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:

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Federal Reserve Board issues guidance on illiquid funds under the Volcker Rule

Since the December 2013 finalization of an interagency rule implementing Section 619 of Dodd-Frank (i.e., the Volcker Rule), covered banking entities have sought guidance on many related interpretive issues. The agencies have issued 21 responses to Frequently Asked Questions (FAQs) during this period,1 but none of the FAQs addressed key questions about investments in illiquid funds.

On December 12, 2016, the Federal Reserve Board (FRB) issued guidance—in the form of a statement of policy2 and Supervision and Regulation (SR) Letter 16-183 —regarding how banking entities may seek an extension to conform their investments in illiquid funds to the requirements of the Volcker Rule.

Section 619 of Dodd-Frank permits the FRB to provide a banking entity up to five years from the end of the conformance period (i.e., five years from July 21, 2017) to conform investments in certain illiquid funds.4

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Dodd-Frank Act Stress Test (DFAST): Our Take

The Federal Reserve (“Fed”) released the results of its Dodd-Frank Act Stress Tests (DFAST) that measure the potential impact of adverse or severely adverse economic conditions on the performance and condition of the 33 banks subject to the rule.  These results will be followed on June 29, 2016 by the Fed’s conclusions regarding the adequacy of bank capital plans as evaluated through the Comprehensive Capital Analysis and Review (CCAR)[1].

Key takeaways for the severely adverse scenario results include:

All firms exceeded minimum capital standards under stress. Despite a somewhat more stressful severely adverse scenario, each firm exceeded the minimum required capital for the second year in a row.

The impact of the severely adverse stress scenario was split, with a lesser impact on trading banks and harsher result for many traditional lenders.  The scenario’s more severe traditional economic recession hit many traditional Commercial & Industrial (C&I) focused lenders harder than last year.  In contrast, other aspects of the scenario lessened the adverse impact to trading focused firms’ pre provision net revenues (PPNR), and model changes lessened ratio pressure from risk-weighted assets (RWAs).

Loan loss rate improvements stalled.  Aggregate loan loss rates over the nine quarters totaled 6.1 percent, the same as the prior DFAST, halting an improving trend compared to the last few years.  However, loss rate trends were mixed across lending sectors with improvements in Commercial Real Estate (CRE) and first lien mortgage loss rates offset by deterioration in C&I and other loans.

Summary of Results

Stress impact on capital ratios is less severe than in prior DFAST

The stress impact on bank holding company (BHC) capital ratios (starting capital ratio compared to minimum post-stress capital ratio) has improved in aggregate this year, overall net reversing a worsening trend.  However, about half of the firms, largely more traditional lenders, continued to experience worsening trends.

Chart1Source:  Deloitte analysis of Dodd-Frank Act Stress Test: Supervisory Stress Test Methodology and Results, years 2014 to 2016

In aggregate, post-stress minimum capital ratios are substantially higher than in prior years and amply exceed the minimum required.

Chart2Source:  Deloitte analysis of Dodd-Frank Act Stress Test: Supervisory Stress Test Methodology and Results, years 2014 to 2016

However, 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 and Tier 1 leverage ratios, sorted in descending order of stress minimum ratios.

Charts3-4.pngSource:  Deloitte analysis of 2016 Dodd-Frank Act Stress Test: Supervisory Stress Test Methodology and Results

Key Drivers of 2016 DFAST Results

Scenario Effect The severely adverse scenario incorporates a more severe recession than in last year’s severely adverse scenario in terms of Gross Domestic Product (GDP) decline and changes in unemployment, among others.  However, negative short-term interest rates moderated the decline in equity prices and market volatility.  Collectively, these scenario changes reduced the severity of aggregate losses compared to the prior year, but results varied significantly across firms, with trading firms less affected and traditional lenders generally having more severe outcomes from negative interest rates and the recession.

Loan loss rate improvements stall.  As shown in the chart below, the improving trend in stress loss rates stalled compared to last year at 6.1 percent of the portfolio.  However results by sub-portfolio were mixed with C&I deteriorating and CRE and first lien mortgages improving compared to the prior year.  Though the severely adverse CRE scenario called for a comparable percentage decline in CRE values as the prior year, continuing actual improvements in property values relative to loan amounts may account for the lower forecast losses.  A similar effect appears to have driven first lien mortgage improvements.  On the other hand, more severe recession assumptions appear to have worsened the outcome on C&I loans.

