Community banks: hanging in there--for now.

• Author: Heffes, Ellen M.
• Position: TREASURY

With the United States banking industry under reconstruction, those who deal with community and regional banks are likely wondering "what next?" We asked FEI member Timothy Hart, a veteran in the banking industry for more than 25 years, to explain the current situation.

According to Hart, who is treasurer of First National Bank of Nebraska, in Omaha, the balance sheets of community and regional banks are stressed from a couple of different asset classes. Over time, he explains, efficient capital markets and monoline businesses, challenged banks by offering bank customers credit cards, auto financing, mortgage financing and other products.

For many regional and community banks this has meant the primary products available to their customers were business loans, commercial real-estate financing and commercial and residential lending.

Residential development has become very difficult, particularly in markets such as Las Vegas, Northern California and Florida--areas where many regional banks expanded with loan-production offices or bank acquisitions when the market was peaking in 2005-08. A number of those banks are reporting quarterly losses, because their underlying assets--the value of their loans--are going down.

Concurrently, many banks lacking significant growth opportunities took additional risk in their investment portfolios. Some of them bought debt issued by other banks and/or purchased private mortgage securities that were not guaranteed by Fannie Mae or Freddie Mac, which have also experienced significant impairment to value. And, certain banks, notes Hart, "are in the unenviable position of having investment portfolio problems at the same time they are having loan problems."

Raising Capital: Difficult, but 'Credit Still Open for Customers'

At press time, the environment for raising capital was "very difficult, if not impossible, for regional and small banks," he says.

Back in the first part of this century, a "bank could raise capital in the form of long-term debt upon 45 days' notice in a pooled transaction with other banks. That market slammed shut in 2007. Presently, the only capital-raising options available to banks are associated with very high-coupon convertible preferred stock that converts into a material amount of the common stock, "if it can get done."

A term being used in community banking right now, says Hart, is "friends and family," referring to some banks having to go to friends and family to raise capital.

Another...