More Stress for Community Banks
On October 18, 2012, the Office of the Comptroller of the Currency (the “OCC”) provided guidance to national banks and federal savings associations with total assets of $10 billion or less on how to conduct stress tests on their loan portfolios.The OCC stated that it expects every bank, regardless of size, to have the capacity to analyze the potential impact of adverse outcomes on its financial condition in order to establish and support its risk appetite and tolerances, set concentration limits, adjust strategies and appropriately plan for and maintain adequate capital levels. OCC Bulletin 2012-33 “Community Bank Stress Testing; Supervisory Guidance” can be accessed here. The OCC stated that it will host a teleconference on December 3, 2012, to discuss the new guidance.
While not endorsing a particular stress test method, the OCC considers some form of stress testing or sensitivity analysis of loan portfolios at least annually to be an integral part of sound risk management for community banks. The OCC states that stress testing is not “one size fits all” but instead encouraged community banks to adopt a stress test method that fits their unique business strategy, size, products, sophistication and overall risk profile. Banks should primarily focus on concentrations of credit or loan portfolio segments that are critical to their overall business strategy.
The OCC advises that an effective stress test will have the following elements: (1) asking plausible “what if” questions about key vulnerabilities; (2) making a reasonable determination of how much impact the stress event or factor might have on earnings and capital; and (3) incorporating the resulting analysis into the bank’s overall risk management process, asset/liability strategies, and strategic and capital planning processes. The OCC’s guidance also provides that the analysis need not be complex, may be completed internally by the bank and does not require the involvement of third parties. The guidance states that the appropriate time frame for a stress test scenario should be at least two years because, in any given credit cycle, losses generally emerge over a two-year period following the downturn.
In May 2012, the OCC, in a joint statement with the Federal Reserve and the FDIC, assured community banks that they would not be subject to stress tests at the levels required for larger banks under the Dodd-Frank Act. The Dodd-Frank Act expressly requires institutions with more than $10 billion of assets to conduct stress tests. While the OCC’s recent guidance only facially applies to national banks and federal savings associations, it is important for other community banks to recognize that their regulators may require them to begin using stress tests to analyze their loan portfolios in the future and that this will likely be a topic of discussion during their next regulatory examination.
If you have any questions regarding the OCC’s guidance or stress testing at your institution, please contact a member of the Troutman Sanders Financial Institutions group.
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