Summary of the Results
The unprecedented nature of the SCAP, together with the extraordinary economic and financial conditions that precipitated it, has led supervisors to take the unusual step of publically reporting the findings of this supervisory exercise. The decision to depart from the standard practice of keeping examination information confidential stemmed from the belief that greater clarity around the SCAP process and findings will make the exercise more effective at reducing uncertainty and restoring confidence in our financial institutions. To this end, a detailed white paper on the SCAP data and methodology was released on April 24th. 1 This companion paper reports‐‐for each of the 19 institutions individually and in the aggregate—the SCAP estimates of losses and loss rates across select categories of loans and securities; the resources available to absorb those losses; and the resulting necessary capital buffers.
There are a number of points to keep in mind when interpreting the SCAP findings:
The estimates reported here are those of the teams of supervisors, economists, and analysts that conducted this exercise, and they may or may not line up with what the firms themselves or external analysts and researchers might have produced, even using a similar set of basic assumptions. These estimates benefit from the input of extremely detailed information collected from each of the 19 BHCs, the extensive review and analysis of that information by the SCAP teams, and the judgment of supervisors and other experts. The breadth and depth of the resources brought to bear in formulating these estimates are unparalleled.
The estimates are not forecasts or expected outcomes; they are the products of a two‐year a head ‘what‐if’ exercise conducted under two alternative macro scenarios. Roughly speaking, the first scenario‐‐referred to as the “baseline”‐‐was an assumed path for the economy that followed the then‐current consensus forecast, and the second‐‐the “more adverse” scenario‐‐was a deeper and more protracted downturn than the consensus. Not only is it virtually certain that the economy will not evolve in lockstep with either of these scenarios, but there were also other factors that had to be assumed constant for the purpose of conducting this exercise, and any of those factors could change materially from what was implicitly or explicitly assumed in this process.
The SCAP was a deliberately stringent test. It was designed to account for the highly uncertain financial and economic conditions by identifying the extent to which a BHC is vulnerable today to a weaker than expected economy in the future. By ensuring that these large BHCs have a capital buffer now that is robust to a range of economic outcomes, this exercise counters the risk that uncertainty itself exerts contractionary pressures on the banking system and the economy. In the event the economy weakens more than expected, the firms will have adequate capital; in the event the economy follows the expected path, or an even stronger path, the firms will still be viewed as stronger today for having higher levels of capital in an uncertain world.
The SCAP focused not only on the amount of capital but also on the composition of capital held by each of the 19 BHCs. That is, SCAP assessed the level of the Tier 1 risk‐based capital ratio and the proportion of Tier 1 capital that is common equity.2 The SCAP’s emphasis on what is termed “Tier 1 Common capital” reflects the fact that common equity is the first element of the capital structure to absorb losses, offering protection to more senior parts of the capital structure and lowering the risk of insolvency. All else equal, more Tier 1 Common capital gives a BHC greater permanent loss absorption capacity and a greater ability to conserve resources under stress by changing the amount and timing of dividends and other distributions. To determine the size of the SCAP buffer for each firm, supervisors used their estimates of each firm’s losses and resources for the more adverse scenario to answer the following two questions:
o If the economy follows the “more adverse” scenario, how much additional Tier 1 capital would an institution need today to be able to have a Tier 1 risk‐based ratio in excess of 6 percent at year‐end 2010?
o If the economy follows the “more adverse” scenario, how much additional Tier 1 Common capital would an institution need today to have a Tier 1 Common capital risk based ratio in excess of 4 percent at year‐end 2010?
The SCAP buffer does not represent a new capital standard and is not expected to be maintained on an ongoing basis. Instead, that capital is available to help BHCs absorb larger‐than‐expected future losses, should they occur, and to support the BHC’s ability to serve their customers, including lending to creditworthy borrowers during the economic downturn.
The results of the SCAP suggest that if the economy were to track the more adverse scenario, losses at the 19 firms during 2009 and 2010 could be $600 billion. The bulk of the estimated losses –approximately $455 billion – come from losses on the BHCs’ accrual loan portfolios, particularly from residential mortgages and other consumer‐related loans. The estimated two‐year cumulative losses on total loans under the more adverse scenario is 9.1 percent at the 19 participating BHCs; for comparison, this two‐year rate is higher than during the historical peak loss years of the 1930s.
Estimated possible losses from trading‐related exposures and securities held in investment portfolios totaled $135 billion. In combination with the losses already recognized by these firms since mid‐2007, largely from charge offs and write‐downs on the values of securities, the SCAP results suggest financial crisis‐related losses at these firms, if the economy were to follow the more adverse scenario, could total nearly $950 billion by the end of 2010. The potential losses facing these 19 firms have to be weighed against the potential resources available to them to absorb those losses. At year‐end 2008, capital ratios at all 19 BHCs exceeded minimum regulatory capital standards, in many cases by substantial margins, and most met supervisory expectations on the composition of capital. Tier 1 capital at these firms totaled about $835 billion in Q4 2008. The practical implication of this capital is that many of the BHCs already had substantial capital buffers in place to absorb their share of the estimated $600 billion of losses. In addition, banks will realize revenues from ongoing businesses to absorb losses, though at a lower level in the weak economic conditions of the stress scenario than in the baseline. However, some of those revenues will need to go into building loan loss reserves against credit problems in 2011.
After taking account of losses, revenues and reserve build requirements, in the aggregate, these firms need to add $185 billion to capital buffers to reach the target SCAP capital buffer at the end of 2010 under the more adverse scenario. There are two important things to note about this estimate.
First, the $185 billion accrues to 10 of the 19 firms, meaning nine of the 19 firms already have capital buffers sufficient to get through the adverse scenario in excess of 6 percent Tier 1 capital and 4 percent Tier 1 Common capital.
Second, the vast majority of this $185 billion comes from a shortfall in Tier 1 Common capital in the more adverse scenario, with virtually no shortfall in overall Tier 1 capital. This result means that while nearly all the firms have sufficient Tier 1 capital to absorb the unusually high losses of the more adverse scenario and still end 2010 with a Tier 1 risk‐based ratio in excess of 6 percent, 10 of these firms had capital structures that are too strongly tilted toward capital other than common equity. T
hus, each of the 10 firms needing to augment their capital because of this exercise must do so by increasing their Tier 1 Common capital. The $185 billion estimated additional capital buffers correspond to the estimate that would have applied at the end of 2008. But a number of these firms have either completed or contracted for asset sales or restructured existing capital instruments since the end of 2008 in ways that increased their Tier 1 Common capital. These actions substantially reduced the final SCAP buffer. In addition, the preprovision net revenues of many of the firms exceeded what was assumed in the more adverse scenario by almost $20B, allowing them to build their capital bases. The effects of these transactions and revenues rendered the additional capital needed to establish the SCAP buffer equal to $75 billion.
