Still stress testing, even when they don’t have to

Here's a surprise — some banks are willingly complying with a Dodd-Frank-era regulation even though they aren’t required to.

A year after Congress passed a regulatory relief law that eliminated certain stress tests for midsize and regional banks, many of those banks are continuing to conduct stress tests anyway.

They are doing so because asset quality remains top of mind — amid continued predictions of a recession and worries about elevated levels of risky leveraged loans — and many bankers believe that stress-testing loan and securities portfolios for economic shocks is simply a sound business practice.

Some, including FirstBank in Lakewood, Colo., are even going beyond what was required under Dodd-Frank and modeling for economic downturns in specific geographic markets. Previously they had used generic models provided by the Federal Reserve.

“The infrastructure is already there to do the tests, so instead of just dismantling it, we’re using it in a different way,” said David Kelly, the chief risk officer at the $18.5 billion-asset bank.

These company-run stress tests had been mandatory under the Dodd-Frank Act for all banks with more than $10 billion of assets. The Economic Growth, Regulatory Relief and Consumer Protection Act, which President Trump signed into law last May, eliminated the stress tests for banks with less than $250 billion of assets, or about 125 institutions.

The Dodd-Frank stress tests are separate from supervisory stress tests run by the Federal Reserve. Those stress tests remain in place, though in February, the Fed said it would exempt banks with assets of $100 billion to $250 billion from the 2019 Comprehensive Capital Analysis and Review stress-testing cycle. (Banks with less than $100 billion were already exempt from the CCAR process.)

Dodd-Frank’s stress-testing requirements forced banks to improve how they manage risk, said Russell Hughes, the banking product manager at Trepp, a New York-based provider of data and analytical software to banks and other financial companies. Before Dodd-Frank, most banks only used historic data to assess risk in their loan and securities books.

“It’s hard to remember this, but prior to Dodd-Frank, the credit and risk management frameworks at banks were a point-in-time snapshot and backwards-looking,” Hughes said.

While many banks say they have ample capital to weather a recession, they say that stress-testing still helps them identify potential trouble spots in their portfolios.

The $45 billion-asset Synovus Financial in Columbus, Ga., was exempted but it still “rigorously” stress-tests, Chairman and CEO Kessel Stelling said during a January conference call.

“We believe we’re well positioned from a credit quality standpoint, regardless of the timing or the severity of the next downturn,” Stelling said.

The upcoming new accounting standards for loan losses, known as current expected credit loss, or CECL, will also require banks to use more forward-looking data, said John Dalton, director of product strategy management at Fiserv. Banks can use the investments they have made in personnel and stress-testing software to help them comply with the new standards.

“The people who are doing the stress testing can inform the core of your CECL team,” Dalton said.

Under CECL, banks will be required to estimate potential future losses on a loan at the time of origination, based on an analysis of historic data going back more years than banks typically use in models, plus current economic conditions and forecasts.

Hughes said it would be understandable if a bank decided to stop running stress tests, given the amount of work involved.

“You’re talking about an exercise that requires thousands of pages of documentation for everything you do,” Hughes said.

Still, only one Trepp client has told Hughes that it plans to stop stress testing. (He declined to identify the bank.)

Dalton said there’s another good reason for banks to continue running stress tests.

“In many cases, regulators are still asking for stress-test results, even though it’s not required,” he said.

FirstBank is taking the approach that examiners will ask for stress-test results and has built several economic models customized to its specific loan portfolio and geographic markets.

It is also building models based on new information that the Fed released last month, such as ranges of loss rates for loans that are grouped by separate risk characteristics. None of this is mandatory for FirstBank, but its executives believe that the various exercises are helping the bank manage risk better.

“We have more flexibility on how to conduct the tests now and we see [stress-testing] as a valuable tool,” said Kelly, its chief risk officer.