Tag: Fitch

Brexit Uncertainty Dampens UK Housing & Mortgage Outlook

Fitch Ratings has revised its UK housing and mortgage outlook from Stable/Positive to Stable in light of the UK’s referendum on leaving the EU, to reflect increased uncertainty around the UK housing market and economic fundamentals created by the vote.

Housing-Key

A Stable sector outlook will continue to support our Stable RMBS ratings Outlook.

UK house price growth and mortgage performance have exceeded our expectations in 1H16. However, the vote to leave the EU has potentially put some of the supportive macroeconomic factors we identified in January, such as strong growth, in jeopardy (Fitch reduced its real GDP growth forecasts for 2016-2018 following the referendum), and house price appreciation and mortgage lending growth are likely to slow. Early indicators suggest that increased economic uncertainty is filtering through to the housing market.

The Bank of England’s policy response will support mortgage performance and keep rates on new lending low over the next one to two years. Arrears are likely to remain low for the short term and certainly through 2H16. Affordability stress-testing rules introduced in 2014 should help ensure that borrowers are resilient to future rate raises.

The buy-to-let (BTL) market has already been affected by higher stamp duty, which saw a very high number of completed purchases in March, immediately before the raise took effect, helping drive a sharp increase in gross mortgage lending overall. But BTL demand could be hit if the prospect of Brexit results in a fall in net migration and/or a notable economic slowdown in London and the South East, to which BTL RMBS pools typically have higher exposure. Upcoming changes to tax relief for landlords and moves by a number of lenders to increase their Interest Coverage Ratio requirements may also hamper BTL growth.

UK Bank Margin Pressure Mitigated by BoE Funding Scheme – Fitch

The Bank of England’s GBP100bn Term Funding Scheme (TFS) should partially offset the lower margins at UK banks stemming from the central bank’s recent rate cut, says Fitch Ratings. The scheme will provide a new source of cheap funding, but the extent to which lenders can avoid a margin squeeze will be linked to the amount of new lending extended by each bank and the deposit rates they offer.

Bank-Lens

We expect the majority of lenders to make use of the scheme because its 25bp charge is substantially lower than funding costs in wholesale markets or savings deposit rates. If lenders expand net lending between June 2016 and end-2017, they will be able to access more TFS funds; if lending shrinks, they will not be able to borrow more and TFS funding costs will rise. Banks and building societies can initially use the TFS to fund up to 5% of their existing loan stock. Lenders will be able to pledge assets and borrow four-year money from the BoE.

The TFS will also indirectly reduce funding costs because it will enable banks to force down deposit rates. With the generous-sized scheme, we think competition for deposits will fall and lenders will readily pass on the BoE’s 25bp base-rate cut to savers.

Under the BoE’s existing Funding for Lending Scheme, the benefit of cheaper funding was dependent on banks increasing their lending to certain sectors. Funding costs fell dramatically and we expect a similar result from the TFS.

A GBP100bn inflow of funding should prove to be ample for anticipated new lending requirements over the short- to medium-term. We also think the TFS will provide the sector with enough cheap funding to offset some pressures arising in the unexpected case that markets become dislocated as Brexit negotiations begin.

The extent of the benefit on net interest margins will be linked to credit demand from borrowers. The direct economic benefit will be reduced if the funds cannot be on-lent. But we still expect some benefit to filter through because savings deposit rates should fall overall and banks should see funding costs reduce as some wholesale funding is replaced with TFS funds.

Our UK GDP forecasts are for growth to slow to 1.7% in 2016 and 0.9% in 2017 – still high enough to support credit demand. But the Brexit negotiation phase is likely to mean that companies might delay decisions on non-urgent investments reflecting greater caution, and consumer spending and housing transactions could slow. We expect any reduction in loan growth in the foreseeable future to be driven by lower demand rather than funding supply given the number of measures introduced by the BoE. The TFS is one of a set of measures to support the economy and preserve financial stability.

