for the Canadian banking sector in 2014, and any sustained period of weakness in the energy sector would be detrimental to activity levels going forward," Malhotra wrote in a note to clients.

Banks doing stress tests on loans

The plummeting oil prices have also caused some concerns about whether oilpatch companies will default on their loans and create financial burdens for the banks.

The big banks say they are regularly performing stress tests on their loan portfolios to see how they will fare in a continued low oil price environment. So far they say there is no cause for concern, even if oil drops down to $60 a barrel and stays that way for up to two years.

"With oil prices, it's always about how long it goes on for," RBC's chief risk officer Mark Hughes told investors during the bank's fourth quarter conference call on Wednesday.

Nonetheless, chief risk officers at all of the big banks say they are keeping tabs on the situation.

"If oil prices remain depressed, there will be some strain on some of these loans," BMO's chief risk officer Surjit Rajpal told investors during a conference call about the bank's fourth quarter results Tuesday.

Malhotra notes that oil and gas related loans make up only about six per cent of the banks' combined business loan portfolios, and only two per cent of their entire combined loan book.

"Though an extended period of weakness in energy prices would clearly impact credit quality trends, in our view the size of the portfolio is not large enough to materially weigh on either credit or growth trends," Malhotra said.

However, there is another way that slumping oil prices could reduce the quality of the banks' loan books.

"I'm looking more at what this means at the guys working the oil fields," said Morningstar equity analyst Dan Werner. "Are they going to be out of a job because rigs are going to be shutting down? It doesn't sound like it at this point because I think the base cost of extraction is below where the price is."

But if plunging prices leave workers unemployed, that may leave them unable to make their mortgage payments, said Werner. That, in turn, would hurt the banks.

"Right now the evidence doesn't seem to be there in terms of wells being shut down yet," said Werner. "So we'll see."