[Federal Register Volume 78, Number 150 (Monday, August 5, 2013)]
[Proposed Rules]
[Pages 47217-47228]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2013-18716]


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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-1461]

FEDERAL DEPOSIT INSURANCE CORPORATION

12 CFR Part 325


Proposed 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

AGENCIES: 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: Proposed supervisory guidance.

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SUMMARY: The Board, FDIC and OCC, (collectively, the ``agencies'') are 
issuing this guidance, which outlines high-level principles for 
implementation of section 165(i)(2) of the Dodd-Frank Act Wall Street 
Reform and Consumer Protection Act (``DFA'') stress tests, applicable 
to all bank and savings-and-loan holding companies, national banks, 
state-member banks, state non-member 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. It also underscores the importance of stress 
testing as an ongoing risk management practice that supports a 
company's forward-looking assessment of its risks and better equips the 
company to address a range of macroeconomic and financial outcomes.

DATES: Comments on this joint proposed guidance are due to the OCC and 
FDIC on September 25th, 2013 and to the Federal Reserve on September 
30th, 2013.

ADDRESSES:
    OCC: Because paper mail in the Washington, DC area and at the OCC 
is subject to delay, commenters are encouraged to submit comments by 
email, if possible. Please use the title ``Proposed 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'' to facilitate the organization and 
distribution of the comments. You may submit comments by any of the 
following methods:
     Email: [email protected].
     Mail: Legislative and Regulatory Activities Division, 
Office of the Comptroller of the Currency, 400 7th Street SW., Suite 
3E-218, Mail Stop 9W-11, Washington, DC 20219.
     Hand Delivery/Courier: 400 7th Street SW., Suite 3E-218, 
Mail Stop 9W-11, Washington, DC 20219.
     Fax: (571) 465-4326.
    Instructions: You must include ``OCC'' as the agency name and 
``Docket ID OCC-2013-0013'' in your comment. In general, OCC will enter 
all comments received into the docket and publish them on the 
Regulations.gov Web site without change, including any business or 
personal information that you provide such as name and address 
information, email addresses, or phone numbers. Comments received, 
including attachments and other supporting materials, are part of the 
public record and subject to public disclosure. Do not enclose any 
information in your comment or supporting materials that you consider 
confidential or inappropriate for public disclosure.
    You may review comments and other related materials that pertain to 
this notice by any of the following methods:
     Viewing Comments Personally: You may personally inspect 
and photocopy comments at the OCC, 400 7th Street SW., Washington, DC. 
For security reasons, the OCC requires that visitors make an 
appointment to inspect comments. You may do so by calling (202) 649-
6700. Upon arrival, visitors will be required to present valid 
government-issued photo identification and to submit to security 
screening in order to inspect and photocopy comments.
     Docket: You may also view or request available background 
documents and project summaries using the methods described above.
    Board: You may submit comments, identified by Docket No. OP-1461, 
``Proposed 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,'' by any of 
the following methods:
     Agency Web site: http://www.federalreserve.gov. Follow the 
instructions for submitting comments at http://www.federalreserve.gov/generalinfo/foia/ProposedRegs.cfm.
     Federal eRulemaking Portal: http://www.regulations.gov. 
Follow the instructions for submitting comments.
     Email: [email protected]. Include the 
docket number in the subject line of the message.
     Fax: (202) 452-3819 or (202) 452-3102.
     Mail: Address to Robert deV. Frierson, Secretary, Board of 
Governors of the Federal Reserve System, 20th Street and Constitution 
Avenue NW., Washington, DC 20551.
    All public comments will be made available on the Board's Web site 
at http://www.federalreserve.gov/generalinfo/foia/ProposedRegs.cfm as 
submitted, unless modified for technical reasons. Accordingly, comments 
will not be edited to remove any identifying or contact information. 
Public comments may also be viewed electronically or in paper in Room 
MP-500 of the Board's Martin Building (20th and C Streets NW., 
Washington, DC

[[Page 47218]]

