CCAR Stress Testing Basics. By: Michael Fadil October 17, 2012 Chicago

Transcription

1 CCAR Stress Testing Basics By: Michael Fadil October 17, 2012 Chicago Risk Practitioner Conference

2 Stress Testing What is It?? Stress testing is a useful method for determining how a portfolio will fare during a period of financial crisis Can mean many things... 2

3 Generically, Stress Testing is Very Broad Can be applied to various risk types Credit Market Liquidity Can be applied at many levels Counterparty / Borrower Portfolio Enterprise Can be static or dynamic Static only changing one variable (sensitivity analysis) Dynamic model a scenario with inter-relationship across variables Methodology Top Down vs Bottoms Up Results can be expressed differently Risk based (EL, EC, VaR...) Accounting based (Net Income, Regulatory Capital Ratios) 3

4 CCAR and Stress Testing CCAR = Comprehensive Capital Adequacy Review All banks > $50B in assets Regulator driven History SCAP (Supervisory Capital Adequacy Program) : Q1 / Q CCAR I : Nov 2010 Feb 2011 CCAR II: Nov 2011 Feb 2012 Fed NPR Dec 20, 2011 / Jan 5, 2012 Federal Register FDIC NPR Jan 23, 2012 Federal Register Fed and FDIC NPRs are highly harmonized Require semi-annual submissions $10 - $50B Banks have until fall of 2013 when required to participate Most bank ICAAPs are converging with CCAR framework I will use stress test to be synonymous with CCAR 4

5 NPR Requirements for Stress Testing Minimum of 3 economic scenarios Baseline Adverse Severely Adverse Output (for each scenario, quarterly) Pro forma Capital positions (Tier 1 Common and Tier 1) Estimated Losses (Charge-offs) by exposure category Pre-Provision Net Revenues (PPNR) Aggregate Loan Balances Total Assets and RWA Allowance for Loan Losses Potential Capital Actions Timeframe - 9 quarters Submissions Annual CCAR (November January, public disclosure early April) Submission of additional stress test (July, public disclosure Oct) 5

6 NPR Requirements for Stress Testing Minimum of 3 economic scenarios Baseline Adverse Severely Adverse Output (for each scenario, quarterly) Pro forma Capital positions (Tier 1 Common and Tier 1) Estimated Losses (Charge-offs) by exposure category Pre-Provision Net Revenues (PPNR) Aggregate Loan Balances Total Assets and RWA Allowance for Loan Losses Potential Capital Actions Timeframe - 9 quarters Submissions Annual CCAR (November January, public disclosure early April) Submission of additional stress test (July, public disclosure Oct) 6

7 Economic Scenarios Requirements A scenario must be consistent across all economic drivers Need to augment Fed scenarios with additional economic inputs Scenarios should be important to each bank s specific risks Decision Internally derived or use a third party? Internal Resource considerations Expertise Most banks are landing on outsourcing Moody s Economic and Consumer Credit Analytics (ECCA) Wide number of off the shelf scenarios ECCA generates a full scenario aligned with the Fed adverse ECCA framework allows clients to create their own scenarios Moody s economists will work with clients on customizations Banks and Regulators like probabilities associates with scenarios 7

8 NPR Requirements for Stress Testing Minimum of 3 economic scenarios Baseline Adverse Severely Adverse Output (for each scenario, quarterly) Pro forma Capital positions (Tier 1 Common and Tier 1) Estimated Losses (Charge-offs) by exposure category Pre-Provision Net Revenues (PPNR) Aggregate Loan Balances Total Assets and RWA Allowance for Loan Losses Potential Capital Actions Timeframe - 9 quarters Submissions Annual CCAR (November January, public disclosure early April) Submission of additional stress test (July, public disclosure Oct) 8

9 Decomposing Capital Ratios Capital Ratios (Common and Total Tier 1) Numerator is Core Capital Denominator is RWA Core Capital Tier 1 Common Equity» Retained Earnings» Common Stock Total Tier 1 Capital» Tier 1 Common Equity, plus» Certain Preferred Shares» Certain Non-Controlling Interests RWA Still Basel 1 RWA Eventually will be Basel 2 / 3 RWA Net Income Capital Actions Charge-offs (Losses) ALLL PPNR Revenues Total Assets Expenses Loan Balances 9