Charts5Source:  Deloitte analysis of Dodd-Frank Act Stress Test: Supervisory Stress Test Methodology and Results, years 2013 to 2016

Pre-Provision Net Revenue (PPNR) as % of average assets

A great deal of divergence in results between trading banks and regional firms can be attributed to PPNR.  In aggregate, PPNR as a percent of average assets was stronger than the previous three stress tests and up 0.4 percentage points relative to 2015.

2013 2014 2015 2016
PPNR as % of Average Assets 2.4 2.3 2.1 2.5
Source:  Deloitte analysis of Dodd-Frank Act Stress Test: Supervisory Stress Test Methodology and Results, years 2013 to 2016

However, 22 of the 31 firms subject to DFAST last year saw their PPNR ratio worsen. The lion share of PPNR improvements came from the six trading firms that are also required to undergo the global market shock.

Global Market Shock and counterparty losses rise:  While the design of the stress scenario was less severe for PPNR of trading banks, losses from the global market shock and counterparty positions applied to the eight trading and custody banks rose in aggregate $10 billion or around 10 percent relative to prior years.  This increase occurred primarily due to one trading bank.

2013[2] 2014 2015 2016
Losses in $Billions 97 98 103 113
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 9.6 percent compared to 13.2 percent in the prior DFAST.  The moderation in RWA growth was concentrated in trading and custody banks and in part driven by changes in the Fed’s approach to market risk RWA calculation.  More than half of the firms were forecasted to have higher rates of RWA growth than last year.  In aggregate, had RWAs grown as much as in the prior DFAST, aggregate capital ratios would have been 30-40 bp lower.

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 2016
  1. Dodd-Frank Act Stress Test 2015: Supervisory Stress Test Methodology and Results, March 2015
  1. Dodd-Frank Act Stress Test 2014: Supervisory Stress Test Methodology and Results, March 2014
  1. Dodd-Frank Act Stress Test 2013: Supervisory Stress Test Methodology and Results, March 2013

 


[1] CCAR is based on both qualitative capital planning soundness factors and stress tests that differ from DFAST in that they incorporate the firm’s requests for future stock repurchases and potentially higher common stock dividends.

[2]Excludes the largest custody banks BK and STT; in 2014 they were subject to an additional counterparty default analysis, but not the global market shock.

NFA reps say examinations vary, and cooperation is part of the answer

NFA reps say examinations vary, and cooperation is part of the answerPosted by Mike Prokop, Director, Deloitte & Touche LLP

On October 2, 2014, two representatives of the National Futures Association (NFA) — an independent self-regulatory organization for the futures industry — co-led a discussion on that body’s examination approach as part of Deloitte’s Dodd-Frank Compliance Leadership Academy.

Dale Spoljaric, managing director of NFA’s Compliance section, and Michael Brosius, director in NFA’s OTC Derivatives section, pointed out that the NFA has substantial authority. In addition to communicating information about violations to the CFTC, it can also bar an NFA member from doing business with other member firms, discipline members that violate its rules, and facilitate arbitrations between its members. In conducting examinations, the NFA can look at any activity covered by CFTC regulations.

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On SDR reconciliation, energy companies find reasons to exceed requirements

On SDR reconciliation, energy companies find reasons to exceed requirementsPosted by Mike Prokop, Director, Deloitte & Touche LLP

At a panel discussion I recently facilitated on swap data repository (SDR) reconciliation, fewer than half the energy industry attendees said they have a solution in place for that function. Still, at least one participant said reconciling data in the SDR is a good idea because it enhances end-users’ understanding of the information being reported and serves as an internal risk mitigation measure. Our October 3, 2014 discussion was part of Deloitte’s Dodd-Frank Compliance Leadership Academy.