The BoE took steps to ensure the banking system has ample liquidity immediately after the Brexit referendum. Regulatory capital requirements have also been reduced slightly through a reduction of the countercyclical buffer and an easing in the leverage ratio calculation.

Compared to many European peers operating in a negative interest rate environment, UK lenders are generally better placed to protect net interest margins. There is still room to lower deposit rates in the UK, whereas many peers already pay nothing for their deposits and would only be able to cut funding costs by charging retail depositors. To date, most lenders have been reluctant to do this.

We do not expect the BoE’s measures to impact the ratings of UK banks and building societies.

BoE Stimulus Cushions But Will Not Offset Brexit Shock

The Bank of England’s (BoE) decision to cut rates, expand its bond buying and set up a new funding scheme for lenders is a proactive policy response to the EU referendum. But it is only likely to cushion, rather than fully offset, the shock to UK growth that June’s Brexit vote will cause, Fitch Ratings says.

City-at-Night

The balance sheet expansion goes beyond our expectations and includes innovative measures to mitigate potential unintended consequences of policy easing.

The BoE cut the base rate to 0.25% from 0.5% – the first change in over seven years. It will expand UK government bond purchases by GBP60bn, and will purchase up to GBP10bn of UK corporate bonds. The BoE also announced a new Term Funding Scheme (TFS) aimed at ensuring the base-rate cut is passed through to borrowers.

We incorporated lower rates into our post-EU referendum update of our UK macro-economic forecasts, cutting our end-2016 policy rate forecast to 0.25% from 0.75%.

The BoE had already reduced the counter cyclical capital buffer for UK banks. Combined with a rate cut and increased quantitative easing, such measures forestall the risk of a significant tightening in credit conditions that would compound the impact of the Brexit vote.

But they will not outweigh the impact on investment as firms reduce capital spending due to sharply heightened uncertainty surrounding the UK’s future international trading arrangements outside the EU and related political and regulatory uncertainty. We expect investment to be 15% lower by 2018 relative to our May forecast.

The referendum will take a significant toll on the economy despite sterling’s fall potentially supporting exports. This is reflected in our latest growth forecasts of 1.7% in 2016 (down from 1.9% in May) and 0.9% in 2017 and 2018 (from 2.0%). The BoE’s assessment suggests sizeable concerns about the near-term outlook as a number of survey-based indicators have deteriorated dramatically. They are now forecasting 0.8% GDP growth in 2017, down from 2.3% in the May Inflation Report.

The BoE’s purchases of corporate bonds may boost investor appetite for higher-yielding instruments, but UK corporates have little need to raise significant new debt. Slightly lower funding costs will be less of a factor for corporate credit profiles than weak growth and sterling depreciation.

The BoE is cognisant of the potential consequences of very low interest rates on the financial sector. The TFS will enable eligible institutions to borrow central bank reserves at close to the Bank Rate. Funding costs will be lowest for banks that maintain or expand net lending.

This reduces the risk that the rate cut further squeezes margins at UK banks as they face additional pressure on revenues from a contraction in investment and slowdown in consumer spending. Nevertheless, while restating his opposition to negative interest rates, BoE Governor Carney emphasised that there was scope to increase all of today’s measures.

Building societies and banks whose business models rely heavily on net interest income and where liquidity buffers are held largely as cash at the BoE are most exposed to lower-for-longer rates. Their net interest margins are generally highly correlated to base rates, and given their low-risk, low-yield model, lower spreads could affect profitability.

The effect on insurers will depend on whether longer-dated bond yields continue falling. UK non-life insurers may feel the most direct impact because they tend to invest in shorter-duration bonds, and their asset portfolios are reinvested relatively quickly into prevailing yields. This would lower investment income, putting pressure on earnings and potentially driving higher premiums, but insurers would balance this against potential loss of market share.

UK life insurers’ balance sheets are less exposed to interest rates or bond yields, because the duration of their assets and liabilities are closely matched. Lower rates and yields could further reduce demand for annuities, but could modestly help demand for unit-linked or with-profits products given the low rates on bank savings.

