Before the stress test results for the 18 firms subject to annual Comprehensive Capital Analysis and Review (“CCAR”) were released in March 2013, analysts had broadly expected that these firms would easily “pass” and be able to reinstate long-awaited dividend or stock repurchase programs. The regulators had a different perspective, however, and gave some firms “failing” grades and others only partial credit. As a result, these firms were sent to summer school and required to resubmit credible capital plans.
Last week, most of these same 18 institutions publicly disclosed the results of their mid-cycle stress tests, which were submitted to the Federal Reserve (“Fed”) in July. This was the first time firms were required to conduct mid-cycle stress tests as part of Dodd-Frank Act Stress Testing (“DFAST”). The mid-cycle DFAST stress test differs from the annual CCAR and DFAST in that whereas annual stress testing includes Fed-specified economic assumptions (under baseline, adverse, and severely adverse scenarios), the mid-cycle DFAST stress test relies on the institution’s assumptions under these scenarios. In addition, the Fed does not run its own stress test in mid-cycle DFAST, nor perform a capital plan review.
Looking forward to the next annual stress testing round in January (CCAR and DFAST 2014), we believe that there will be greater scrutiny of divergence between company-run and supervisory-run results than was demonstrated in 2013, given the regulators’ new access to a significant amount of data across firms (via the FR Y-14 regulatory reports) and due to the ongoing enhancements of supervisory models.
Furthermore, the regulatory bar is rising, as evidenced by the Capital Planning Guidance’s range of practices discussion. CCAR 2013 was unlikely the end of the Fed’s objections to firms’ capital plans. Merely fixing last year’s supervisory issues will not guarantee a passing grade in 2014.
In this Financial Services Regulatory Brief, we (a) provide background and analysis of the mid-cycle DFAST results, (b) offer our view of the August Capital Planning Guidance, and (c) suggest how firms can efficiently meet stress testing regulatory expectations going forward.