Commercial real estate losses are only about halfway finished at large-cap banks and just a third through at the midcaps, a Morgan Stanley banking analyst said Tuesday.

Ken Zerbe, advising clients to avoid heavy commercial real estate exposure, said the down cycle "could last much longer than we previously expected."

Zerbe and four other analysts also wrote in a note to clients, "We believe we are still in the early stages of the credit cycle for commercial real estate credit losses."

The note predicted that total U.S. commercial real estate losses this cycle are likely to be about 10% and could reach as high as 15% of the loans, giving the sector more risk than any other asset class for banks.

The new, cautionary assessment on banks, which reflects widely held worries about commercial real estate, was noteworthy for its specificity as well as its source at a firm that advises clients to go long on banks despite the recent run-up in their stock prices.

Morgan Stanley said it arrived at a 32% credit loss for midcap banks and a 49% credit loss for large-cap banks by examining maturity schedules for banks that release them, and factoring in expectations on jobs, the credit market and other variables.

Not all corners of commercial real estate are equally troublesome, Zerbe wrote.

Banks with high exposure to retail and office loans are at the highest risk, while those with high amounts of hotel or apartment loans are subject to more moderate risk from trends in commercial real estate.

Morgan Stanley did not change its "buy" and "sell" recommendations on any banks following the new outlook, but it cut its 2011 earnings outlook for most midcap banks.

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