Proposed Supervisory Guidance on Implementing Dodd-Frank Act Company-Run Stress Tests for Banking Organizations With Total Consolidated Assets of More Than $10 Billion But Less Than $50 Billion, 47217-47228 [2013-18716]

Download as PDF Federal Register / Vol. 78, No. 150 / Monday, August 5, 2013 / Proposed Rules may be done without risk of harm to the animals or to the public? • Should exhibitors and dealers be required to keep additional records (beyond those already required) regarding big cats, bears, and nonhuman primates? If so, what kinds of information should be required to be kept? • Should exhibitors and dealers be required to identify big cats, bears, and nonhuman primates by means of tattoos, microchips, retinal scans, or the like? We encourage the submission of scientific data, studies, or research to support your comments and position, including scientific data or research that supports any industry or professional standards that pertain to the humane treatment of big cats, bears, and nonhuman primates. We also invite data on the costs and benefits associated with any recommendations. We will consider all comments and recommendations we receive. Authority: 7 U.S.C. 2131–2159; 7 CFR 2.22, 2.80, and 371.7. Done in Washington, DC, this 31st day of July 2013. Kevin Shea, Administrator, Animal and Plant Health Inspection Service. The Board, FDIC and OCC, (collectively, the ‘‘agencies’’) are issuing this guidance, which outlines high-level principles for implementation of section 165(i)(2) of the Dodd-Frank Act Wall Street Reform and Consumer Protection Act (‘‘DFA’’) stress tests, applicable to all bank and savings-and-loan holding companies, national banks, statemember banks, state non-member banks, Federal savings associations, and state chartered savings associations with more than $10 billion but less than $50 billion in total consolidated assets (collectively, the ‘‘$10–50 billion companies’’). The guidance discusses supervisory expectations for DFA stress test practices and offers additional details about methodologies that should be employed by these companies. It also underscores the importance of stress testing as an ongoing risk management practice that supports a company’s forward-looking assessment of its risks and better equips the company to address a range of macroeconomic and financial outcomes. DATES: Comments on this joint proposed guidance are due to the OCC and FDIC on September 25th, 2013 and to the Federal Reserve on September 30th, 2013. SUMMARY: [FR Doc. 2013–18874 Filed 8–2–13; 8:45 am] BILLING CODE 3410–34–P ADDRESSES: OCC: Because paper mail in the Washington, DC area and at the OCC is subject to delay, commenters are encouraged to submit comments by email, if possible. Please use the title ‘‘Proposed Supervisory Guidance on Implementing Dodd-Frank Act Company-Run Stress Tests for Banking Organizations with Total Consolidated Assets of more than $10 Billion but less than $50 Billion’’ to facilitate the organization and distribution of the comments. You may submit comments by any of the following methods: • Email: regs.comments@occ.treas.gov. • Mail: Legislative and Regulatory Activities Division, Office of the Comptroller of the Currency, 400 7th Street SW., Suite 3E–218, Mail Stop 9W–11, Washington, DC 20219. • Hand Delivery/Courier: 400 7th Street SW., Suite 3E–218, Mail Stop 9W–11, Washington, DC 20219. • Fax: (571) 465–4326. Instructions: You must include ‘‘OCC’’ as the agency name and ‘‘Docket ID OCC–2013–0013’’ in your comment. In general, OCC will enter all comments received into the docket and publish them on the Regulations.gov Web site without change, including any business or personal information that you provide such as name and address information, email addresses, or phone DEPARTMENT OF THE TREASURY Office of the Comptroller of the Currency 12 CFR Part 46 [Docket No. OCC–2013–0013] FEDERAL RESERVE SYSTEM 12 CFR Part 252 [Docket No. OP–1461] FEDERAL DEPOSIT INSURANCE CORPORATION emcdonald on DSK67QTVN1PROD with PROPOSALS 12 CFR Part 325 Proposed Supervisory Guidance on Implementing Dodd-Frank Act Company-Run Stress Tests for Banking Organizations With Total Consolidated Assets of More Than $10 Billion But Less Than $50 Billion Board of Governors of the Federal Reserve System (‘‘Board’’ or ‘‘Federal Reserve’’); Federal Deposit Insurance Corporation (‘‘FDIC’’); Office of the Comptroller of the Currency, Treasury (‘‘OCC’’). ACTION: Proposed supervisory guidance. AGENCIES: VerDate Mar<15>2010 16:53 Aug 02, 2013 Jkt 229001 PO 00000 Frm 00004 Fmt 4702 Sfmt 4702 47217 numbers. Comments received, including attachments and other supporting materials, are part of the public record and subject to public disclosure. Do not enclose any information in your comment or supporting materials that you consider confidential or inappropriate for public disclosure. You may review comments and other related materials that pertain to this notice by any of the following methods: • Viewing Comments Personally: You may personally inspect and photocopy comments at the OCC, 400 7th Street SW., Washington, DC. For security reasons, the OCC requires that visitors make an appointment to inspect comments. You may do so by calling (202) 649–6700. Upon arrival, visitors will be required to present valid government-issued photo identification and to submit to security screening in order to inspect and photocopy comments. • Docket: You may also view or request available background documents and project summaries using the methods described above. Board: You may submit comments, identified by Docket No. OP–1461, ‘‘Proposed Supervisory Guidance on Implementing Dodd-Frank Act Company-Run Stress Tests for Banking Organizations with Total Consolidated Assets of more than $10 Billion but less than $50 Billion,’’ by any of the following methods: • Agency Web site: https:// www.federalreserve.gov. Follow the instructions for submitting comments at https://www.federalreserve.gov/ generalinfo/foia/ProposedRegs.cfm. • Federal eRulemaking Portal: https:// www.regulations.gov. Follow the instructions for submitting comments. • Email: regs.comments@federalreserve.gov. Include the docket number in the subject line of the message. • Fax: (202) 452–3819 or (202) 452– 3102. • Mail: Address to Robert deV. Frierson, Secretary, Board of Governors of the Federal Reserve System, 20th Street and Constitution Avenue NW., Washington, DC 20551. All public comments will be made available on the Board’s Web site at https://www.federalreserve.gov/ generalinfo/foia/ProposedRegs.cfm as submitted, unless modified for technical reasons. Accordingly, comments will not be edited to remove any identifying or contact information. Public comments may also be viewed electronically or in paper in Room MP– 500 of the Board’s Martin Building (20th and C Streets NW., Washington, DC E:\FR\FM\05AUP1.SGM 05AUP1 emcdonald on DSK67QTVN1PROD with PROPOSALS 47218 Federal Register / Vol. 78, No. 150 / Monday, August 5, 2013 / Proposed Rules 20551) between 9:00 a.m. and 5:00 p.m. on weekdays. FDIC: You may submit comments, identified as ‘‘Stress Test Guidance’’, by any of the following methods: Agency Web site: https:// www.fdic.gov/regulations/laws/federal/ propose.html. Follow instructions for submitting comments on the Agency Web site. • Email: Comments@fdic.gov. Include ‘‘Stress Test Guidance’’ on the subject line of the message. • Mail: Robert E. Feldman, Executive Secretary, Attention: Comments, Federal Deposit Insurance Corporation, 550 17th Street NW., Washington, DC 20429. • Hand Delivery: Comments may be hand delivered to the guard station at the rear of the 550 17th Street Building (located on F Street) on business days between 7:00 a.m. and 5:00 p.m. Public Inspection: All comments received must include the agency name and ‘‘Stress Test Guidance’’. All comments received will be posted without change to https://www.fdic.gov/ regulations/laws/federal/propose.html, including any personal information provided. Paper copies of public comments may be ordered from the FDIC Public Information Center, 3501 North Fairfax Drive, Room E–1002, Arlington, VA 22226 by telephone at (877) 275–3342 or (703) 562–2200. FOR FURTHER INFORMATION CONTACT: Board: David Palmer, Senior Financial Analyst, (202) 452–2904; Joseph Cox, Financial Analyst, (202) 452–3216; Keith Coughlin, Manager, (202) 452–2056; Benjamin McDonough, Senior Counsel, (202) 452–2036; or Christine Graham, Senior Attorney, (202) 452–3005, Board of Governors of the Federal Reserve System, 20th and C Streets NW., Washington, DC 20551. FDIC: Ryan Sheller, Senior Financial Analyst, (202) 412–4861; Mark Flanigan, Counsel, (202) 898–7427; or Jason Fincke, Senior Attorney, (202) 898– 3659, Federal Deposit Insurance Corporation, 550 17th Street NW., Washington, DC 20429. OCC: Harry Glenos, Senior Financial Advisor, (202) 649–6409; Kari Falkenborg, Financial Analyst, (202) 649–6831; Ron Shimabukuro, Senior Counsel, or Henry Barkhausen, Attorney, Legislative and Regulatory Affairs Division, (202) 649–5490, Office of the Comptroller of the Currency, 400 7th Street SW., Washington, DC 20219. SUPPLEMENTARY INFORMATION: I. Background In October 2012, the agencies issued final rules implementing stress testing VerDate Mar<15>2010 16:53 Aug 02, 2013 Jkt 229001 requirements for companies 1 with over $10 billion in total assets pursuant to section 165(i)(2) of the Dodd-Frank Wall Street Reform and Consumer Protection Act (‘‘DFA stress test rules’’).2 At that time, the agencies also indicated that they intended to publish supervisory guidance to accompany the final rules and assist companies in meeting rule requirements, including separate guidance for companies between $10 billion and $50 billion in total assets. Accordingly, the agencies are issuing this proposed guidance, which would apply to all companies with total consolidated assets of more than $10 billion but less than $50 billion ($10–50 billion companies). The agencies invite public comment on this proposed guidance. The agencies expect $10–50 billion companies to follow the DFA stress rule requirements, other relevant supervisory guidance,3 and if adopted, the expectations set forth in this document, when conducting DFA stress tests.4 The proposed guidance addresses the following key areas: • Supervisory scenarios. Under the DFA stress test rules, $10–50 billion companies must assess the potential impact of a minimum of three macroeconomic scenarios—baseline, adverse, and severely adverse—on their consolidated losses, revenues, balance sheet (including risk-weighted assets), and capital. The proposed guidance indicates that $10–50 billion companies should apply each scenario across all business lines and risk areas so that they can assess the effect of a common scenario on the entire enterprise, though the effect of the given scenario on different business lines and risk areas may vary. These companies may use all or, as appropriate, a subset of the 1 For the OCC, the term ‘‘company’’ is used in this guidance to refer to national banks and Federal savings associations that qualify as ‘‘covered institutions’’ under the OCC Annual Stress Test Rule. 12 CFR 46.2. For the Board, the term ‘‘company’’ is used in this guidance to refer to state member banks, bank holding companies, and savings and loan holding companies. 12 CFR 252.153. For the FDIC, the term ‘‘company’’ is used in this guidance to refer to insured state nonmember banks and insured state savings associations that qualify as a ‘‘covered bank’’ under the FDIC Annual Stress Test Rule. 12 CFR 325.202. 2 See 77 FR 61238 (October 9, 2012) (OCC final rule), 77 FR 62378 (October 12, 2012) (Board final rule), and 77 FR 62417 (October 15, 2012) (FDIC final rule). 3 In particular, companies should conduct tests in accordance with 77 FR 29458, ‘‘Supervisory Guidance on Stress Testing for Banking Organizations With More Than $10 Billion in Total Consolidated Assets,’’ (May 17, 2012). 4 To the extent that the guidance conflicts with the requirements imposed with respect to any future statutory or regulatory stress test, companies must comply with the requirements set forth in the relevant statute or regulation. PO 00000 Frm 00005 Fmt 4702 Sfmt 4702 variables from the supervisory scenarios to conduct a stress test, depending on whether the variables are relevant or appropriate to the company’s line of business. The companies may, but are not required to, include additional variables or additional quarters to improve their company-run stress tests. For example, the proposed guidance includes a set of questions on translating supervisory scenarios to regional variables and minimum expectations for loss estimation. However, the paths of any additional regional or local variables that a company uses would be expected to be consistent with the path of the national variables in the supervisory scenarios. • Data sources and segmentation. In conducting a stress test, a company should segment its portfolios and business activities into categories based on common or related risk characteristics. The company should select the appropriate level of segmentation based on the size, materiality, and riskiness of a given portfolio, provided there are sufficiently granular historical data available to allow for the desired segmentation. A company would be expected to be able to segment its data at a level at least as granular as the reporting form it uses to report the results to its primary regulator and the Board (‘‘$10–50 billion reporting form’’), but may use a more granular segmentation, particularly for more material or riskier portfolios.5 If a company does not currently have sufficient internal data to conduct a stress test, it may use an alternative data source as a proxy for its own risk profile and exposures. However, companies with limited data would be expected to construct strategies to develop sufficient data to improve their stress test estimation processes over time. • Loss estimation. In conducting a stress test, for each quarter of the planning horizon, a company must estimate the following for each required scenario: losses, pre-provision net revenue (PPNR), provision for loan and lease losses, and net income.6 Credit losses associated with loan portfolios and securities holdings should be estimated directly and separately, whereas other types of losses should be incorporated into estimated preprovision net revenue. Larger or more sophisticated companies should consider more advanced loss estimation practices that identify the key drivers of 5 For Federal Reserve-regulated companies the relevant reporting form is the FR Y–16, for OCCregulated companies the relevant form is the OCC DFAST 10–50, and for FDIC-regulated companies the relevant form is the FDIC DFAST 10–50. 6 12 CFR 252.155(a)(1). E:\FR\FM\05AUP1.SGM 05AUP1 emcdonald on DSK67QTVN1PROD with PROPOSALS Federal Register / Vol. 78, No. 150 / Monday, August 5, 2013 / Proposed Rules losses for a given portfolio, segment, or loan; determine how those drivers would be affected in supervisory scenarios; and estimate resulting losses. Loss estimation practices should be commensurate with the materiality of the risks measured and well supported by sound, empirical analysis. Companies may use different processes for the baseline scenario, including their budgeting process if it is conditioned on the supervisory scenario, than for the adverse and severely adverse scenarios in order to better capture the loss potential under stressful conditions. • Pre-provision net revenue. The proposed guidance indicates that companies that are less complex or less sophisticated could estimate projected PPNR based on the three main components of PPNR (net interest income, non-interest income, noninterest expense) at an aggregate, company-wide level based on industry experience. Companies that are more complex or more sophisticated should consider methods that more fully capture potential risks to their business and strategy by collecting internal revenue data, estimating revenues within specific business lines, exploring more advanced techniques that identify the specific drivers of revenue, and analyzing how the supervisory scenarios affect those revenue drivers. In addition to credit losses, companies may determine that other types of losses could arise under the supervisory scenarios. These other types of losses should be included in projections of PPNR to the extent they would arise under the specified scenario conditions. For example, companies should include in their PPNR projections any trading losses, any losses related to mortgage repurchase agreements, mortgage servicing rights, or losses related to operational risk arising in the scenarios. • Balance sheet and risk-weighted assets projections. Under the proposed guidance, a company would be expected to ensure that projected balance sheet and risk-weighted assets remain consistent with regulatory and accounting changes, are applied consistently across the company, and are consistent with the scenario and the company’s past history of managing through different business environments. Companies should document and explain key underlying assumptions about changes in balances or risk-weighted assets under stressful conditions, including justifying major changes, justifying any assumptions about strategies that may mitigate losses under the stressful conditions, and ensuring that the assumptions do not VerDate Mar<15>2010 16:53 Aug 02, 2013 Jkt 229001 substantially alter the company’s core businesses and earnings capacity. • Governance and controls. Under the DFA stress test rules, a $10–50 billion company is required to establish and maintain a system of controls, oversight, and documentation, including policies and procedures, that are designed to ensure that its stress testing processes are effective in meeting the requirements of the DFA stress test rule. The proposed guidance describes supervisory expectations and sound practices regarding the controls, oversight, and documentation required by the rule. All $10–50 billion companies must consider the role of stress testing results in normal business including in the capital planning, assessment of capital adequacy, and risk management practices of the company. For instance, a $10–50 billion company would be expected to ensure that its post-stress capital results are aligned with its internal capital goals and risk appetite. For cases in which post-stress capital results are not aligned with a company’s internal capital goals, senior management should provide options it and the board would consider to bring them into alignment. II. Request for Comments The agencies invite comment on all aspects of the proposed guidance. Specifically, the agencies seek comment on the following questions. Question 1: What challenges do companies expect in relating the national variables in the scenarios to regional and local market footprints? Question 2: What additional clarity might be needed regarding the appropriate use of historical experience in the loss, revenue, balance sheet, and risk-weighted asset estimation process? Question 3: What additional clarity should the guidance provide about the use of vendor or other third-party products and services that companies might choose to employ for DFA stress tests? Question 4: How could the proposed guidance be clearer about the manner in which the required capital action assumptions between holding companies and banks differ, and how those different assumptions should be reconciled within a consolidated organization? Question 5: What additional clarification would be helpful to companies about the responsibilities of their boards and senior management with regard to DFA stress tests? The agencies request that commenters reference the question numbers above when providing answers to those questions. PO 00000 Frm 00006 Fmt 4702 Sfmt 4702 47219 III. Administrative Law Matters A. Paperwork Reduction Act Analysis This guidance references currently approved collections of information under the Paperwork Reduction Act (44 U.S.C. 3501–3520) provided for in the DFA stress test rules.7 This guidance does not introduce any new collections of information nor does it substantively modify the collections of information that Office of Management and Budget (OMB) has approved. Therefore, no Paperwork Reduction Act submissions to OMB are required. B. Regulatory Flexibility Act Analysis Board: While the guidance is not being adopted as a rule, the Board has considered the potential impact of the guidance on small companies in accordance with the Regulatory Flexibility Act (5 U.S.C. 603(b)). Based on its analysis and for the reasons stated below, the Board believes that the proposed guidance will not have a significant economic impact on a substantial number of small entities. Nevertheless, the Board is publishing a regulatory flexibility analysis. For the reason discussed in the Supplementary Information above, the agencies are issuing this guidance to provide additional details regarding the supervisory expectations for the DFA stress tests conducted by $10–50 billion companies. Under regulations issued by the Small Business Administration (‘‘SBA’’), a small entity includes a depository institution, bank holding company, or savings and loan holding company with total assets of $500 million or less (a small banking organization).8 The proposed guidance would apply to companies supervised by the agencies with more than $10 billion but less than $50 billion in total consolidated assets, including state member banks, bank holding companies, and savings and loan holding companies. Companies that would be subject to the proposed guidance therefore substantially exceed the $500 million total asset threshold at which a company is considered a small company under SBA regulations. In light of the foregoing, the Board does not believe that the guidance would 7 See OMB Control Nos. 1557–0311 and 1557– 0312 (OCC); 3064–0186 and 3064–0187 (FDIC); and 7100–0348 and 7100–0350 (Board). 