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After a provincial order to shut all non-essential businesses in Ontario, a normally bustling Queen Street West is lined with closed stores and empty of shoppers in Toronto on March 25, 2020.

Melissa Tait/The Globe and Mail

As banks brace for the expiration of hundreds of thousands of payment deferrals granted early in the coronavirus pandemic, experts are warning that the biggest risk for a spike in defaults may not come from mortgages, but from a smaller number of loans made to vulnerable businesses.

About 76,000 small and mid-sized business clients are still deferring payments on approximately $66-billion in commercial loans, preserving cash flow as economies start to recover. The risk to a portion of those loans has been overshadowed by a more intense public focus on larger volumes of deferred mortgages, and the potential knock-on effects for lenders and for housing markets if any meaningful number can’t be repaid.

Yet commercial loans pose a different kind of risk. Though there are fewer under deferral, on average they are much larger. And many are concentrated in sectors of the economy that have been hit hardest by the pandemic, and could take longer to recover: discretionary retail spending; oil and gas; hospitality and tourism; transportation; and commercial real estate.

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“It’s certainly a concern for us as well, just given the size of those [commercial] loans,” said Rob Colangelo, an analyst at DBRS Ltd., in an interview. “I think there are some risks, but I think they are fairly well-contained and probably limited to those sectors that are most vulnerable.”

As public-health measures locked down economies to slow the spread of the novel coronavirus, banks allowed households and businesses to defer payments on an array of loans, many of them for up to six months. Loans worth about $267-billion were still under deferral at the end of July, but nearly all of those deferrals will run out in September or October.

A large majority of the deferred balances – about $179-billion to about 684,000 borrowers – are made up of residential mortgages. The risk that any significant slice of those borrowers might not be able to resume payments initially had experts worried about a looming “cliff” of defaults. But it is now apparent that it will likely take months – and in some cases years – to gauge the fallout. Commercial loans could be among those that take the longest to unravel.

canadian banks’ loans on deferral

Canada’s largest banks have deferred payments on hundreds

of thousands of loans, from mortgages and credit cards to

business loans, for up to six months in an effort to provide

relief to companies and consumers hit hard by the pandemic.

Most of those deferrals expire before the end of October,

creating uncertainty about how many loans might default.

Total loans with deferred payments

(in billions of dollars, as of July 31)

Residential

mortgages

Credit cards/other

personal loans

Commercial and

small business loans

RBC

TD

Scotiabank

BMO

CIBC

National

0

10

20

30

40

50

60

70

$80

Total loan deferrals by geography

(in billions of dollars, as of July 31)

Canada

International

TD

Scotiabank

BMO

CIBC

0

10

20

30

40

50

60

70

$80

Note: Banks’ disclosures on deferrals differ. RBC and National Bank did not

disclose statistics on international deferrals, and some deferral balances have

been converted from U.S. dollars. Residential mortgage numbers include home

equity lines of credit in some cases.

james bradshaw and JOHN SOPINSKI/THE GLOBE AND MAIL

SOURCE: company filings

canadian banks’ loans on deferral

Canada’s largest banks have deferred payments on hundreds

of thousands of loans, from mortgages and credit cards to

business loans, for up to six months in an effort to provide

relief to companies and consumers hit hard by the pandemic.

Most of those deferrals expire before the end of October,

creating uncertainty about how many loans might default.

Total loans with deferred payments

(in billions of dollars, as of July 31)

Residential

mortgages

Credit cards/other

personal loans

Commercial and

small business loans

RBC

TD

Scotiabank

BMO

CIBC

National

0

10

20

30

40

50

60

70

$80

Total loan deferrals by geography

(in billions of dollars, as of July 31)

Canada

International

TD

Scotiabank

BMO

CIBC

0

10

20

30

40

50

60

70

$80

Note: Banks’ disclosures on deferrals differ. RBC and National Bank did not

disclose statistics on international deferrals, and some deferral balances have

been converted from U.S. dollars. Residential mortgage numbers include home

equity lines of credit in some cases.

james bradshaw and JOHN SOPINSKI/THE GLOBE AND MAIL

SOURCE: company filings

canadian banks’ loans on deferral

Canada’s largest banks have deferred payments on hundreds of thousands of loans,

from mortgages and credit cards to business loans, for up to six months in an effort to

provide relief to companies and consumers hit hard by the pandemic. Most of those

deferrals expire before the end of October, creating uncertainty about how many loans

might default.

