Roughly around the time the market troughed in early February, we asked “After The European Bank Bloodbath, Is Canada Next?” The reason for this question was simple: we said that “when compared to US banks’ (artificially low) reserves for oil and gas exposure, Canadian banks are…not.”
Stated otherwise, we warned that the biggest threat facing Canada’s banking sector is how woefully underreserved it is to future oil and gas loan losses.
We added that unlike their US peers, “Canadian banks like to wait for impairment events to book PCLs rather than build reserves, in effect throwing the entire process of reserving for future losses out of the window.”
We then cited an RBC analysis according to which a 7% loss reserve would be sufficient to offset loan losses in what is shaping up as the biggest commodity crash in history. We disagreed:
We wish we could be as confident as RBC that this is sufficient, however we are clearly concerned that if and when Canada’s banks finally begin to write down their assets and flow the impariments though the income statement, that things could go from bad to worse very quickly, and not necessarily because Canada’s banks are under or over provisioned, but for a far simpler reason – once the market focuses on Canadian energy exposure, it will realize just how little information is freely available, and if European banks are any indication, it will sell first and ask questions much later if at all.
However, indeed assuming a worst case scenario, one in which the banks will have to “eat” the losses and suffer impairments, then the question emerges just how much capital do these banks truly have, which in turn goes back full circle to our post from the summer of 2011 which led to much gnashing of teeth at the Globe and Mail.
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