Large Canadian Banks: U.S. Commercial Real Estate Exposure a Primary Driver of Credit Quality Deterioration

The U.S. office sector, including property valuations, continues to face the greatest pressure as a result of expanding capitalization rates and weakening demand. For the Big Six with a material presence in the U.S., office typically makes up a larger proportion of commercial real estate (CRE) loans for the U.S. book compared with CRE loan portfolios outside of the U.S. Nonetheless, Big Six total global office exposures remain very manageable at 0.8% to 1.9% of total loans and acceptances.

Key highlights include the following:

-- U.S. CRE remains a key area of concern, particularly the office sector where U.S. commercial property prices have taken a beating and vacancy levels are the highest in decades.

-- U.S. CRE has become a primary driver of credit quality deterioration, and we expect this trend to continue in F2024 with higher delinquencies, provisions for credit losses, and loan losses.

-- Large Canadian bank CRE exposure remains very manageable, and capital buffers are sufficient to absorb higher-than-expected losses.

“Prospects for the U.S. CRE sector remain challenging, despite anticipated interest rate cuts in 2024 and the expectations of a soft landing for the economy. With the rapid pace of interest rate hikes and sharp increase in borrowing costs, commercial property prices have been hit harder than in previous Federal Reserve tightening cycles,” said Carl De Souza, Senior Vice President, North American Financial Institutions Group. “Additionally, increasing amounts of U.S. CRE debt will mature at a time when vacancy rates are at decades-high levels and valuations have declined, leaving many borrowers needing to add equity to refinance.”