20551) between 9:00 a.m. and 5:00 p.m. on weekdays.
    FDIC: You may submit comments, identified as ``Stress Test 
Guidance'', by any of the following methods:
    Agency Web site: http://www.fdic.gov/regulations/laws/federal/propose.html. Follow instructions for submitting comments on the Agency 
Web site.
     Email: [email protected]. Include ``Stress Test Guidance'' 
on the subject line of the message.
     Mail: Robert E. Feldman, Executive Secretary, Attention: 
Comments, Federal Deposit Insurance Corporation, 550 17th Street NW., 
Washington, DC 20429.
     Hand Delivery: Comments may be hand delivered to the guard 
station at the rear of the 550 17th Street Building (located on F 
Street) on business days between 7:00 a.m. and 5:00 p.m.
    Public Inspection: All comments received must include the agency 
name and ``Stress Test Guidance''. All comments received will be posted 
without change to http://www.fdic.gov/regulations/laws/federal/propose.html, including any personal information provided. Paper copies 
of public comments may be ordered from the FDIC Public Information 
Center, 3501 North Fairfax Drive, Room E-1002, Arlington, VA 22226 by 
telephone at (877) 275-3342 or (703) 562-2200.

FOR FURTHER INFORMATION CONTACT:
    Board: David Palmer, Senior 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, Senior Financial Analyst, (202) 412-4861; 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: Harry Glenos, Senior Financial Advisor, (202) 649-6409; Kari 
Falkenborg, Financial Analyst, (202) 649-6831; 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 between $10 billion and $50 billion in total 
assets.
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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. 12 CFR 252.153. 
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).
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    Accordingly, the agencies are issuing this proposed guidance, which 
would apply to all companies with total consolidated assets of more 
than $10 billion but less than $50 billion ($10-50 billion companies). 
The agencies invite public comment on this proposed guidance. The 
agencies expect $10-50 billion companies to follow the DFA stress rule 
requirements, other relevant supervisory guidance,\3\ and if adopted, 
the expectations set forth in this document, when conducting DFA stress 
tests.\4\
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    \3\ In particular, companies should conduct tests in accordance 
with 77 FR 29458, ``Supervisory Guidance on Stress Testing for 
Banking Organizations With More Than $10 Billion in Total 
Consolidated Assets,'' (May 17, 2012).
    \4\ To the extent that the guidance conflicts with the 
requirements imposed with respect to any future statutory or 
regulatory stress test, companies must comply with the requirements 
set forth in the relevant statute or regulation.
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    The proposed guidance addresses the following key areas:
     Supervisory scenarios. Under the DFA stress test rules, 
$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 
indicates that $10-50 billion 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 risk areas may 
vary. These companies may use all or, as appropriate, a subset of the 
variables from the supervisory scenarios to conduct a stress test, 
depending on whether the variables are relevant or appropriate to the 
company's line of business. The companies may, but are not required to, 
include additional variables or additional quarters to improve their 
company-run stress tests. For example, the proposed guidance includes a 
set of questions on translating supervisory scenarios to regional 
variables and minimum expectations for loss estimation. However, the 
paths of any additional regional or local variables that a company uses 
would be expected to be consistent with the path of the national 
variables in the supervisory scenarios.
     Data sources and segmentation. In conducting a stress 
test, a company should segment its 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 riskiness of a given portfolio, provided 
there are sufficiently granular historical data available to allow for 
the desired segmentation. A company would be expected to be able to 
segment its data at a level at least as granular as the reporting form 
it uses to report the results to its primary regulator and the Board 
(``$10-50 billion reporting form''), but may use a more granular 
segmentation, particularly for more material or riskier portfolios.\5\ 
If a company does not currently have sufficient internal data to 
conduct a stress test, it may use an alternative data source as a proxy 
for its own risk profile and exposures. However, companies with limited 
data would be expected to construct strategies to develop sufficient 
data to improve their stress test estimation processes over time.
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    \5\ For Federal Reserve-regulated companies the relevant 
reporting form is the FR Y-16, for OCC-regulated companies the 
relevant form is the OCC DFAST 10-50, and for FDIC-regulated 
companies the relevant form is the FDIC DFAST 10-50.
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     Loss estimation. In conducting a stress test, for each 
quarter of the planning horizon, a company must estimate the following 
for each required scenario: losses, pre-provision net revenue (PPNR), 
provision for loan and lease losses, and net income.\6\ 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. Larger or 
more sophisticated companies should consider more advanced loss 
estimation practices that identify the key drivers of

[[Page 47219]]

