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Community Banks expected to face difficulty in Q3 2010

In the regional and community banking space, the third quarter (Q3) of 2010 is expected to show some improvement over previous quarters, but banks continue to struggle with slow loan growth, stricter regulatory standards, continuing losses and increased competition.

Revenue growth, which is generally considered to be the engine for success is still very limited, leaving investors with limited choices when seeking growth-oriented banks. The good news is that majority of the regional banks are expected to be in the black for the quarter and are showing a positive trend from previous quarters. Most are expected to maintain losses at current levels and according to a report by Howe Barnes, over half of the smaller players will likely show better performance as compared to Q2. The efforts to strengthen reserves continue, but the activity is expected to provide little relief, as credit cost remains high.

Existing loans in both raw land and non-owner occupied properties continue to add to asset quality concerns as banks struggle to workout or sell the assets in a slow real estate market. The prospect of organic loan growth remains low and is resulting in no-to-slow expansion in new assets. Although, interest rates remain at historic lows, the slow demand coupled with higher credit standards required by both regulators and secondary market participants is increasing competitive pressures for those borrowers with the ability to qualify for new loans. For most banks the return to normalized returns is expected to begin in late 2012 and early 2013.

The passage of the financial reform bill and the agreement on new Basel 3 standards is providing a more defined regulatory environment and has lifted some uncertainty about theĀ overall regulatory sentiment. But considerable risk remains as the implementation rules for these standards are still unclear.

The impact of slower growth, increased competition and new regulatory standards is likely to clear a path for increased M&A activity in the coming quarters as banks struggle to cope with the changing macro and micro environments. Regardless of the decision to stay independent or to merge/acquire, most banks will find a need to raise additional capital.

For most bank investors, selectivity will be the key to longer-term success as the sector overall is expected to underperform when compared to broader indexes. Banks that have adequate capital, presence in growing markets, ability to conduct targeted acquisitions and a superior strategy/focus to steal Marketshare exhibit some of the best indicators for success. Additionally, banks focused on niche, ethnic or non- traditional markets are well positioned to outperform the pack as they face limited competition for customers in an improving economy.

Disclosure: I am a community banking consultant - no ownership