[Federal Register Volume 79, Number 49 (Thursday, March 13, 2014)]
[Rules and Regulations]
[Pages 14153-14169]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2014-05518]



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Rules and Regulations
                                                Federal Register
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Federal Register / Vol. 79, No. 49 / Thursday, March 13, 2014 / Rules 
and Regulations

[[Page 14153]]



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-1485]

FEDERAL DEPOSIT INSURANCE CORPORATION

12 CFR Part 325


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

AGENCY: 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: Final supervisory guidance.

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SUMMARY: The Board, FDIC, and OCC, (collectively, the agencies) are 
issuing this guidance, which outlines principles for implementation of 
the stress tests required under section 165(i)(2) of the Dodd-Frank 
Wall Street Reform and Consumer Protection Act (Dodd-Frank Act or DFA 
stress tests), applicable to all bank and savings and loan holding 
companies, national banks, state member banks, state nonmember 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.

DATES: Effective dates are as follows:
    For the Board: April 1, 2014.
    For the FDIC: March 31, 2014.
    For the OCC: March 31, 2014.

FOR FURTHER INFORMATION CONTACT:
    Board: David Palmer, Senior Supervisory 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, Section Chief, (202) 412-4861; Alisha 
Riemenschneider, Senior Financial Institutions Specialist, (712) 212-
3280; 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: Kari Falkenborg, Financial Analyst, (202) 649-6831; Harry 
Glenos, Senior Financial Advisor, (202) 649-6409; 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 
with between $10 billion and $50 billion in total assets. To supplement 
these rules, on July 30, 2013, the agencies sought public comment on 
proposed supervisory guidance (``proposed guidance'') that discussed 
supervisory expectations regarding the conduct of the DFA stress tests 
and offered additional details about methodologies that should be 
employed by these companies.\3\
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    \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. See 12 CFR 
252.13. 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\ See 78 FR 47217 (August 5, 2013).
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    The proposed guidance was organized around the DFA stress test rule 
requirements. In the proposed guidance, the agencies indicated that 
they would expect $10-50 billion companies to follow the DFA stress 
test rule requirements, other relevant supervisory guidance, and the 
expectations from the proposed guidance when conducting DFA stress 
tests. The final guidance is organized in a similar manner.
    Consistent with the proposal, other relevant guidance includes 
``Supervisory Guidance on Stress Testing for Banking Organizations With 
More Than $10 Billion in Total Consolidated Assets'' issued by the 
agencies in May 2012 (``May 2012 guidance'').\4\ The May 2012 guidance 
sets forth broad principles for a satisfactory stress testing framework 
for banking organizations with total assets of more than $10 billion, 
including principles related to governance, controls, and use of 
results.
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    \4\ See 77 Federal Register 29458 (May 17, 2012).
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    However, it is important to note that other guidance relevant for 
the $10-50 billion companies does not include, and these firms are not 
subject to, other requirements and expectations applicable to bank 
holding companies with assets of at least $50 billion, including the 
Federal Reserve's capital plan rule, annual Comprehensive Capital 
Analysis and Review, supervisory stress tests for capital adequacy, or 
the related data collections supporting the supervisory stress test.\5\
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    \5\ See 12 CFR 225.8 (capital plan rule); Supervisory and 
Company-Run Stress Test Requirements for Covered Companies, 12 CFR 
part 252, subparts E and F; and the Capital Assessment and Stress 
Testing information collection (FR Y-14Q, FR Y-14M, and FR Y-14A).

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[[Page 14154]]

II. Summary of Comments

    The agencies received 13 comments on the guidance from trade 
organizations, industry participants, vendors, and individuals. In 
addition to the comments, the agencies held a series of discussions 
with trade groups, state banking supervisors, and the banking 
organizations to raise awareness about the proposed guidance and 
solicit feedback. Some commenters expressed support for the proposed 
guidance. However, several commenters recommended changes to, or 
clarification of, certain provisions of the proposed guidance, as 
discussed below. In response to these comments, the agencies have 
clarified the principles set forth in the guidance and modified the 
proposed guidance in certain respects as described in this section of 
the SUPPLEMENTARY INFORMATION.

A. Overall Comments on the Proposed Guidance

    Commenters provided several suggestions for clarifying or modifying 
the proposed guidance. Commenters requested additional clarity around 
what practices are commensurate with a company's size and complexity 
and what constitutes a larger or more sophisticated company. Some 
commenters requested that the agencies provide additional tailoring of 
expectations based on the size and complexity of companies, and on each 
company's familiarity with stress testing. Other commenters argued that 
the guidance adopted an approach that was too prescriptive and should 
provide each company with flexibility to focus its stress test on the 
company's assessment of its idiosyncratic risks. Commenters also 
recommended that the agencies consider requiring other types of stress 
testing besides scenario analysis and that a more comprehensive set of 
risks should be addressed in the guidance.
    The final guidance retains the overall structure and content of the 
proposal. In addition, the final guidance provides additional detail 
about certain key requirements already established in the DFA stress 
testing rules. The proposed guidance emphasized that the expectations 
regarding stress testing for $10-50 billion companies would generally 
be reduced compared to expectations for companies with $50 billion or 
more in assets. In order to underscore that point, the final guidance 
provides additional examples of certain tailored expectations for $10-
50 billion companies. In addition, the final guidance provides 
information on the circumstances under which a $10-50 billion company 
should use the more advanced practices described in the guidance.
    Several commenters opposed stress testing for $10-50 billion 
companies. The commenters argued that conducting the stress tests would 
be expensive, time-consuming, and of limited benefit. One commenter 
suggested that the stress tests would distract key personnel from 
conducting other types of risk management. Commenters requested that 
$10-50 billion companies be exempt from stress testing requirements 
under certain circumstances, such as if the company was well 
capitalized, or be allowed to use an alternative simplified stress 
test, such as assuming certain loss rates or conducting a local market 
and concentration analysis.
    Stress testing for companies with more than $10 billion but less 
than $50 billion in total consolidated assets is a requirement of the 
Dodd-Frank Act. The agencies are not exempting a company based on its 
pre-stress capital ratios or allowing companies to conduct a simplified 
stress test that is not based on the supervisory scenarios provided by 
each agency, as those practices may not address the possibility of 
losses under stressful circumstances. However, as noted above, the 
agencies have sought to tailor the stress testing requirements and 
expectations for $10-50 billion companies. For example, the 
expectations for data sources, data segmentation, sophistication of 
estimation practices approaches, reporting and public disclosure are 
elevated for larger and more complex organizations than for $10-50 
billion companies.
    Commenters requested that the agencies modify the timing of the 
stress tests to reduce the regulatory reports that need to be completed 
at or shortly after year-end. Commenters noted that companies were 
required to file many other regulatory reports at the end of a year and 
that other regulatory changes are implemented at the beginning of a 
year. One commenter's request was to allow companies to conduct their 
stress tests with an as of date of December 31 and a due date of June 
30. The agencies note that the DFA stress test rules do not require 
$10-50 billion companies to file regulatory reports by year-end. 
Compared to larger banking organizations, the DFA stress test rules for 
$10-50 billion companies provide these companies with additional time 
to conduct their stress tests each year, with the report due by March 
31, rather than the reporting deadline of January 5 that is required 
for companies with $50 billion or more in assets. The agencies 
recognize that some companies may still face resource constraints based 
on the timeline of the annual stress tests, but the timeline was 
codified in the DFA stress test rules. Thus, modification of that 
timeline is outside of the scope of the final guidance.
    Some commenters were appreciative of the agencies' communication 
regarding the guidance and one commenter requested that the agencies 
set up a dedicated electronic mailbox for companies to use to submit 
questions to the agencies about the stress tests. The agencies 
recognize that additional clarification about the stress tests may be 
necessary and are evaluating additional tools to assist in this regard. 
In the meantime, companies should direct questions regarding the 
guidance to their examination staff or to the contacts identified in 
the guidance.

