19 banks stress tested, but what about the rest?

Only 19 of the nation’s roughly 7,400 commercial banks were involved earlier this year in the Federal Reserve’s test of whether the banks could weather a severe recession that included 13 percent unemployment, a 50 percent drop in stock markets and a 21 percent decline in housing prices.

Customers of the four institutions that failed the so-called stress tests should be aware of the financial condition, but you should be safe as long as you don’t have more than $250,000 per person, per account – the level insured by the Federal Deposit Insurance Corp., experts have said in published reports.

Since 10 of the 19 banks failed the first round of major stress tests in 2009, the current round “looks a lot better than 2009 for sure,” said Michael Lubanksy, a senior financial analyst with Sageworks, a financial information company that provides stress testing and credit analysis software. “Banks have deleveraged a lot, and the four that did fail this time, most of them have unique situations.”

But what about customers of the thousands of other banks holding some 40 percent of U.S. deposits? Those banks weren’t part of the Fed’s latest round of stress tests, so are customers worried about the health of their banks?

“It’s not something the average customer is stressing over, no pun intended,” said Frank Sorrentino, chairman and CEO of North Jersey Community Bank, a $700 million community bank that opened in 2005. “In our particular case, I can count on one hand the number of customers that have asked about them.”

“For the most part, most community banks do a stress test analysis on their portfolios on a regular basis,” said Sorrentino. “Stressing your loan portfolio, your assets, your liquidity ratios – all the things that make up how a bank runs – that is just part of running a prudent bank.” 

Bank-related stress testing gained widespread attention in 2009 as regulators required the largest U.S. bank holding companies to undergo tests demonstrating their ability to maintain minimum capital requirements, even in the event of extreme economic conditions.

But even before that, the FDIC in 2006 outlined guidance for institutions to conduct stress tests if 100 percent of their total capital was in loans tied to construction, development and other land deals, or if they had commercial real estate loans representing 300 percent or more of their risk-based capital. It reiterated that guidance in 2008 in the wake of the housing market’s tumble and the U.S. financial crisis.

Lubansky said regulators are concerned about the soundness of community banks.  However, he said, “they are not as systemically important to the stability of the global economy” as the 19 largest banks that underwent the high-profile stress tests.

Even so, there are weekly bank failures, and at least 300 community banks remain under increased oversight because they’ve borrowed funds under the U.S. government’s Troubled Asset Relief Program, or TARP. “It is a given that there will continue to be some challenges for individual community banks,” said Lubansky, who is also a senior product consultant with Sageworks.

Under the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act, FDIC-regulated institutions with more than $10 billion in assets will be required to perform stress testing on an annual basis, so that will expand the scope of the current stress tests, Lubansky said.  Regardless of their size, however, many banks are feeling pressure to test their commercial real estate portfolios amid concerns that more volatility in real estate markets may be ahead, he said. 

Banks that are well managed have been looking at this process for some time, said Tim McPeak, director of the financial institutions market for Sageworks. “But there are also a lot of banks being told that they need to start stress testing, and they’re saying, ‘What does that mean?’” 

Lubansky said that for most community and smaller regional banks, it will be important to focus on a bottom-up approach that identifies specific areas of their portfolios, such as commercial real estate, that may be troubled under a stressed scenario. 

Critics of Dodd-Frank worry that for the most part, new procedures put in place as a result of Dodd-Frank regarding stress testing will accomplish little but will add costs.  “Those banks will either have to turn around and charge their customers more, or they’re going to decide that the commercial business is not profitable and give up the ghost,” Sorrentino said.

McPeak said that in the end, banking customers may not even be aware their bank is conducting stress tests, but the process matters. “As long as the bank is on top of their portfolio, the bank should remain sound,” he said. “End users just want a responsive, customer-focused bank that is well managed and is going to be around.”

See the original post on Forbes.com here.

For more information on who must perform stress tests, benefits the analysis provides and challenges financial institutions could face, download the whitepaper, Stress Testing: The Who, What, When & Why.