February 6, 2017
Banking Organization Capital Plans and Stress Tests
Federal Reserve Issues Instructions, Guidance and Supervisory Scenarios for the 2017 Comprehensive Capital Analysis and Review Program
On February 3, 2017, the Federal Reserve issued information applicable to the 2017 capital plan review programs for bank holding companies ("BHCs") with $50 billion or more in total consolidated assets and U.S. intermediate holding companies ("IHCs") of foreign banking organizations (collectively, "CCAR firms"), for each of three main categories of CCAR firms.1 The Federal Reserve issuances included:
its annual summary instructions (the "CCAR 2017 Instructions") for its supervisory CCAR program for 2017 ("CCAR 2017") applicable to firms subject to the Large Institution Supervision Coordination Committee framework ("LISCC firms") and "large and complex firms" (those that are global systemically important BHCs ("G-SIBs"), or that have $250 billion or more of total consolidated assets or $75 billion or more of total nonbank assets);
three letters:2 one setting forth information on the qualitative assessment applicable to the capital plans of LISCC firms or large and complex firms that are newly formed IHCs ("New IHCs") of foreign banking organizations (the "New IHC Letter");3 one providing information on the 2017 "horizontal capital review" applicable to CCAR firms that are "large and noncomplex firms" (those that are not GSIBs, and that have less than $250 billion of total consolidated assets and less than $75 billion of total nonbank assets)4 (the "Horizontal Review Letter");5 and a third setting forth the enhancements to the Federal Reserve's supervisory models used to estimate post-stress capital ratios used in the DoddFrank Act Stress Test program ("DFAST"); and
its three supervisory scenarios--base, adverse and severely adverse (together, the "2017 CCAR Scenarios")--for CCAR 2017.6
All CCAR firms must submit their capital plans for 2017 to the Federal Reserve on or before April 5, 2017. The Federal Reserve will release the CCAR 2017 results and its objection or non-objection to the capital
New York Washington, D.C. Los Angeles Palo Alto London Paris Frankfurt Tokyo Hong Kong Beijing Melbourne Sydney
plans (other than with respect to New IHCs, for which the Federal Reserve's decisions will not be publicly
disclosed) no later than June 30, 2017.
Important elements of each of these releases are summarized below, with a particular focus on
assessment information applicable to each category of CCAR firm, as well as changes and clarifications
to the CCAR 2017 Instructions for large and complex BHCs compared with the 2016 instructions.7
Assessment of Capital Plans Submitted by New IHCs. New IHCs are "not participating in CCAR 2017" but are required to submit a capital plan to the Federal Reserve that "will be subject to a confidential review process."8
The New IHC Letter sets forth the general assessment criteria for these firms. The Federal Reserve will determine whether to object or not object to a New IHC's capital plan based on the assessment and criteria in the capital plan rule (which apply to all CCAR firms),9 but New IHCs will not be subject to the Federal Reserve's supervisory quantitative assessment (sometimes referred to by industry participants as the "black box")--which evaluates a firm's ability to meet its capital requirements under stress--in DFAST or CCAR in 2017.
The Federal Reserve may object to a submitted capital plan on qualitative grounds for New IHCs that are LISCC or large and complex firms, but may not object on qualitative grounds for New IHCs that are large and noncomplex firms consistent with recent amendments to the capital plan rule.
