Canadian Banks' Office Exposure Is Manageable Despite a Challenging Environment

Commercial real estate (CRE) is a key area of concern facing Canada's financial system. The office sector, in particular, faces significant challenges, and DBRS Morningstar maintains a negative outlook on the sector in both Canada and the U.S. In DBRS Morningstar's view, headwinds facing the office sector, which include oversupply, obsolescence, and work-from-home dynamics, are secular and the sector will take longer to recover than during normal cyclical lows, particularly in weaker markets.

Key highlights include:

-- The office sector in Canada and the U.S. faces challenges resulting from elevated interest rates and continuing hybrid work arrangements, leading to high vacancy rates and lower valuations. These stresses are being more acutely felt in some cities, and in lower quality properties.

-- DBRS Morningstar remains cautious that office loan portfolio credit metrics could deteriorate; however, total office exposure at Canadian banks, including in the U.S., is a manageable proportion of overall loan books.

“Canadian banks have prudently limited new lending in the office space and are closely monitoring and increasing provisions for credit losses on existing CRE loans. Conservative underwriting should help mitigate potential credit risks, with generally low loan-to-value levels at origination providing a buffer against collateral value risk,” said Josh Veenkamp, Assistant Vice President, North American FIG.