Federal Reserve Board Issues Final Rule Regarding Capital Plan and Formal Stress Test Requirements for Certain Large Bank Holding Companies

Transcription

1 Federal Reserve Board Issues Final Rule Regarding Capital Plan and Formal Stress Test Requirements for Certain Large Bank Holding Companies BACKGROUND On November 22, 2011, the Board of Governors of the Federal Reserve System (the Board ) published a final rule (the Final CCAR Rule ) requiring most bank holding companies ( BHCs ) with $50 billion or more of total consolidated assets ( Covered BHCs ) to submit annual capital plans, with their related stress test requirements, to the appropriate Federal Reserve Bank and to generally obtain regulatory approval before making capital distributions, which include dividends and purchases of capital securities and instruments. 1 The Final CCAR Rule expands the capital plan requirements from 19 to 34 BHCs, including, for the first time, foreign-owned BHCs. In addition, the Board released (i) two sets of instructions (the Instructions ) that provide guidance on compliance with capital requirements in the Final CCAR Rule, one for Covered BHCs that did not participate in the 2011 Comprehensive Capital Analysis and Review ( CCAR and such BHCs, the non-ccar BHCs ) 2 and another for the 19 Covered BHCs that participated in the 2011 CCAR (the CCAR BHCs ) 3 and (ii) the data templates (namely, the FR Y- 14A and FR Y-14Q) that will be used to collect data from the CCAR BHCs to support the data collection contemplated by the Final CCAR Rule. 4 The Final CCAR Rule generally incorporates the core features of the Board s June 17, 2011 proposal regarding capital planning (the Proposed CCAR Rule ). 5 As part of the capital planning exercise, Covered BHCs on an annual basis must submit comprehensive capital plans, including pro forma capital analyses and supporting projections, based on four scenarios a BHC-defined baseline scenario; a baseline scenario provided by the Board; at least one BHC-defined stressed scenario; and a stressed scenario provided by the Board. In addition, six BHCs with large trading operations (the Trading BHCs ) will be required to estimate potential losses stemming from a hypothetical global market shock based on market price movements seen during the second half of 2008, New York Washington, D.C. Los Angeles Palo Alto London Paris Frankfurt Tokyo Hong Kong Beijing Melbourne Sydney

2 with adjustments made to incorporate potential sharp market price movements in European sovereign and financial sectors. The Final CCAR Rule will become effective December 30, Covered BHCs will be required to submit their first comprehensive capital plans under the Final CCAR Rule by January 9, 2012, covering the nine quarter period commencing with the fourth quarter of 2011 and ending with the fourth quarter of Although the Final CCAR Rule only applies to large BHCs with over $50 billion in assets, it remains to be seen whether the Board will, over time, come to expect BHCs that do not technically meet the size requirement to adopt some portions of the capital planning and stress test methodologies of the Final CCAR Rule as part of their own policies and procedures as a prudential supervisory matter. CAPITAL PLANNING REQUIREMENTS Applicability The Final CCAR Rule will generally apply to every top-tier BHC domiciled in the United States that has $50 billion or more in total consolidated assets. 6 Total consolidated assets is defined as the average of a company s total consolidated assets over the previous four calendar quarters, as reflected on the BHC s FR Y-9C (Consolidated Financial Statements for Bank Holding Companies). 7 The Final CCAR Rule also applies to any BHC that the Federal Reserve 8 determines, by order, is subject to its requirements based on the institution s size, level of complexity, risk profile, scope of operations or financial condition. 9 Annual Capital Planning Requirement As under the Proposed CCAR Rule, the Final CCAR Rule requires a Covered BHC to develop and maintain a capital plan. At least annually, the board of directors, or a designated committee, of a Covered BHC is required to review the robustness 10 of the Covered BHC s process for assessing capital adequacy, ensure that any deficiencies in its process for assessing capital adequacy are appropriately remedied and approve its capital plan. Capital plans will be due by January 5th each year. 11 The Federal Reserve will object or issue a non-objection to such capital plans, in whole or in part, by March For 2012 only, the deadline for submission has been extended to January 9th, 13 and the Federal Reserve will respond by March 15, 2012 if a Covered BHC submits its capital plan on a timely basis. 14 Mandatory Components of a Capital Plan Each capital plan must include the following mandatory components: an assessment of the expected uses and sources of capital over the requisite planning horizon that reflects the Covered BHC s size, complexity, risk profile and scope of operations, assuming both expected and stressful conditions. The planning horizon for these purposes must be at least nine quarters, beginning with the quarter preceding the quarter in which the Covered BHC submits its capital plan (for example, using the initial capital plan as an example, beginning with the fourth quarter of 2011 and continuing through the fourth quarter of 2013); -2-

