Uncertainty Breeds Opportunity
December 2019
WHAT’S INSIDE:
We analyze the trends in sector specific impaired loans across Canada’s six major banks
The last four quarters has seen a meaningful uptick in impaired loans with agriculture, energy, manufacturing and retail sectors leading the way
Economic data points and impaired loan increases likely results in less available bank capital and an increased reliance on alternative lenders
FLUSHING OUT IMPAIRED LOAN TRENDS IN CANADA’S BANKING SECTOR
Last weeks onslaught of Tier 1 Canadian Bank earnings led us down our most recent rabbit hole as we rolled up our sleeves and dug into the impaired loans data from Canada’s largest banks. Gathering quarterly loan data by sector over the past six years for the usual suspects (BMO, CIBC, RBC, Scotia, TD and National) has yielded some eyebrow raising results with big-picture data suggesting growth in loans deemed impaired has materially outpaced growth in total loans outstanding over the past two years (35% vs 25%). Digging deeper and breaking down loan exposure by sector suggests that agriculture, retail and wholesale, energy and financial services sectors are behind the recent increase in loan impairment exposure.
Canadian Banking - Impaired Loans by Major Sector
WHAT ARE THE IMPLICATIONS?
Simply put, we see the outsized growth rate of impaired loans and persistent economic headwinds likely motivating banks to tighten their purse strings. Ultimately, Tier 1 Bank special loans groups get busier and we expect alternative lenders to see a material increase in deal flow to help fill the gap.
Total Outstanding Loans by Sector
% Impaired Loans by Sector
DECIPHERING WHAT ALL THE LINES MEAN
Since Q4 2015, total outstanding loan sector exposure has increased on a relative basis for: financial services, other services and real estate/construction, while it has decreased modestly for energy and retail/wholesale sectors.
Impaired loans in the energy sector peaked at 39% of the total impaired loans outstanding (across all sectors) in Q2/2016 and subsequently dropped to 11% in Q1/2019. We have seen a steady increase in impaired energy loans over the past three quarters.
Other sectors seeing a noteworthy uptick in impaired loans on a relative basis over the past year include agriculture (up $280 million), manufacturing (up $188 million) and retail/wholesale (up $206 million).
Energy sector impaired loans
Energy sector impaired loan exposure grew to nearly $3 billion in 2016
Over the past three quarters we have seen a $600 million increase in impaired loans
Agriculture sector impaired loans
While not a major lending sector in terms of loan exposure, worth noting the significant increase in impaired agriculture loans ($280 million in 1 year)
Impaired agriculture vs total outstanding has increased to 1.3%, the 2nd highest in all sectors
Manufacturing sector impaired loans
The $200+ million increase isn’t overly concerning on its own but the uptick in total impaired versus total outstanding is noteworthy
Retail and wholesale impaired loans
Retail impaired loans have seen a steady increase since the middle of 2018 as the sector has added nearly $300 million in impaired loans over the past 18 months
THE NEED FOR ALTERNATIVES
The way we see it, trends in impaired loans (both relative to total loans outstanding and absolute amounts) can serve as leading indicators for activity levels of special loans groups and alternative lenders. Business borrowers, especially those operating in sectors that are seeing an upward trajectory of impaired loan amounts need to be prepared to stomach a higher cost of capital. As Canada starts to face an increasing amount of economic headwinds and the dreaded “R” word is increasingly tossed around, the role of non-traditional lenders to fill the funding gap will be needed more than ever.
For those not overly familiar with the non-bank/crown corporation lending sector, Diamond Willow has a network of over 170 capital providers in this space who help solve some of the most complex financial situations.
Sources: Company reports, Diamond Willow Advisory
