A Federal Reserve proposal to alter the stress-testingprocess and exempt certain banks from the qualitative portion of the exercisecould serve as a boon for a handful of institutions whose businesses focus moreon consumer lending activities.
The Fed's Comprehensive Capital Analysis and Review evaluates thecapital planning processes and capital adequacy of bank holding companies with$50 billion or more in total consolidated assets, and includes quantitative andqualitative assessments of each firm. On Sept. 26 the Fed proposed removing thequalitative portion for certain banks with total consolidated assets between$50 billion and $250 billion. The proposal would also replace a 2.5% capitalconservation buffer finalized in April 2014 as part of the Basel III capitalrules with a larger, more flexible cushion based upon an ,Fed Governor Daniel Tarullo said in a speech on Sept. 26.
The proposed changes to the CCAR exercise could reduce theamount of time and money banks with assets ranging from $50 billion to $250billion spend on the stress-test process, while potentially offeringconsiderable capital relief for a handful of institutions, particularly thosewith more consumer-centric business models. And that capital relief could inturn offer a boost to shareholders who could see dividends and share repurchaseprograms climb in the process.
The Fed's proposed actions represent a willingness to createa distinction between smaller banks and systemically important institutionslarge enough to create "a contagion effect," said Tom Kimner, head ofglobal marketing and operations SAS Institute, a data and analytics firm.
In order to qualify for the qualitative exemption, banksmust also have less than $10 billion in on-balance sheet foreign exposure andunder $75 billion in total consolidated non-bank assets. Jim Sinegal, senioranalyst Morningstar Inc., noted that companies that meet the standards forexemption from the qualitative portion of CCAR could save "tens, if nothundreds of millions of dollars annually," by scaling back theirpreparation for the exercise.
Banks may opt to cut costs even further by eliminating highearners such as financial engineers from their workforce or reducinginvestments in costly software platforms. A senior quantitative risk analyst withexperience building stress-test models can command a salary between $180,000and $215,000 a year with an annual bonus of up to 40%, said Joseph Sullivan,president of International Market Recruiters. Banks can also contain costs ifthey avoid rash changes to their testing programs, which can lead to a surge inconsulting costs, according to Novantas Managing Director Peter Gilchrist.
"I think what you've seen [from banks] is a realizationthat 'we don't have to pay a consulting firm $5 million to move in two monthsfor what we can do on our own in a year,'" Gilchrist said.
Banks could see changes to their required capital levels aswell. RBC Capital Markets worked to project capital surplus/shortfall levelsunder the proposed changes for two dozen publicly traded banks over a two-yearperiod through the first quarter of 2018. Discover Financial Services, which had total assets of$87.51 billion as of June 30, topped that list with a capital surplus of 6.8%while American ExpressCo. and CitizensFinancial Group Inc. followed closely behind with surpluses of 6.0%and 4.0% respectively. Only at Bankof America Corp. did RBC project a capital shortfall, of 0.7% or$9.57 billion.
RBC calculated its estimates by looking at each bank's 2016second-quarter common equity Tier 1 ratio and subtracting its projected Tier 1capital run-rate over the two-year span. RBC took into account considerationssuch as a bank's minimum capital requirement, the Fed's modified stress capitalbuffer, an added buffer for global systemically important banks, and a built-insafety cushion of 50 basis points when calculating the capital run-rate.
The CCAR tests are geared to larger companies required tohold added capital due in part to their high appetite for risk, said GerardCassidy, an analyst at RBC. He noted that banks such as Discover and AmericanExpress tend to avoid risky activity on commercial real estate, derivatives andcapital markets in favor of holding safer consumer assets.
"Companies that don't participate in a meaningful wayin those lines of businesses are going to come up with very high capitallevels," Cassidy said.
RBC noted that the U.S. G-SIBs — , , Bank of America,Goldman Sachs GroupInc., MorganStanley, Wells Fargo& Co., State StreetCorp. and Bank of NewYork Mellon Corp. — would see their capital requirements rise as aresult of the proposal, while their smaller counterparts could be given theopportunity to return "a large amount of capital" to shareholderswithout the risk of violating the qualitative test.