The New IHC Letter explains that the 2017 assessment of capital plans submitted by New IHCs will focus on the strength of practices "in areas that are foundational to sound capital planning" as described in SR Letter 15-18,10 including governance, internal controls, and risk identification that "support the firm's capital planning process and methods used to estimate losses and revenues for material exposures."11 With respect to estimation approaches, the Federal Reserve will focus "added attention" on areas that are material to the firm, including "market and counterparty default risks from broker-dealer activities [that] are particularly material to new IHCs."12
The New IHC Letter further states that the Federal Reserve "does not plan to publish its decision regarding the capital plans" of New IHCs and that New IHCs will not "be required to disclose the results of their stress tests in 2017."13
Assessment of Capital Plans Submitted by All Large and Noncomplex Firms. As a result of recently adopted amendments to the Federal Reserve's capital plan rule,14 large and noncomplex firms are "no longer subject to CCAR's qualitative review" or objection by the Federal Reserve to their capital plans on qualitative grounds, but "continue to be subject to a quantitative review of their capital plans."15
The Federal Reserve explains in the Horizontal Review Letter that, "in place of the CCAR qualitative assessment, the Federal Reserve will assess the strength of each [large and noncomplex] firm's capital planning processes through a narrow and more targeted horizontal review of specific areas of capital planning, referred to as the Horizontal Capital Review (HCR), which will begin in the third quarter of 2017."16
Rather than conducting this qualitative assessment under its CCAR program, the Federal Reserve plans to conduct this "HCR" as part of the "normal supervisory process" and to address any related findings or concerns through "supervisory communications."17
Consistent with the recent amendments to the capital plan rule, the Horizontal Review Letter also confirms that large and noncomplex firms (other than New IHCs) will remain subject to the quantitative assessment in CCAR.18
Consistent with past practice with respect to all CCAR firms, the Horizontal Review Letter confirms that before public disclosure of the results of its quantitative assessment, the -2-
Banking Organization Capital Plans and Stress Tests February 6, 2017
Federal Reserve will provide a large and noncomplex firm with the results of its post-stress capital analysis and allow it the opportunity for a one-time adjustment to planned capital distributions.19
Qualitative Assessment of Capital Plans Submitted by Large and Complex Firms. The Federal Reserve provided significant additional detail in the CCAR 2017 Instructions with respect to the process and substantive focus of the qualitative assessment element of CCAR for large and complex firms.20
In conducting its qualitative assessment, the Federal Reserve will consider not only the information gathered by dedicated supervisory teams engaged in the CCAR assessment, but also "supervisory activities that are conducted throughout the year to assess a BHC's practices and processes used, in part, to support its capital planning."21 Based on this information, the Federal Reserve will assign ratings with respect to each of the qualitative assessment factors indicating the extent to which the BHC meets supervisory expectations. A decision to object to a capital plan based on the qualitative assessment may be due to a critical deficiency with respect to one factor, or significant deficiencies with respect to multiple factors.22
The six factors considered in making the qualitative assessment (governance, risk management, internal controls, capital policies, incorporating stressful conditions and events, and estimating impact on capital positions) have not changed; however, the CCAR 2017 Instructions describe in greater detail the conditions or scenarios related to these factors that could lead to an objection to a capital plan.
With respect to supervisory issues, the Federal Reserve may object if a firm has material unresolved supervisory issues that are severe or pervasive in nature, or if they have remained outstanding for at least one supervisory cycle with limited progress made toward resolution.23 While the instructions suggest that the Federal Reserve will focus on issues associated with the capital adequacy process, the assessment is "not limited to" these issues.24
In assessing the assumptions and analysis underlying the firm's capital plan, the CCAR 2017 Instructions clarify that the Federal Reserve will focus on whether a firm's capital adequacy assessment process evidences "a clear link between stress scenarios and its material risks; sound approaches used to quantify the effect of the scenarios on the firm's financial performance and capital positions; critical assessments of the assumptions, analysis, and output of its stress testing; and strong controls and governance surrounding the capital planning process."25 The Federal Reserve may object to a capital plan if a firm has material or pervasive deficiencies in areas such as risk assessment and model development.26
The Federal Reserve may object to a firm's capital plan due to problems with the firm's controls and governance over the capital planning process if the firm has material or pervasive deficiencies around key elements of the firm's capital planning process, internal audits, controls around the data and information technology infrastructure or senior management oversight.
The Federal Reserve expressly noted in the CCAR 2017 Instructions that "[d]ecisions to object or not object to a BHC's capital plan for qualitative reasons are based on an absolute assessment of the firm's practices relative to the supervisory expectations as detailed in SR letter 15-18."27 Past years' CCAR instructions have not included this general statement.
Enhancements to DFAST Supervisory Models. Consistent with practice in prior years, the Federal Reserve released a letter detailing the "key enhancements" to certain aspects of the supervisory models used in the DFAST and CCAR stress testing programs.28
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Enhancements for the 2017 program include those intended to (i) better align the operational risk and mortgage repurchase models, (ii) modify certain pre-provision net review ("PPNR") component models to account for firm-specific differences, (iii) modify the commercial real estate loan loss model to better accommodate different data sources, and (iv) add the supplementary leverage ratio ("SLR") to the post-stress capital calculations.29
The Federal Reserve also notes, as outlined by Governor Tarullo in his September 26, 2016 speech on stress testing, that going forward it will "adhere to a policy of phasing in the most material model enhancements over two stress test cycles to smooth the effect on post-stress capital ratios," which for the 2017 cycle will include enhancements to the model estimating components of PPNR.30
2017 CCAR Scenarios. The Federal Reserve also published the three supervisory scenarios for its annual supervisory stress test program as well as the global market shock and counterparty default components of the stress tests applicable to certain firms. The primary differences between these 2017 CCAR Scenarios or components as compared to those provided in 2016 are outlined below.
