In my June 19 analysis of the distribution of banks' commercial real estate owned (REO), I described how a small subset of institutions accounted for a disproportionate share of all REO held in the nation's banking system. Depending on one's perspective, this is not entirely a bad thing. After all, it means that thousands of institutions have only very small REO pools to manage. The challenge of REO management is more compartmentalized and less pervasive than it is sometimes described when only average statistics are employed. On the other hand, the data also shows that investors seeking to acquire assets from banks will have to work very hard to uncover opportunities. The set of banks with large REO pools are generally well known to investors and policymakers. The latter does not necessarily see one-off dispositions as an efficient path to balance sheet health.

Another set of statistics, relating to the performance of loans not yet in REO, also shows a skewed distribution of loans in default. The default rate on banks' CRE mortgages has come off its peak over the last two quarters, albeit only slightly. As it turns out, that headline statistic masks extraordinary variation in banks' recent experience. Many institutions that already reported low default rates on their CRE balance sheets have seen those default rates fall even further. At the same time, many of the most exposed lenders have been stymied in their efforts at managing their legacy portfolios.

Is legacy commercial real estate a drag on the entire banking sector? The most current data suggest that is less the case than it was a year ago. Based on my compilation of data for all regulated institutions with $5M or more in CRE loans, 40.3 percent show a CRE default rate of 1.0 percent or less. Almost two-thirds show a default rate of less than 3.0 percent.

For policymakers, borrowers, and investors, the largest challenge in managing (or taking advantage of) distress is in the tail, not on the average. 7.3 percent of institutions have default rates of 10 percent or more. At the top end of the distribution, in particular, the institutions with the highest default rates are generally larger than the average bank. And so while only 1.3 percent of banks have default rates of 20.0 percent or more, these institutions collectively account for $12.8 billion in CRE lending. No doubt, some of these banks are in secondary markets that will recover value over time, allowing for higher recoveries. Others remain a challenge; for policymakers, and also for the borrowers and small businesses that rely on them for access to credit.