Supervisory Capital Assessment Program
Encyclopedia
The Supervisory Capital Assessment Program, publicly described as the bank stress tests (even though a number of the companies that were subject to them were not banks), was an assessment of capital
conducted by the Federal Reserve System
and thrift supervisors
to determine if the largest U.S. financial organizations
had sufficient capital buffers to withstand the recession
and the financial market turmoil
. The test used two macroeconomic scenarios, one based on baseline conditions
and the other with more pessimistic expectations, to plot a 'What If?' exploration into the banking situation in the rest of 2009 and into 2010. The capital levels at 19 institutions were assessed based on their Tier 1 common capital
, although it was originally thought that regulators would use tangible common equity
as the yardstick. The results of the tests were released on May 7, 2009, at 5pm EST.
Before the tests were completed, the central problems facing the Treasury Department were 1) whether the tests would increase or decrease confidence in any companies that did badly on their tests and 2) whether or not the $350 billion in bailout funds that remained could cover the needed funding after the tests.
The supervisors conducted the capital assessments on an interagency basis to ensure that they were carried out in a timely and consistent manner. Each participating financial institution was instructed to analyze potential firm‐wide losses, including in its loan and securities portfolios, as well as from any off‐balance sheet commitments and contingent liabilities/exposures, under two defined economic scenarios over a two year time horizon
(2009 – 2010). In addition, firms with trading assets of $100 billion or more were asked to estimate potential trading‐related losses under the same scenarios.
Participating financial institutions also forecasted internal resources available to absorb losses, including pre‐provision net revenue
and the allowance for loan losses. As part of the supervisory process, the supervisors met with senior management
at each financial institution to review and discuss the institution’s loss and revenue forecasts. Based on those discussions, the supervisors assessed institution‐specific potential losses and estimated resources to absorb those losses under the baseline and more adverse case, and determined whether the institution had a sufficient capital buffer necessary to ensure it had the amount and quality of capital necessary to perform its vital role in the economy.
and the unemployment rate
for 2009 and 2010 were assumed to be equal to the average of the projections published by Consensus Forecasts, the Blue Chip survey, and the Survey of Professional Forecasters
in February 2009. This baseline was intended to represent a consensus view about the depth and duration of the recession. Given the current uncertain environment, there is a risk that the economy could turn out to be appreciably weaker than expected in the baseline outlook.
The assumptions for the baseline economic outlook are consistent with the house price
path implied by futures prices for the Case‐Shiller 10‐City Composite index and the average response to a special question on house prices in the latest Blue Chip survey.
practices, the supervisors have also put together an alternative “more adverse” scenario. By design, the path of the US economy in this alternative more adverse scenario reflects a deeper and longer recession than in the baseline. The consensus expectation is that economic activity is likely to be better than shown in the more adverse alternative; nonetheless, an outcome such as the alternative cannot be ruled out. The “more adverse” scenario was constructed from the historical track record of private forecasters as well as their current assessments of uncertainty. In particular, based on the historical accuracy
of Blue Chip forecasts made since the late 1970s, the likelihood that the average unemployment rate in 2010 could be at least as high as in the alternative more adverse scenario is roughly 10 percent. In addition, the subjective probability
assessments provided by participants in the January Consensus Forecasts survey and the February Survey of Professional Forecasters imply a roughly 15 percent chance that real GDP
growth could be as least as low, and unemployment at least as high, as assumed in the more adverse scenario.
For the more adverse scenario, house prices are assumed to be about 10 percent lower at the end of 2010 relative to their level in the baseline scenario. Based on the year‐to‐year variability in house prices since 1900, and controlling for macroeconomic factors, there is roughly a 10 percent probability that house prices will be 10 percent lower than in the baseline by 2010.
Supervisors will carefully evaluate the forecasts submitted by each financial institution to ensure they are appropriate, consistent with the firm’s underlying portfolio performance and reflective of each entity’s particular business activities and risk profile. The assessment of the firm’s capital and the size of any potential needed additions to capital will be determined by the supervisors.