8 Effective July 22, 2013, the Small Business Administration revised the size standards for small banking organizations to $500 million in assets from $175 million in assets. 78 FR 37409 (June 20, 2013). E:\FR\FM\05AUP1.SGM 05AUP1 47220 Federal Register / Vol. 78, No. 150 / Monday, August 5, 2013 / Proposed Rules have a significant economic impact on a substantial number of small entities. IV. Proposed Supervisory Guidance The text of the proposed supervisory guidance is as follows: Office of the Comptroller of the Currency Federal Reserve System Federal Deposit Insurance Corporation Proposed Supervisory Guidance on Implementing Dodd-Frank Act Company-Run Stress Tests for Banking Organizations With Total Consolidated Assets of More Than $10 Billion but Less Than $50 Billion I. Introduction emcdonald on DSK67QTVN1PROD with PROPOSALS In October 2012, the U.S. Federal banking agencies issued the Dodd-Frank Act stress test rules 9 requiring companies with total consolidated assets of more than $10 billion to conduct annual company-run stress tests pursuant to section 165(i)(2) of the Dodd-Frank Wall Street Reform and Consumer Protection Act (DFA).10 This guidance outlines key expectations for companies with total consolidated assets of more than $10 billion but less than $50 billion that are required to conduct DFA stress tests (collectively ‘‘companies’’ or ‘‘$10–50 billion companies’’).11 It builds upon the interagency stress testing guidance issued in May 2012 for companies with more than $10 billion in total consolidated assets (‘‘May 2012 stress testing guidance’’).12 9 See 77 FR 61238 (October 9, 2012) (OCC), 77 FR 62396 (October 12, 2012) (Board: Annual CompanyRun Stress Test Requirements for Banking Organizations with Total Consolidated Assets over $10 Billion Other than Covered Companies), and 77 FR 62417 (October 15, 2012) (FDIC). 10 Public Law 111–203, 124 Stat. 1376 (2010). Each entity that meets the applicability criteria must conduct a separate stress test and provide a separate submission. For example, both a bank holding company between $10–50 billion in assets and its subsidiary bank with between $10–50 billion in assets must conduct a separate stress test; however, if a subsidiary bank of a $10–50 billion bank holding company has $10 billion or less in assets then it does not need to conduct a DFA stress test. 11 For the OCC, the term ‘‘company’’ is used in this guidance to refer to a banking organization that qualifies as a ‘‘covered institution’’ under the OCC Annual Stress Test Rule. 12 CFR 46.2. For the Board, the term ‘‘company’’ is used in this guidance to refer to state member banks, bank holding companies, and savings and loan holding companies. 12 CFR 252.153. For the FDIC, the term ‘‘company’’ is used in this guidance to refer to insured state nonmember banks and insured state savings associations that qualifies as a ‘‘covered bank’’ under the FDIC Annual Stress Test Rule. 12 CFR 325.202. 12 77 FR 29458, ‘‘Supervisory Guidance on Stress Testing for Banking Organizations With More Than VerDate Mar<15>2010 16:53 Aug 02, 2013 Jkt 229001 The expectations described in this guidance are tailored to the $10–50 billion companies, similar to the manner in which the requirements in the DFA stress test rules were tailored for this set of companies.13 The additional information provided in this guidance should assist companies in complying with the DFA stress test rules and conducting DFA stress tests that are appropriate for their risk profile, size, complexity, business mix, and market footprint. The DFA stress test rules allow flexibility to accommodate different practices across organizations, for example by not specifying specific methodological practices. Consistent with this approach, this guidance sets general supervisory expectations for stress tests, and provides, where appropriate, some examples of possible practices that would be consistent with those expectations. This guidance does not represent a comprehensive list of potential practices, and companies are not required to use any specific methodological practices for their stress tests. Companies may use various practices to project their losses, revenues, and capital that are appropriate for their risk profile, size, complexity, business mix, market footprint and the materiality of a given portfolio. II. Background Stress tests are an important part of a company’s risk management practices, supporting a company’s forward-looking assessment of its risks and helping to ensure that the company has sufficient capital to support its operations through periods of stress. The agencies have previously highlighted the importance of stress testing as a means for companies to better understand the range of potential risks. Specifically, the May 2012 stress testing guidance sets forth the following five principles for an effective stress testing regime: 1. A company’s stress testing framework should include activities and exercises that are tailored to and sufficiently capture the company’s exposures, activities, and risks; 2. An effective stress testing framework should employ multiple conceptually sound stress testing activities and approaches; $10 Billion in Total Consolidated Assets,’’ (May 17, 2012). 13 As indicated in the DFA stress test final rules, the agencies also plan to issue supervisory guidance for companies with at least $50 billion in total assets. Consistent with the approach taken in the DFA stress test final rules, the agencies expect the guidance for companies with at least $50 billion to contain standards that are comparable or elevated in all areas. PO 00000 Frm 00007 Fmt 4702 Sfmt 4702 3. An effective stress testing framework should be forward-looking and flexible; 4. Stress test results should be clear, actionable, well supported, and inform decision-making; and 5. A company’s stress testing framework should include strong governance and effective internal controls. The agencies expect that companies will follow the principles and expectations in the May 2012 stress testing guidance when conducting their DFA stress tests. This DFA stress test guidance builds upon the May 2012 stress testing guidance, sets forth the supervisory expectations regarding each requirement of the DFA stress test rules, and provides illustrative examples of satisfactory practices. The guidance indicates where different requirements apply to banks, thrifts, and holding companies. The guidance is structured as follows: A. DFA Stress Test Timelines B. Scenarios for DFA Stress Tests C. DFA Stress Test Methodologies and Practices D. Estimating the Potential Impact on Regulatory Capital Levels and Capital Ratios E. Controls, Oversight, and Documentation F. Report to Supervisors G. Public Disclosure of DFA Stress Tests The agencies expect that the annual company-run stress tests required under the DFA stress test rules will be one component of the broader stress-testing activities conducted by $10–$50 billion companies. The DFA stress tests may not necessarily capture a company’s full range of risks, exposures, activities, and vulnerabilities that have a potential effect on capital adequacy. For example, DFA stress tests may not account for regional concentrations and unique business models, or they may not fully cover the potential capital effects of interest rate risk or an operational risk event such as a regional natural disaster.14 Consistent with the May 2012 stress testing guidance, a company is expected to consider the results of DFA stress testing together with other capital assessment activities to ensure that the company’s material risks and vulnerabilities are appropriately considered in its overall assessment of capital adequacy. Finally, the DFA stress tests assess the impact of stressful 14 For purposes of this guidance, the term ‘‘concentrations’’ refers to groups of exposures and/ or activities that have the potential to produce losses large enough to bring about a material change in a banking organization’s risk profile or financial condition. E:\FR\FM\05AUP1.SGM 05AUP1 Federal Register / Vol. 78, No. 150 / Monday, August 5, 2013 / Proposed Rules outcomes on capital adequacy, and are not intended to measure the adequacy of a company’s liquidity in the stress scenarios. III. Annual Tests Conducted by Companies A. DFA Stress Test Timelines Rule Requirement: A company must conduct a stress test over a nine-quarter planning horizon based on data as of September 30 of the preceding calendar year.15 Stress test projections are based on exposures with the as-of date of September 30 and extend over a ninequarter planning horizon that begins in the quarter ending December 31 of the same year and ends with the quarter ending December 31 two years later.16 For example, a stress test beginning in the fall of 2013 would use an as-of date of September 30, 2013, and involve quarterly projections of losses, PPNR, balance sheet, risk-weighted assets, and capital beginning on December 31, 2013 of that year and ending on December 31, 2015. In order to project quarterly provisions, a company would need to estimate the adequate level of the allowance for loan and lease losses (‘‘ALLL’’) to support remaining credit risk at the end of each quarter— including the final quarter—which may require additional projections of credit losses beyond 2015 to ensure the ALLL is consistent with Generally Accepted Accounting Principles (GAAP). emcdonald on DSK67QTVN1PROD with PROPOSALS B. Scenarios for DFA Stress Tests Rule Requirement: A company must use the scenarios provided annually by its primary Federal financial regulatory agency to assess the potential impact of the scenarios on its consolidated earnings, losses, and capital.17 Under the DFA stress test rules, $10– 50 billion companies must assess the potential impact of a minimum of three macroeconomic scenarios—baseline, adverse, and severely adverse— provided by their primary supervisor on their consolidated losses, revenues, balance sheet (including risk-weighted assets), and capital. The rule defines the three scenarios as follows: • Baseline scenario means a set of conditions that affect the U.S. economy or the financial condition of a company 15 12 CFR 46.5 (OCC); 12 CFR 252.154 (Board); 12 CFR 325.204 (FDIC). 16 Planning horizon means the period of at least nine quarters, beginning with the quarter ending December 31, over which the relevant stress test projections extend. 17 12 CFR 46.6 (OCC); 12 CFR 252.154 (Board); 12 CFR 325.204 (FDIC). VerDate Mar<15>2010 16:53 Aug 02, 2013 Jkt 229001 that reflect the consensus views of the economic and financial outlook. • Adverse scenario means a set of conditions that affect the U.S. economy or the financial condition of a company that are more adverse than those associated with the baseline scenario and may include trading or other additional components. • Severely adverse scenario means a set of conditions that affect the U.S. economy or the financial condition of a company that overall are more severe than those associated with the adverse scenario and may include trading or other additional components. The agencies will provide a description of the supervisory scenarios to companies no later than November 15 each calendar year. The scenarios provided by the agencies are not forecasts but rather are hypothetical scenarios that companies will use to assess their capital strength in baseline and stressed economic and financial conditions. Companies should apply each scenario across all business lines and risk areas so that they can assess the effect of a common scenario on the entire enterprise, though the effect of the given scenario on different business lines and risks may vary. The agencies believe that a uniform set of supervisory scenarios is necessary to provide a basis for comparison across companies. However, a company is not required to use all of the variables provided in the scenario, if those variables are not relevant or appropriate to the company’s line of business. In addition, a company may, but is not required to, use additional variables beyond those provided by the agencies. For example, a company may decide to use a regional unemployment rate to improve the robustness of its stress test projections. When using additional variables, companies should ensure that the paths of such variables (including their timing) are consistent with the general economic environment assumed in the supervisory scenarios. Any use of additional variables should be well supported and documented. In addition, a company may choose to project the paths of variables beyond the timeframe of the supervisory scenarios, if a longer horizon is necessary for the company’s stress testing methodology. For example, a company may project the unemployment rate for additional quarters in order to calculate inputs to its end-of-horizon ALLL or to estimate the projected value of certain types of securities under the scenario. Companies may use third-party vendors to assist in the development of additional variables based on the supervisory stress scenarios. In such PO 00000 Frm 00008 Fmt 4702 Sfmt 4702 47221 instances, consistent with existing supervisory expectations,18 companies should understand the third-party analysis used to develop additional variables, including the potential limitations of such analysis as it relates to stress tests, and be able to challenge key assumptions. Companies should also ensure that vendor-supplied variables they use are relevant for and relate to company-specific characteristics. C. DFA Stress Test Methodologies and Practices Rule Requirement: In conducting a stress test, for each quarter of the planning horizon, a company must estimate the following for each required scenario: losses, pre-provision net revenue, provision for loan and lease losses, and net income.19 As noted above, companies must identify and determine the impact on capital from the supervisory scenarios, as represented through the supervisory scenario variables and any additional variables chosen by the company. A company’s estimation processes should reasonably capture the relationship between the assumed scenario conditions and the projected impacts and outcomes to the company. The agencies expect that the specific methodological practices used by companies to produce the estimates may vary across organizations. Supervisors generally expect that all banking organizations, as part of overall safety and soundness, will continue to enhance their risk management practices. Accordingly, a $10–50 billion company’s DFA stress testing practices should evolve and improve over time. In addition, DFA stress testing practices for $10–50 billon companies should be commensurate with each company’s size, complexity, and sophistication. This means that, generally, larger or more sophisticated companies should employ not just the minimum expectations, but the more advanced practices described in this guidance. The remainder of this section outlines key practices that all $10–50 billion companies should incorporate into their methodologies for estimating losses, PPNR, PLLL, and net income. It begins with general expectations that apply across various types of estimation methodologies, and then provides additional expectations for specific areas, such as loss estimation, revenue 18 ‘‘Supervisory Guidance on Model Risk Management,’’ OCC 2011–12, or ‘‘Guidance on Model Risk Management,’’ Federal Reserve SR 11– 7, April 4, 2011. 19 12 CFR 46.6 (OCC); 12 CFR 252.155(a)(1) (Board); 12 CFR 325.205(a)(1) (FDIC). E:\FR\FM\05AUP1.SGM 05AUP1 47222 Federal Register / Vol. 78, No. 150 / Monday, August 5, 2013 / Proposed Rules emcdonald on DSK67QTVN1PROD with PROPOSALS estimation, and balance sheet projections. In making projections, companies should make conservative assumptions about management responses in the stress tests, and should include only those responses for which there is substantial support. For example, companies may account for hedges that are already in place as potential mitigating factors against losses but should be conservative in making assumptions about potential future hedging activities and not necessarily anticipate that actions taken in the past could be taken under the supervisory scenarios. 1. Data Sources Companies are expected to have appropriate management information systems and data processes that enable them to collect, sort, aggregate, and update data and other information efficiently and reliably within business lines and across the company for use in DFA stress tests. Data used for DFA stress tests should be reliable and generally consistent across time. In cases where a company may not currently have a full cycle of historical data or data in sufficient granularity on which to base its analyses, it may use an alternative data source, such as a data history drawn from other organizations of demonstrably comparable market presence, concentrations, and risk profile (for example, regulatory reporting or vendor-supplied data), as a proxy for its own risk profile and exposures. Companies with limited internal data should develop specific strategies to accumulate the data necessary to improve their estimation practices over time, as having internal data relevant to current exposures generally improves loss projections and provides a better basis for assessment of those projections. Over the long term, companies may continue to use such proxy data to benchmark the estimates produced using internal data or to augment any gaps in internal data (for example, if a company is moving into a new business area). However, companies should use proxy data cautiously, as these data may not adequately represent a company’s own exposures, business activities, underwriting, and risk characteristics. Even when a company has extensive historical data, it should look beyond the assumptions based on or embedded in those historical data. Companies should challenge conventional assumptions to ensure that a company’s stress test is not constrained by its own past experience. This is particularly important when historical data does not contain stressful periods or if the VerDate Mar<15>2010 16:53 Aug 02, 2013 Jkt 229001 specific characteristics of the scenarios are unlike the conditions in the available historical data. 2. Data Segmentation To account for differences in risk profiles across various exposures and activities, companies should segment their portfolios and business activities into categories based on common or related risk characteristics. The company should select the appropriate level of segmentation based on the size, materiality, and risk of a given portfolio, provided there are sufficiently granular historical data available to allow for the desired segmentation. The minimum expectation is that companies will segment their portfolios and business activities using the categories listed in the $10–50 billion reporting form.20 A company may use more granular segmentation than the $10–50 billion reporting form categories, particularly for more material, concentrated, or relatively riskier portfolios. For instance, a company could have a commercial loan portfolio containing loans to different industries with varying sensitivities to the scenario variables. More advanced portfolio segmentation can take several forms, such as by product (construction versus income-producing real estate), industry, loan size, credit quality, collateral type, geography, vintage, maturity, debt service coverage, or loan-to-value (LTV) ratio. The company may also pool exposures with common or correlated risk characteristics, such as segmenting loans to businesses related to automobile production. Companies may also segment the portfolio according to geography, if they engage in activities in geographic areas with differing economic and financial characteristics. Such segmentation may be particularly valuable in situations where geographic areas show varying sensitivity to national economic and financial changes or where different scenario variables are necessary to capture key risks (such as projecting wholesale loan losses for regions with different industrial concentrations). For any type of segmentation that is more granular than the categories in the $10–50 billion reporting form, a company should maintain a map of internally defined 20 For purposes of this guidance, the term ‘‘$10– 50 billion reporting form’’ refers to the relevant reporting form a $10–50 billion company will use to report the results of its DFA stress tests to its primary Federal financial regulatory agency. For Federal Reserve-regulated companies the relevant reporting form is the FR Y–16, for OCC-regulated companies the relevant form is the OCC DFAST 10– 50, and for FDIC-regulated companies the relevant form is the FDIC DFAST 10–50. PO 00000 Frm 00009 Fmt 4702 Sfmt 4702 segments to the $10–50 billion reporting form categories for accurate reporting. Some companies’ business line or risk assessment functions may already segment data with more granularity, i.e., beyond the $10–50 billion reporting form categories, which would support their DFA stress tests. Enhanced data details on borrower and loan characteristics may identify distinct and separate credit risks within a reporting category more effectively, and therefore yield a more accurate risk assessment than simply analyzing the larger aggregate portfolio. Greater segmentation, particularly for larger or riskier portfolios, may prove especially useful in estimating the risks to a portfolio under the adverse or severely adverse scenarios, because aggregated or less segmented portfolios may mask or distort the effect of potentially more stressful conditions on sub-portfolios. While $10–50 billion reporting form categories represent the minimum acceptable segmentation, larger or more sophisticated $10–50 billion companies should consider whether that level of segmentation is sufficient for the risk in their portfolios. 