B. Scenarios for DFA Stress Tests

    Under the stress test rules required by the Dodd-Frank Act, $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 
indicated that $10-50 billion companies should apply each supervisory 
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.
    Some commenters opposed requiring $10-50 billion companies to use 
the supervisory scenarios in their DFA stress tests, arguing that the 
national variables would not be useful or relevant for many companies, 
that the agencies do not have a strong record of identifying emerging 
risks in the past, and that the scenario variables were not 
sufficiently plausible to be useful as a risk management tool. Other 
commenters argued that translating scenario variables into projections 
of losses, revenues, the balance sheet, risk-weighted assets, and 
capital would be time-consuming, complicated, and without sufficient 
benefit to justify the cost. The commenters stated that $10-50 billion 
companies do not have the staff or expertise to perform the 
quantitative analysis necessary to properly translate the scenarios in 
the stress tests.
    The use of common supervisory scenarios by all companies subject to 
annual company-run stress tests is a key feature of the stress test 
rules required

[[Page 14155]]

by the Dodd-Frank Act. However, the proposed guidance indicated that 
$10-50 billion companies are not required to use all of the variables 
in the supervisory scenarios. In addition, the proposed guidance stated 
that $10-50 billion companies could, but would not be required to, 
include additional variables or additional quarters to improve the 
robustness of their company-run stress tests. However, the proposed 
guidance indicated that the paths of any additional regional or local 
variables that a company used would be expected to be consistent with 
the path of the national variables in the supervisory scenarios. The 
agencies believe that the final guidance allows for substantial 
flexibility in translating scenario variables and are retaining these 
principles. Thus, consistent with the final guidance, a company is not 
required to use all the variables in the supervisory scenarios but 
could use additional variables or quarters to improve their company-run 
stress tests.
    Commenters requested further clarification regarding the 
translation of the supervisory scenarios into projections of losses and 
revenues. One commenter questioned whether idiosyncratic risks should 
be addressed in relation to the supervisory scenarios or through the 
use of alternative scenarios that might not be consistent with the 
supervisory scenarios. Consistent with principles articulated in the 
May 2012 stress testing guidance, the final guidance reiterates that no 
single stress test can accurately estimate the effect of all stressful 
events and circumstances. Accordingly, the final guidance clarifies 
that while additional variables may be used to better link the scenario 
variables in the supervisory scenarios with companies' projections, the 
DFA stress tests may not capture the effects of all of a company's 
risks and vulnerabilities.
    The agencies received several comments regarding the translation of 
national variables in the supervisory scenarios to regional variables. 
Commenters requested additional flexibility in the use of regional 
variables and in projecting regional variables in cases where data on 
local conditions may be less readily available. Commenters suggested 
that $10-50 billion companies will have to rely on vendors for 
intermediate variables as they lack the expertise to create those 
variables internally. For these reasons, some commenters suggested that 
the agencies assist companies in developing regional variables, either 
by directly providing local variables or by approving of specific 
third-party provided variables or specific vendors who provide scenario 
variables.
    The agencies believe that the guidance provides sufficient 
flexibility regarding the use of regional variables. The guidance does 
not require a $10-50 billion company to project regional variables, and 
to the extent that a $10-50 billion company decides to project one or 
more regional variables, the guidance simply provides that the paths of 
the regional variables should be consistent with the paths of the 
national variables. For example, it would be inappropriate to use a 
regional or local variable that exhibited limited stress compared to 
variables in the macroeconomic scenarios provided by the agencies 
because the approach for deriving that additional variable would be 
based on relatively benign conditions. The agencies do not currently 
plan to include regional variables in the supervisory scenarios as it 
would be difficult to provide a single set of regional variables that 
would be appropriate and stressful for every company subject to DFA 
stress tests. The agencies do not supervise third-party vendors or 
consultants and do not endorse any vendor products, including those 
relating to scenario variables for use in the DFA stress tests. The 
final guidance retains the expectation that each company should ensure 
that they understand any vendor-supplied variables they use and confirm 
that such variables are relevant for and relate to company-specific 
characteristics.