Total loans with deferred payments (in billions of dollars, as of July 31)

Residential

mortgages

Credit cards and other

personal loans

Commercial and small

business loans

RBC

TD

Scotiabank

BMO

CIBC

National

0

10

20

30

40

50

60

70

$80

Total loan deferrals by geography (in billions of dollars, as of July 31)

Canada

International

TD

Scotiabank

BMO

CIBC

0

10

20

30

40

50

60

70

$80

Note: Banks’ disclosures on deferrals differ. RBC and National Bank did not disclose statistics on internation-

al deferrals, and some deferral balances have been converted from U.S. dollars. Residential mortgage num-

bers include home equity lines of credit in some cases.

james bradshaw and JOHN SOPINSKI/THE GLOBE AND MAIL, SOURCE: company filings

When banks reported their latest quarterly results, executives sounded optimistic that expiring deferrals will unwind more gently. For most banks, more than 90 per cent of customers whose payment deferrals had already expired returned to making normal payments. At Bank of Montreal, which is particularly focused on commercial lending in Canada and the United States, chief risk officer Pat Cronin told analysts that only 1 per cent to 2 per cent of loans that have already come off deferrals have gone delinquent. This means they are late making payments, but yet to be written off as losses.

However, Mr. Cronin estimated that 1 per cent to 5 per cent of deferred commercial loans may turn delinquent after the relief program expires. Not all of those will result in actual losses, as banks have specialized teams that work on problematic loans, and have already begun reaching out to companies that may be in distress. In some cases, banks may offer other options such as refinancing or restructuring the loans.

“It’s really hard for me to forecast because it’s going to depend so much on the health path that we take over the fall,” Mr. Cronin said on a conference call in late August, referring to continuing measures to contain COVID-19.

It is especially difficult to predict how much money banks might lose on business loans gone sour. Because most of those loans are partly secured by the business’s assets, such as inventory or equipment, a bank might only lose 20 per cent to one third of the total value of a commercial loan that defaults. But that would also vary by different types of businesses, and depend on how much of the loan has already been repaid.

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By contrast, a large share of mortgages are insured, which protects the banks against losses. In addition, the average balance of uninsured home loans is only about half the estimated value of a customer’s home. As a result, bank executives and analysts expect losses on mortgages to be relatively small.

And while banks are at risk of losing all of the credit-card balances and personal loans that end up in default, because those loans are unsecured, they make up less than $23-billion of all balances still under deferral.

The six largest banks also earmarked $11-billion in provisions for credit losses – the money banks set aside to cover loans that may go bad – in the fiscal second quarter, and a further $6.2-billion in provisions in the third quarter. That created a considerable cushion to absorb future losses if they materialize. Even so, as the path to economic recovery remains uncertain, some investors are still wary.

"While management guidance was generally optimistic around deferrals, we believe many investors remain concerned about the prospects for a more negative outcome, which in our view, is definitely a risk given the uncertainty with the pace of the economic rebound going forward,” said Mike Rizvanovic, an analyst at Credit Suisse, in a note to clients.

In many cases, as deferrals expire, companies and consumers that can’t start making payments again will be counted as delinquent after they are 90 days late on payments. Even then, banks will try to work with customers case by case to help them recover. That means most new impaired loans will not show up in banks' results until the first two fiscal quarters of 2021, which end Jan. 31 and April 30, respectively.

Some problematic loans could take longer to surface, and bankers are aware that even some companies and consumers that return to making normal payments may still be near the edge of insolvency. As some small and medium-sized businesses go under, banks stand to lose some clients and the future revenue they might have earned from them.

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“This forces the banks to certainly think about the various sectors and their exposures and where they feel it makes sense to allocate capital to lend to businesses that have a more viable business plan,” DBRS analyst Mr. Colangelo said.

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