2017 Dodd-Frank Act Stress Test (DFAST): Our take

The Federal Reserve (“Fed”) released the results of its Dodd-Frank Act Stress Tests (DFAST)1 that measure the potential impact of adverse or severely adverse economic conditions on the performance and condition of the 34 banks subject to the rule.  These results will be followed on June 28, 2017 by the Fed’s conclusions regarding the adequacy of bank capital plans as evaluated through the Comprehensive Capital Analysis and Review (CCAR).

Key takeaways for the severely adverse scenario results include:

  • All firms exceeded minimum required capital under stress for the third year in a row
  • This year’s test had a lower stress impact than previous years, resulting in improved post-stress minimum capital levels, continuing a multi-year trend. The moderation in stress was evidenced by improvements to pre-provision net revenue (PPNR), lower trading and counterparty losses, and lower loan losses.
  • Most firms required to meet the supplementary leverage ratio were well above the minimum  Of the 15 advanced approaches firms required to meet the new capital measure beginning in 2018, the vast majority exceeded the 3.0 percent minimum by 2.0 percentage points or more under the severely adverse scenario.
  • Aggregate loan loss rates improved compared to 2016, driven by significantly lower loss rates for mortgage-related portfolios but somewhat offset by moderate deterioration in credit cards, commercial & industrial (C&I), and other consumer loans.
  • Trading and counterparty losses dropped 24 percent compared to 2016, or $27 billion.

Summary of Results

Stress impact on capital ratios is again less severe than in prior DFASTs

The stress impact on bank holding company (BHC) capital ratios (starting capital ratio compared to minimum post-stress capital ratio) has lessened in aggregate this year for the second year in a row, but at a reduced pace.  However, firms more heavily weighted in credit card exposures generally saw worsening trends while those weighted towards mortgage exposures saw improving trends.Source:  Deloitte analysis of Dodd-Frank Act Stress Test: Supervisory Stress Test Methodology and Results, years 2014 to 2017
In aggregate, post-stress minimum capital ratios are substantially higher than in prior years and amply exceed the minimum required, including for the new supplementary leverage ratio.

Source:  Deloitte analysis of Dodd-Frank Act Stress Test: Supervisory Stress Test Methodology and Results, years 2014 to 2017
As in prior years, the degree of headroom between the stress minimum ratio and the regulatory minimum varied widely across banks as illustrated below for the common equity Tier 1 ratio, sorted in descending order of stress minimum ratios.Source:  Deloitte analysis of 2017 Dodd-Frank Act Stress Test: Supervisory Stress Test Methodology and Results
Similarly headroom over the supplementary leverage ratio2 was wide ranging as well for those advance approaches firms required to meet the new standard beginning in 2018.

Key drivers of 2017 DFAST results for the severely adverse scenario

A slightly tougher severely adverse scenario.  Progress in the economy since last year led to an improved jumping off point for the scenarios, but relatively greater stress is assumed than last year in US gross domestic product (GDP), unemployment, and commercial real estate prices offsetting much of those gains.  Credit spreads under severely adverse conditions are much higher than last year for mortgages, commercial real estate and prime loans. Internationally, there are relatively more severe recessions assumed for Japan, U.K and the Euro area, but less severe in developing Asia.  On the positive side, interest rates do not go negative this year and are at generally higher levels that may have contributed to improvements in PPNR.

Loan loss rates improve.  Despite a somewhat tougher scenario this year, loan loss rates improved in aggregate by 0.3 percentage points as shown in the chart below.  Results across portfolios were mixed however, with significant improvements centered in first-lien mortgages and junior liens more than offsetting moderate deterioration in commercial and industrial (C&I), credit cards, and other consumer and other loans.  Commercial real estate (CRE) results were flat compared to last year.Source:  Deloitte analysis of Dodd-Frank Act Stress Test: Supervisory Stress Test Methodology and Results, years 2013 to 2017

Pre-provision net revenue (PPNR)

In aggregate, PPNR under stress improved by $34 billion, the largest single contributor to improved results for 2017 over 2016.  As a percent of average assets, PPNR improved by 0.1 percent registering the highest level over the past 5 years.Source:  Deloitte analysis of Dodd-Frank Act Stress Test: Supervisory Stress Test Methodology and Results, years 2013 to 2017
PPNR improvements relative to average assets were varied, with about two-thirds of firms seeing improvement, and one third experiencing deterioration.

Global market shock and counterparty losses fell markedly:  Losses from the global market shock and counterparty positions applied to the eight trading and custody BHCs fell a dramatic $27 billion or 24 percent. The severely adverse global market shock assumptions for 2017 relative to 2016 had damped shocks to interest rates and other liquid market and less severe widening in spreads for mortgage securities.Source:  Deloitte analysis of Dodd-Frank Act Stress Test: Supervisory Stress Test Methodology and Results, years 2013 to 2016
Growth in forecasted risk-weighted asset (RWA) moderated, reducing pressure on ratios:  Aggregate RWAs rose by 8.2 percent compared to 9.6 percent in the prior DFAST.  However, forecasted RWA growth differed widely across firms, with 20 of the firms actually forecast to have accelerating RWA growth relative to the prior year.

Sources of data utilized within this document from the Board of Governors of the Federal Reserve System are listed below.

  1. Dodd-Frank Act Stress Test 2016: Supervisory Stress Test Methodology and Results, June 2017
  2. Dodd-Frank Act Stress Test 2016: Supervisory Stress Test Methodology and Results, June 2016
  3. Dodd-Frank Act Stress Test 2015: Supervisory Stress Test Methodology and Results, March 2015
  4. Dodd-Frank Act Stress Test 2014: Supervisory Stress Test Methodology and Results, March 2014
  5. Dodd-Frank Act Stress Test 2013: Supervisory Stress Test Methodology and Results, March 2013

Authors:

David Wright
Managing Director | Deloitte Risk and Financial Advisory
Deloitte & Touche LLP

Craig Brown
Managing Director | Deloitte Risk and Financial Advisory
Deloitte & Touche LLP

1DFAST applies to all BHCs and U.S. IHCs with $50 billion or more in consolidated assets, except certain U.S. IHCs that have been newly formed.
2The supplementary leverage ratio is defined as tier 1 capital divided by total leverage exposure, and becomes effective beginning in January of 2018 for BHCs that are subject to the advanced approaches capital framework. Advanced approaches BHCs were required to forecast their supplementary leverage ratios under stress for forecast quarters 1Q2018 through 1Q2019. The 15 advanced approaches BHCs have consolidated assets greater than or equal to $250 billion or total consolidated on-balance sheet foreign exposure of at least $10 billion as of December 31, 2016.
3Excludes the largest custody banks BK and STT; in 2014 they were subject to an additional counterparty default analysis, but not the global market shock.

This publication contains general information only and Deloitte is not, by means of this publication, rendering accounting, business, financial, investment, legal, tax, or other professional advice or services. This publication is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified professional advisor.

Deloitte shall not be responsible for any loss sustained by any person who relies on this publication.

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