C. Data Sources and Segmentation

    The proposed guidance indicated that if a company does not 
currently have sufficient internal data to conduct a stress test, it 
would be permitted to use an alternative data source as a proxy for its 
own risk profile and exposures. However, the proposed guidance noted 
that companies with limited data would be expected to develop 
strategies to accumulate sufficient data to improve their stress test 
estimation processes over time.
    While one commenter appreciated the proposed guidance's caution 
regarding the use of historical data, several commenters requested 
further clarification on expectations for data sources. Commenters 
believed that compiling internal historical data would be cost 
prohibitive and suggested that companies should be able to make 
reasonable assumptions to address limitations of the history or 
applicability of data. Other commenters requested that the agencies 
specify what factors are most relevant to determining whether proxy 
data are appropriate and another commenter requested that the agencies 
specifically instruct companies about which historical periods from 
which to collect data. Other commenters requested that the agencies 
clarify the expected timeline for improving the quality of internal 
data and circumstances where use of proxy data would be appropriate on 
a continuing basis.
    Developing high-quality internal data is a crucial project for 
improving a company's stress testing estimation practices. However, in 
response to comments, the final guidance states that in some cases 
where a company may initially lack internal data on certain portfolios 
it may need to rely on proxy data for some time. Such practices may be 
acceptable provided that the company demonstrates that proxy data are 
relevant to the company's own exposures and appropriate for the 
estimation being conducted, and that the company is actively collecting 
internal data.

D. Model Risk Management

    The proposed guidance indicated that 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.\6\ Commenters requested additional guidance on 
the use of benchmarking and challenger models and on whether models 
needed to be validated before the stress test results are submitted to 
the agencies.
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    \6\ ``Supervisory Guidance on Model Risk Management,'' OCC 2011-
12 and ``Guidance on Model Risk Management,'' Federal Reserve SR 
letter 11-7.
---------------------------------------------------------------------------

    In response, the agencies have clarified that, consistent with 
existing supervisory guidance on model risk management, in some cases, 
companies may not be able to validate all the models used in their DFA 
stress tests prior to submission. The final guidance indicates that the 
use of such models may be appropriate provided that companies made an 
effort to identify and prioritize validation for models based on 
materiality and highest risk; applied compensating controls so that the 
output from models that have not been validated or have only been 
partially validated is not treated the same as the output from fully 
validated models; and documented clearly such cases and made them 
transparent in reports to model users, senior management, and other 
relevant parties. The final guidance also notes that companies should 
have timelines with explicit plans for conducting the remaining areas 
of validation for such

[[Page 14156]]

models and recognize that any provisional use of models without 
validation is temporary. Furthermore, the final guidance does not 
contain any expectations regarding the use of challenger or 
benchmarking models.
    The proposed guidance indicated that companies should ensure that 
their model risk management policies and practices generally apply to 
the use of vendor and third-party products as well. While some 
commenters stated that the expectations regarding the use of vendor 
models from the proposed guidance seemed fairly straightforward, other 
commenters requested modifications. One suggestion was that the 
agencies encourage companies to take ownership of stress tests rather 
than relying on vendors. One commenter suggested that $10-50 billion 
companies be provided discretion to select and utilize vendor products 
and services as long as the companies, with the help of the vendors, 
conduct their stress tests in accordance with the rules and supervisory 
guidance.
    Other commenters requested clarification on the validation of 
vendor models. Some noted that it would be burdensome to require 
independent parties to validate vendor models and duplicative for each 
company to independently validate models from the same vendor. The 
commenters requested that the agencies evaluate and approve the use of 
certain products and services from vendors that meet stress testing 
guidelines. Alternatively, commenters suggested the agencies should put 
out specific guidelines for vendors to follow and allow a company to 
rely on vendor certification that it follows these guidelines.
    Regarding vendor models, similar to the existing supervisory 
guidance on model risk management, the final guidance does not indicate 
whether $10-50 billion companies should or should not use vendor models 
and does not prescribe which vendors should be used. The guidance does 
indicate that existing supervisory guidance provides guidelines for 
companies regarding model risk management for vendors, and states that 
vendor models should be validated in a manner similar to internal 
models. Because model risk management, including validation of vendor 
models, is the responsibility of individual companies, it would not be 
appropriate for the agencies to provide the specific assistance 
suggested by commenters, such as vetting vendors. Consistent with their 
past practice, the agencies plan to use the normal supervisory process 
to work with individual companies regarding expectations for 
appropriate model risk management for vendor products and services.

E. Loss Estimation

    The proposed guidance clarified that 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 (``PPNR''). The proposed 
guidance stated that larger or more sophisticated 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 estimation practices should be 
commensurate with the materiality of the risks measured and well 
supported by sound, empirical analysis.
    Commenters requested that the agencies provide additional 
information about credit loss estimation, as this is by far the most 
material risk to $10-50 billion companies. Some commenters suggested 
that the agencies provide explicit instructions for how to calculate 
loan losses under the stress tests. The final guidance retains the 
substantial flexibility regarding loss estimation practices, including 
for credit losses, provided in the proposed guidance. Notwithstanding 
some commenters' request for additional specificity, the agencies 
believe it is important for the guidance to provide this flexibility in 
light of evolving loss estimation techniques and the different levels 
of complexity at different companies.
    Another commenter requested clarification regarding when it would 
be appropriate to use the simpler estimation approaches described in 
the guidance, especially because in some cases simpler approaches may 
be superior or more robust than sophisticated quantitative approaches 
for estimating loan losses. Similarly, one commenter requested that the 
agencies state that they did not have a preference for bottom-up stress 
testing for $10-50 billion companies. The final guidance provides some 
additional information on when a $10-50 billion company should use the 
more advanced practices described in the guidance. For example, the 
final guidance notes that each company's loss estimation practices 
should be commensurate with the materiality of the risks measured and 
that $10-50 billion companies should consider using more than just the 
minimum expectations for the exposures and activities that present the 
highest risk. However, the final guidance does not categorically 
preclude any specific estimation approach, including bottom-up stress 
testing.
    The proposed guidance stated that companies could use different 
processes for the baseline scenario than for the adverse and severely 
adverse scenarios in order to better capture the loss potential under 
stressful conditions, including using their budgeting process if it was 
conditioned on the supervisory scenario. While some commenters 
supported the potential use of the budgeting process for projections 
under the baseline scenario, one commenter noted that companies will be 
challenged to use their internal budgeting processes if the internal 
process must be conditioned on the supervisory baseline scenario. The 
use of scenarios provided by each agency is a requirement of the Dodd-
Frank Act that was codified in the DFA stress test rules. While a 
company may use its budgeting process for the DFA stress tests 
conducted under the baseline scenario, provided that the company can 
link the budgeting process to the supervisory baseline scenario, 
companies are not required or expected to use the supervisory baseline 
scenario for any of their budgeting processes.