The assessment of capital adequacy
considers many factors including: the inherent risks of the institution’s exposures and business activities, the quality of its balance sheet
assets and its off-balance-sheet
commitments, the firm’s earning projections, expectations regarding economic conditions and the composition and quality of its capital.
Specific factors supervisors consider include: uncertainty about the potential impact on earnings and capital from current and prospective economic conditions; asset quality and concentrations of credit exposures; the potential for unanticipated losses and declines in asset values; off‐balance sheet and contingent liabilities
(e.g., implicit and explicit liquidity and credit commitments); the composition, level and quality of capital; the ability of the institution to raise additional common stock
and other forms of capital in the market; and other risks that are not fully captured in regulatory capital calculations.
Under current rules for bank holding companies, supervisors expect bank holding companies to hold capital above minimum regulatory capital levels, commensurate with the level and nature of the risks to which they are exposed. That amount of capital held in excess of minimum capital requirements should be commensurate with their firm‐specific risk profiles, and account for all material risks. The assessment of capital under the two macroeconomic scenarios being used in the capital assessment program will permit supervisors to ascertain whether the buffer over the regulatory capital minimum is appropriate under more severe but plausible scenarios.
An institution that requires additional capital will enter into a commitment to issue a CAP convertible preferred security to the U.S. Treasury
in an amount sufficient to meet the capital requirement determined through the supervisory assessment. Each institution will be permitted up to six months to raise private capital in public markets to meet this requirement and would be able to cancel the capital commitment without penalty. The CAP convertible preferred securities will be converted into common equity shares on an as‐needed basis. Financial institutions that issued preferred capital under Treasury’s existing Capital Purchase Program
(TARP 1) will have the option of redeeming those securities and replacing them with the new CAP convertible preferred securities.
The capital assessment is part of the supervisory process and thus subject to the same framework used for bank examinations or bank holding company inspections. There will be ample opportunity for discussions between the financial institutions and supervisory agencies regarding the loss estimates and earnings forecasts during the capital assessment process.
The capital needs found by the test are based on the adverse scenario for the recession. All of these bank holding companies currently exceed the legally mandated capital requirements. However, the government will try by extra-legal means to compel those who are found to need more to obtain it.
Capital requirement
Capital requirement refers to -The standardized requirements in place for banks and other depository institutions, which determines how much capital is required to be held for a certain level of assets through regulatory agencies such as the Bank for International Settlements, Federal Deposit...
conducted by the Federal Reserve System
Federal Reserve System
The Federal Reserve System is the central banking system of the United States. It was created on December 23, 1913 with the enactment of the Federal Reserve Act, largely in response to a series of financial panics, particularly a severe panic in 1907...
and thrift supervisors
Office of Thrift Supervision
The Office of Thrift Supervision was a United States federal agency under the Department of the Treasury that charters, supervises, and regulates all federally- and state-chartered savings banks and savings and loans associations. It was created in 1989 as a renamed version of another federal agency...
to determine if the largest U.S. financial organizations
Banking in the United States
Banking in the United States is regulated by both the federal and state governments.The U.S. banking sector's short-term liabilities as of October 11, 2008 are 15% of the gross domestic product of the United States or 43% of its national debt, and the average bank leverage ratio is 12 to...
had sufficient capital buffers to withstand the recession
Late 2000s recession
The late-2000s recession, sometimes referred to as the Great Recession or Lesser Depression or Long Recession, is a severe ongoing global economic problem that began in December 2007 and took a particularly sharp downward turn in September 2008. The Great Recession has affected the entire world...
and the financial market turmoil
Subprime mortgage crisis
The U.S. subprime mortgage crisis was one of the first indicators of the late-2000s financial crisis, characterized by a rise in subprime mortgage delinquencies and foreclosures, and the resulting decline of securities backed by said mortgages....
