Bank earnings to take hit as risk of losses on office loans grows: OSFI

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As the risk of sizable losses on commercial real estate loans grows, Canadian banks’ earnings are poised to take a hit, according to the head of Canada’s financial-system regulator.

“It’s likely that banks across the world are going to suffer some” commercial real estate losses “and they’re likely to be meaningful,” Peter Routledge, head of the Office of the Superintendent of Financial Institutions, said Friday at a conference in Toronto hosted by TD Securities. Those losses will probably be “earnings events” for Canadian banks, but not a major capital risk, he added. “We’re expecting institutions to act early, to identify troubled loans, take provisions early and work them out, move them through capital.”

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Office buildings are under particular stress as both property valuations and revenue have slumped amid occupancy levels that remain well below pre-pandemic levels in many places. Using a traffic-light analogy, Routledge said office loans are a “dark orange” issue in Canada and a “dark red” problem in the U.S.

OSFI knows which banks are most highly exposed and has been working with them to make sure they’re “putting in place the capital and operational buffers to absorb a greater deterioration in the asset class than they might expect,” Routledge said.

While Canadian banks put more money aside for potentially souring commercial-property loans in fiscal 2023, “more pain is likely, given the state of real estate markets,” Paul Gulberg, senior industry analyst with Bloomberg Intelligence, said in an email Friday. There are particular challenges with loans in the U.S., he said, because lenders in the country don’t have recourse to debtors’ other assets, and borrowers are facing more near-term refinancing needs.

Toronto-Dominion Bank, Bank of Montreal, Royal Bank of Canada and Canadian Imperial Bank of Commerce are more exposed to U.S. commercial real estate, Gulberg said. “Yet the banks’ earnings power and high levels of capital are sufficient to absorb the risks, likely leaving some pressure on quarterly earnings.”

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Analysts have said CIBC is particularly exposed on U.S. office properties, and Bloomberg News reported last week that the bank is exploring selling US$316 million in U.S. office debt.

Routledge said at the conference that commercial real estate, residential properties and bank liquidity and capital are his top three concerns at the moment.

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