F. Pre-Provision Net Revenue Estimation

    With respect to PPNR, commenters requested that $10-50 billion 
companies be allowed to focus on projecting net-interest margin rather 
than on projecting expenses or revenue from fees unless there were 
material risks uncovered as part of the stress tests. The proposed 
guidance indicated that in some cases it may be appropriate for 
companies to use simpler approaches for projecting PPNR. For example, 
companies could project each of three main components of PPNR (net 
interest income, non-interest income, and non-interest expense) on an 
aggregate level for the entire company or by business line based on 
internal or industry historical experience. The agencies agree that 
net-interest margin is an important component of projecting PPNR and 
that, where fees are not a material source of revenue, a company would 
not be expected to use the same level of sophistication in estimating 
fee income as it used in estimating the company's net interest margin.
    Some commenters requested additional information about the 
expectations for addressing operational risk in the stress tests. One 
commenter noted that operational risk is central to managing the key 
risks to banking organizations because operational risk directly 
affects the implementation of a business model, and its execution 
affects market, liquidity, and credit risk.

[[Page 14157]]

However, the commenter argued it would be a mistake to apply credit 
risk models to strategic or operational risk modeling. Another 
commenter noted that a company's operational risk may not be directly 
related to the scenarios, and requested additional clarification about 
estimating operational risk losses in DFA stress testing.
    The proposed guidance did not prescribe the use of any specific 
type of operational risk modeling and indicated that losses from 
operational risk events would need to be estimated only 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. The final guidance 
follows a similar approach and clarifies there may be certain aspects 
of operational risk that a company is not required to address in its 
DFA stress tests; however, the company should consider those other 
aspects of operational risk as part of broader stress testing described 
in the May 2012 stress testing guidance.

G. Balance Sheet and Risk-Weighted Assets

    Under the proposed guidance, a company would have been 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. The guidance noted that 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.
    One commenter asked for examples of circumstances where it would be 
appropriate to assume a constant portfolio. In response, the final 
guidance states that $10-50 billion companies may be able to use an 
assumption of a static balance sheet and static risk-weighted assets 
over the planning horizon; however, companies should consider whether 
such an approach is appropriate if the company has more volatile 
balance sheets and risk-weighted assets, such as from mergers and 
acquisitions or internal growth. In addition, the final guidance 
clarifies that cases in which balance sheet and risk-weighted asset 
projections decline over the planning horizon, and thus positively 
affect capital ratios, should be very well supported by analysis and 
documentation.

H. Projections for Quarterly Provisions and Ending Allowance for Loan 
and Lease Losses (ALLL)

    The proposed guidance stated that 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. The proposed guidance noted that the ALLL 
at the end of the planning horizon should be consistent with generally 
accepted accounting principles (GAAP), including any losses projected 
beyond the nine-quarter horizon.
    While some commenters said that the guidance was clear on 
projecting ALLL, other commenters requested that the agencies clarify 
expectations regarding consistency between projections of the ALLL and 
GAAP. One commenter argued that determining the credit impairment of a 
loan in accordance with GAAP required loan-level examination of credit 
quality. Another commenter requested that the agencies clarify the 
interaction between the supervisory scenarios and GAAP requirements for 
the appropriate level of the ALLL.
    In response to comments, the final guidance clarifies that, because 
loss projections for the stress tests can in some cases be conducted at 
a portfolio level, the ALLL projections may also be conducted at a 
similar level, provided that they are not inconsistent with the 
company's existing methodologies to calculate ALLL for other regulatory 
purposes and for current financial statements. The key supervisory 
expectation in this regard is that management ensures that the 
company's projected ALLL is sufficient to cover remaining loan losses 
under the scenario for each quarter of the planning horizon, including 
the last quarter.

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

    The proposed guidance stated that projected capital levels and 
ratios should reflect applicable regulations and accounting standards 
for each quarter of the planning horizon. In particular, the proposed 
guidance noted that, in July 2013, the Board and the OCC issued a final 
rule and the FDIC issued an interim final rule regarding regulatory 
capital requirements for banking organizations (revised capital 
framework). Except for the stress testing cycle that began on October 
1, 2013, $10-50 billion companies must measure their regulatory capital 
levels and regulatory capital ratios for each quarter of the planning 
horizon in accordance with the rules that would be in effect during 
that quarter, including the transition arrangements set forth in the 
revised capital framework.\7\
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    \7\ Each of the agencies is providing a one-year transition 
period for the vast majority of $10-50 billion companies where the 
companies would not be required to reflect the revised regulatory 
capital framework in their DFA stress tests. For the stress test 
cycle that began on October 1, 2013, $10-50 billion companies should 
calculate their regulatory capital ratios using the regulatory 
capital framework in effect as of September 30, 2013. See 12 CFR 
252.12(n) (Board); 12 CFR 46.6 (OCC); 12 CFR 325.205 (FDIC).
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    The proposed guidance indicated an expectation that post-stress 
capital ratios under the adverse and severely adverse scenarios will be 
lower than under the baseline scenario. Commenters believed that 
expecting capital to be lower under stress scenarios may not be 
appropriate for $10-50 billion companies. Commenters argued that other 
factors, such as slower originations, higher paydowns, and accelerated 
charge-offs could result in improved credit quality and higher capital 
ratios in the adverse and severely adverse scenarios. Another commenter 
noted that it was difficult to get scenario-based forecasts of asset 
balances to match up with circumstances that lead to declining ratios 
and requested additional information about assumptions that would 
necessarily lead to lower capital ratios in stressful conditions than 
in baseline scenarios.
    While there could be rare cases in which capital ratios are higher 
under the adverse and severely adverse scenarios, any such case should 
be very well supported by a $10-50 billion company with analysis and 
documentation. Since the stress tests are intended to assess the 
hypothetical negative impact on companies' capital positions from 
stressful conditions, the agencies generally expect companies' post-
stress capital ratios under the adverse and severely adverse scenarios 
to be lower than under the baseline scenario.
    One commenter requested clarification regarding what constitutes a 
reasonable and conservative management response. Another commenter 
suggested that dynamic hedging should not be anticipated as a risk-
mitigation technique under stress scenarios. In response, the agencies 
note that companies should make conservative assumptions about 
management responses in the stress tests, and should include only those 
responses for which there is substantial support. Any assumptions that 
materially mitigate losses should be well justified. For example, as 
discussed

