The banking industry may be on the mend, but its recovery could be hindered by heavy-handed regulation and more pain in the housing market, among other things.

That was the consensus of three banking analysts who participated in an American Banker roundtable late last month in New York.

The veteran market watchers — Anthony Polini of Raymond James, David Hendler of CreditSights Inc. and David Ritter of Argus Research Co. — said the worst of the financial meltdown may be over, but banks are still facing heavy losses and depressed profits, particularly if the government gets carried away with financial and other reform efforts.

"I'm much more concerned about government intervention than I am about the financial crisis," said Polini, a senior vice president of financial services equity research at Raymond James. "I think we'll be in a recovery mode next year, but I'm not quite so sure where the job creation is going to come from. Tax reform, health-care reform, executive pay reform — these things do not bode well for job creation."

Hendler, CreditSights' head of U.S. financial services, said potential new consumer rights laws could cut into profits by forcing lenders to provide more low-fee, low-rate basic banking products to middle-class and poor people. This kind of "social policy lending" could "have a big impact on the traditional retail, branch bank systems," Hendler said. "Why should banks be providing all these access points to people that they do not really make much money off of? It does get some liquidity, but it may cost too much."

Banks' ability to set prices based on customer risk will also be hobbled by regulatory limits and legislation capping credit card fees and checking account overdraft fees, he said.

Ritter, director of financial services research at Argus, said government intervention in the housing sector could be postponing inevitable pain or could inadvertently revive old problems.

"There are just unprecedented government subsidies out there right now, first for the housing market. And it isn't just the tax credit and the fact that mortgage rates are probably artificially low because of quantitative easing," Ritter said. "Then aside from that you've had this massive explosion now of FHA loans. It's being done to prop up the housing market and the broader economy for sure, but many of the same practices that got us into this mess in the first place are being done again now by the FHA with low-down-payment loans and relatively easy approvals."

Hendler said the banks could face $500 billion to $1 trillion more in mortgage losses. People with good credit who bought a house at the height of the bubble are having trouble making payments, he said, thanks to rising unemployment.

"My view is that the prime residential mortgage crisis is probably going to require another massive government assistance program in that range of half a trillion [dollars] or more," Hendler said. "And if this program is extended, it will lead to more bank regulatory restrictions with more capital and higher prudential liquidity levels. This would reduce the banks' appetite and ability to take lending risks and put pressure on profitability."

Hendler expects "600 to 1,200" banks to fail in the next two years. The large banks that passed the government stress test are well positioned to handle the "lagging phases" of the recession, he said. But regional banking companies sensitive to local real estate trends, such as Zions Bancorp. and Marshall & Ilsley Corp., face tougher challenges, especially if economic trends take a bad turn. Some regionals might become acquisition targets, he said. Many community banks are still vulnerable to real estate and economic problems, too.

Polini said he expects a "few hundred" more bank failures in 2010.

He and Hendler both said the government should tread carefully when adopting policies regarding institutions deemed "too big too fail."

Polini said breaking up the largest banks would be misguided, since it was investment banks and mortgages that ruined the economy, not the giant depositories. He said having three of the country's largest lenders — Bank of America Corp., JPMorgan Chase & Co. and Wells Fargo & Co. — controlling an outsized share of the nation's deposits should have a stabilizing effect on the industry.

The government shouldn't bail out any organization, regardless of its size, Polini said.

"If AIG was going to fail, AIG should have failed. If GM was going to fail, GM should have failed," he said. "The biggest problems come into play when we try to regulate the failures or to control the process. Capitalism works just fine."

Hendler said failures of small and midsize banks will cause the most headaches for regulators in the coming years. Banks that cannot compete with the national players will be pushed into receivership, the Federal Deposit Insurance Corp. doesn't have enough capital to handle that wave of failures, and soliciting more funds from the Treasury Department is a "political football," he said.

"We have to somehow depoliticize this problem," Hendler said. "There were mistakes made all around. It's a group problem. To say that the taxpayer should not have to pay for things — look the taxpayer was engorging on debt from home equity and credit cards for 10 years. They, too, were part of the problem."

A slew of other issues could weigh on banks' profits in coming years.

Hendler said banks could be hurt by consumers' newfound thrift.

The average American is "deleveraging by paying down personal debt and finally learning what their grandmother or great-grandmother said, that you've got to save for a rainy day," he said. "So we have more than just a banking problem; we have a societal reassessment of fundamental values and spending ways."

Ritter said new regulations on how derivatives are bought and sold could test megabanks like JPMorgan Chase.

"The other big issue for the big banks is going to be [where] do we end up with the trading of over-the-counter derivatives," he said. "Is it going to end up being traded on an exchange? I know a lot of the big banks are arguing against that. They're in favor of it going through clearing houses. That's a huge source of revenue for the top banks."

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