Banks Brace

For Canadian banks, lending to energy producers is a riskier bet than ever. The last time borrowing-base redeterminations took on such heightened importance was in 2015 and 2016 as oil prices plunged from above $100 a barrel to around $30.

While crude pulled itself out of the abyss on Wednesday, June futures are still at less than $15. Some estimates suggest measures to combat Covid-19 are destroying as much as 30% of global oil demand — and the road back to a profitable price may a long one.

“In the last oil downturn we saw some borrowing bases reduced, but not at a significant enough level that would compromise an oil-and-gas company’s viability,” Michelle Dathorne, director of oil and gas ratings at S&P Global Ratings in Toronto, said in an interview. “But is 2020 different than 2015 to 2016? Absolutely. The scope and severity is certainly worse.”

Canada’s six largest lenders had about C$58.5 billion ($41.2 billion) in energy loans on their books at the end of January, representing an average 5% of their corporate loan portfolios or 2% of overall lending, according to company disclosures.

The sharp drop in energy prices may weigh on the banks’ earnings. If 10% of energy loans go sour, it could generate a collective loss of C$6 billion from the sector and reduce earnings by 18%, according to Bloomberg Intelligence analyst Paul Gulberg.

“Canadian banks’ energy exposure risks are increasing, with oil in a freefall and Canadian oil producers fighting to survive, as cash burn accelerates and liquidity dwindles,” Gulberg and his colleague Fernando Valle said in an email.

Non-investment-grade loans make up about 53% of the banks’ energy portfolios. Royal Bank of Canada has the most at 77%, followed by Bank of Montreal at about 58%, according to a Bloomberg Intelligence report.

Still, Canadian banks have been willing to keep the credit flowing in previous downturns.

“I’ve always said that energy, and oil and gas in Canada, is our family business,” Canadian Imperial Bank of Commerce Chief Executive Officer Victor Dodig said in an interview earlier this month. “We’re lending to our oil-and-gas clients and working with them through this patch.”

Bonds Dive

Investors are getting anxious though. About 70% of Canadian energy companies in the Bloomberg Barclays Global High Yield Index are now trading in distressed territory. That compares with about 10% in early March, according to data compiled by Bloomberg. A bond is usually defined as distressed when its yield is 1,000 basis points, or 10 percentage points, over the government benchmark.

Investors in some high-yield issues have lost money with breathtaking speed. Oil-sands producer Athabasca Oil Corp. and oil fields producer Ensign Drilling Inc are the most distressed names in the patch, Bloomberg data show. In the investment grade universe, Husky Energy Inc. and Canadian Natural Resources Ltd. are the companies with the widest spread versus the Canadian BBB curve.

S&P Global’s Dathorne has reduced credit ratings for 14 oil and gas producers in the month through April 17 and downgraded the outlooks for four others. Canadian companies that rely on international banks for financing may face tougher negotiations, she said.

“We have no reason to believe that Canadian banks will make any wholesale exit out of Canadian energy, and we assume that support was there in 2015 and 2016 will remain in place,” she said. “But that doesn’t mean that support is going to replace non-Canadian banks if they choose to exit any kind of lending arrangements.”