Community bankers are fighting a battle along two fronts over the Transaction Account Guarantee program: trying to get TAG extended while at the same time searching for new sources of liquidity should the program end.

The banking lobby is working feverishly to keep the program going beyond its current Dec. 31 expiration date, and lobbyists say congressional leaders are seriously considering an extension. The program, created by the Federal Deposit Insurance Corp., provides unlimited federal backing for noninterest-bearing deposits.

If those efforts fail, community bankers expect to lose a significant number of accounts with more than $250,000 to bigger banks.

"Our customers are comfortable with our bank, but with everything they read and hear" about the possible end of TAG "scares the crap out of them," says Kreg Denton, a senior vice president at First Community Bank of Western Kentucky. He says the $82 million-asset bank would turn to the Federal Home Loan Bank of Cincinnati if TAG ends.

Other banks are less confident, expressing frustration about the FHLB system's collateral requirements. For instance, some Federal Home Loan Banks will not accept loans backed by the U.S. Small Business Administration as collateral.

"Their collateral requirements are so stringent, it's hard for us to borrow from them," Ronald Paul, the chairman, president and chief executive of Eagle Bancorp (EGBN) in Bethesda, Md., told attendees at American Banker's Regulatory Symposium in September.

Those concerns are unfounded, says Susan Elliott, executive vice president and chief business officer at the Federal Home Loan Bank of Boston. "Most of our members are in an excellent position to borrow from their Federal Home Loan Bank," she says.

Community banks have steadily reduced their reliance on FHLB advances in recent months. At banks with $1 billion or less in assets, FHLB advances at June 30 fell 1% from a quarter earlier and 13% from a year earlier, to $33.9 billion, according to FDIC data.

The end of TAG could lead more community banks to seek such funding, which could provide a boost to the FHLB system.

First Community Bank of Western Kentucky, a unit of First Trust Financial in Clinton, Ky., needs deposits; its loan-to-deposit ratio at June 30 was 95%, Denton says. First Community Bank had $2.4 million in outstanding FHLB advances at the end of the second quarter.

"We definitely use the Federal Home Loan Bank now, and we would have to rely a little more heavily on" it if the TAG expires, Denton says.

Another risk is that the banks that are in the greatest need of liquidity may have the most difficulty replacing deposits backed by the TAG. Financial institutions with lingering credit issues or operating losses have historically struggled to qualify for FHLB advances, says Ron Riggins, a bank consultant at RP Financial in Arlington, Va.

"It's the weaker banks that will be most affected," Riggins says. "Those banks have already suspended lending and they're trying to build liquidity now", even ahead of a possible TAG expiration.

Some Federal Home Loan Banks have responded to bankers' concerns about collateral requirements by expanding what they will accept. The Federal Home Loan Bank of Atlanta recently began accepting commercial mortgage-backed securities as collateral, says Chief Credit Officer Robert Kovach.

The FHLB of Atlanta is also considering a policy change to start accepting SBA loans as well. "My priority is risk management, but right behind that is to help membership, particularly community banks, access the liquidity they need," Kovach says.

Some industry observers are wondering if community banks, by and large, need the added liquidity. FHLB advances with strict collateral requirements are not the cheapest source of funding, says John Soffronoff, the president of compliance at Fidelity National Information Services' ICS Risk Advisors. It would be better to compete for deposits through traditional means, such as offering competitive interest rates.

"What do [community banks] need the funding for?" Soffronoff says. "Loan demand isn't particularly robust right now."

Even with those questions, the banking industry's trade lobby in Washington has made a TAG renewal its highest priority during Congress' lame duck session in the closing weeks of 2012. Congressional leaders are said to be considering including an extension in any broad legislative packages to be voted on by the end of the year.

— Joe Adler contributed to this story.

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