[[Page 14158]]

in the proposed guidance, projecting changes in balances that mitigate 
losses are expected to also reduce revenues.
    The proposed guidance noted that while holding companies are 
required to use specified capital action assumptions, there are no 
specified capital actions for banks and thrifts. The proposed guidance 
indicated that 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. Additionally, the proposed guidance noted that 
holding companies should consider that the Board's DFA stress test 
rules require the use of certain capital assumptions in the DFA stress 
tests, which may not be the same as the assumptions used by the holding 
company's subsidiary depository institutions.
    The agencies recognize that the consistency between the capital 
action assumptions at the holding company level and at the subsidiary 
depository institution level is a complicated aspect of the DFA stress 
test requirements. The key supervisory expectation is that if the 
stress test submissions for the bank or thrift and its holding company 
differ in terms of projected capital actions as a result of the 
different requirements of the DFA stress test rules, the companies 
should address such differences in the narrative portion of their 
submissions to their primary regulators and the Board. For example, if 
a bank assumed that it would curtail dividends to a bank holding 
company, the bank holding company should discuss how it would fund any 
capital distributions in a stressed environment.
    Some commenters appreciated the flexibility that the guidance 
affords regarding capital actions in stress tests. However, others 
stated that the capital action assumptions at the holding company level 
are unrealistic. One commenter noted that while the capital action 
differences are clearly articulated, there was no guidance on how to 
reconcile those differences. Another commenter requested additional 
flexibility for holding company capital actions as that would enhance 
the usefulness of the stress tests as a business planning tool and make 
it more actionable. In response, the agencies note that the capital 
action assumptions specified for holding companies are a requirement of 
the Board's DFA stress test rules and that modifying those assumptions 
is outside of the scope of this guidance.

J. Controls, Oversight, and Documentation

    The proposed guidance indicated that, as required by the DFA stress 
test rules, a company's 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. In addition, the guidance provided 
additional detail on responsibilities for senior management and boards 
of directors relating to the DFA stress test. Commenters requested that 
the agencies modify the guidance to further embed risk oversight and 
management into daily business decisions and activities. One commenter 
suggested that companies should be able to reconcile how final outcomes 
compare to expected outcomes.
    Certain requirements for controls and oversight are codified in the 
DFA stress test rules. Moreover, the agencies believe that the 
expectations in the final guidance are appropriate and sufficient, and 
to a large degree, are already contained in the May 2012 stress testing 
guidance. Specifically, there is no need for additional guidance on 
controls and oversight, including on reconciling final and expected 
outcomes of the stress tests, since the proposed guidance, as well as 
related guidance, indicated the importance of evaluating stress test 
outcomes and the practices that produce those outcomes.
    Some commenters requested that the agencies clarify their 
expectations for the boards of directors. Specific clarification was 
requested on the level of detail that the senior management should 
report to the board of directors regarding methodologies used in the 
stress tests. Another commenter suggested it was inappropriate for a 
board to review and approve the stress testing framework and policies. 
One suggestion was that the agencies hold training programs for boards 
that reflect stress testing obligations. Another requested that the 
agencies communicate to the board of directors the relative importance 
of the DFA stress tests as a supervisory matter. Another commenter 
stated that there were too many requirements for boards and that the 
stress testing requirements would be burdensome.
    Certain requirements for boards of directors are codified in the 
DFA stress test final rules. These requirements will help ensure that 
boards of directors provide proper oversight of DFA stress tests, 
thereby enhancing the tests' integrity and credibility. The agencies 
believe that the proposed guidance and the May 2012 stress testing 
guidance sufficiently convey the expectations for boards of directors, 
by indicating that they should play an oversight role and be advised 
and educated about key stress testing information, but they do not need 
to be intimately involved in every detail of the stress testing 
process. For example, the proposed guidance noted that boards should 
receive ``summary information'' and allowed boards to have designees to 
evaluate such information. In addition, the proposed guidance 
articulated the different expectations for boards of directors versus 
the expectations for senior management, with the expectation that 
senior management should be more involved in the details of the 
company's stress testing activities. These expectations have been 
retained in the final guidance.
    The proposed guidance indicated that 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 were not aligned with a company's internal 
capital goals, senior management would be expected to provide options 
that senior management and the board would consider to bring them into 
alignment. One commenter suggested that management should not be 
required to create action plans to enhance the level and composition of 
capital in response to stress tests, and that stress tests are just one 
of many relevant factors for evaluating capital adequacy.
    The agencies' stress test rules do not require $10-50 billion 
companies to create capital action plans; furthermore, the DFA stress 
test rules do not require companies to submit a capital plan to the 
agencies. The agencies have existing supervisory expectations for $10-
50 billion companies regarding appropriate capital planning practices 
that incorporate new information about their capital positions, 
including from capital stress tests. However, $10-50 billion companies 
are not subject to the Board's capital plan rule, which includes 
specific capital planning and assessment requirements beyond those 
specified in the DFA stress test rules. In addition, the agencies' DFA 
stress test rules do not require $10-50 billion companies to meet or 
maintain any specific post-stress capital ratios or targets. However, 
the final guidance does retain the expectation that companies determine 
whether their post-stress results are aligned with their own internal 
capital goals. The final guidance also retains the expectation that in 
cases in which post-stress capital results are not aligned with a 
company's internal capital goals, the company should provide options it 
would consider to bring them into alignment.