3 a detailed description of the Covered BHC s process for assessing capital adequacy, including a discussion of how under expected and stressful conditions it will (i) maintain capital commensurate with its risks, maintain capital above the minimum regulatory capital ratios and above a Tier 1 common equity ratio of 5 percent and serve as a source of strength to its subsidiary depository institutions and (ii) maintain sufficient capital to continue its operations by maintaining ready access to funding, meeting its obligations to creditors and other counterparties and continuing to serve as a credit intermediary; the Covered BHC s capital policy; and a discussion of any expected changes to the Covered BHC s business. 15 The first component listed above requires an assessment of the expected uses and sources of capital over the planning horizon under both expected and stressful conditions. This assessment must contain the following elements: estimates of projected revenues, losses, 16 reserves and pro forma capital levels, including any minimum regulatory capital ratios and any additional capital measures deemed relevant by the Covered BHC, over the planning horizon under expected conditions and under a range of stressed scenarios, including any scenarios provided by the Federal Reserve and at least one stressed scenario developed by the Covered BHC appropriate to its business model and portfolios; a calculation of the pro forma Tier 1 common equity ratio over the planning horizon under expected conditions and under a range of stressed scenarios and a discussion of how the Covered BHC will maintain a pro forma Tier 1 common equity ratio above 5 percent 17 under the stressed scenarios required by the Final CCAR Rule; a discussion of the results of any stress test required by law or regulation, and an explanation of how the capital plan takes these results into account; and a description of all planned capital actions over the planning horizon. 18 A capital action for purposes of the Final CCAR Rule means any issuance of a debt or equity capital instrument, any capital distribution and any similar action that the Federal Reserve determines could impact a Covered BHC s consolidated capital. A capital distribution means a redemption or repurchase of any debt or equity capital instrument, a payment of common or preferred stock dividends, a payment that may be temporarily or permanently suspended by the issuer on any instrument that is eligible for inclusion in the numerator of any minimum regulatory capital ratio and any similar transaction that the Federal Reserve determines to be in substance a distribution of capital. 19 Baseline and Stress Scenarios As noted above, in assessing its expected uses and sources of capital over the planning horizon, a Covered BHC must estimate projected revenues, losses, reserves and pro forma capital levels under expected conditions and under a range of stressed scenarios. The Instructions provide additional detail regarding the scenarios that Covered BHCs must use to support their pro forma capital analyses and projections. In particular, the Instructions state that the pro forma capital analyses and supporting projections included in Covered BHCs annual capital plans must be based on at least four scenarios: a BHC-defined baseline scenario; a baseline scenario provided by the Federal Reserve (the Supervisory Baseline scenario ); at least one BHC-defined stressed scenario; and a stressed scenario provided by the Federal Reserve (the Supervisory Stress scenario )

4 The Instructions indicate that the BHC-defined baseline scenario should reflect the Covered BHC s view of the most likely path of the economy over the forecast horizon. 21 In addition, the Instructions provide that the BHC-defined stress scenario should be based on a coherent, logical narrative of a stressful economic environment and should reflect the [Covered] BHC s unique vulnerabilities to factors that affect its exposures, activities, and risks. 22 The Supervisory Baseline scenario broadly follows the consensus outlook from the Blue Chip Economic Indicators and other sources as of mid November. The Supervisory Stress scenario assumes a deep recession commencing in the fourth quarter of 2011 in which the unemployment rate increases by an amount similar to that experienced, on average, in severe recessions such as those in , [19]82, and , with a sizable shortfall in U.S. economic activity and employment, accompanied by a notable decline in global economic activity. 23 The Supervisory Stress scenario also includes hypothetical sharp declines in asset prices and risk premia increases. In addition to the above-described scenarios, the Trading BHCs which comprise Bank of America Corporation, Citigroup Inc., The Goldman Sachs Group, Inc., JPMorgan Chase & Co., Morgan Stanley and Wells Fargo & Company will also be required to conduct a stress test of their trading book, private equity positions and counterparty credit exposures as of market close on November 17, For purposes of this global market shock scenario, losses will be calculated based on an instantaneous re pricing of trading and private equity positions for the changes in market pricing variables that occurred over the period June 30, 2008, to December 31, The Instructions for CCAR BHCs state that this scenario should reflect where appropriate additional stresses related to the ongoing events in Europe and include estimates of changes in the size of counterparty exposures and the impact of deterioration of counterparties creditworthiness. 25 Data Submissions In connection with the submission of an annual capital plan, a Covered BHC is required to provide certain data to the Federal Reserve. Data required by the Federal Reserve may include, but are not limited to, information regarding the Covered BHC s financial condition, structure, assets, risk exposure, policies and procedures, liquidity and management. 26 Failure to submit complete data to the Federal Reserve in a timely manner may be a basis for objection to a capital plan. 27 CCAR BHCs will generally be required to report all required data elements pertaining to their 2012 capital plans pursuant to the schedules specified in the FR Y-14A and FR Y-14Q forms. 28 Federal Reserve Review of a Capital Plan The Federal Reserve will consider the following factors in reviewing a Covered BHC s capital plan: the comprehensiveness of the capital plan; the reasonableness of the Covered BHC s assumptions and analysis underlying the capital plan and its methodologies for reviewing the robustness of its capital adequacy process; and -4-

