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Fitch: US Mid-Tier Bank DFAST Process Matters More than Results

August 31, 2015, 07:13 AM
Filed Under: Banking

Fitch Ratings views the 2015 Dodd-Frank Act Stress Test (DFAST) process applied to mid-tier regional banks ($10 billion-$50 billion in assets) as a positive development. While the DFAST for mid-tiers is not as rigorous as the Comprehensive Capital Analysis and Review (CCAR) for banks that have over $50 billion in assets, Fitch considers the DFAST process, in and of itself, to be more important than the actual results, as it should lead to a better understanding of capital and credit risk management for these institutions.

The DFAST process for the 60 mid-tier banks only applied the severely adverse scenario which included, among over a dozen stresses, a 50% decline in real estate prices and a nearly 60% decline in equity markets over a multi-year period.

Of the 20 Fitch-rated mid-tier banks, most passed DFAST by comfortable margins, reporting average minimum common equity Tier 1 (CET1) ratios in excess of the required capital minimums. The Fitch-rated group's average minimum CET1 ratio over the nine-quarter evaluation period ending December 2016 is 9.9%, nearly double the minimum 5% threshold.

As a comparison, the self-reported bank holding company minimum CET1 ratio average for large regionals under DFAST in March 2015 was 9.1%. And under the Fed's analysis, that same minimum CET1 ratio average was 8.1%. Details can be found here. Fitch notes that these stress test results indicate that the banking industry's capital profile is more resilient post-crisis compared to the period leading up to it.

Fitch also observes that cumulative loan losses reported by the universe of rated mid-tier banks over the nine-quarter stress period averaged around 3%, compared to a 4.3% internally calculated cumulative loss average for the large regional peer group. In our view, this difference mainly reflects the large regionals' loan portfolio make-up which, in general, includes a larger share of credit card and auto loans that have higher credit loss content embedded within them during credit downturns. Fitch notes that the loss factors associated with these asset classes have been more punitive than other asset classes such as commercial real estate or 1-4 family residential in the Fed-run stress tests.

We note that disclosure formats limit the potential for bank-to-bank comparisons. Of our Fitch-rated sample group, only eight of 20 provided a breakout of cumulative loan losses by loan type. However, we also recognize that overly burdensome evaluations could become a costly distraction, with an incrementally diminishing benefit for considerably more time spent on the test processes.

There might be limitations to using the disclosed results for comparison purposes. Nevertheless, we believe there is value in the stress-testing process in terms of improving both risk management and capital planning. Leading up to the last credit cycle, we believe it was clear that many banks lacked sufficient tools to monitor risks, particularly concentration risks, which led to significant credit losses and depleted capital levels.

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