Pent-Up Shorts Ravage Regional Banks

"Commercial credit continues to deteriorate, and, while regional banks are still experiencing relatively low loss levels in their [commercial and industrial] portfolios ... Management teams have shifted from being optimistic to cautiously optimistic about commercial credit," the note says.

Friedman Billings suggests that Comerica (CMA Quote), City National (CYN Quote), Webster Financial (WBS Quote), UCBH (UCBH Quote) and Sovereign remain among those banks with the highest risk related to business loans.

"Compounding potential credit problems is the current liquidity crisis, which is making it harder for businesses to fund their operations, therefore decreasing the likelihood that many businesses will be able to earn their way out of the current down cycle," the analysts write. "Ultimately, we believe that the contrails of a consumer (or consumer-related) recession have yet to be seen fully in commercial credit, preventing us from becoming more bullish on banks at current valuations."

The M&A trend has picked up amongst the largest banks as investors become increasingly nervous about which companies may not make it through the credit crisis.

Citigroup (C Quote) and Wells Fargo (WFC Quote) are locked in a legal battle over the ownership of Wachovia (WB Quote). Both sides agreed to take a break from the legal spats -- extended until Friday -- so that the two companies, along with the Federal Reserve, can come to a resolution. The Wall Street Journal says the two banks were hung up on certain key issues pertaining to how exactly the Charlotte, N.C., lender would be carved up and how much in bad loans it actually has on its books.