5 the Covered BHC s ability to maintain capital above each minimum regulatory capital ratio and above a Tier 1 common equity ratio of 5 percent on a pro forma basis under expected and stressful conditions throughout the planning horizon. 29 In reviewing a Covered BHC s capital plan, the Federal Reserve will also consider relevant supervisory information about the Covered BHC and its subsidiaries, the Covered BHC s regulatory and financial reports and, as applicable, the Federal Reserve s own pro forma estimates of the Covered BHC s potential losses, revenues, reserves and resulting capital adequacy under expected and stressful conditions. 30 It appears that the Federal Reserve, at least in 2012, will only generate supervisory pro forma estimates for CCAR BHCs. 31 Federal Reserve Objection to a Capital Plan The Federal Reserve may object to a capital plan for any of the following reasons: the Covered BHC has material unresolved supervisory issues, including but not limited to issues associated with its capital adequacy process; 32 the assumptions and analysis underlying the capital plan, or the Covered BHC s methodologies for reviewing the robustness of its capital adequacy process, are not reasonable or appropriate; the Covered BHC failed to demonstrate it could maintain capital above each minimum regulatory capital ratio or above a Tier 1 common equity ratio of 5 percent on a pro forma basis under expected and stressful conditions throughout the planning horizon; or the Covered BHC s capital planning process or proposed capital distributions otherwise constitute an unsafe or unsound practice, or would violate any law, regulation or Federal Reserve order, directive, written agreement or condition. 33 Resubmission of a Capital Plan A Covered BHC is required to update and re-submit its capital plan to the Federal Reserve within 30 days (subject to an extension of up to an additional 60 days) 34 of the occurrence of any of the following events: the Covered BHC determines there has been or will be a material change 35 in the Covered BHC s risk profile, financial condition or corporate structure since the Covered BHC adopted the capital plan; the Federal Reserve objects to the capital plan; or the Federal Reserve directs the Covered BHC to revise and resubmit its capital plan for any of the following reasons: the capital plan is incomplete or it, or the Covered BHC s internal capital adequacy process, contains material weaknesses; there has been or will likely be a material change in the Covered BHC s risk profile, financial condition or corporate structure; the stressed scenario or scenarios developed by the Covered BHC are not appropriate to its business model and portfolios, or changes in financial markets or the macro-economic outlook that could impact the Covered BHC s risk profile and financial condition require the use of updated scenarios; or the capital plan or condition of the Covered BHC raises any issues to which the Federal Reserve could object to in its review of a capital plan

