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Perspectives

The Federal Reserve's 2018 CCAR and DFAST results

Our key takeaways

The Federal Reserve (Fed) released the results of its Dodd-Frank Act Stress Tests (DFAST) on June 21, 2018, and the results of the Comprehensive Capital Analysis and Review (CCAR) on June 28, 2018. In response, Deloitte Risk and Financial Advisory has summarized key facts and takeaways and offers our view on what may be in store for large US banks.

CCAR: Key facts

  • The Fed objected to one firm, Deutsche Bank USA, on qualitative grounds, and granted conditional non-objections for three firms, Goldman Sachs, Morgan Stanley, and State Street.
  • A record number of firms, six, adjusted their dividend or stock buy-back requests to avoid objection, the so-called mulligan, exceeding the prior record of four firms making adjustments in 2015 (see below).
  • Capital planning internal controls in many instances continue to fall below the Federal Reserve’s supervisory expectations.

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. A link to our take on the DFAST results can be found here.

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Read the Deloitte Center for Regulatory Strategies June 29, 2018, blog: CCAR: A mixed story of surprises and more work to do.

DFAST (severely adverse scenario): Key facts

  • 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 losses (up 22 percent)1
    • Lower offsetting tax benefits in loss and recovery periods from the new tax law (32bp on risk-weighted assets (RWA) on average)
    • Declines in other comprehensive income (OCI) (30 bp 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 threshold2, 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.

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Read the Deloitte Center for Regulatory Strategies June 22, 2018, blog: Dodd-Frank Act Stress Test (DFAST): Our take.

Our take on the CCAR results

A mixed story of surprises and more work to do

More remediation work is required to satisfy the Fed in multiple areas. The Fed noted that several firms continue to fall short in the following areas:

  • Internal controls: In many instances, firms’ internal controls around capital planning fall below supervisory expectations
  • Stress loss forecasting: Inability to incorporate changing market dynamics, lack of access to relevant data, and weak judgement-based estimation approaches particularly for credit cards, auto loans, and revenues from certain business lines.
  • Trading strategy vulnerabilities: Several firms purchased large trading positions to hedge against a global market shock but may have not adequately taken into account or analyzed execution risk or communicated that risk to their boards.

The breadth and depth of the noted deficiencies suggests the Fed will be issuing to firms a number of matters requiring attention and expecting institutions to put together concrete remediation plans.

  • Quantitative exceptions signal new flexibility. No firms received a quantitative objection; however, three firms, (Goldman Sachs, Morgan Stanley, and State Street) each fell slightly below minimum capital requirements under stress. 
  • 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 this year requested capital actions trimmed capital ratios by 1.6 percentage points compared to the DFAST results that use historical dividend averages.
  • Dress rehearsals pay off. Last year, six IHCs underwent a dress rehearsal for CCAR and received examiner feedback before undergoing this years’ public version. Five of the six were able to make sufficient enough progress in their capital planning and stress testing processes to pass this year, marking a significant milestone in their progression as IHCs.
  • Next year quantitative objections may be a thing of the past. In April, the Fed proposed a number of changes to its Basel III and capital planning and stress testing rules that would push stress test results into ongoing capital requirements.

 

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Our take on the DFAST 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 50 basis points 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 for the common equity tier 1 ratio. Similarly, headroom over the supplementary leverage ratiowas 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
  • 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.
  • 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.
  • 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.

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What’s in store for CCAR in 2019

Transformation

The Federal Reserve proposed significant changes to both the capital rules and the CCAR process in its notice of proposed rulemaking in April of 2018.  In essence, the proposal would:

  • Eliminate the CCAR quantitative objection in favor of taking the Fed’s stress test results and incorporating them directly into each firm’s day-to-day capital requirements.
  • Reduce the severity of the test by removing several conservative assumptions. These changes include allowing capital buy backs and dividends to be scaled back under stress as well as assuming flat growth in assets, thereby reducing pressure on capital ratios significantly.
  • Eliminate the adverse scenario from CCAR and the SCB, which is consistent with changes in the recently passed banking legislation, 2155, Economic Growth, Regulatory Reform, and Consumer Protection Act “EGRRCPA”
  • Effectively eliminate stress requirements for the SLR. Under the proposal, no stress capital buffer sized from the stress tests would be maintained for the SLR.
  • Tailor CCAR. Under the proposal, capital plans would continue to be submitted and qualitative reviews would continue to be conducted. However, the new legislation EGRRCPA has raised the threshold for application of enhanced prudential standards for domestic BHCs from $50 billion to $100 billion in assets.
Going forward.

Regardless of how the qualitative portion of CCAR may be modified or tailored, examiners will be reviewing the strength of capital planning processes in one forum or another. In fact, the Fed’s new proposed rating system includes an explicit rating covering capital governance and planning processes. 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 suggests the need for sustaining momentum in the areas of loss forecasting, data quality, model risk management, and internal audit, among others. In addition, firms not subject to the Fed’s CCAR qualitative review are nevertheless undergoing capital planning horizontals as part of their ongoing supervision. Maintaining a focus on remediation will be paramount to enter a more sustainable and cost effective phase of capital planning.

Shift to efficiency, robotics, and operational excellence

As we noted last year, after the intensive build stage for capital planning, 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 taking a disciplined look at business process improvement and experimenting with the use of robotics in ways that can reduce the likelihood of operational error, reduce costs, and produce more reliable results.

Given that capital is one of the Fed’s four fundamental pillars of its supervisory framework, institutions will need to further mature their current approaches. Institutions that transition their efforts from project mode to a business-as-usual process for risk management, governance, and financial monitoring will bring a continued process improvement to their institutions that will help them identify and manage emerging risks and issues.

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What’s in store for DFAST in 2019

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  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.

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DFAST CCAR Analysis Tool (DCAT)

Deloitte is currently no longer offering access to the DCAT tool. Should you or your organization need additional analysis, please contact our subject matter advisors, David Wright or Craig Brown (contact information listed below).

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Endotes

1For consistency purposes, the aggregate growth rate excludes new entrants to DFAST.

2CIT, Comerica, and Zions

3Dodd-Frank Act Stress Test 2015: Supervisory Stress Test Methodology and Results, March 2015

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