Bank Capital Plans and Stress Tests: Federal Reserve Approves Final Rule Amending Certain Aspects of Existing Capital Plan and Stress Test Rules

Sullivan & Cromwell LLP - October 24, 2014

Last Friday, the Board of Governors of the Federal Reserve System approved a final rule (the “Final Rule”) amending certain aspects of the existing capital plan (the “Capital Plan Rule”) and stress test rules (the “Stress Test Rules”) applicable to bank holding companies with $50 billion or more in total consolidated assets and the company-run Stress Test Rules applicable to bank holding companies with more than $10 billion but less than $50 billion in total consolidated assets and savings and loan holding companies and state member banks with more than $10 billion in total consolidated assets. The Capital Plan Rule is designed to enable the Federal Reserve to assess the internal capital planning process of each bank holding company with total consolidated assets of $50 billion or more (a “Large BHC”) and its ability to maintain sufficient capital to continue its operations under expected and stressful conditions. The Stress Test Rules require Large BHCs to conduct annual and mid-cycle company-run stress tests. State member banks and savings and loan holding companies with total consolidated assets of more than $10 billion and bank holding companies with total consolidated assets of more than $10 billion but less than $50 billion are subject to less stringent Stress Test Rules. The Federal Reserve also conducts annual supervisory stress tests of Large BHCs under its Comprehensive Capital Assessment and Review program (“CCAR”).

While the Final Rule largely has been adopted as initially proposed by the Federal Reserve in June 2014 (the “Proposed Rule”), in response to public comment, the Final Rule contains a number of notable revisions and clarifications, such as:

  • Alignment between capital plans and actual capital issuances and distributions: As under the Proposed Rule, Large BHCs generally will be required to cap quarterly capital distributions if the amount of actual capital raised for a particular quarter is less than as indicated in its capital plan.  However, the Final Rule makes several important adjustments to this requirement as compared to the Proposed Rule, including:
  • the net distribution limit does not apply to scheduled payments on instruments that qualify as additional tier 1 and tier 2 capital;
  • the Final Rule essentially treats distributions for each category of capital instrument (that is, common equity tier 1, additional tier 1 and tier 2) on a stand-alone basis for purposes of the net distribution limit so that, for example, failure to raise sufficient common equity tier 1 as planned would not affect distributions related to additional tier 1 capital instruments;
  • the Final Rule does not permit a bank to raise greater amounts of more loss-absorbing capital (for example, common equity tier 1) than planned and thereby avoid the quarterly net distribution limit with respect to failures to raise regulatory capital with relatively lower loss-absorbing characteristics (for example, additional tier 1 capital), although the Federal Reserve indicates a bank could seek a waiver from the Federal Reserve in such circumstances; and
  • the Final Rule measures issuances and distributions on a cumulative basis, thus providing Large BHCs with flexibility to credit excess issuances or lower distributions of capital in a given quarter to a later quarter, in each case, relative to the amounts included in the Large BHC’s capital plan for a given class of regulatory capital instrument.
  • Timing of disclosure by Large BHCs of their mid-cycle stress tests:  The Final Rule extends the time period during which a Large BHC may release the results of its mid-cycle company-run stress test. For the cycle beginning October 1, 2014, a Large BHC will have 30 days from the date it submits the results of its mid-cycle company-run stress test to the Federal Reserve (that is, for the cycle beginning October 1, 2014, from July 5 to August 4, and for subsequent cycles beginning with the cycle commencing January 1, 2016, from October 5 to November 4) to disclose these results publicly. Under the Proposed Rule, a Large BHC had only 15 days to disclose these results.
  • Definition of “BHC Stress Scenario: The Final Rule attempts to clarify that a BHC Stress Scenario should be both appropriately severe and relevant to the specific idiosyncratic risks of the particular Large BHC, rather than engineered solely to produce a more severe impact on projected pre-tax net income than the results of the Large BHC’s stress test under the Federal Reserve’s severely adverse scenario.
  • Timeline for applicability of the Capital Plan Rule to U.S. Intermediate Holding Companies: The Final Rule clarifies that a bank holding company subsidiary of a foreign banking organization (an “FBO”) designated as the FBO’s U.S. intermediate holding company (its “U.S. IHC”) must first reflect the effects of any transfers associated with the IHC rule (the “IHC Rule”), including any capital issuances or contributions planned in connection with the capitalization of the U.S. IHC, in the Large BHC’s capital plan due by April 5, 2016.
  • Submission of loss, revenue and expense estimation models to the Federal Reserve: The Final Rule clarifies that a Large BHC must submit only an inventory and description of the models and methodologies used in the preparation of its stress scenario rather than the models themselves.
The Final Rule will take effect on November 26, 2014, other than the amendment to the Capital Plan Rule establishing a limitation on net capital distributions, which will be effective on April 1, 2015.