C C A R EY Regula tory Alert

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1 C C A R EY Regula tory Alert F eb r u ar y 2016 O n T h u r sday, J an u ar y 28, 2016, t h e F eder al R eser ve B o ar d ( F R B ) p u b l i sh ed t h e C o m p r eh en si ve C ap i t al A n al y si s an d R evi ew ( C C A R ) 2016 i n st r u c t i o n s an d t h e su p er vi so r y sc en ar i o s f o r t h e an n u al st r ess t est s r eq u i r ed u n der t h e D o dd-f r an k A c t st r ess t est ( D F A S T ) r u l es an d t h e c ap i t al p l an r u l e 1 t h at ap p l y t o t h e 33 b an k h o l di n g c o m p an i es ( B H C s) p ar t i c i p at i n g i n C C A R t h i s y ear. 2 While there are no significant surprises in the instructions, some new features in the CCAR 2016 scenarios warrant particular attention. Specifically, the supervisory severely adverse scenario introduces a period of negative short-term interest rates. T e c h n i c a l i n s t r u c t i o n s r e i n f o r c e t h e n o w - e x p l i c i t a n d d i f f e r e n t i a t e d e x p e c t a t i o n s o f S R a n d S R T h e C C A R 2016 i n st r u c t i o n s ar e g en er al l y c o n si st en t w i t h l ast y ear s C C A R ex er c i se. H o w ever, t h ey c o n t ai n addi t i o n al det ai l s o n h o w B H C s sh o u l d i m p l em en t t ec h n i c al am en dm en t s t o st r ess t est an d c ap i t al r u l es an d r ei t er at e c h an g es f r o m u p dat ed g u i dan c e p u b l i sh ed si n c e C C A R 2015, i n c l u di n g : November 25, 2015 amendments to the capital plan and stress testing rules December 21, 2015 supervisory letters SR and SR January 21, 2016 updates to the FR Y-14A/Q/M Instructions W h i l e t h e sc en ar i o s m ay i m p ac t t h e ab i l i t y f o r B H C s t o m eet q u an t i t at i ve r eq u i r em en t s under CCAR, SR and SR reinforce the high supervisory expectations that form t h e b asi s o f t h e F R B s q u al i t at i ve C C A R assessm en t A p p l i c ab i l i t y : 31 C C A R B H C s f r o m l ast y ear p l u s t w o n ew p ar t i c i p an t s: B an c W est C o r p o r at i o n an d T D G r o u p U S Holdings LLC. The same 6 US global systemically important banks (G-SIBs) as last year are subject to the FRB s Global Market Shock (GMS), and the same 8 G-SIBs as last year are subject to the FRB s Counterparty Default S c en ar i o c o m p o n en t. 3 The new guidance supersedes SR 09-4 and SR and provides core expectations for capital planning, w h i c h b u i l ds u p o n ex i st i n g m i n i m u m ex p ec t at i o n s p u b l i sh ed i n o t h er r eg u l at o r y g u i dan c e ( i.e., C C A R R an g e o f Current Practices (2013), Comprehensive Capital Analysis and Review 2015 Summary Instructions and Guidance, Instructions for the Capital Assessments and Stress Testing information collection, SR 11-7, SR letter 12-17/CA, an d S R 13-1).