Global Macro Risks Deteriorate Post-Brexit – Fitch

Fitch Ratings says its global growth forecast revisions since May have been modest but this belies a significant deterioration in the balance of global macro risks post-Brexit. This will mean central banks remain cautious and monetary policy normalisation is even further away, says Fitch in its latest bi-monthly Global Economic Outlook report.

Keys

“The political debate in the UK over Brexit highlighted concerns with the impact of globalisation and immigration which are present not just in Europe, but in other major economies around the world,” says Brian Coulton, Chief Economist at Fitch. “The risk of political events disrupting market confidence has increased. A rise in trade protectionism in the context of faltering growth would be damaging for the global economy. Threats to European integration could impinge on eurozone growth prospects over the medium term.”

Brexit is likely to amplify the divergence in global monetary policy that sparked the US dollar’s rally in mid-2014, with central banks now focussed on preventing a widespread tightening in credit conditions.

“Fitch expects the Fed to raise rates only once in 2016 and twice in 2017 compared with our previous forecast in May for two rates hikes in 2016 and three in 2017. In the eurozone, the ECB is increasingly likely to extend its asset purchase programme beyond March 2017 but may need to revisit the programme’s eligibility criteria in order to do so. Both the Bank of England and Bank of Japan will likely cut rates soon,” added Coulton.

While Brexit sent shockwaves through financial markets it is unlikely to spark a global recession as direct trade linkages from the UK to the rest of the world are small. Overall, world growth based on the ‘Fitch 20’ group of countries we use as a proxy for global growth is 0.1% weaker than forecast in May in both 2017 and 2018. With advanced economy growth now expected to remain steady at just over 1.5% over the next two years, world growth is no longer expected to return to 3% by 2018.

UK growth will be sharply affected by elevated Brexit uncertainty on investment and hiring, although our latest forecasts do not foresee an outright recession. UK GDP growth is expected to fall to 0.9% in 2017, a downward revision of 1.1% compared with the previous forecast. Eurozone GDP growth in 2017 has been reduced to 1.4% from 1.6%, with a similar adjustment made to 2018.

Economic developments outside of Europe point to a steady, rather than deteriorating, growth picture. US growth forecasts for 2017 and 2018 have been shaved by 0.1%, reflecting weaker eurozone growth and a slightly stronger dollar. Japanese growth has been revised up in 2017 as the previously planned consumption tax hike has been delayed, but the recent strengthening of the yen has capped this upward revision at just 0.1%.

In stark contrast to recent forecast changes, the outlook for emerging market growth is looking slightly better. Growth in China has been revised up to 6.5% in 2016 following better-than-expected data, while both Russia and Brazil are now expected to see shallower recessions in 2016. The stabilisation of global commodity prices is easing pressure on commodity producers.

New Credit-Loss Rules Manageable for US Banks – Fitch

The FASB’s new standard on accounting for credit losses on financial instruments will affect US banks’ reserving practices, says Fitch Ratings. However, it will be manageable as banks have adequate time to prepare for implementation.

P&PThe new standard will require institutions to estimate credit losses for loans and debt instruments, financial guarantees and noncancellable loan commitments and disclose credit quality indicators by vintage year. Forward-looking reserves and enhanced disclosures will be helpful to analysts, although there may be some unintended consequences.

Fitch expects the transition to current expected credit loss (CECL) model will, in aggregate, result in higher reserves for credit losses than under the current “incurred loss” model. The transitional adjustment will be applied to the beginning balance of retained earnings at adoption in 2020 (or 2019 for early adopters), bypassing earnings.

If CECL were implemented today, we estimate loan loss reserves would increase by $50 billion to $100 billion, which would translate into a 25bps-50bps hit to tangible common equity ratios across the US banking system in aggregate. Fitch’s analysis used simplifying assumptions and focused on loan portfolios and loan commitments, and excluded securities and financial guarantees. We used regulatory data, historical average loss rates by asset type and Fitch’s assumptions of expected loan lives and credit conversion factors. This is not meant to be construed as a technical application of the standard.

