Board of Governors of the Federal Reserve System

Supervisory Stress Test Results

This section describes the Federal Reserve's projections of RWAs, losses, revenues, expenses, and capital positions for the 34 BHCs participating in DFAST 2017 under the severely adverse and adverse scenarios. Results are presented both in the aggregate for the 34 BHCs and for individual BHCs. The aggregate results provide a sense of the stringency of the adverse and severely adverse scenario projections and the sensitivities of losses, revenues, and capital at these BHCs as a group to the stressed economic and financial market conditions contained in those scenarios. The range of results across individual BHCs reflects differences in business focus, asset composition, revenue and expense sources, and portfolio risk characteristics. The comprehensive results for individual BHCs are reported in Appendix C.

Year-over-year changes in supervisory stress test results reflect changes in

• BHC starting capital positions;
• scenarios used for the supervisory stress test;
• portfolio composition and risk characteristics; and
• models used in the supervisory stress test.

In the aggregate, changes in portfolio composition and risk characteristics have contributed to lower loss rates in DFAST 2017 compared to DFAST 2016. However, the trend varied across the firms. In the aggregate, DFAST firms have increased the share of agency MBS and Treasuries in their securities portfolios and have reduced the holdings of less liquid assets like securitized products in their trading portfolios. Overall loan portfolios have grown, driven by strong growth in corporate, commercial real estate, and credit card loans. Residential mortgage growth lagged behind the overall loan growth, as healthy growth in first-lien mortgages was offset by a notable decline in home equity loans. The credit quality of some loan portfolios, including first-lien mortgages and commercial mortgages, has improved, in large part due to recent rises in real estate prices. However, improvements in portfolios collateralized by real estate were partially offset by continued stress on certain corporate loans due to persistently low oil prices and a recent uptick in delinquency rates in credit card portfolios.

Severely Adverse Scenario

Stressed Regulatory Capital Ratios and Risk-Weighted Assets

The projections suggest declines in capital ratios for all the BHCs under the severely adverse scenario. In the aggregate, each of the four capital ratios calculated in the fourth quarter of 2016 declines over the course of the planning horizon, with first-quarter 2019 levels ranging from 2.1 percentage points to 3.2 percentage points lower than at the start of the planning horizon (see table 2).³⁹ Tables 4.A, 4.B, and 4.C present these ratios for each of the 34 BHCs.

The changes in post-stress capital ratios vary considerably across BHCs (see figure 10). The capital ratios for all firms decline over the course of the planning horizon. The post-stress capital ratios incorporate Federal Reserve projections of the levels of total average assets and RWAs over the planning horizon. Declines in capital ratios in part reflect an increase in projected RWAs over the planning horizon. The increase in RWAs reflects projected asset and loan growth in the scenario and the impact of the scenario's assumed increase in equity market volatility on market risk-weighted assets (MRWAs) at firms with large trading portfolios.

Projected Losses

The Federal Reserve projects that the 34 BHCs as a group would experience significant losses on positions and loans under the severely adverse scenario. In this scenario, losses are projected to be $493 billion for the 34 BHCs in the aggregate over the nine quarters of the planning horizon. These losses include

• $383 billion in accrual loan portfolio losses;
• $5 billion in OTTI and other realized securities losses;
• $86 billion in trading and/or counterparty losses at the eight BHCs with substantial trading, processing, or custodial operations; and
• $18 billion in additional losses from items such as loans booked under the fair-value option (see table 2).

The largest losses derive from two sources: (i) accrual loan portfolios and (ii) trading and counterparty positions subject to the global market shock and counterparty default component. Together, these account for 95 percent of the projected losses for the 34 BHCs in the severely adverse scenario (figure 9).

