
SRA Stress Testing
More and more banks are embracing stress tests as a great way to identify potential problem areas and to project future capital needs. When used on individual loans, stress tests can point out loans most susceptible to negative changes, and allows the bank the opportunity to focus on those loans and to take steps to miimize the impact of future problems. Stress tests are also a good tool for testing a bank’s capital adequacy. Are capital and the ALLL sufficient to absorb potential loan losses identified in the stress test? In today’s dynamic banking environment, bank examiners use stress tests to measure bank’s capital adequacy and ability to survive a weak economy and weak loan portfolios. If capital or ALLL is light, they are requiring banks to increase reserves and raise more capital. Strategic Risk Associates (SRA) performs three stress tests for banks: Loan by Loan Stress Test Portfolio Stress Test High-Level Stress Test To learn more about stress testing and to schedule your test, contact an SRA Representative today. Loan by Loan Stress Test The first test is a stress test of specific loans or specific types of loans. SRA tests the sensitivity of individual loans to changes in such attributes as borrower income and expenses, interest rates, and collateral values. In order to recognize differences in the primary sources of repayment, we have designed different tests for income producing properties, for sale properties, and loans to operating businesses (C&I loans). SRA measures the impact of changes, and projects the impact on collateral values, which ultimately projects if there is any potential loss or not. The relative strength of guarantors is then assessed to determine if they can be counted on for additional credit support if needed. This loan-by-loan stress test is a great way for banks to identify which loans are weakest and most likely to underperform. It can also be used as a scoring system to augment credit reviews or even assist in initial underwriting. This specificity helps banks avoid problems, focus on their weakest credits, and take actions to strengthen those loans prior to problems actually occurring. SRA also performs stress tests on consumer type portfolios including residential loans, HELOC portfolios, credit cards, and other consumer loans. As a general rule, stress tests for these portfolios are done using various macro economic factors assigned to the entire portfolio to ascertain potential impact. A great example today is the change in unemployment rate. How would unemployment rising to 10.5% affect losses in the residential portfolio? A well designed stress test from SRA can help answer that question. -->More details Portfolio Stress Test The second test is a bank-wide capital stress test and is considered the most thorough of all. A large sample of assets, primarily the loan portfolio, is reviewed to identify potential losses. From that information and many years’ experience making these projections, SRA projects the amount of loss for the bank as a whole. In form, this test is very similar to the test described below. But in this case, we are actually reviewing credit files to get actual loss projections vs. making assumptions based on industry statistics. As a result, this test is much more accurate for the bank being tested. The end result is to determine whether or not capital is adequate now and in the future. This test is especially helpful in identifying capital needs for strategic planning and in making decisions about future business opportunities. In many respects SRA’s capital stress test is similar to the test performed by the Fed on the largest 19 financial institutions in early 2009. -->More details High-Level Stress Test The third test is a high level stress test mostly using public information such as Call Reports and Uniform Bank Performance Reports, etc. Based on many years of experience in analyzing bank performance, assumptions are made about projected losses by asset type along with future profitability of the bank. The balance sheet is then analyzed to determine if the bank has sufficient capital, reserves (ALLL) and profitability to absorb projected losses. All assumptions can be easily changed to reflect better or worse economic environments, providing bank management and the Board of Directors with the necessary information from which well-founded contingency plans can be developed if needed. With the intense focus on stress tests by regulators and increasing stress on a bank’s loan portfolio during the current economic downturn, all banks should consider performing some type of stress testing. At Strategic Risk Associates, we’ve completed numerous stress tests for banks and buyers of banks. For banks, these tests have enabled our clients to gain a better understanding of their exposure to potential losses and their bank’s capacity to absorb those losses. For buyers, these tests have helped them determine the price they should pay for a bank, or if they should even consider acquiring the bank. -->More details
Loan by Loan Stress Test Loan by loan stress tests show how changes in net operating income and capitalization rates may affect specific loans and lead to loan losses. This test also shows how the financial strength of guarantors may be able to reduce those losses. In this example, it is evident that most loans can absorb substantial changes in income and cap rates. It also shows the guarantors can substantially reduce the potential for losses. Loan Scoring Loan scoring is an excellent way to complement a loan by loan stress test by measuring and grading various attributes of a loan to determine its collectability. Just as consumer loans are measured and graded according to different factors, commercial loans are measured and graded according to factors typically measured in commercial loans. In this example, it would appear that two loans have a potential for loss and require the support of guarantors to offset or reduce those losses. -->Back to top Portfolio Stress Test A portfolio stress test shows how changes in specific loans can affect the portfolio as a whole. This example analyzed changes to income, collateral values and cost of funds. It showed that the median loan in the portfolio had a 1.49 debt service coverage ratio (DSCR) and 66% loan to value (LTV). Although the DSCR appeared satisfactory, a 20% decrease in borrowers’ income would cause the ratio for the median loan to fall to 1.19 which was below the underwriting standard for this bank. A 20% decline in collateral values would increase the LTV for the median loan to 82% which was still within underwriting standards. The cost of funds analysis showed the impact of changes in funding rates to the net interest income on the bank’s fixed rate loan portfolio. Even moderate hanges in funding costs could significantly erode this bank’s net interest earnings. -->Back to top High-Level Stress Test The high level stress test analyzes and stresses the components which comprise the bank’s balance sheet. In this example, the stress test suggests that the bank has sufficient capital to fund operations and absorb projected loan losses. -->Back to top

