CCAR: Reaching the summit

The Federal Reserve (“Fed”) released the results of its Comprehensive Capital Analysis and Review (CCAR) for 2017 on June 28.  Key Facts:

  • For the first time in CCAR’s seven-year history, the Fed did not object to any of the capital plans or capital distributions.
  • One firm, Capital One, was required to resubmit its capital plan to address certain capital planning process weaknesses.
  • The aggregate quantitative results were very similar to last year’s test, with all 34 firms exceeding required minimums.
  • Two firms, American Express and Capital One, adjusted their original requested capital distributions taking advantage of a so called “mulligan” to fine tune their capital levels.

The prior week’s release of the Dodd-Frank Act Stress Test (DFAST) results provided more detailed information on the Fed’s stress test.  Compared to CCAR, those results exclude buybacks and capital issuances and hold past common dividends constant.

Key takeaways

  • CCAR firms appear to have reached the summit of capital planning and stress testing. With no objections this year and just one firm requiring resubmission, it appears the industry’s multi-year investment in capital planning and stress testing has paid off.
  • Short falls in expectations still remain. For the systemic and complex firms1 that are subject to the qualitative portion of the Fed’s CCAR reviews, the Fed noted that some firms continue to fall short in the following areas:
    • Risk identification
    • Weaknesses in stress loss estimation for models geared toward expected conditions
    • Controls for data accuracy
    • Model risk management
    • Internal audit
  • Capital actions continue to matter. As in previous years, the requested capital actions have a material influence on minimum post-stress ratios for most firms and were significantly higher than the prior year. Requested capital actions trimmed the aggregate common equity tier 1 ratio by 2.0 percentage points compared to DFAST.
  • Most firms exceed post-stress minimums by a comfortable margin. For each traditional capital measure, more than 30 firms exceeded the minimum requirement under stress by 1.0 percentage point or more. For the new supplementary leverage ratio2, 11 of the 15 firms required to calculate the new measure exceeded the minimum under stress by 1.0 percentage point or more.  Two firms, Goldman Sachs and Morgan Stanley, were within 0.2 percentage points of the minimum requirement under stress.
  • Greater transparency for the CCAR process. A new section of the CCAR results provided a more thorough discussion of the qualitative framework and process, a commitment the Fed had made to improve transparency—in part—based on recommendations of a report from the GAO.  This section also provided examples of historical deficiencies for governance, risk management, internal controls, capital policies, scenario design, and projection methodologies.

Summary of CCAR results for severely adverse scenario

Aggregate results and buffers over minimums

In aggregate, stress minimums were well above minimum regulatory requirements as shown below.Source:  Deloitte analysis of Comprehensive Capital Analysis and Review 2017: Assessment and Framework and Results

The size of buffers over minimum requirements varied widely across banks as illustrated below for the Common Equity Tier 1 capital ratio, sorted in descending stress minimum ratio order.  The dark blue portion of the bar indicates the degree of stress impact on the actual starting capital ratio.

Source:  Deloitte analysis of 2017 Dodd-Frank Act Stress Test: Supervisory Stress Test Methodology and Results

Capital actions matter

The Fed stress tests include the conservative assumption that historical or requested capital distributions under normal conditions will also continue during stress. While DFAST incorporates the assumption that dividends will be maintained at the same rate as in the prior four quarters, CCAR results include firm requests for dividend increases and stock buy backs.  Consequently, stress capital ratios can be lower in the CCAR results due to these potentially higher capital distribution levels.  In aggregate, the effect on common equity Tier 1 of requested capital actions was a reduction in the minimum ratio of 2.0 percentage points, compared to 1.3 percentage points for 2016 and 1.0 percentage point in 2015.  The amount of capital action impact varied widely across firms, with 30 firms trimming their capital by 1.0 percentage point or more.

Source:  Deloitte analysis of 2017 Dodd-Frank Act Stress Test: Supervisory Stress Test Methodology and Results

More aggressive capital distributions resulted in a plateau in post-stress minimum ratios, with each measure within 0.2 percentage points of the prior years’ minimums.Source: Deloitte analysis of 2017 Dodd-Frank Act Stress Test: Supervisory Stress Test Methodology and Results

What is in store for CCAR next year?

The past year has seen a number of actual and proposed changes for the CCAR program.  How the program will evolve in the coming year has prompted a great deal of speculation.  Here are some areas where shifts are likely to occur.

Future of qualitative review

Both Governor Tarullo and Governor Powell have suggested that the qualitative portion of CCAR may have played out its useful life and might be rolled into ongoing supervision similar to what was done for large noncomplex firms (LNFs)3.  Governor Powell did caveat that this would be considered only for firms that achieve and sustain acceptable capital planning processes.  The recent recommendations from the Treasury department on regulatory reform also proposed phasing out the qualitative portion of CCAR in acting as a sole reason for objection.

Regardless of how the qualitative portion of CCAR is modified, examiners will be reviewing the strength of capital planning processes in one forum or another.  They will be evaluating past remediation efforts and issuing new matters requiring attention as new issues are uncovered.  The Fed’s list of outstanding shortfalls suggest the need for sustaining momentum in the areas of risk identification, data quality, model risk management and internal audit, among others.  In addition, LNFs not subject to the Fed’s CCAR qualitative review are nevertheless undergoing capital planning horizontals focused on auto, commercial real estate and internal audit.  Those types of reviews may foreshadow what ongoing supervision for the largest firms might look like in the future.

