Bank watch lists early warning sign of trouble for oil and gas industry

They are the early warning signs that a company may struggle to repay its debts: watch lists.

In releasing their latest quarterly earnings, Royal Bank, CIBC and Scotiabank each added nine oil and gas firms to their loan watch lists, the latest sign of trouble in the oilpatch. The names of those companies are kept confidential.

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Gordon Sick, a finance professor at the Haskayne School of Business at the University of Calgary, said many energy companies are struggling and likely behind in their loans.

"There's a lot of them who are potentially in default," said Sick. "The banks in Canada are potentially looking at some hits."

Royal Bank's watch list grew after it did a name-by-name stress test on its oil and gas portfolio, said chief risk officer Mark Hughes.

"Following this stress test, we've seen a small increase to our oil & gas watch list for closer monitoring," Hughes said in an email.

One step before 'impaired'

The watch list has the banks keeping a close eye on the companies, and is one step before impaired status when a bank considers the loan at risk of default.

Scotiabank said five per cent of its energy portfolio was on the watch list and it moved four loans to impaired status in the first quarter. CIBC said it impaired one loan.

Like the other big banks, oil and gas loans only make up a small portion of Royal Bank's total holdings, Royal Bank CEO David McKay emphasized in a conference call with investors last month.

The Bank of Montreal saw a $200 million increase in gross impaired loans in the last quarter. Close to half of that represented loans to the oil and gas sector, said Surjit Rajpal, the bank's chief risk officer.

"Impaired status is based on where we feel that the loan that we have is now in danger of not getting repaid," Rajpal told investors last month.

"If low oil prices persist this year, we expect our current loan loss rate to increase."

Sick said the banks are doing what they can to accommodate companies and keep loans alive. They would also likely push for a merger or sale before resorting to calling in loans and triggering a full bankruptcy, said Sick.

Credit-rating agencies making downgrades, too

But the financial picture isn't improving for Canada's oil and gas companies, with the credit ratings agencies also making waves of downgrades.

Moody's recently downgraded Canadian Oil Sands, Cenovus Energy and Encana Corp. to speculative grade, and further downgraded Baytex Energy Corp., Paramount Resources Ltd., MEG Energy Corp. and Bellatrix Exploration Ltd. into the 'C' level credit ratings.

Sick said the agencies look especially at two key metrics when assessing companies: how much higher cash flow is than interest payments, and how the overall value of the company compares with its debts. When either of those ratios are off, it could lead to a lower rating.

"You're getting into situations where the cash flow is the same as the interest owed or even less, and that's where you're definitely going to be in the junk bond," said Sick.