6 The Federal Reserve will respond to a resubmitted capital plan within 75 days of its resubmission. 37 Prior Approval Requirements A Covered BHC generally must obtain prior approval from the Federal Reserve before making capital distributions under any of the following circumstances (regardless of whether the distribution in question had been provided for in a capital plan that had received a non-objection, if applicable): after giving effect to the capital distribution, the Covered BHC will not meet a minimum regulatory capital ratio or a Tier 1 common equity ratio of at least 5 percent; the Federal Reserve notifies the Covered BHC that it has determined that (i) the capital distribution will result in a material adverse change to the Covered BHC s capital or liquidity structure or (ii) the Covered BHC s earnings were materially underperforming projections; the dollar amount of the capital distribution will exceed the amount described in the Covered BHC s approved capital plan; or the capital distribution will occur after the occurrence of an event requiring resubmission (other than an objection to a capital plan) and before the Federal Reserve has acted on the resubmitted plan. 38 A Covered BHC is not permitted to make any capital distributions, to the extent the Federal Reserve has objected to its capital plan, until the Federal Reserve issues a non-objection to the Covered BHC s capital plan. The Final CCAR Rule provides a limited exception to the above rule regarding prior approval for capital distributions (together with all capital distributions made under this limited exception) that do not exceed one percent of the Covered BHC s Tier 1 capital as reported on its first quarter FR Y-9C. This exception may only be utilized by well-capitalized Covered BHCs. In addition, before a distribution can be made pursuant to this exception, Covered BHCs must provide the Federal Reserve with notice 15 calendar days before the proposed capital distribution, and the Federal Reserve must not object to the proposed distribution. 39 Disclosure of Supervisory Post-Stress Capital Analysis The Instructions for CCAR BHCs indicate that the Federal Reserve intends to publish the results of the supervisory stress test component of CCAR 2012 on a BHC-specific basis. 40 The Instructions for non- CCAR BHCs do not include a comparable discussion of disclosure, apparently reflecting a Federal Reserve decision not to publish results for non-ccar BHCs. The Federal Reserve took a similar step at the end of the first large bank capital stress test program in 2009, known as the Supervisory Capital Assessment Program, or SCAP. The Federal Reserve did not publish results of the 2011 CCAR review. The Instructions for CCAR BHCs state that the purpose of releasing this information is to provide insight to market participants into the resilience of the BHCs [in] very stressful hypothetical environments and to provide information about the post-stress capital analysis performed by supervisors during the CCAR 2012 process. 41 The information to be released will include, among other things, BHC-specific information about pro forma, post-stress capital ratios leverage, Tier 1 risk-based and total risk-based -6-

7 capital ratios and the Tier 1 common equity ratio including the minimum value of these ratios over the planning horizon. Common Dividend Payouts The Instructions repeat, for both CCAR BHCs and non-ccar BHCs, the statement from the Federal Reserve s November 2010 Revised Temporary Addendum to SR Letter 09-4 that common dividend payout ratios above 30% of projected after-tax net income will receive particularly close scrutiny. Like the Revised Temporary Addendum, the statement appears to be limited to common dividends and does not seem to reference other capital distributions, including stock repurchases. MODIFICATIONS AND CLARIFICATIONS Although the Final CCAR Rule generally incorporates the fundamental features of the Proposed CCAR Rule, certain aspects of the Proposed CCAR Rule were modified and clarified. Some of the most important of these modifications and clarifications are as follows: Compliance with Basel III. The Proposed CCAR Rule did not address the Federal Reserve s expectations for compliance with Basel III. The Instructions now indicate that the Federal Reserve expects that a Covered BHC will demonstrate that it can achieve readily and without difficulty the ratios required by the Basel III framework as they would come into effect in the United States. 42 The Instructions for CCAR BHCs (but not the Instructions for non-ccar BHCs) provide that the CCAR BHCs should provide a transition plan that includes pro forma estimates under baseline conditions of the Covered BHC s regulatory capital ratios under the proposed Basel III capital framework. 43 Regarding a Covered BHC s obligation to satisfy the Basel III minima, the Instructions for CCAR BHCs provide that BHCs that meet the minimum ratio requirement during the Basel III transition period but remain below the 7 percent Tier 1 common equity target (minimum plus conservation buffer) will be expected to maintain prudent earnings retention policies with a view to meeting the conservation buffer as soon as reasonably possible. 44 CCAR BHCs that exceed the Basel III transition targets over the near term, but do not yet meet the fully phased in targets, are expected to submit plans reflecting steady accretion of capital at a sufficient pace to demonstrate continual progress toward full compliance with the proposed Basel III framework. 45 The Instructions for CCAR BHCs go on to note that these CCAR BHCs should demonstrate an ability to maintain no less than steady progress along a path between its existing capital ratios and the fully phased in Basel III requirement in The Federal Reserve will closely scrutinize plans that fall short of this supervisory expectation. 46 In addition, the Instructions for CCAR BHCs state that the Federal Reserve expects that BHCs that have achieved full compliance with the fully phased in Basel III ratios would not be constrained on distributions by Basel III considerations, provided the BHC s forecast suggests that it would maintain full compliance during the planning horizon through December 31,

