The nation's biggest regional banking companies are likely to use a defensive strategy most of next year as they continue to absorb loan losses and chew through capital.

Most of the largest banking companies took advantage of acquisitions encouraged or brokered by regulators to build scale this year, but most of the next tier avoided major deals.

The prevailing thought is that firms like Fifth Third Bancorp, Regions Financial Corp., and SunTrust Banks Inc. may remain on the sidelines until at least mid-2009, except to take advantage of failed-bank deals offered by the Federal Deposit Insurance Corp.

The regionals are expected instead to spend time and resources — including billions of dollars from the Treasury Department's Capital Purchase Program — on getting a handle on their credit quality, which many observers say deteriorated at an alarming rate this quarter and will remain a major problem through a prolonged recession.

Regions may have set the tone for large regionals Monday by saying it would report up to $1 billion of nonperforming asset sales for the fourth quarter; the $144 billion-asset Birmingham, Ala., company did not reveal the prices. Analysts said the moves could lead to a quarterly loss and cut into capital.

Other large regionals are expected to follow suit with hefty chargeoffs in subsequent quarters. Doing so might force them to seek more capital, perhaps by selling common stock when equity markets stabilize. The financial health of such companies could be critical to bailing out crippled competitors, and those that regain their footing the fastest should be in the best shape to solidify balance sheets and build their retail banking operations through transformative acquisitions.

Jeff K. Davis, a principal at Wolf River Capital LLC, said the first half of next year "will be abysmal and will be all about reserve building" at large regionals. "Ultimately, how bad does asset quality get, and therefore how do investors view the capital bases of these companies?"

Before making a purchase, he said, bankers should wait another six to nine months "to see how the economy is going to play out in their own portfolios, as well as those of their targets."

SunTrust and Regions are drawing the most scrutiny for worsening credit and capital levels that might need further fortification. The continued drop in real estate values in Florida and Georgia could spur both companies to be more aggressive in shedding assets at depressed prices.

Regions said its actions should reduce nonperforming assets to less than the $1.77 billion it had on Sept. 30. While giving no specifics, it said its fourth-quarter provision would outstrip chargeoffs, thus padding overall reserves. Both actions should eat into capital levels fortified by a dividend cut this year and $3.5 billion of capital from the Troubled Asset Relief Program.

Still, Regions has "some fairly formidable problems," said Frank Barkocy, the director of research at Mendon Capital Advisors Corp. "They are exposed to markets that continue to deteriorate, and loan demand will be an issue for them."

Capital is also a concern at SunTrust, which drew attention this month by going back to the Treasury for the full $4.5 billion it was eligible to receive under the Capital Purchase Program. The $175 billion-asset Atlanta company has largely cashed out its profits on its Coca-Cola Co. stock, and it cut its dividend in October.

As of Sept. 30, SunTrust's nonperforming assets as a percentage of equity stood at 22.7%, compared with 9.2% at the end of last year, according to data from SNL Financial LC in Charlottesville, Va. (See chart.)

James M. Wells 3rd, SunTrust's chairman and chief executive, said in a Dec. 9 press release that it sold more preferred stock to the Treasury because of a "decidedly bleaker" economic outlook. "We have concluded that further augmenting our capital at this point is a prudent step, especially if the current recession proves to be longer and more severe than previously expected."

SunTrust's loan-loss allowance represented 1.54% of total loans at Sept. 30, and building reserves further in a slow economy would make profitability a challenge.

"The need to build reserves and a higher level of chargeoffs are going to deliver a double whammy to their earnings," said Albert Savastano, an analyst at Fox-Pitt Kelton Cochran Caronia Waller.

Earnings have held up reasonably well at BB&T Corp., leading many analysts to view it as a likely consolidator. But souring loans continue to accrue, particularly in its residential development portfolio. At Sept. 30, nonperforming assets as a percentage of equity was 12.7%, leading some analysts to wonder if the company will reconsider its decision this year to raise its dividend.