2 K ey i ssu es h i g h l i g h t ed i n t h e C C A R 2016 i n st r u c t i o n s t h at w er e p r evi o u sl y c o m m u n i c at ed i n c l u de: R e i t e r a t e d c h a n g e s f r o m N o v e m b e r 2 5, F i n a l R u l e a m e n d i n g t h e c a p i t a l p l a n a n d s t r e s s t e s t i n g r u l e s Removal of tier 1 common ratio, indefinite delay of stressed advan c ed ap p r o ac h es r i sk -w ei g h t ed asset c al c u l at i o n s, an d o n e- y ear del ay f o r i n c o r p o r at i n g su p p l em en t ar y l ever ag e r at i o i n t o stress projections Modification of DFAST capital action assumptions to highlight t h e i n c o r p o r at i o n o f p l an n ed m er g er s an d ac q u i si t i o n s i n c ap i t al projections Requirement to include Volcker Rule deductions from regulatory capital in FR Y-14A schedules, as appropriate, over the nine-quarter p l an n i n g h o r i z o n H i g h l i g h t e d k e y a r e a s f r o m S R a n d S R The SR and SR guidance effectively subdivides the current 33 CCAR BHCs and future filers into two tiers, with higher expectations for the first tier of Large Institution Supervision Coordinating Committee (LISCC) and Large and Complex firms. 4 R e f e r e n c e d c h a n g e s f r o m J a n u a r y 2 1, u p d a t e o f F R Y A / Q / M s c h e d u l e s R eq u i r em en t t o p o p u l at e n ew S c h edu l e F ( B u si n ess P l an C h an g es) with planned material business changes (e.g., merger, acquisition, di vest i t u r e) f o r t h e 2016 C C A R c y c l e, f o r m al i z i n g i n f o r m at i o n t h at h ad b een c ap t u r ed i n p r i o r C C A R c y c l es o n an ad-h o c b asi s. CFO attestation (which will start December 31, 2016, for FR Y-14A/Q/Ms as of that date) for nine current and seven future LISCC firms focusing on attestation that: Projections and actuals data is prepared in conformance w i t h F R B i n st r u c t i o n s Data is materially accurate and supported by effective internal c o n t r o l s an d r evi ew s b y sen i o r m an ag em en t, an d t h at m at er i al w eak n esses an d er r o r s i n dat a ar e p r o m p t l y r ep o r t ed t o t h e F R B as they are identified S R h as en h an c ed em p h asi s an d r el at i vel y h i g h er expectations for LISCC and Large and Complex firms in the areas of modeling, risk identification, data management and g o ver n an c e. H i g h l i g h t s i n c l u de: Higher expectations toward usage of models and q uantitative methods f o r l o sses, b al an c e sh eet an d p r e-p r o vi si o n n et r even u e i n c l u di n g i n c r eased sc r u t i n y o n assumptions i n b al an c e sh eet f o r ec ast i n g Expectation to evaluate risk identification and assessment at l east q uarterly Expectation to use multiple internal scenarios ac r o ss m at er i al r i sk s i n o n g o i n g c ap i t al p l an n i n g Elevated expectations on controls related to q ualitative approaches and overlays Elevated expectations on model perf ormance assessment ( p o t en t i al addi t i o n al sensitivity testing) Enhanced standards for the use of b enchmark models i n c ap i t al p l an n i n g Increased engagement of the RWA production function in the projections of standardized RW A Specific requirement for senior management to review the c ap i t al p l an n i n g p r o c ess q uarterly Re-emphasis on internal audit s role in evaluating the firm s c ap i t al p l an n i n g p r o c ess an d su p p o r t i n g r i sk -m an ag em en t an d i n t er n al c o n t r o l p r ac t i c es More emphasis on use of scenarios for operational risk loss proj ections Elevated expectations on use of internal data S R includes differentiated expectations for Large and Noncomplex firms primarily in the following areas: Use of quantitative approaches Use of internal data Use of benchmark models Operational risk loss projections Trading exposures Validation of vendor models RWA projections 4 LISCC Firms and Large and Complex Firms are defined as US BHCs and intermediate holding companies (IHCs) of FBOs that have total consolidated assets greater than $250 billion, have consolidated total on-balance sheet foreign exposure greater than $10 billion and/or are subject to the Federal Reserve s LISCC. Large and Complex applies to slightly less than half of the current 33 CCAR firms. Large and Noncomplex Firms are defined as US BHCs and IHCs of FBOs that have total consolidated assets greater than $10 billion but less than $250 billion, have consolidated total on-balance sheet foreign exposure less than $10 billion and are not subject to the Federal Reserve s LISCC. The remaining CCAR firms are designated Large and Noncomplex All Rights Reserved.