Looking to next year, certain foreign banking organizations with intermediate holding companies (IHCs) underwent a private version of CCAR this year including the qualitative review.  While the future of the qualitative review is uncertain, Governor Powell’s comments indicating that firms must achieve and sustain acceptable capital planning processes to exit the qualitative portion of CCAR would suggest these firms are likely to undergo a qualitative review for their first public CCAR.

Potential changes to the Fed’s quantitative stress test

In recent testimony, Governor Powell mentioned that the Fed is considering adjusting assumptions around balance sheet growth and capital distributions in ways that would address industry concerns and be less conservative.  On the other hand, he mentioned integrating the stress tests into firms’ ongoing capital requirements.  These comments echoed those made late last year in a speech by Governor Tarullo in which he suggested replacing Basel III’s stress capital buffer with the Fed’s calculation of peak-to-trough stress.  Significantly, he also suggested incorporating the surcharge for global systemically important banks (G-SIBs) into post stress capital requirements, creating a higher stress hurdle.  These changes to the Fed’s capital plan rule and capital regulations would be subject to notice and comment.

Other changes for next year include more fully phasing in enhanced operational loss modeling, which may affect the stress impact of operational losses for a firm relative to prior years.

Better transparency into industry practice and Fed stress models

In recent testimony, Governor Powell indicated the Fed would publish a document summarizing the performance of the industry in achieving the Fed’s qualitative expectations.  To provide better transparency into Fed models, the Fed will be disclosing indicative loss rates for various loan and securities portfolios and disclosing information about risk characteristics that contribute to loss-estimate ranges.

Shift to efficiency, robotics, and operational excellence

After as many as seven years of intensive efforts in building robust capital planning processes and infrastructure and largely meeting supervisory expectations, institutions are ready to pivot to a more sustainable and efficient program that fits more seamlessly into an institution’s business-as-usual operations.  Increasingly, firms are taking a step back to look at what they have built and are rationalizing the number of steps, handoffs, and overall complexity, with an eye toward streamlining and automating where possible.  Several firms are experimenting with the use of robotics in ways that can reduce the likelihood of operational error, reduce costs, and produce more reliable results.

The next destination

Now that firms have reached the summit, they can take a well-deserved moment to savor the view.  But like all good climbers, they know they must also prepare for the next stage of the journey, and take what they have learned from this part of the trip and use it wisely in getting to their next destination along the trail.  Hopefully, it will be largely downhill from here.

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

  1. Comprehensive Capital Analysis and Review 2017: Assessment and Framework and Results, June 2017
  2. Comprehensive Capital Analysis and Review 2016: Assessment and Framework and Results, June 2016
  3. Comprehensive Capital Analysis and Review 2015: Assessment and Framework and Results, March 2015
  4. Comprehensive Capital Analysis and Review 2014: Assessment and Framework and Results, March 2014
  5. Comprehensive Capital Analysis and Review 2013: Assessment and Framework and Results, March 2013
  6. Dodd-Frank Act Stress Test 2015: Supervisory Stress Test Methodology and Results, June 2016
  7. Dodd-Frank Act Stress Test 2015: Supervisory Stress Test Methodology and Results, March 2015
  8. Dodd-Frank Act Stress Test 2014: Supervisory Stress Test Methodology and Results, March 2014
  9. 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

Appendix

  1. Does not include five newly formed intermediate holding companies (IHCs), which submitted capital plans subject to a confidential supervisory process
  2. Systemic firms supervised by the Large Institutions Supervision Coordinating Committee (LISCC) and Large Complex Firms (LCFs) with average consolidated assets of more than $250 billion, or average nonbank assets in excess of $75 billion.
  3. Large Noncomplex Firms (LNFs) with consolidated average assets equal to or greater than $50 billion but less than $250 billion,  nonbank assets less than $75 billion, and not a LISCC firm.
  4. BHCs subject to the advanced approaches capital framework are subject to the supplementary leverage ratio beginning in 1Q2018, and are required to incorporate that ratio under stress starting for that forecast period and beyond.

Endnotes

1Systemic and complex firms are bank holding companys (BHCs) subject to the Large Institution Supervision Coordinating Committee (LISCC) or BHCs designated as Large and Complex Firms (LCFs). These BHCs have heightened expectations compared to other CCAR firms and are subject to the Fed’s qualitative review. See appendix for listings and criteria.
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. See the appendix for a listing of firms subject to this ratio.
3See appendix for firms no longer subject to the qualitative portion of CCAR

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.

About Deloitte

Deloitte refers to one or more of Deloitte Touche Tohmatsu Limited, a UK private company limited by guarantee (“DTTL”), its network of member firms, and their related entities. DTTL and each of its member firms are legally separate and independent entities. DTTL (also referred to as “Deloitte Global”) does not provide services to clients. In the United States, Deloitte refers to one or more of the US member firms of DTTL, their related entities that operate using the “Deloitte” name in the United States and their respective affiliates. Certain services may not be available to attest clients under the rules and regulations of public accounting. Please see http://www.deloitte.com/about to learn more about our global network of member firms.

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