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NEW YORK CITY-Real Estate Econometrics says an analysis of FDIC data shows that the national default rate for commercial real estate mortgages held by depository institutions rose from 2.88% in the second quarter of 2009 to 3.4% in the third quarter. During that same period, multifamily mortgage defaults increased by 44 basis points, rising from 3.14% to 3.58%. And it’s a trend that’s expected to continue for two more years.

By Q4 of this year, commercial mortgage defaults are expected to rise to 4%, nosing up further to 5.2% by the end of 2010, and then finally topping out at 5.3% in 2011. The report says that by ’11 and 2012, the larger share of commercial mortgages originated at the peak of the asset cycle in 2006 and 2007 will mature. Ultimately, that means those mortgages will require balance adjustments in larger numbers as a consequence of high loan-to-value ratios and weak debt service coverage that fails to meet prevailing criteria.

Simply put, Sam Chandan, president and chief economist at REEcon, tells GlobeSt.com, “We continue to observe increases in default rates, consistent with projections from one year ago.” And Chandan says that in part, at least so far, policy interventions have not stemmed the increase in distress among bank-held portfolios.

REEcon’s analysis says that 211 institutions, or 4.6%, are homes to commercial mortgage default rates of 10% or higher, with 1% of the analyzed banks having default rates of 16.5% or higher.

It was just this past June that commercial real estate mortgages started coming home to roost in droves and default levels reached the highest levels seen in 15 years. Add to that recent Federal Reserve data from Q3 showing delinquency and writeoff rates for commercial real estate loans at all banks in the US at 8.74%, nearly double the number for the same quarter in 2008 at 4.74%. By all indications, it could be headed beyond a 1991 peak of 12.06%.

Thus far this year, 124 FDIC-insured banks have failed. On Nov. 24, the agency’s insurance fund sunk into negative territory, with an $18.6-billion deficit.

Despite those grim sounding numbers, Chandan says it’s only been in recent weeks that new policy initiatives promulgated and intended to directly support banks’ management of the commercial loans have been enacted. He says the primary focus has been on encouraging securitization activity. In fact, he says the TALF program has only encouraged the minimalist contribution to the commercial real estate market.

“The Q3 results underline that a shift in policy attention to the challenges of banks is warranted,” says Chandan. As a good example, he says, “the loan workout guidance released by the FFIEC some weeks ago is an initial step in addressing some of the banks’ issues.”

Digging deeper, Chandan says there’s been a tendency to paint a broad stroke over the entire regional bank sector, creating the perception that they are a significant problem area. For example, it’s been widely reported that among 36 banks Fitch Ratings evaluated with less than $20 billion in assets, commercial property exceeded 25% of total loans, compared with 10% or less at the nation’s four biggest lenders.

Still, Chandan says “it’s important to evaluate each bank’s performance individually,” and point out there is significant variation. In fact, the REEcon report says default rates for institutions in larger asset size groups are higher, despite having significantly commercial real estate concentrations.

“Some banks that have similar concentrations may have, as a result of institutional factors, made less aggressive loans and underwritten loans differently,” Chandan says. “In many cases, the capacity of these banks to manage risks in their portfolios as we go forward is tempering the rate of defaults and loss severity.” He adds that after examining actual data, he finds that “some regional banks that have large CRE exposures are managing them really well.”

And therein lies today’s lesson for the future, according to Chandan, who says “risk management culture, management and accountability structure within an organization as well as data collection practices” all figure into his preliminary analysis. “If some banks are managing this well, and doing a reasonably good job, let’s study what they are doing and try to tease out what those practices are, so they can be replicated elsewhere at institutions less prepared to deal with increased levels of distress.”

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