02/22/2015 10:00 EST | Updated 04/24/2015 05:59 EDT

Canadian Banks' Q1 Earnings To Take A Hit From Oil Price Collapse

TORONTO - Canada's top lenders are expected to report a decline in their investment banking profits when they release their first quarter financial results this week, largely due to a slowdown in oilpatch business.

Oil and gas companies are major clients when it comes to investment and corporate banking services, enlisting banks to help them generate cash for new projects by issuing stocks or debt on the public markets. It's a lucrative division that contributes up to 20 per cent of the bank earnings.

But the recent plunge in the price of oil has dragged down energy sector spending with it, reducing the need to raise capital on the markets.

"We do expect that the advisory fees that were contributed by energy previously are going to drop to fairly close to zero," said Barclays analyst John Aiken.

James Shanahan, an analyst with Edward Jones, says investment banking generates higher profit margins than other lines of business.

It is also the segment that is likely to show the first signs of weakness due to the drastic decline in the price of oil, which has been hovering at US$50 in recent weeks — a sharp drop from last summer when it traded for about $100 a barrel.

Analysts are also concerned about the impact on the banks' loan books if oil and gas companies get into financial trouble or oilsand workers lose their jobs and begin defaulting on their mortgage payments.

But analysts do not expect credit issues to begin surfacing until late this year.

"We don't expect to see the credit implications, if any, until late in 2015, early 2016," Aiken said.

The impact of oil prices on banks' bottom lines will be among the key issues for analysts and investors as the lenders report their first-quarter results.

The Bank of Montreal will lead the group, releasing its earnings report on Tuesday. Royal Bank and National Bank will report on Wednesday, followed by TD Bank and CIBC on Thursday. Scotiabank will wrap up the earnings season on March 3.

Last quarter, Canada's five biggest banks earned a total of $7.4 billion of net income, up slightly from $7.3 billion a year ago. But they warned that a slew of headwinds — including a sluggish global economy and volatile stock markets — will make 2015 a challenging year. Since then oil has continued its precipitous decline, adding to the growing list of concerns.

Even if oilpatch companies manage to avoid bankruptcy, the layoffs and other cost-cutting will have an impact on the Alberta economy and, in turn, the banks, said Aiken.

"The first area of weakness is going to be on the consumer borrowing book — all those people in Alberta that have lost their jobs because of the headcount reductions. They are going to be the first defaults that the banks see on their loans," Aiken said.

In addition to their oil price woes, Canadian banks face several other challenges, including strained lending margins stemming from the Bank of Canada's surprise rate cut in January. Meanwhile Canadian consumers, weighed down by record-high debt loads, are beginning to lose their appetite for borrowing.

With their revenues under pressure, Aiken says the banks will turn to cost-cutting to achieve earnings growth. They have already been carefully managing their expenses, but Aiken says he expects them to become more aggressive.

"We do think that the bank will try to manage the bottom line by managing expenses — not necessarily by letting go employees, but also being very judicious in their project spending initiatives," he said.

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