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Energy companies eye compliance monitoring; panel advises close ties with business

Energy companies eye compliance monitoring; panel advises close ties with businessPosted by Paul Campbell, Principal, Deloitte & Touche LLP and Ron Chovanec, Specialist Leader

Trade surveillance is a rising concern in the energy industry, and regulators have an increasing expectation that companies in the industry will have trade monitoring solutions in place. At Deloitte’s Dodd-Frank Compliance Leadership Academy on October 2, 2014 we joined a group of industry representatives in a panel discussing where trends are headed.

Establishing a trade monitoring and surveillance program isn’t just to avoid regulatory scrutiny. Internally, it can also make the gathering, review, and presentation of trade data a lot easier. But there are challenges involved. When you gather more data, regulators may ask for more data. Compliance teams will need to partner with people on the operational side to review what they learn. Management buy-in, budget, and other resources can stand between the blueprint and the reality. And while a monitoring system may be simple in concept, applying it across multiple divisions can be less simple, especially in a global organization.

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In compliance data, quality rivals quantity

Energy companies eye compliance monitoring; panel advises close ties with businessPosted by Paul Campbell, Principal, Deloitte & Touche LLP and Howard Friedman, Director, Deloitte & Touche LLP

“Our best metric is still a gut feel.” That’s how one panelist summed up his company’s approach to making sure its compliance program provides the most useful feedback.

That comment was part of a panel discussion on compliance data benchmarks we facilitated on October 2, 2014 as part of Deloitte’s Dodd-Frank Compliance Leadership Academy. The participants were eager to get in front of compliance trends so they could apply the indicators today they’ll need to report on tomorrow. And while many of those indicators arise directly from the compliance function, we found it’s just as important to keep abreast of operations-related data, such as the management of physical assets.

But first, back to that “gut feel.” One theme that ran through our discussion was the need to take a broad view of what constitutes useful compliance data.

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2014 Compliance Trends Survey Report

2014 Compliance Trends Survey ReportPosted by Tom Rollauer, Executive Director, Center for Regulatory Strategies, Deloitte & Touche LLP

Deloitte and Compliance Week magazine recently released a joint survey report on key compliance trends in 2014. The annual survey, which is in its fourth year, included 209 responses representing a wide range of industries from America and around the world. Questions focused on three major issues:

  • Do compliance executives have the appropriate authority and resources to do their jobs?
  • Are compliance executives addressing the right risks?
  • Do compliance executives use the right metrics to measure progress?

This year’s survey found some level of improvement in all three areas; however, the results were a mixed bag and overall there is still a burning need for organizations to improve how they handle their compliance activities — particularly in light of today’s increasingly demanding compliance environment and the complex new requirements associated with laws such as the Dodd-Frank Act and Affordable Care Act.

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Responding to Medicare’s New Short Stay Rules

Responding to Medicare's New Short Stay RulesPosted by Kelly Sauders, Partner, Deloitte & Touche LLP

The issue of short inpatient stays is probably the biggest Medicare challenge that hospitals currently face. This issue has been an ongoing challenge for years, but until now many hospitals didn’t know how to tackle it ¬ or didn’t think they had to. That all changed on October 1, 2013, when the Centers for Medicare & Medicaid Services’ (CMS) new ‘2 midnight rule’ went into effect. Now, it’s clear that a hospital stay must include two midnights in order for associated services to be classified as inpatient. This rule change has tremendous financial and operational implications and should be addressed immediately. Hospitals that continue to ignore the problem are at significant risk of facing more and more Medicare denials. Here are five steps hospitals can consider taking to help address this risk:

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CFTC commodity market moves take commercial end-users into account

CFTC commodity market moves take commercial end-users into account

Commissioners are not only signaling greater cooperation with the congressional intent of Dodd-Frank; they’re also cooperating with one another and with industry to get things done. Part of the collaborative mindset owes to the way new CFTC Chairman, Timothy Massad, has guided the business of the commission as he also works on the international scene to seek agreement on challenges involving OTC derivatives and the location of clearinghouses. The new era of cooperation could signify a big plus for the markets, in that it can help eliminate lingering questions and move regulatory matters in a direction that’s sensitive to the needs and the burdens of industry. And as the CFTC extends its cooperative approach directly toward industry, opportunities open up for more organizations to engage in discussions directly with commissioners. Of particular note are two recent proposals that the commission has addressed with a sympathetic ear toward commercial end-users in commodity markets.

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