Federal Reserve Issues Instructions and Guidance for the 2016 Comprehensive Capital Analysis and Review Program
On January 28, 2016, the Federal Reserve issued its annual summary instructions1 (the “CCAR 2016 Instructions”) for its supervisory Comprehensive Capital Analysis and Review program for 2016 (“CCAR 2016”) applicable to bank holding companies with $50 billion or more of total consolidated assets (“Covered BHCs”). Thirty-three institutions will participate in CCAR 2016, including 30 of the 31 Covered BHCs that participated in CCAR in 20142 and three institutions that are new to the program.3 Covered BHCs must submit their capital plans for CCAR 2016 to the Federal Reserve on or before April 5, 2016. The Federal Reserve will release the CCAR 2016 results and its objection or non-objection to Covered BHCs’ capital plans, including the reasons for any objections, no later than June 30, 2016.
In general, the CCAR 2016 Instructions are substantively similar to the instructions provided in prior CCAR cycles. However, they include several changes, updates and other notable provisions, including:
- Supervisory Expectations for Capital Planning Processes. The CCAR 2016 Instructions no longer contain detailed guidance regarding expectations for Covered BHCs’ capital planning practices. (Indeed, the title of the instructions changed from “Summary Instructions and Guidance” for CCAR 2015 to “Summary Instructions” for CCAR 2016.) Instead, the CCAR 2016 Instructions now reference the two Federal Reserve supervisory guidance letters which set forth consolidated guidance for Covered BHCs according to their size and level of complexity (the “SR Letters”) that were issued in late December 2015.4
- Capital Conservation Buffer. Although the capital conservation buffer will be phased-in during the planning horizon, the CCAR 2016 Instructions indicate that such buffer will not be taken into account—that is, dipping into the buffer will not result for CCAR purposes in the reductions of planned capital distributions—by the Federal Reserve when computing its supervisory stressed capital ratios for Covered BHCs. The instructions also direct Covered BHCs not to assume the operation of the buffer’s distribution limitations when conducting their stress tests.
- Adjustments to Planned Capital Actions. The 2016 CCAR Instructions expand the set of capital instruments the Federal Reserve will consider for a Covered BHC’s one-time reduction in planned capital distributions to include preferred stock or other instruments eligible for inclusion in regulatory capital. Previously, the Federal Reserve would only consider common stock distributions.
- Projection of “Out-Quarters” Distributions. The CCAR 2016 Instructions re-emphasize that projections of capital distributions in the final three quarters of the planning horizon (referred to as “out-quarters”) must be “based on realistic assumptions about the future and [made] in a manner broadly consistent with previous quarters.”5 The instructions clarify that a Covered BHC should only reflect a reduction in planned capital distributions in the out-quarters if it “has a justification to do so, based on its planned business activities and prudent capital planning.”6 The instructions reiterate the warning first made for CCAR 2015 that reductions in planned out-quarter distributions may be indicative of shortcomings in the Covered BHC’s capital adequacy or capital plan and may lead the Federal Reserve to object to the relevant plan. Similarly, if a Covered BHC utilizes the adjustment to planned capital actions mechanism, it “should avoid concentrating the adjustment in the quarters not subject to objection in CCAR 2016 without providing an explanation.”7
- Expected Changes to Business Plans. The CCAR 2016 Instructions attempt to provide additional guidance with respect to how Covered BHCs should approach expected changes to business plans affecting capital adequacy and funding for purposes of their capital plan filing.
- First, “[e]ach [Covered] BHC should include in its capital plan a discussion of any expected changes to the BHC’s business plan that are likely to have a material impact on the BHC’s capital adequacy. . . . For projections under the BHC baseline scenario, a [Covered] BHC may [emphasis added] include all planned mergers, acquisitions, and divestitures that represent the BHC’s current view of the most likely outlook over the planning horizon. For projections under all other scenarios, the [Covered] BHC should [emphasis added] include planned mergers and acquisitions, reflecting the terms and conditions that would likely prevail under a given scenario, but only include divestitures that are completed or contractually committed to before the submission date of April 5, 2016.”8
- Second, the CCAR 2016 Instructions state that Covered BHCs should reflect such material business plan changes in the FR Y-14A Summary and Business Plan Changes schedules and provide supporting documentation, and, consistent with prior year instructions, note that the Federal Reserve may request additional information.
