Can banks weather the commercial real estate storm?

It's become sort of a cliché as of late to note the looming storms represented by souring commercial real estate loans. But how bad will it be? 

CNNmoney.com notes that in testimony before the Congressional Joint Economic Committee, a Fed associate director of banking supervision and regulation, said this: "At the end of the first quarter, about 7 percent of commercial real estate loans on banks' books were considered delinquent.  This was almost double from the level a year earlier." That's among the highest estimates. Other estimates of delinquencies hover just above 4 percent. But assuming the 7 percent is accurate--consider it an upper boundary--and assuming about $1.8 trillion of the $3.5 trillion of outstanding commercial real estate debt, then about $126 billion in delinquent commercial mortgages are on banks' books. 

No wonder banks are writing more losses at an accelerating rate. It would suggest that steeper charge offs are ahead of us. 

The Washington Post notes that the government is sufficiently concerned that its Plan C working group--which is looking at risks that remain in the fragile economy--considers commercial real estate one of the most vexing challenges that remain, now that the subprime-related crisis has been dealt with. According to a Deutsche Bank report, as much as $40 billion will be needed to shore up about $420 billion of CMBS mortgages that will mature over the next 10 years. 

This of course spells opportunity for some. In the past two months, eight REITs have filed for IPOs, aiming to raise up to $3.9 billion, according to Reuters. That's a larger pipeline than that of traditional IPOs. A unit of Apollo Management last week filed for a $600 million offering to fill a "void of several hundred-billion dollars" that must be filled by new mortgage lenders." The idea here is that banks do not offer enough liquidity to restructure commercial loans. These REITs aim to fill the liquidity hole. 

These new IPOs may be on to something. But existing property REITs have raised more than $15.2 billion in secondary offerings this year in a bid to lower debt levels, and their stocks have rebounded. It remains to be seen how all this shakes out. Some think a bottom to the market is taking shape now that prices have fallen 35 percent from a year ago. But for now, the whole issue remains a wildcard in the banking system. - Jim