Section 165(i) of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”) requires:

  • The Board of Governors of the Federal Reserve System (“Board”) to conduct an annual stress test (“Supervisory Test”) on each systemically important bank holding company (“BHCs”) and systemically-important nonbank;
  • All banking organizations with total consolidated assets of more than $10 billion (on an average basis over the prior four quarters) to conduct an annual company-run stress test (“Annual Self-Test”); and
  • Systemically important BHCs and nonbanks to conduct an additional mid-cycle company-run stress test each year (“Mid-Cycle Self-Test”).

Last week, the Board, the Office of the Comptroller of the Currency (“OCC”) and the Federal Deposit Insurance Corporation (“FDIC”) all issued final rules to effectuate these Dodd-Frank Act stress testing requirements.

The Board published two final rules.1 One of the final rules (the “Covered Company Rule”) imposes all three stress testing requirements, and applies to the following:

  • U.S. BHCs2 with $50 billion or more in consolidated assets;3 and
  • Nonbank financial companies (U.S. and non-U.S.) designated as “systemically important” by the Financial Stability Oversight Council (“Council”)

(collectively, “Covered Companies”).

The other final rule issued by the Board (the “Other Fed Regulatee Rule”) imposes only the Annual Self-Test, and applies to the following:

  • BHCs with total consolidated assets of greater than $10 billion but less than $50 billion; and
  • Savings and loan holding companies (“SLHCs”) and state member banks with total consolidated assets of greater than $10 billion

(collectively, “Other Fed Regulatees”).

Concurrently with the Board’s action, the OCC and the FDIC also finalized stress testing requirements substantially similar to the Other Fed Regulatee Rule (respectively, the “OCC Rule” and the “FDIC Rule”).4 The OCC Rule applies to national banks and federal savings associations with total consolidated assets of greater than $10 billion, while the FDIC rule applies to similarly-sized state nonmember banks and state savings associations.

In each case, the agencies’ final stress testing rules largely mirror their earlier proposals. For a summary of the Board’s original proposal, please see our Jan. 11, 2012 Memorandum; for a summary of the original FDIC proposal, please see our Jan. 19, 2012 Alert; and for a summary of the original OCC proposal, please see our Jan. 25, 2012 Alert.

This Alert highlights the differences between the final rules and those proposals.

I. The Board Rules

Effective Date

One of the most significant changes between the Board’s original proposal and the two final rules are the dates on which different types of entities must comply with the new stress testing requirements. In general, the final rules issued by the Board give Covered Companies and Other Fed Regulatees more time before the new requirements take effect.

Click here to see table.

Stress Testing Cycles

While largely retaining the stress testing cycles contained in the original proposal, the final rules incorporated a few changes. Most importantly, all entities subject to the Other Fed Regulatee Rule (except (1) SLHCs with more than $50 billion in total consolidated assets and (2) state member banks that are owned by Covered Companies) are given approximately three extra months each year to complete the Annual Self-Test and to submit the required regulatory report to the Board, as well as to publicly disclose a summary of the results. In addition, the original public disclosure deadlines (early April for the Supervisory Test and Annual Self-Test, and early October for the Mid-Cycle Self-Test) have been adjusted for all entities under both rules, so that they no longer interfere with the “quiet periods” preceding earnings announcements of publicly-traded entities.

Final Testing Cycle Timeline

Click here to see table.

Tailoring of Annual Self-Tests

The Board’s original proposal would have applied consistent Annual Self-Test requirements on all Covered Companies and Other Fed Regulatees. However, recognizing that entities with less than $50 billion in total consolidated assets are generally less complex and pose less risk to U.S. financial stability, the final rules incorporate a somewhat tailored approach, which modify the requirements for smaller institutions in several ways.

First, as discussed above, most entities with $50 billion or less in total consolidated assets will have more time to complete and disclose the results of their Annual Self-Test. Second, such smaller entities are also generally not required to provide as detailed a public disclosure of the results as larger entities and Covered Companies.7 Third, in the Other Fed Regulatee Rule, the Board indicated that it expects the forms used to report the Annual Self-Test results to the Board will be tailored according to entity size, with smaller entities using a “significantly more limited” form than larger entities and Covered Companies.