8 .. and any BHC performance projections that suggest that ratios would fall below the transitional Basel III targets at any point over the Basel III projection period would be accompanied by proposed actions that reflect affirmative steps to improve the BHC s capital ratios, including actions such as external capital raises. 47 The foregoing Federal Reserve statements could be read to suggest that no dividend increases or stock repurchases will be permitted until a Covered BHC is Basel III-compliant on a fully phased-in basis. CCAR BHCs transition plans must include management s best estimate of any likely surcharge pursuant to the Basel Committee on Banking Supervision s rule regarding a common equity surcharge on certain designated global systemically important banks (the G-SIB Surcharge ). 48 This raises the further question of whether dividend increases or stock repurchases will be permissible until a Covered BHC is in compliance with both Basel III and the G-SIB Surcharge on a fully phased-in basis. The Instructions for CCAR BHCs also indicate that the Federal Reserve expects that these Covered BHCs will demonstrate that, assuming the G-SIB Surcharge framework is adopted, they can achieve the required ratios readily and without difficulty over the transition period for the G-SIB Surcharge. 49 Additional Guidance Regarding Potential Black Out Periods. The Proposed CCAR Rule s timing sequence for submission of capital plans and Federal Reserve responses had the effect of imposing a black out on capital distributions for substantially all of the first quarter of each year. Commenters had expressed concern with this feature. The Federal Reserve clarified in the Preamble that the foregoing result was not intended and that, for a capital plan submitted in the first quarter, a non-objection would cover the four-quarter period commencing with the second quarter of the year in which the capital plan is submitted and continuing through the first quarter of the following year. 50 Relationship to Section 165 of the Dodd-Frank Wall Street Responsibility and Consumer Protection Act of 2010 (the Dodd-Frank Act ). In the Preamble, the Federal Reserve notes that it intends for Covered BHCs to integrate into their capital plans the results of the company-run stress tests conducted pursuant to Section 165 of the Dodd-Frank Act. The Federal Reserve provides that it does not expect that the results of stress tests conducted under the Dodd-Frank Act alone will be sufficient to address all relevant adverse outcomes that should be covered in a satisfactory capital plan for purposes of the final rule, thus implying that, to comply with the Final CCAR Rule, Covered BHCs will need to conduct stress tests beyond those required under Section Nevertheless, the Federal Reserve expects that the stress scenarios that it provides under the [Final CCAR Rule] will be consistent with the stress scenarios it will provide to [Covered BHCs] for stress tests they conduct under [S]ection 165 of the Dodd-Frank Act. 52 Additional Guidance Regarding the Transition Period. BHCs have been concerned that the Final CCAR Rule may have the effect of precluding dividends and other capital distributions until they receive -8-

9 non-objections from the Federal Reserve with respect to their 2012 capital plans that is, a black out on dividends and other capital distributions during the period between the effective date of the Final CCAR Rule and the date on which capital distributions would be permitted pursuant to a Covered BHC s initial capital plan (the Transition Period ). The Preamble partially addresses this by providing that CCAR BHCs will continue to be subject to the Revised Temporary Addendum to SR letter 09-4 until they receive a notice of objection or non-objection from the Federal Reserve with respect to their 2012 capital plans. With respect to non-ccar BHCs, the Preamble provides that these BHCs may make capital distributions during the Transition Period, but are expected to consult with the Federal Reserve before increasing capital distributions. In addition, with respect to common dividends, the Instructions provide that CCAR and Non-CCAR BHCs wishing to make a common dividend declaration prior to the March 15, 2012 decision may retain the same per share dividends as in the fourth quarter of 2011, unless the Federal Reserve explicitly informs the BHC otherwise. 53 The Instructions for non-ccar BHCs provide that these Covered BHCs should inform the Federal Reserve no later than December 9, 2011 of their intent to carry over certain capital actions (such as share repurchases and redemptions of trust preferred securities) that were previously not objected to during 2011 by their responsible Federal Reserve Bank. Similarly, the Instructions for CCAR BHCs provide that these Covered BHCs should give prior notice to the Federal Reserve of their intent to carry over certain capital actions that were previously not objected to through 2011 during the CCAR exercise in 2011, but not yet fully executed in The Instructions for CCAR BHCs add that a notice from a Covered BHC seeking to exercise approved but not yet fully executed share repurchases or redemptions in 2011 should be provided to the appropriate [Federal] Reserve Bank no later than December 9, 2011 and that a response to such requests will be provided no later than December 31, Change to 5 Percent Tier 1 Common Benchmark: Under the Proposed CCAR Rule, until January 1, 2016, a Covered BHC would be required to calculate its pro forma Tier 1 common equity ratio under expected and stressful conditions and discuss in its capital plan how it would maintain a pro forma Tier 1 common equity ratio of 5 percent under those conditions throughout the planning horizon. Under the Final CCAR Rule, this requirement remains but the time limit (that is, January 1, 2016) has been removed. 55 In addition, the definition of Tier 1 common ratio in the Final CCAR Rule has been revised to say that it is the ratio of a [Covered BHC s] [T]ier 1 common capital to total risk-weighted assets. This definition will remain in effect until the [Federal Reserve] adopts an alternative [T]ier 1 common ratio definition as a minimum regulatory capital ratio. 56 In the Proposed CCAR Rule, this definition did not include the foregoing limit on its effectiveness. The foregoing changes create additional uncertainty about how the implementation of the Basel III framework will impact compliance with the requirements in the Final CCAR Rule. -9-