. The test used two macroeconomic scenarios, one based on baseline conditions
Baseline (configuration management)
Configuration management is the process of managing change in hardware, software, firmware, documentation, measurements, etc. As change requires an initial state and next state, the marking of significant states within a series of several changes becomes important...
and the other with more pessimistic expectations, to plot a 'What If?' exploration into the banking situation in the rest of 2009 and into 2010. The capital levels at 19 institutions were assessed based on their Tier 1 common capital
Tier 1 capital
Tier 1 capital is the core measure of a bank's financial strength from a regulator's point of view. It is composed of core capital, which consists primarily of common stock and disclosed reserves , but may also include non-redeemable non-cumulative preferred stock...
, although it was originally thought that regulators would use tangible common equity
Tangible Common Equity
Tangible Common Equity refers to the subset of shareholders' equity that is not preferred equity and not intangible assets.TCE is an uncommonly used measure of a company’s financial strength. It indicates how much ownership equity owners of common stock would receive in the event of a company’s...
as the yardstick. The results of the tests were released on May 7, 2009, at 5pm EST.
Before the tests were completed, the central problems facing the Treasury Department were 1) whether the tests would increase or decrease confidence in any companies that did badly on their tests and 2) whether or not the $350 billion in bailout funds that remained could cover the needed funding after the tests.
Scope and purpose
The exercise was limited to bank holding companies (national banks and companies which own banks) with assets greater than $100 billion. The 19 banking organizations included in the exercise comprised the core of the US banking system, representing roughly two‐thirds of aggregate U.S. bank holding company assets.The supervisors conducted the capital assessments on an interagency basis to ensure that they were carried out in a timely and consistent manner. Each participating financial institution was instructed to analyze potential firm‐wide losses, including in its loan and securities portfolios, as well as from any off‐balance sheet commitments and contingent liabilities/exposures, under two defined economic scenarios over a two year time horizon
Time horizon
A time horizon, also known as a planning horizon, is a fixed point of time in the future at which point certain processes will be evaluated or assumed to end. It is necessary in an accounting, finance or risk management regime to assign such a fixed horizon time so that alternatives can be...
(2009 – 2010). In addition, firms with trading assets of $100 billion or more were asked to estimate potential trading‐related losses under the same scenarios.
Participating financial institutions also forecasted internal resources available to absorb losses, including pre‐provision net revenue
Net profit
Net profit or net revenue is a measure of the profitability of a venture after accounting for all costs. In a survey of nearly 200 senior marketing managers, 91 percent responded that they found the "net profit" metric very useful...
and the allowance for loan losses. As part of the supervisory process, the supervisors met with senior management
Senior management
Senior management, executive management, or management team is generally a team of individuals at the highest level of organizational management who have the day-to-day responsibilities of managing a company or corporation, they hold specific executive powers conferred onto them with and by...
at each financial institution to review and discuss the institution’s loss and revenue forecasts. Based on those discussions, the supervisors assessed institution‐specific potential losses and estimated resources to absorb those losses under the baseline and more adverse case, and determined whether the institution had a sufficient capital buffer necessary to ensure it had the amount and quality of capital necessary to perform its vital role in the economy.
Macroeconomic scenarios and assumptions
The capital assessment covered two economic scenarios: a baseline scenario and a more adverse scenario.Baseline scenario
For implementation of the supervisory capital assessment program, the baseline assumptions for real GDP growthEconomic growth
In economics, economic growth is defined as the increasing capacity of the economy to satisfy the wants of goods and services of the members of society. Economic growth is enabled by increases in productivity, which lowers the inputs for a given amount of output. Lowered costs increase demand...
and the unemployment rate
Unemployment
Unemployment , as defined by the International Labour Organization, occurs when people are without jobs and they have actively sought work within the past four weeks...
for 2009 and 2010 were assumed to be equal to the average of the projections published by Consensus Forecasts, the Blue Chip survey, and the Survey of Professional Forecasters
Survey of Professional Forecasters
The Survey of Professional Forecasters, also called, The Anxious Index, is a highly predictive report on the prospects for the Economy of the United States issued quarterly by the Federal Reserve Bank of Philadelphia. "The Survey of Professional Forecasters is the oldest quarterly survey of...
in February 2009. This baseline was intended to represent a consensus view about the depth and duration of the recession. Given the current uncertain environment, there is a risk that the economy could turn out to be appreciably weaker than expected in the baseline outlook.