 

Loan Losses

Projected losses on consumer-related lending--domestic residential mortgages, credit cards, and other consumer loans--represent 48 percent of projected loan losses and 37 percent of total projected losses for the 34 BHCs (see table 2). This is consistent with the severely adverse scenario, which features high unemployment rates and significant declines in housing prices. Credit card and commercial and industrial loan losses are the two largest categories of losses at $100 billion each, combined representing 52 percent of total projected loan losses. This is followed by $56 billion of losses in domestic commercial real estate loans.

For the 34 BHCs as a group, the nine-quarter cumulative loss rate for all accrual loan portfolios is 5.8 percent, where the loss rate is calculated as total projected loan losses over the nine quarters of the planning horizon divided by average loan balances over the horizon. Total loan loss rates vary significantly across BHCs, ranging between 2.5 percent and 13.0 percent across these institutions (see table 7 and figure 11).

The differences in total loan loss rates across the BHCs reflect differences in the risk characteristics of the portfolios held by each BHC with regard to both the type of lending of each portfolio and the loans within each portfolio. Loan portfolio composition matters because projected loss rates vary significantly by loan type. In the aggregate, nine-quarter cumulative loss rates vary between 2.2 percent on domestic first-lien mortgages and 13.7 percent on credit cards, reflecting both differences in typical performance of these loans--some loan types tend to generate higher losses, though generally also higher revenue--and differences in the sensitivity of different types of lending to the severely adverse scenario. In particular, lending categories for which performance is sensitive to unemployment rates or housing prices may experience high stressed loss rates due to the considerable stress on these factors in the severely adverse scenario.

Projected loss rates on most loan categories show similar dispersion across BHCs (see table 7 and figures D.1 through D.7).⁴⁰ There are significant differences across BHCs in the projected loan loss rates for similar types of loans. For example, while the median projected loss rate on commercial and industrial loans is 6.0 percent, the rates among BHCs with commercial and industrial loans vary from a low of 3.4 percent to a high of 13.8 percent. For commercial real estate loans, the range of projected loss rates is from 2.2 percent to 15.5 percent, with a median of 7.4 percent.

Projected loss rates for first-lien residential mortgages and home equity loans declined significantly from DFAST 2016, continuing a downward trend in recent years. This decline reflects continued improvement in the quality of bank mortgage portfolios, including a higher share of loans drawn from recent vintages for which underwriting standards are significantly tighter than the pre-2008 period and recent house price appreciation. Also contributing to the lower loss rates are a number of refinements to the estimation of the first-lien mortgage and home equity models and the adjustment to default rates applied to home equity lines of credit reaching the end of their draw period.

Differences in projected loss rates across BHCs primarily reflect differences in loan and borrower characteristics. In addition, some BHCs have taken write-downs on portfolios of impaired loans either purchased or acquired through mergers. Losses on these loans are projected using the same loss models used for loans of the same type, and the resulting loss projections are reduced by the amount of such write-downs. For these BHCs, projected loss rates will be lower than for BHCs that hold similar loans that have not been subject to purchase-related write-downs.

Losses on Trading, Private Equity, SFT, and Derivatives Positions

The severely adverse scenario results include $86 billion in trading losses from the global market shock at the six BHCs with large trading and private-equity exposures and losses from the counterparty default component at the eight BHCs with substantial trading, processing, or custodial operations. Trading and counterparty losses range between $0.4 billion and $25 billion across the eight BHCs (see table 5), with the largest losses at those BHCs that were subject to both the global market shock and the counterparty default component. Even so, the relative size of losses across firms depends not on nominal portfolio size but rather on the specific risk characteristics of each BHC's trading positions, inclusive of hedges. Importantly, these projected losses are based on the trading positions and counterparty exposures held by these firms on a single date (January 3, 2017) and could have differed if they had been based on a different date.