"Is BB&T out of the woods? No," Mr. Barkocy said. "They are still exposed to the same problem markets" as Regions and SunTrust, "and there's still the question of how they can best utilize Tarp funds and maintain a relatively reasonable level of asset quality." (BB&T sold $3.1 billion of preferred stock to the Treasury.)

So far these companies have not shown interest in large acquisitions without government backing, though each has swooped in after a bank failure to buy deposits and assets.

Christopher Marinac, an analyst at FIG Partners LLC, said bankers need to face reality when it comes to asset values. "Losses are just getting bigger, because values continue to drop, so they need to start taking more bids and larger haircuts to move on."

Analysts say Capital One Financial Corp., which has agreed to buy Chevy Chase Bank in Maryland for $520 million in cash and stock, could be an acquirer again in the early part of next year. The rationale is that the $155 billion-asset McLean, Va., company still has a lot of capital and a need to boost funding from deposits.

Richard Fairbank, Capital One's chairman and CEO, said at a Dec. 11 investor conference that its main markets of New York and the Gulf Coast are "a bit of a constrained footprint to ultimately build the kind of business that we want."

However, Capital One is dealing with rising delinquencies in its credit card business and in auto lending. Its third-quarter loan-loss provision rose 32% from the second quarter and 84% from a year earlier, to $1.09 billion. And buying Chevy Chase, with its $4.1 billion of option adjustable-rate mortgages, would add to the pressure.

"Capital One's main question, undoubtedly, it will be … where losses peak," said Craig Maurer, an analyst at Credit Agricole Group's Calyon Securities LLC. "That applies to all of the company's portfolios."

KeyCorp has said throughout this quarter that it is well capitalized and open to possible deals in the year ahead, but analysts say the $101 billion-asset Cleveland company is likely to be cautious, given its recent moves to beef up capital. Last month it slashed its quarterly dividend by two-thirds; that cut followed a similarly steep move in June.

Henry L. Meyer 3rd, KeyCorp's chairman and CEO, said last month that the dividend cuts, coupled with the $2.5 billion of capital secured through the Capital Purchase Program, provided "the financial flexibility to make loans and expand our business."

Fifth Third is also likely to avoid large acquisitions and look inward. The $116 billion-asset Cincinnati company has posted two straight quarterly losses after setting aside more than $1.6 billion to cover possible loan losses. Analysts expect it to be aggressive with chargeoffs next quarter to counter nonperforming assets that jumped 28.7% in the third quarter from a quarter earlier, to $2.83 billion.

Kevin Kabat, Fifth Third's chairman and CEO, downplayed big purchases during an interview last week, saying that ample capital "certainly gives you more flexibility" dealing with credit issues. "We have been aggressively attacking credit and will continue to do so. Is it where we aspire it to be? No, but I think we are doing a very good job in a difficult environment."

All the regionals want to see how PNC Financial Services Group Inc.'s integration of National City Corp. plays out. Depending on the depth of loan losses, PNC might have to raise more money to offset future losses; it received $7.7 billion of capital from the Treasury.

"The sheer size of National City represents a challenge in and of itself, and it will take a lot of resources and time to make this happen, even without any glitches," said Matthew Shultheis, a senior analyst at Boenning & Scattergood Inc. "Then, of course, the general economy is not going to be good for anyone, and that's bound to leave PNC dealing with its own and National City's elevated credit losses."

In an interview after announcing PNC's deal for Nat City, James Rohr, the $128 billion-asset Pittsburgh company's CEO, said it has "a lot of experience with trouble … and we realized a long time ago we're in the risk management business, not in the risk-taking business, and I think that will serve us well with National City."

Analysts said the key for the large regionals will be managing capital and striking at the appropriate time; the edge will clearly go to those that get a handle on credit quality and maintain enough powder to capitalize on those who struggle.

"All of these companies have markets that, when the cycle turns, will put them in pretty good shape," Mr. Barkocy said.

Executives at the companies mentioned in this story declined interview requests.

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Corrected December 31, 2008 at 1:16PM: An earlier version of this story understated SunTrust's loan-loss allowance rate on Sept. 30. It was 1.54% of total loans.