At present, the Canadian banks have outstanding asset quality. Although provisions rose notably for the second consecutive quarter in Q2, provision and gross impaired loan ratios remain below long-term averages. With Q3 reporting beginning August 23rd, we believe the market will be focused on two areas of potential deterioration: (i) energy loans (which have been driving higher loan losses), and (ii) Alberta consumer, particularly uninsured.

Given the large size and increasing complexity of the Canadian banks, we thought we would provide investors with an easy-to-understand chart that breaks down the Big-6’s total $2.4 trillion loan portfolio, which roughly speaking is almost equally divided between “lower” and “higher” risk loans[1]. The former (shown in the grey area in the chart below) consists of ~$1.2 trillion of residential mortgages, both insured and heavily-collateralized uninsured.

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The latter (in the light pink area, at the bottom) is comprised of ~$800 billion in business and government loans and over $300 billion in non-residential (unsecured) retail loans. Generally in credit cycles, the vast majority of “higher than expected” loan losses originate from these two categories.

canadian-banks-more-risky-vs-less-risky-loans-in-one-chart

Included within the “higher risk” loans are ~$50 billion in drawn oil and gas loans, and $30 billion of non-residential retail loans in Alberta (which is in year #2 of a recession). In our view, this $80 billion of loans is currently under direct credit pressure. So if the sector continues to see rising loan losses, they are highly likely to come from these two portfolios.


Notes

[1] Some figures from Q1 2016 as they were not disclosed in Q2 2016.

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