(Bloomberg) -- Bank of Montreal and Canadian Imperial Bank of Commerce may need to raise new equity over the medium term to build capital levels as the bank regulator bolsters its requirements, according to analyst Nigel D’Souza. 

Bank of Montreal issued shares in December and there’s been talk of CIBC doing the same after Canada’s financial watchdog boosted the minimum buffers that large banks must hold to absorb losses.

Stock sales are unlikely to happen in the short term, said D’Souza, who works for Toronto-based Veritas Investment Research Corp. But an economic slowdown and higher loan losses may eventually force both Canadian lenders to tap the market, he said. 

“We think BMO is most at risk of higher credit losses because they are overweight commercial lending, and within the commercial lending portfolio, they have a higher weighting to cyclically sensitive sectors,” said D’Souza, referring to what would happen in a deep recession, which isn’t his base case. The bank is also in the midst of the acquisition of Bank of the West for US expansion, which will eat into capital levels. 

The Office of the Superintendent of Financial Institutions last month raised the required common equity tier 1 ratio for the country’s largest banks by 50 basis points, to 11% of risk-weighted assets as of Feb. 1. It also increased the range of the “domestic stability buffer” — setting the stage for possible further increases to capital thresholds.

All large Canadian banks target a capital ratio that’s higher than the regulatory minimum, and OSFI’s new, wider range may force them to carry even larger surpluses over what’s required.

The other four large banks — Royal Bank of Canada, Toronto-Dominion Bank, Bank of Nova Scotia and National Bank of Canada — are all on track to reach a 12.5% CET1 ratio over the next two fiscal years based on their internal capital generation, said D’Souza. 

By contrast, Bank of Montreal and CIBC wouldn’t achieve that level until fiscal 2025, so if they would like to catch up with other large banks they’ll need to raise other capital, he said.

Rapidly-rising interest rates have led to concerns about financial distress in Canadian households, which have high leverage that may result in loan defaults during an economic downturn. 

Of the six largest domestic banks, National Bank is least at risk because of its concentration in Quebec. “Historically Quebec has experienced lower credit losses through recessions than the larger banks that have exposure across multiple provinces,” D’Souza said.  

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