Aggregate data masks individual outliers and some banks will be better positioned than others. Our estimates do not consider potential future changes from evolving regulation, macroeconomic conditions, technological disruptions and lenders’ behavioral motivations. The day-one impact on individual institutions will vary based on reserving practices, loan type, economic assumptions, credit quality and tenor. Much will depend on the economy and expectations at implementation.

Changes to systems and processes to estimate credit losses may be required. The standard does not specify a method for calculating expected credit losses, and the level of data robustness that auditors will deem sufficient is unclear. Auditors may have concerns over auditing economic assumptions and management judgment used in CECL estimates. We believe the transition will be operationally simpler for advanced approach banks with robust data warehouses to leverage.

Expected loss estimates will be more sensitive to management’s judgment under CECL models as it generally covers a longer time horizon and sudden changes in economic conditions will create earnings volatility. The new rule could incentivize banks to originate loans earlier in a reporting period, as full provisions are taken upon origination while the interest is recognized in earnings over the life of the loan. Banks may be less inclined to offer noncancellable loan commitments or raise costs of commitments as reserves must be recorded up front. Unused credit card lines and home equity lines of credit, which Fitch estimates to be $3.8 trillion at year-end 2015, are excluded as these are deemed unconditionally cancellable.

The change to a CECL model will require banks to estimate credit losses over the life of certain financial assets using economic forecasts and historical data. Allowances must be recorded in the same period instruments are originated or purchased. Today, banks estimate credit losses over a shorter horizon and only when losses are deemed “probable”. This represents a timing difference of when reserves are established; however, actual credit losses realized will remain the same.

The International Accounting Standards Board released a similar standard, IFRS 9, although there are important differences between the two standards which will inhibit comparability. The IFRS 9 model is operationally more complex but provisions will be lower (all else equal) than under CECL.

Sovereign Outlooks Highlight EM Challenges – Fitch

The negative trend in sovereign rating Outlooks in the year to date emphasizes the challenges faced by emerging market (EM) issuers dependent on oil and gas exports, Fitch Ratings says in a new report.

Negative outlooks in Russia and Brazil result in ratings pressure on financial institutions and select sovereign-owned entities. Financial institutions and corporations have weaker rating mixes than five years ago, partly reflecting enduring challenges from the global financial crisis.

The negative trend in rating Outlooks for sovereigns during 1H16 was the most pronounced since 2011 and encompassed both developed market (DM) and EM issuers, indicating that sovereign ratings are on track for a record number of downgrades this year. At 30 June, there were 22 sovereigns on Negative Outlook and only six on Positive Outlook. The former include major economies such as the UK, Japan, Brazil and Russia as well as Saudi Arabia.

Current sovereign rating pressures focus on emerging markets, many of which face continued fiscal and external sector adjustments to lower commodity prices, even though prices recovered somewhat recently. In advanced economies, persistently high government debt is the most common rating constraint as fiscal consolidation has slowed. The UK’s vote to exit the EU adds a primary risk in Europe.

Negative rating actions on sovereigns can have knock-on effects in other sectors, particularly financial institutions and corporates. Some sovereign downgrades have placed downward pressure on bank ratings, especially in countries where banks are rated on the assumption of sovereign support. Negative Outlooks for banks in Brazil, Russia and the Gulf Cooperation Countries reflect negative sovereign Outlooks and/or weaker operating environments.

Outlooks for banks in the EU, where sovereign support now rarely drives ratings, are increasingly diverging. They are turning negative for Italy as recapitalization pressures increase from high non-performing loans. Belgium, France, Ireland and Spain bank Outlooks are turning positive as banks work through legacy issues and improve capitalisation. Low DM interest rates have kept impairment charges low but pressure profitability.

