US CREDIT-Regional banks risk weakness as credit losses rise

By Karen Brettell

NEW YORK, May 14 (Reuters) - Community banks in hard-hit
U.S. regions are struggling due to rising default rates on
mortgage loans. While regional banks may be better capitalized
to handle weakness, in some places they also risk coming under
pressure.

Last week, ANB Financial, a small Arkansas bank, was taken
over after it failed because it made construction and
development loans with poor underwriting standards in states
that included Utah, Wyoming and Idaho.

It was the third Federal Deposit Insurance Corp-insured
bank to fail this year.

The effect of a commercial bank failure is contained within
its community, unlike the systemic risks posed by large
investment banks.

However, in certain areas where the housing downturn is
more pronounced, regional banks with the same types of
exposures may come under further pressure.

If community bank failures significantly increase or
regional banks fail, this would weigh on overall credit market
sentiment.

"The million-dollar question is: What effect could
potential failures of the small banks have on the large
regional and money center banks?" said Mikhail Foux, credit
products strategist at Citigroup Global Markets in New York.

"To the best of our knowledge, we do not know of any large
counterparty risks, but the potential fears and actual defaults
could still put pressure on the spreads of the larger
financials," he said.

Capital positions at regional banks are generally strong,
analysts say, though losses at National City Corp NCC.N are
flashing warning signals that some are coming under strain.

Cleveland-based National City last month said mortgage and
home equity problems led to its third straight quarterly loss.
The Midwest bank struggled with exposure to the Ohio and
Michigan real estate markets, and a badly timed foray into
Florida.

Analysts at JPMorgan said on Wednesday that large U.S.
commercial banks now also face accelerating credit weakness in
new regions and loan categories.

Several banks have recently cited credit weakness from some
new parts of the United States, including Virginia, Maryland,
the Washington, D.C. area, Illinois and Minnesota, lead analyst
Vivek Juneja said in a report.

Banks are also seeing rising losses from credit cards, auto
and small business loans and other consumer loans in addition
to problem areas like home equity lines, residential and
commercial mortgages, he said.

A key factor for the health of regional banks will be how
high losses from credit card, home equity loans and other
credit products rise, analysts said.

"A lot of asset-backed security exposure was effectively
securitized off their balance sheets," said Citigroup's Foux.
"But some of their construction exposure and home equity loans
were not."

"In certain communities, like in California, Florida,
Arizona, Ohio, you might see some problems on that front," Foux
said.

Community and regional banks are not directly linked in a
way that the failure of a smaller bank would itself topple a
larger one.

"Nevertheless, if you see some banks in a certain area or
certain state start falling one after another, and one of the
big regionals have big operations there, you might start
wondering," Foux said.

"Not only that you might actually see something like a run
on a bank," he said.
(Additional reporting by John Poirier, Paritosh Bansal and Joe
Giannone)