10 NPR Requirements for Stress Testing Minimum of 3 economic scenarios Baseline Adverse Severely Adverse Output (for each scenario, quarterly) Pro forma Capital positions (Tier 1 Common and Tier 1) Estimated Losses (Charge-offs) by exposure category Pre-Provision Net Revenues (PPNR) Aggregate Loan Balances Total Assets and RWA Allowance for Loan Losses Potential Capital Actions Timeframe - 9 quarters Submissions Annual CCAR (November January, public disclosure early April) Submission of additional stress test (July, public disclosure Oct) 10

11 Losses Estimated Losses by exposure category Losses for CCAR Stress Testing are NCOs, not EL The two can be materially different Assumptions PD = 2.00% 30% qtr 1 LGD = 50% LGD timing = 70% year 1 15% qtr 2 EL = 1.00% 25% year 2 15% qtr 3 5% year 3 10% qtr NCOs Defaults Q1 Q2 Q3 Q4 Year Q1 0.50% 0.08% 0.04% 0.04% 0.03% 0.18% Q2 0.50% 0.08% 0.04% 0.04% 0.15% Q3 0.50% 0.08% 0.04% 0.11% Q4 0.50% 0.08% 0.08% Total = 2.00% 0.08% 0.11% 0.15% 0.18% 0.51% vs EL = 1.00% For the geeks in the group Q1 Default Cohort, Q1 NCOs NCO ~ (PD / 4) * (LGD * Q1 LGD NCO) NCO ~ (2.00% / 4) * (50% * 30%) NCO ~ (0.50%) * (15%) NCO ~ ~ 0.08% 11

12 Loss Forecasting Solutions Retail / Consumer Top down» Credit Cycle Bottoms up» Mortgage Portfolio Analyzer» Credit Card Portfolio Analyzer» Auto Portfolio Analyzer Wholesale / Commercial Top down» Commercial Loan transition matrices Bottoms up» RiskCalc» Credit Monitor» LossCalc 12

13 NPR Requirements for Stress Testing Minimum of 3 economic scenarios Baseline Adverse Severely Adverse Output (for each scenario, quarterly) Pro forma Capital positions (Tier 1 Common and Tier 1) Estimated Losses (Charge-offs) by exposure category Pre-Provision Net Revenues (PPNR) Aggregate Loan Balances Total Assets and RWA Allowance for Loan Losses Potential Capital Actions Timeframe - 9 quarters Submissions Annual CCAR (November January, public disclosure early April) Submission of additional stress test (July, public disclosure Oct) 13

14 PPNR / Loan Balances Pre-Provision = ALLL changes are excluded here Revenues and expenses must align to loss scenario Revenue Forecast Net Interest Income» Loans Balances Fixed / Floating Mix Terms Riskiness» Funding mix» Yield curve Fee Income Expense Forecast Generally derived from activity based costing Need to acknowledge semi-fixed nature of many costs Generally least sophisticated of banks models 14

15 NPR Requirements for Stress Testing Minimum of 3 economic scenarios Baseline Adverse Severely Adverse Output (for each scenario, quarterly) Pro forma Capital positions (Tier 1 Common and Tier 1) Estimated Losses (Charge-offs) by exposure category Pre-Provision Net Revenues (PPNR) Aggregate Loan Balances Total Assets and RWA Allowance for Loan Losses Potential Capital Actions Timeframe - 9 quarters Submissions Annual CCAR (November January, public disclosure early April) Submission of additional stress test (July, public disclosure Oct) 15

16 Total Assets / RWA Loan balances will be primary driver for total assets Straight-forward application of Basel 1 RW to various asset classes and loan types RWA Currently requires only Basel 1 Additional Basel RWA calculations will happen Banks are implementing regulatory capital engines Thinking ahead of integration into CCAR stress testing 16

17 NPR Requirements for Stress Testing Minimum of 3 economic scenarios Baseline Adverse Severely Adverse Output (for each scenario, quarterly) Pro forma Capital positions (Tier 1 Common and Tier 1) Estimated Losses (Charge-offs) by exposure category Pre-Provision Net Revenues (PPNR) Aggregate Loan Balances Total Assets and RWA Allowance for Loan Losses Potential Capital Actions Timeframe - 9 quarters Submissions Annual CCAR (November January, public disclosure early April) Submission of additional stress test (July, public disclosure Oct) 17