Projected Pre-provision Net Revenue and Net Income

In the aggregate, the 34 BHCs are projected to generate $418 billion in PPNR cumulatively over the nine quarters of the planning horizon, equal to 2.6 percent of their combined average assets (see table 2). PPNR projections reflect low levels of noninterest income, consistent with the falling asset prices, rising equity market volatility, and sharply contracting economic activity in the severely adverse scenario. In addition, the PPNR projections incorporate expenses stemming from estimates of elevated levels of losses from operational-risk events such as fraud, employee lawsuits, litigation-related expenses, or computer system or other operating disruptions.⁴¹ In aggregate for the 34 banks, those operational risk losses of almost $109 billion this year are within the range of losses projected over the past several stress test cycles.

The ratio of projected cumulative PPNR to average assets varies across BHCs (see figure 12). A significant portion of this variation reflects differences in business focus across the institutions. For instance, the ratio of PPNR to assets tends to be higher at BHCs focusing on credit card lending, reflecting the higher net interest income that credit cards generally produce relative to other forms of lending.⁴² Importantly, lower PPNR rates do not necessarily imply lower net income, since the same business focus and revenue risk characteristics determining differences in PPNR across firms could also result in offsetting differences in projected losses across BHCs.

Projected PPNR and losses are the primary determinants of projected pre-tax net income. Table 5 presents projections of the components of pre-tax net income, including provisions into the ALLL and one-time income and expense and extraordinary items, under the severely adverse scenario for each of the 34 BHCs (see table 2 for aggregate). The projections are cumulative for the nine quarters of the planning horizon.

Of note, following U.S. GAAP, the net income projections incorporate loan losses indirectly through provisions, which equal projected loan losses plus the amount needed for the ALLL to be at an appropriate level at the end of each quarter. The $421 billion in total provisions includes $383 billion in net charge-offs, with the remainder being the reserve build. These amounts are cumulative over the planning horizon and mask variation in the ALLL during the course of the nine quarters. Specifically, the projected ALLL increases during the early quarters of the planning horizon, given the increased economic stress in the severely adverse scenario, and then declines as the economic stress abates.

The Federal Reserve's projections of pre-tax net income under the severely adverse scenario imply negative net income at most of the 34 BHCs individually and for the BHCs as a group over the nine-quarter planning horizon. Projected net income before taxes (pre-tax net income) is an aggregate net loss of -$111 billion over the planning horizon for the 34 BHCs.

The ratio of pre-tax net income to average assets for each of the 34 BHCs ranges between -3.3 percent and 2.9 percent (see figure 13). Projected cumulative net income for most of the BHCs (25 of 34) is negative over the planning horizon. Differences across the firms reflect differences in the sensitivity of the various components of net income to the economic and financial market conditions in the supervisory scenarios. Projected net income for the eight BHCs subject to the global market shock and/or the counterparty default component includes the effect of those additional scenario components in the adverse and severely adverse scenarios, introducing some additional variation in projected net income between these eight BHCs and the other firms participating in DFAST 2017.

Final capital ratios for advanced approaches firms and other BHCs that opt into advanced approaches treatment for AOCI are also impacted by other comprehensive income (OCI) (table 5), which is driven by unrealized gains and losses on securities in the supervisory stress test.

Table 2. 34 participating bank holding companies Projected stressed capital ratios, risk-weighted assets, losses, revenues, net income before taxes, and loan losses Federal Reserve estimates: Severely adverse scenario

 

Capital ratios, actual 2016:Q4 and projected 2017:Q1-2019:Q1

Projected loan losses, by type of loan, 2017:Q1-2019:Q1

Risk-weighted assets, actual 2016:Q4 and projected 2019:Q1

Projected losses, revenue, and net income before taxes through 2019:Q1

Table 3. Projected minimum common equity tier 1 ratio under the severely adverse scenario, 2017:Q1-2019:Q1: 34 participating bank holding companies

Table 4.A. Capital ratios, actual 2016:Q4 and projected 2017:Q1-2019:Q1 under the severely adverse scenario: Advanced approaches firms

Table 4.B. Capital ratios, actual 2016:Q4 and projected 2017:Q1-2019:Q1 under the severely adverse scenario: Non-advanced approaches firms