The rating profile of Fitch’s portfolios is weaker today than in 3Q11 – the last time sovereign rating Outlooks took a sharp negative turn. Today, only 35% of sovereigns are rated in the ‘A’ or above category, compared with 38% in 3Q11. The trend has been similar for financial institutions and corporates: to 42% from 46%, and to 20% from 22% respectively over the same period. Only the insurance sector has bucked the trend, with 74% of ratings currently at ‘A’ or higher, up from 60% five years ago.

Australia Policy Uncertainty Rises After Election – Fitch

The projected narrow victory for Australia’s Coalition government in the recent Federal election will make policy implementation more of a challenge from the previous parliament, and raises uncertainty over the medium-term legislative agenda, says Fitch Ratings. The fiscal outlook and the outcome for major Coalition policy proposals could be altered with the government reduced to a slim majority in the House of Representatives – and Senate results still to be finalised.

The governing Coalition is projected to lose 14 seats in the election held on 2 July, but will be able to form a government with 76 of 150 seats in the House. In the Senate, preliminary results indicate that the Coalition may have lost seats, which may raise the risks to government policy implementation – including for fiscal consolidation. Prior to the election, saving measures from previous budgets had been stalled when the government was unable to gather sufficient support from cross-benchers or the Opposition to implement legislation.

A credible long-term fiscal consolidation strategy remains a key sovereign rating consideration for Australia. Both the Coalition and Labour have expressed support for sound fiscal management, but have disagreed over the policy mix to achieve this objective. The inability to find political agreement has contributed to a slower pace of fiscal repair than projected in previous budgets. It remains to be seen whether the fiscal outlook will be altered by the new balance of power in parliament. For example, proposed changes by the Coalition to superannuation and corporate tax could be altered or blocked, while new measures may be initiated as part of negotiation processes.

The lack of a strong electoral mandate could also exacerbate internal politics within the major parties and act as another source of political uncertainty. Australia has had six prime ministers in the past five years, with internal challenges in both major federal parties contributing to the frequent leadership changes.

It is notable that the potential domestic political constraints on policymaking come at a time when the economy faces heightened risks. These include potential exogenous shocks from a sharp Chinese slowdown or economic risks from Europe or the US. A shock to the domestic housing market, while not our core scenario, is another potential tail risk. Political constraints could impair the Federal Government from responding effectively and in a timely manner in the event of one of these risk scenarios, which could lead to a sharper downturn than necessary.

Australia is also still undergoing a process of economic rebalancing away from commodities and faces structural challenges from an ageing population. Productivity enhancing reforms to boost growth will help to narrow the structural deficit, while failure to enact reforms could worsen the long-term fiscal trajectory.

Australia’s credit profile remains consistent with its ‘AAA’ rating, with relatively low public debt and high growth compared with its peers. The sovereign retains some fiscal headroom, with growth expected to be 2.6% and 2.9% in 2016 and 2017, respectively. Its ratings strengths are balanced by a high level of external indebtedness and dependence on commodities and Chinese demand, however.

Global Sovereign Downgrades Set for a Record Year – Fitch

Sovereign credit ratings are on track for a record number of downgrades in 2016, driven by the impact of lower commodity prices in emerging market economies, Fitch Ratings says in its latest bi-annual Sovereign Review and Outlook. There were 15 downgrades in 1H16 compared with the previous annual high of 20 in 2011, and 22 ratings are on Negative Outlook, suggesting this year’s final total is likely to exceed that of 2011.

Lower commodity prices continue to be the single most important factor responsible for downward sovereign ratings momentum. Seven of the 10 most commodity-dependent sovereigns rated by Fitch have been downgraded in 2016 or are on Negative Outlook. All are in emerging markets.

The partial recovery in commodity prices in 1H16 has led to improved market sentiment towards emerging markets, but not necessarily to improvements in sovereign credit fundamentals. Public and external finances in a number of commodity-exporting countries are not yet aligned with the new structurally-lower price environment.

The Middle East and Africa region accounts for more than half of the negative rating actions in 1H16 and 10 of the 22 Negative Outlooks assigned currently. Unlike 2011, when the previous record-number of sovereign downgrades was concentrated in investment-grade sovereigns, this year’s ratings deterioration is led by speculative-grade credits. As of end-June, the ratings of more than one in three sovereigns in the ‘B’ and ‘BB’ categories had a Negative Outlook.

