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Tickers in this Article: BAC, C, MS, GS, HBAN
Despite the improvement in the economy, the banking industry still faces hurdles to a return to the normalcy that prevailed prior to the financial crisis and recession. These hurdles impact both large money center banks, and smaller community banks.

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Small Banks
The Congressional Oversight Panel (COP) was set up to monitor the Troubled Asset Relief Plan (TARP) under the Emergency Economic Stabilization Act of 2008. The February 2010 report released by the COP highlights the dangers that Commercial Real Estate (CRE) lending poses to the nation's smaller banks.

These loans were taken out to finance the building of hotels, shopping centers, office buildings and other commercial properties. (Learn more about TARP, read Liquidity And Toxicity: Will TARP Fix The Financial System?)

The COP report said that $1.4 trillion of these loans need to be refinanced over the next five years, while 50% are underwater, which is a colloquial term for an outstanding loan that exceeds the property value. The problem with lower collateral value is compounded by higher vacancy rates and falling rents for all classes of commercial real estate.

The report also noted that 2,988 out of 8,108 banks have a "CRE concentration" which is defined by Federal regulators in two ways - those banks having CRE more than 300% of total risk based capital, or construction and land loan exposure greater than 100% of total risk based capital. The report didn't cite any banks but many have substantial real estate exposure.

Higher losses in CRE will force these banks to restrict lending in 2010, just when the economy may need such lending to grow.

Huntington Bancshares (NYSE:HBAN) has a substantial portfolio of CRE loans that it has been managing during the recession. During its fourth quarter of 2009 earnings conference call, management cited single-family homebuilders and retail as its "two highest risk segments."

Large Banks
If that wasn't enough of an ominous warning, Standard & Poor's revised its outlook on Bank of America (NYSE:BAC) and Citigroup (NYSE:C) from stable to negative. Standard & Poor's cited uncertainty over new regulation pending in the U.S. and how that would impact the government's willingness to protect systemically important institutions from failure. Standard & Poor's had previously put Goldman Sachs (NYSE:GS) and Morgan Stanley (NYSE:MS) on negative outlook.

These new regulations will impact future profitability for the larger banks, as rules are under discussion that will prohibit proprietary trading and reduce the leverage permitted. The net effect of these new regulations is that some of these banks may be as profitable as previously.

The Bottom Line
Some investors may feel that the worst is over for the U.S. financial system, but there is some evidence that more pain may be coming. This year should be an interesting one for those who dare to invest in banks.

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