Table 4.C. Capital ratios, actual 2016:Q4 and projected 2017:Q1-2019:Q1 under the severely adverse scenario: 34 participating bank holding companies

 

 

Table 5. Projected losses, revenue, and net income before taxes through 2019:Q1 under the severely adverse scenario: 34 participating bank holding companies

Table 6. Projected loan losses by type of loan for 2017:Q1-2019:Q1 under the severely adverse scenario: 34 participating bank holding companies

Table 7. Projected loan losses by type of loan for 2017:Q1-2019:Q1 under the severely adverse scenario: 34 participating bank holding companies

 

 

Adverse Scenario

Stressed Capital Ratios and Risk-Weighted Assets

The adverse scenario projections suggest moderate declines in aggregate capital ratios for the 34 BHCs. The aggregate CET1 ratio is projected to fall 1.8 percentage points to its minimum over the planning horizon and to be 1.3 percentage points lower at the end of the planning horizon (see table 8). In addition, at the end of the planning horizon, the tier 1 risk-based capital ratio and the total risk-based capital ratio are 1.3 and 1.7 percentage points lower than at the start of the planning horizon, respectively. The tier 1 leverage ratio is projected to decline 1.0 percentage points over the planning horizon.

Generally, the projected declines in post-stress capital ratios are smaller than those under the severely adverse scenario, reflecting the less severe economic conditions assumed in the adverse scenario. As compared to the severely adverse scenario, the adverse scenario projections imply higher aggregate net income driven by higher PPNR and lower losses. Offsetting somewhat the effect of aggregate higher net income on capital, the adverse scenario also features more robust projected balance sheet and RWA growth than the severely adverse scenario, which on net tends to reduce post-stress capital ratios.

Projected Losses

The Federal Reserve's projections suggest that the 34 BHCs as a group would face elevated losses under the adverse scenario, though not as large as the losses under the severely adverse scenario. In this scenario, total losses are projected to equal $322 billion for the 34 BHCs over the nine-quarter planning horizon.

These losses include

• $257 billion in accrual loan losses,
• $3 billion in OTTI and other realized securities losses,
• $46 billion in losses from the global market shock and the largest counterparty default components, and
• $15 billion in additional losses from items such as loans booked under the fair-value option.

These results are presented in aggregate (table 8) and individually for each of the 34 BHCs (table 11 and appendix C). Aggregate loss amounts are lower than those projected under the severely adverse scenario, once again reflecting the relatively less stressful macroeconomic and financial market conditions assumed in the adverse scenario.

 

Loan Losses

As in the severely adverse scenario, the accrual loan portfolio is the largest source of losses in the adverse scenario, accounting for $257 billion of projected losses for the 34 BHCs. The lower peak unemployment rate and more moderate residential and commercial real estate price declines in the adverse scenario result in lower projected accrual loan losses on consumer and real estate-related loans relative to the severely adverse scenario. In aggregate, the nine-quarter loan loss rate of the 34 BHCs is 3.9 percent. As in the severely adverse scenario results, there is considerable diversity across firms in projected loan loss rates, both in the aggregate and by loan type (see figures 16 and D.8 to D.14).

 

Losses on Trading, Private Equity, and Derivatives Positions

Projected losses resulting from the impact of the global market shock and the largest counterparty default on trading, private equity, and counterparty exposures for the eight BHCs with large trading, processing, or custodial operations equal $46 billion under the adverse scenario. These losses are slightly more than half those projected under the severely adverse scenario, reflecting the less severe market shocks assumed in the global market shock component of the adverse scenario.

Projected PPNR and Net Income

Aggregate PPNR is projected to equal $541 billion for the 34 BHCs under the adverse scenario, equal to 3.3 percent of average projected assets for these firms. Projected PPNR is higher than under the severely adverse scenario due to a steeper yield curve and less severe economic and financial market conditions, resulting in a smaller reduction in noninterest income and operational risk losses. However, projected operational risk losses are lower compared to the severely adverse scenario, the latter being consistent with the adverse scenario's more moderate housing price decline. Projected ratios of PPNR to assets vary significantly across the 34 BHCs (see figure 17).

