RBC, TD, BMO, Scotiabank, CIBC Seen Hit by Troubled US Commercial Real Estate Market

Canadian banks' quarterly results due next week may offer a window into how they are navigating the challenges at home at a time when consumers are under financial strain while the housing market is hurting from higher interest rates. But they also have worse problems elsewhere.

About 14% of CRE loans and 44% of office loans are backed by properties whose values have fallen below their outstanding loan balances, the National Bureau of Economic Research said in a paper published in December.

NBER estimates that about a third of all the $2.7 trillion in CRE loans held by US banks and a majority of office loans could face "substantial cash flow problems and refinancing challenges," researchers Erica Xuewei Jiang, Gregor Matvos, Tomasz Piskorski and Amit Seru said in the paper.

That could prompt Canadian banks to set aside more money for credit losses on loans that customers won't be able to pay. A hypothetical write-off of an additional 2% of the C$402 billion commercial real estate loans held by Canada's six biggest banks could cut about 12% of fiscal 2024 consensus earnings for Canadian banks, Bloomberg Intelligence analyst Ethan Kaye wrote in a note Feb. 12.

Most of the commercial real estate risks are in the office category after the pandemic lockdown spurred the work-from-home practice by employees, leaving many buildings empty even after the world has moved on from coronavirus.

Bank of Montreal, the fourth-largest Canadian bank, is due to report financial results on Feb. 27. BMO, as the bank is known, holds C$35.3 billion in US commercial real estate exposure, the second highest among Canada's six big banks, according to data from company filings and presentations compiled by Bloomberg Intelligence. That's equal to about 5% of BMO's total loan portfolio and represents a C$1.8 billion in potential loss, according to Bloomberg Intelligence.

"Writing off 5% of the US exposure exposure in isolation represents an 11% profit cut, or a 1.4% book-value hit, with CIBC, BMO, RBC and TD most exposed" Bloomberg Intelligence's Kaye said.

Scotiabank's Small Hit

Royal Bank of Canada, which reports first quarter financial results on Feb. 28, has a C$29.4 billion exposure in US CRE, with a potential loss of C$1.5 billion that could result to a 7% hit on its fiscal 2024 consensus earnings, according to Bloomberg Intelligence.

While RBC Wealth Management acknowledged the problems in the US commercial real estate, these are not catastrophic, according to a blog post penned by Michael Capobianco on Feb. 9. He said the practical risk in the bank system is a small fraction of the $2.7 trillion figure from NBER and the risks on the largest loans have been distributed through securitizations and other transfer mechanisms.

But the US commercial real estate market isn't the only problem. Canada's national downtown office vacancy rate hit a record high of 19.4% in the fourth quarter, according to commercial real estate services and investment firm CBRE said in a press release on Jan. 9.

TD Bank, due to report financial results on Feb. 29, has a C$40 billion exposure to the US commercial real estate, the biggest pile among the Canada's top five banks, according to Bloomberg Intelligence data. That means a potential loss of C$2 billion or an 11% hit on the fiscal 2024 consensus earnings, the BI data showed.

Canada's Record Office Vacancies

The US commercial real estate market isn't the only problem. The national downtown office vacancy rate hit a record high of 19.4% in the fourth quarter, according to commercial real estate services and investment firm CBRE said in a press release on Jan. 9.

Consumer loans could also pose challenges. Canada's household debt obligations as a proportion of disposable income climbed to record highs, Royal Bank of Canada said on Jan. 31. "2024 is still likely to be a challenging year for Canadian consumers as higher interest rates continue to trickle through the economy and push debt payments higher," RBC said in a blog post.

Consumer debt in the country climbed $81 billion in the third quarter to $2.4 trillion, according to Equifax. Total credit card balances jumped 16% to an all-time high of $113.4 billion during the period.