The access of most of Canada’s largest banks to the commercial property market in the United States may cause unpleasant surprises for these financial institutions against the background of deterioration in the quality of some real estate loans.
The mentioned surprises, which have nothing to do with what can be described as sudden joy, may manifest themselves as early as this week, during which lenders from the specified country will publish the results of operations in the first fiscal quarter.
On average, commercial property loans account for about 10% of the loan books in the five largest banks in Canada. Currently, the lending sector is under pressure from factors such as high interest rates and plunging valuations. Financial institutions have been increasing provisions for possible loan losses for several quarters.
Nigel D’Souza, an analyst at Veritas Investment Research Corp., says that forecasting the scale of future reserves is difficult due to the idiosyncratic nature of which particular loans could go bad. At the same time, housing price indices, including in the safest city in Canada, and an array of monthly data allow banks to form an understanding of the state of residential mortgages. The analyst also noted that there are no analogs to commercial loans, which is why investors pay attention to higher-level risk categories.
Nigel D’Souza says that the United States is probably more vulnerable than Canada in the context of the impact of difficulties in the lending sector. The analyst says that some weakness in financing the purchase of multi-family residential buildings may become a problem for both countries. The expert noted that Canadian banks do not face a drop in the level of solvency against the background of losses on commercial loans, unlike regional financial institutions from the United States. At the same time, the analyst said that the corresponding losses could become a question mark for the profitability of creditors from Canada.
Nigel D’Souza stated that provisions have an outsized impact on and contribute to a lot of volatility. The expert clarified that other line items, such as margins, loan balances, and revenue from fees, don’t change significantly from quarter to quarter.
