Yesterday, the Fed released three scenarios for the upcoming Comprehensive Capital Analysis and Review (CCAR) resubmission—baseline, severely adverse, and alternative severe. This second set of 2020 CCAR scenarios is a result of the Fed’s announcement earlier this year that due to uncertainty about the actual path of economic recovery and the risk of banks approaching capital minimums, it is requiring the 34 banks that participate in CCAR to resubmit their capital plans.
The severely adverse scenario, which continues to follow the Fed’s scenario design framework, includes an increase in unemployment to 12.5% and gradual decline to 10.2% by the end of the nine quarter scenario, five quarters of real GDP decline totaling 12.4% starting in 4Q20, and recessions in the EU, UK and Japan. The alternative adverse scenario is designed to reflect the impact of a staggered second global wave of the current pandemic and includes a less sharp initial unemployment peak of 11% but more limited recovery with a decline to 10.3% by the end of the nine quarter scenario. The resubmission scenarios include the global market shock, which applies to 11 of the largest banks, and continue the previous test’s emphasis on exposure to leveraged lending but also contain larger shocks to equity values and more severe stresses in the municipal bond market.
Unlike the additional sensitivity analyses the Fed performed as part of the original 2020 CCAR exercise, firm-specific results of the resubmission will be released by the end of the year. The Fed also stated that it will announce by the end of September whether it will extend its cap on dividends and restriction on share repurchases through Q4.
The Fed will not yet have the results of the resubmission before it announces whether the cap on dividends and restriction on share restrictions will be extended. As a result, it will need to weigh whether improved economic conditions since the original restrictions were put in place merit giving banks back their discretion or whether it should be conservative until the results come out.
As the economic impact of the crisis continues to unfold, there is now less uncertainty about its potential impact, and the Fed’s new stress scenarios reflect this reality in that peak stress is now forecast to be less severe than in the sensitivity analysis conducted earlier this year. In addition, while not included in the disclosure, asset price movements for equities and real estate were comparable to annual severely adverse moves. Given that all the firms did not breach capital minima in the sensitivity analyses, the resubmission scenario design bodes well for banks’ quantitative results.
That said, firms will face the not insignificant challenge of incorporating the end of certain government support programs in credit loss forecasts. To date, credit losses have been offset by the effectiveness of such programs, but firms should not assume new programs or extensions not already in place in their forecasts. Given that unemployment and other risk factors deteriorate and remain stressed from starting levels that are unusually high for this exercise, many firms will need to make adjustments to their models to achieve a result that is intuitive and also consistent with regulatory expectations.
While we do not expect the Fed to resize firms’ stress capital buffers (SCBs) as a result of this resubmission, it will likely want to return to the new normal of adjusting ongoing capital requirements via the SCB following the 2021 CCAR exercise. The Fed will have the results of the resubmission and a more up-to-date picture of the likely path of the economic recovery before it releases the 2021 scenarios, which should allow it to return some measure of bank discretion on payouts.