18 Change in Loan Losses Reserves Change in ALLL = Provision = Impact on Net Income Accounting treatment for ALLL is in flux Most banks ALLL is not 100% formulaic Must treat it as such for this exercise Challenge for adverse and severely adverse scenarios Banks can look at ALLL as coverage of future losses ALLL will not be a function of perfect foresight regarding NCOs ALLL at any future point will be conditional» Adverse scenario to that point of analysis» Thereafter, expected baseline given the economic path to that point Change in reserves can be a material earnings lever Since earnings affect capital, ALLL changes are material Increasing scrutiny from Regulators in process 18

19 NPR Requirements for Stress Testing Minimum of 3 economic scenarios Baseline Adverse Severely Adverse Output (for each scenario, quarterly) Pro forma Capital positions (Tier 1 Common and Tier 1) Estimated Losses (Charge-offs) by exposure category Pre-Provision Net Revenues (PPNR) Aggregate Loan Balances Total Assets and RWA Allowance for Loan Losses Potential Capital Actions Timeframe - 9 quarters Submissions Annual CCAR (November January, public disclosure early April) Submission of additional stress test (July, public disclosure Oct) 19

20 Capital Actions Dividends Dividend changes Capital issuances Capital repurchases High level views regarding acquisitions and divestitures Mostly discretionary actions of bank but with constraints 20

21 Visualization of Integrated Stress Test Capital Plan 21

22 Other Important Considerations Data, data, and more data Documentation Component models especially weaknesses Capital Plan Formal governance Executive level communication and interaction Executive Management Board of Directors 22

23 Conclusions CCAR is huge dividends and other capital actions Enterprise-wide challenge Treasury Risk Finance LOBs Banks > $50B are generally in pretty good shape Banks between $10B and $50B are in various states of preparedness Few off the shelf / integrated solutions CCAR will continue to evolve 23

24 Moody s Analytics Stress Testing Product Offering By Asset Class WHOLESALE LENDING RETAIL LENDING DEBT DATA, MODELING & SOFTWARE SOLUTIONS USAGE Large Public Commercial & Industrial Large Private Small-Med Size Privately Held Domestic Commercial Real Estate Domestic Residential First Lien, HELOC, HELOANS Credit Cards Retail Auto Loans Business Other Retail Lending Consumer & Student Loan Portfolios Int l Retail Loan Portfolio Structured Finance Corporate & Financial Debt Securities Bonds Municipal Sovereign Public Firm Historical EDF Data: PD Default Recovery Database (DRD) Credit Research Database (CRD): PD, EAD DATA (Historical & Loan Level) Structured Finance (Loan By Loan, non-corporate) Case-Shiller Indices: historical, projected & aggregated Structured Finance Performance Data Service (PDS) Default Pre-Payment Loss Curve (DPLC): securitized assets only, projected & aggregated data Credit Forecast.com: historical, projected & aggregated Structured Finance Default & Recovery Service (SFDRS) Moody s Financial Metrics: historical, projected & loan level EL Market Implied Ratings (MIR): same as above Municipal Financial Ratio Analysis (MFRA) Fiscal Space: historical, projected, aggregated & loan level Credit Cycle: Custom, Aggregated Level Model CreditEdge Plus (Stressed EDFs) LossCalc: Custom Model RiskCalc: Custom Model Credit Transition Matrix (CTM): Ratings Based EL EL, EAD PD LGD PD EL MODELING (Loan Level) Commercial Mortgage Metrics (CMM) CreditForecast.com (Generic Model) Aggregate level Mortgage Portfolio Analyzer (MPA & MPA, UK) Credit Card Portfolio Analyzer (CCPA) Auto Portfolio Analyzer (APA) Wall Street Analytics Platform, EAD CDORom CDOEdge: Ratings based Moody s Financial Metrics Scorecards (FM Scorecards): Ratings Based QRATE - Ratings based EL EL PLAT- FORM Definitions: PD: Probability of Default; LGD: Loss Given Default; EL: Expected Loss; EAD: Expected At Default Note: Custom solutions available across all asset classes CREDIT CYCLE: Web-based platform that houses and aggregates stress testing models and analytics SCENARIO ANALYZER: Integrated software solution that consolidates enterprise-wide stress testing data, modeling results, capital requirements and regulatory reporting 24

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