The 2017 adverse scenario is similar to that of 2016 in that it is a global economic recession across economic sectors and regions; however, the 2016 adverse scenario features higher long-term rates and a steeper yield curve across all of the economies during the recession, and concentrates inflation in certain regions, rather than featuring wide-spread deflation in all regions, as in the 2016 scenario.31 These changes may reflect the fact that the Federal Reserve uses the results of the adverse scenario to inform its "macroeconomic assessments of the ability of firms to withstand a variety of economic conditions."32 For a CCAR firm that is affected to a greater degree by rising interest rates than higher credit losses, it is possible that the 2017 supervisory adverse scenario could result in post-stress capital ratios that are equivalent to or potentially lower than those under the 2017 supervisory severely adverse scenario.
The 2017 severely adverse scenario is a severe global recession accompanied by heightened stress in corporate loan markets and commercial real estate markets.33 The severity of the recession differs across regions, with greater severity in the euro area and the United Kingdom, but less severity in developing Asia. The principal differences between this scenario and the 2016 severely adverse scenario are that the 2017 scenario features a slightly more severe downturn in the U.S. economy, with a peak unemployment rate of 10 percent, and a larger decline in commercial real estate prices. In addition, the 2017 scenario does not feature a path of negative short-term U.S. Treasury rates.
The 2017 global market shock component of the adverse scenario is largely similar to that of the 2016 adverse scenario.34 The global market shock component of the severely adverse scenario is centered on three main elements: a sudden sharp increase in general risk premiums and credit risk, significant market illiquidity, and the distress of one or more large entities that rapidly sell a variety of assets into an already fragile market.35 The major differences between this year's component and that of 2016 are that this year's features dampened shocks to interest rates and other liquid markets, increased shocks to select commodities and equities basis risks, and a less severe widening in spreads between agency mortgage-backed securities and to be announced ("TBA") forwards.
The 2017 counterparty default component of the adverse and severely adverse scenarios is similar to that applied in 2016. Each firm subject to the counterparty default component will be required to estimate and report the potential losses and capital impacts associated with the default of the counterparty that would generate the largest net stressed losses across the firm's securities financing and derivatives activities, calculated by applying the global market shock to revalue exposures and collateral.
Other Guidance. The CCAR 2017 Instructions also include the following clarifications:
Consistent with the instructions issued in 2016, the CCAR 2017 Instructions note that although the capital conservation buffer continues to be phased in during the planning
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horizon, such buffer will not be taken into account--that is, dipping into the buffer will not result in the reductions of planned capital distributions for CCAR purposes--by the Federal Reserve when computing its supervisory stressed capital ratios for CCAR firms. The instructions also direct firms not to assume the operation of the buffer's distribution limitations when conducting their stress tests.
The CCAR 2017 Instructions remind firms that, because a BHC must reflect the regulatory capital rules that will be in effect for each quarter of the planning horizon, advanced approaches firms must project and report their SLR, which comes into effect on January 1, 2018, from the first quarter of 2018 through the first quarter of 2019.36 Accordingly, advanced approaches firms must maintain a minimum 3 percent SLR under the base and stressed scenarios during those quarters.
The CCAR 2017 Instructions provide that a BHC should apply accounting standards that were effective for the firm as of December 31, 2016 and that the BHC's projections should not reflect the adoption of new standards--for example, new standards relating to revenue recognition, leases or credit losses--during the planning horizon.37
The Federal Reserve confirmed that the potential changes to stress tests and the CCAR program that Governor Tarullo discussed in a speech on September 26, 201638 will not be incorporated into the 2017 CCAR exercise.39 The Federal Reserve will publish and invite public comment on a formal proposal relating to these changes.