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. Companies may use different processes for the 
baseline scenario, including their budgeting process if it is 
conditioned on the supervisory scenario, than for the adverse and 
severely adverse scenarios in order to better capture the loss 
potential under stressful conditions.
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    \6\ 12 CFR 252.155(a)(1).
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     Pre-provision net revenue. The proposed guidance indicates 
that companies that are less complex or less sophisticated could 
estimate projected PPNR based on the three main components of PPNR (net 
interest income, non-interest income, non-interest expense) at an 
aggregate, company-wide level based on industry experience. Companies 
that are more complex or more sophisticated should consider methods 
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. In addition to 
credit losses, 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, companies 
should include in their PPNR projections any trading losses, any losses 
related to mortgage repurchase agreements, mortgage servicing rights, 
or losses related to operational risk arising in the scenarios.
     Balance sheet and risk-weighted assets projections. Under 
the proposed guidance, a company would be 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. Companies 
should document and explain key underlying assumptions about changes in 
balances or risk-weighted assets under stressful conditions, including 
justifying major changes, justifying any assumptions about strategies 
that may mitigate losses under the stressful conditions, and ensuring 
that the assumptions do not substantially alter the company's core 
businesses and earnings capacity.
     Governance and controls. Under the DFA stress test rules, 
a $10-50 billion company is required to 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. The proposed guidance describes supervisory expectations and 
sound practices regarding the controls, oversight, and documentation 
required by the rule. All $10-50 billion companies 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. For instance, 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 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.

II. Request for Comments

    The agencies invite comment on all aspects of the proposed 
guidance. Specifically, the agencies seek comment on the following 
questions.
    Question 1: What challenges do companies expect in relating the 
national variables in the scenarios to regional and local market 
footprints?
    Question 2: What additional clarity might be needed regarding the 
appropriate use of historical experience in the loss, revenue, balance 
sheet, and risk-weighted asset estimation process?
    Question 3: What additional clarity should the guidance provide 
about the use of vendor or other third-party products and services that 
companies might choose to employ for DFA stress tests?
    Question 4: How could the proposed guidance be clearer about the 
manner in which the required capital action assumptions between holding 
companies and banks differ, and how those different assumptions should 
be reconciled within a consolidated organization?
    Question 5: What additional clarification would be helpful to 
companies about the responsibilities of their boards and senior 
management with regard to DFA stress tests?
    The agencies request that commenters reference the question numbers 
above when providing answers to those questions.

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.\7\ This guidance does not 
introduce any new collections of information nor does it substantively 
modify the collections of information that Office of Management and 
Budget (OMB) has approved. Therefore, no Paperwork Reduction Act 
submissions to OMB are required.
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    \7\ See OMB Control Nos. 1557-0311 and 1557-0312 (OCC); 3064-
0186 and 3064-0187 (FDIC); and 7100-0348 and 7100-0350 (Board).
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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 proposed 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 agencies are 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 savings and loan 
holding company with total assets of $500 million or less (a small 
banking organization).\8\ The proposed guidance would apply to 
companies supervised by the agencies with more than $10 billion but 
less than $50 billion in total consolidated assets, including state 
member banks, bank holding companies, and savings and loan holding 
companies. Companies that would be subject to the proposed 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

[[Page 47220]]

have a significant economic impact on a substantial number of small 
entities.
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    \8\ Effective July 22, 2013, the Small Business Administration 
revised the size standards for small banking organizations to $500 
million in assets from $175 million in assets. 78 FR 37409 (June 20, 
2013).
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IV. Proposed Supervisory Guidance

    The text of the proposed supervisory guidance is as follows:
Office of the Comptroller of the Currency
Federal Reserve System
Federal Deposit Insurance Corporation