[[Page 14159]]

K. Report to Supervisors and Public Disclosure of Stress Test Results

    The proposed guidance indicated that companies must report the 
results of their DFA company-run stress tests on the $10-50 billion 
reporting form.\8\ One commenter requested clarification on whether a 
company must submit two reports even if the subsidiary bank or thrift 
is 98 percent of the holding company. Under the stress test rules 
required by the Dodd-Frank Act, all companies subject to DFA stress 
testing, including holding companies and subsidiary banks and thrifts, 
must conduct stress tests and report information to the agencies. If 
the holding company's assets are substantially held in the subsidiary 
bank or thrift the agencies expect that the report will not be 
significantly different at the bank and at the holding company. In 
addition, the agencies note that they closely coordinated on the 
creation of the $10-50 billion reporting form and it is generally 
identical for all $10-50 billion companies.
---------------------------------------------------------------------------

    \8\ 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.
---------------------------------------------------------------------------

    Regarding public disclosure, the proposed guidance stated that $10-
50 billion companies would need to follow the requirements of the 
stress test rules required by the Dodd-Frank Act. One commenter 
expressed concern that the public disclosure of the stress tests could 
provide fodder for short sellers and requested that the agencies 
explain the hypothetical nature of the stress test results to the 
public. The agencies recognize the sensitive nature of public 
disclosure of stress testing results and have designed the disclosure 
requirements to reflect that sensitivity--for example, public 
disclosure is only required for stress tests conducted under the 
severely adverse scenario. However, public disclosure of the results of 
the stress tests is a requirement of the Dodd-Frank Act. The agencies 
have sought to tailor the disclosure requirement for $10-50 billion 
companies both in the stress testing rules required under the Dodd 
Frank Act and through the expectations in this guidance. The agencies 
have frequently communicated the hypothetical nature of the stress 
tests, but, in response to the commenter request, the agencies have 
added that clarification to the final guidance.

L. Stress Testing at Savings and Loan Holding Companies (SLHCs)

    The agencies received several comments regarding the application of 
the guidance to SLHCs. Commenters generally stated that the guidance 
did not reflect the unique concerns of SLHCs that are substantially 
engaged in either insurance underwriting or commercial activities and 
requested further tailoring of the supervisory expectations for 
conducting DFA stress tests at nonbank SLHCs. Commenters noted the 
fundamental differences in the nonbank business and insurance risk and 
the banking risks in the proposed guidance. For these reasons, the 
commenters requested delaying the implementation for excluded SLHCs, 
tailoring expectations for SLHCs with substantial nonbank businesses, 
and providing a general exemption from stress testing for SLHCs with 
thrift subsidiaries with less than $10 billion in assets.
    The Board's rules implementing the Dodd-Frank Act stress tests 
provide that an SLHC that meets the asset threshold on or before the 
date on which it is subject to minimum regulatory capital requirements 
must comply with the requirements of that subpart beginning with the 
stress test cycle that commences in the calendar year after the year in 
which the company becomes subject to the Board's minimum regulatory 
capital requirements, unless the Board accelerates or extends the 
compliance date. On July 2, 2013, the Board approved a final rule that 
would implement regulatory capital requirements for SLHCs, other than 
those that are substantially engaged in insurance underwriting or 
commercial activities. As discussed in the preamble to that rule, the 
Board excluded SLHCs that are substantially engaged in insurance 
underwriting or commercial activities in order to consider further 
development of appropriate capital requirements of these companies, and 
is exploring further whether and how the proposed rule should be 
modified for these companies in a manner consistent with section 171 of 
the Dodd-Frank Act and safety and soundness expectations. That preamble 
indicated that the Board expects to implement a framework for SLHCs 
that are not subject to the final rule by the time covered SLHCs must 
comply with the final rule in 2015.
    SLHCs that are substantially engaged in insurance underwriting or 
commercial activities will become subject to DFA stress testing in the 
stress test cycle that commences in the calendar year after the year in 
which those companies become subject to the Board's minimum regulatory 
capital requirements, unless the Board accelerates or extends the 
compliance date. As such, the Board does not anticipate that 
supervisors will assess the extent to which SLHCs that are 
substantially engaged in insurance underwriting and commercial 
activities are meeting the expectations in this guidance until such 
SLHCs are subject to the requirements of the stress test rules required 
under the Dodd-Frank Act. The Board may further tailor the application 
of DFA stress testing as it implements the stress test requirements for 
these SLHCs.

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.\9\ This guidance does not 
introduce any new collections of information nor does it substantively 
modify the collections of information that the Office of Management and 
Budget (OMB) has approved. Therefore, no Paperwork Reduction Act 
submissions to OMB are required.
---------------------------------------------------------------------------

    \9\ 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 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 Board is 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 SLHCs with total 
assets of $500 million or less (a small banking organization).\10\ The 
guidance would apply to companies supervised by the agencies with more 
than $10 billion but

[[Page 14160]]

less than $50 billion in total consolidated assets, including state 
member banks, bank holding companies, and SLHCs. Companies that would 
be subject to the 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 have a significant economic 
impact on a substantial number of small entities.
---------------------------------------------------------------------------

    \10\ Effective July 22, 2013, the SBA 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. Supervisory Guidance

    The text of the supervisory guidance is as follows:

Office of the Comptroller of the Currency
Federal Reserve System
Federal Deposit Insurance Corporation

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 (``agencies'') 
issued the Dodd-Frank Act stress test rules \1\ 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'').\2\ 
This guidance outlines key supervisory 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'').\3\ As discussed further 
below, 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''), that set forth general 
principles for a satisfactory stress testing framework.\4\
---------------------------------------------------------------------------

    \1\ 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).
    \2\ 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.
    \3\ 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 252.13. 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.
    \4\ See 77 FR 29458, ``Supervisory Guidance on Stress Testing 
for Banking Organizations With More Than $10 Billion in Total 
Consolidated Assets,'' (May 17, 2012).
---------------------------------------------------------------------------

