Executive Summary
The results of this year's stress test cycle (DFAST 2019) suggest that, in the aggregate, the 18 firms subject to the supervisory stress test would experience substantial losses under both the adverse and severely adverse scenarios but could continue lending to businesses and households, due to the substantial build of capital since the financial crisis.
In the severely adverse scenario, the aggregate common equity tier 1 (CET1) capital ratio would fall from an actual 12.3 percent in the fourth quarter of 2018 to its minimum of 9.2 percent, before rising to 9.7 percent at the end of nine quarters (see figure 1). The DFAST cycle begins in the first quarter of 2019 and ends in the first quarter of 2021.
Figure 1. Historical and stressed tier 1 common ratio and common equity tier 1 ratio
Note: Historical and stressed capital ratios are calculated for all firms subject to the supervisory stress test in each exercise.
For DFAST 2019, key components of stress test projections, such as losses and revenue, are broadly similar to those of prior years' exercises.
Aggregate losses at the 18 firms under the severely adverse scenario are projected to be $410 billion. These losses represent a slight decline from $464 billion for the same 18 firms in DFAST 2018. Aggregate loan losses as a percent of average loan balances in the severely adverse scenario have declined since early stress test exercises, due in large part to improvements in firms' portfolio quality (see figure 2). The loss rates in DFAST 2019 are well in line with loss rates in the 2015–17 stress test exercises.3
Figure 2. Loan loss rates, severely adverse scenario
Note: Loan loss rates as a percent of average total loan balances is calculated for all firms subject to the supervisory stress test in each exercise.
Aggregate projected pre-provision net revenue (PPNR) in DFAST 2019 for the 18 firms under the severely adverse scenario is projected to be $327 billion, compared to $389 billion for the same set of firms in DFAST 2018. PPNR as a percent of average total assets in DFAST 2019 is broadly similar to projected PPNR in prior years' exercises (see figure 3).
Figure 3. PPNR as a percent of average total assets, severely adverse scenario
Note: PPNR as a percent of average total assets is calculated for all firms subject to the supervisory stress test in each exercise.
Provisions for loan losses and PPNR are the main drivers of pre-tax net income. The projected decline in pre-tax net income is -0.8 percent average total assets, equivalent to the decline in pre-tax net income in the DFAST 2018 exercise (see figure 4).
Figure 4. Pre-tax net income as a percent of average total assets, severely adverse scenario
Note: Pre-tax net income as a percent of average total assets is calculated for all firms subject to the supervisory stress test in each exercise.
In DFAST 2019, the effect of the decline in pre-tax net income on firms' post-stress capital ratios was partially offset by projected unrealized gains on available-for-sale (AFS) securities, resulting from a more muted widening of credit spreads and a larger downward shift in the yield curve in the 2019 severely adverse scenario. These securities may have projected gains, as in DFAST 2019, or projected losses as in DFAST 2018, depending on the nature of the stress scenario. Only the largest and most complex firms are required to recognize those unrealized gains and losses in regulatory capital.4
In the adverse scenario, aggregate projected losses, PPNR, and net income before taxes are $255 billion, $387 billion, and $128 billion, respectively. The aggregate CET1 capital ratio under the adverse scenario would fall to a minimum of 11.4 percent.
Further details of the results are provided in the Supervisory Stress Test Results section of this report.
Differences between the DFAST 2019 Results Disclosure and Previous Results Disclosures
Fewer Firms This Year
The Board previously announced that certain less-complex BHCs and IHCs would not be subject to the stress test in 2019. As a result, these firms were not subject to the supervisory stress test during the 2019 stress test cycle. Effectively moving these institutions to an extended stress test cycle for 2019 recognizes the smaller risk they present, while still allowing the Board to assess the resiliency of these firms.5
While 35 firms remain subject to stress testing requirements, 18 firms have been tested this year under DFAST.6 As such, only results from the 18 firms are being published in this document.7
Because fewer firms participated in the 2019 stress test cycle, the aggregate results this year are not fully comparable to results from prior years.
No Further Changes from the Tax Law
While the Tax Cuts and Jobs Act8 is in effect for DFAST 2019, the one-time effects of transitioning to the new tax law that had material effects on the results of DFAST 2018 are not a factor in this year's stress test cycle.
Specifically, in the 2018 stress test cycle, the Federal Reserve modified its calculation of projected capital to account for the passage of the Tax Cuts and Jobs Act.9 The effective tax rate was reduced from 35 percent to 21 percent, and the calculation of capital was changed to reflect the elimination of net operating loss (NOL) carrybacks and the 80 percent limit on carryforward utilization.
Transparency Enhancements
This document contains projections of net interest income, noninterest income, and noninterest expense for firms subject to DFAST 2019. These subcomponent estimates are more granular than the PPNR estimates published in prior DFAST disclosures.
In March 2019, the Board published for the first time a disclosure containing additional information about its supervisory models. This disclosure was designed to improve the public's understanding and interpretation of stress test results and enhance the credibility of the test.10 It is one part of recent efforts to increase supervisory stress test transparency while still maintaining the effectiveness of the stress test. Because the Board has published these descriptions in advance of the stress test cycle and intends to publish a disclosure of supervisory model methodology in advance of future stress test cycles, the description of supervisory models (formerly appendix B) has been removed from the supervisory stress test results disclosure.
