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hat tip to BB for sending along this article, from the FT:

http://www.ft.com/cms/s/0/4040006c-a2f9-11de-ba74-00144feabdc0.html?nclick_check=1

The Federal Reserve is reviewing banks’ exposure to commercial real estate, the troubled sector whose slide poses a risk to many institutions because of the wide distribution of loans and mortgage-backed securities.

In its regulatory role, the Fed will look into a cross-section of banks to build a picture of how resilient institutions are to the troubled market. It is keen not to characterise the exercise as a “stress test”, which has come to evoke the audit of 19 large banks earlier in the year.

A cross-disciplinary team will look at the variety of commercial real estate assets on banks’ balance sheets, encompassing loans and commercial mortgage-backed securities.

The Fed’s own Beige book reported last week that the economy continued to stabilise during July and August, but loan demand and commercial real estate remained weak.

Commercial property prices are now 26.9 per cent lower than one year ago and 33.9 per cent below the level seen two years ago, according to an index compiled by Moody’s Investor Service. Values on commercial property prices are now 35.5 per cent below the peak seen in October 2007.

Commercial real estate ”is ground zero for the distress happening over the next 3 to 5 years,” said Rich Friedman, head of Merchant Banking at Goldman Sachs on Wednesday. It will be five to six years before there is any real improvement, Mr Friedman added. Real estate deals were often more leveraged than the buyout deals done at the height of the bubble, precisely because there was so much leverage, to refinance will be a huge challenge.

“The deterioration continues,” said Richard Parkus, analyst at Deutsche Bank. “There’s been no dramatic acceleration…but there’s been no slowing.”

Other regulators are also trying to assess the impact of the problems in commercial real estate, which has seen large increases in vacancy rates, declines in rents and high levels of defaults.

Banks and bank regulators decide the extent to which loan problems are reflected on the books, said Mr. Parkus. It’s “highly uncertain” when they will be fully realised, he added.

Positive news about the broader economy is unlikely to be “manifested commensurately in CRE,” he said. “The fact that we don’t have 10 banks a day going under [does not mean] that things are not as bad as we thought…We have a relatively enormous amount of deleveraging that has to take place.”

Analysts consider a blockage in refinancing as potentially the most serious impact of the deteriorating commercial real estate market. The Fed has tried to help by opening up its Term Asset-Backed Securities Loan Facility (Talf) to investors in CRE securities.

But some with links to smaller banks believe the doomsday consequences of the troubled market have been over-played. “I don’t think it’s the doom and gloom scenario that we had in housing,” said Steve Brown, chief executive of Pacific Coast Bankers’ Bank, which serves thousands of community banks. “Spreads are tightening in a lot of the paper that’s out there.”

Richard Levenson, president of San Diego-based Western Financial, a niche investment bank that works with community banks, said he had noticed increased regulatory attention on commercial real estate. Regulators, he said, are “making sure [community banks] understand where their collateral values are”.

He noted that in California’s “strip malls there are a lot of vacancies” but argued there were also investors waiting in the wings who might provide a boost to the market.

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