Portfolio Stress TestingOne Size Doesn’t Fit All
Panel:Bob Koch
Dave Kampff
History & background
• Initial focus on CRE
• Reg. requirements emerge with issuance of 2006 guidelines
• Obtain current valuation data by portfolio segment
• Request updated financials, P&L’s, Schedule E’s, etc.
• Obtain debt service data (or NOI) by portfolio segment
Data requirements
• Consider valuation sources other than appraisals
• Update financial info for C&I/SBA
• Update credit reports for consumers
• Update NOI data for multi-family borrowers
• Update appraisals where appropriate
Data requirements
Consider a high level segmentation
• Multi-family residential
• Land & construction
• Consumer mortgages & HELOC’s
• SBA owner occupied business properties
• Commercial real estate
High level portfolio segmentation
• Type of property
• Loan type
• Industry
• Ownership/occupancy
• Property location
Examine the demographics…
• Valuation and LTV (e.g., cap rates, etc.)
• Impacts on debt service requirement (e.g., interest rates, etc.)
• Impacts on NOI/Debt service capacity (e.g. rents, op exp, etc.)
Possible stress points
• Economic conditions, trends
• Consider the portfolio’s stressed performance as it affects bank earnings and capital
• Stressed portfolio trends based on prior stress tests – Ratings migration analysis
Other considerations…
• Quantifies risk levels under changing market conditions
• Provides critical analysis for capital and strategic planning
• Encourages management’s focus on a range of possible future scenarios
How stress testing benefits the Bank
Develop & run stress test(s)Develop & run stress test(s)
Impact on strategic plansImpact on strategic plans
Impact on nonaccrualsImpact on nonaccruals
Impact on Interest IncomeImpact on Interest Income
Impact on debt service capacity
Impact on debt service capacity
Impact on loan (risk) gradesImpact on loan (risk) grades
Impact on profitabilityImpact on profitability
Impact on capitalImpact on capital
Impact on DSC, LTVImpact on DSC, LTV
ALLL impactALLL impact
The process
The Bank’s corporate culture
Current Management Information Systems
• Perception that the portfolio is sound
Hurdles
• Too complex, requires staffing and expertise you don’t have
• Systems don’t support the ability to work on aggregated/disaggregated data
Start simple
Breaking down the barriers
• What are the Bank’s primary concerns
Create simple models• Thinking about the issues may be as important
as the actual stress models • Stress one or two variables to start
Create the methods and practices to be used• Establish the portfolio segments to stress
Getting started
• Decide which variables to stress• Create relevant scenarios – BC, WC, MLC
• Decide which variables to stress
• Implement systems so you can repeat and improve the process
• Establish a framework to analyze results
Determining the factors to stress
Macroeconomic Microeconomic• Interest rates • NOI• Unemployment • Vacancy rates
• Changes in cap rates • Appraised value
Evaluate Macro influences at the Micro level
Stress testing fundamentals
Each variable stressed can & likely will result in a number of measurable impacts
For example…
Stressing a variety of changes in cap rates will yield insight into changes in property value, LTV and more
For example…
Whereas stressing Gross Rents yields other insights…
Stressing entities vs. portfolios
Models should work at the entity and portfolio levels
Design models to stress independent variables to determine impacts on dependent variables
• To stress the CRE portfolio, models need to support stressing individual properties/projects
• Stress Rents for impact on NOI, Cap Rates for impact on LTV, Interest Rates for impact on DSC…
Stressing “single” variables
Stressing a single variable simplifies testing a broad range of possible outcomes:
• For C&I deals, evaluate how a 5%, 10%, 15%, 20% reduction in revenue affects profit, EBITDA, UCA Cash Flow, etc.• For CRE deals, evaluate how a 5%, 10%, 15%, 20%
increase in vacancies affects NOI, DSC, etc.
Stress testing fundamentals
Stress tests should be constructed to consider a range of possible future outcomes
Single variable entity stress testing
Analyze the full range of outcomes at the property, business or individual level
CRE Example
Single variable portfolio testing
Stress portfolio segments that operate in a similar space to enhance the test’s relevance
Stressing multiple variables
Concurrently stressing several variables enhances the ability to test combined impacts on performance• For CRE, concurrently stress changes in Rents, Op
Exp, Interest and Cap Rates to determine impacts on NOI, DSC, LTV and more• For C&I, stress changes in Revenues, Margins,
Op Exp, etc. to determine impacts on Profits, EBITDA, UCA Cash Flow and more
Stressing multiple variables
C&I Example
Stressing multiple variables
Assess the impact of changes in interrelated drivers on performance.
C&I “Entity” Example
Stressing multiple variables
C&I Portfolio Example
Anticipate the impact of changes in key areas affect the capacity of the portfolio or any segment of it.
In the final analysis…
• More effective capital planning• Better risk management
• Improved portfolio performance
Effective stress testing at the entity and portfolio level provides substantial benefits: