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) - It's eat or be eaten for most regional banks these days.

While most of the headlines go to the four multinational money-center banks --


(C) - Get Citigroup Inc. Report


JPMorgan Chase

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Bank of America

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Wells Fargo

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-- and "super regional" banks names like

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U.S. Bancorp

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, the bulk of publicly traded U.S. banks operate on a much smaller scale and scope. Call them the modest majority.

The asset size of these banks ranges widely from mid-cap banks such as

Fifth Third Bancorp

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Zions Bank

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Valley National

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to small-caps like

East West Bancorp

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Sterling Bancshares

( SBIB) or

Umpqua Holdings

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And as the banking landscape changes, observers say these smaller players will need to carve out well-defined strategic niches for themselves and execute, or else prepare to be trampled down or gobbled up.

"If you're a smaller bank that's just kind of average, then what is in front of you is a very difficult environment where the market is demanding a lot of capital," says Gary Townsend, Hill-Townsend Capital, a private investment firm that focuses on bank stocks.

The new banking landscape of higher capital requirements and rising regulatory expenses could ultimately squeeze these banks more than their bigger brethren, who have sheer size and diversity on their side. In addition, the lesser regionals are still dealing with lingering credit costs and lower profits in general as the economy remains in a sluggish state.

Many banks "are still trying to work through a loan portfolio that's replete with nonperforming assets; regulators are banging at you daily and you're profitability is poor and prospects are murky. So I think the ability

for smaller banks to earn anything like a reasonable return on capital is going to be very hard going forward," Townsend of Hill-Townsend Capital says.

For smaller banks, whereas once it may have been a cinch to get further capital from either private investors or the public markets, it is difficult to do so these days for the small banks.

"Although private investors may be interested, there is a lot more scrutiny in what they invest in and it's more of a challenge to get capital," says bank consultant Gregg Noonan, who primarily works with smaller banks with $1 billion to $10 billion assets. "Smaller community banks -- there are a lot of them and highly competitive and some of them have asset quality issues, so they're going to have to work through them and get their earnings back on track in order to get investors into their company."

That being said, there is also plenty of opportunity for these banks, particularly in picking up displaced customers and employees from the wave of mergers over the last few years as well as banks that have failed.

But to succeed over the long term, regional banks must be well managed and "doing something better or different than everyone else," Townsend says.

"The larger banks for the most part are not very good in the area of

personal retail relationships. They're too divided in their interests and ... don't do commercial banking well, particularly to small business customers, you're just one of a million," he explains. "So they can be competed against effectively, but it has to be doing something better, not just as good as your larger competitors," which could be a specialty lending area or geographic niche not served very well.

Signature Bank

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, for one, is a particularly well-operated commercial lender in the New York metropolitan area, Townsend noted.

Another niche bank

New York Community Bank( NYB)

has made its name in the commercial space by focusing primarily on multi-family loans and commercial real estate also in the New York metro area.

First Horizon

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is the biggest bank headquartered in Tennessee, which the company is looking to take advantage of as it carves out its future. The regional bank is also looking to expand via acquisitions in markets similar to ones in their home state.

>>>First Horizon's Long Road Back

CFO William 'BJ' Losch says the economy certainly still has a fair amount of challenges for smaller banks.

"For some in the industry the structural changes that will occur will be significant," Losch said in an interview with


last month. "There are certainly going to be clear winners in this environment and we think we are extremely well positioned to take advantage of those opportunities being a regional bank that has a great business model, good returns, the ability to drive returns over time. We're actually seeing this as an opportunity for us to fill a void that may come in the future."

But the biggest question is where are the profits are going to come from with lending remains in a holding pattern and revenue from fee-based businesses set to be dramatically lowered by the new rules. Observers say it's not an easy question to answer.

Bob Phillips, managing partner and co-founder to Spectrum Management Group in Indianapolis, says banks, particularly regional banks, still have a ton of commercial real estate on their books which will eventually have to be restructured.

"On a global level there is still $1.5 trillion in commercial real estate debt that has yet to be dealt with" that will mature over the next two to three years, says Phillips, who is underweight in the financial sector.

Commercial real estate properties are producing enough cash flow to "service the debt, but not justify the value of the loan," he says. "So the banks are playing a game which they have to play ... I think that there is lots of stuff being carried at values that can't be supported," and so the profits made each quarter on good loans will have to be used to write down the bad commercial real estate loans.

"The point being that the assets the banks currently have are over-priced and they are going to fix that over-pricing over the next few years by continuing to write down the loans," Phillips added in a follow-up email. "So consequently their bottom lines won't be growing - either they won't be making more money (or just very little money)."

But if it gets to a point where a regional bank either doesn't have a strong enough strategy to adhere to the changing regulations or is getting squeezed too hard, there is really only one solution: "They sell," Townsend says, who is another believer of the coming


trend in the bank sector.

There will be no shortage of banks that are licking their chops to take advantage of the coming consolidation.

Oppenheimer analyst Craig Siegenthaler believes that a significant amount of consolidation will occur in the

mid-cap bank

sector as larger regional banks turn from the failed bank space to larger banks.

Jim Sinegal, regional bank analyst at Morningstar, says that some banks are even scaling back deposit taking with no place to deploy the excess capital back out, except via acquisitions.

"M&A is actually going to be huge in the coming years," Sinegal says. "The banks have built up so much capital ... One of the only places they will be able to get growth is in M&A."

--Written by Laurie Kulikowski in New York.

Disclosure: TheStreet's editorial policy prohibits staff editors, reporters and analysts from holding positions in any individual stocks.