The Office of the Superintendent of Financial Institutions (“OSFI”) is elevating scrutiny on how FRFI’s are managing their commercial real estate (“CRE”) portfolios.

“Commercial real estate is highly cyclical with the potential for significant losses, especially when risks are not effectively managed,” OSFI said in a Regulatory Notice released last Thursday, September 29th. Rising interest rates alongside high office vacancies from the widespread adoption of hybrid and remote work following the COVID-19 pandemic have illuminated vulnerabilities in the commercial real estate sector, including increased potential for a rise in the number of borrower defaults.

The regulatory notice is intended to both respond to and provide support for ongoing supervisory work. It also functions as an “interim” regulatory guidance by reinforcing and clarifying expectations regarding sound risk management of lending, including governance, underwriting, account management, and portfolio management.

The announcement defines CRE as a broad asset class: “including but not limited to loans secured by income-producing real estate used for business purposes (e.g., shopping malls, office buildings), loans provided for the acquisition, development and construction (ADC) of such real estate, loans for residential real estate with five or more units where repayment depends on sale or rental income (e.g., apartment buildings), real estate held for lease to third parties, and non-residential real estate occupied by its owner or a related party.”

The guideline is further structured into three categories: governance and risk management, prudent underwriting and account management, and portfolio management. OSFI is looking for a range of expectations, including clearly defined limits on acceptable risk, an ongoing review process, rigorous limits for ongoing debt serviceability, and scrutiny of a borrower’s ongoing collateral valuations. Other areas of focus should include market monitoring, ensuring adequate diversification, and portfolio stress testing.

OSFI’s last semi-annual update to its 2023-24 Annual Risk Outlook occurred on April 18^th. Commercial real estate risk was cited as a key concern during the spring update, in which OSFI communicated that its supervisory work would include enhanced monitoring of provisioning and account management practices relative to exposure to capital. OSFI’s next semi-annual update is scheduled for October 12^th. CCUA will provide an update on OSFI’s risks at that time.