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2018 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 35 Bank Holding Companies (BHCs) and Intermediate Holding Companies (IHCs)¹ subject to the rule.
June 22, 2018 | Financial services
These results will be followed on June 28, 2018, 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 fourth year in a row.
- This year’s test had a higher stress impact than previous years resulting in lower post-stress minimum capital levels, reversing an improving trend. The increase in stress was evidenced by:
- Higher loss rates on loans (6.4 percent vs 5.8 percent)
- Higher global market shock (GMS) losses (up 22 percent)2
- Lower offsetting tax benefits in loss and recovery periods from the new tax law (32 basis points (bp) on risk-weighted assets (RWA) on average)
- Declines in other comprehensive income (OCI) (30bp on RWA in aggregate)
- These more stressful results were somewhat offset by lower growth in risk-weighted assets and higher pre-provision net revenue.
- Impact from changes in law. In response to provisions in the recently passed regulatory relief legislation (S.2155, Economic Growth, Regulatory Reform, and Consumer Protection Act (EGRRCPA)), the Fed excluded the three firms below the $100 billion asset threshold3, and announced they would also exclude those firms from the CCAR results.
- The supplementary leverage ratio was more constraining than last year. For most firms, post-stress supplemental leverage ratios were closer to minimum levels than last year and all firms exceeded the minimum ratio of 3.0 percent.
Summary of results
Stress impact on capital ratios is more severe than in recent DFASTs
The stress impact on capital ratios (starting capital ratio compared to minimum post-stress capital ratio) has worsened in aggregate this year, reversing an improving trend. The downward stress on capital ratios rose by 1.0 percentage point or more for risk-based capital ratios and by 50bp for the leverage ratio. It should also be noted that changes in the panel of institutions may have dampened or deepened the aggregate impact relative to prior years.
In aggregate, post-stress minimum capital ratios are substantially lower than in prior years but they still amply exceed the minimum required, including for the supplementary leverage ratio.
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 one ratio, sorted in descending order of stress minimum ratios.
Similarly headroom over the supplementary leverage ratio4 was wide ranging as well for those firms required to meet the new standard beginning this year. Headroom declined for most firms compared to 2017.
Key drivers of 2017 DFAST results for the severely adverse scenario
A tougher severely adverse scenario: Once again, progress in the economy since last year led to an improved jumping off point for the scenarios, but relatively greater stress is assumed than in prior years as shown in the chart below.
Declines in US GDP and the rise in unemployment have become progressively more severe in each severely adverse scenario since 2015. Declines in the stock market, house prices, and commercial real estate are the most severe since the 2015 DFAST. The greater severity is consistent with the Fed’s approach of making the stress scenarios countercyclical. That is, as conditions improve, stresses are increased to act as a counterweight to potentially over optimistic capital positioning. Similarly, should conditions deteriorate, severity would moderate to avoid double counting the stressful period of the cycle.
Loan loss rates: The tougher scenarios resulted in rising loss rates across portfolios, with the exception of the “other consumer” category. Commercial and Industrial (C&I), commercial real estate, and credit cards had particularly large jumps in loss rates.
The loan loss increase compared to last year varied widely across firms depending on loan mix and underlying asset quality as shown below.
Loan loss as percent of average balances—Difference by BHC (2018 minus 2017) in severely adverse scenario
Pre-Provision Net Revenue (PPNR)
As a percent of average assets, PPNR improved by 0.4 percentage points, compared to last year registering a record level. PPNR improvements may be due in part to the Fed’s phase in of new modeling approaches.
Improvements to PPNR compared to last year varied widely across firms, with a handful of firms showing declines, shown below.
PPNR as percent of average assets—Difference by BHC (2018 minus 2017) in severely adverse scenario
Global market shock and counterparty losses: Losses from the global market shock and counterparty positions applied to the eight trading and custody BHCs rose $19 billion or 22 percent.
The severely adverse global market shock scenario incudes a sudden sharp increase in general market and credit risk spreads, a rise and steepening of the US yield curve; and a general selloff of US assets compared to other developed countries. Markets with stronger linkages to interest rates such as corporate debt, RMBS and CMBS markets are more severely affected than US equities. The major differences relative to the 2017 severely adverse scenario include a rise and steepening of the US yield curve; greater depreciation of the US dollar relative to other developed country currencies; and less severe shocks to some credit-sensitive assets, such as non-agency RMBS.
Interim market risk shock for six IHCs
Starting in 2019, an additional six firms with significant trading activities will be subject to the global market shock. For 2018, an interim approach using simplifying loss rate assumptions was used. For the severely adverse scenario the loss rates are as follows:
- Securitized products losses: 46.4 percent
- Trading mark-to-market and trading incremental default risk losses: 1.8 percent loss rate on market risk RWAs
- Credit valuation adjustments: 2.8 percent loss rate on over-the-counter derivatives RWAs
- Large counterparty default losses: 1.5 percent loss rate on repo-style transactions and over-the-counter derivatives RWAs
Losses for the six firms totaled $7.5 billion.
Growth in forecasted risk-weighted assets moderated, reducing pressure on ratios: Aggregate RWAs rose by 5.1 percent compared to 8.2 percent in the prior DFAST.
Sources of data utilized within this document from the Board of Governors of the Federal Reserve System are listed below.
- Dodd-Frank Act Stress Test 2018: Supervisory Stress Test Methodology and Results, June 2018
- Dodd-Frank Act Stress Test 2017: Supervisory Stress Test Methodology and Results, June 2017
- Dodd-Frank Act Stress Test 2016: Supervisory Stress Test Methodology and Results, June 2016
- Dodd-Frank Act Stress Test 2015: Supervisory Stress Test Methodology and Results, March 2015
- Dodd-Frank Act Stress Test 2014: Supervisory Stress Test Methodology and Results, March 2014
- Dodd-Frank Act Stress Test 2013: Supervisory Stress Test Methodology and Results, March 2013
1 Six IHCs were added for this year’s DFAST: Barclays, Credit Suisse, UBS, RBC, Deutsche Bank USA, and BNP Paribas. Both Deutsche Bank USA and BNP Paribas subsumed BHC subsidiaries of their parent organizations that were previous filers, Deutche Bank TC and BancWest, respectively.
2 For consistency purposes, the aggregate growth rate excludes new entrants to DFAST.
3 CIT, Comerica, and Zions
4 The supplementary leverage ratio is defined as tier 1 capital divided by total leverage exposure, and became effective beginning in January of 2018. The BHCs and IHCs that are subject to the SLR 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, 2017.
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