Finally, depending on the systemic footprint and span of operations and activities of a Covered Company or Other Fed Regulatee, the Board may require that entity to include additional components in its adverse or severely adverse scenarios, or to use additional scenarios designed to capture particular risks to specific lines of business. In particular, the Board may require:

  • A trading and counterparty component in the “adverse” and “severely adverse” scenarios for an entity with significant trading activity (as determined by the Board and specified in the Capital Assessments and Stress Testing report (FR Y-14));
  • One or more additional components in the adverse and severely adverse scenarios based on a particular entity’s financial condition, size, complexity, risk profile, scope of operations, or activities, or risks to the U.S. economy; and
  • One or more additional scenarios (in addition to the “baseline,” “adverse,” and “severely adverse” scenarios to be used by all Covered Companies and Other Fed Regulatees) based on a particular entity’s financial condition, size, complexity, risk profile, scope of operations, or activities, or risks to the U.S. economy.8

Assumptions Regarding Capital Ratios

In response to requests to the Board to adopt the disclosure approach used for CCAR9 in 2012 (which included some common assumptions of capital actions across bank holding companies) and to enable comparisons across firms and between the company-run and supervisory stress tests, the final rules require Covered Companies and Other Fed Regulatees to make the following assumptions regarding their capital actions over the planning horizon:

  • For the first quarter of the planning horizon, the entity must take into account its actual capital actions as of the end of that quarter; and
  • For each of the second through ninth quarters of the planning horizon, the entity must include in the projections of capital:
    • Common stock dividends equal to the quarterly average dollar amount of common stock dividends paid in the previous year (that is, the first quarter of the planning horizon and the preceding three calendar quarters);
    • Payments on any other instrument that is eligible for inclusion in the numerator of a regulatory capital ratio equal to the stated dividend, interest, or principal due on such instrument during the quarter; and
    • An assumption of no redemption or repurchase of any capital instrument that is eligible for inclusion in the numerator of a regulatory capital ratio.

Public Reporting

Another important change between the Board’s original proposal and the final rules is that only the results from the “severely adverse” scenario will be included when the Board publishes the results of a Covered Company’s Supervisory Test or when a Covered Company or Other Fed Regulatee reposts the results of its Self-Tests.

II. The OCC Rule

Effective Date

As discussed above, the OCC Rule applies to national banks and federal savings associations with total consolidated assets of greater than $10 billion.10 The final OCC Rule divides such depository institutions into two categories: (1) those with total assets between $10 and $50 billion (“Mid-Sized OCC Regulatees”) and (2) those with total consolidated assets over $50 billion (“Large OCC Regulatees”). Under the OCC’s original proposal all covered institutions would have been required to conduct their first Annual Self-Test in 2012. Under the OCC Rule, however, only Large OCC Regulatees are required to begin stress testing in 2012.11 Mid-Sized OCC Regulatees are given until 2013, and the public disclosure requirement is further delayed until their second Annual Self-Test. Under both the original proposal and the OCC Rule, depository institutions that later grow above the $10 billion threshold are required to conduct their first Annual Self-Test in the following calendar year.

Stress Testing Cycle

The OCC originally proposed distributing the scenarios to be used for the Annual Self-Test on Oct. 15 of each year. However, the OCC Rule moves that date to Nov. 15, to be consistent with the Fed. In addition, like the Other Fed Regulatee Rule, the OCC Rule gives Mid-Sized OCC Regulatees approximately three extra months each year to complete the Annual Self-Test and submit the required regulatory report to the OCC, as well as to publicly disclose a summary of the results.

Final Testing Cycle Timeline

Click here to see table.

Tailoring of Annual Self-Tests

The OCC Rule incorporates certain methods for tailoring the Annual Self-Tests that are similar some of the methods used in the Fed’s final rules. Like the Fed, the OCC may require the use of additional components or scenarios, including the use of a trading and counterparty component in the “adverse” and “severely adverse” scenarios for an entity with significant trading activity.12 In addition, as in the Other Fed Regulatee Rule, the OCC Rule suggests that the form used by Mid-Sized OCC Regulatees to report the Annual Self-Test results to the OCC will be more limited than the form used by Large OCC Regulatees.

Public Reporting

The OCC Rule also adopts the change made in the Fed’s final rules to only require public disclosure of the results of the “severely adverse” scenario.

III. The FDIC Rule

Effective Date

As discussed above, the FDIC Rule applies to state nonmember banks and state savings associations with total consolidated assets of greater than $10 billion. Like the OCC Rule, the FDIC Rule divides such depository institutions into two categories: (1) those with total assets between $10 and $50 billion (“Mid-Sized FDIC Regulatees”) and (2) those with total consolidated assets over $50 billion (“Large FDIC Regulatees”). Moreover, the FDIC Rule incorporates all of the same revised effective dates for testing and disclosure as the OCC Rule (applying in the same manner to Mid-Sized and Large FDIC Regulatees, as they apply to Mid- Sized and Large OCC Regulatees).13

Stress Testing Cycle

The FDIC Rule adopts the same revised Annual Self-Test cycle as the OCC Rule (with the Mid-Sized FDIC Regulatees afforded the same more relaxed timeframes as Mid-Sized OCC Regulatees).

Tailoring of Annual Self-Tests

The FDIC Rule incorporates the same methods for tailoring the Annual Self-Tests that were adopted in the OCC Rule.14

Public Reporting

Like the Fed’s final rules and the OCC Rule, the FDIC Rule also limits the public disclosure requirements to the results of only the “severely adverse” scenario.