Bay Street analyst warns of office real estate exposure for banks

Soaring interest rates and remote work are making it difficult for investors and owners of commercial real estate, and work from home set-ups are leaving many office buildings underutilized and affecting rent prospects. The first quarter saw a rise in the U.S. office vacancy rate to 12.9%, breaking the previous record set during the financial crisis of 2008, according to a report from the Wall Street Journal.

Using historical examples such as the financial crisis of 2008 and the recession and real estate downturn in the early 1990s as intermediaries, Dechaine ran settings and concluded that the downside risk to earnings per share could be in a high single digit count or “well over” 20%, though “likely at the lower end” of that variation.

“Of course, in either scenario, earnings downside would be even greater considering that losses would also be incurred in other lending portfolios,” he said.

No significant bank would likely fall below the minimal capital buffers required by regulators, the analyst said despite the possible impact on profitability. Around 70% of the commercial real estate loans in the banking system are held on the balance sheets of banks with less than US$180 billion in assets, according to research by Goldman Sachs Group Inc. Twenty-five percent of the loans made by regional U.S. banks with assets between $10 and $20 billion are secured by commercial real estate.

Despite some exposure to the U.S., Dechaine said that Canadian banks’ exposure to weakened commercial real estate loans has not increased dramatically. However, Canadian financial institutions don’t provide as much information about set-aside provisions as their American counterparts do. Provisions of two to three percent have been noted by U.S. banks.

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