Federal Reserve’s bank stress tests overlook a big one

At banks across the country, workers are busy crunching numbers to determine how their firms would fare under the hypothetical scenarios outlined in the mandatory Federal Reserve stress tests installed after the financial crisis.

At first blush, the tests appear to be pretty comprehensive. There are 28 variables, everything from U.S. economic growth and inflation to various Treasury yields, home prices and mortgage rates, stock-market levels and the VIX index of equity volatility. Overseas risks are measured by testing against economic, inflation and exchange-rate variables for Asia and Europe. Each variable is tested under three scenarios: base line, adverse and severely adverse.

If a bank were a middle-aged person being forced by a doctor to hop on a treadmill for a different kind of stress test, this may feel like being asked to run a marathon.

However, one important variable is conspicuously missing: the price of oil.

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While oil prices might not be as important for the big money-center banks, where loans to the energy industry are in the low single-digit percentages of their total loan books, they are still a chief focus of attention. What a lower-for-longer crude price means for real-estate prices and indirectly related industries in energy-producing areas is a big factor to consider. So is the fact that sovereign wealth funds of energy- producing nations tend to be big holders of bank stocks, which may be attractive assets to dump first as oil dollars dry up.

For smaller banks that are more exposed to energy loans, the stress is far more acute. On Wednesday, Moody’s Investors Service warned that the slump in the price of crude would intensify pressure on regional banks that are most exposed to energy debt. The ratings provider placed BOK Financial, Cullen/Frost Bankers, Hancock Holding Company and Texas Capital Bancshares on review for downgrade and changed the outlook on Comerica and Associated Banc-Corp to negative. The banks have direct energy-related loans equal to 40 percent to 110 percent of tangible common equity, compared with the 10 percent to 15 percent median for regional banks, according to Moody’s.

To see the stress that the oil slump is causing these banks, look no further than their stock prices, all of which have suffered severely in recent months. In fact, worries about credit exposure at all banks is often one of the first issues brought up when trying to explain the causes of the bear market in bank stocks.

This is not to say the Fed is ignoring the stress being caused by the crash in oil prices. It’s a safe bet that regulators are keeping a close eye on banks’ exposure to energy credits, especially as the spring redetermination season approaches when banks go through their energy credits with a fine-tooth comb.

But to be a successful tool, the Fed stress tests need to be on top of emerging threats in addition to the hazards that caused the last financial crisis. If an argument is to be made for adding a 29th variable to the Fed’s stress tests, a good case can be made for making it crude oil.

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