"What banks in this situation are doing is raising capital-that is their first and last resort," Gardner says. "That way, they can sell the problem assets, realize the loss and still be in good shape."

Most community banks are turning to local businesses to raise capital, Gardner continues. "In a few cases, you might have a large institution or some institutional money available but not much." As one can easily imagine, the local business communities are not all poised to step up. Or if they are, they may decide that the local bank is not worth saving, he says.

In other words, it is the same story, writ small on a market-by-market basis, that has been playing out with developers and the large-money banks for the past two years. Community banks, though, have their own special set of problems that are exacerbating their situation. They do not have the protection of relaxed mark-to market accounting standards, or for that matter, a helpful TARP-backed handout. They also have, despite soothing words from Washington to the contrary, local regulators who are more rigid than ever in what constitutes an appropriate level of reserve capital.

"From what I've heard, the talk from Washington about providing new loans to small- and medium-sized businesses doesn't mesh with the way the regulators treat these banks," says David Webb, managing director in Cassidy Turley's Capital Markets group in Washington, DC. "It is not so easy for community banks to make new loans because the local regulators are going over everything."

It's little wonder that the Congressional Oversight Panel, which was set up to monitor TARP, identified these banks as having a higher concentration of distressed loans. Back in February, the panel concluded that community banks were more likely to experience a disproportionate share of defaults and would have to sell off their distressed loans and raise the necessary capital to offset the loss.

This confluence of events poses a quandary for both community banks and the larger commercial real estate space: if these banks let go of their sour loans, more deals would come to market, more price points would be established-perhaps not at the levels that sellers would like-and the general machinations of the industry would finally get moving.

No doubt there are potential investments for distressed buyers sitting on many community banks' balance sheets, Webb says. "These banks typically hold land loans and small construction loans." In the process, though, many community banks would go under. Plus, developers that have come to rely on community banks since the demise of the conduit market would feel the finance gap pinch even harder.

However, the tide appears to be turning against the community banks, as a number of new trends emerge. For instance, community banks are finding themselves competing with the same players that used to steamroll them in the halcyon days-players that have been made healthy thanks to government intervention, says Dan Gorczycki, managing director of Savills US in New York City.

"The bigger banks that borrowed from the Fed were supposed to lend with that money. Instead, they put it in the stock market and made record earnings," he says. "But the community banks didn't have the same luxury because they don't have trading departments or the expertise to do that in house. So they don't have the '09 earnings that the large banks have had."

Gorczycki continues, "Now these larger banks-and the conduits and life insurance companies-are getting back into lending again, maybe not at the same rate they did in 2007, but they are getting back in." Real estate borrowers are taking the best deals back to their old sources and leaving the pickings from the community banks.

"Suddenly no one wants to do recourse anymore," Gorczycki says. "We are moving back to the old days where the community banks are limping along with their legacy portfolios."

These same trends are making their impact felt with government policy. Whether it has been made official or not, the PPIP program-at least for its legacy loans-is dead or dormant, says Ira Bergstein, principal of Fort Lee, NJ based Palisades Financial, an alternative commercial real estate lender and fund operator. "The banks, many of them community institutions, didn't want the price discovery," he says.

Because community banks aren't able to mark their loans to market, they instead reserve capital against them. But they have been concerned that if they put a distressed loan out for bid from a PPIP fund, regulators would come along and see that the bank could have gotten 60 cents on the dollar for that loan, even if the deal hadn't gone through, Bergstein explains.

That would make the loan valuation "official" in the eyes of the regulator. Conversely, if there is no bid for the asset, loans can't be acknowledged as being distressed. "Community banks just can't afford that right now," Bergstein says. "They need time to rebuild profits to soften the blow when they do write down the loans." On the other hand, the real estate industry can't afford the status quo much longer either, he continues. "What the government needs to do is give incentives to banks to sell off those loans and assure them that we won't penalize them and that it won't affect their capital."

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