3 3 O t h e r n o t e w o r t h y i t e m s i n t h e i n s t r u c t i o n s CCAR will be integrated into the FRB s ongoing supervisory activities conducted throughout the year, and ongoing reviews will be focused specifically on risk management, internal controls, audit and corporate governance. The qualitative assessment for CCAR 2016 will focus on areas highlighted in SR and SR 15-19, including governance, risk management, internal controls, capital policies, scenario design and projection methodologies. Related to bank holding company (BHC) baseline planned capital actions, BHCs may include lower distributions in the second quarter of the p l an n i n g c y c l e b u t c an n o t, w i t h o u t F R B ap p r o val, i n c l u de o r ex ec u t e a l ar g er am o u n t o f c ap i t al di st r i b u t i o n s t h an i n t h e p r i o r y ear s c ap i t al p l an. BHCs are expected to reflect conservative common dividend payout ratios in their capital plans. Payout ratios above 30% will receive higher scrutiny and will be reviewed against a BHC s ability to meet its baseline earnings projections. Unless effective December 31, 2015, new accounting standards should not be reflected in projections. BHC subsidiaries of foreign banking organizations (FBOs) that will be designated as the US intermediate holding company (IHC) must include i n t h ei r c ap i t al p l an an assessm en t o f h o w t h e t r an sf er s o f su b si di ar y asset s an d l i ab i l i t i es w o u l d af f ec t t h e B H C s c ap i t al adeq u ac y. T h e C C A R s c e n a r i o s h a v e s o m e k e y d i f f e r e n c e s i n f e a t u r e s a n d s e v e r i t y, i n c l u d i n g n e g a t i v e U S s h o r t - t e r m i n t e r e s t r a t e s T h e F R B p r o vi ded t h e sam e 28 i n di c at o r s o f ec o n o m i c an d m ar k et c o n di t i o n s t o desc r i b e t h e 2016 C C A R sc en ar i o s as i n T h e global market shock (GMS) risk factor shock templates were not released and are expected by March 1, 2016 as per Regulation YY. 5 S u p e r v i s o r y s e v e r e l y a d v e r s e ( s e v e r e l y a d v e r s e ) s c e n a r i o T h e S ever el y A dver se S c en ar i o assu m es n eg at i ve U S sh o r t -t er m i n t er est r at es an d a m o r e sever e do w n t u r n i n t h e U S ec o n o m y as c o m p ar ed t o l ast y ear. T h e sc en ar i o i n c l u des a g l o b al r ec essi o n, w i t h a severe recession in three of the four country blocks (US, EU, UK, J ap an ) an d a m i l d r ec essi o n i n devel o p i n g A si a, an d a h ei g h t en ed period of corporate financial stress. [See more detail on the severely adverse scenario in Tables 1-9 on pages 5 and 6] S u p e r v i s o r y a d v e r s e ( a d v e r s e ) s c e n a r i o The Adverse Scenario assumes mild deflation with consumer prices falling and lower paths of US Treasury yields relative to last year. It al so assu m es a m o der at e r ec essi o n i n t h e U S, b r o adl y c o n si st en t w i t h l ast y ear s adver se sc en ar i o, an d m o der at e r ec essi o n s i n t h e eu r o ar ea, t h e U n i t ed K i n g do m, an d J ap an, as w el l as b el o w -t r en d g r o w t h i n devel o p i n g A si a. S u p e r v i s o r y b a s e l i n e ( b a s e l i n e ) s c e n a r i o T h e B asel i n e S c en ar i o h as a m o der at e ec o n o m i c ex p an si o n i n t h e U S an d i n t er n at i o n al l y at g r o w t h r at es an d l evel s si m i l ar t o l ast y ear s b asel i n e sc en ar i o. 6 G M S a n d c o u n t e r p a r t y d e f a u l t s e v e r e l y a d v e r s e s c e n a r i o The 2016 GMS severely adverse scenario is qualitatively described in t h e o ver al l sc en ar i o r el ease, w i t h h i g h l i g h t s i n c l u di n g : A sudden sharp increase in general risk premiums