(Bloomberg) -- With most of Canada’s biggest banks exposed to the US commercial-property market, the deteriorating quality of some real estate loans could lead to nasty surprises as lenders report fiscal first-quarter results this week.

Commercial-property lending accounts for about 10% of the loan books on average at Canada’s five largest banks. With the sector under pressure amid elevated interest rates and plunging valuations, banks have been booking higher provisions for potential credit losses for several quarters now.

The idiosyncratic nature of which particular loans could go bad makes it hard to predict the scale of coming provisions, said Nigel D’Souza, an analyst with Veritas Investment Research Corp. While home-price indexes and an array of monthly data provide insight into the health of residential mortgages, there’s no equivalent for commercial loans, leaving investors looking at higher-level categories of exposure and making educated predictions, he said.

The “US is probably more vulnerable than Canada, office is more vulnerable than other categories, and you are seeing some weakness creep into multifamily residential as well, and that could become an issue both in the US and in Canada,” D’Souza said in an interview.

Unlike some US regional players, Canadian banks aren’t facing a solvency issue over commercial-loan losses, but they will be a “question mark” for profitability, D’Souza said.

“Provisions have an outsized impact on and contribute to a lot of volatility,” he said, adding that other line items, such as margins, loan balances and revenue from fees, don’t move around significantly from quarter to quarter. “But credit provisions do.”

Provisions are likely to keep heading higher this quarter, “albeit at a more modest pace than last year,” Bank of Nova Scotia analysts Meny Grauman and Felix Fang said in a report this month.

“We also expect some lumpiness from banks’ US office exposures, even though those exposures are quite small when measured as a share of total loans,” they wrote.

Analyst forecasts compiled by Bloomberg predict that fiscal first-quarter adjusted earnings per share for Canada’s six biggest banks will be up by an average of 9.1% from the previous three months, but down 8.8% from a year earlier.

Investors and analysts also will be watching net interest margins — the difference between what banks earn from loans and what they pay for deposits. Analysts expect them to be largely unchanged or slightly down quarter over quarter, with customers still seeking out higher-interest deposits while loan growth has been slowing.

The Canadian banks begin reporting on Tuesday with Scotiabank and Bank of Montreal, followed by Royal Bank of Canada and National Bank of Canada on Wednesday and Canadian Imperial Bank of Commerce and Toronto-Dominion Bank on Thursday. 

Scotiabank has very little exposure to the US office market, according to Lidia Parfeniuk, director at S&P Global Ratings in Toronto. But Royal Bank, Toronto-Dominion, Bank of Montreal and CIBC all have US loan books that are likely to be the subject of continued scrutiny as quarterly earnings are reported.

The quality of CIBC’s US office loans, which are only about 2% of its total portfolio, has been a major theme for investors in recent months and will be closely watched this week.

“We believe investors will remain focused on CRE-related losses, where CIBC has been a consistent outlier the past few quarters due to its US office portfolio,” Keefe, Bruyette & Woods analysts Mike Rizvanovic and Abhilash Shashidharan said in a note to clients this month.

“Given what happened to New York Community Bancorp, there will certainly be more market attention of this portfolio in particular, but we expect the maturity profile of the book to be more manageable by next year,” wrote the Scotiabank analysts, who upgraded their rating on CIBC to sector outperform, equivalent to a buy, from sector perform, their version of hold.

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(Updates with net interest margins in 10th paragraph. A previous version of this story corrected the year-earlier EPS comparison in ninth paragraph.)

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