The door has been kicked wide open for community banks to gain a foothold in mortgage lending, as national financial institutions work to recover from rising mortgage loan losses.

A power shift is in the works in the banking industry-and it's on the magnitude of Barack Obama winning the traditionally Republican state of Indiana. Smaller community banks are attracting new customers with broader service offerings, while the behemoth financial institutions are being forced to downsize.

Community banks have always beat out their larger competitors in terms of personal service, but they haven't always been able to compete on price. Those tables may be turning, however. Now that the big banks are struggling to absorb rising default costs, the community banks are moving into the mortgage space and offering their customers very attractive rates.

Volume lending gone sour

The mortgage boom that peaked in 2006 was fueled, in part, by strong secondary market demand for mortgage-backed securities. To fill that demand, big banks and mortgage lenders would make loans and sell them off for securitization. The money recouped through the loan sales would replenish the coffers, so that more loans could be made. Over time, loan volume took priority over loan quality, and underwriting standards began to loosen.

Many community banks chose not to participate in that frenetic loan-making activity. Instead, they stuck with the loans they could fund with their own deposits, and held true to their traditional underwriting standards. In hindsight, that turned out to be a smart strategy: those banks now enjoy a financial advantage, because they aren't weighed down by a mountain of bad loans on the books.

Pricing suffers, bank branches to close

In contrast, the situation at Wells Fargo, Bank of America, and their other large counterparts isn't so rosy. These giant financial institutions are grappling with higher-than-expected default costs and uncertain economic futures. As a result, they're more willing to charge higher prices, and they're not as eager to take on every mortgage applicant who comes their way. Indeed, some mortgage applicants have reported large pricing discrepancies between local mortgages and big-name mortgages; these discrepancies are showing up in both the mortgage interest rate and in the upfront mortgage fees.

Service at the big banks may suffer, as well. Closed branches and customer service staff reductions are on the horizon, and those actions are likely to alienate their banking customers.

Many community banks are now better equipped to offer mortgage applicants the complete package: personalized customer service and competitively-priced local loans, to boot. This presents a window of opportunity that some of these lenders won't pass up. Expect community banks to reach out more definitively to their existing depositors as they actively grow their mortgage lending prowess.

Meanwhile, the big banks will be using their energies to retrench and rebuild-just as the Republican Party has to do if it wants to win back Indiana.

Published on February 28, 2009