With severe pressure in the energy sector threatening investors, analysts at Moody’s have released a stress-test report of its potential impact, concluding that Canada’s seven largest banks could take several steps before resorting to slashing dividend payouts.
“Dividend cuts would be a last resort,” lead author David Beattie, who is also a senior vice-president at the firm, related in an interview. Some measures he suggested include stopping share buy-back programs and issuing new shares, not replacing securities in their portfolios when they mature to reduce their risk-weighted assets, and tweaking pricing so they would attract less new business in their loan accounts.
The report is based on a scenario-based test, which assumes that oil-producing provinces would sustain above-historical recession loss in consumer loan portfolios and that capital markets’ net income would sustain a hit of 20%.
“Under the expected case in our stress test of the Canadian banks’ energy exposures, the profitability of the banks will decline but their capital would not be impaired,” the report says, adding that “in a severe stress scenario… some of the banks might be required to take capital conservation measures, cut dividends or raise additional equity.”
In such a case, the investment bank estimates losses of around 1.5 times quarterly net income for the group of banks. “In this scenario, the banks would still generate sufficient capital to cover stress losses within two quarters, but not at the current payout ratio,” the report explains. “Unless the banks reduced dividends and/or raised new common equity, it would take multiple quarters to absorb stress losses through retained earnings.”
According to Moody’s, 6% of corporate credit at Canada’s largest banks is composed of loans to the oil and gas industry. It is also equivalent to 2% of total gross credit and 26% of the CET1 capital cushions. The ratings agency rates more than half of the banks’ loans to energy companies as investment grade, as the balance of exposures are mostly reserve-based facilities secured by proven and viable oil and gas reserves.
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