The assumptions for the baseline economic outlook are consistent with the house price
Real estate pricing
Real estate pricing deals with the valuation of real estate and all the standard methods of determining the price of fixed assets apply....
path implied by futures prices for the Case‐Shiller 10‐City Composite index and the average response to a special question on house prices in the latest Blue Chip survey.
More adverse scenario
To aid financial institutions in their ongoing risk managementRisk management
Risk management is the identification, assessment, and prioritization of risks followed by coordinated and economical application of resources to minimize, monitor, and control the probability and/or impact of unfortunate events or to maximize the realization of opportunities...
practices, the supervisors have also put together an alternative “more adverse” scenario. By design, the path of the US economy in this alternative more adverse scenario reflects a deeper and longer recession than in the baseline. The consensus expectation is that economic activity is likely to be better than shown in the more adverse alternative; nonetheless, an outcome such as the alternative cannot be ruled out. The “more adverse” scenario was constructed from the historical track record of private forecasters as well as their current assessments of uncertainty. In particular, based on the historical accuracy
Historicity
Historicity may mean:*the quality of being part of recorded history, as opposed to prehistory*the quality of being part of history as opposed to being a historical myth or legend, for example:** Historicity of the Iliad**Historicity...
of Blue Chip forecasts made since the late 1970s, the likelihood that the average unemployment rate in 2010 could be at least as high as in the alternative more adverse scenario is roughly 10 percent. In addition, the subjective probability
Bayesian probability
Bayesian probability is one of the different interpretations of the concept of probability and belongs to the category of evidential probabilities. The Bayesian interpretation of probability can be seen as an extension of logic that enables reasoning with propositions, whose truth or falsity is...
assessments provided by participants in the January Consensus Forecasts survey and the February Survey of Professional Forecasters imply a roughly 15 percent chance that real GDP
Gross domestic product
Gross domestic product refers to the market value of all final goods and services produced within a country in a given period. GDP per capita is often considered an indicator of a country's standard of living....
growth could be as least as low, and unemployment at least as high, as assumed in the more adverse scenario.
For the more adverse scenario, house prices are assumed to be about 10 percent lower at the end of 2010 relative to their level in the baseline scenario. Based on the year‐to‐year variability in house prices since 1900, and controlling for macroeconomic factors, there is roughly a 10 percent probability that house prices will be 10 percent lower than in the baseline by 2010.
Scenario macroeconomic variables
| 2009 | 2010 | |
|---|---|---|
| Real GDP (percent change in annual average) | ||
| Average Baseline (as released in February 2009) | -2.0 | 2.1 |
| Consensus Forecasts | ‐2.1 | 2.0 |
| Blue Chip | -1.9 | -2.0 |
| Survey of Professional Forecasters | ‐2.0 | 2.2 |
| Alternative More Adverse | -3.3 | 0.5 |
| Civilian unemployment rate (annual average) | ||
| Average Baseline (released in February 2009) | 8.4 | 8.8 |
| Consensus Forecasts | 8.4 | 9.0 |
| Blue Chip | 8.3 | 8.7 |
| Survey of Professional Forecasters | 8.4 | 8.8 |
| Alternative More Adverse | 8.9 | 10.3 |
| House Prices (Case‐Shiller 10‐City Composite, percent change, fourth quarter of the previous year to fourth quarter of the year indicated) | ||
| Baseline | -14 | -4 |
| Alternative More Adverse | -22 | -7 |
Results and consequences
The capital assessment is intended to capture all aspects of a financial institution’s business that would be impacted under the baseline and more adverse scenarios.Supervisors will carefully evaluate the forecasts submitted by each financial institution to ensure they are appropriate, consistent with the firm’s underlying portfolio performance and reflective of each entity’s particular business activities and risk profile. The assessment of the firm’s capital and the size of any potential needed additions to capital will be determined by the supervisors.
