Canadian Commercial Real Estate: Rising Credit Risks Amid Challenging Economic Backdrop

Since the onset of the Coronavirus Disease (COVID-19) pandemic, there have been widespread concerns that the commercial real estate (CRE) sector in Canada could be adversely affected by a deteriorating economic environment. DBRS Morningstar has released a commentary discussing Canadian banks and credit unions’ exposure to CRE sector.

Key highlights include:

-- Overall, CRE portfolios at Canadian banks and credit unions have grown in the past two years, while the commercial mortgage-backed security (CMBS) market rebounded last year following the global pandemic driven decline in 2020.

-- Asset quality of Canadian banks’ and credit unions’ CRE portfolios, like other asset classes, has remained broadly resilient in the past two years although credit unions have incurred relatively higher credit costs.

-- DBRS Morningstar remains cautious that CRE lenders may experience higher credit costs as higher rents and rising interest rates raise concerns around the affordability and sustainability of high valuations and may also lead to refinancing challenges; however, the overall impact should be manageable from a credit quality perspective.

“In DBRS Morningstar’s view, the CRE sector remains under pressure in the current environment of rising interest rates and weakening economic outlook,” said Shokhrukh Temurov, Vice President, North American Financial Institutions at DBRS Morningstar. “At the same time, we also note that the overall impact of rising vulnerabilities across the financial sector should be manageable from a credit quality perspective given the banks’ and credit unions’ good capital buffers and conservative credit terms.”