This morning, Treasury, the Federal Reserve, the FDIC, OCC and OTS issued a joint statement announcing that the Treasury's Capital Adequacy Program (CAP), a key element of the Financial Stability Plan (FSP) announced by Treasury Secretary Geithner two weeks ago, would "be "initiated on February 25." The statement provided few additional details about the CAP, and appeared to be intended primarily to reassure the market and quell rumors about the imminent nationalization of one or more large institutions. The joint statement emphasizes that:

The U.S. government stands firmly behind the banking system during this period of financial strain to ensure it will be able to perform its key function of providing credit to households and businesses. The government will ensure that banks have the capital and liquidity they need to provide the credit necessary to restore economic growth. Moreover, we reiterate our determination to preserve the viability of systemically important financial institutions so that they are able to meet their commitments.

With respect to the CAP, most details will have to await release of a detailed term sheet (presumably on or about February 25), but the statement does include the following:

  1. "Under this program, which will be initiated on February 25, the capital needs of the major U.S. banking institutions will be evaluated under a more challenging economic environment." - It is unclear from this statement whether the "major banking organizations" that will be the subject of stress test evaluations will be limited to the $100 billion-of-assets institutions described in Treasury's FSP Fact Sheet, but it is clear, both from this announcement and the Fact Sheet, that the stress test is not optional for those institutions.
  2. "Should that assessment indicate that an additional capital buffer is warranted, institutions will have an opportunity to turn first to private sources of capital. Otherwise, the temporary capital buffer will be made available from the government." - These statements clearly indicate a preference for private capital, but it remains unclear whether an institution whose stress test indicates a need for a capital buffer can refuse the participate in the CAP. Treasury's Fact Sheet had merely stated that institutions subject to the stress test would "have access to a Treasury provided capital buffer," but this latest statement indicates that the buffer "will be made available."
  3. "Any government capital will be in the form of mandatory convertible preferred shares, which would be converted into common equity shares only as needed over time to keep banks in a well-capitalized position and can be retired under improved financial conditions before the conversion becomes mandatory. Previous capital injections under the Troubled Asset Relief Program will also be eligible to be exchanged for the mandatory convertible preferred shares." - The Fact Sheet merely described the CAP capital as "a preferred security investment from Treasury in convertible securities that [institutions] can convert into common equity if needed to preserve lending in a worse-than-expected economic environment." This new statement describes the investment as a "mandatory convertible" preferred stock that "would be" subject to early conversion "as needed." The announcement of a mandatory conversion feature, and the ability to exchange existing non-convertible preferred stock for the new mandatory convertible preferred stock, is intended to assuage concerns about the need to repay preferred investments in cash, but it is not clear when the new preferred stock might convert to common stock in advance of the mandatory conversion date. Does Treasury intend to draw a meaningful distrinction between "can [be converted] if needed" and "would be [converted] as needed"? The statement also indicates that institutions would be able to redeem the new preferred prior to its conversion to common stock, but it is not clear whether the redemption price would, in those circumstances, be at par or reflect the as-converted value of the underlying common stock into which the preferred stock is convertible, if greater than par.