The Avalanche Picks Up Speed

CNBC's Jeff Cox looks at the growing damage the commercial real estate collapse is causing for small and medium sized banks.

The commercial real estate beast has begun to expose its claws in earnings, posing the single greatest threat to the banking industry's recovery through the rest of the year.

As bank earnings begin to pour in, a recurring theme has established itself: More diversified institutions like Goldman Sachs and JPMorgan Chase are showing stronger resiliency, while others, particularly at the regional and local level with little ability to offset commercial real estate losses, are going to suffer.

"The larger banks that have multiple revenue streams, some of those streams are doing very well," said David Twibell, president of wealth management at Colorado Capital Bank in Denver. "For the smaller banks, the primary revenue generator is going to be the lending side of the business. That's still a real mess out there. Particularly relating to commercial real estate, it's getting worse, not better."

By "multiple revenue streams" we of course mean "fat counterparty checks from the $100 billion plus the government threw into the AIG black hole." That's something regional and local banks didn't get a slice of, and that's why they are hurting badly and will continue to hurt well into 2010 and beyond.

"Banks are writing off commercial real estate loans now at a bigger rate than in the last 20 years," said Kathy Boyle, president of Chapin Hill Advisors in New York. "It's a double-whammy. Banks have another shoe to drop on their balance sheets, and regional banks tend to have a much bigger exposure."

The larger money center banks like Goldman and JPMorgan either have active trading desks or diversified enough interests that they won't be saddled as badly as some of their smaller brethren.

Some analysts had been growing more bullish on the sector as a whole as the contagion from the subprime mortgage collapse seemed to fade.

But second-quarter earnings are showing that the industry now must wrestle with deterioration in the commercial markets, as well as continued consumer weakness likely to be reflected in credit card defaults.

Analysts say they'll be watching regional bank earnings as they accelerate in the coming days. The current poster child for commercial loan troubles,CIT Group , is scheduled to report earnings Thursday.

"There are still significant problems in the commercial real estate market," Twibell said. "We're probably in the third or fourth inning of that, whereas in the residential side we're in the seventh or eighth inning. There are so many problems, it's tough for me to get excited about banks despite the move higher."

Oh, I'm betting some banks are going to be moving higher...the megabanks who have gotten the huge payouts from the government. The banks that weren't Too Big To Fail? Watch for them to keep being snapped up by the big boys. So far 57 banks have gone under in 2009. A whole lot more are going to go under before all are said and done and the FDIC quietly assumes all the debt and sells the assets to bigger banks.

The practical upshot of the financial crisis and bailout will be that the financial industry will be an oligarchy within several years. There's your reform, folks. Your local hometown bank, serving the tri-county area since 1908? It's not going to survive the commercial real estate bust. It'll get dismantled, stripped, and recycled into another Wells Fargo or Chase or BoA branch. Even better, it'll get closed down...after all there's already a megabank a tenth of a mile down the road next to the Wal-Mart.

Meanwhile, the FDIC gets stuck with all the bad assets...and that means we all get stuck with them.