Bank and credit union examiners are especially scrutinizing the quality of financial institutions' assets and their sensitivity to market risk, according to a recent survey of institutions that have recently undergone routine federal examinations.
Sageworks, a financial information company, also found in its survey that while many smaller banks may not be required to conduct formal concentration or portfolio stress testing to ensure capital will be adequate under various scenarios, they are facing regulatory pressure to do so.
The Sageworks Bank & Credit Union Exam Survey found that many respondents, 99 percent of which had asset levels below $10 billion, are receiving encouragement or pressure related to stress testing. Forty-three percent of institutions said they are already stress testing, and one-third said examiners pressured them to start or expand stress testing practices. A small number (3 percent) said examiners required stress testing implementation by the next exam.
Most U.S. banks are small and generally aren't required to stress test, even though giant banks conducting stress tests under the Federal Reserve's Comprehensive Capital Analysis and Review (CCAR) and the 2010 Dodd-Frank Act get a lot of headlines. Banks under $10 billion in assets have nonetheless been encouraged in recent years by regulators to implement the practice on their own, especially related to commercial real estate (CRE) loans. In addition, new rules under Basel III will impose significant changes to the regulatory capital framework, prompting many smaller institutions to integrate stress testing into their risk management.
"The big banks perform a different version of stress testing, but that doesn't preclude smaller banks from the practice," Sageworks Senior Risk Management Consultant Robert Ashbaugh said. "In working with clients, we have found that these smaller institutions - especially those with sizable CRE portfolios - are being asked to do something."
Periodic Safety and Soundness Examinations that financial institutions undergo about every 12 to 18 months are one way that federal regulators ensure banks and credit unions are stable enough to maintain public confidence in the system. Financial institutions spend months preparing for the exams, which also ensure financial institutions are complying with laws and regulations, such as Dodd-Frank and the Bank Secrecy Act.
Overall, the Sageworks survey found, financial institutions named asset quality as an area of most focus during their most recent exams by the Office of the Comptroller of the Currency (OCC), the Federal Deposit Insurance Corporation (FDIC), the Federal Reserve and the National Credit Union Administration (NCUA). In fact, 60 percent of respondents said asset quality was the top focus of examiners.
"Asset quality could be a catch-all category, but in general, examiners want to make sure banks have higher quality assets and that they're properly accounted for in terms of risk," said Ashbaugh. "Examiners are really focused on that whole portfolio and the mix and the overall quality of the portfolio."
Some of the asset-quality issues receiving criticism from examiners, according to respondents, included:
• Failing to complete annual loan reviews
• Inconsistency in how cash flow analyses were conducted
• Stale loan-file documentation, appraisals and financial information
• Handling of problem loans and TDRs
• Concentration levels of commercial real estate, and
• Risk-rating systems.
Fortunately for those being examined, asset quality was also the area for which respondents said they were most prepared. Numerous institutions indicated their groundwork had been in response to previous criticism, or, as one FDIC-examined bank put it, "due to severe beatings taken over [the] last several years." Others reported having implemented new underwriting systems or new ways to monitor and resolve problem loans, and some indicated that improving trends in the portfolio mean examiners' spotlights are shining less brightly on asset quality.
Related to market-risk sensitivity, some respondents said examiners had been critical of their institution's interest rate risk model, and they noted widespread anticipation of increasing interest rates.
Representatives from 180 financial institutions participated in the online survey, conducted between April 6 and June 6. Poll respondents, who were not randomly selected, included Sageworks financial institution clients as well as members of the ALLL Forum for Bankers LinkedIn Group, recipients of Sageworks newsletters, and other institutions reached through state association announcements. Respondents included chief executives, chief financial and chief credit officers, credit analysts, compliance and risk management staff and institutions' third-party consultants involved in the examination.
Financial institutions represented a range of assets: approximately half had total assets of $75 million to $500 million; about 18 percent had assets ranging from $500 million to $1 billion; and 14 percent had assets of $1 billion to $2 billion. Eight percent of respondents had assets topping $2 billion.