More detail on the Treasury’s planned stress tests and newest bank capital replenishing programme emerged yesterday.

As a reminder, the stress tests will be applied to roughly 20 US banks (those with assets over $100bn), examining their potential losses over a two-year period. The tests will look at two scenarios — a baseline and an “adverse” scenario.

• Baseline: Assumes a 2 per cent contraction in the economy in 2009, with a rebound of 2.1 per cent growth in 2010. 8.4 per cent unemployment in 2009, and 8.8 per cent in 2010. House prices dropping 14 per cent in 2009, and another 4 per cent next year.

• Adverse: Assumes US GDB contracts 3.3 per cent this year and grows by 0.5 per cent next year. Unemployment at 8.9 per cent this year and 10.3 per cent next year. Housing prices fall 22 per cent in 2009 and 7 per cent in 2010.

Critics have already noted that those stress tests may be far too optimistic (Amazingly, the Fed’s own projections for the economy are more optimistic than even the optimistic baseline scenario). In any case, the idea of the stress tests is that regulators will be able to get a handle on just how much capital the banks require to survive these scenarios. Banks will then have an incredibly short period of six months to raise private capital, one of the centrepieces of the financial stability programme, or else participate in the government’s new Capital Assistance Program (CAP).Government capital will be provided in the form of preferred shares that are convertible into common equity (at discount). The idea is that the banks can choose to convert those shares into common stock as needed to protect against losses, common equity, being the first tranche of capital against which losses are taken. However, lots of onerous conditions on government capital will be imposed — things like caps on executive pay and oversight procedures.

Amazingly, the Treasury is providing application forms  for the CAP already — even before the stress tests are due to finish in April.

So banking uber-pessimists can get a head start on their application for government assistance here. FT Alphaville has got the ball rolling, we figure it’s worth a shot.

Related links:
US Treasury releases terms of capital assistance program – Treasury
Stressing the stress tests – FT Alphaville
Stress tests, debunked – FT Alphaville

This entry was posted by Tracy Alloway on Thursday, February 26th, 2009 at 17:32 and is filed under Capital markets. Tagged with Banks, Financial Stability plan, TARP, Treasury. Edit this entry.