Stocks Have Mild Pullback, Close Above Morning Lows

With an hour left in trading, the market had climbed all the way back to positive territory. A late day selloff caused the major indexes to close with -1% declines, but this isn't all bad considering yesterday's +4% surge. Volume also looks to have run lighter than yesterday's levels, a plus.

This afternoon the Fed and Treasury released some key details pertaining to the bank stress-test plan, which will be conducted on the nations largest financial institutions -- those with over $100 bln in assets -- over the next two months. Here are some of the details (from Briefing.com):

Essentially, govt supervisors will meet with the bank mgmt teams to assess the bank's potential losses and estimated resources to absorb those losses. If it is determined that the institution requires additional capital to absorb the estimated losses, it will enter into a commitment to issue a "CAP" (capital assessment program) convertible preferred security to the U.S. Treasury in an amount sufficient to meet the capital requirements.

Notably, the terms of these securities appear fair, with the capital provided under the CAP coming in the form of a preferred security that is convertible into common equity at a 10% discount to the price prevailing prior to February 9th (determined by the average closing price of the 20-day trading period prior to 2/9).

CAP securities will carry a 9% dividend yield and would be convertible at the issuer's option (the bank issuing the security will decide when it is converted). After 7 years, the security would automatically convert into common equity if not redeemed or converted before that date.

This Feb 9th conversion price fixes the amount of dilution to common shareholders upon conversion. Additionally, if the banks are determined to require additional capital, they have the option to obtain private capital if it is available to them... The plan essentially backstops the nations biggest financial institutions, with a few strings attached (although the restrictions are not surprising) -- the banks receiving capital will be required to submit to Treasury monthly reports on their lending and will be subject to restrictions on paying quarterly common stock dividends, repurchasing shares, and pursuing cash acquisitions.

Bottom line: The release of additional details is a clear positive for the financial sector, and thus the market. The terms appear to be non-punitive (a 9% yield is not egregious in the current environment), and the participating banks have flexibility with regards to the conversion decision.

A number of banks that could be participants in this program have moved higher in the wake of these details, including the following: RF, KEY, STI, BBT, BAC, JPM, WFC, PNC, USB, FITB.