(Reuters) - The U.S. government on Wednesday launched a “stress test” program that will assess the ability of the nation’s largest banks to cope with worse-than-expected financial conditions. Roughly 20 U.S. banks and their supervisors began the tests today, which will determine how much additional capital the banks would need under the adverse economic scenarios in the tests. Banks will then be instructed to fill the capital hole with private funds or will be allowed to participate in a new U.S. Treasury capital assistance program.
Below are details on the stress tests and the related capital assistance program:
* Roughly 20 U.S. banks with assets over $100 billion will be subjected to stress tests conducted in conjunction with their primary supervisors.
* The tests will analyze banks’ potential firm-wide losses, including in their loan securities portfolios, as well as from any off-balance sheet commitments and contingent liabilities/exposures over a 2-year period beginning in 2009.
* The banks’ conditions will be tested under two economic scenarios: a baseline scenario and a more adverse scenario.
* Banks will forecast internal resources available to absorb losses, including pre-provision net revenue and allowance for loan losses.
* Supervisors will determine whether the institution has a capital buffer sufficient to ensure the bank can perform its “vital role in the economy.”
* The tests must be concluded by the end of April.
* The government will not publicly disclose the results of the stress tests.
* Under the “baseline” scenario, economists at the Fed are assuming a contraction of 2 percent for the economy in 2009, followed by a quick rebound to 2.1 percent growth in 2010.
* The baseline scenario also assumes 8.4 percent unemployment this year and 8.8 percent in 2010. House prices are seen dropping 14 percent in 2009 and another 4 percent next year.
* Under the “adverse” scenario, the economy is expected to contract as much as 3.3 percent this year and return to an anemic 0.5 percent growth next year. Unemployment is expected to rise as high as 8.9 percent this year and surge to 10.3 percent next year. Housing prices are seen falling 22 percent in 2009 and another 7 percent on top of those declines next year.
* The Fed’s own projections are more optimistic than either scenario.
CAPITAL ASSISTANCE PROGRAM:
* Once supervisors determine the amount of additional capital a bank requires, the bank will have six months to raise private capital or can participate in the Treasury’s new Capital Assistance Program (CAP).
* Officials say they are “agnostic” about whether banks fill the capital hole through private sources or the CAP.
* There will be no explicit limit on the amount of capital that the government will provide to a bank under the CAP.
* Capital provided under the CAP will be in the form of a preferred security that is convertible into common equity at a 10 percent discount to the price prevailing prior to February 9.
* CAP securities will carry a 9 percent dividend yield and would be convertible at the issuer’s option, subject to the approval of their regulator.
* After seven years, the securities would automatically convert into common equity if not redeemed or converted before that date.
* With supervisory approval, banks will be able to request capital under the CAP in addition to preferred stock they received under the Treasury’s prior Capital Purchase Program (CPP), and will be allowed to exchange the CPP preferred stock to the new CAP securities.
* CAP recipients will be subjected to executive compensation requirements, will be required to detail how they plan to use the capital and how they will increase lending, and will be subjected to limits on dividends and acquisitions.
Reporting by Karey Wutkowski and Corbett B. Daly
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