3. Model risk management Companies should have in place effective model risk management practices, including validation, for all models used in DFA stress tests, consistent with existing supervisory guidance.21 This includes ensuring that DFA stress test models are subject to appropriate standards for model development, implementation and use, model validation and model governance. Companies should ensure an effective challenge process by unbiased, competent, and qualified parties is in place for all models. There should also be sufficient documentation of all models, including model assumptions, limitations, and uncertainties. Senior management should have appropriate understanding of DFA stress test models to provide summary information to the company’s board of directors that allows directors to assess and question methodologies and results. Companies should ensure that their model risk management policies and practices generally apply to the use of vendor and third-party products as well. This includes all the standards and expectations outlined above and in existing supervisory guidance. If a company is using vendor models, senior management is expected to demonstrate knowledge of the model’s design, intended use, applications, limitations 21 OCC E:\FR\FM\05AUP1.SGM 2011–12 and FR SR 11–7. 05AUP1 Federal Register / Vol. 78, No. 150 / Monday, August 5, 2013 / Proposed Rules emcdonald on DSK67QTVN1PROD with PROPOSALS and assumptions. For cases in which knowledge about a vendor or third-party model is limited for proprietary or other reasons, companies should take additional steps to ensure that they have an understanding of the model and can confirm it is functioning as intended. For example, companies may need to conduct more sensitivity analysis and benchmarking if information about a vendor model is limited for proprietary or other reasons. Additionally, a company should have as much in-house knowledge as possible in the event of vendor contract termination and should have contingency plans in cases where a vendor model is no longer available. In cases where there are noted weaknesses or limitations in models or data used for stress tests, a company may choose to apply qualitative adjustments to the model or its output that are expert judgment-based. In most cases, however, estimation based solely or heavily reliant on qualitative adjustments should not be the main component of final loss estimates. Where qualitative adjustments are made, they should be consistently determined and applied, and subject to a well-defined process that includes a well-supported rationale, methodology, proper controls and strong documentation. When expert judgment is used on an ongoing basis, the estimates generated by such judgment should be subject to outcomes analysis, to assess performance equivalent to that used to evaluate a quantitative model. Large qualitative adjustments to the stress test results, especially on a repeated basis, may be indicative of a flawed process. 4. Loss estimation For their DFA stress tests, companies are expected to have credible loss estimation practices that capture the risks associated with their portfolios, business lines, and activities. Credit losses associated with loan portfolios and securities holdings should be estimated directly and separately (as described in this section), whereas other types of losses should be incorporated into estimated PPNR (as described in the next section). Processes for loss estimation should be consistent, repeatable, transparent, and well documented. Companies should have a transparent and consistent approach for aggregating loss estimates across the enterprise. For example, inputs from all parts of the company should rely on common assumptions and map to specific loss categories of the $10–50 billion reporting form. A company should ensure that all enterprise loss estimation approaches reflect VerDate Mar<15>2010 16:53 Aug 02, 2013 Jkt 229001 reasonably sufficient rigor and conservatism, and that, for loss estimation, the scenarios are applied consistently across the company. Each company’s loss estimation practices should be commensurate with the materiality of the risks measured and well supported by sound, empirical analysis. The practices may vary in complexity, depending on data availability and the materiality of a given portfolio. In general, loss estimation practices for credit risk are expected to be more advanced than other elements of the stress test, given that credit risk usually represents the largest potential risk to capital adequacy among $10–50 billion companies. Companies should be mindful that the credit performance in a benign economic environment could differ markedly from that during more stressful periods, and the differences could become greater as the severity of stress increases. For example, companies that experienced low losses on their construction loans during a benign economic environment, due to the presence of interest reserves or other risk mitigating factors, may experience a sharp and rapid rise in losses in a scenario where market conditions deteriorate for a prolonged period. A company’s decision whether to use consistent or different loss estimation processes for various supervisory scenarios would depend on the sensitivity of a company’s loss estimation process to a given scenario. A company may use a consistent process for loss estimation for all scenarios if that process is sufficiently sensitive to the severity of each scenario. Alternately, a company may use different loss estimation processes for different scenarios if the process it uses for the baseline scenario does not adequately capture the sensitivity of loss estimates to adverse and severely adverse scenarios. For example, a company may use its budgeting process for its baseline loss projections, if appropriate, but it should use a different process for the adverse and severely adverse scenarios if its budgeting process does not capture the potential for sharply elevated losses during stressful conditions. Whatever processes a company chooses should be conditioned on each of the three macroeconomic scenarios provided by supervisors. Companies may choose loss estimation processes from a range of available methods, techniques, and levels of granularity, depending on the type and materiality of a portfolio, and the type and quality of data available. For instance, some companies may PO 00000 Frm 00010 Fmt 4702 Sfmt 4702 47223 choose to base their stress loss estimates on industry historical loss experience, provided that those estimates are consistent with the conditions in the supervisory scenarios. Companies should choose a method that best serves the structure of their credit portfolios, and they may choose different methods for different portfolios (for example, wholesale versus retail). Furthermore, companies may use multiple methods to estimate losses on any given credit portfolio, and investigate different methods before settling on a particular approach or approaches. Regardless of whether a company uses historical loss experience or a more sophisticated modeling technique to estimate losses in a given scenario, the company should verify that resulting loss estimates are appropriately conditioned on the scenario, and any assumptions used are well understood and documented. In estimating losses based on historical experiences, companies should ensure that historical loss experience contains at least one period when losses were substantially elevated and revenues substantially reduced, such as the downturn of a credit cycle. In addition, companies should ensure that any historical loss data used are consistent with the company’s current exposures and condition. This could occur, for instance, if a company has shifted the proportion of its commercial lending from large corporations to smaller businesses, and the shift is not appropriately reflected in its historical loss data. If neither a company’s own data history nor industry loss data include periods of stress comparable to the supervisory adverse or severely adverse scenario, the company should make reasonable, conservative assumptions based on available data. Companies may choose to estimate credit losses at an aggregate level, at a loan-segment level, or at a loan-by-loan level. Aggregate approaches generally involve estimating loan losses for portfolios of loans, such as the $10–50 billion reporting form categories or more granular categories. Loan segmentation approaches group individual loans into segments or pools of obligors with similar risk characteristics to estimate losses. For example, individual 30-year fixed-rate mortgage loans may be pooled into one segment, and 5-year adjustablerate mortgages (ARMs) into another segment, each to be modeled separately based on the balance, loss, and default history in that loan segment. Loan segments can also be determined based on additional risk characteristics, such as credit score, LTV ratio, borrower location, and payment status. Finally, loan-level approaches estimate losses E:\FR\FM\05AUP1.SGM 05AUP1 emcdonald on DSK67QTVN1PROD with PROPOSALS 47224 Federal Register / Vol. 78, No. 150 / Monday, August 5, 2013 / Proposed Rules for each loan or borrower and aggregate those estimates to arrive at portfoliolevel losses. Some of the more commonly used modeling techniques for estimating loan losses include net charge-off models, roll-rate models, and transition matrices. Net charge-off models typically estimate the net charge-off rate for a given portfolio, based on the historical relationship between the net charge offs and relevant risk factors, including macroeconomic variables. Roll-rate models generally estimate the rate at which loans that are current or delinquent in a given quarter roll into delinquent or default status in the next quarter, conditioning such estimates on relevant risk factors. Transition matrices estimate the probability that risk ratings on loans could change from quarter to quarter and observe how transition rates differ in stressful periods compared with less stressful or baseline periods. Some companies may also use an expected loss approach, where the probability of default, loss given default, and exposure at default are estimated for individual loans, conditioning such estimates on each loan or portfolio risk characteristics and the economic scenario. Companies can benefit from exploring different modeling approaches, giving due consideration to cost effectiveness and with the understanding that more sophisticated methodologies will not necessarily prove more practicable or robust. Loss estimation practices should be commensurate with the overall size, complexity and sophistication of the company, as well as with individual portfolios, to ensure they fully capture a company’s risk profile. Accordingly, smaller, less sophisticated $10–50 billion companies may employ simpler loss estimation practices that rely on industry historical loss experience at a higher level of aggregation. On the other hand, larger or more sophisticated $10– 50 billion companies should consider more advanced loss estimation practices that identify the key drivers of losses for a given portfolio, segment, or loan, determine how those drivers would be affected in supervisory scenarios, and estimate resulting losses. Loss projections should include projections of other-than-temporary impairments (OTTI) for securities both held for sale and held to maturity. OTTI projections should be based on positions as of September 30 and should be consistent with the supervisory scenarios and standard accounting treatment. Companies should ensure that their securities loss estimation practices, including definitions of loss VerDate Mar<15>2010 16:53 Aug 02, 2013 Jkt 229001 used, remain current with regulatory and accounting changes. 5. Pre-provision net revenue estimation The projection of potential revenues is a key element of a stress test. For the DFA stress test, companies are required to project PPNR over the planning horizon for each supervisory scenario.22 Companies should estimate PPNR at a level at least as granular as the components outlined in the $10–50 billion reporting form. Companies should be mindful that revenue patterns could differ markedly in baseline versus stress periods, and should therefore not make assumptions that revenue streams will remain the same or follow similar paths across all scenarios. In estimating PPNR, companies should consider, among other things, how potentially higher nonaccruals, increased collection costs, and changes in funding sources during the adverse and severely adverse scenarios could affect PPNR. Companies should ensure that PPNR projections are generally consistent with projections of losses, the balance sheet, and riskweighted assets. For example, if a company projects that loan losses would be reduced because of declining loan balances under a severely adverse scenario, PPNR would also be expected to decline under the same scenario due to the decline in interest income. Companies should ensure transparency and appropriate documentation of all material assumptions related to PPNR. There are various ways to estimate PPNR under stress scenarios and companies are not required to use any specific method. For example, companies may project each of three main components of PPNR (net interest income, non-interest income, and noninterest expense) or sub-components of PPNR (e.g., interest income or fee income), on an aggregate level for the entire company or by business line. Companies may base their PPNR estimates on internal or industry historical experience, or use a more sophisticated model-based approach to project PPNR. For example, some companies may project PPNR based on a historical relationship between PPNR or broad components of PPNR and macroeconomic variables. In those instances, companies may use the level of PPNR or the ratio of PPNR to a relevant balance sheet measure, such as assets or loans. Some companies may use a more granular breakout of PPNR (for example, interest income on loans), 22 The DFA stress test rules define PPNR as net interest income plus non-interest income less noninterest expense. Non-operational or non-recurring income and expense items should be excluded. PO 00000 Frm 00011 Fmt 4702 Sfmt 4702 identify relevant economic variables (for example, interest rates), and employ models based on historical data to project PPNR. Some companies may use their asset-liability management models to project some components of PPNR, such as net interest income. A company may estimate the stressed components of PPNR based on its own or industry-wide historical income and expense experience, particularly during the early development of a company’s stress testing practices. When using its own history, a company should ensure that the data include at least one stressful period; when using industry data, a company should ensure that such data are relevant to its portfolios and businesses and appropriately reflect potential PPNR under each supervisory scenario. If neither its own data nor industry data include the period of stress that is comparable to the supervisory adverse or severely adverse scenario, a company should make conservative assumptions, based on available data, and appropriately adjust its historical PPNR data downward in its stressed estimate. A company that has been experiencing merger activity, rapid growth, volatile revenues, or changing business models should rely less on its own historical experience, and generally make conservative assumptions. Smaller or less sophisticated $10–50 billion companies may employ PPNR estimation approaches that project the three main components of PPNR at the aggregate, company-wide level based on industry experience. Larger or more sophisticated $10–50 billion companies should consider PPNR estimation practices that more fully capture potential risks to their business and strategy by collecting internal revenue data, estimating revenues within specific business lines, exploring more advanced techniques that identify the specific drivers of revenue, and analyzing how the supervisory scenarios affect those revenue drivers. Whatever process a company chooses to employ, projected revenues and expenses should be credible and reflect a reasonable translation of expected outcomes consistent with the key scenario variables. In addition to the credit losses associated with loan portfolios and securities holdings, described in the previous section, that should be estimated directly and separately, companies may determine that other types of losses could arise under the supervisory scenarios. These other types of losses should be included in projections of PPNR to the extent they would arise under the specified scenario E:\FR\FM\05AUP1.SGM 05AUP1 Federal Register / Vol. 78, No. 150 / Monday, August 5, 2013 / Proposed Rules emcdonald on DSK67QTVN1PROD with PROPOSALS conditions. For example, any trading losses arising from the scenario conditions should be included in the non-interest income component of PPNR. As another example, companies should estimate under the non-interest expense component of PPNR any losses associated with requests by mortgage investors—including both governmentsponsored enterprises as well as privatelabel securities holders—to repurchase loans deemed to have breached representations and warranties, or with investor litigation that broadly seeks damages from companies for losses. Companies with material representation and warranty risk may consider a range of legal process outcomes, including worse than expected resolutions of the various contract claims or threatened or pending litigation against a company and against various industry participants. Additionally, in estimating non-interest income, companies with significant mortgage servicing operations should consider the effect of the supervisory scenarios on revenue and expenses related to mortgage servicing rights and the associated impact to regulatory capital. PPNR estimates should also include any operational losses that a company estimates based on the supervisory scenarios provided. Companies should address operational risk in their PPNR projections if such events are related to the supervisory scenarios provided, or if there are pending related issues, such as ongoing litigation, that could affect losses or revenues over the planning horizon. 6. Balance sheet and risk-weighted asset projections A company is expected to project its balance sheet and risk-weighted assets for each of the supervisory scenarios. In doing so, these projections should be consistent with scenario conditions and the company’s prior history of managing through the different business environments, especially stressful ones. For example, if a company has reduced its business activity and balance sheet during past periods of stress or if it has contingent exposures, that should be taken into consideration. The projections of the balance sheet and risk-weighted assets should be consistent with other aspects of stress test projections, such as losses and PPNR. In addition, balance sheet and risk-weighted asset projections should remain current with regulatory and accounting changes. Companies may use a variety of methods to project balance sheet and risk-weighted assets. In certain cases, it VerDate Mar<15>2010 16:53 Aug 02, 2013 Jkt 229001 may be appropriate for a company to use simpler approaches for balance sheet and risk-weighted asset projections, such as a constant-portfolio assumption. Alternatively, a company may rely on estimates of changes in balance sheet and risk-weighted assets based on their own or industry-wide historical experience, provided that the internal or external historical balance sheet and risk-weighted asset experience contains stressful periods. As in the case of loss estimation and PPNR, using industry-wide data might be more appropriate when internal data lack sufficient history, granularity, or observations from stressful periods; however, companies should take caution when using the industry data and provide appropriate documentation for all material assumptions. In stress scenarios, companies should justify major changes in the composition of risk-weighted assets, for example, based on assumptions about a company’s strategic direction, including events such as material sales, purchases, or acquisitions. Furthermore, companies should be mindful that any assumptions about reductions in business activity that would reduce its balance sheet and risk-weighted assets over the planning horizon (such as tightened underwriting) are also likely to reduce PPNR. Such assumptions should also be reasonable in that they do not substantially alter the company’s core businesses and earnings capacity. Companies should document and explain key underlying assumptions, as appropriate. Some companies may choose to employ more advanced, model-based approaches to project balance sheet and risk-weighted assets. For example, a company may project outstanding balances for assets and liabilities based on the historical relationship between those balances and macroeconomic variables. In other cases, a company could project certain components of the balance sheet, for example, based on projections for originations, pay-downs, drawdowns, and losses for its loan portfolios under each scenario. Estimated prepayment behavior conditioned on the relevant scenario and the maturity profile of the asset portfolio could inform balance projections. 7. Estimates for immaterial portfolios Although stress testing should be applied to all exposures as described above, the same level of rigor and analysis may not be necessary for lowerrisk, immaterial, portfolios. Portfolios considered immaterial are those that would not represent a consequential PO 00000 Frm 00012 Fmt 4702 Sfmt 4702 47225 effect on capital adequacy under any of the scenarios provided. For such portfolios, it may be appropriate for a company to use a less sophisticated approach for its stress test projections, provided that the results of that approach are conservative and well documented. For example, estimating losses under the supervisory scenarios for a small portfolio of municipal securities may not involve the same sophistication as a larger portfolio of commercial mortgages. 