10 The Ability to Make Distributions Following an Objection. Commenters had requested additional clarity regarding a Covered BHC s ability to continue to make distributions pursuant to a current, approved plan if its capital plan for the upcoming planning period is objected to. In the Preamble, the Federal Reserve clarified that distributions under a current approved capital plan would be permitted following an objection to a capital plan for an upcoming year, assuming the criteria for resubmission of a capital plan have not been triggered. 57 The Ability to Make Distributions Following a Resubmission. The Federal Reserve modified the Proposed CCAR Rule to provide that, if the Federal Reserve has objected to a Covered BHC s capital plan (and the Covered BHC has resubmitted its capital plan), no capital distributions may be made, except for those distributions that have not been objected to. If the capital plan has not been objected to and is, for instance, being submitted because of a material change in the risk profile of the Covered BHC, the Covered BHC must obtain the Federal Reserve s prior approval before making a capital distribution. 58 The extent to which capital distributions were permitted under the above described circumstances had been unclear under the Proposed CCAR Rule. Time Frame for Reviews. The Proposed CCAR Rule did not provide an explicit time frame for a review of a re-submitted capital plan. The Final CCAR Rule provides that the Federal Reserve will respond to a resubmitted capital plan within 75 days of its resubmission, although the Federal Reserve adds that it intends to respond to a resubmitted capital plan in a shorter time period if possible. 59 Confidentiality of Capital Plan Submissions. The Federal Reserve indicated in the Preamble that the confidentiality of information submitted in connection with the Final CCAR Rule would be determined in accordance with applicable exemptions under the Freedom of Information Act and the Federal Reserve s regulations regarding the availability of information (12 C.F.R., part 261 et seq.). One commenter had requested that such information be treated as confidential supervisory information. CONCLUDING OBSERVATIONS The highly pessimistic stress test assumptions incorporated in the Final CCAR Rule, including, particularly, the market shock assumptions for the Trading BHCs, raise the question of whether the Final CCAR Rule will be (and is designed to be) a more stringent capital requirement than Basel III on a fully phased-in basis, perhaps even including the G-SIB Surcharge where applicable. Although BHCs would not be required to meet the 5 percent Tier 1 common stress test, the apparent prohibition on dividend increases and stock repurchases resulting from a failure to meet this ratio is likely to compel BHCs to achieve that ratio. Whether or not the stress 5 percent Tier 1 common equity ratio requires more Tier 1 common than Basel III or even the G-SIB surcharge, the 5 percent test certainly accelerates the need for capital increases as compared to the Basel III phase-in. The overall tone of the Final CCAR Rule and Instructions suggests that the Federal Reserve may very well constrain dividend increases and stock repurchases for at least the near future. -10-