and credit risk, significant market illiquidity and the distress of one or more large en t i t i es t h at r ap i dl y sel l a var i et y o f asset s i n t o a f r ag i l e m ar k et General decline in US Treasury rates, resulting in negative shortt er m r at es Peak-to-trough asset value changes that are generally comparable to , with declines in markets less affected by det er i o r at i n g l i q u i di t y g en er al l y c o m p ar ab l e t o t h e sec o n d h al f o f 2008 Breakdowns in historical basis spreads, with spread widening b et w een c ash an d t o -b e-an n o u n c ed ( T B A ) f o r w ar d m ar k et s an d c o r p o r at e b o n ds an d c r edi t def au l t sw ap s Larger widening of credit spreads for municipal, sovereign and advan c ed ec o n o m i es c o r p o r at e p r o du c t s an d g r eat er dec l i n es i n t h e val u e o f p r i vat e eq u i t y i n vest m en t s, r ec en t l y i ssu ed sec u r i t i z ed p r o du c t s an d n o n -ag en c y r esi den t i al m o r t g ag e-b ac k ed sec u r i t i es as c o m p ar ed t o 2015 G M S a n d c o u n t e r p a r t y d e f a u l t a d v e r s e s c e n a r i o The adverse scenario simulates an extended low growth en vi r o n m en t an d m u t ed vo l at i l i t y ac r o ss m o st asset c l asses an d t er m st r u c t u r es. K ey c h an g es f r o m t h e 2015 adver se sc en ar i o i n c l u de n ew el em en t s t h at ar e di st i n c t f r o m an d n o t m ec h an i c al l y l i n k ed t o t h e sever el y adver se sc en ar i o s d&r=PART&n=12y #se _154 6 Note: the GMS as-of date is January 4, 2016, and similar to prior year, banks may use an al t er n at e as-o f dat e t h at c o r r esp o n ds t o t h ei r w eek l y i n t er n al r i sk r ep o r t i n g b et w een January 4 8, C C AR 2016 EY Regula tory Alert

4 a n d n e g a t i v e i n t e r e s t r a t e s i n t r o d u c e s o m e n e w a n a l y t i c a l c o n s i d e r a t i o n s A k ey an al y t i c al c h al l en g e f o r C C A R 2016 w i l l c o m e f r o m t h e n eg at i ve 3-m o n t h T r easu r y r at e t h at em er g es i n t h e sec o n d q u ar t er o f t h e nine-quarter severely adverse scenario and will also be a feature for the GMS severely adverse scenario. Negative short-term interest rates ar e a p h en o m en o n w h i c h h as n o t y et o c c u r r ed i n t h e U S b u t ar e o c c u r r i n g at t h e m o m en t i n sever al m ar k et s ar o u n d t h e w o r l d ( e.g., i n t er b an k markets for CHF, DKK, EUR, JPY and SEK). Negative US short-term interest rates may require firms to challenge and enhance the output from certain projection and valuation models. S cenario expansion model adj ustments. S c en ar i o ex p an si o n m o del s u sed t o t r an sl at e t h e c o r e m ac r o ec o n o m i c var i ab l es o r m ar k et r i sk factors to the full suite of revaluation or projection model input parameters may have to be examined to assess if the use of floors or lower boundaries in such expansion models will need modification to accommodate the projection of negative interest rates. PPN R (pre-provision net revenue) proj ection adj ustments. Models or other approaches to project income using variables that are directly or c l o sel y r el at ed t o t h e 3-m o n t h T r easu r y r at e m ay n eed addi t i o n al r evi ew an d an al y si s, an d p o t en t i al o ver l ay s t o r esu l t s. A s n eg at i ve U S r at es w o u l d n o t h ave f eat u r ed i n m o del h i st o r i c al devel o p m en t al dat a set s b an k s m ay w an t t o l o o k c l o sel y at t h e c al i b r at i o n o f t h ei r m o del s, an d challenge results in the context of potential customer/counterparty behavior and product pricing in the negative rate scenario. Valuation model adj ustments. Certain valuation models