The assessment of capital adequacy
Capital requirement
Capital requirement refers to -The standardized requirements in place for banks and other depository institutions, which determines how much capital is required to be held for a certain level of assets through regulatory agencies such as the Bank for International Settlements, Federal Deposit...
considers many factors including: the inherent risks of the institution’s exposures and business activities, the quality of its balance sheet
Balance sheet
In financial accounting, a balance sheet or statement of financial position is a summary of the financial balances of a sole proprietorship, a business partnership or a company. Assets, liabilities and ownership equity are listed as of a specific date, such as the end of its financial year. A...
assets and its off-balance-sheet
Off-balance-sheet
Off-balance sheet usually means an asset or debt or financing activity not on the company's balance sheet.Some companies may have significant amounts of off-balance sheet assets and liabilities. For example, financial institutions often offer asset management or brokerage services to their clients...
commitments, the firm’s earning projections, expectations regarding economic conditions and the composition and quality of its capital.
Specific factors supervisors consider include: uncertainty about the potential impact on earnings and capital from current and prospective economic conditions; asset quality and concentrations of credit exposures; the potential for unanticipated losses and declines in asset values; off‐balance sheet and contingent liabilities
Contingent Liabilities
Contingent liabilities are liabilities that may or may not be incurred by an entity depending on the outcome of a future event such as a court case. These liabilities are recorded in a company's accounts and shown in the balance sheet when both probable and reasonably estimable. A footnote to the...
(e.g., implicit and explicit liquidity and credit commitments); the composition, level and quality of capital; the ability of the institution to raise additional common stock
Common stock
Common stock is a form of corporate equity ownership, a type of security. It is called "common" to distinguish it from preferred stock. In the event of bankruptcy, common stock investors receive their funds after preferred stock holders, bondholders, creditors, etc...
and other forms of capital in the market; and other risks that are not fully captured in regulatory capital calculations.
Under current rules for bank holding companies, supervisors expect bank holding companies to hold capital above minimum regulatory capital levels, commensurate with the level and nature of the risks to which they are exposed. That amount of capital held in excess of minimum capital requirements should be commensurate with their firm‐specific risk profiles, and account for all material risks. The assessment of capital under the two macroeconomic scenarios being used in the capital assessment program will permit supervisors to ascertain whether the buffer over the regulatory capital minimum is appropriate under more severe but plausible scenarios.
An institution that requires additional capital will enter into a commitment to issue a CAP convertible preferred security to the U.S. Treasury
United States Department of the Treasury
The Department of the Treasury is an executive department and the treasury of the United States federal government. It was established by an Act of Congress in 1789 to manage government revenue...
in an amount sufficient to meet the capital requirement determined through the supervisory assessment. Each institution will be permitted up to six months to raise private capital in public markets to meet this requirement and would be able to cancel the capital commitment without penalty. The CAP convertible preferred securities will be converted into common equity shares on an as‐needed basis. Financial institutions that issued preferred capital under Treasury’s existing Capital Purchase Program
Capital Purchase Program
The Capital Purchase Program or CPP is a preferred stock and equity warrant purchase program conducted by the US Treasury's Office of Financial Stability as part of Troubled Assets Relief Program...
(TARP 1) will have the option of redeeming those securities and replacing them with the new CAP convertible preferred securities.
The capital assessment is part of the supervisory process and thus subject to the same framework used for bank examinations or bank holding company inspections. There will be ample opportunity for discussions between the financial institutions and supervisory agencies regarding the loss estimates and earnings forecasts during the capital assessment process.