8. Projections for quarterly provisions and ending allowance for loan and lease losses The DFA stress test rules require companies to project quarterly PLLL. Companies are expected to project PLLL based on projections of quarterly loan and lease losses and the appropriate ALLL balance at each quarter-end for each scenario. In projecting PLLL, companies are expected to maintain an adequate loan-loss reserve through the planning horizon, consistent with supervisory guidance, accounting standards, and a company’s internal practice. Estimated provisions should recognize the potential need for higher reserve levels in the adverse and severely adverse scenarios, since economic stress leads to poorer loan performance. The ALLL at the end of the planning horizon should be consistent with GAAP, including any losses projected beyond the nine-quarter horizon. 9. Projections for quarterly net income Under the DFA stress test rules, companies must estimate projected quarterly net income for each scenario. Net income projections should be based on loss, revenue, and expense projections described above. Companies should also ensure that tax estimates, including deferred taxes and tax assets, are consistent with relevant balance sheet and income (loss) assumptions and reflect appropriate accounting, tax, and regulatory changes. D. Estimating the Potential Impact on Regulatory Capital Levels and Capital Ratios Rule Requirement: In conducting a stress test, for each quarter of the planning horizon a company must estimate: the potential impact on regulatory capital levels and capital ratios (including regulatory capital ratios and any other capital ratios specified by the primary supervisor), incorporating the effects of any capital actions over the planning horizon and maintenance of an allowance for loan E:\FR\FM\05AUP1.SGM 05AUP1 emcdonald on DSK67QTVN1PROD with PROPOSALS 47226 Federal Register / Vol. 78, No. 150 / Monday, August 5, 2013 / Proposed Rules losses appropriate for credit exposures throughout the planning horizon.23 In the DFA stress test rules, companies are required to estimate the impact of supervisory scenarios on capital levels and ratios, based on the estimates of losses, PPNR, loan and lease provisions, and net income, as well as projections of the balance sheet and risk-weighted assets. Companies must estimate projected quarterly regulatory capital levels and regulatory capital ratios for each scenario. The agencies expect companies’ post-stress capital ratios under the adverse and severely adverse scenarios will be lower than under the baseline scenario. Projected capital levels and ratios should reflect applicable regulations and accounting standards for each quarter of the planning horizon. In particular, in July 2013, the Board and OCC issued a final rule and the FDIC issued an interim final rule regarding regulatory capital requirements for banking organizations. The final rules revise the criteria for regulatory capital, introduce a new minimum common equity tier 1 capital requirement of 4.5 percent of riskweighted assets, as well as a minimum supplementary leverage ratio requirement of 3 percent that would apply to companies subject to the advanced approaches capital rules. The new minimum capital requirements would be phased in over a transition period. The final rules will take effect beginning on January 1, 2014, for banking organizations subject to the agencies’ advanced approaches rules (other than savings and loan holding companies) and on January 1, 2015, for all other banking organizations. Compliance with the supplementary leverage ratio for companies subject to the advanced approaches rules will be required starting in 2018. $10–50 billion companies should measure their regulatory capital levels and regulatory capital ratios for each quarter in accordance with the rules that would be in effect during that quarter in accordance with the transition arrangements set forth in the final rules. Rule Requirement: A bank holding company or savings and loan holding company is required to make the following assumptions regarding its capital actions over the planning horizon: 1. For the first quarter of the planning horizon, the bank holding company or savings and loan holding company must take into account its 23 12 CFR 46.6(a)(2) (OCC); 12 CFR 252.155(a)(2) (Board); 12 CFR 325.205(a)(2) (FDIC). VerDate Mar<15>2010 16:53 Aug 02, 2013 Jkt 229001 actual capital actions as of the end of that quarter. 2. For each of the second through ninth quarters of the planning horizon, the bank holding company or savings and loan holding company must include in the projections of capital: (a) Common stock dividends equal to the quarterly average dollar amount of common stock dividends that the company paid in the previous year (that is, the first quarter of the planning horizon and the preceding three calendar quarters); (b) 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 (c) An assumption of no redemption or repurchase of any capital instrument that is eligible for inclusion in the numerator of a regulatory capital ratio.24 In their DFA stress tests, bank holding companies and savings and loan holding companies are required to calculate pro forma capital ratios using a set of capital action assumptions based on historical distributions, contracted payments, and a general assumption of no redemptions, repurchases, or issuances of capital instruments. A holding company should also assume it will not issue any new common stock, preferred stock, or other instrument that would count in regulatory capital in the second through ninth quarters of the planning horizon, except for any common issuances related to expensed employee compensation. While holding companies are required to use specified capital action assumptions, there are no specified capital actions for banks and thrifts. A bank or thrift should use capital actions that are consistent with the scenarios and the company’s internal practices in their DFA stress tests. For banks and thrifts, projections of dividends that represent a significant change from practice in recent quarters, for example to conserve capital in a stress scenario, should be evaluated in the context of corporate restrictions and board decisions in historical stress periods. Additionally, a holding company should consider that it is required to use certain capital assumptions that may not be the same as the assumptions used by its bank subsidiaries. Finally, any assumptions about mergers or acquisitions, and other strategic actions should be well documented and should 24 12 PO 00000 Fmt 4702 E. Controls, Oversight, and Documentation Rule requirement: Senior management must establish and maintain a system of controls, oversight and documentation, including policies and procedures, that are designed to ensure that its stress testing processes are effective in meeting the requirements of the DFA stress test rule. These policies and procedures must, at a minimum, describe the company’s stress testing practices and methodologies, and describe the processes for validating and updating practices and methodologies consistent with applicable laws, regulations, and supervisory guidance. The board of directors, or a committee thereof, of a company must approve and review the policies and procedures of the stress testing processes as frequently as economic conditions or the condition of the company may warrant, but no less than annually.25 Pursuant to the DFA stress test requirement, a company must establish and maintain a system of controls, oversight, and documentation, including policies and procedures that apply to all of its DFA stress test components. This system of controls, oversight, and documentation should be consistent with the May 2012 stress testing guidance. Policies and procedures for DFA stress tests should be comprehensive, ensure a consistent and repeatable process, and provide transparency regarding a company’s stress testing processes and practices for third parties. The policies and procedures should provide a clear articulation of the manner in which DFA stress tests should be conducted, roles and responsibilities of parties involved (including any external resources), and describe how DFA stress test results are to be used. These policies and procedures also should be integrated into other policies and procedures for the company. The board (or a committee thereof) must approve 25 12 CFR 46.5(d) (OCC); 12 CFR 252.155(c) (Board); 12 CFR 325.205(b) (FDIC). CFR 252.155(b). Frm 00013 be consistent with past practices of management and the board during stressed economic periods. Should the stress-test submissions for the bank or thrift and its holding company differ in terms of projected capital actions (e.g., different dividend payout assumptions during the stress test horizon for the bank versus the holding company) as a result of the different requirements of the DFA stress test rules, the institution should address such differences in the narrative portion of their submissions. Sfmt 4702 E:\FR\FM\05AUP1.SGM 05AUP1 emcdonald on DSK67QTVN1PROD with PROPOSALS Federal Register / Vol. 78, No. 150 / Monday, August 5, 2013 / Proposed Rules and review the policies and procedures for DFA stress tests to ensure that policies and procedures remain current, relevant, and consistent with existing regulatory and accounting requirements and expectations as frequently as economic conditions or the condition of the company may warrant, but no less than annually. Senior management must establish policies and procedures for DFA stress tests and should ensure compliance with those policies and procedures, assign competent staff, oversee stress test development and implementation, evaluate stress test results, and review any findings related to the functioning of stress testing processes. Senior management should ensure that weaknesses—as well as key assumptions, limitations and uncertainties—in DFA stress testing processes and results are identified, communicated appropriately within the organization, and evaluated for the magnitude of impact, taking prompt remedial action where necessary. Senior management, directly and through relevant committees, should also be responsible for regularly reporting to the board regarding DFA stress test developments (including the process to design tests and augment or map supervisory scenarios), DFA stress test results, and compliance with a company’s stress testing policy. A company’s system of documentation should include the methodologies used, data types, key assumptions, and results, as well as coverage of the DFA stress tests (including risks and exposures included). For any models used, documentation should include sufficient detail about design, inputs, assumptions, specifications, limitations, testing, and output. In general, documentation on methodologies used should be consistent with existing supervisory guidance. Companies should ensure that other aspects of governance over methodologies used for DFA stress tests are appropriate, consistent with the May 2012 stress testing guidance. Specifically, companies should have policies, procedures, and standards for any models used. Effective governance would include validation and effective challenge for any assumptions or models used, and a description of any remedial steps in cases where models are not validated or validation identifies substantial issues. A company should ensure that internal audit evaluates model risk management activities related to DFA stress tests, which should include a review of whether practices align with policies, as well as VerDate Mar<15>2010 16:53 Aug 02, 2013 Jkt 229001 how deficiencies are identified, monitored, and addressed. Rule requirements: The board of directors and senior management of the company must receive a summary of the results of the stress test. The board of directors and senior management of a company must consider the results of the stress test in the normal course of business, including, but not limited to, the company’s capital planning, assessment of capital adequacy, and risk management practices.26 A company’s board of directors is ultimately responsible for the company’s DFA stress tests. Board members must receive summary information about DFA stress tests, including results from each scenario. The board or its designee should actively evaluate and discuss this information, ensuring that the DFA stress tests appropriately reflect the company’s risk appetite, overall strategy and business plans, overall stress testing practices, and contingency plans, directing changes where appropriate. The board should ensure it remains informed about critical review of elements of the DFA stress tests conducted by senior management or others (such as internal audit), especially regarding key assumptions, uncertainties, and limitations. All $10–50 billion companies must consider the role of stress testing results in normal business including in the capital planning, assessment of capital adequacy, and risk management practices of the company. A company should document the manner in which DFA stress tests are used for key decisions about capital adequacy, including capital actions and capital contingency plans. The company should indicate the extent to which DFA stress tests are used in conjunction with other capital assessment tools, especially if the DFA stress tests may not necessarily capture a company’s full range of risks, exposures, activities, and vulnerabilities that have the potential to affect capital adequacy. Importantly, a company should ensure that its post-stress capital results are aligned with its internal capital goals and risk appetite. For cases in which post-stress capital results are not aligned with a company’s internal capital goals, senior management should provide options it and the board would consider to bring them into alignment. F. Report to Supervisors Rule Requirement: A company must report the results of the stress test to its 26 12 CFR 46.5(d) and 46.6(c)(2) (OCC); 12 CFR 252.155(c)(3) (Board); 12 CFR 325.205(b)(2) and (3) (FDIC). PO 00000 Frm 00014 Fmt 4702 Sfmt 4702 47227 primary supervisor and to the Board of Governors by March 31, in the manner and form prescribed by the agency.27 All $10–50 billion companies must report the results of their DFA companyrun stress tests on the $10–50 billion reporting form. This report will include a company’s quantitative projections of losses, PPNR, balance sheet, riskweighted assets, ALLL, and capital on a quarterly basis over the duration of the scenario and planning horizon. In addition to the quantitative projections, companies are required to submit qualitative information supporting their projections. The report of the stress test results must include, under each scenario: a description of the types of risks included in the stress test, a description of the methodologies used in the stress test, an explanation of the most significant causes for the changes in regulatory capital ratios, and any other information required by the agencies. In addition, the agencies may request supplemental information, as needed. If significant errors or omissions are identified subsequent to filing, a company must file an amended report. For additional information, see the instructions provided with the reporting templates. G. Public Disclosure of DFA Test Results Rule Requirement: A company must disclose a summary of the results of the stress test in the period beginning on June 15 and ending on June 30.28 Under the DFA stress test rules, a company must make its first DFA stress test-related public disclosure between June 15 and June 30, 2015, by disclosing summary results of its annual DFA stress test, using September 30, 2014, financial statement data. The regulation requires holding companies to include in their public disclosure a summary of the results of the stress tests conducted by any subsidiaries subject to DFA stress testing.29 A bank can satisfy this public disclosure requirement by including a summary of the results of its stress test in its parent company’s public disclosure (on the same timeline); however the agencies can require a separate disclosure if the parent company’s public disclosure does not adequately capture the impact of the scenarios on the bank. The summary of the results of the stress test, including both quantitative 27 12 CFR 46.7 (OCC); 12 CFR 252.156 (Board); 12 CFR 325.206 (FDIC). 28 12 CFR 46.8 (OCC); 12 CFR 252.157 (Board); 12 CFR 325.207 (FDIC). 29 12 CFR 252.157(b). E:\FR\FM\05AUP1.SGM 05AUP1 47228 Federal Register / Vol. 78, No. 150 / Monday, August 5, 2013 / Proposed Rules and qualitative information, should be included in a single release on a company’s Web site, or in any other forum that is reasonably accessible to the public. Each bank or thrift must publish a summary of its stress tests results separate from the results of stress tests conducted at the consolidated level of its parent holding company, but the company may include this summary with its holding company’s public disclosure. Thus, a bank or thrift with a parent holding company that is required to conduct a company-run DFA stress test under the Federal Reserve Board’s DFA stress test rules will have satisfied its public disclosures requirement when the parent holding company discloses summary results of subsidiary’s annual stress test in satisfaction of the requirements of the applicable regulations of the company’s primary Federal regulator, unless the company’s primary regulator determines that the disclosures at the holding company level does not adequately capture the potential impact of the scenarios on the capital of the companies. A company must disclose, at a minimum, the following information regarding the severely adverse scenario: a. A description of the types of risks included in the stress test; b. A summary description of the methodologies used in the stress test; c. Estimates of— Aggregate losses; PPNR; PLLL; Net income; and Pro forma regulatory capital ratios and any other capital ratios specified by the primary supervisor; d. An explanation of the most significant causes for the changes in regulatory capital ratios; and e. For bank holding companies and savings and loan holding companies: for a stress test conducted by an insured depository institution subsidiary of the bank holding company or savings and loan holding company pursuant to section 165(i)(2) of the Dodd-Frank Act, changes in regulatory capital ratios and any other capital ratios specified by the primary Federal financial regulatory agency of the depository institution subsidiary over the planning horizon, including an explanation of the most significant causes for the changes in regulatory capital ratios. It should be clear in the company’s public disclosure that the results are conditioned on the supervisory scenarios. Items to be publicly disclosed should follow the same definitions as those provided in the confidential report to supervisors. Companies should disclose all of the required items in a single public release, as it is difficult to interpret the quantitative results without the qualitative supporting information. DIFFERENCES IN DFA STRESS TEST REQUIREMENTS FOR HOLDING COMPANIES VERSUS BANKS AND THRIFTS Bank Holding Companies and Savings and Loan Holding Companies Capital actions used for company-run stress tests. Public disclosure of company-run stress tests .. Capital actions prescribed in Federal Reserve No prescribed capital actions. Banks and Board’s DFA stress tests rules. Generally thrifts should use capital actions consistent based on historical dividends, contracted with the scenario and their internal business payments, and no repurchases or issuances. practices. Disclosure must include information on stress Disclosure requirement met when parent comtests conducted by subsidiaries subject to pany disclosure includes the required inforDFA stress tests. mation on the bank or thrift’s stress test results, unless the company’s primary regulator determines that the disclosure at the holding company level does not adequately capture the potential impact of the scenarios on the capital of the company. DEPARTMENT OF TRANSPORTATION [FR Doc. 2013–18716 Filed 8–2–13; 8:45 am] emcdonald on DSK67QTVN1PROD with PROPOSALS Dated: July 25, 2013. Thomas J. Curry, Comptroller of the Currency. By order of the Board of Governors of the Federal Reserve System, July 24, 2013. Robert deV. Frierson, Secretary of the Board. Dated at Washington, DC, this 30th day of July, 2013. Federal Deposit Insurance Corporation. Robert E. Feldman, Executive Secretary. AGENCY: BILLING CODE 4810–33–P; 6714–01–P; 6210–01–P Federal Aviation Administration 14 CFR Part 39 [Docket No. FAA–2013–0561; Directorate Identifier 2013–NE–23–AD] RIN 2120–AA64 Airworthiness Directives; Thielert Aircraft Engines GmbH Reciprocating Engines Federal Aviation Administration (FAA), DOT. ACTION: Notice of proposed rulemaking (NPRM). We propose to adopt a new airworthiness directive (AD) for all Thielert Aircraft Engines GmbH TAE 125–01 reciprocating engines. This proposed AD was prompted by a report SUMMARY: VerDate Mar<15>2010 16:53 Aug 02, 2013 Jkt 229001 Banks and Thrifts PO 00000 Frm 00015 Fmt 4702 Sfmt 4702 of engine power loss due to engine coolant contaminating the engine clutch. The design of the engine allows the crankcase assembly opening to be susceptible to contamination from external sources. This proposed AD would require applying sealant to close the engine clutch housing (crankcase assembly) opening. We are proposing this AD to prevent in-flight engine power loss, which could result in loss of control of, and damage to, the airplane. We must receive comments on this proposed AD by October 4, 2013. ADDRESSES: You may send comments by any of the following methods: • Federal eRulemaking Portal: Go to https://www.regulations.gov and follow the instructions for sending your comments electronically. • Mail: Docket Management Facility, U.S. Department of Transportation, 1200 DATES: E:\FR\FM\05AUP1.SGM 05AUP1