    The supervisory expectations described in this guidance are 
tailored to the $10-50 billion companies, similar to the manner in 
which the requirements in the stress test rules required under the 
Dodd-Frank Act were tailored for this set of companies.\5\ The 
additional information provided in this guidance should assist 
companies in complying with the stress test rules required under the 
Dodd-Frank Act 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.\6\
---------------------------------------------------------------------------

    \5\ For example, expectations for data sources, data 
segmentation, sophistication of estimation practices, reports and 
public disclosure are generally reduced compared to the expectations 
for larger organizations. Consistent with the approach taken in the 
DFA stress test final rules, in general the expectations for Dodd-
Frank stress testing practices among companies with at least $50 
billion are elevated compared to $10-50 billion companies.
    \6\ Companies subject to this guidance are not subject to the 
Federal Reserve's capital plan rule, the Federal Reserve's annual 
Comprehensive Capital Analysis and Review, supervisory stress tests 
for capital adequacy, or the related data collections supporting the 
supervisory stress test. 12 CFR 225.8 (capital plan rule); 
Supervisory and Company-Run Stress Test Requirements for Covered 
Companies 12 CFR part 252, subparts E and F; and the Capital 
Assessment and Stress Testing information collection (FR Y-14Q, FR 
Y-14M, and FR Y-14A).
---------------------------------------------------------------------------

    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, and the agencies have previously highlighted that importance 
as a means for companies to better understand the range of potential 
risks facing them. 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.
    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, and
G. Public Disclosure of DFA Stress Tests

    The agencies expect that the annual company-run stress tests 
required by the Dodd-Frank Act and the agencies' stress test rules will 
be one component of the broader stress testing activities conducted by 
$10-50 billion companies. Notably, the DFA stress tests produce 
projections of hypothetical results and are not intended to be 
forecasts of expected or most likely outcomes. 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

[[Page 14161]]

concentrations and unique business models and they may not fully cover 
the potential capital effects of interest rate risk or an operational 
risk event such as a regional natural disaster.\7\ 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 outcomes on capital adequacy, and are not intended to measure 
the adequacy of a company's liquidity in the stress scenarios.
---------------------------------------------------------------------------

    \7\ 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.\8\
---------------------------------------------------------------------------

    \8\ 12 CFR 46.5 (OCC); 12 CFR 252.14 (Board); 12 CFR 325.204 
(FDIC).
---------------------------------------------------------------------------

    Under the DFA stress test rules, 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.\9\ 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, pre-provision net revenue (``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 should estimate the adequate 
level of the allowance for loan and lease losses (``ALLL'') to support 
remaining credit risk at the end of each quarter. The ALLL estimation 
should include the final quarter of the planning horizon, which may 
require additional projections of credit losses beyond 2015. The ALLL 
projections for DFA stress testing should be generally consistent with 
a company's internal ALLL approach; however, some modifications might 
be necessary, as discussed in more detail below.
---------------------------------------------------------------------------

    \9\ 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.\10\
---------------------------------------------------------------------------

    \10\ 12 CFR 46.6 (OCC); 12 CFR 252.14 (Board); 12 CFR 325.204 
(FDIC).
---------------------------------------------------------------------------

    Under the stress test rules implementing Dodd-Frank Act 
requirements, $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 rules 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.
    Each agency will provide a description of the supervisory scenarios 
to companies no later than November 15 each calendar year. The 
scenarios provided by each agency 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.\11\ 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. More specifically, it would be inappropriate to 
use a regional or local variable that exhibited limited stress compared 
to variables in the macroeconomic scenarios provided by the agencies, 
such as if the approach for deriving that additional variable was based 
on relatively benign conditions. Any use of additional variables should 
be well supported and documented.
---------------------------------------------------------------------------

    \11\ The use of additional variables may be used by companies to 
better link the DFA stress test scenario variables in the 
supervisory scenarios with a company's unique portfolios and risks. 
However, consistent with the May 2012 stress testing guidance, no 
single stress test can capture all possible effects on capital, 
meaning that the DFA stress tests may not capture the effects of all 
of a company's risks and vulnerabilities and may need to be 
supplemented by other stress testing activities.
---------------------------------------------------------------------------

    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,\12\ 
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.
---------------------------------------------------------------------------

    \12\ ``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

[[Page 14162]]

scenario: Losses, PPNR, provision for loan and lease losses, and net 
income.\13\
---------------------------------------------------------------------------

    \13\ 12 CFR 46.6 (OCC); 12 CFR 252.15(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.\14\ The agencies expect 
that the specific methodological practices used by companies to produce 
the estimates may vary across organizations.
---------------------------------------------------------------------------

    \14\ Additionally, companies' methodologies should be 
sufficiently documented and transparent so that limitations and 
areas of uncertainty are clearly identified for users of stress test 
results and other stakeholders.
---------------------------------------------------------------------------

    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 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 consider employing not just the minimum expectations, but the 
more advanced practices described in this guidance. In addition, $10-50 
billion companies should consider using more than just the minimum 
expectations for the exposures and activities of highest impact and 
that present the highest risk.
    The remainder of this section outlines key practices that all $10-
50 billion companies should incorporate into their methodologies for 
estimating losses, PPNR, provision for loan and lease losses 
(``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 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 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 
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. The agencies recognize that 
in some cases companies may not initially have internal data on certain 
portfolios and thus may rely on proxy data for some time. Such 
practices may be acceptable provided that the company demonstrates that 
proxy data are relevant to the company's own exposures and appropriate 
for the estimation being conducted, and that the company is actively 
collecting internal data.
    Over the long term, companies may continue to use 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.\15\ 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.
---------------------------------------------------------------------------

    \15\ 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.
---------------------------------------------------------------------------

    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 
segment data with more granularity, that is, beyond

[[Page 14163]]