While the system that the Federal Reserve uses to communicate with firms regarding their CCAR assessments remains the same as in previous years, the Federal Reserve has made several enhancements to the FAQ process by which it will communicate responses to questions both to the specific inquirer and to the broader group of CCAR firms.40 The Federal Reserve will provide a direct response to every firm that submits a question and will publish generic versions of responses to those questions that are applicable to multiple firms. In addition, the Federal Reserve will publish CCAR FAQ reports at least quarterly and with "greater than quarterly frequency in the months preceding the annual CCAR exercise."41
Copyright Sullivan & Cromwell LLP 2017
Banking Organization Capital Plans and Stress Tests
February 6, 2017
1 "CCAR" refers to the Federal Reserve's Comprehensive Capital Analysis and Review of capital plans filed annually by CCAR firms under the Federal Reserve's capital plan rule, Section 225.8
of Regulation Y, and supervisory and company-run stress tests under its Dodd-Frank Act Stress Test ("DFAST") rules, Subparts E and F of Regulation YY, 12 C.F.R. Part 252.
2 Federal Reserve, Division of Supervision and Regulation, Qualitative Assessment of Capital
Plans for U.S. Intermediate Holding Companies of Foreign Banking Organizations (IHCs) (Feb. 3, 2017) (the "New IHC Letter"); Federal Reserve, Division of Supervision and Regulation, 2017 Horizontal Capital Review for Large and Noncomplex Firms (Feb. 3, 2017) (the "Horizontal Review Letter"); Federal Reserve, Division of Supervision and Regulation, Enhancements to Federal Reserve Models Used to Estimate Post-Stress Capital Ratios (Feb. 3, 2017) (the "DFAST Letter").
3 Footnote 2 to the CCAR 2017 Instructions identifies these LISCC or large and complex firms that
are New IHCs as including Barclays US LLC, Credit Suisse Holdings (USA), Inc., Deutsche Bank
USA Corporation, RBC USA Holdco Corporation and UBS Americas Holdings LLC; however, Footnote 1 to the New IHC Letter states that it applies "only to Barclays US LLC; Credit Suisse Holdings (USA), Inc.; RBC USA Holdco Corporation; and UBS Americas Holding LLC."
4 Federal Reserve System, Amendments to the Capital Plan and Stress Test Rules, available at https://www.federalreserve.gov/newsevents/press/bcreg/bcreg20170130a1.pdf (Jan. 30, 2017). For a detailed discussion of the amendments, please see our Memorandum to Clients entitled Banking Organization Capital Plans and Stress Tests: Federal Reserve Finalizes Elimination of the Qualitative CCAR Assessment for Smaller Firms, Reduction in the De Minimis Exception for Additional Capital Distributions, and Other Notable Revisions to Its Capital Plan and Stress Testing Rules (Feb. 1, 2017), available at https://sullcrom.com/banking-organization-capitalplans-and-stress-tests-02-01-2017.
5 Footnote 3 to the CCAR 2017 Instructions identifies these large and noncomplex firms as
including Ally Financial Inc., American Express Company, BancWest Corporation, BB&T
Corporation, BBVA Compass Bancshares, Inc., BMO Financial Corp., BNP Paribas USA, Inc., CIT Group Inc., Citizens Financial Group, Inc., Comerica Incorporated, Discover Financial
Services, Fifth Third Bancorp, Huntington Bancshares Incorporated, KeyCorp, M&T Bank
Corporation, MUFG Americas Holdings Corporation, Northern Trust Corporation, Regions
Financial Corporation, Santander Holdings USA, Inc., SunTrust Banks, Inc. and Zions Bancorporation, noting, in Footnote 2, that "Deutsche Bank Trust Corporation is a subsidiary of a
newly formed IHC which has participated in CCAR in previous years, and will be subject to the quantitative assessment in CCAR."
6 Federal Reserve, 2017 Supervisory Scenarios for Annual Stress Tests Required under the Dodd-
Frank Act Stress Testing Rules and the Capital Plan Rule (Feb. 3, 2017), available at https://www.federalreserve.gov/newsevents/press/bcreg/bcreg20170203a5.pdf (the "2017 CCAR Scenarios").
7 See Federal Reserve, Comprehensive Capital Analysis and Review 2016:
https://www.federalreserve.gov/newsevents/press/bcreg/bcreg20160128a1.pdf. For a detailed
discussion of the amendments, please see our Memorandum to Clients entitled Bank Capital
Plans and Stress Tests: Federal Reserve Issues Instructions and Guidance for the 2016
Comprehensive Capital Analysis and Review Program (Feb. 3, 2016), available at
8 CCAR 2017 Instructions, at 1. The CCAR 2017 Instructions state that details of this review process will be "described in a supervisory communication sent to each firm."
