How the Big Banks Are Weathering the Downturn

The major financial institutions are certainly weathering this commodities slump better than those before it. But can we say the same about the oil patch?

December 07, 2016

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“For every day or for every week or month that this recession drags on, there are going to be more and more customers that aren’t able to hold on any longer.”
– Todd Hirsch

Odin Waldal is one of the fortunate few. When oil prices tumbled in late 2014, his oilfield services company was well-positioned to weather the storm. He had expanded conservatively during the boom, only buying drilling rigs for his Calgary-based Lonestar Directional when he had the contracts to pay for them. As the bust worsened through 2015, loyal customers threw him as much business as they could, even if rates were much lower, forcing him to cut field wages in half. And his bank was very supportive, appreciating his strong balance sheet and willingness to cut costs during the downturn. Waldal isn’t alone. “From the guys I’ve been talking to, the banks have tried just about everything they can to give them hope,” he says. “But after a few years, they eventually just said enough is enough and shut them down.” Oilfield businesses, both producers and service companies, might not have enjoyed as much latitude in previous downturns.

This bust in the oil patch—and the impact on regional and national financial institutions—seems different than those in the recent past, according to Todd Hirsch, chief economist for the Alberta Treasury Branches (ATB), who calls the 1980s in Alberta “a remarkable downturn.” The memory of Pierre Trudeau’s National Energy Program can still invoke a strong reaction from those unfortunate enough to remember the economic devastation that accompanied it. Artificially low oil prices were compounded by interest rates rising 20 percent, plus the provincial economy was much smaller and less diversified, says Hirsch. “If you were a small business or household financing debt at 18 percent and suddenly your revenue dropped through the floor, you had almost no chance,” he says. “Today, it’s much better.”

Peter Routledge agrees. The managing director of financial services for National Bank Financial says the mid-1980s saw “very high elevated loan losses” in banks’ energy portfolios. “This current cycle has produced losses that are maybe 10 percent to 20 percent of what we saw 30 years ago,” he says. “So it looks much more like what we saw in the 2007 through 2009 recession. Very mild.” Routledge hastens to add that he means “mild” in its effect on Canadian financial institutions, not for the oil patch or consumers. Hirsch points out that the structure of the national financial system also helps because the Big Five national banks can spread their losses over bigger portfolios than, say, regional or local American banks.

One might expect the two smaller Alberta-based banks, ATB and Canadian Western Bank (CWB), to be feeling the pinch a bit more, but that doesn’t appear to be the case. Chris Fowler, the president and CEO of Canadian Western, says its direct exposure to the energy industry is “relatively small”—about 3 percent of the bank’s total loans outstanding. “This is comprised of loans to exploration and production companies representing approximately one per cent and loans to energy service companies representing approximately two per cent,” he says. Net impaired loans within its energy portfolio at the end of the third-quarter were only $3 million, less than 0.02 percent of the bank’s overall loan book.

One reason for such low loan losses is that banks are much more likely to have secured loans than during previous downturns, according to Routledge. “The collateral for the exploration and production companies tends to be minerals in the ground, which banks have tended to look at as sustaining its value,” he says. “So they’re being patient.”

Fowler says Canadian Western has taken a “proactive approach” to resolving problems and intends to “conservatively manage exposures” to energy loans. “Nearly three-quarters of CWB’s direct exposure to exploration and production companies is now comprised of syndicated loans to borrowers with strong balance sheets and substantial proven, developed, and producing resources.” Routledge says all banks are doing the same, working with clients to cut costs and funding exploration for new reserves. “If I look at it from a 50,000-foot perspective, they’ve been quite willing to work with their clients and wait and see where the oil price settles.”

Waldal says banks have the opposite problem with service companies because equipment is worth almost nothing in a depressed market. “There was a business that just went under and I’d known those guys for years. The bank put their assets up for sale and they basically got, I think, it was five cents on the dollar, if they got that really,” he says, adding that banks know “they’re in a pickle” and try harder to keep companies operating in hopes of an upturn in the price of oil. Fowler says his institution’s loans to service companies are mostly term-reducing advances secured by industrial equipment, rather than operating lines of credit or loans secured against receivables or inventory. “These factors mitigate the loss potential of CWB’s limited exposures to the energy services sector,” he said. “To date, the impact of lower oil prices outside of the direct oil and gas portfolio has been minimal.”

“The services sector is being devastated and the banks are sitting there holding the books of a number of companies barely making ends meet.”
– Mark Sakeld

That could change in the months ahead. Mark Salkeld, president of the Petroleum Services Association of Canada (PSAC), says his organization has lost a hundred members already thanks to the downturn. That number includes major hydraulic fracturing service firm Sanjel Energy Services, some of whose assets were sold into the American market. “The services sector is being devastated and the banks are sitting there holding the books of a number of companies barely making ends meet,” he says. Oil and gas producers have driven rates down to the point that some companies are working at cost, or even less, just to keep staff employed and cash flowing. All of Waldal’s staff have taken pay cuts and some are job-sharing just to hang on to a paycheck. The veteran driller thinks a return to some level of normal is probably still a year away, and he wonders how many service companies can continue hanging on by their fingertips.

Surprisingly, Alberta consumers have fared better than expected, according to Hirsch. “Those sectors that are driven by the consumer—like retail, like the housing market, like the restaurant and bar industry—we haven’t really seen a big drop and it’s quite amazing, actually.” For instance, he notes that Calgary housing prices “wobbled,” dropping three to four per cent, but low mortgage rates minimized the impact, unlike in the mid-1980s when prices dropped 25 percent.

Hirsch chalks some of the resilience up to the nature of oil and gas layoffs this time around, especially in Calgary, where more high salary professionals like engineers and managers lost their jobs, but received significant severance packages. “I don’t want to imply that it hasn’t been a horrible experience for them, but a lot of the unemployment is concentrated among high-income earners and they haven’t really yet had to adjust their consumer patterns all that much,” he says. “For every day or for every week or month that this recession drags on, there are going to be more and more customers that aren’t able to hold on any longer,” he continues. “The longer this drags on, the more pain we’re going to see for the financial institutions.” CIBC, for instance, said in its second-quarter analyst call that it has $40 billion of retail exposure in Saskatchewan and Alberta, with the latter accounting for $31 billion. Credit cards and unsecured personal lending delinquencies had been trending up, mainly driven by the oil-producing provinces, he says. Even though that trend had plateaued, CIBC expected them to remain elevated.

The next 12 to 18 months are likely a good news/bad news scenario for financial institutions servicing Alberta. Hirsch expects oil prices to recover to the $50 to $55 per barrel range late this year, enough to stabilize the petroleum sector, but not enough to stop further deterioration of the labor market, where unemployment crept up to 8.4 percent by October.

“I think the oil and gas challenge for the banks is in the rearview mirror,” says Routledge, but cautions that there is still plenty of opportunity for prices to slump again, creating a “double dip” in the energy economy and more problems for lenders. Salkeld says that even after prices stay above $50 per barrel for an extended period, oil and gas producers will do everything within their power to use the additional revenue to shore up their own balance sheets before they begin accepting higher rates from service companies.

“Once things do pick up, the banks and investors are going to be there to collect their money back,” says the PSAC head. “Then, after banks and investors are satisfied, they might have some revenue to start hiring people.” Waldal says he’s an optimistic person by nature, but adds that he’s been in the oil patch too long to expect that good times are just around the next corner. “Some of these companies that have gone under, we’ve been lucky enough to pick up some of that work,” he says. “I guess one man’s misfortune is another man’s good luck. We’ve been on the good side this time, but I’ve been on the bad side far too often.”

More posts by Markham Hislop

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