CCAR: The journey continues

The Federal Reserve (“Fed”) released the results of its Comprehensive Capital Analysis and Review (CCAR) for 2016 on June 29.  Some key facts:

  • Fed noted objections to two firms out of thirty-three (Deutsche Bank and Santander) and required resubmission for one (Morgan Stanley)
  • All objections and resubmissions were driven by Fed-cited weaknesses around qualitative issues
  • No firm failed to meet post-stress capital minimums, and compared to four the previous year, only one firm (M&T) needed to scale back its capital distribution request to do so, taking a so-called “mulligan”

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.

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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.

Proposed CCAR attestation change would be about more than just forms

CCAR attestation change would be about more than just forms
Posted by David Wright, on October 05, 2015.

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Expectations for the largest banks continue to rise with the latest Federal Reserve proposal for CFOs to attest to the integrity and accuracy of the firm’s regulatory stress testing reports. On September 16, 2015, the Fed published a proposal in the Federal Register to revise the FR Y-14A/Q/M Capital Assessments and Stress Testing Reports.  While proposed changes to reporting forms and instructions are typically viewed as a routine process, the inclusion of a CFO attestation of the filed reports, for both the actual data as well as the projections, raises the bar on expectations and accountability and reflects the Federal Reserve’s ongoing concerns with data quality.

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