Losses at small banks could lead to mergers

The government may view Bank of America and Citigroup as too big to fail, and dozens of other banks may soon find they have to get bigger.

Capital One Financial, Fifth Third Bancorp, KeyCorp, Huntington Bancshares and SunTrust Banks announced sharp fourth-quarter losses last week, the start of a trickle of red ink at the nation's small and midsize lenders that could result in a flood of mergers in an industry that is already consolidating.

Most of these banks were never big players in credit cards, subprime mortgages or credit-default swaps. But they were major lenders to commercial real estate developers, home builders and small corporations. As the recession tightens, losses have started to surge.

Syringa Bancorp in Boise expects to report a net loss of between $7 million and $8 million for 2008 in a few days, said Jerry Aldape, president and CEO. Syringa, which makes a lot of residential and commercial real estate loans, will use its net income to increase loan loss reserves to project against a possible rise in bad loans as property values decline.

Syringa has never had a conversation with anyone about being sold or merging, Aldape said. But in this financial environment, anything is possible: "That could happen next week," he said. "You never know."

If bank consolidations and mergers create a new round of mega-banks, that may not serve the economy well, said Don Holley, Boise State University economics department chairman.

"If they are too big to fail, they are too big to have," he said.

Most small and regional banks will probably be able to slog through several more quarters. But as their losses swell, pressure from investors and regulators could lead dozens of banks to start cutting deals.

Gerard Cassidy, a veteran banking analyst, projected that 200 to 300 small banks might fail or be forced into mergers over the next year or so. While that is still a fraction of the industry's 8,400 banks, it is up sharply from the 25 bank failures in 2008.

"It is really going to be a combination of the depth of the recession and how long the regulators allow these things to stay open," Cassidy added.

Federal officials have been giving money from the $700 billion Troubled Asset Recovery Program to selected weaker banks. Lawmakers want the banks to make more loans to consumers and small businesses. Regulators, nervous about the banks' fragile finances, have been making some investments conditional on a good-faith effort to find a stronger institution to merge with, according to several financial advisers.

So far, 288 small and midsize banks have received $78.8 billion of government money. That is about one-third of the nearly $249 billion awarded to the industry and less than the combined $90 billion in capital injections that Bank of America and Citigroup have received since last fall.

As with larger banks, private investors are reluctant to pour capital into smaller institutions to offset their deepening losses. And because additional government support is uncertain, many small and midsize banks may be forced to take aggressive steps to survive.

On Wednesday, SunTrust cut its dividend to 10 cents, from 54 cents; Huntington Bancshares slashed its dividend to a penny a share. Analysts say dozens of banks may follow suit.

Still others may be forced to take more drastic action. Some are already looking to sell off stronger businesses.

"The banks have to sell what they can just to get by," said David Hendler, a financial analyst at CreditSights.

Other banks are ratcheting back on lending, even if it causes lawmakers to grumble. Bankers are already fearful about their exposure to troubled consumers running up big credit card balances and corporate loans tapping revolving credit lines. After enduring huge losses from doling out easy money in a boom economy, they are reluctant to lend into a global slump.