Agencies

[Federal Register Volume 78, Number 150 (Monday, August 5, 2013)]
[Proposed Rules]
[Pages 47217-47228]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2013-18716]

=======================================================================
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DEPARTMENT OF THE TREASURY

Office of the Comptroller of the Currency

12 CFR Part 46

[Docket No. OCC-2013-0013]

FEDERAL RESERVE SYSTEM

12 CFR Part 252

[Docket No. OP-1461]

FEDERAL DEPOSIT INSURANCE CORPORATION

12 CFR Part 325

Proposed Supervisory Guidance on Implementing Dodd-Frank Act
Company-Run Stress Tests for Banking Organizations With Total
Consolidated Assets of More Than $10 Billion But Less Than $50 Billion

AGENCIES: Board of Governors of the Federal Reserve System (``Board''
or ``Federal Reserve''); Federal Deposit Insurance Corporation
(``FDIC''); Office of the Comptroller of the Currency, Treasury
(``OCC'').

ACTION: Proposed supervisory guidance.

-----------------------------------------------------------------------

SUMMARY: The Board, FDIC and OCC, (collectively, the ``agencies'') are
issuing this guidance, which outlines high-level principles for
implementation of section 165(i)(2) of the Dodd-Frank Act Wall Street
Reform and Consumer Protection Act (``DFA'') stress tests, applicable
to all bank and savings-and-loan holding companies, national banks,
state-member banks, state non-member banks, Federal savings
associations, and state chartered savings associations with more than
$10 billion but less than $50 billion in total consolidated assets
(collectively, the ``$10-50 billion companies''). The guidance
discusses supervisory expectations for DFA stress test practices and
offers additional details about methodologies that should be employed
by these companies. It also underscores the importance of stress
testing as an ongoing risk management practice that supports a
company's forward-looking assessment of its risks and better equips the
company to address a range of macroeconomic and financial outcomes.

DATES: Comments on this joint proposed guidance are due to the OCC and
FDIC on September 25th, 2013 and to the Federal Reserve on September
30th, 2013.

ADDRESSES:
OCC: Because paper mail in the Washington, DC area and at the OCC
is subject to delay, commenters are encouraged to submit comments by
email, if possible. Please use the title ``Proposed Supervisory
Guidance on Implementing Dodd-Frank Act Company-Run Stress Tests for
Banking Organizations with Total Consolidated Assets of more than $10
Billion but less than $50 Billion'' to facilitate the organization and
distribution of the comments. You may submit comments by any of the
following methods:
Email: regs.comments@occ.treas.gov.
Mail: Legislative and Regulatory Activities Division,
Office of the Comptroller of the Currency, 400 7th Street SW., Suite
3E-218, Mail Stop 9W-11, Washington, DC 20219.
Hand Delivery/Courier: 400 7th Street SW., Suite 3E-218,
Mail Stop 9W-11, Washington, DC 20219.
Fax: (571) 465-4326.
Instructions: You must include ``OCC'' as the agency name and
``Docket ID OCC-2013-0013'' in your comment. In general, OCC will enter
all comments received into the docket and publish them on the
Regulations.gov Web site without change, including any business or
personal information that you provide such as name and address
information, email addresses, or phone numbers. Comments received,
including attachments and other supporting materials, are part of the
public record and subject to public disclosure. Do not enclose any
information in your comment or supporting materials that you consider
confidential or inappropriate for public disclosure.
You may review comments and other related materials that pertain to
this notice by any of the following methods:
Viewing Comments Personally: You may personally inspect
and photocopy comments at the OCC, 400 7th Street SW., Washington, DC.
For security reasons, the OCC requires that visitors make an
appointment to inspect comments. You may do so by calling (202) 649-
6700. Upon arrival, visitors will be required to present valid
government-issued photo identification and to submit to security
screening in order to inspect and photocopy comments.
Docket: You may also view or request available background
documents and project summaries using the methods described above.
Board: You may submit comments, identified by Docket No. OP-1461,
``Proposed Supervisory Guidance on Implementing Dodd-Frank Act Company-
Run Stress Tests for Banking Organizations with Total Consolidated
Assets of more than $10 Billion but less than $50 Billion,'' by any of
the following methods:
Agency Web site: https://www.federalreserve.gov. Follow the
instructions for submitting comments at https://www.federalreserve.gov/generalinfo/foia/ProposedRegs.cfm.
Federal eRulemaking Portal: https://www.regulations.gov.
Follow the instructions for submitting comments.
Email: regs.comments@federalreserve.gov. Include the
docket number in the subject line of the message.
Fax: (202) 452-3819 or (202) 452-3102.
Mail: Address to Robert deV. Frierson, Secretary, Board of
Governors of the Federal Reserve System, 20th Street and Constitution
Avenue NW., Washington, DC 20551.
All public comments will be made available on the Board's Web site
at https://www.federalreserve.gov/generalinfo/foia/ProposedRegs.cfm as
submitted, unless modified for technical reasons. Accordingly, comments
will not be edited to remove any identifying or contact information.
Public comments may also be viewed electronically or in paper in Room
MP-500 of the Board's Martin Building (20th and C Streets NW.,
Washington, DC

[[Page 47218]]

20551) between 9:00 a.m. and 5:00 p.m. on weekdays.
FDIC: You may submit comments, identified as ``Stress Test
Guidance'', by any of the following methods:
Agency Web site: https://www.fdic.gov/regulations/laws/federal/propose.html. Follow instructions for submitting comments on the Agency
Web site.
Email: Comments@fdic.gov. Include ``Stress Test Guidance''
on the subject line of the message.
Mail: Robert E. Feldman, Executive Secretary, Attention:
Comments, Federal Deposit Insurance Corporation, 550 17th Street NW.,
Washington, DC 20429.
Hand Delivery: Comments may be hand delivered to the guard
station at the rear of the 550 17th Street Building (located on F
Street) on business days between 7:00 a.m. and 5:00 p.m.
Public Inspection: All comments received must include the agency
name and ``Stress Test Guidance''. All comments received will be posted
without change to https://www.fdic.gov/regulations/laws/federal/propose.html, including any personal information provided. Paper copies
of public comments may be ordered from the FDIC Public Information
Center, 3501 North Fairfax Drive, Room E-1002, Arlington, VA 22226 by
telephone at (877) 275-3342 or (703) 562-2200.

FOR FURTHER INFORMATION CONTACT:
Board: David Palmer, Senior Financial Analyst, (202) 452-2904;
Joseph Cox, Financial Analyst, (202) 452-3216; Keith Coughlin, Manager,
(202) 452-2056; Benjamin McDonough, Senior Counsel, (202) 452-2036; or
Christine Graham, Senior Attorney, (202) 452-3005, Board of Governors
of the Federal Reserve System, 20th and C Streets NW., Washington, DC
20551.
FDIC: Ryan Sheller, Senior Financial Analyst, (202) 412-4861; Mark
Flanigan, Counsel, (202) 898-7427; or Jason Fincke, Senior Attorney,
(202) 898-3659, Federal Deposit Insurance Corporation, 550 17th Street
NW., Washington, DC 20429.
OCC: Harry Glenos, Senior Financial Advisor, (202) 649-6409; Kari
Falkenborg, Financial Analyst, (202) 649-6831; Ron Shimabukuro, Senior
Counsel, or Henry Barkhausen, Attorney, Legislative and Regulatory
Affairs Division, (202) 649-5490, Office of the Comptroller of the
Currency, 400 7th Street SW., Washington, DC 20219.

SUPPLEMENTARY INFORMATION:

I. Background

In October 2012, the agencies issued final rules implementing
stress testing requirements for companies \1\ with over $10 billion in
total assets pursuant to section 165(i)(2) of the Dodd-Frank Wall
Street Reform and Consumer Protection Act (``DFA stress test
rules'').\2\ At that time, the agencies also indicated that they
intended to publish supervisory guidance to accompany the final rules
and assist companies in meeting rule requirements, including separate
guidance for companies between $10 billion and $50 billion in total
assets.
---------------------------------------------------------------------------

\1\ For the OCC, the term ``company'' is used in this guidance
to refer to national banks and Federal savings associations that
qualify as ``covered institutions'' under the OCC Annual Stress Test
Rule. 12 CFR 46.2. For the Board, the term ``company'' is used in
this guidance to refer to state member banks, bank holding
companies, and savings and loan holding companies. 12 CFR 252.153.
For the FDIC, the term ``company'' is used in this guidance to refer
to insured state nonmember banks and insured state savings
associations that qualify as a ``covered bank'' under the FDIC
Annual Stress Test Rule. 12 CFR 325.202.
\2\ See 77 FR 61238 (October 9, 2012) (OCC final rule), 77 FR
62378 (October 12, 2012) (Board final rule), and 77 FR 62417
(October 15, 2012) (FDIC final rule).
---------------------------------------------------------------------------

Accordingly, the agencies are issuing this proposed guidance, which
would apply to all companies with total consolidated assets of more
than $10 billion but less than $50 billion ($10-50 billion companies).
The agencies invite public comment on this proposed guidance. The
agencies expect $10-50 billion companies to follow the DFA stress rule
requirements, other relevant supervisory guidance,\3\ and if adopted,
the expectations set forth in this document, when conducting DFA stress
tests.\4\
---------------------------------------------------------------------------

\3\ In particular, companies should conduct tests in accordance
with 77 FR 29458, ``Supervisory Guidance on Stress Testing for
Banking Organizations With More Than $10 Billion in Total
Consolidated Assets,'' (May 17, 2012).
\4\ To the extent that the guidance conflicts with the
requirements imposed with respect to any future statutory or
regulatory stress test, companies must comply with the requirements
set forth in the relevant statute or regulation.
---------------------------------------------------------------------------

The proposed guidance addresses the following key areas:
Supervisory scenarios. Under the DFA stress test rules,
$10-50 billion companies must assess the potential impact of a minimum
of three macroeconomic scenarios--baseline, adverse, and severely
adverse--on their consolidated losses, revenues, balance sheet
(including risk-weighted assets), and capital. The proposed guidance
indicates that $10-50 billion companies should apply each scenario
across all business lines and risk areas so that they can assess the
effect of a common scenario on the entire enterprise, though the effect
of the given scenario on different business lines and risk areas may
vary. These companies may use all or, as appropriate, a subset of the
variables from the supervisory scenarios to conduct a stress test,
depending on whether the variables are relevant or appropriate to the
company's line of business. The companies may, but are not required to,
include additional variables or additional quarters to improve their
company-run stress tests. For example, the proposed guidance includes a
set of questions on translating supervisory scenarios to regional
variables and minimum expectations for loss estimation. However, the
paths of any additional regional or local variables that a company uses
would be expected to be consistent with the path of the national
variables in the supervisory scenarios.
Data sources and segmentation. In conducting a stress
test, a company should segment its portfolios and business activities
into categories based on common or related risk characteristics. The
company should select the appropriate level of segmentation based on
the size, materiality, and riskiness of a given portfolio, provided
there are sufficiently granular historical data available to allow for
the desired segmentation. A company would be expected to be able to
segment its data at a level at least as granular as the reporting form
it uses to report the results to its primary regulator and the Board
(``$10-50 billion reporting form''), but may use a more granular
segmentation, particularly for more material or riskier portfolios.\5\
If a company does not currently have sufficient internal data to
conduct a stress test, it may use an alternative data source as a proxy
for its own risk profile and exposures. However, companies with limited
data would be expected to construct strategies to develop sufficient
data to improve their stress test estimation processes over time.
---------------------------------------------------------------------------

\5\ For Federal Reserve-regulated companies the relevant
reporting form is the FR Y-16, for OCC-regulated companies the
relevant form is the OCC DFAST 10-50, and for FDIC-regulated
companies the relevant form is the FDIC DFAST 10-50.
---------------------------------------------------------------------------

Loss estimation. In conducting a stress test, for each
quarter of the planning horizon, a company must estimate the following
for each required scenario: losses, pre-provision net revenue (PPNR),
provision for loan and lease losses, and net income.\6\ Credit losses
associated with loan portfolios and securities holdings should be
estimated directly and separately, whereas other types of losses should
be incorporated into estimated pre-provision net revenue. Larger or
more sophisticated companies should consider more advanced loss
estimation practices that identify the key drivers of

[[Page 47219]]

losses for a given portfolio, segment, or loan; determine how those
drivers would be affected in supervisory scenarios; and estimate
resulting losses. Loss estimation practices should be commensurate with
the materiality of the risks measured and well supported by sound,
empirical analysis. Companies may use different processes for the
baseline scenario, including their budgeting process if it is
conditioned on the supervisory scenario, than for the adverse and
severely adverse scenarios in order to better capture the loss
potential under stressful conditions.
---------------------------------------------------------------------------

\6\ 12 CFR 252.155(a)(1).
---------------------------------------------------------------------------

Pre-provision net revenue. The proposed guidance indicates
that companies that are less complex or less sophisticated could
estimate projected PPNR based on the three main components of PPNR (net
interest income, non-interest income, non-interest expense) at an
aggregate, company-wide level based on industry experience. Companies
that are more complex or more sophisticated should consider methods
that more fully capture potential risks to their business and strategy
by collecting internal revenue data, estimating revenues within
specific business lines, exploring more advanced techniques that
identify the specific drivers of revenue, and analyzing how the
supervisory scenarios affect those revenue drivers. In addition to
credit losses, companies may determine that other types of losses could
arise under the supervisory scenarios. These other types of losses
should be included in projections of PPNR to the extent they would
arise under the specified scenario conditions. For example, companies
should include in their PPNR projections any trading losses, any losses
related to mortgage repurchase agreements, mortgage servicing rights,
or losses related to operational risk arising in the scenarios.
Balance sheet and risk-weighted assets projections. Under
the proposed guidance, a company would be expected to ensure that
projected balance sheet and risk-weighted assets remain consistent with
regulatory and accounting changes, are applied consistently across the
company, and are consistent with the scenario and the company's past
history of managing through different business environments. Companies
should document and explain key underlying assumptions about changes in
balances or risk-weighted assets under stressful conditions, including
justifying major changes, justifying any assumptions about strategies
that may mitigate losses under the stressful conditions, and ensuring
that the assumptions do not substantially alter the company's core
businesses and earnings capacity.
Governance and controls. Under the DFA stress test rules,
a $10-50 billion company is required to establish and maintain a system
of controls, oversight, and documentation, including policies and
procedures, that are designed to ensure that its stress testing
processes are effective in meeting the requirements of the DFA stress
test rule. The proposed guidance describes supervisory expectations and
sound practices regarding the controls, oversight, and documentation
required by the rule. All $10-50 billion companies must consider the
role of stress testing results in normal business including in the
capital planning, assessment of capital adequacy, and risk management
practices of the company. For instance, a $10-50 billion company would
be expected to ensure that its post-stress capital results are aligned
with its internal capital goals and risk appetite. For cases in which
post-stress capital results are not aligned with a company's internal
capital goals, senior management should provide options it and the
board would consider to bring them into alignment.

II. Request for Comments

The agencies invite comment on all aspects of the proposed
guidance. Specifically, the agencies seek comment on the following
questions.
Question 1: What challenges do companies expect in relating the
national variables in the scenarios to regional and local market
footprints?
Question 2: What additional clarity might be needed regarding the
appropriate use of historical experience in the loss, revenue, balance
sheet, and risk-weighted asset estimation process?
Question 3: What additional clarity should the guidance provide
about the use of vendor or other third-party products and services that
companies might choose to employ for DFA stress tests?
Question 4: How could the proposed guidance be clearer about the
manner in which the required capital action assumptions between holding
companies and banks differ, and how those different assumptions should
be reconciled within a consolidated organization?
Question 5: What additional clarification would be helpful to
companies about the responsibilities of their boards and senior
management with regard to DFA stress tests?
The agencies request that commenters reference the question numbers
above when providing answers to those questions.