Overview
This report provides
- details of the adverse and severely adverse supervisory scenarios used in DFAST 2019;
- an overview of the analytical framework and methods used to generate the Federal Reserve's projected results, highlighting notable changes from last year's program;
- information about recent efforts to increase transparency;
- additional details about the Federal Reserve's assumptions in the supervisory stress test; and
- the results of the supervisory stress test under adverse and severely adverse scenarios for the firms that participated in DFAST 2019, presented both for individual institutions and in the aggregate.
The adverse and severely adverse supervisory scenarios used in DFAST 2019 feature U.S. and global recessions. In particular, the severely adverse scenario is characterized by a severe global recession accompanied by a period of heightened stress in commercial real estate (CRE) markets and corporate debt markets. The adverse scenario is characterized by weakening economic activity across all of the economies included in the scenario, accompanied by a moderate correction in asset prices and a rise in volatility.
In conducting the supervisory stress test, the Federal Reserve projects capital levels and regulatory capital ratios under stress over nine quarters, generally using a set of pre-defined capital action assumptions. The projections are based on macroeconomic scenarios that are developed annually by the Federal Reserve.11
The Federal Reserve calculates its projections of each firm's balance sheet, risk-weighted assets (RWAs), net income, and resulting regulatory capital ratios under these scenarios using data on firms' financial conditions and risk characteristics provided by the firms and a set of models developed or selected by the Federal Reserve.
As in past years, the Federal Reserve enhanced some of the supervisory models in advance of DFAST 2019. The supervisory stress test models may be enhanced to reflect advances in modeling techniques; enhancements in response to model validation findings; incorporation of richer and more detailed data; and identification of more stable models or models with improved performance, particularly under stressful economic conditions. These changes are highlighted in box 1.
The publication of supervisory model methodology and other ongoing efforts to increase the transparency of the supervisory stress test are described in box 2.
References
3. Loss rates were higher in DFAST 2018 due to features of the 2018 severely adverse macroeconomic scenario. Return to text
4. In contrast, these projected unrealized gains would not have been reflected in the capital ratios of smaller and less complex firms, as they are not required to include unrealized gains and losses on AFS securities in regulatory capital. Return to text
5. See Board of Governors of the Federal Reserve System, "Federal Reserve Board releases scenarios for 2019 Comprehensive Capital Analysis and Review (CCAR) and Dodd-Frank Act stress test exercises," press release, February 5, 2019, https://www.federalreserve.gov/newsevents/pressreleases/bcreg20190205b.htm. Return to text
6. The 18 firms required to participate in DFAST 2019 are Bank of America Corporation; The Bank of New York Mellon Corporation; Barclays US LLC; Capital One Financial Corporation; Citigroup Inc.; Credit Suisse Holdings (USA) LLC; DB USA Corporation; The Goldman Sachs Group, Inc.; HSBC North America Holdings Inc.; JPMorgan Chase & Co.; Morgan Stanley; Northern Trust Corporation; The PNC Financial Services Group, Inc.; State Street Corporation; TD Group US Holdings LLC; UBS Americas Holdings LLC; U.S. Bancorp; and Wells Fargo & Company. In addition to DB USA Corporation, DWS USA Corporation, a second U.S. intermediate holding company subsidiary of Deutsche Bank AG, was subject to DFAST 2019. Return to text
7. The 17 firms not subject to DFAST 2019 are Ally Financial Inc.; American Express Company; BB&T Corporation; BBVA Compass Bancshares, Inc.; BMO Financial Corp.; BNP Paribas USA, Inc.; Citizens Financial Group, Inc.; Discover Financial Services; Fifth Third Bancorp; Huntington Bancshares Incorporated; KeyCorp; M&T Bank Corporation; MUFG Americas Holdings Corporation; RBC US Group Holdings LLC; Regions Financial Corporation; Santander Holdings USA, Inc.; and SunTrust Banks, Inc. Return to text
8. Pub. L. No. 115-97 (2017). Return to text
9. See Board of Governors of the Federal Reserve System, "Dodd-Frank Act Stress Test 2018: Supervisory Stress Test Methodology and Results," (Washington, DC: Board of Governors, June 2018), box 2, https://www.federalreserve.gov/publications/files/2019-march-supervisory-stress-test-methodology.pdf. Return to text
10. See Board of Governors of the Federal Reserve System, "Dodd-Frank Act Stress Test 2018: Supervisory Stress Test Methodology and Results," (Washington, DC: Board of Governors, June 2018), box 2, https://www.federalreserve.gov/publications/files/2019-march-supervisory-stress-test-methodology.pdf. Return to text
11. The Board has issued and recently amended a policy statement regarding its process for designing the scenarios. See Policy Statement on the Scenario Design Framework for Stress Testing, 84 Fed. Reg. 6651 (February 28, 2019), https://www.federalregister.gov/documents/2019/02/28/2019-03504/amendments-to-policy-statement-on-the-scenario-design-framework-for-stress-testing, 12 CFR part 252, appendix A. Return to text