Canada’s big six banks are considered well insulated against declining prospects in the office sector. Newly released commentary from the credit rating service, DBRS Morningstar, reiterates the general negative outlook for office properties in both Canada and the United States, but highlights lending and underwriting trends that have limited the big six banks’ exposure.
As of the third quarter of 2023, office properties account for 13 per cent of the six banks’ collective commercial real estate (CRE) loan portfolio, while CRE represents about 10 per cent of total loans. The total exposure to office is pegged at $51 billion or 1.2 per cent of total loans.
“Canadian banks have prudently limited new lending in the office space and are closely monitoring and increasing provisions for credit losses on existing CRE loans. Conservative underwriting should help mitigate potential credit risks, with generally low loan-to-value levels at origination providing a buffer against collateral value risk,” says Josh Veenkamp, assistant vice president, North America, with DBRS Morningstar’s financial institutions group.
In contrast to the United States, there was a 0 per cent delinquency rate on office loans packaged into Canadian commercial mortgage backed securities (CMBS) as of August. The outstanding loan volume shrank quarter-over-quarter, attributed to tightened lending and negligible loan growth of 0.1 per cent.
Exposure to the U.S. market is considered more of an issue for four of the six banks — BMO, CIBC, TD and RBC — accounting for about half of their office loans. “The Big Six’s impaired loans on CRE have started to tick up, and a substantial portion of the increase is likely being driven by the U.S. office portfolio,” the commentary submits.
However, this is deemed to be “manageable” given it remains such a small portion of their total loan portfolios. Meanwhile, in tallying the office sector’s frequently chronicled woes related to climbing interest and vacancy rates and falling values, DBRS Morningstar analysts also make equally unstartling observations about the unevenness of the impacts.
“The Big Six maintain office portfolios that are generally well-diversified by geography, location and class, with many properties backed by strong financial sponsors,” they conclude. “In the near term, long-term leases to high-quality tenants and the aforementioned flight to quality should continue to mitigate downside risk for rated real estate issuers, to some extent. In the longer-term, a shrinking construction pipeline expected to reach a 20-year low at the start of 2024 and conversion of obsolete office buildings into alternative uses point to reduced supply growth, which will help supply and demand find equilibrium.”
