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Almost without interruption, commercial lending by the Big Six banks has increased rapidly since the country emerged from the last financial crisis – at a compound annual rate of roughly 9 per cent over the past eight years.

The trend continued in the fourth quarter of 2018, when Canadian commercial loans were 11.3 per cent higher than a year earlier. The increase was most pronounced at Royal Bank of Canada, where business loans climbed 12.9 per cent from a year ago.

Commercial lending can be less visible or flashy than retail or investment banking; providing working capital to smaller enterprises, backing commercial real estate projects or serving specialty niches such as providing financing to retail franchises. But it has been a reliable engine at a time when softer housing markets dampened by new federal mortgage regulations have put the brakes on the rate of growth in banks' mortgage books, which increased by only 2.6 per cent last quarter.

Yet after years of aggressive expansion, the question now is how much longer banks can continue to pile on commercial loans at a rate that far outpaces the country’s economic growth. One theory, outlined in a research note by National Bank Financial Inc. analyst Gabriel Dechaine, is that hot housing markets have been a key driver in part because commercial loans fund residential construction projects. As mortgage lending slows, commercial loans have helped fill the void. But if housing markets stay cool, there are concerns that commercial lending could feel a chill as well.

“I would not be surprised [if] there’s a lag effect and we see the deceleration in mortgage growth and housing starts actually pull down commercial real estate growth next year," Mr. Dechaine said.

In mid-December, the Office of the Superintendent of Financial Institutions warned that corporate indebtedness is “growing, representing a potential future risk," as the regulator requires Canada’s largest banks to hold more capital as a buffer against a future economic downturn.

Canada’s six largest banks collectively hold nearly $373-billion in domestic commercial loans, according to data compiled by Scotia Capital Inc., and it is typically a highly profitable business. Some banks have also enjoyed double-digit increases in commercial loan balances in the United States and other international markets, year over year. So far, there’s no evidence of a slowdown, but there are reasons to be wary.

“Growth in the commercial portfolio was counted on as a major offset for the Canadian business coming out of the 2008-09 credit crisis, and it has clearly delivered,” said Sumit Malhotra, an analyst at Scotia Capital Inc. “However, given the consistently strong pace of increase in the commercial book over the past eight years, we think it is reasonable to expect some deceleration in the rate of growth, particularly given the sluggish trends evident in both the real estate and energy sectors.”

There are also signals that some banks may be taking on more risk to sustain flow through their commercial loan pipelines. That in turn raises concerns that some of those loans could come back to bite lenders in the form of higher loan losses in tougher economic times.

On Toronto-Dominion Bank’s fourth-quarter earnings conference call, head of Canadian personal banking Teri Currie hinted that some other banks may be loosening conditions on commercial loans. “What we’ve seen in the marketplace is a pricing dynamic in some cases that we aren’t willing to match from an economic standpoint and some covenants that don’t meet our risk appetite," Ms. Currie said. That means TD is “walking away sometimes," she added.

Bankers think they can sustain the recent momentum, however. On a late-November conference call, Bank of Nova Scotia’s Canadian banking head, James O’Sullivan, said bank economists have observed that increases in business loans can typically outpace growth in nominal GDP for about a decade. The current run of good fortune began around 2012, which suggests there may be some runway left. “Our view is that this period of kind of heightened investment in businesses can and should continue," Mr. O’Sullivan said. "And that’s what we’re planning on.”

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Royal Bank of Canada
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Bank of Nova Scotia

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