Stress tests find small banks need to raise capital, too

— -- A large number of smaller banks will need to raise additional capital if they want to fortify themselves against a sharp downturn in the U.S. economy.

Out of 418 U.S. banks with assets of $1 billion to $100 billion, 367 will need to raise a total of $75 billion, according to a report released Wednesday by researcher SNL Financial. The group used the same adverse conditions under which the government conducted its recent stress test on the top 19 banks. Those tests found that 10 of the 19 would also need a total of $75 billion more capital over the next six months.

Many of the relatively smaller banks don't own the kind of toxic securities that have hurt the large Wall Street banks. However, they are more exposed to losses from traditional lending. With unemployment rising, consumers continuing to keep their purse strings tied and businesses folding, defaults are expected to soar on loans for homes and office buildings.

"Shopping malls are weak, office-vacancy rates are surging and industrial loans will start going bad as more companies file for Chapter 11," says Martin Weiss of Weiss Research.

The government seems to be preparing for such pockets of weaknesses. On Wednesday, Treasury Secretary Tim Geithner said smaller banks, too, will be able to apply for government bailout funds in the next six months. It's something they might need if their loans to local businesses turn sour.

"Traditionally, regional banks' competitive advantage is making loans to businesses and builders where relationship is extremely important," says Frederick Cannon, an analyst at Keefe Bruyette & Woods.

Some of the regional economies in which they operate are already worse off than the national economy. For instance, Huntington Bancshares and Zions Bancorp are among the top five banks required to raise additional capital, according to research from both SNL and Keefe Bruyette & Woods.

Huntington, which has taken in $1.4 billion from the government bailout plan, will have to raise an additional $3.3 billion, according to SNL. Headquartered in Ohio, where the unemployment rate has reached 9.7%, Huntington also has branches in Michigan, where unemployment has climbed to 12.6%. Similarly, Zions, of Salt Lake City, has branches in California, where unemployment has climbed to 11.2%. That compares with the U.S. unemployment rate of 8.6%.