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Differences with the Fed accompany bumpy stress-test results

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Differences with the Fed accompany bumpy stress-test results

As policymakers consider raising the bar on large banks' stress tests, companies want more predictability in the annual testing and capital planning exercise.

In aggregate, the banking industry's stress tests this year were closer to the Federal Reserve's version. Still, some banks saw significant differences in their results, including banks that had some difficulty in passing the test.

Morgan Stanley and Goldman Sachs Group Inc. both posted supplementary leverage ratios that were below the regulatory minimum in the latest capital planning exercise, contributing to conditional nonobjections of their capital plans. Both banks reported stress-test results that were significantly different from the Fed's calculations, and next year's exercise could be even tougher. Some Fed members have advocated for implementation of the countercyclical capital buffer, and the regulator is considering the stress capital buffer, a rule that would raise the minimum capital ratio needed to pass a stress test.

With potentially higher capital ratios in next year's test, the stress-test troubles attracted attention during each bank's earnings call.

"This year, they got really tough. And I think everybody is kind of taking a little pause on that and trying to figure out what is the right level of capital you need in the financial system to fund the economic growth and what's the right leverage of the institutions," said Morgan Stanley CEO James Gorman.

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The capital planning process, known as the Comprehensive Capital Analysis and Review, or CCAR, uses the results from the Dodd-Frank Act Stress Test, or DFAST, to evaluate banks' capital requests. On a net income basis, Morgan Stanley's DFAST results were much more optimistic than the Fed's. Morgan Stanley predicted the stressed scenario would produce $15.9 billion of losses, compared to the Fed's modeling that showed $20.8 billion of losses.

"One of the things that we've been asking for is incremental transparency, so we can better understand the models," said CFO Jonathan Pruzan.

Goldman Sachs executives were also calling for more clarity in stress tests following the bank's bumpy CCAR. The bank's net income figure in the stress test was nearly identical to the Federal Reserve's, but the bank varied wildly when it came to its leverage ratio. The bank saw its supplementary leverage ratio dropping to a low of 4.3% in the stressed scenario, compared to the Fed's estimate of 3.1%.

"We've been very public in saying this, we saw differences, divergences in our calculations from the Fed's. ... And I'm not going to comment on an individual asset class as it plays through CCAR, but certainly more transparency into the process and the modeling and the calculations would benefit everyone," said Goldman Sachs CFO R. Martin Chavez.

Goldman Sachs' and Morgan Stanley's business models rely more heavily on trading operations than other large banks, something that has contributed to the large gaps between the banks and regulators in how the companies would perform in a crisis.

"The equities profile of the wealth management business is suggestive that it's more volatile than our actual business is," said Morgan Stanley CEO Gorman. "That's an adjustment that I think and hope will be more appreciated over time in the way the models are constructed under the stress test."

Across the banking industry, the Fed's results this year were closer to the banks' than previous exercises. Among the participating banks, the average Tier 1 leverage ratio was 7.2%, as calculated by the companies themselves, compared to an average of 6.6% as calculated by the Fed. That difference of 60 basis points was smaller than last year's gap of 76 basis points. The gap in performance on the common equity Tier 1 ratio was even smaller at 20 basis points, compared to a difference of 72 basis points a year ago.

Still, even banks whose company-run results were similar or even more negative than the Fed's would like more transparency on how the regulator calculates its figures. Wells Fargo & Co.'s company-run results showed a larger net loss and lower common equity Tier 1 ratio than the Fed-run results. But bank executives still called for more clarity, saying the unpredictability of the stress test forces banks to hold excessive capital. Consultants have said the lack of transparency is essentially a feature of the test, an intentional hurdle so banks cannot "game" the results.

"There's not a lot of transparency currently in how those outcomes are calculated by the regulatory community," said CFO John Shrewsberry. "So there's work to do there, and that's a little bit of an overhang, I think, for everybody until it's better understood."

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To read an article on the release of the 2018 Dodd-Frank Act stress test results, click here.

Click here to access a template with stress test results and supplemental data for the participating bank holding companies.

Click here to access a template of the Federal Reserve-run and the company-run 2018 Dodd-Frank Act stress-test results for the participating bank holding companies.