This afternoon, the Treasury Department, Federal Reserve, FDIC and OCC issued a joint statement addressed a variety of questions arising under the pending Supervisory Capital Assessment Program (SCAP) and its interrelationship with Treasury's Capital Assistance Program (CAP). The release also outlines criteria that will have to be met by institutions desiring to redeem outstanding Capital Purchase Program (CPP) preferred stock.
Tomorrow afternoon, the Federal Reserve will publicly release SCAP results, under the "more adverse" scenario outlined in SCAP, for the 19 bank holding companies that have been reviewed. Those results will include supervisory "estimates of: losses and loss rates across select categories of loans; resources available to absorb those losses; and the resulting necessary additions to capital buffers." The Federal Reserve emphasized again that these estimates "represent values for a hypothetical 'what-if' scenario and are not forecasts of expected losses or revenues for the firms."
The thresholds used under SCAP to assess the adequacy of each institution's capital buffer are Tier 1 risk-based capital ratio of at least 6% and a "Tier 1 Common" risk-based capital ratio of at least 4% at the end of 2010, "under a more adverse macroeconomic scenario than is currently anticipated." The Federal Reserve describes "Tier 1 Common capital" as "voting common stockholders' equity" subject to the same adjustments used to calculate Tier 1 capital, and justifies the use of that alternative measure in light of "the fact that common equity is the first element of the capital structure to absorb loss and offers protection to more senior parts of the capital structure. All else equal, more Tier 1 Common capital gives a BHC greater permanent loss absorption capacity and a greater ability to conserve resources under stress by changing the amount and timing of dividends and other distributions."
The release emphaizes that "supervisors evaluated the extent to which each of the 19 BHCs would need to alter either the amount or the composition (or both) of its Tier 1 capital today to be able to comfortably exceed minimum regulatory requirements at year-end 2010, even under an more adverse economic scenario." If an institution is found to need an additional capital buffer under the Tier 1 Common component of the test, one potential alterantive would be to seek permission to convert other existing preferred stock or other Tier 1 or Tier 2 capital securities into common stock.
Institutions that are determined to need an additional SCAP capital buffer will have until June 8, 2009 to develop and submit a "detailed capital plan" and until November 9, 2009 to implement that plan. The capital plan, which must be approved by the BHC’s primary federal regulator and the FDIC, will be expected to have three main elements:
- A detailed description of the specific actions to be taken to increase the level of capital and/or to enhance the quality of capital consistent with establishing the SCAP buffer. The release encourages institutions to design capital plans that, wherever possible, actively seek to raise new capital from private sources, including such actions as:
- Issuance of new private capital instruments;
- Restructuring current capital instruments;
- Sales of business lines, legal entities, assets or minority interests through private transactions and through sales to the Public-Private Investment Program (PPIP);
- Use of joint ventures, spin-offs, or other capital enhancing transactions; and
- Conservation of internal capital generation, including continued restrictions on dividends and stock repurchases and dividend deferrals, waivers and suspensions on preferred securities including trust preferred securities, with the expectation that plans should not rely on near-term potential increases in revenues to meet the capital buffer it is expected to have.
- A list of steps to address weaknesses, where appropriate, in the institution's internal processes for assessing capital needs and engaging in effective capital planning.
- An outline of the steps the institution will take over time to repay capital provided by Treasury under the CPP, Targeted Investment Program (TIP), or the CAP, and to reduce its reliance on guaranteed debt issued under the FDIC's Temporary Liquidity Guarantee Program (TLGP).
Perhaps most significant, "as part of the 30-day planning process, firms will need to review their existing management and Board in order to assure that the leadership of the firm has sufficient expertise and ability to manage the risks presented by the current economic environment and maintain balance sheet capacity sufficient to continue prudent lending to meet the credit needs of the economy."
As previously announced, institutions that are determined under SCAP to need a capital buffer may apply for mandatory convertible preferred (MCP) under the CAP in an amount up to 2% of risk-weighted assets (or more, upon request, although amounts come with additional restrictions). Treasury reiterates in this release that the "CAP application process remains open to these institutions under the same terms and conditions applicable to the 19 SCAP BHCs" and that "Treasury stands ready to review and process any applications received in an expedient manner." The release states that although "[t]here is no intention to expand the SCAP beyond the 19 BHCs that have recently completed this exercise," institutions applying under CAP should expect their supervisors to "review those firms' risk profiles and capital positions" and "evaluate the firms' internal capital assessment processes, including capital planning efforts that incorporate the potential impact of stressful market conditions and adverse economic outcomes."
Redeeming CPP Preferred
The release warns that institutions seeking permission to redeem Treasury's CPP preferred securities must still comply with "existing supervisory procedures for approving redemption requests for capital instruments," and that, in assessing those requests, supervisors will "carefully weigh an institution's desire to redeem outstanding CPP preferred stock against the contribution of Treasury capital to the institutions overall soundness, capital adequacy, and ability to lend, including confirming that BHCs have a comprehensive internal capital assessment process."
In addition, any of the 19 institutions that were the subject of the SCAP process and desire to redeem CPP preferred must "have a post-repayment capital base at least consistent with the SCAP buffer, and must be able to demonstrate its financial strength by issuing senior unsecured debt for a term greater than five years not backed by FDIC guarantees, in amounts sufficient to demonstrate a capacity to meet funding needs independent of government guarantees."