for products such as interest rate caps/floors and swaptions may rely on traditional l o g -n o r m al m o del s, w h i c h do n o t al l o w f o r n eg at i ve i n t er est r at e p ar am et er s. D ep en di n g o n w h i c h ( i f an y ) r at e sh o c k s r esu l t i n n eg at i ve i n t er est r at es, so m e b an k s m ay st i l l n eed t o assess al l p r o du c t s t h at ar e i m p ac t ed b y n eg at i ve i n t er est r at e p ar am et er s an d t est t h ei r val u at i o n m o del s f r o m b o t h a m et h o do l o g y an d i m p l em en t at i o n p er sp ec t i ve t o p r o vi de t h at t h ese m o del s c an f u n c t i o n p r o p er l y u n der n eg at i ve r at e sc en ar i o s. Credit loss models. These models may be impacted to a lesser extent because the majority of credit models typically do not use interest rates as a material direct input, relying instead on House Price Index (HPI), unemployment, GDP and so on. W h a t i s n e x t? U p c om ing da tes: March 1, 2 016: g l o b al m ar k et sh o c k f ac t o r s du e ( w i l l l i k el y b e r el eased ear l i er ) A pril 5, 2 016: 2016 capital plan and FR Y-14A submissions due E arly J une: F R B t o p r o vi de B H C s w i t h an o p p o r t u n i t y f o r a o n e-t i m e r edu c t i o n o f p l an n ed c ap i t al di st r i b u t i o n s b ased o n i n i t i al p o st -st r ess results, which may include reduction in all types of capital distributions, not just common stock distributions J une 30, 2 016: c o m m u n i c at i o n deadl i n e f o r dec i si o n s b y t h e F R B BHCs to disclose company-run stress test results within 15 days of the release of final FRB results All Rights Reserved.

5 Comparison of select FRB variables (CCAR 2015 vs. 2016) severely adverse Table 1: Real GDP growth Table 2: Unemployment 5.0 Real GDP Growth (15 V 16) 15.0 Unemployment (15 V 16) sev. adv sev. adv sev. adv sev. adv. Table 3: CPI 6.0 CPI (15 V 16) Table 4: 3-Month Treasury yield Month Treasury Yield (15 V 16) sev. adv sev. adv sev. adv sev. adv. Table 5: BBB corporate yield 7.0 BBB Corporate Yield (15 V 16) Table 6: Fixed-rate 30-year mortgage 6.0 Fixed-rate 30-year mortgage (15 V 16) sev. adv sev. adv sev. adv sev. adv. Table 7: House Price Index 190 HPI (15 V 16) Table 8: VIX 100 VIX over Forecast Horizon (15 V 16) sev. adv sev. adv sev. adv sev. adv. 0 CCAR 2016 EY Regulatory Alert 5

6 T a b l e 9 : C o m p a r i s o n o f s e l e c t F R B v a r i a b l e s ( C C A R v s ) s e v e r e l y a d v e r s e s c e n a r i o Macroeconomic factor 3Q 14 jump-off 9Q 7 C C A R C C A R C C A R Δ from 3Q 14 t o 4Q 16 en di n g val u e 4Q 15 jump-off 9Q 7 Δ from 4Q 15 to 1Q 18 en di n g val u e vs. C C A R 2015 R el at i ve S ever i t y Indicator vs , 8 Real GDP growth (%) Unemployment rate (%) CPI inflation rate (%) month Treasury yield (%) year Treasury yield (%) BBB corporate yield (%) Fixed-rate 30-year mortgage (%) Prime Rate (%) Dow Jones Total Stock Market Index 20, , , , , , , ,789 House Price Index CRE Price Index Market Volatility Index T r o u g h i s an i n di c at o r o f sever i t y an d as a r esu l t val u es f o r u n em p l o y m en t, B B B corporate yield and VIX represent the peak value over the nine projection quarters. 8 Actual scenario severity is based on each BHC s specific exposure and the relative assessm en t i s a g en er al i n di c at o r o f ex p ec t ed sever i t y ac r o ss B H C s All Rights Reserved.

7 EY contacts Adam Girling Principal adam.girling@ey.com Marc Saidenberg Principal marc.saidenberg@ey.com Michael Sheptin Principal michael.sheptin@ey.com Darrin Williams Principal darrin.williams@ey.com Tom Jackson Executive Director tom.jackson@ey.com Preston Thompson Executive Director preston.thompson@ey.com

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