Canadian banks could feel impact of low oil, analysts say

Canadian bank earnings are at risk this year because of low oil prices, an economic slowdown in Canada and the impact ofrate cuts, according to two recent reports by analysts.

Barclays analyst John Aiken says investors are already factoring in these factors on bank earnings and taking short positions in bank stocks.

• Cheap oil will last through 2018 at least, Moody's says

"With more than three-quarters of 'Big 6'earningsstill tied to domestic-based operations, beset by the deteriorating domestic economic outlook, the market appears to be taking an increasingly negative view on the Canadianbanks," he said.

Bank margins are under pressure because of low interest rates and the Bank of Canada's two rate cuts this year increased that pressure, he said.

But the real pain for the banks could come as the impact of lower oil prices work through the Canadian economy, according to CIBC Markets analyst Rob Sedran.

CIBC 'stress test' for banks

He released a research report earlier this week that gave a "stress test" to Canada's big banks to weigh the effectsof lower oil prices.

These could include:

• Exposure to corporate oil and gas assets.
• How capital markets react to low oil prices.
• Exposure to Alberta mortgages.
• Involvement with non-energy business loans in Alberta.

The report concluded exposure to oil and gas assets posed the greatest danger for the banks and could reduce 2016 earnings by up to 4.3 per cent.

That is a worst case scenario, assuming a prolonged period of low oil prices combined with weak economic activity that led to defaults on loans in the oilpatch.

The impact of a milder downturn was estimated at 1.1 per cent of 2016 bank earnings.

Trading revenue from capital markets could be hurt by a long period of low oil prices and there may also be a higher level of default on non-energy business loans in Alberta if the province goes into recession, the report said.

But it anticipated little impact from a downturn in the housing market as the Canadian mortgage market is usually very safe, with the banks self-insuring loans that don't have CMHC backing.

Sedran points out that Canadian banks have lower valuations than U.S. banks, despite having better earnings growth and a more diversified business mix. He said he believes the market has already discounting the impact of low oil on financial stocks.