The OCC has issued guidance to national banks and federal savings associations with assets of $10 billion or less on using stress testing to assess risk in their loan portfolios. The October 18 guidance contained in OCC Bulletin 2012-33 clarifies the OCC’s stress testing expectations for community banks and provides an example of a simple stress test framework for banks to consider. The OCC said that some form of stress testing or sensitivity analysis of loan portfolios on at least an annual basis is a key part of sound risk management for community banks. According to the guidance, the OCC expects all banks, regardless of size, to have the capacity to analyze the potential impact of adverse outcomes on their financial condition in order to establish and support their risk appetite and tolerances, set concentration limits, adjust strategies, and appropriately plan for and maintain adequate capital levels. According to the guidance, stress tests do not need to involve sophisticated analysis or third-party consultative support. The OCC said that effective methods can range from a single spreadsheet analysis to a more sophisticated model, depending on portfolio risk and the complexity of the bank. The OCC also announced that it is making a new portfolio level stress test tool for income producing commercial real estate (CRE) loans available to national banks and federal savings associations through its BankNet website. The spreadsheet-based tool is designed to provide bankers a simple method to perform portfolio stress testing on income producing CRE loans, particularly in institutions with significant CRE loan concentrations, according to the OCC.

     Nutter Notes: The OCC guidance includes appendices with additional information on a variety of stress testing methods that community banks may employ. According to the guidance, any effective stress testing method has common elements that a community bank should consider, such as asking plausible “what if” questions about key vulnerabilities, making a reasonable determination of how much impact the stress event or factor might have on earnings and capital, and incorporating the resulting analysis into the bank’s overall risk management process, asset/liability strategies, and strategic and capital planning processes. The guidance suggests that a simple, stressed loss-rate analysis based on call report categories may provide an acceptable foundation for most community banks to at least determine if additional analysis is necessary. The OCC said that banks should primarily focus on concentrations of credit or loan portfolio segments that are significant to the overall business strategy. According to the guidance, loss stress rates may be derived from a review of historical loss experience during previous stressful periods, historical market experience, or other estimates. If a stress test reveals critical vulnerabilities, the guidance recommends that the bank’s management and board take steps to mitigate those risks. Depending on the nature of the vulnerability, the bank’s response may include modifying loan growth, revising the risk tolerance strategy, adjusting the portfolio mix and underwriting criteria, altering concentration limits or other policies and procedures, and strengthening capital.