Proposed 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 issued the Dodd-
Frank Act stress test rules \9\ 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).\10\ This guidance 
outlines key 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'').\11\ 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'').\12\
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    \9\ 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).
    \10\ 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.
    \11\ 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 252.153. For the FDIC, the term 
``company'' is used in this guidance to refer to insured state 
nonmember banks and insured state savings associations that 
qualifies as a ``covered bank'' under the FDIC Annual Stress Test 
Rule. 12 CFR 325.202.
    \12\ 77 FR 29458, ``Supervisory Guidance on Stress Testing for 
Banking Organizations With More Than $10 Billion in Total 
Consolidated Assets,'' (May 17, 2012).
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    The expectations described in this guidance are tailored to the 
$10-50 billion companies, similar to the manner in which the 
requirements in the DFA stress test rules were tailored for this set of 
companies.\13\ The additional information provided in this guidance 
should assist companies in complying with the DFA stress test rules 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.
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    \13\ As indicated in the DFA stress test final rules, the 
agencies also plan to issue supervisory guidance for companies with 
at least $50 billion in total assets. Consistent with the approach 
taken in the DFA stress test final rules, the agencies expect the 
guidance for companies with at least $50 billion to contain 
standards that are comparable or elevated in all areas.
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    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, supporting a company's forward-looking assessment of its 
risks and helping to ensure that the company has sufficient capital to 
support its operations through periods of stress. The agencies have 
previously highlighted the importance of stress testing as a means for 
companies to better understand the range of potential risks. 
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.
    The agencies expect that companies will follow the principles and 
expectations in the May 2012 stress testing guidance when conducting 
their DFA stress tests. 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
G. Public Disclosure of DFA Stress Tests

    The agencies expect that the annual company-run stress tests 
required under the DFA stress test rules will be one component of the 
broader stress-testing activities conducted by $10-$50 billion 
companies. 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 concentrations and unique business 
models, or they may not fully cover the potential capital effects of 
interest rate risk or an operational risk event such as a regional 
natural disaster.\14\ 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

[[Page 47221]]

outcomes on capital adequacy, and are not intended to measure the 
adequacy of a company's liquidity in the stress scenarios.
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    \14\ 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.
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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.\15\

    \15\ 12 CFR 46.5 (OCC); 12 CFR 252.154 (Board); 12 CFR 325.204 
(FDIC).

    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.\16\ 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, 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 would need to estimate the 
adequate level of the allowance for loan and lease losses (``ALLL'') to 
support remaining credit risk at the end of each quarter--including the 
final quarter--which may require additional projections of credit 
losses beyond 2015 to ensure the ALLL is consistent with Generally 
Accepted Accounting Principles (GAAP).
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    \16\ 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.
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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.\17\

    \17\ 12 CFR 46.6 (OCC); 12 CFR 252.154 (Board); 12 CFR 325.204 
(FDIC).

    Under the DFA stress test rules, $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 rule 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.
    The agencies will provide a description of the supervisory 
scenarios to companies no later than November 15 each calendar year. 
The scenarios provided by the agencies 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. 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. Any use of additional variables should be well 
supported and documented.
    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,\18\ 
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.
---------------------------------------------------------------------------

    \18\ ``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 scenario: losses, pre-provision net revenue, provision for 
loan and lease losses, and net income.\19\
---------------------------------------------------------------------------

    \19\ 12 CFR 46.6 (OCC); 12 CFR 252.155(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. The agencies expect that 
the specific methodological practices used by companies to produce the 
estimates may vary across organizations.
    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 and improve 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 employ not just the minimum 
expectations, but the more advanced practices described in this 
guidance.
    The remainder of this section outlines key practices that all $10-
50 billion companies should incorporate into their methodologies for 
estimating losses, PPNR, 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

[[Page 47222]]

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 demonstrably 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 
specific 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.
    Over the long term, companies may continue to use such 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.\20\ 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.
---------------------------------------------------------------------------

    \20\ 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. For 
Federal Reserve-regulated companies the relevant reporting form is 
the FR Y-16, for OCC-regulated companies the relevant form is the 
OCC DFAST 10-50, and for FDIC-regulated companies the relevant form 
is the FDIC DFAST 10-50.
---------------------------------------------------------------------------

    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 
already segment data with more granularity, i.e., beyond 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.\21\ 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.
---------------------------------------------------------------------------

    \21\ 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

[[Page 47223]]

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 in-house knowledge as possible in the event of vendor contract 
termination and should have contingency plans in cases where 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 based solely 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 mindful 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 would 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 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

[[Page 47224]]

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 expected loss 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 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 projections 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.\22\ 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.
---------------------------------------------------------------------------

    \22\ 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 specific method. For example, 
companies may project each of 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.
    Smaller or less sophisticated $10-50 billion companies may 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

[[Page 47225]]

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.

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, if a company has 
reduced its business activity and balance sheet during past periods of 
stress or if it has contingent exposures, that should be taken 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 constant-portfolio assumption. 
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.
    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 its balance sheet 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. Companies should document and explain key underlying 
assumptions, as appropriate.
    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 balance sheet, for example, based on 
projections for originations, pay-downs, 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 projections.