- Third, if a Covered BHC’s submission is missing data regarding assets and liabilities expected to be acquired in a material business plan change, the CCAR 2016 Instructions specify that the Federal Reserve will apply loss and pre-provision net revenue (“PPNR”) estimates based on the Federal Reserve’s assessment of all relevant information submitted by the firm (rather than applying the typically harsher missing data treatment).9
Covered BHCs that are in the process of or contemplating M&A transactions should nevertheless discuss the relevant issues with the Federal Reserve prior to the filing of their capital plans on April 5, 2016.
- Incorporation of Previous Amendments to the Capital Plan Rule and Stress Test Rules. On November 25, 2015, the Federal Reserve adopted a final rule amending certain aspects of the Capital Plan Rule and Stress Test Rules.10 The CCAR 2016 Instructions incorporate many of these amendments, including by:
- Removing the tier 1 common ratio related requirements
- Delaying incorporation of the supplementary leverage ratio into the FR Y-14A Summary Schedule for one year11 and of the advanced approaches risk-weighted assets calculation indefinitely,
- Requiring Covered BHCs to “reflect the regulatory capital rules in effect for each quarter of the planning horizon (other than the advanced approaches or the supplementary leverage ratio), including the minimum capital ratios and any applicable transition arrangements”,12
- Requiring deductions from regulatory capital under the Volcker Rule13 to be reflected on the FR Y-14A Summary Schedule and the FR Y-14A Regulatory Capital Transitions Schedule, and
- Requiring Covered BHCs to include in capital projections for each of the second through ninth quarters of the planning horizon (1) issuances of common and preferred stock (a) related to expensed employee compensation or (b) in connection with a planned merger or acquisition (to the extent such transaction is reflected on the firm’s pro forma balance sheet estimates), and (2) common stock dividends attributable to such issuances.
- Pending Changes in Accounting Standards. The CCAR 2016 Instructions note that there are certain revisions to U.S. Generally Accepted Accounting Principles (“GAAP”) which are underway but have not yet become effective. For CCAR 2016, Covered BHCs should not reflect the adoption of a new accounting standard in their capital projections unless and until they adopt such standard for their financial reporting.
- Supervisory Expectations for Reviews of Covered BHCs’ Regulatory Reporting. While the recently finalized CFO attestation requirements for LISCC firms will not come into effect until 2017,14 the CCAR 2016 Instructions emphasize for all Covered BHCs that internal controls around data integrity are crucial to assuring the quality of the capital planning process. In addition to reiterating the need for a strong internal control framework, the instructions highlight the “key role” played by a firm’s internal audit function “in evaluating the adequacy of the firm’s capital planning process and in assessing whether the risk-management and internal control practices supporting that process are comprehensive and effective.”15 The instructions also note that a firm’s financial records “should be maintained in such a manner and scope” to ensure that the FR Y-14 forms are prepared in accordance with the CCAR 2016 Instructions and fairly present the firm’s financial condition and assessment of performance under stressed scenarios.16
- Information Material to Loss Estimates but Not Captured in FR Y-14 Schedules. If there are aspects of a Covered BHC’s portfolios and exposures that are material to loss estimates for its portfolios but are not adequately captured in the FR Y-14 schedules, the CCAR 2016 Instructions require that the firm be able to explain why the exposures are not adequately captured, but not that the firm affirmatively provide such explanation.17
- Grounds for Objection or Non-Objection; Integration of CCAR Into Year-Round Supervision. The CCAR 2016 instructions state that “[b]oth the quantitative and qualitative assessments are key inputs to the decision to object, or not object, to a [Covered] BHC’s capital plan,” thus suggesting that the Federal Reserve may object to a capital plan on grounds extrinsic to these two prongs of the review process.18 In addition, the Federal Reserve indicates that “[c]ertain supervisory activities that are conducted throughout the year assess the [Covered] BHC’s practices and processes that are used, in part, to support its capital planning, including reviews that look at risk management, internal controls, audit, and corporate governance. Reviews of these areas inform the annual CCAR qualitative assessment. The integration also allows the Federal Reserve to consistently incorporate supervisory issues identified across the full range of examination work conducted throughout the year into the overall qualitative assessment.”19
- BHC Subsidiaries of Foreign Banking Organizations. Unlike previous CCAR cycles, a BHC subsidiary of a foreign banking organization that will be designated as the U.S. IHC must include in its capital plan an assessment of how the transfers of subsidiary assets and liabilities would affect the Covered BHC’s capital adequacy over the planning horizon and reflect the relevant data on the FR Y-14A Summary and Business Plan Changes schedules.