11 Although the Final CCAR Rule clarified certain aspects of the Proposed CCAR Rule, important questions regarding the application and impact of the Final CCAR Rule remain unanswered: Compliance with Basel III. The Federal Reserve expects Covered BHCs to demonstrate in their capital plans that they can readily and without difficulty satisfy the ratios under the Basel III capital framework as they come into effect. As indicated above, it remains to be determined how the various Basel III related guidance will be implemented in practice. Impact on Acquisitions. As discussed above, material changes in a Covered BHC s risk profile trigger a requirement under the Final CCAR Rule to resubmit a Covered BHC s capital plan, and, while its plan is being reviewed, the Covered BHC must obtain the Federal Reserve s prior approval before making any capital distribution. Because some larger acquisitions may cause a material change in a Covered BHC s risk profile, acquisitions may have a disruptive effect on a Covered BHC s capital plan and planned capital distributions. As a consequence, the Final CCAR Rule may affect new acquisitions by Covered BHCs. Application to Non-Bank Financial Firms. The Final CCAR Rule by its terms only applies to U.S. BHCs. It remains to be determined whether the Federal Reserve will, at some point in the future, promulgate a version of the Final CCAR Rule that applies to non-bank financial firms (for example, nonbank financial companies that the Financial Stability Oversight Council determines should be subject to Federal Reserve supervision). * * * Copyright Sullivan & Cromwell LLP

12 ENDNOTES See Federal Reserve, Capital Plans (Nov. 22, 2011), available at newsevents/press/bcreg/bcreg b1.pdf. The non-ccar BHCs are BBVA USA Bancshares Inc., BMO Financial Corp., Citizens Financial Group Inc., Comerica Inc., Discover Financial Services, HSBC North America Holdings Inc., Huntington Bancshares Inc., M&T Bank Corp., Northern Trust Corp., RBC USA Holdco Corp., UnionBanCal Corp. and Zions Bancorporation. See Federal Reserve, Capital Plan Review: Summary Instructions and Guidance (Nov. 22, 2011), available at (providing instructions to non-ccar BHCs regarding compliance with the Final CCAR Rule) (the Instructions for non-ccar BHCs ); Federal Reserve System, Comprehensive Capital Analysis and Review: Summary Instructions and Guidance, November 22, 2011, available at (providing instructions to CCAR BHCs regarding compliance with the Final CCAR Rule) (the Instructions for CCAR BHCs ). The 19 CCAR BHCs are Ally Financial Inc., American Express Company, Bank of America Corporation, The Bank of New York Mellon Corporation, BB&T Corporation, Capital One Financial Corporation, Citigroup Inc., Fifth Third Bancorp, The Goldman Sachs Group, Inc., JPMorgan Chase & Co., Keycorp, MetLife, Inc., Morgan Stanley, The PNC Financial Services Group, Inc., Regions Financial Corporation, State Street Corporation, SunTrust Banks, Inc., U.S. Bancorp and Wells Fargo & Company. See Federal Reserve, Capital Plans; Final Agency Information Collection Activities (Nov. 22, 2011), available at FRY14AQ_ _OMB.pdf. 76 FR (June 17, 2011). Until July 21, 2015, the Final CCAR Rule will not apply to any BHC that is a subsidiary of a foreign banking organization that is currently relying on Supervision and Regulation Letter SR See Id (b)(2)(i). Section 171 of the Dodd-Frank Wall Street Reform and Consumer Protection Act requires that, commencing July 21, 2015, U.S. domiciled BHC subsidiaries of foreign banks may no longer rely upon SR-Letter Supervision and Regulation Letter SR generally provides that a U.S. BHC that is owned and controlled by a foreign bank that is a financial holding company that the Federal Reserve has determined to be well-capitalized and well-managed is not required to comply with the Federal Reserve s capital adequacy guidelines. See SR Letter (Jan. 5, 2001), available at boarddocs/srletters/2001/sr0101.htm. See 12 C.F.R (b)(1)(i). Federal Reserve as used herein refers to the Board of Governors of the Federal Reserve System and/or one or more of the Federal Reserve Banks, as applicable. See Id (b)(1)(ii). The preamble to the Final CCAR Rule (the Preamble ) provides that the robustness of a Covered BHC s capital adequacy process should be evaluated based on elements, including, without limitation, a sound risk management infrastructure, an effective process for translating risk measures into estimates of potential loss and a clear definition of available capital resources. See Preamble, IV.A. See 12 C.F.R (d)(1)(ii). See Id (e)(2)(i)(A). See Background of the Instructions for non-ccar BHCs; Background of the Instructions for CCAR BHCs. -12-