From a regional perspective, the significance of the UK’s pending exit from the EU is difficult to overstate. The short-term economic impact of the vote to leave the EU will be decidedly negative in the UK, leading us to downgrade the UK’s rating to AA and assign a Negative Outlook on 27 June. We revised our GDP growth forecasts lower for 2016-2018, and project a corresponding deterioration in the fiscal balance and consequent rise in government debt as a share of GDP. There is considerable uncertainty over the political outlook, and no agreement as yet on when the country should trigger Article 50 of the Treaty on European Union, the formal mechanism for EU withdrawal.

Fitch believes that developments in the UK make it more probable that populist or Eurosceptic movements find greater support elsewhere in the EU, providing added impetus for political fragmentation and polarisation trends that became evident in the aftermath of the eurozone crisis. A referendum in Italy in October on constitutional reform will be another test of populist pressures and could trigger political instability.

Europe’s political backdrop could have negative implications for sovereign ratings, as fiscal consolidation may drop further down the list of policy priorities. An easing of fiscal policy in the eurozone has already been evident, prompted by the shift of focus to issues surrounding migration and security, and austerity fatigue. In addition, the fiscal space made available by lower interest rates is not being used to bring fiscal deficits down. Several eurozone sovereigns have comparatively high government debt levels, which are likely to remain effective rating constraints.

Markets reacted positively in 1H16 to accelerated Chinese credit growth and other signs of activity picking up in response to policy easing, but volatility is likely to persist as long as Chinese policymakers send mixed signals with respect to addressing the country’s corporate debt problem. Fitch expects higher US interest rates and a stronger US dollar to result in renewed downward pressure on the renminbi later this year, with possible regional implications.

In the US, Fitch recently revised down its US GDP growth forecasts, but we still expect the Federal Reserve to raise policy rates by year-end. Latin America is headed for its second consecutive year of contractions as it faces subdued commodity prices, weak external demand (notably China, relative to previous growth rates) and tighter external financing conditions. Larger government deficits and tepid growth combined with currency depreciations are contributing to rising government debt.

UK Will See Large Investment Shock Post-Brexit – Fitch

Fitch Ratings says that there is little doubt that the UK referendum vote in favour of leaving the EU will take a significant toll on the economy.

Businesses are facing a surge in uncertainty on three separate fronts – the future of the UK’s trading relationship with the EU, the shape of the regulatory framework, and domestic political uncertainty, including the future status of Scotland. This uncertainty will prompt firms to delay investment and hiring decisions, while elevated financial market volatility will further damage business confidence.

We expect investment to fall by 5% in 2017 and by 2018 for it to be 15% lower than previously expected in Fitch’s May 2016 Global Economic Outlook (GEO). Consumption will not be immune to this shock and overall spending by UK residents will see a mild decline in 2017. The sharp fall in the value of sterling will provide some offset to the demand shock, with exports likely to benefit somewhat in the near term. Imports look likely to decline as investment contracts and foreign products become more expensive, resulting in expenditure switching to domestically produced goods and services and higher inflation. UK GDP growth is expected to fall to around 1% in both 2017 and 2018. This is a downward revision of 1 percentage point in each year from the May 2016 GEO.

The long-term impacts of Brexit on the economy are harder to estimate with great precision. However, in addition to less favourable access to the European Single Market, reductions in trade openness and inward FDI could harm productivity performance, while reduced immigration would slow labour supply and potential GDP. These negatives will likely outweigh any GDP gains from deregulation outside the EU or the redirection of EU budget transfers.

