08/31/2012 | by
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During the second quarter of 2012, the bank default rates on commercial real estate loans witnessed its largest drop in three years, according to an analysis released Aug. 29.

A Chandan Economics analysis of loan data found that the default rate fell to 3.1 percent in the second quarter, representing a decline of 34 basis points from the first quarter of the year. The default rate was 4 percent in the second quarter of 2011.

Sam Chandan, president and chief economist with Chandan Economics, said two parallel developments are driving the downward trend in defaults.

"More banks are lending as each quarter passes, so legacy loans are a smaller share of the banking system's aggregate balance sheet," he said in an telephone interview with REIT.com. "Also, while the distressed loans that remain unresolved are generally of lower quality, they are being drawn down over time through charge-offs and liquidations."

Chandan attributed the overall decline in defaults to the apartment sector's continuing cash flow gains and the broader availability of debt for acquisitions and refinancing of maturing loans. The default rate for the apartment sector alone fell from 2.4 percent to 2.0 percent in the second quarter of 2012.

Additionally, the report noted that the default rate for construction loans, which Chandan said are still "exerting considerable drags" on the health of many banks, dropped to 10.8 percent in the second quarter of 2012, down from 12.5 percent in the first quarter.

"Land and stalled residential and commercial development valuations are not recovering strongly in secondary and tertiary markets, but the shorter duration and higher loss severities on their loans are helping to accelerate the cleanup," Chandan said.

His analysis also found that bank's net lending to commercial real estate increased by close to $50 billion in the second quarter. However, he pointed out that almost three-quarters of that amount went to the apartment sector.

Chandan also said that he doesn't foresee any major risks in new apartment loans, except in the subset of markets where the development pipelines are overheated and where single family housing demand will pick back up.