How Stress Testing Strengthens CAMELS

A Client’s Perspective

After Community First Bank’s last safety and soundness exam, regulators told CEO Charles W. Daily that capital stress testing had strengthened the bank’s management rating in its CAMELS composite score.  The examiner was “especially impressed that we’re doing this complex stress testing as a small bank,” Daily said.

Community First Bank, a $208.2 million bank in Fairview Heights, Ill, a suburb of St. Louis, isn’t required to do stress testing. Bank regulators now mandate capital stress testing only for banks with assets of $10 billion or more, though most regulators say it is best practice for smaller banks.

“It’s not mandated, but we decided to do it anyway,” Daily said. “Small banks like ours that are not doing it are not going to be downgraded, but he said it helped strengthen it, for sure.”

Daily, one of the bank’s founders, has been CEO since the bank opened in 1988. He attended a regulatory conference hosted by the Conference of State Bank Supervisors in 2011, where Invictus Consulting Group chairman Kamal Mustafa and partner Adam Mustafa were speaking on a panel. He was impressed by their knowledge of banking, and the explanation of the Invictus stress testing process.

Other firms also presented stress testing plans, but their processes seemed “like window dressing for regulators,” Daily said. The Invictus stress testing “had a lot of merit,” offering the bank “meaningful information” it could use, he added.

“I’d been in banking a long time, but we really hadn’t done stress testing before. We always kept extra capital. We never quantified it. Examiners could never tell you that it was enough. They would say that it’s good you’re keeping extra.”

Regulators Reward Bank

Flash forward a few years, and Daily couldn’t be happier. Not only have regulators rewarded him for being proactive, but he and his board have confidence that Community First has enough capital to continue on its strategic growth plan, even if there is another financial crisis.

“The Invictus stress test model is a tool that has helped us evaluate our capital adequacy in conjunction with our strategic plan for future growth. We want to grow, but we want to keep an eye on our capital to make sure we have enough to survive a severe economic downturn,” he said.

He likes the fact that the Invictus model gives “absolute results” because it incorporates the bank’s specific loan makeup, internal loan ratings, loss history and risk migration. Trends in stress testing over the past few years have also been revealing. “Analyzing a compilation of individual stress tests done over time has been important in validating the model as a tool in capital planning,” he said. “The Invictus model also helps us look at the migration of risk in our ALLL model. We’ve gotten more insight into that process and it helps us do a better job of allowance for loan losses.”

Management presents the stress test results to the board semiannually. Graphics make it easy for the board to read and comprehend the results. “The board relies on them to understand our capital adequacy under a combination of growth and adverse scenarios,” he said. “We tell them the bank’s growth goals and what capital is needed and they can look at all that and see we would be able to have adequate capital, even in a crisis.”

And he appreciates the individualized, flexible service he gets from Invictus, which includes conference calls and a willingness to tailor graphics to the bank’s needs. “They are very accommodating. They take the time to learn about the uniqueness of our bank,” Daily said. “Over the years, they have been very willing to change and customize various managerial reports when requested.”

The bank incorporates the stress testing results into its overall enterprise risk management program. “Everything revolves around having capital. We’re a small bank. Our ability to get new capital is limited. We have a strategic plan on the direction we want to take the bank without putting strain on our capital,” he said. “The Invictus test results show that if we have a severe economic downturn, even worse than the last one, that we would have the reserves to survive it.”

The process allows Daily to demonstrate to regulators that the bank understands what is happening with its capital. “At our most recent exam, the regulator mentioned that since our bank had been stress testing for several years, it helped demonstrate our bank’s proactive management approach, which is what they want to see at community banks,” he said.