 

In the aggregate, the 34 BHCs are projected to have cumulative pre-tax net income of $214 billion over the nine-quarter planning horizon under the adverse scenario. Twenty-seven of the BHCs are projected to have positive cumulative pre-tax net income, though 20 firms experience at least one quarter of negative pre-tax net income during the planning horizon. The higher net income, as compared to the severely adverse scenario projections, reflects the combination of higher projected PPNR and lower projected losses, especially on trading, private equity and counterparty positions, and on the accrual loan portfolio. The $264 billion in total provisions reported in table 8 includes $257 billion in net charge-offs, with the remainder being the reserve build, or the increase in loan loss reserves.

Aggregate pre-tax net income under the adverse scenario is positive, with a ratio of income to average assets of 1.3 percent. Projected nine-quarter return on assets under the adverse scenario ranges between -0.8 and 5.8 percent for the 34 BHCs (see figure 18).

 

The interest rate path and credit spreads assumed in the scenario result in -$21 billion of OCI over the nine quarters of the planning horizon for advanced approaches BHCs and other BHCs that opt into advanced approaches treatment for AOCI. Reflecting the gradual phasing-in of portions of AOCI in the revised regulatory capital framework, -$80 billion in AOCI is included in post-stress regulatory capital as of the first quarter of 2019.

Table 8. 34 participating bank holding companies Projected stressed capital ratios, risk-weighted assets, losses, revenues, net income before taxes, and loan losses Federal Reserve estimates: Adverse scenario

 

Capital ratios, actual 2016:Q4 and projected 2017:Q1-2019:Q1

Projected loan losses, by type of loan, 2017:Q1-2019:Q1

Risk-weighted assets, actual 2016:Q4 and projected 2019:Q1

Projected losses, revenue, and net income before taxes through 2019:Q1

Table 9. Projected minimum common equity tier 1 ratio under the adverse scenario, 2017:Q1-2019:Q1: 34 participating bank holding companies

Table 10.A. Capital ratios, actual 2016:Q4 and projected 2017:Q1-2019:Q1 under the adverse scenario: Advanced approaches firms

Table 10.B. Capital ratios, actual 2016:Q4 and projected 2017:Q1-2019:Q1 under the adverse scenario: Non-advanced approaches firms

Table 10.C. Capital ratios, actual 2016:Q4 and projected 2017:Q1-2019:Q1 under the adverse scenario: 34 participating bank holding companies

Table 11. Projected losses, revenue, and net income before taxes through 2019:Q1 under the adverse scenario: 34 participating bank holding companies

Table 12. Projected loan losses by type of loan for 2017:Q1-2019:Q1 under the adverse scenario: 34 participating bank holding companies

Table 13. Projected loan losses by type of loan for 2017:Q1-2019:Q1 under the adverse scenario: 34 participating bank holding companies

Table 14. Mapping of loan categories to disclosure categories

 

References

 

 39. In table 2, the decline from starting to ending aggregate tier 1 leverage ratio is 2.2 percentage points. The difference is due to rounding. Return to text

 40. Losses are calculated based on the exposure at default, which includes both outstanding balances and any additional drawdown of the credit line that occurs prior to default, while loss rates are calculated as a percent of average outstanding balances over the planning horizon. See appendix B for more detail on the models used to project net income and stressed capital. Return to text

 41. These estimates are conditional on the hypothetical adverse and severely adverse scenario and on conservative assumptions. They are not a supervisory estimate of the BHCs' current or expected legal liability. Return to text

 42. As noted, credit card lending also tends to generate relatively high loss rates, so the higher PPNR rates at these BHCs do not necessarily indicate higher profitability. Return to text