Banks tested
In order of decreasing assets, the nineteen bank holding companies being stress-tested are:| Asset ranking | Bank | Result: additional capital needed, or adequate |
|---|---|---|
| 1 | Bank of America Bank of America Bank of America Corporation, an American multinational banking and financial services corporation, is the second largest bank holding company in the United States by assets, and the fourth largest bank in the U.S. by market capitalization. The bank is headquartered in Charlotte, North Carolina... |
$33.9 billion |
| 2 | JPMorgan Chase | adequate |
| 3 | Citigroup Citigroup Citigroup Inc. or Citi is an American multinational financial services corporation headquartered in Manhattan, New York City, New York, United States. Citigroup was formed from one of the world's largest mergers in history by combining the banking giant Citicorp and financial conglomerate... |
$5.5 billion |
| 4 | Wells Fargo Wells Fargo Wells Fargo & Company is an American multinational diversified financial services company with operations around the world. Wells Fargo is the fourth largest bank in the U.S. by assets and the largest bank by market capitalization. Wells Fargo is the second largest bank in deposits, home... |
$13.7 billion |
| 5 | Goldman Sachs Goldman Sachs The Goldman Sachs Group, Inc. is an American multinational bulge bracket investment banking and securities firm that engages in global investment banking, securities, investment management, and other financial services primarily with institutional clients... |
adequate |
| 6 | Morgan Stanley Morgan Stanley Morgan Stanley is a global financial services firm headquartered in New York City serving a diversified group of corporations, governments, financial institutions, and individuals. Morgan Stanley also operates in 36 countries around the world, with over 600 offices and a workforce of over 60,000.... |
$1.8 billion |
| 7 | Metropolitan Life Insurance Company Metropolitan Life Insurance Company MetLife, Inc. is the holding corporation for the Metropolitan Life Insurance Company, or MetLife, for short, and its affiliates. MetLife is among the largest global providers of insurance, annuities, and employee benefit programs, with 90 million customers in over 60 countries... |
adequate |
| 8 | PNC Financial Services PNC Financial Services PNC Financial Services Group, Inc. is a U.S.-based financial services corporation, with assets of approximately $264.3 billion... |
$0.6 billion |
| 9 | U.S. Bancorp U.S. Bancorp U.S. Bancorp is a diversified financial services holding company, headquartered in Minneapolis, Minnesota. It is the parent company of U.S. Bank, the fifth largest commercial bank in the United States based on $330 billion in assets. U.S. Bank ranks as the sixth largest bank in the U.S. based on... |
adequate |
| 10 | The Bank of New York Mellon | adequate |
| 11 | GMAC | $11.5 billion |
| 12 | SunTrust Banks SunTrust Banks SunTrust Banks, Inc., is an American bank holding company. The largest subsidiary is SunTrust Bank. It had US$172.7 billion in assets as of September 30, 2009... |
$2.2 billion |
| 13 | Capital One Capital One Capital One Financial Corp. is a U.S.-based bank holding company specializing in credit cards, home loans, auto loans, banking and savings products... |
adequate |
| 14 | BB&T BB&T BB&T Corporation is an American bank with assets of $157 billion , offering full-service commercial and retail banking services along with other financial services like insurance, investments, retail brokerage, mortgage, corporate finance, consumer finance, payment services, international... |
adequate |
| 15 | Regions Financial Corporation | $2.5 billion |
| 16 | State Street Corporation | adequate |
| 17 | American Express American Express American Express Company or AmEx, is an American multinational financial services corporation headquartered in Three World Financial Center, Manhattan, New York City, New York, United States. Founded in 1850, it is one of the 30 components of the Dow Jones Industrial Average. The company is best... |
adequate |
| 18 | Fifth Third Bank Fifth Third Bank Fifth Third Bank is a U.S. regional banking corporation, headquartered in Cincinnati, Ohio and is the principal subsidiary of holding company Fifth Third Bancorp .... |
$1.1 billion |
| 19 | KeyCorp | $1.8 billion |
The capital needs found by the test are based on the adverse scenario for the recession. All of these bank holding companies currently exceed the legally mandated capital requirements. However, the government will try by extra-legal means to compel those who are found to need more to obtain it.