III. Administrative Law Matters

A. Paperwork Reduction Act Analysis

This guidance references currently approved collections of
information under the Paperwork Reduction Act (44 U.S.C. 3501-3520)
provided for in the DFA stress test rules.\7\ This guidance does not
introduce any new collections of information nor does it substantively
modify the collections of information that Office of Management and
Budget (OMB) has approved. Therefore, no Paperwork Reduction Act
submissions to OMB are required.
---------------------------------------------------------------------------

\7\ See OMB Control Nos. 1557-0311 and 1557-0312 (OCC); 3064-
0186 and 3064-0187 (FDIC); and 7100-0348 and 7100-0350 (Board).
---------------------------------------------------------------------------

B. Regulatory Flexibility Act Analysis

Board:
While the guidance is not being adopted as a rule, the Board has
considered the potential impact of the guidance on small companies in
accordance with the Regulatory Flexibility Act (5 U.S.C. 603(b)). Based
on its analysis and for the reasons stated below, the Board believes
that the proposed guidance will not have a significant economic impact
on a substantial number of small entities. Nevertheless, the Board is
publishing a regulatory flexibility analysis.
For the reason discussed in the Supplementary Information above,
the agencies are issuing this guidance to provide additional details
regarding the supervisory expectations for the DFA stress tests
conducted by $10-50 billion companies. Under regulations issued by the
Small Business Administration (``SBA''), a small entity includes a
depository institution, bank holding company, or savings and loan
holding company with total assets of $500 million or less (a small
banking organization).\8\ The proposed guidance would apply to
companies supervised by the agencies with more than $10 billion but
less than $50 billion in total consolidated assets, including state
member banks, bank holding companies, and savings and loan holding
companies. Companies that would be subject to the proposed guidance
therefore substantially exceed the $500 million total asset threshold
at which a company is considered a small company under SBA regulations.
In light of the foregoing, the Board does not believe that the guidance
would

[[Page 47220]]

have a significant economic impact on a substantial number of small
entities.
---------------------------------------------------------------------------

\8\ Effective July 22, 2013, the Small Business Administration
revised the size standards for small banking organizations to $500
million in assets from $175 million in assets. 78 FR 37409 (June 20,
2013).
---------------------------------------------------------------------------

IV. Proposed Supervisory Guidance

The text of the proposed supervisory guidance is as follows:
Office of the Comptroller of the Currency
Federal Reserve System
Federal Deposit Insurance Corporation

Proposed Supervisory Guidance on Implementing Dodd-Frank Act

Company-Run Stress Tests for Banking Organizations With Total
Consolidated Assets of More Than $10 Billion but Less Than $50 Billion

I. Introduction

In October 2012, the U.S. Federal banking agencies issued the Dodd-
Frank Act stress test rules \9\ requiring companies with total
consolidated assets of more than $10 billion to conduct annual company-
run stress tests pursuant to section 165(i)(2) of the Dodd-Frank Wall
Street Reform and Consumer Protection Act (DFA).\10\ This guidance
outlines key expectations for companies with total consolidated assets
of more than $10 billion but less than $50 billion that are required to
conduct DFA stress tests (collectively ``companies'' or ``$10-50
billion companies'').\11\ It builds upon the interagency stress testing
guidance issued in May 2012 for companies with more than $10 billion in
total consolidated assets (``May 2012 stress testing guidance'').\12\
---------------------------------------------------------------------------

\9\ See 77 FR 61238 (October 9, 2012) (OCC), 77 FR 62396
(October 12, 2012) (Board: Annual Company-Run Stress Test
Requirements for Banking Organizations with Total Consolidated
Assets over $10 Billion Other than Covered Companies), and 77 FR
62417 (October 15, 2012) (FDIC).
\10\ Public Law 111-203, 124 Stat. 1376 (2010). Each entity that
meets the applicability criteria must conduct a separate stress test
and provide a separate submission. For example, both a bank holding
company between $10-50 billion in assets and its subsidiary bank
with between $10-50 billion in assets must conduct a separate stress
test; however, if a subsidiary bank of a $10-50 billion bank holding
company has $10 billion or less in assets then it does not need to
conduct a DFA stress test.
\11\ For the OCC, the term ``company'' is used in this guidance
to refer to a banking organization that qualifies as a ``covered
institution'' under the OCC Annual Stress Test Rule. 12 CFR 46.2.
For the Board, the term ``company'' is used in this guidance to
refer to state member banks, bank holding companies, and savings and
loan holding companies. 12 CFR 252.153. For the FDIC, the term
``company'' is used in this guidance to refer to insured state
nonmember banks and insured state savings associations that
qualifies as a ``covered bank'' under the FDIC Annual Stress Test
Rule. 12 CFR 325.202.
\12\ 77 FR 29458, ``Supervisory Guidance on Stress Testing for
Banking Organizations With More Than $10 Billion in Total
Consolidated Assets,'' (May 17, 2012).
---------------------------------------------------------------------------

The expectations described in this guidance are tailored to the
$10-50 billion companies, similar to the manner in which the
requirements in the DFA stress test rules were tailored for this set of
companies.\13\ The additional information provided in this guidance
should assist companies in complying with the DFA stress test rules and
conducting DFA stress tests that are appropriate for their risk
profile, size, complexity, business mix, and market footprint. The DFA
stress test rules allow flexibility to accommodate different practices
across organizations, for example by not specifying specific
methodological practices. Consistent with this approach, this guidance
sets general supervisory expectations for stress tests, and provides,
where appropriate, some examples of possible practices that would be
consistent with those expectations.
---------------------------------------------------------------------------

\13\ As indicated in the DFA stress test final rules, the
agencies also plan to issue supervisory guidance for companies with
at least $50 billion in total assets. Consistent with the approach
taken in the DFA stress test final rules, the agencies expect the
guidance for companies with at least $50 billion to contain
standards that are comparable or elevated in all areas.
---------------------------------------------------------------------------

This guidance does not represent a comprehensive list of potential
practices, and companies are not required to use any specific
methodological practices for their stress tests. Companies may use
various practices to project their losses, revenues, and capital that
are appropriate for their risk profile, size, complexity, business mix,
market footprint and the materiality of a given portfolio.

II. Background

Stress tests are an important part of a company's risk management
practices, supporting a company's forward-looking assessment of its
risks and helping to ensure that the company has sufficient capital to
support its operations through periods of stress. The agencies have
previously highlighted the importance of stress testing as a means for
companies to better understand the range of potential risks.
Specifically, the May 2012 stress testing guidance sets forth the
following five principles for an effective stress testing regime:
1. A company's stress testing framework should include activities
and exercises that are tailored to and sufficiently capture the
company's exposures, activities, and risks;
2. An effective stress testing framework should employ multiple
conceptually sound stress testing activities and approaches;
3. An effective stress testing framework should be forward-looking
and flexible;
4. Stress test results should be clear, actionable, well supported,
and inform decision-making; and
5. A company's stress testing framework should include strong
governance and effective internal controls.
The agencies expect that companies will follow the principles and
expectations in the May 2012 stress testing guidance when conducting
their DFA stress tests. This DFA stress test guidance builds upon the
May 2012 stress testing guidance, sets forth the supervisory
expectations regarding each requirement of the DFA stress test rules,
and provides illustrative examples of satisfactory practices. The
guidance indicates where different requirements apply to banks,
thrifts, and holding companies. The guidance is structured as follows:

A. DFA Stress Test Timelines
B. Scenarios for DFA Stress Tests
C. DFA Stress Test Methodologies and Practices
D. Estimating the Potential Impact on Regulatory Capital Levels and
Capital Ratios
E. Controls, Oversight, and Documentation
F. Report to Supervisors
G. Public Disclosure of DFA Stress Tests

The agencies expect that the annual company-run stress tests
required under the DFA stress test rules will be one component of the
broader stress-testing activities conducted by $10-$50 billion
companies. The DFA stress tests may not necessarily capture a company's
full range of risks, exposures, activities, and vulnerabilities that
have a potential effect on capital adequacy. For example, DFA stress
tests may not account for regional concentrations and unique business
models, or they may not fully cover the potential capital effects of
interest rate risk or an operational risk event such as a regional
natural disaster.\14\ Consistent with the May 2012 stress testing
guidance, a company is expected to consider the results of DFA stress
testing together with other capital assessment activities to ensure
that the company's material risks and vulnerabilities are appropriately
considered in its overall assessment of capital adequacy. Finally, the
DFA stress tests assess the impact of stressful

[[Page 47221]]

outcomes on capital adequacy, and are not intended to measure the
adequacy of a company's liquidity in the stress scenarios.
---------------------------------------------------------------------------

\14\ For purposes of this guidance, the term ``concentrations''
refers to groups of exposures and/or activities that have the
potential to produce losses large enough to bring about a material
change in a banking organization's risk profile or financial
condition.
---------------------------------------------------------------------------

III. Annual Tests Conducted by Companies

A. DFA Stress Test Timelines

Rule Requirement: A company must conduct a stress test over a nine-
quarter planning horizon based on data as of September 30 of the
preceding calendar year.\15\

\15\ 12 CFR 46.5 (OCC); 12 CFR 252.154 (Board); 12 CFR 325.204
(FDIC).

Stress test projections are based on exposures with the as-of date
of September 30 and extend over a nine-quarter planning horizon that
begins in the quarter ending December 31 of the same year and ends with
the quarter ending December 31 two years later.\16\ For example, a
stress test beginning in the fall of 2013 would use an as-of date of
September 30, 2013, and involve quarterly projections of losses, PPNR,
balance sheet, risk-weighted assets, and capital beginning on December
31, 2013 of that year and ending on December 31, 2015. In order to
project quarterly provisions, a company would need to estimate the
adequate level of the allowance for loan and lease losses (``ALLL'') to
support remaining credit risk at the end of each quarter--including the
final quarter--which may require additional projections of credit
losses beyond 2015 to ensure the ALLL is consistent with Generally
Accepted Accounting Principles (GAAP).
---------------------------------------------------------------------------

\16\ Planning horizon means the period of at least nine
quarters, beginning with the quarter ending December 31, over which
the relevant stress test projections extend.
---------------------------------------------------------------------------

B. Scenarios for DFA Stress Tests

Rule Requirement: A company must use the scenarios provided annually by
its primary Federal financial regulatory agency to assess the potential
impact of the scenarios on its consolidated earnings, losses, and
capital.\17\

\17\ 12 CFR 46.6 (OCC); 12 CFR 252.154 (Board); 12 CFR 325.204
(FDIC).

Under the DFA stress test rules, $10-50 billion companies must
assess the potential impact of a minimum of three macroeconomic
scenarios--baseline, adverse, and severely adverse--provided by their
primary supervisor on their consolidated losses, revenues, balance
sheet (including risk-weighted assets), and capital. The rule defines
the three scenarios as follows:
Baseline scenario means a set of conditions that affect
the U.S. economy or the financial condition of a company that reflect
the consensus views of the economic and financial outlook.
Adverse scenario means a set of conditions that affect the
U.S. economy or the financial condition of a company that are more
adverse than those associated with the baseline scenario and may
include trading or other additional components.
Severely adverse scenario means a set of conditions that
affect the U.S. economy or the financial condition of a company that
overall are more severe than those associated with the adverse scenario
and may include trading or other additional components.
The agencies will provide a description of the supervisory
scenarios to companies no later than November 15 each calendar year.
The scenarios provided by the agencies are not forecasts but rather are
hypothetical scenarios that companies will use to assess their capital
strength in baseline and stressed economic and financial conditions.
Companies should apply each scenario across all business lines and risk
areas so that they can assess the effect of a common scenario on the
entire enterprise, though the effect of the given scenario on different
business lines and risks may vary.
The agencies believe that a uniform set of supervisory scenarios is
necessary to provide a basis for comparison across companies. However,
a company is not required to use all of the variables provided in the
scenario, if those variables are not relevant or appropriate to the
company's line of business. In addition, a company may, but is not
required to, use additional variables beyond those provided by the
agencies. For example, a company may decide to use a regional
unemployment rate to improve the robustness of its stress test
projections. When using additional variables, companies should ensure
that the paths of such variables (including their timing) are
consistent with the general economic environment assumed in the
supervisory scenarios. Any use of additional variables should be well
supported and documented.
In addition, a company may choose to project the paths of variables
beyond the timeframe of the supervisory scenarios, if a longer horizon
is necessary for the company's stress testing methodology. For example,
a company may project the unemployment rate for additional quarters in
order to calculate inputs to its end-of-horizon ALLL or to estimate the
projected value of certain types of securities under the scenario.
Companies may use third-party vendors to assist in the development
of additional variables based on the supervisory stress scenarios. In
such instances, consistent with existing supervisory expectations,\18\
companies should understand the third-party analysis used to develop
additional variables, including the potential limitations of such
analysis as it relates to stress tests, and be able to challenge key
assumptions. Companies should also ensure that vendor-supplied
variables they use are relevant for and relate to company-specific
characteristics.
---------------------------------------------------------------------------

\18\ ``Supervisory Guidance on Model Risk Management,'' OCC
2011-12, or ``Guidance on Model Risk Management,'' Federal Reserve
SR 11-7, April 4, 2011.
---------------------------------------------------------------------------

C. DFA Stress Test Methodologies and Practices

Rule Requirement: In conducting a stress test, for each quarter of the
planning horizon, a company must estimate the following for each
required scenario: losses, pre-provision net revenue, provision for
loan and lease losses, and net income.\19\
---------------------------------------------------------------------------

\19\ 12 CFR 46.6 (OCC); 12 CFR 252.155(a)(1) (Board); 12 CFR
325.205(a)(1) (FDIC).

As noted above, companies must identify and determine the impact on
capital from the supervisory scenarios, as represented through the
supervisory scenario variables and any additional variables chosen by
the company. A company's estimation processes should reasonably capture
the relationship between the assumed scenario conditions and the
projected impacts and outcomes to the company. The agencies expect that
the specific methodological practices used by companies to produce the
estimates may vary across organizations.
Supervisors generally expect that all banking organizations, as
part of overall safety and soundness, will continue to enhance their
risk management practices. Accordingly, a $10-50 billion company's DFA
stress testing practices should evolve and improve over time. In
addition, DFA stress testing practices for $10-50 billon companies
should be commensurate with each company's size, complexity, and
sophistication. This means that, generally, larger or more
sophisticated companies should employ not just the minimum
expectations, but the more advanced practices described in this
guidance.
The remainder of this section outlines key practices that all $10-
50 billion companies should incorporate into their methodologies for
estimating losses, PPNR, PLLL, and net income. It begins with general
expectations that apply across various types of estimation
methodologies, and then provides additional expectations for specific
areas, such as loss estimation, revenue

[[Page 47222]]

estimation, and balance sheet projections. In making projections,
companies should make conservative assumptions about management
responses in the stress tests, and should include only those responses
for which there is substantial support. For example, companies may
account for hedges that are already in place as potential mitigating
factors against losses but should be conservative in making assumptions
about potential future hedging activities and not necessarily
anticipate that actions taken in the past could be taken under the
supervisory scenarios.

1. Data Sources

Companies are expected to have appropriate management information
systems and data processes that enable them to collect, sort,
aggregate, and update data and other information efficiently and
reliably within business lines and across the company for use in DFA
stress tests. Data used for DFA stress tests should be reliable and
generally consistent across time.
In cases where a company may not currently have a full cycle of
historical data or data in sufficient granularity on which to base its
analyses, it may use an alternative data source, such as a data history
drawn from other organizations of demonstrably comparable market
presence, concentrations, and risk profile (for example, regulatory
reporting or vendor-supplied data), as a proxy for its own risk profile
and exposures. Companies with limited internal data should develop
specific strategies to accumulate the data necessary to improve their
estimation practices over time, as having internal data relevant to
current exposures generally improves loss projections and provides a
better basis for assessment of those projections.
Over the long term, companies may continue to use such proxy data
to benchmark the estimates produced using internal data or to augment
any gaps in internal data (for example, if a company is moving into a
new business area). However, companies should use proxy data
cautiously, as these data may not adequately represent a company's own
exposures, business activities, underwriting, and risk characteristics.
Even when a company has extensive historical data, it should look
beyond the assumptions based on or embedded in those historical data.
Companies should challenge conventional assumptions to ensure that a
company's stress test is not constrained by its own past experience.
This is particularly important when historical data does not contain
stressful periods or if the specific characteristics of the scenarios
are unlike the conditions in the available historical data.

