Feds Begin ‘Stress Tests’; New Capital Injection Plan Rolls Out

The Treasury Department late Wednesday released details surrounding a “core element” of President Barack Obama’s financial stability initiatives. The Capital Assistance Program (CAP) will use the results of “economic assessments” of major banks to determine whether “an additional capital buffer is warranted,” at which time banks would be able to seek private sources of capital before receiving additional government aid. “In light of the current challenging market environment, the Treasury is making government capital available immediately through the CAP to eligible banking institutions to provide this buffer,” according to a media statement about the program. The Treasury will distribute capital through the program in the form of a preferred security that would be convertible to common equity at a 10 percent discount from the price before Feb. 9. Any CAP securities distributed will carry a 9 percent dividend yield and would be convertible “at the issuer’s option”; the securities would automatically convert to common equity after seven years if not already redeemed or converted. Qualifying banks would be able to request CAP securities in addition to existing Capital Purchase Program (CPP) preferred stock, or to apply to exchange the existing CPP preferred stock for the new CAP instrument, with supervisory approval, the Treasury said. Capital recipients under the CAP will be subject to revised executive compensation requirements inherent in the Emergency Economic Stabilization Act of 2008 as it applies to the recipients of funds through the whole Troubled Asset Relief Program. Recipients will also be subject to restrictions on paying quarterly common stock dividends, repurchasing shares and pursuing cash acquisitions; they’ll also be required to submit monthly reports on lending by category to the Treasury. Applying banks will be required to submit plans for the intended use of the new CAP capital “to preserve and strengthen teir lending capacity — specifically, to increase lending above levels relative to what would have been possible without government support,” the Treasury said. “The purpose of the CAP is to restore confidence throughout the financial system that the nation’s largest banking institutions have a sufficient capital cushion against larger than expected future losses, should they occur due to a more severe economic environment, and to support lending to creditworthy borrowers,” Treasury officials said in the statement. The purpose is also to “give banks the incentive to replace [government]-provided capital with private capital,” according to the statement. The Federal Reserve had announced earlier on Wednesday that federal agencies would begin conducting “forward-looking economic assessments” of major U.S. bank holding companies with assets in excess of $100 billion. These assessments — the bank “stress tests” that have received much hype in recent weeks — will be conducted under two scenarios, a baseline and a “more adverse” scenario, according to the Fed. “Supervisors will work with institutions to estimate the range of possible future losses and the resources to absorb such losses over a two-year period,” Fed officials said in a press statement. The assessments will be carried out in a “timely and consistent manner” and should be completed no later than April 2009, according to the statement. Write to Diana Golobay at diana.golobay@housingwire.com.