Higher defaults in a CRE book don't necessarily translate to more losses

Consumer lending, be it residential mortgage, home equity, or automobile lending, is rather binary when it comes to the issue of defaults.  It is exceedingly difficult to predict losses and reserve for losses, as defaults occur when payments are missed.  Once payments are missed, the horse has left the barn, so to speak, and rehabiliation of the impaired credit is difficult.   Banks with a large portfolio of residential mortgages and consumer loans often refer to the "black box" of unknown future deliquencies and losses.

In contrast, CRE (and C&I for that matter) have the benefit of more frequent financial reporting and also performance and condition covenants.  Long before payments are missed, lenders are made aware of impairment in the borrower's condition,or in the progress of a particular project.  In those cases, most lenders utilize a risk rating model that provides for ongoing loan loss provisions.  Once a CRE loan or customer is recognized as impaired, they are compelled to submit more frequent financial reports, which lends to more transparency, more accurate risk ratings, and ultimatley more accurate loan loss provisions.

So, while it is undoubtedly true that banks with heavy CRE concentrations will be dealing with impairment to their portfolios, both banks and investors alike will benefit from more timely loan loss predictions, and thus should not unleash sudden surprises of the like we witnessed in the fall of 2008.  I expect banks to emerge from this CRE situation bruised, but otherwise well capitalized and intact.