2. Data Segmentation

To account for differences in risk profiles across various
exposures and activities, companies should segment their portfolios and
business activities into categories based on common or related risk
characteristics. The company should select the appropriate level of
segmentation based on the size, materiality, and risk of a given
portfolio, provided there are sufficiently granular historical data
available to allow for the desired segmentation. The minimum
expectation is that companies will segment their portfolios and
business activities using the categories listed in the $10-50 billion
reporting form.\20\ A company may use more granular segmentation than
the $10-50 billion reporting form categories, particularly for more
material, concentrated, or relatively riskier portfolios. For instance,
a company could have a commercial loan portfolio containing loans to
different industries with varying sensitivities to the scenario
variables.
---------------------------------------------------------------------------

\20\ For purposes of this guidance, the term ``$10-50 billion
reporting form'' refers to the relevant reporting form a $10-50
billion company will use to report the results of its DFA stress
tests to its primary Federal financial regulatory agency. For
Federal Reserve-regulated companies the relevant reporting form is
the FR Y-16, for OCC-regulated companies the relevant form is the
OCC DFAST 10-50, and for FDIC-regulated companies the relevant form
is the FDIC DFAST 10-50.
---------------------------------------------------------------------------

More advanced portfolio segmentation can take several forms, such
as by product (construction versus income-producing real estate),
industry, loan size, credit quality, collateral type, geography,
vintage, maturity, debt service coverage, or loan-to-value (LTV) ratio.
The company may also pool exposures with common or correlated risk
characteristics, such as segmenting loans to businesses related to
automobile production. Companies may also segment the portfolio
according to geography, if they engage in activities in geographic
areas with differing economic and financial characteristics. Such
segmentation may be particularly valuable in situations where
geographic areas show varying sensitivity to national economic and
financial changes or where different scenario variables are necessary
to capture key risks (such as projecting wholesale loan losses for
regions with different industrial concentrations). For any type of
segmentation that is more granular than the categories in the $10-50
billion reporting form, a company should maintain a map of internally
defined segments to the $10-50 billion reporting form categories for
accurate reporting.
Some companies' business line or risk assessment functions may
already segment data with more granularity, i.e., beyond the $10-50
billion reporting form categories, which would support their DFA stress
tests. Enhanced data details on borrower and loan characteristics may
identify distinct and separate credit risks within a reporting category
more effectively, and therefore yield a more accurate risk assessment
than simply analyzing the larger aggregate portfolio. Greater
segmentation, particularly for larger or riskier portfolios, may prove
especially useful in estimating the risks to a portfolio under the
adverse or severely adverse scenarios, because aggregated or less
segmented portfolios may mask or distort the effect of potentially more
stressful conditions on sub-portfolios. While $10-50 billion reporting
form categories represent the minimum acceptable segmentation, larger
or more sophisticated $10-50 billion companies should consider whether
that level of segmentation is sufficient for the risk in their
portfolios.

3. Model risk management

Companies should have in place effective model risk management
practices, including validation, for all models used in DFA stress
tests, consistent with existing supervisory guidance.\21\ This includes
ensuring that DFA stress test models are subject to appropriate
standards for model development, implementation and use, model
validation and model governance. Companies should ensure an effective
challenge process by unbiased, competent, and qualified parties is in
place for all models. There should also be sufficient documentation of
all models, including model assumptions, limitations, and
uncertainties. Senior management should have appropriate understanding
of DFA stress test models to provide summary information to the
company's board of directors that allows directors to assess and
question methodologies and results.
---------------------------------------------------------------------------

\21\ OCC 2011-12 and FR SR 11-7.
---------------------------------------------------------------------------

Companies should ensure that their model risk management policies
and practices generally apply to the use of vendor and third-party
products as well. This includes all the standards and expectations
outlined above and in existing supervisory guidance. If a company is
using vendor models, senior management is expected to demonstrate
knowledge of the model's design, intended use, applications,
limitations

[[Page 47223]]

and assumptions. For cases in which knowledge about a vendor or third-
party model is limited for proprietary or other reasons, companies
should take additional steps to ensure that they have an understanding
of the model and can confirm it is functioning as intended. For
example, companies may need to conduct more sensitivity analysis and
benchmarking if information about a vendor model is limited for
proprietary or other reasons. Additionally, a company should have as
much in-house knowledge as possible in the event of vendor contract
termination and should have contingency plans in cases where a vendor
model is no longer available.
In cases where there are noted weaknesses or limitations in models
or data used for stress tests, a company may choose to apply
qualitative adjustments to the model or its output that are expert
judgment-based. In most cases, however, estimation based solely or
heavily reliant on qualitative adjustments should not be the main
component of final loss estimates. Where qualitative adjustments are
made, they should be consistently determined and applied, and subject
to a well-defined process that includes a well-supported rationale,
methodology, proper controls and strong documentation. When expert
judgment is used on an ongoing basis, the estimates generated by such
judgment should be subject to outcomes analysis, to assess performance
equivalent to that used to evaluate a quantitative model. Large
qualitative adjustments to the stress test results, especially on a
repeated basis, may be indicative of a flawed process.

4. Loss estimation

For their DFA stress tests, companies are expected to have credible
loss estimation practices that capture the risks associated with their
portfolios, business lines, and activities. Credit losses associated
with loan portfolios and securities holdings should be estimated
directly and separately (as described in this section), whereas other
types of losses should be incorporated into estimated PPNR (as
described in the next section). Processes for loss estimation should be
consistent, repeatable, transparent, and well documented. Companies
should have a transparent and consistent approach for aggregating loss
estimates across the enterprise. For example, inputs from all parts of
the company should rely on common assumptions and map to specific loss
categories of the $10-50 billion reporting form. A company should
ensure that all enterprise loss estimation approaches reflect
reasonably sufficient rigor and conservatism, and that, for loss
estimation, the scenarios are applied consistently across the company.
Each company's loss estimation practices should be commensurate
with the materiality of the risks measured and well supported by sound,
empirical analysis. The practices may vary in complexity, depending on
data availability and the materiality of a given portfolio. In general,
loss estimation practices for credit risk are expected to be more
advanced than other elements of the stress test, given that credit risk
usually represents the largest potential risk to capital adequacy among
$10-50 billion companies.
Companies should be mindful that the credit performance in a benign
economic environment could differ markedly from that during more
stressful periods, and the differences could become greater as the
severity of stress increases. For example, companies that experienced
low losses on their construction loans during a benign economic
environment, due to the presence of interest reserves or other risk
mitigating factors, may experience a sharp and rapid rise in losses in
a scenario where market conditions deteriorate for a prolonged period.
A company's decision whether to use consistent or different loss
estimation processes for various supervisory scenarios would depend on
the sensitivity of a company's loss estimation process to a given
scenario.
A company may use a consistent process for loss estimation for all
scenarios if that process is sufficiently sensitive to the severity of
each scenario. Alternately, a company may use different loss estimation
processes for different scenarios if the process it uses for the
baseline scenario does not adequately capture the sensitivity of loss
estimates to adverse and severely adverse scenarios. For example, a
company may use its budgeting process for its baseline loss
projections, if appropriate, but it should use a different process for
the adverse and severely adverse scenarios if its budgeting process
does not capture the potential for sharply elevated losses during
stressful conditions. Whatever processes a company chooses should be
conditioned on each of the three macroeconomic scenarios provided by
supervisors.
Companies may choose loss estimation processes from a range of
available methods, techniques, and levels of granularity, depending on
the type and materiality of a portfolio, and the type and quality of
data available. For instance, some companies may choose to base their
stress loss estimates on industry historical loss experience, provided
that those estimates are consistent with the conditions in the
supervisory scenarios. Companies should choose a method that best
serves the structure of their credit portfolios, and they may choose
different methods for different portfolios (for example, wholesale
versus retail). Furthermore, companies may use multiple methods to
estimate losses on any given credit portfolio, and investigate
different methods before settling on a particular approach or
approaches. Regardless of whether a company uses historical loss
experience or a more sophisticated modeling technique to estimate
losses in a given scenario, the company should verify that resulting
loss estimates are appropriately conditioned on the scenario, and any
assumptions used are well understood and documented.
In estimating losses based on historical experiences, companies
should ensure that historical loss experience contains at least one
period when losses were substantially elevated and revenues
substantially reduced, such as the downturn of a credit cycle. In
addition, companies should ensure that any historical loss data used
are consistent with the company's current exposures and condition. This
could occur, for instance, if a company has shifted the proportion of
its commercial lending from large corporations to smaller businesses,
and the shift is not appropriately reflected in its historical loss
data. If neither a company's own data history nor industry loss data
include periods of stress comparable to the supervisory adverse or
severely adverse scenario, the company should make reasonable,
conservative assumptions based on available data.
Companies may choose to estimate credit losses at an aggregate
level, at a loan-segment level, or at a loan-by-loan level. Aggregate
approaches generally involve estimating loan losses for portfolios of
loans, such as the $10-50 billion reporting form categories or more
granular categories. Loan segmentation approaches group individual
loans into segments or pools of obligors with similar risk
characteristics to estimate losses. For example, individual 30-year
fixed-rate mortgage loans may be pooled into one segment, and 5-year
adjustable-rate mortgages (ARMs) into another segment, each to be
modeled separately based on the balance, loss, and default history in
that loan segment. Loan segments can also be determined based on
additional risk characteristics, such as credit score, LTV ratio,
borrower location, and payment status. Finally, loan-level approaches
estimate losses

[[Page 47224]]

for each loan or borrower and aggregate those estimates to arrive at
portfolio-level losses.
Some of the more commonly used modeling techniques for estimating
loan losses include net charge-off models, roll-rate models, and
transition matrices. Net charge-off models typically estimate the net
charge-off rate for a given portfolio, based on the historical
relationship between the net charge offs and relevant risk factors,
including macroeconomic variables. Roll-rate models generally estimate
the rate at which loans that are current or delinquent in a given
quarter roll into delinquent or default status in the next quarter,
conditioning such estimates on relevant risk factors. Transition
matrices estimate the probability that risk ratings on loans could
change from quarter to quarter and observe how transition rates differ
in stressful periods compared with less stressful or baseline periods.
Some companies may also use an expected loss approach, where the
probability of default, loss given default, and exposure at default are
estimated for individual loans, conditioning such estimates on each
loan or portfolio risk characteristics and the economic scenario.
Companies can benefit from exploring different modeling approaches,
giving due consideration to cost effectiveness and with the
understanding that more sophisticated methodologies will not
necessarily prove more practicable or robust.
Loss estimation practices should be commensurate with the overall
size, complexity and sophistication of the company, as well as with
individual portfolios, to ensure they fully capture a company's risk
profile. Accordingly, smaller, less sophisticated $10-50 billion
companies may employ simpler loss estimation practices that rely on
industry historical loss experience at a higher level of aggregation.
On the other hand, larger or more sophisticated $10-50 billion
companies should consider more advanced loss estimation practices that
identify the key drivers of losses for a given portfolio, segment, or
loan, determine how those drivers would be affected in supervisory
scenarios, and estimate resulting losses.
Loss projections should include projections of other-than-temporary
impairments (OTTI) for securities both held for sale and held to
maturity. OTTI projections should be based on positions as of September
30 and should be consistent with the supervisory scenarios and standard
accounting treatment. Companies should ensure that their securities
loss estimation practices, including definitions of loss used, remain
current with regulatory and accounting changes.

5. Pre-provision net revenue estimation

The projection of potential revenues is a key element of a stress
test. For the DFA stress test, companies are required to project PPNR
over the planning horizon for each supervisory scenario.\22\ Companies
should estimate PPNR at a level at least as granular as the components
outlined in the $10-50 billion reporting form. Companies should be
mindful that revenue patterns could differ markedly in baseline versus
stress periods, and should therefore not make assumptions that revenue
streams will remain the same or follow similar paths across all
scenarios. In estimating PPNR, companies should consider, among other
things, how potentially higher nonaccruals, increased collection costs,
and changes in funding sources during the adverse and severely adverse
scenarios could affect PPNR. Companies should ensure that PPNR
projections are generally consistent with projections of losses, the
balance sheet, and risk-weighted assets. For example, if a company
projects that loan losses would be reduced because of declining loan
balances under a severely adverse scenario, PPNR would also be expected
to decline under the same scenario due to the decline in interest
income. Companies should ensure transparency and appropriate
documentation of all material assumptions related to PPNR.
---------------------------------------------------------------------------

\22\ The DFA stress test rules define PPNR as net interest
income plus non-interest income less non-interest expense. Non-
operational or non-recurring income and expense items should be
excluded.
---------------------------------------------------------------------------

There are various ways to estimate PPNR under stress scenarios and
companies are not required to use any specific method. For example,
companies may project each of three main components of PPNR (net
interest income, non-interest income, and non-interest expense) or sub-
components of PPNR (e.g., interest income or fee income), on an
aggregate level for the entire company or by business line. Companies
may base their PPNR estimates on internal or industry historical
experience, or use a more sophisticated model-based approach to project
PPNR. For example, some companies may project PPNR based on a
historical relationship between PPNR or broad components of PPNR and
macroeconomic variables. In those instances, companies may use the
level of PPNR or the ratio of PPNR to a relevant balance sheet measure,
such as assets or loans. Some companies may use a more granular
breakout of PPNR (for example, interest income on loans), identify
relevant economic variables (for example, interest rates), and employ
models based on historical data to project PPNR. Some companies may use
their asset-liability management models to project some components of
PPNR, such as net interest income.
A company may estimate the stressed components of PPNR based on its
own or industry-wide historical income and expense experience,
particularly during the early development of a company's stress testing
practices. When using its own history, a company should ensure that the
data include at least one stressful period; when using industry data, a
company should ensure that such data are relevant to its portfolios and
businesses and appropriately reflect potential PPNR under each
supervisory scenario. If neither its own data nor industry data include
the period of stress that is comparable to the supervisory adverse or
severely adverse scenario, a company should make conservative
assumptions, based on available data, and appropriately adjust its
historical PPNR data downward in its stressed estimate. A company that
has been experiencing merger activity, rapid growth, volatile revenues,
or changing business models should rely less on its own historical
experience, and generally make conservative assumptions.
Smaller or less sophisticated $10-50 billion companies may employ
PPNR estimation approaches that project the three main components of
PPNR at the aggregate, company-wide level based on industry experience.
Larger or more sophisticated $10-50 billion companies should consider
PPNR estimation practices that more fully capture potential risks to
their business and strategy by collecting internal revenue data,
estimating revenues within specific business lines, exploring more
advanced techniques that identify the specific drivers of revenue, and
analyzing how the supervisory scenarios affect those revenue drivers.
Whatever process a company chooses to employ, projected revenues and
expenses should be credible and reflect a reasonable translation of
expected outcomes consistent with the key scenario variables.
In addition to the credit losses associated with loan portfolios
and securities holdings, described in the previous section, that should
be estimated directly and separately, companies may determine that
other types of losses could arise under the supervisory scenarios.
These other types of losses should be included in projections of PPNR
to the extent they would arise under the specified scenario

[[Page 47225]]

conditions. For example, any trading losses arising from the scenario
conditions should be included in the non-interest income component of
PPNR. As another example, companies should estimate under the non-
interest expense component of PPNR any losses associated with requests
by mortgage investors--including both government-sponsored enterprises
as well as private-label securities holders--to repurchase loans deemed
to have breached representations and warranties, or with investor
litigation that broadly seeks damages from companies for losses.
Companies with material representation and warranty risk may
consider a range of legal process outcomes, including worse than
expected resolutions of the various contract claims or threatened or
pending litigation against a company and against various industry
participants. Additionally, in estimating non-interest income,
companies with significant mortgage servicing operations should
consider the effect of the supervisory scenarios on revenue and
expenses related to mortgage servicing rights and the associated impact
to regulatory capital.
PPNR estimates should also include any operational losses that a
company estimates based on the supervisory scenarios provided.
Companies should address operational risk in their PPNR projections if
such events are related to the supervisory scenarios provided, or if
there are pending related issues, such as ongoing litigation, that
could affect losses or revenues over the planning horizon.

6. Balance sheet and risk-weighted asset projections

A company is expected to project its balance sheet and risk-
weighted assets for each of the supervisory scenarios. In doing so,
these projections should be consistent with scenario conditions and the
company's prior history of managing through the different business
environments, especially stressful ones. For example, if a company has
reduced its business activity and balance sheet during past periods of
stress or if it has contingent exposures, that should be taken into
consideration. The projections of the balance sheet and risk-weighted
assets should be consistent with other aspects of stress test
projections, such as losses and PPNR. In addition, balance sheet and
risk-weighted asset projections should remain current with regulatory
and accounting changes.
Companies may use a variety of methods to project balance sheet and
risk-weighted assets. In certain cases, it may be appropriate for a
company to use simpler approaches for balance sheet and risk-weighted
asset projections, such as a constant-portfolio assumption.
Alternatively, a company may rely on estimates of changes in balance
sheet and risk-weighted assets based on their own or industry-wide
historical experience, provided that the internal or external
historical balance sheet and risk-weighted asset experience contains
stressful periods. As in the case of loss estimation and PPNR, using
industry-wide data might be more appropriate when internal data lack
sufficient history, granularity, or observations from stressful
periods; however, companies should take caution when using the industry
data and provide appropriate documentation for all material
assumptions.
In stress scenarios, companies should justify major changes in the
composition of risk-weighted assets, for example, based on assumptions
about a company's strategic direction, including events such as
material sales, purchases, or acquisitions. Furthermore, companies
should be mindful that any assumptions about reductions in business
activity that would reduce its balance sheet and risk-weighted assets
over the planning horizon (such as tightened underwriting) are also
likely to reduce PPNR. Such assumptions should also be reasonable in
that they do not substantially alter the company's core businesses and
earnings capacity. Companies should document and explain key underlying
assumptions, as appropriate.
Some companies may choose to employ more advanced, model-based
approaches to project balance sheet and risk-weighted assets. For
example, a company may project outstanding balances for assets and
liabilities based on the historical relationship between those balances
and macroeconomic variables. In other cases, a company could project
certain components of the balance sheet, for example, based on
projections for originations, pay-downs, drawdowns, and losses for its
loan portfolios under each scenario. Estimated prepayment behavior
conditioned on the relevant scenario and the maturity profile of the
asset portfolio could inform balance projections.

