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Commercial real estate loans represent the second largest lending exposure of Canada’s six largest banks
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Published on May 08, 2023 • Last updated 2 days ago • 3 minutes read
Bank and office towers in Toronto’s financial district. Photo by Peter J. Thompson/Financial Post
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According to a prominent Bay Street analyst, Canada’s banks may not be as heavily invested in commercial real estate as their counterparts in the United States, but that doesn’t mean their earnings aren’t at risk, particularly from the office segment, which is beset by remote work.
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According to National Bank financial analyst Gabriel Dechaine, commercial real estate loans represent the second-largest loan exposure of Canada’s top six banks, only proportionally behind residential real estate and accounting for around 10 percent of loan portfolios.
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“Not only is the portfolio large, but it has also grown faster than the entire wholesale portfolio over the past seven years,” the analyst said in a May 7 note to clients. “Office exposures are of particular concern, accounting for 12 percent of the average Big Six CRE (commercial real estate) book.”
Rising interest rates have presented challenges for commercial property owners and investors, while at the same time many office buildings are underutilized due to remote work and hurting rental prospects.
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Dechaine ran scenarios using the historical precedents of the 2008 financial crisis and the early 1990s recession and real estate downturn as proxies and concluded that the per-share downside risk was in the high single digits or “well above.” 20 percent, although “probably at the lower end of that range.”
Office loads are of particular concern
Gabriel Dechaine, Analyst, National Bank
“Obviously, the drop in earnings would be even greater in either scenario, given that there would be losses in other loan portfolios as well,” he said.
Despite the potential impact on earnings, the analyst said none of the big banks are likely to fall below the required minimum capital buffers controller.
Commercial real estate lending has garnered a lot of attention in the US since the Silicon Valley bank collapse in March because, according to research by Goldman Sachs Group Inc., banks with less than $180 billion in assets hold about 70 percent of commercial real estate lending in the banking system in their balance sheets. US regional banks with assets between $10 billion and $20 billion have 25 percent of their loans tied to commercial real estate.
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Dechaine said non-performing commercial real estate loans for Canadian banks are not yet rising significantly, apart from some US exposures. But he added that Canadian financial institutions are not disclosing as much as their US counterparts when it comes to retirement provisions on their commercial real estate books, where US banks have left off Commissions of two to three percent.
“Despite the excellent (Canadian) credit metrics today, investors are undoubtedly questioning coverage ratios in the event of an actual downturn in commercial real estate (particularly in the office category),” Dechaine said.
“With the CRE overhang and ongoing turmoil in the regional US banking sector potentially triggering a recession, we believe most investors will maintain a cautious stance on the Big 6 banks.”
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The Royal Bank of Canada in Toronto’s financial district. Photo by Mark Blinch/Reuters
Dechaine calculated that a trio of financial institutions — Bank of Montreal, Toronto-Dominion Bank, and National Bank — have about 10 percent exposure to office real estate, while Royal Bank of Canada tops the group with nearly 20 percent.
Other market observers expressed less concern about Canadian banks’ ability to survive exposure to commercial real estate. In an April 5 column, David-Alexandre Brassard, chief economist at CPA Canada, said the big banks were “well positioned” to deal with historically high vacancy rates and higher interest rates, noting that commercial real estate was two by comparison percent of their total assets account for 13 percent for US banks.
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“It’s the smaller banks that have more risk in this space and there are very few in this country,” he said.
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