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.\16\ 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. In some cases, companies may not be 
able to validate all the models used in their DFA stress tests prior to 
submission; this may be appropriate provided that companies have (1) 
made an effort to identify models based on materiality and highest risk 
and prioritize validation activities accordingly, (2) applied 
compensating controls so that the output from models that are not 
validated or are only partially validated is not treated the same as 
the output from fully validated models, and (3) clearly documented such 
cases and made them transparent in reports to model users, senior 
management, and other relevant parties. Companies should have an 
explicit exception process when models are put into production without 
validation, with heightened levels of management approval for more 
material models. There should also be timelines with explicit plans for 
conducting the remaining areas of validation for such models and 
recognition that any provisional use without validation is temporary.
---------------------------------------------------------------------------

    \16\ 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 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 internal knowledge as possible and contingency 
plans to prepare for the possibility of vendor contract termination or 
other situations in which 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 solely based 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 aware 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 should 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

[[Page 14164]]

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 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 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, including those with more complex portfolios, 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 estimates 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.\17\ 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.
---------------------------------------------------------------------------

    \17\ 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

[[Page 14165]]

specific method. For example, companies may project each of the 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.
    It may be appropriate for smaller or less sophisticated $10-50 
billion companies to 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 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.\18\
---------------------------------------------------------------------------

    \18\ As noted above, there may be certain aspects of operational 
risk that a company is not expected to address in DFA stress tests; 
however, the company should consider those other aspects of 
operational risk as part of broader stress testing described in the 
May 2012 stress testing guidance.
---------------------------------------------------------------------------

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, a company that 
has reduced its business activity and balance sheet during past periods 
of stress or that has contingent exposures should take these factors 
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 static balance sheet and static risk-
weighted assets over the planning horizon; however, companies should 
consider whether such an approach is appropriate if they have more 
volatile balance sheets and risk-weighted assets, such as from mergers, 
acquisitions, or organic growth. 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.
    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

[[Page 14166]]

balance sheet, for example, based on projections for originations, 
paydowns, 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 sheet projections.
    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 their balance sheets 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. Any case in which balance sheet and risk-
weighted asset projections decline over the period, and therefore 
positively affect capital ratios, should be well supported by analysis 
and data.
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.\19\ 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.
---------------------------------------------------------------------------

    \19\ 12 CFR 46.6(a)(1) (OCC); 12 CFR 252.15(a)(1) (Board); 12 
CFR 325.206(b) (FDIC).
---------------------------------------------------------------------------

    The ALLL at the end of the planning horizon should include any 
losses projected beyond the nine-quarter horizon. Given that loss 
projections for the stress tests can in some cases be conducted at a 
portfolio level, the ALLL projections may also be conducted at a 
similar level, provided that they are consistent with the company's 
existing methodologies to calculate ALLL. Management should ensure that 
the company's projected ALLL is sufficient to cover remaining loan 
losses under the scenario for each quarter of the planning horizon, 
including the last quarter.
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 losses 
appropriate for credit exposures throughout the planning horizon.\20\
---------------------------------------------------------------------------

    \20\ 12 CFR 46.6(a)(2) (OCC); 12 CFR 252.15(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. Stress tests 
are intended to assess the negative impact on companies' capital 
positions from hypothetical stress conditions; as such, the agencies 
expect companies' post-stress capital ratios under the adverse and 
severely adverse scenarios to be lower than under the baseline 
scenario. Any rare cases in which ratios are higher under the adverse 
and severely adverse scenarios should be very well supported by 
analysis and documentation. Projected capital levels and ratios should 
reflect applicable regulations and accounting standards for each 
quarter of the planning horizon.
    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.\21\
---------------------------------------------------------------------------

    \21\ 12 CFR 252.15(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

[[Page 14167]]

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.\22\
---------------------------------------------------------------------------

    \22\ 12 CFR 46.5(d) (OCC); 12 CFR 252.15(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 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 should 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.\23\
---------------------------------------------------------------------------

    \23\ 12 CFR 46.5(d) and 46.6(c)(2) (OCC); 12 CFR 252.15(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 appropriately evaluate and 
discuss this information, ensuring that the DFA stress tests are 
consistent with the company's risk appetite and overall business 
strategy. 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. In addition, the board of 
directors and senior management of a $10-50 billion company 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 
appropriately 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

[[Page 14168]]

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. In addition, a company should 
determine whether its post-stress capital results are aligned with its 
internal capital goals. 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.\24\
---------------------------------------------------------------------------

    \24\ 12 CFR 46.7 (OCC); 12 CFR 252.16 (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.\25\
---------------------------------------------------------------------------

    \25\ 12 CFR 46.8 (OCC); 12 CFR 252.17 (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.\26\ 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.\27\ 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.
---------------------------------------------------------------------------

    \26\ The exception is any $10-50 billion state member bank that 
is a subsidiary of a bank holding company or a savings and loan 
holding company with average total consolidated assets of $50 
billion or more; in that case, the state member bank subsidiary must 
disclose a summary of the results of the stress test in the period 
beginning on March 15 and ending on March 31.
    \27\ 12 CFR 252.17(b).
---------------------------------------------------------------------------

    The summary of the results of the stress test, including both 
quantitative 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 its 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 Federal 
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 Federal regulator;
    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 regulator 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      Capital actions       No prescribed
 company-run stress tests.     prescribed in         capital actions.
                               Federal Reserve       Banks and thrifts
                               Board's DFA stress    should use capital
                               tests rules.          actions consistent
                               Generally based on    with the scenario
                               historical            and their internal
                               dividends,            business practices.
                               contracted
                               payments, and no
                               repurchases or
                               issuances.

[[Page 14169]]

 
Public disclosure of company- Disclosure must       Disclosure
 run stress tests.             include information   requirement met
                               on stress tests       when parent company
                               conducted by          disclosure includes
                               subsidiaries          the required
                               subject to DFA        information on the
                               stress tests.         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: February 19, 2014.
Thomas J. Curry,
Comptroller of the Currency.
    By order of the Board of Governors of the Federal Reserve 
System, March 5, 2014.
Robert deV. Frierson,
Secretary of the Board.
    Dated at Washington, DC, this 5th day of March, 2014.

    Federal Deposit Insurance Corporation.
Robert E. Feldman,
Executive Secretary.
[FR Doc. 2014-05518 Filed 3-12-14; 8:45 am]
BILLING CODE 4810-33-P; 6714-01-P; 6210-01-P