Stress testing for community banks was high on a list of regulatory issues up for discussion during the annual convention of the Missouri Bankers Association at the Chateau on the Lake in Branson last month.
The subject for speaker John McQueen of UMB Bank in Kansas City was stress testing, and he began by noting that market interest rates have been rising since the beginning of 2013; unrealized gains in the investment portfolio are shrinking; the market still expects the Federal Reserve to maintain current monetary policy through the end of 2013; and long-term yields are rising faster than short-term yields. He added that UMB investment bankers are using gradual, non-parallel shifts in market yield curves for their clients to simulate the impact of these factors on portfolio valuation and cash flows.
The program includes what-if simulation — unchanged rates vs. yield curve steepening; gradual change in market interest rates over a 12-month period; simulating change in MBS and CMO payment speeds; calculating call probabilities; and estimating the impact on market valuation and cash flows.
If the decline in market valuations exceeds policy limits or comfort zone, McQueen suggested these options: consider selling off bonds with the greatest potential losses now; rotate out of sectors most vulnerable to shifts in market rates; estimate the impact on borrowing capacity, pledging and liquidity; and measure the impact on overall economic value of equity.
McQueen, a member of the financial services group in the investment banking division at UMB bank, suggested that loan portfolio stress testing include the following: use data from Schedule RC-C of the call report; assume a two-year loss rate from a stress period in time and then apply that rate to the quarter-end loan balances to derive the estimated loss over the two-year period; and use the estimated loss to calculate the impact on earnings and capital.
He also pointed out that the regulatory agencies are emphasizing the importance of liquidity monitoring and have updated their examination procedures to include updated liquidity stress testing. Banks are now required to provide reports displaying the impact of various stress events that impact liquidity. Stress test results should be incorporated into contingency funding plans, McQueen added.
Ed Krei of the Baker Group, based in Oklahoma City, advised the MBA members that regulators have “higher and higher” expectation for bank directors. That being the case, CEOs should ask themselves if they are presenting relevant data “in the most understandable way” for boards and committees, he suggested, and how the maximum contribution can be extracted from board members.
Krei also described ways he believes high-performing financial institutions can seize on opportunities presented by the current uncertain times. They should clearly define their markets and listen to their customers, he said. Who are your customers going to be and what will they want five years from now?
Community banks also should think, plan and act with a long-term focus and build effective processes including customer service standards for such things as how long it takes to open a checking account, Krei believes. They should invest in employees and an organizational structure that promotes accountability. “Give employees something they cannot get anywhere else,” he said.
Another characteristic of high-performing banks is the will to resist complacency and the status quo, Krei told the Missouri bankers. “They embrace and manage change with a sense of urgency,” he said.
Division of Finance Commissioner Rich Weaver reported that the overall condition of Missouri’s state-chartered banks is improving, with earnings performance stable, albeit in the face of continued margin pressures. The aggregate return on average assets as of March 31 was 0.99 percent, with 118 of 256 state banks above 1 percent; 16 with net losses; 15 that lost money before loan loss provisions. The average net interest margin was 3.74 percent and “trending downward,” according to Weaver.
Loan portfolios grew in just 150 of the 256 state banks his department regulates. “There are just not a lot of good loans out there,” Weaver said. The loan to assets ratio, at 56.63 percent, is the lowest it has been in 15 years, he pointed out. “I think you’re going to have to realize you’re not going to make much money for the next couple of years,” he added. “You may have to be satisfied with a return on assets of 0.80 percent.”
There was good news from Weaver in the decline in number of problem banks — rated 3, 4 or 5 — from 77 in 2011 to 37 today. He noted that 13 Missouri banks failed from 2008 through 2012, and that the troubled economy was often cited as an excuse. If that were the case, “You all should have failed,” he quipped.
Bill Poquette is editor-in-chief of BankNews.
Copyright (c) July 2013 by BankNews Media