13 ENDNOTES (continued) See Preamble, IV.E (providing that the Federal Reserve commits to respond by March 15, 2012 if a Covered BHC submits its 2012 capital plan on a timely basis). See 12 C.F.R (d)(2). The Instructions for both the CCAR BHCs and non-ccar BHCs provide that Covered BHCs will be expected to estimate losses associated with requests by mortgage investors (which include both GSEs and private label securities holders) to repurchase loans deemed to have breached representations and warranties or associated with investor litigation that seeks compensation from Covered BHCs for losses. In addition, Covered BHCs are instructed to consider how the macro scenarios could impact repurchase losses as well as how a range of legal process outcomes, such as worse than expected resolutions of contract claims or threatened or pending litigation, could impact losses. See Instructions for CCAR BHCs, 2.1.1; Instructions for Non- CCAR BHCs, The Preamble states that the existing supervisory definition of Tier 1 common capital under Appendix A of Regulation Y (12 C.F.R., part 225) will remain in force under the final capital plan rule until the Federal Reserve adopts the Basel III Tier 1 common equity ratio. See Preamble, IV.B.1.b. See 12 C.F.R (d)(2)(i). Id (c)(3), (c)(4). See Appendix III of the Instructions for CCAR BHCs; Appendix III of the Instructions for non- CCAR BHCs. Summary statistics and a brief description of the Supervisory Baseline and Supervisory Stress scenarios are provided in Appendix III of the Instructions. See Instructions for CCAR BHCs, 2.1.1; Instructions for Non-CCAR BHCs, Instructions for CCAR BHCs, 2.1.1; Instructions for Non-CCAR BHCs, Instructions for CCAR BHCs, 1.3; Instructions for non-ccar BHCs, 1.3. Instructions for CCAR BHCs, Id. See 12 C.F.R (d)(3). See Instructions for CCAR BHCs, 1.5; Instructions for non-ccar BHCs, 1.5. See Instructions for CCAR BHCs, 1.5. See 12 C.F.R (e)(1)(i). See Id (e)(1)(ii). See Instructions for CCAR BHCs, 3.1. The Instructions for non-ccar BHCs do not discuss the generation of supervisory pro forma estimates for non-ccar BHCs. At least one commenter on the Proposed CCAR Rule had requested that the Federal Reserve clarify in the Final CCAR Rule that material unresolved supervisory issues should not include issues that do not, or are unlikely to, materially impact a Covered BHC s capital position, liquidity or financial results. In response to this comment, the Federal Reserve indicated that it would review supervisory issues on a case-by-case basis and that it generally expects an institution to correct such deficiencies before making any significant capital distributions. See Preamble, IV.F. It would, therefore, appear that the Federal Reserve does not agree that material unresolved supervisory issues should be limited as suggested. This raises the question of whether dividends or stock repurchases will be prohibited or restricted pending correction of, for example, unrelated consumer compliance violations. See 12 C.F.R (e)(2)(ii). -13-

14 ENDNOTES (continued) See Id (d)(4)(ii). The Federal Reserve did not clarify in the Final CCAR Rule whether material improvements to a Covered BHC s risk profile would also necessitate a resubmission, simply noting that the Final CCAR Rule leaves the decision to resubmit based on a material change in the [Covered BHC] s risk profile to the [Covered BHC] in the first instance. See Preamble, IV.G. See 12 C.F.R (d)(4)(i). See Id (e)(2)(i)(B). See Id (f)(1). See Id (f)(2). See Instructions for CCAR BHCs, 5. Id. See Background of Instructions for CCAR BHCs; Background of Instructions for Non-CCAR BHCs. See Instructions for CCAR BHCs, Id. Id Id. Id. See Basel Committee on Banking Supervision, Global Systemically Important Banks: Assessment Methodology and Additional Loss Absorbency Requirement (Nov. 4, 2011). The Instructions for CCAR BHCs do not provide any guidance as to how the CCAR BHCs should estimate the G-SIB Surcharge and it is unclear how any bank could accurately estimate its surcharge at this time given that (i) the final thresholds for the various buckets used to determine the magnitude of the G-SIB Surcharge as well as the final values of the denominators of the various indicators used to calculate a bank s systemic importance score (which is used to determine the ultimate surcharge) have not been released and (ii) the data needed to calculate at least some of the indicators do not at present exist. See Instructions for CCAR BHCs, See Preamble, IV.E. See Id. IV.B.1.a. Id. Instructions for CCAR BHCs, 4; Instructions for Non-CCAR BHCs, 4. See Instructions for Non-CCAR BHCs, 4. See 12 C.F.R (d)(2)(i)(B). Id (c)(9) (emphasis omitted). See Preamble, V.A. See Id. Preamble, IV.G. -14-

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16 Los Angeles Patrick S. Brown Stanley F. Farrar Tokyo Keiji Hatano SC1: