Special assessment and tax-increment financing bonds from regions prone to property bubbles and busts are most vulnerable to the continuing weakness of the commercial real estate market, according to a Fitch Ratings report released Tuesday.

Numerous types of municipal securities are backed by property taxes or fees charged on commercial real estate. As the commercial property sector suffers from sliding real estate values and heightened foreclosures, it threatens the cash flows backing some municipal security structures, Fitch said.

Based on the Moody’s/REAL CPPI index, commercial real estate values are down 37.9% since the end of 2007.

To determine what level of risk a municipal bond faces from commercial real estate exposure, Fitch created a matrix with three vectors: type of bond, primary type of commercial property backing the bond, and the region in which the commercial property is located.

Out of that matrix Fitch can assign the bond one of five risk classifications based on commercial real estate exposure, ranging from very low risk to very high risk.

Because commercial properties are usually only one factor determining the strength of a municipal bond, the matrix does not lead directly to a rating impact. Elevated exposure to weak commercial properties, though, could hamper municipal credit ratings, Fitch said.

“The commercial real estate market is an important driver of credit for many types of ­municipal securities,” said the report, which was written by a team including Eric Friedland and Amy Laskey. “Fitch believes the U.S. CRE market downturn will continue to have a negative impact on some municipal ratings.”

Commercial properties such as shopping centers, hotels, office buildings, warehouses, and apartment buildings are typically purchased with a mortgage from a bank.

There are $3.3 trillion in outstanding loans secured by commercial property, according to the Federal Reserve.

Income produced by the commercial property is used to repay the mortgage. Unlike residential properties, commercial property values are generally determined only by their ability to generate income.

With the economy mired in recession and consumer spending down, more commercial properties are not producing sufficient income to repay their debt.

More than 8% of commercial properties rated by Fitch are at least 60 days overdue on their debt or in foreclosure, according to a Fitch index. At the beginning of 2008, only 0.27% of commercial properties were in default.

Fitch expects the default rate to reach 12% in 2012. What this means for a municipal security depends on how vital payments from commercial property owners are to meeting that security’s debt service, analysts said.

The most susceptible securities are bonds backed by narrow payment streams from risky commercial properties.

Tax-increment financing, for example, is when a community is built out using debt secured by future increases in property tax receipts within a geographic area.

TIF deals that include large concentrations of commercial property are highly exposed to that property shutting down, Fitch said, in which case the property tax receipts in the TIF district may not increase enough to pay off the debt.

Another category of debt with significant exposure to commercial real estate volatility is debt secured by special assessments. The bonds are backed by fees charged to property owners, usually within specific dimensions. Such districts can be used to finance infrastructure or expansion of services such as water and sewer connections.

Some of the bonds are backed by a significant commercial presence, Fitch said. Exposure to these properties is exacerbated by a tendency to charge commercial properties a higher fee than residential properties, meaning if the commercial property goes into foreclosure it results in a more significant loss of revenue to the debt service account.

Bonds backed by taxes charged on hotel stays are also among the most vulnerable. Bonds backed by sales taxes or the full faith and credit of a government are less exposed, Fitch said, though they are not completely sheltered from the commercial property sector.

The dominant type of commercial property providing the payment streams to these securities is also an important factor in Fitch’s matrix. Hotels and offices tend to suffer from more volatile revenues than do warehouses or apartment buildings.

Hotel vacancy rates peaked at 41.8% last year, according to Property and Portfolio Research, while office vacancy rates climbed to nearly 20% in the first quarter of 2010 compared with 14.6% in the fourth quarter of 2007.

Fitch considers geographical category — the characteristics of the region as opposed to the location — a crucial factor in assessing commercial property risk. The riskiest categories are rust belt regions, areas with high resort or retirement levels, and regions that tend to expand rapidly in speculative bubbles and then burst.

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