Ex-FDIC Official, Banker Discuss Exam Priorities, Stress Testing, M&A

Thomas Dujenski retired as the FDIC Regional Director in Atlanta in May, after a 31-year career at the agency. He now works as a managing director for Alvarez & Marsal, a consulting firm. Bank Insights posed questions to Dujenksi and Bruce Stevenson, a former senior vice president of HSBC North America Holdings, who also recently joined A&M. This is a condensed version of the conversation.

Q: What are the supervisory priorities for the FDIC? The OCC indicated in its latest risk perspective that it is focusing on strategic and capital planning and interest rate risk. Are those priorities for the FDIC as well?

A Dujenski: This is the lowest interest rate environment we’ve ever been in. Examiners will be focusing attention, in my opinion, on the longer term assets on balance sheets. There will be also a focus on corporate governance, information technology and risk related to cyber threats. Strategic and capital planning will be priorities for all the regulators. Many institutions in the last 4 1⁄2 years were working through the crisis and are now focusing on strategic plans. They need to ask themselves: Where do they want to be and where do they want to grow in the next three to five years? Banks need to make sure when they are developing their strategic plans that they have a good understanding of the risk profile that the institution wants to have.

Stress testing and strategic planning are linked. What we are seeing is that a bank that has a good stress testing program in place will be able to make sure it has adequate capital to withstand any of the changes in the economy that will impact its strategic plans.

Banks should engage in stress testing based on the level and complexity of the institution. For institutions that fall below the concentration thresholds, look at the interest-rate risk guidance on stress testing and the guidance on concentration of credits.

Stevenson: While there is not a specific mandated program for community bank stress testing, the regulatory expectations are quite clear. If you look at the regulatory guidance, the FDIC and the OCC have come pretty close to saying you have to do this.

Q: What lessons can smaller banks learn from the CCAR stress testing of the largest banks?

A Stevenson: If you have never done capital planning before, be prepared for challenges and difficulties of doing it. Doing risk assessments and capital planning is hard. It takes a change of mindset to do stress testing. Often bankers are somewhat reluctant to anticipate the downside risks emerging with the largest bank customer, or individual counterparties. To the extent that CRE lending is a major driver of earnings, there should be a stress testing program in place to assess the downside risk in that business.

Q: Invictus Consulting Group’s whitepaper “Bleeders and Leaders: Redefining the 2014 U.S. M&A Banking Market,” concluded that stress testing should be a critical component of any bank’s M&A analytics. What do you think?

A Dujenski: When you have a comprehensive stress testing plan in place to look at a merger, it provides invaluable information to management, the board and regulators.

Stevenson: I agree with the overall assessment. It’s a very significant opportunity for the best banks to differentiate themselves. One of the most valuable tools is the ability to do loss forecasting on not only the acquiring bank but also on the combined entity.

That can lead to an accurate assessment of losses on acquired portfolios. It’s a clear competitive advantage for banks that are seeking to grow through acquisitions.

The largest of the smallest banks are very much at a place where they do need to do a very thorough job of stress testing, for their own purposes, and for the acquisition to be approved by the regulators.

Q: What can community banks do to improve their CAMELS scores?

A Dujenski: The best thing an institution can do is to make sure they have a good strategic plan in place, good policies and procedures, robust plans for BSA compliance, good underwriting criteria and that they are preparing for capital planning and for stress testing. They need to be approaching risk from an enterprise-wide basis. If it’s a new area of risk, the bank must engage all areas in an integrated basis rather than a silo approach. To have a good exam, make sure you have good capital planning, good assets, a plan for sufficient liquidity and a board of directors that is engaged in all activities of the bank. You must also have the type of information systems that are necessary to make sure that management is following the bank’s policies.

Stevenson: My sense is that community banks that focus on enterprise risk assessment and the ability to do scenario analysis on an enterprise-wide basis will significantly improve their M and C portions as well.