9 12 C.F.R. 225.8.
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10 Federal Reserve System, SR Letter 15-18, Federal Reserve Supervisory Assessment of Capital Planning and Positions for LISCC Firms and Large and Complex Firms (Dec. 18, 2015), available at https://www.federalreserve.gov/bankinforeg/srletters/sr1518.htm.
11 New IHC Letter, at 2.
12 New IHC Letter, at 2.
13 New IHC Letter, at 1.
14 Federal Reserve System, Amendments to the Capital Plan and Stress Test Rules, available at https://www.federalreserve.gov/newsevents/press/bcreg/bcreg20170130a1.pdf (Jan. 30, 2017) ("2017 CCAR Amendments"). For a detailed discussion of the amendments, please see our Memorandum to Clients entitled Banking Organization Capital Plans and Stress Tests: Federal Reserve Finalizes Elimination of the Qualitative CCAR Assessment for Smaller Firms, Reduction in the De Minimis Exception for Additional Capital Distributions, and Other Notable Revisions to Its Capital Plan and Stress Testing Rules (Feb. 1, 2017), available at https://sullcrom.com/banking-organization-capital-plans-and-stress-tests-02-01-2017.
15 CCAR 2017 Instructions, at 1.
16 Horizontal Review Letter, at 1.
17 Horizontal Review Letter, at 1.
18 Horizontal Review Letter, at 1.
19 Horizontal Review Letter, at 2.
20 This may be in response to a report by the Government Accountability Office which found that, with respect to the Federal Reserve's qualitative assessment, the Federal Reserve "ha[d] not disclosed information needed to fully understand its assessment approach or the reasons for decisions to object to a company's capital plan." Government Accountability Office, Additional Actions Could Help Ensure the Achievement of Stress Test Goals, GAO-17-48 (Nov. 2016), available at http://www.gao.gov/assets/690/681020.pdf.
21 CCAR 2017 Instructions, at 13.
22 CCAR 2017 Instructions, at 13.
23 CCAR 2017 Instructions, at 14.
24 CCAR 2017 Instructions, at 14.
25 CCAR 2017 Instructions, at 14.
26 CCAR 2017 Instructions, at 14.
27 CCAR 2017 Instructions, at 13.
28 DFAST Letter, at 1.
29 DFAST Letter, at 2-3.
30 DFAST Letter, at 1.
31 2017 CCAR Scenarios, at 5.
32 2017 CCAR Amendments, supra note 14, at 37. This point is discussed further in our Memorandum to Clients dated February 1, 2017, supra note 14.
33 2017 CCAR Scenarios, at 5.
34 See 2017 CCAR Scenarios, at 7.
35 2017 CCAR Scenarios, at 7.
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ENDNOTES (CONTINUED) 36 CCAR 2017 Instructions, at 6. For a detailed description of the timing of effectiveness of the
requirement that a firm estimate is supplementary leverage ratio for stress testing purposes, see our Memorandum to Clients entitled Federal Reserve Finalizes Attestation Requirement for Intermediate Holding Companies of Foreign Banking Organizations and Addresses the Introduction of the Supplementary Leverage Ratio as a Post-Stress Minimum Requirement for the 2017 CCAR Cycle (Dec. 22, 2017), available at https://sullcrom.com/siteFiles/Publications/SC_ Publication_Bank_Capital_Plans_and_Stress_Tests_12_22_16.pdf. 37 CCAR 2017 Instructions, at 3. 38 For a detailed description of the changes proposed in this speech, please see our Memorandum to Clients entitled Federal Reserve Governor Tarullo Previews Proposal for Multiple Revisions to Capital Plans and Stress Tests That Will Increase Effective Capital Requirements for G-SIBs and May Reduce Effective Capital Requirements for Other CCAR Banking Organizations (Sep. 26, 2016), available at https://sullcrom.com/siteFiles/Publications/SC_Publication_Banking_Organizat ion_Capital_Plans_and_Stress_Tests.pdf. 39 CCAR 2017 Instructions, at 2. 40 CCAR 2017 Instructions, at 4. 41 CCAR 2017 Instructions, at 4.
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