The Canadian commercial mortgage-backed securities market remains very strong, growing to a total of $12.6 billion since 1998, says Dominion Bond Rating Service says in a report released today.

Defaults remain low at a cumulative rate of 0.24% through May 2005.

“Property markets remain strong, as the average Canadian is spending more, which bodes well for retail and hotel sectors,” says DBRS analyst Erin Stafford. “In addition, office properties continue to show greater stability as national office vacancy rates continue to decline across all provinces.”

DBRS notes that market challenges include inflated values due to capitalization-rate compression as a result of the low-interest-rate environment. Current capitalization rates and constants are 200 basis points to 300 basis points below historical rates and are not likely to be this low in the future.

The ability of CMBS loans to refinance is highly dependent on future market conditions and amortization of existing debt, it adds. Also, the Canadian CMBS market originates loans on shorter amortization schedules; therefore, the remaining challenges arise from vulnerability to concentrations and dependence on market conditions.

“There are a few markets to watch and exposure to a single retailer could pose a problem in the event that the retail market slows,” adds Stafford.

It notes that over 7.4% of the loans in Canadian CMBS have exposure to the retail tenants of Hudson’s Bay Co., doing business as Zellers and The Bay. HBC’s debt ratings were downgraded by DBRS on May 10, as HBC has been unable to maintain sales volumes or profitability.

On October 6, DBRS placed the ratings of HBC “Under Review with Negative Implications” due to the potential sale of HBC’s credit card business. Of all Canadian CMBS transactions issued, 24 have exposure to HBC.

DBRS notes also that Canadian CMBS structures remain similar, if not more straightforward, to those in the U.S. CMBS market. Security-enforcement procedures and creditor-oriented safeguards in bankruptcy proceedings limit the remedies available to a delinquent borrower in Canada.