BPInsights: June 27, 2020

BPInsights: June 27, 2020

Top of the Agenda

Federal Reserve Releases Results of 2020 Stress Tests and Additional Sensitivity Analyses

On Thursday the Federal Reserve released the results of the 2020 stress tests and additional sensitivity analyses, which uses three hypothetical recessions that could result from the coronavirus event to assess the resiliency of large banks. In response to the results of the stress tests and sensitivity analyses, the Fed announced that it is:

  • Suspending share repurchases which, in recent years, have represented approximately 70 percent of shareholder payouts from large banks;
  • Capping the growth of dividends to the amount paid in the second quarter and imposing a limit that does not exceed recent income (to an amount equal to the average of the firm’s net income for the four preceding calendar quarters), unless otherwise specified by the Fed;
  • For the first time in 10 years since stress testing began, requiring banks to re-assess their capital needs and resubmit their capital plans later this year to reflect current stresses (within 45 days after the Fed provides updated scenarios); and
  • Conducting additional stress analyses later this year as data from banks becomes available and economic conditions evolve. The Fed will conduct additional analyses each quarter to determine if adjustments to this response are appropriate.

The restrictions will apply for the third quarter of 2020 and may be extended by the Fed quarter-by-quarter, as the economic situation continues to evolve.

The Fed also released the results of its full stress test designed before the coronavirus. The results from that test are comparable to one of the scenarios in the sensitivity analyses, in aggregate, and show that all large banks remain strongly capitalized. The Fed will use the results of this test to set the new stress capital buffer requirement for these firms, which will take effect, as planned, in the fourth quarter. Banks are permitted to disclose their preliminary stress capital buffer after market close on Monday, June 29. Learn More >>

 

Stories Driving the Week

Large Banks Are Serving the Credit Needs of Small Businesses In Low- And Moderate-Income and Minority Communities

The Bank Policy Institute released data from a new survey of the nine largest retail banks. The analysis looks at PPP lending by large banks within low- and moderate-income communities and predominately minority communities. BPI’s findings indicate that America’s large banks were successful in providing PPP loans to small businesses in these communities.

As noted in prior studies, minority-owned small businesses are disproportionately more exposed to negative financial shocks. While PPP does not address the long-standing structural vulnerabilities of the small business sector generally or of minority businesses in particular, it may serve as a lifeline during this health and economic crisis.

The BPI survey found:

  • The largest banks have disbursed close to 1.1 million loans to small businesses.
  • The average loan size was $103 thousand (smaller than the program average of $112 thousand as of June 12).
  • About 39 percent of PPP loans went to businesses located in census tracts with 50 percent or greater minority population or that are classified as low- or moderate-income.
  • Nearly one in three PPP loans (31 percent) went to businesses located in areas with 50 percent or greater minority population.
  • About three in four loans to businesses located in minority areas and a similar share of loans to businesses located in low- or moderate-income areas went to companies with fewer than 10 employees, similar to the overall distribution of PPP loans by size of business for this group of banks.

The results are based on PPP loans originated through June 2 and include data on the neighborhood distribution of the small businesses they served. It does not specifically examine lending to minority-owned businesses as these data were not available. The participating banks were the largest nine banks as measured by their amount of deposits outstanding (Bank of America, Capital One, Citibank, JPMorgan Chase, PNC, TD Bank, Truist, US Bank, and Wells Fargo). Learn More >>

 

BankThink: Forbearance During Coronavirus a Double-Edged Sword

The CARES Act allows a financial institution to temporarily engage in loan forbearance without having to designate the loan as a trouble debt restructuring (TDR) for accounting purposes. In a new BankThink op-ed submitted by BPI President & CEO Greg Baer titled “Forbearance During Coronavirus a Double-Edged Sword,” Baer argues that this short-term relief was enacted by Congress with clear, understandable and commendable motives: “to prevent the bank examiners and accountants from criticizing banks for taking actions the government was simultaneously encouraging the banks to take.” The policy appeared sound when the pandemic could have been quite temporary; however, the current application of the policy has debatable merits and should be allowed to expire, as planned, at year-end.

In his post, Baer offers a history of forbearance in the context of bank examination and details the risk that these relief practices could pose, including an example from the 1980s savings and loan crisis where “insolvent thrifts were able to continue paying deposits in order to grow their way out of their problems.” He also raises concerns related to examination secrecy and the complexity this adds for policymakers, investors and the broader public to understand the health of an institution through its balance sheet. Learn More >>

 

 

Agencies Finalize Amendments to the Volcker Rule’s Prohibition on Investments in ‘Covered Funds’ and to Initial Margin Rules for Inter-Affiliate Swaps

On Thursday, the prudential regulatory agencies finalized a long-awaited amendment to the Volcker Rule provisions that generally prohibit bank investments in, or sponsoring of, private equity and hedge funds. The final rule, which is broadly similar to the proposal issued earlier this year, offers clarifications and allows banks to engage in additional funds-related activities that do not raise the types of concerns that the Volcker Rule was intended to address, such as financing venture capital investments and providing payment, settlement and clearing services to custodial clients.

