Some Canadian banks could be instructed to preserve capital by raising equity or even cutting dividends if oil prices still slump, Moody’s warns inside a new report.
In a “severe stress” scenario modelled through the ratings agency, and contained in the are accountable to be widely circulated Monday, losses in consumer lending portfolios would exceed historic peaks and capital markets activity in the country’s biggest banks could be significantly crimped.
“Under the moderate stress scenario we modeled, the profitability of Canadian banks will decline but their capital would not be impaired,” David Beattie, a senior vice-president at Moody’s, wrote in the report.
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“In our severe stress scenario, however,” he warned, “some from the banks’ CET1 (capital) ratios could fall under 9.5 percent, in which case we believe they might be required to take capital conservation measures, cut dividends, or raise additional equity.”
In an interview, Beattie characterized the probability of the severe stress case as “very remote” and said dividend cuts would be avoided through the big banks “except under extreme duress.”
Still, with oil prices slumping to levels not observed in more than a decade, the ratings agency expects banks will need to absorb the pain of oil producers, drillers, and repair companies, in addition to consumers in oil-producing provinces.
In the severe stress test scenario outlined by Moody’s, losses within the big banks’ consumer portfolios would rise above the historical peak, and there would be a 20 percent decline in capital markets’ net gain, driving losses to 1.5 times quarterly net gain.
In this scenario, unless banks lessen the payout ratio – the percentage of earnings paid to shareholders as dividends – or issued shares, “it would take multiple quarters to soak up stress losses through retained earnings,” Beattie wrote.
Among Canada’s biggest banks, Canadian Imperial Bank of Commerce and Bank of Nova Scotia emerge because the “negative outliers” in the Moody’s stress testing.
CIBC’s rank reflects the truth that the bank’s operations are primarily in Canada. The nation’s fifth-largest bank also offers “considerable gas and oil concentration in the corporate loan book, and a material part of its earnings originates from capital markets activities,” Beattie wrote.
Scotiabank would face higher stress losses from the corporate loan book and the segment mix of its corporate loans.
In the severe stress scenario, both CIBC and Scotiabank would lose about 100 basis points from CET1, a key measure accustomed to gauge a bank’s capital cushion.
However, Beattie said that doesn’t mean those banks will be the first to have to tap the market for funds through an equity issue, in order to reduce dividends.
“Each of the banks is originating from a different starting place in terms of capital,” he said, adding that Canada’s big banks hold capital well above the regulatory minimum. What’s more, any of the banks could invoke capital conservation measures quickly and pre-emptively if the probability of a serious stress situation were to start to rise, he said.
Toronto-Dominion Bank is a “positive outlier” in the Moody’s analysis, losing just 53 basis points of CET1 within the severe stress scenario. Beattie said Canada’s second-largest bank by market capitalization includes a relatively small oil and gas corporate loan book, despite the fact that book growing considerably over the past year.
TD also has a comparatively low concentration of retail operations in oil-producing provinces, and low reliance upon earnings from capital markets, he wrote.
The effect on capital markets activity is tough to calculate, Beattie said, adding that underwriting earnings will be hurt by reduced equity issues in the energy sector, but that could be a minimum of partly offset by mergers and acquisitions activity that takes place during a downturn.
bshecter@nationalpost.com
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