Brexit hits the world economy at a fragile juncture, with US growth recently weighed down by external shocks, but the direct near-term impact on the global economy is likely to be manageable. The trade exposures of US and Asian economies to the UK economy are small. The eurozone will suffer a larger shock from weaker UK demand and the depreciation of the pound, but for the block as a whole, growth adjustments will likely be significantly smaller than for the UK. Global financial market contagion beyond the UK has not been particularly severe since the vote, although European bank shares have fallen sharply as concerns about profitability have risen. Liquidity provision and monetary policy adjustments by global central banks should be able to contain the risk of a significant and widespread tightening in global credit conditions, although a further strengthening of the dollar – with implications for emerging market currencies and debt service – cannot be ruled out. Further Fed tightening is now likely to be delayed until December 2016 and the ECB is expected to persist with asset purchases beyond March 2017. The Bank of England is likely to lower interest rates to 25 bps later this year.

Nevertheless, medium to long-term risks to the global economy from the Brexit vote would rise in the event of increased political fragmentation pressures in the rest of the EU or a reversal of globalisation that culminated in rising trade protectionism.

US Bank Stress Tests Highlight Improving Resilience – Fitch

The first stage of this year’s US bank stress tests highlights improving resilience with solid results despite a severely harsher scenario that included a more severe downturn than previous tests and negative short-term US Treasury rates, Fitch Ratings says. All 33 US bank holding companies passed the minimum capital ratio requirements. Tested firms overall generally performed better, posting higher capital ratios and smaller declines in capital ratios than in the past.

The largest global banks generally performed better than last year, although they still account for over half of projected losses under the severely adverse scenario, since they are subject to global market shock and counterparty default component. Pre-provision net revenue (PPNR) projections were noticeably higher this cycle, particularly for the five largest global trading and universal banks – Goldman Sachs, JP Morgan, Morgan Stanley, Citigroup and Bank of America. This more than offset higher losses from the stress scenario and may mean that some large global firms that typically revised capital plans post-DFAST won’t do so this year.

The test hit Morgan Stanley hardest in terms of capital erosion, although very high starting risk-weighted capital ratios gives it greater flexibility. It is more constrained by the leverage ratio, which had a projected minimum of 4.9%, leaving only a 90bp cushion above the requirement.

Among other weaker performers, two firms in the midst of M&A performed significantly worse than last year. Capital ratios for Huntington Bancshares may have taken a hit from the pending FirstMerit acquisition, resulting in a projected minimum common equity tier 1 (CET1) ratio of 5% – the lowest of all 33 banks. The First Niagara merger may be a key driver for the erosion of KeyCorp’s CET1 ratio to minimum 6.4%. These banks and others close to the 4.5% CET1 minimum threshold may constrain their capital return requests.

For firms that fared well quantitatively, the threat of a capital plan rejection for qualitative reasons under the second stage – Comprehensive Capital Adequacy Review (CCAR) – is still a significant hurdle. Modeling negative interest rates is likely to be more challenging for regional banks than global banks, like Citigroup, that already operate in markets with negative rates. The qualitative assessment may also bring up issues for new participants. Both are foreign-owned banks, which historically haven’t performed as well in the CCAR.

Credit card issuers and trust and processing banks performed well with the least capital erosion. However, their pre-provision net revenue projections were down compared to 2015, probably because of negative rate assumptions depressing interest income, which particularly impacts processing banks. Bank of New York Mellon and State Street’s PPNR projections fell around 20%-30%. Still, as in previous cycles, these firms showed projected net income over the nine quarters of the stress horizon, in contrast to net losses for firms with other business models.

Negative rates also had more impact on regional banks. The Fed said that firms more focused on traditional lending activities were more affected by this assumption.

Almost three quarters of the $526 billion in losses projected under the severely adverse scenario stemmed from loans, while 21% arose from trading and counterparty positions subject to the global market shock and counterparty default component. Projected loan loss rates varied significantly from 3.2% on domestic first lien mortgages to 13.4% on credit cards. The loss rate for domestic commercial real estate loans improved by 160bp to 7%, the first rise since 2012. The rate for commercial and industrial (C&I) loans deteriorated, jumping 90bp to 6.3%. C&I loan growth has been strong and the weaker performance may reflect energy sector weakness within these portfolios.