Losses on commercial real estate loans could top $150 billion by the end of 2011, meaning banks have just started dealing with the problem, Moody's Investors Service said.

The 65 U.S. banks rated by Moody's lost $43 billion on CRE credits from 2008 through the third quarter of 2009. Those lenders are projected to lose another $77 billion through the end of next year, the firm said in a report late last week.

The industry's total losses "may well exceed" $150 billion when taking into account potential losses on the roughly $900 billion of CRE loans sitting on the books of the 8,000 or so community and regional banks that Moody's doesn't cover.

Joseph Pucella, an assistant vice president on Moody's North American banking team, said community banks tend to have as much as 40% of their assets tied to commercial real estate. That percentage hovers at around 15% for the larger banks Moody's covers. That means smaller lenders are more vulnerable.

"Those banks are highly concentrated in the commercial real estate sector," Pucella said. "We expect to see many more small bank failures, and that is obviously going to have an impact in terms of overall costs to the entire banking sector."

Moody's estimated that U.S. banks had $1.8 trillion of CRE loans at Sept. 30, with about half held by the banks it covers and the other half at the smaller banks it doesn't.

Moody's said the highest concentration of losses will be in land and development real estate loans, followed by construction loans.

CRE is one of the top concerns plaguing U.S. banks, as the recession has taken a toll on real estate values and business borrowers' ability to retire and stay current on their loans. Recognizing the problem, regulators late last year urged banks to help borrowers avoid default. They said banks should grant business borrowers loan concessions like longer maturities or lower interest rates as long as they are making enough money to service a portion of their debt.
It is unclear whether that policy is mitigating CRE losses, although the fourth quarter was relatively quiet on the CRE front at large banks, analysts said. Though Moody's has not compiled its fourth-quarter data yet, Pucella said preliminary data shows elevated losses in line with projections. Moody's also does not expect CRE losses to drive any more bank ratings downgrades.

"We're seeing some erosion and some higher loss rates in CRE, but nothing that would match the degree to which it is discussed and debated in the press," said Anthony Davis, an analyst with Stifel, Nicolaus & Co.

Davis said CRE probably will not melt down like the residential construction loan market, as CRE loans tend to mature over a number of years. Also, most loans covering new business property developments have collateral value and are generating some cash flow, even if they may be underwater. Broader economic conditions and the health of the securitization market will determine what happens to the billions of dollars in CRE loans projected to mature in coming years.

"There is a lot of this stuff that is still coming up for maturity in the next 18 to 24 months," Davis said. "It's an open question exactly how much of that paper gets rolled over."

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