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. 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. The ALLL at the end of the planning horizon should be 
consistent with GAAP, including any losses projected beyond the nine-
quarter horizon.

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

[[Page 47226]]

losses appropriate for credit exposures throughout the planning 
horizon.\23\
---------------------------------------------------------------------------

    \23\ 12 CFR 46.6(a)(2) (OCC); 12 CFR 252.155(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. The agencies 
expect companies' post-stress capital ratios under the adverse and 
severely adverse scenarios will be lower than under the baseline 
scenario. Projected capital levels and ratios should reflect applicable 
regulations and accounting standards for each quarter of the planning 
horizon.
    In particular, in July 2013, the Board and OCC issued a final rule 
and the FDIC issued an interim final rule regarding regulatory capital 
requirements for banking organizations. The final rules revise the 
criteria for regulatory capital, introduce a new minimum common equity 
tier 1 capital requirement of 4.5 percent of risk-weighted assets, as 
well as a minimum supplementary leverage ratio requirement of 3 percent 
that would apply to companies subject to the advanced approaches 
capital rules. The new minimum capital requirements would be phased in 
over a transition period. The final rules will take effect beginning on 
January 1, 2014, for banking organizations subject to the agencies' 
advanced approaches rules (other than savings and loan holding 
companies) and on January 1, 2015, for all other banking organizations. 
Compliance with the supplementary leverage ratio for companies subject 
to the advanced approaches rules will be required starting in 2018. 
$10-50 billion companies should measure their regulatory capital levels 
and regulatory capital ratios for each quarter in accordance with the 
rules that would be in effect during that quarter in accordance with 
the transition arrangements set forth in the final rules.

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.\24\
---------------------------------------------------------------------------

    \24\ 12 CFR 252.155(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 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.\25\
---------------------------------------------------------------------------

    \25\ 12 CFR 46.5(d) (OCC); 12 CFR 252.155(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

[[Page 47227]]

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 would 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.\26\
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    \26\ 12 CFR 46.5(d) and 46.6(c)(2) (OCC); 12 CFR 252.155(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 actively evaluate and 
discuss this information, ensuring that the DFA stress tests 
appropriately reflect the company's risk appetite, overall strategy and 
business plans, overall stress testing practices, and contingency 
plans, directing changes where appropriate. 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.
    All $10-50 billion companies 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 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 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. Importantly, a company should 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 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.\27\
---------------------------------------------------------------------------

    \27\ 12 CFR 46.7 (OCC); 12 CFR 252.156 (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.\28\
---------------------------------------------------------------------------

    \28\ 12 CFR 46.8 (OCC); 12 CFR 252.157 (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. 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.\29\ 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.
---------------------------------------------------------------------------

    \29\ 12 CFR 252.157(b).
---------------------------------------------------------------------------

    The summary of the results of the stress test, including both 
quantitative

[[Page 47228]]

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 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 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 supervisor;
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 financial regulatory agency 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 company- Capital actions     No prescribed
 run stress tests.                 prescribed in       capital actions.
                                   Federal Reserve     Banks and thrifts
                                   Board's DFA         should use
                                   stress tests        capital actions
                                   rules. Generally    consistent with
                                   based on            the scenario and
                                   historical          their internal
                                   dividends,          business
                                   contracted          practices.
                                   payments, and no
                                   repurchases or
                                   issuances.
Public disclosure of company-run  Disclosure must     Disclosure
 stress tests.                     include             requirement met
                                   information on      when parent
                                   stress tests        company
                                   conducted by        disclosure
                                   subsidiaries        includes the
                                   subject to DFA      required
                                   stress tests.       information on
                                                       the 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: July 25, 2013.
Thomas J. Curry,
Comptroller of the Currency.
    By order of the Board of Governors of the Federal Reserve 
System, July 24, 2013.
Robert deV. Frierson,
Secretary of the Board.
    Dated at Washington, DC, this 30th day of July, 2013.

Federal Deposit Insurance Corporation.
Robert E. Feldman,
Executive Secretary.
[FR Doc. 2013-18716 Filed 8-2-13; 8:45 am]
BILLING CODE 4810-33-P; 6714-01-P; 6210-01-P