7. Estimates for immaterial portfolios

Although stress testing should be applied to all exposures as
described above, the same level of rigor and analysis may not be
necessary for lower-risk, immaterial, portfolios. Portfolios considered
immaterial are those that would not represent a consequential effect on
capital adequacy under any of the scenarios provided. For such
portfolios, it may be appropriate for a company to use a less
sophisticated approach for its stress test projections, provided that
the results of that approach are conservative and well documented. For
example, estimating losses under the supervisory scenarios for a small
portfolio of municipal securities may not involve the same
sophistication as a larger portfolio of commercial mortgages.

8. Projections for quarterly provisions and ending allowance for loan
and lease losses

The DFA stress test rules require companies to project quarterly
PLLL. Companies are expected to project PLLL based on projections of
quarterly loan and lease losses and the appropriate ALLL balance at
each quarter-end for each scenario. In projecting PLLL, companies are
expected to maintain an adequate loan-loss reserve through the planning
horizon, consistent with supervisory guidance, accounting standards,
and a company's internal practice. Estimated provisions should
recognize the potential need for higher reserve levels in the adverse
and severely adverse scenarios, since economic stress leads to poorer
loan performance. The ALLL at the end of the planning horizon should be
consistent with GAAP, including any losses projected beyond the nine-
quarter horizon.

9. Projections for quarterly net income

Under the DFA stress test rules, companies must estimate projected
quarterly net income for each scenario. Net income projections should
be based on loss, revenue, and expense projections described above.
Companies should also ensure that tax estimates, including deferred
taxes and tax assets, are consistent with relevant balance sheet and
income (loss) assumptions and reflect appropriate accounting, tax, and
regulatory changes.

D. Estimating the Potential Impact on Regulatory Capital Levels and
Capital Ratios

Rule Requirement: In conducting a stress test, for each quarter of the
planning horizon a company must estimate: the potential impact on
regulatory capital levels and capital ratios (including regulatory
capital ratios and any other capital ratios specified by the primary
supervisor), incorporating the effects of any capital actions over the
planning horizon and maintenance of an allowance for loan

[[Page 47226]]

losses appropriate for credit exposures throughout the planning
horizon.\23\
---------------------------------------------------------------------------

\23\ 12 CFR 46.6(a)(2) (OCC); 12 CFR 252.155(a)(2) (Board); 12
CFR 325.205(a)(2) (FDIC).

In the DFA stress test rules, companies are required to estimate
the impact of supervisory scenarios on capital levels and ratios, based
on the estimates of losses, PPNR, loan and lease provisions, and net
income, as well as projections of the balance sheet and risk-weighted
assets. Companies must estimate projected quarterly regulatory capital
levels and regulatory capital ratios for each scenario. The agencies
expect companies' post-stress capital ratios under the adverse and
severely adverse scenarios will be lower than under the baseline
scenario. Projected capital levels and ratios should reflect applicable
regulations and accounting standards for each quarter of the planning
horizon.
In particular, in July 2013, the Board and OCC issued a final rule
and the FDIC issued an interim final rule regarding regulatory capital
requirements for banking organizations. The final rules revise the
criteria for regulatory capital, introduce a new minimum common equity
tier 1 capital requirement of 4.5 percent of risk-weighted assets, as
well as a minimum supplementary leverage ratio requirement of 3 percent
that would apply to companies subject to the advanced approaches
capital rules. The new minimum capital requirements would be phased in
over a transition period. The final rules will take effect beginning on
January 1, 2014, for banking organizations subject to the agencies'
advanced approaches rules (other than savings and loan holding
companies) and on January 1, 2015, for all other banking organizations.
Compliance with the supplementary leverage ratio for companies subject
to the advanced approaches rules will be required starting in 2018.
$10-50 billion companies should measure their regulatory capital levels
and regulatory capital ratios for each quarter in accordance with the
rules that would be in effect during that quarter in accordance with
the transition arrangements set forth in the final rules.

Rule Requirement: A bank holding company or savings and loan holding
company is required to make the following assumptions regarding its
capital actions over the planning horizon:

1. For the first quarter of the planning horizon, the bank holding
company or savings and loan holding company must take into account its
actual capital actions as of the end of that quarter.
2. For each of the second through ninth quarters of the planning
horizon, the bank holding company or savings and loan holding company
must include in the projections of capital:
(a) Common stock dividends equal to the quarterly average dollar
amount of common stock dividends that the company paid in the previous
year (that is, the first quarter of the planning horizon and the
preceding three calendar quarters);
(b) 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
(c) An assumption of no redemption or repurchase of any capital
instrument that is eligible for inclusion in the numerator of a
regulatory capital ratio.\24\
---------------------------------------------------------------------------

\24\ 12 CFR 252.155(b).

In their DFA stress tests, bank holding companies and savings and
loan holding companies are required to calculate pro forma capital
ratios using a set of capital action assumptions based on historical
distributions, contracted payments, and a general assumption of no
redemptions, repurchases, or issuances of capital instruments. A
holding company should also assume it will not issue any new common
stock, preferred stock, or other instrument that would count in
regulatory capital in the second through ninth quarters of the planning
horizon, except for any common issuances related to expensed employee
compensation.
While holding companies are required to use specified capital
action assumptions, there are no specified capital actions for banks
and thrifts. A bank or thrift should use capital actions that are
consistent with the scenarios and the company's internal practices in
their DFA stress tests. For banks and thrifts, projections of dividends
that represent a significant change from practice in recent quarters,
for example to conserve capital in a stress scenario, should be
evaluated in the context of corporate restrictions and board decisions
in historical stress periods. Additionally, a holding company should
consider that it is required to use certain capital assumptions that
may not be the same as the assumptions used by its bank subsidiaries.
Finally, any assumptions about mergers or acquisitions, and other
strategic actions should be well documented and should be consistent
with past practices of management and the board during stressed
economic periods. Should the stress-test submissions for the bank or
thrift and its holding company differ in terms of projected capital
actions (e.g., different dividend payout assumptions during the stress
test horizon for the bank versus the holding company) as a result of
the different requirements of the DFA stress test rules, the
institution should address such differences in the narrative portion of
their submissions.

E. Controls, Oversight, and Documentation

Rule requirement: Senior management must establish and maintain a
system of controls, oversight and documentation, including policies and
procedures, that are designed to ensure that its stress testing
processes are effective in meeting the requirements of the DFA stress
test rule. These policies and procedures must, at a minimum, describe
the company's stress testing practices and methodologies, and describe
the processes for validating and updating practices and methodologies
consistent with applicable laws, regulations, and supervisory guidance.
The board of directors, or a committee thereof, of a company must
approve and review the policies and procedures of the stress testing
processes as frequently as economic conditions or the condition of the
company may warrant, but no less than annually.\25\
---------------------------------------------------------------------------

\25\ 12 CFR 46.5(d) (OCC); 12 CFR 252.155(c) (Board); 12 CFR
325.205(b) (FDIC).

Pursuant to the DFA stress test requirement, a company must
establish and maintain a system of controls, oversight, and
documentation, including policies and procedures that apply to all of
its DFA stress test components. This system of controls, oversight, and
documentation should be consistent with the May 2012 stress testing
guidance. Policies and procedures for DFA stress tests should be
comprehensive, ensure a consistent and repeatable process, and provide
transparency regarding a company's stress testing processes and
practices for third parties. The policies and procedures should provide
a clear articulation of the manner in which DFA stress tests should be
conducted, roles and responsibilities of parties involved (including
any external resources), and describe how DFA stress test results are
to be used. These policies and procedures also should be integrated
into other policies and procedures for the company. The board (or a
committee thereof) must approve

[[Page 47227]]

and review the policies and procedures for DFA stress tests to ensure
that policies and procedures remain current, relevant, and consistent
with existing regulatory and accounting requirements and expectations
as frequently as economic conditions or the condition of the company
may warrant, but no less than annually.
Senior management must establish policies and procedures for DFA
stress tests and should ensure compliance with those policies and
procedures, assign competent staff, oversee stress test development and
implementation, evaluate stress test results, and review any findings
related to the functioning of stress testing processes. Senior
management should ensure that weaknesses--as well as key assumptions,
limitations and uncertainties--in DFA stress testing processes and
results are identified, communicated appropriately within the
organization, and evaluated for the magnitude of impact, taking prompt
remedial action where necessary. Senior management, directly and
through relevant committees, should also be responsible for regularly
reporting to the board regarding DFA stress test developments
(including the process to design tests and augment or map supervisory
scenarios), DFA stress test results, and compliance with a company's
stress testing policy.
A company's system of documentation should include the
methodologies used, data types, key assumptions, and results, as well
as coverage of the DFA stress tests (including risks and exposures
included). For any models used, documentation should include sufficient
detail about design, inputs, assumptions, specifications, limitations,
testing, and output. In general, documentation on methodologies used
should be consistent with existing supervisory guidance.
Companies should ensure that other aspects of governance over
methodologies used for DFA stress tests are appropriate, consistent
with the May 2012 stress testing guidance. Specifically, companies
should have policies, procedures, and standards for any models used.
Effective governance would include validation and effective challenge
for any assumptions or models used, and a description of any remedial
steps in cases where models are not validated or validation identifies
substantial issues. A company should ensure that internal audit
evaluates model risk management activities related to DFA stress tests,
which should include a review of whether practices align with policies,
as well as how deficiencies are identified, monitored, and addressed.

Rule requirements: The board of directors and senior management of the
company must receive a summary of the results of the stress test. The
board of directors and senior management of a company must consider the
results of the stress test in the normal course of business, including,
but not limited to, the company's capital planning, assessment of
capital adequacy, and risk management practices.\26\
---------------------------------------------------------------------------

\26\ 12 CFR 46.5(d) and 46.6(c)(2) (OCC); 12 CFR 252.155(c)(3)
(Board); 12 CFR 325.205(b)(2) and (3) (FDIC).

A company's board of directors is ultimately responsible for the
company's DFA stress tests. Board members must receive summary
information about DFA stress tests, including results from each
scenario. The board or its designee should actively evaluate and
discuss this information, ensuring that the DFA stress tests
appropriately reflect the company's risk appetite, overall strategy and
business plans, overall stress testing practices, and contingency
plans, directing changes where appropriate. The board should ensure it
remains informed about critical review of elements of the DFA stress
tests conducted by senior management or others (such as internal
audit), especially regarding key assumptions, uncertainties, and
limitations.
All $10-50 billion companies must consider the role of stress
testing results in normal business including in the capital planning,
assessment of capital adequacy, and risk management practices of the
company. A company should document the manner in which DFA stress tests
are used for key decisions about capital adequacy, including capital
actions and capital contingency plans. The company should indicate the
extent to which DFA stress tests are used in conjunction with other
capital assessment tools, especially if the DFA stress tests may not
necessarily capture a company's full range of risks, exposures,
activities, and vulnerabilities that have the potential to affect
capital adequacy. Importantly, a company should ensure that its post-
stress capital results are aligned with its internal capital goals and
risk appetite. For cases in which post-stress capital results are not
aligned with a company's internal capital goals, senior management
should provide options it and the board would consider to bring them
into alignment.

F. Report to Supervisors

Rule Requirement: A company must report the results of the stress test
to its primary supervisor and to the Board of Governors by March 31, in
the manner and form prescribed by the agency.\27\
---------------------------------------------------------------------------

\27\ 12 CFR 46.7 (OCC); 12 CFR 252.156 (Board); 12 CFR 325.206
(FDIC).

All $10-50 billion companies must report the results of their DFA
company-run stress tests on the $10-50 billion reporting form. This
report will include a company's quantitative projections of losses,
PPNR, balance sheet, risk-weighted assets, ALLL, and capital on a
quarterly basis over the duration of the scenario and planning horizon.
In addition to the quantitative projections, companies are required to
submit qualitative information supporting their projections. The report
of the stress test results must include, under each scenario: a
description of the types of risks included in the stress test, a
description of the methodologies used in the stress test, an
explanation of the most significant causes for the changes in
regulatory capital ratios, and any other information required by the
agencies. In addition, the agencies may request supplemental
information, as needed.
If significant errors or omissions are identified subsequent to
filing, a company must file an amended report. For additional
information, see the instructions provided with the reporting
templates.

G. Public Disclosure of DFA Test Results

Rule Requirement: A company must disclose a summary of the results of
the stress test in the period beginning on June 15 and ending on June
30.\28\
---------------------------------------------------------------------------

\28\ 12 CFR 46.8 (OCC); 12 CFR 252.157 (Board); 12 CFR 325.207
(FDIC).

Under the DFA stress test rules, a company must make its first DFA
stress test-related public disclosure between June 15 and June 30,
2015, by disclosing summary results of its annual DFA stress test,
using September 30, 2014, financial statement data. The regulation
requires holding companies to include in their public disclosure a
summary of the results of the stress tests conducted by any
subsidiaries subject to DFA stress testing.\29\ A bank can satisfy this
public disclosure requirement by including a summary of the results of
its stress test in its parent company's public disclosure (on the same
timeline); however the agencies can require a separate disclosure if
the parent company's public disclosure does not adequately capture the
impact of the scenarios on the bank.
---------------------------------------------------------------------------

\29\ 12 CFR 252.157(b).
---------------------------------------------------------------------------

The summary of the results of the stress test, including both
quantitative

[[Page 47228]]

and qualitative information, should be included in a single release on
a company's Web site, or in any other forum that is reasonably
accessible to the public.
Each bank or thrift must publish a summary of its stress tests
results separate from the results of stress tests conducted at the
consolidated level of its parent holding company, but the company may
include this summary with its holding company's public disclosure.
Thus, a bank or thrift with a parent holding company that is required
to conduct a company-run DFA stress test under the Federal Reserve
Board's DFA stress test rules will have satisfied its public
disclosures requirement when the parent holding company discloses
summary results of subsidiary's annual stress test in satisfaction of
the requirements of the applicable regulations of the company's primary
Federal regulator, unless the company's primary regulator determines
that the disclosures at the holding company level does not adequately
capture the potential impact of the scenarios on the capital of the
companies.
A company must disclose, at a minimum, the following information
regarding the severely adverse scenario:

a. A description of the types of risks included in the stress test;
b. A summary description of the methodologies used in the stress test;
c. Estimates of--

Aggregate losses;
PPNR;
PLLL;
Net income; and
Pro forma regulatory capital ratios and any other capital ratios
specified by the primary supervisor;
d. An explanation of the most significant causes for the changes in
regulatory capital ratios; and
e. For bank holding companies and savings and loan holding companies:
for a stress test conducted by an insured depository institution
subsidiary of the bank holding company or savings and loan holding
company pursuant to section 165(i)(2) of the Dodd-Frank Act, changes in
regulatory capital ratios and any other capital ratios specified by the
primary Federal financial regulatory agency of the depository
institution subsidiary over the planning horizon, including an
explanation of the most significant causes for the changes in
regulatory capital ratios.

It should be clear in the company's public disclosure that the
results are conditioned on the supervisory scenarios. Items to be
publicly disclosed should follow the same definitions as those provided
in the confidential report to supervisors. Companies should disclose
all of the required items in a single public release, as it is
difficult to interpret the quantitative results without the qualitative
supporting information.

Differences in DFA Stress Test Requirements for Holding Companies Versus
Banks and Thrifts
------------------------------------------------------------------------
Bank Holding
Companies and
Savings and Loan Banks and Thrifts
Holding Companies
------------------------------------------------------------------------
Capital actions used for company- Capital actions No prescribed
run stress tests. prescribed in capital actions.
Federal Reserve Banks and thrifts
Board's DFA should use
stress tests capital actions
rules. Generally consistent with
based on the scenario and
historical their internal
dividends, business
contracted practices.
payments, and no
repurchases or
issuances.
Public disclosure of company-run Disclosure must Disclosure
stress tests. include requirement met
information on when parent
stress tests company
conducted by disclosure
subsidiaries includes the
subject to DFA required
stress tests. information on
the bank or
thrift's stress
test results,
unless the
company's primary
regulator
determines that
the disclosure at
the holding
company level
does not
adequately
capture the
potential impact
of the scenarios
on the capital of
the company.
------------------------------------------------------------------------

Dated: July 25, 2013.
Thomas J. Curry,
Comptroller of the Currency.
By order of the Board of Governors of the Federal Reserve
System, July 24, 2013.
Robert deV. Frierson,
Secretary of the Board.
Dated at Washington, DC, this 30th day of July, 2013.

Federal Deposit Insurance Corporation.
Robert E. Feldman,
Executive Secretary.
[FR Doc. 2013-18716 Filed 8-2-13; 8:45 am]
BILLING CODE 4810-33-P; 6714-01-P; 6210-01-P

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