Thursday also saw the interagency finalization of a rule exempting bank swap dealers from requirements to collect initial margin (IM) on non-cleared swaps with affiliates, subject to an aggregate threshold calibrated at 15% of tier 1 capital. In connection with the finalization of the rule by a 4-1 vote, the Fed issued a statement providing guidance on the interplay between the new rule and the Federal Reserve’s inter-affiliate transaction restrictions (set out in the Fed’s Regulation W). According to the Fed, it should in many cases be sufficient for a bank to collect only variation margin from its affiliates on bank-affiliate derivatives transactions for purposes of Regulation W, though collection of IM may be warranted in certain cases. The rule will go into effect 60 days after its publication in the Federal Register.

 

FDIC Publishes Final Rule Codifying that Loan Interest Rates are ‘Valid When Made’

The FDIC published its final rule on Federal Interest Rate Authority on June 25. The final rule largely adopts the provisions outlined in the proposal, with some technical changes to conform the rule to that of the OCC and is intended to address the Madden v. Midland Funding decision by the Second Circuit.

In its discussion regarding the final rule, the FDIC noted the following:

  • To fill the statutory gap, in cases where the usury laws of the state where the bank is located change or where a loan made in reliance on the federal commercial paper rate changes prior to payment of the loan, “the FDIC concludes that the validity and enforceability under section 27 of the interest-rate term of a loan must be determined when the loan is made, not when a particular interest payment is ‘taken’ or ‘received.’”
  • The FDIC further notes the potential impacts to the Deposit Insurance Fund (DIF), stating that Madden could “potentially significantly impact the FDIC’s statutory obligation to resolve failed banks using the least costly resolution option and minimizing losses to the DIF.”
  • Finally, in response to comments, such as those submitted in a comment letter by BPI and the Structured Finance Association, the final rule more closely conforms to the OCC’s final rule, to ensure parity among state and national banks and to limit any potential varying judicial interpretations due to the differences in language.

 

European Commission to Launch Pilot Scheme to Regulate Cryptocurrency and Digital Finance

The European Commission Executive Vice President Valdis Dombrovskis announced new plans to regulate cryptocurrencies and digital finance in a speech delivered on June 23 at Digital Finance Outreach 2020. In his remarks, Dombrovskis recognized that “[t]echnology has changed our societies in a way that we could not have imagined even a few decades ago,” and emphasized the “need to continue regulating and supervising risks appropriately…to preserve trust in finance.”

As part of the proposed actions, Dombrovskis announced a new pilot scheme that would give “regulatory flexibility for experimentation” to digital currencies while maintaining close supervisory oversight. He also remarked that the Commission would pursue “a bespoke regime and a passport for markets” for crypto-assets currently outside of regulatory purview.

In addition to new regulations on cryptocurrencies, Dombrovskis pledged new legislation to require financial institutions to comply with operational resilience standards related to cybersecurity and cyber resilience, including a new financial oversight mechanism to regulate relationships with third-party providers, such as cloud services. Learn More >>

 

In Case You Missed It

CFPB Releases Two NPRs to Replace Qualified Mortgage DTI Requirements with Priced-Based Approach

The Consumer Financial Protection Bureau (CFPB) announced two Notice of Proposed Rulemakings (NPRs) on June 22 that would modify the ability-to-repay (ATR) and qualified mortgage (QM) provisions of the Government-Sponsored Enterprises Patch (GSE Patch), which establish standards for eligible residential mortgage loans that may be acquired by Fannie Mae and Freddie Mac. The current QM standards maintain that eligible loans may only be made to borrowers with debt-to-income (DTI) ratios of 43 percent or less. The changes in the first NPR would replace DTI requirements with a price-based approach that would compare the loan’s annual percentage rate to the average prime offer rate, in addition to encouraging a more holistic view of the borrower’s income, debt, and DTI ratio.

The second NPR would extend the expiration date of the GSE Patch to correspond with the passage of the proposed changes, as opposed to the currently scheduled date of expiration in January 2021, or when Fannie Mae and Freddie Mac exit conservatorship, whichever comes first.


German Fintech Company Collapses and CEO Jailed Following $2 Billion Fraud Scandal

Germany-based digital payment and fintech giant Wirecard AG is embroiled in a $2 billion scandal that resulted in the company filing for insolvency proceedings on Monday and the arrest of the company’s now-former CEO, Markus Braun, according to a Wall Street Journal report. The company — one of the largest in Germany with over 6,000 employees — reportedly falsified $2.1 billion in assets on the company’s balance sheet, which was uncovered following a failed audit by Ernst & Young GmbH. The company’s stock has plummeted 98% since the news was revealed on June 18, and Germany’s head financial regulator Felix Huferd has described the circumstances as a “total disaster.”


Citadel Securities Profits from Growth in Retail Investing Influenced by Zero-Fee Trading

Business has been good for Citadel Securities thanks in part to a surge in trading volume influenced by an increase in retail investment as zero-fee trading becomes the new normal, according to a recent report by the Financial Times. The report indicates that about 40% of shares traded by individual investors are acquired by Citadel Securities, which then profits by selling the security and pocketing the spread between the buy and sell price. The company is now the largest retail market maker by volume and has reportedly experienced a big upturn in first-quarter earnings due to higher trading volumes — possibly influenced by stay-at-home orders — and larger spreads.

 

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