SRA Stress Testing

More and more banks are embracing stress tests as a great way to identify potential problem areas and to project future capital needs. When used on individual loans, stress tests can point out loans most susceptible to negative changes, and allows the bank the opportunity to focus on those loans and to take steps to miimize the impact of future problems.

Stress tests are also a good tool for testing a bank’s capital adequacy. Are capital and the ALLL sufficient to absorb potential loan losses identified in the stress test? In today’s dynamic banking environment, bank examiners use stress tests to measure bank’s capital adequacy and ability to survive a weak economy and weak loan portfolios. If capital or ALLL is light, they are requiring banks to increase reserves and raise more capital. Strategic Risk Associates (SRA) performs three stress tests for banks:

Loan by Loan Stress Test
Portfolio Stress Test
High-Level Stress Test

To learn more about stress testing and to schedule your test, contact an SRA Representative today.

Loan by Loan Stress Test

The first test is a stress test of specific loans or specific types of loans. SRA tests the sensitivity of individual loans to changes in such attributes as borrower income and expenses, interest rates, and collateral values. In order to recognize differences in the primary sources of repayment, we have designed different tests for income producing properties, for sale properties, and loans to operating businesses (C&I loans). SRA measures the impact of changes, and projects the impact on collateral values, which ultimately projects if there is any potential loss or not. The relative strength of guarantors is then assessed to determine if they can be counted on for additional credit support if needed.

This loan-by-loan stress test is a great way for banks to identify which loans are weakest and most likely to underperform. It can also be used as a scoring system to augment credit reviews or even assist in initial underwriting. This specificity helps banks avoid problems, focus on their weakest credits, and take actions to strengthen those loans prior to problems actually occurring.

SRA also performs stress tests on consumer type portfolios including residential loans, HELOC portfolios, credit cards, and other consumer loans. As a general rule, stress tests for these portfolios are done using various macro economic factors assigned to the entire portfolio to ascertain potential impact. A great example today is the change in unemployment rate. How would unemployment rising to 10.5% affect losses in the residential portfolio? A well designed stress test from SRA can help answer that question. -->More details

Portfolio Stress Test

The second test is a bank-wide capital stress test and is considered the most thorough of all. A large sample of assets, primarily the loan portfolio, is reviewed to identify potential losses. From that information and many years’ experience making these projections, SRA projects the amount of loss for the bank as a whole. In form, this test is very similar to the test described below. But in this case, we are actually reviewing credit files to get actual loss projections vs. making assumptions based on industry statistics. As a result, this test is much more accurate for the bank being tested. The end result is to determine whether or not capital is adequate now and in the future. This test is especially helpful in identifying capital needs for strategic planning and in making decisions about future business opportunities. In many respects SRA’s capital stress test is similar to the test performed by the Fed on the largest 19 financial institutions in early 2009. -->More details

High-Level Stress Test

The third test is a high level stress test mostly using public information such as Call Reports and Uniform Bank Performance Reports, etc. Based on many years of experience in analyzing bank performance, assumptions are made about projected losses by asset type along with future profitability of the bank. The balance sheet is then analyzed to determine if the bank has sufficient capital, reserves (ALLL) and profitability to absorb projected losses. All assumptions can be easily changed to reflect better or worse economic environments, providing bank management and the Board of Directors with the necessary information from which well-founded contingency plans can be developed if needed.

With the intense focus on stress tests by regulators and increasing stress on a bank’s loan portfolio during the current economic downturn, all banks should consider performing some type of stress testing. At Strategic Risk Associates, we’ve completed numerous stress tests for banks and buyers of banks. For banks, these tests have enabled our clients to gain a better understanding of their exposure to potential losses and their bank’s capacity to absorb those losses. For buyers, these tests have helped them determine the price they should pay for a bank, or if they should even consider acquiring the bank. -->More details

Loan by Loan Stress Test

Loan by loan stress tests show how changes in net operating income and capitalization rates may affect specific loans and lead to loan losses. This test also shows how the financial strength of guarantors may be able to reduce those losses. In this example, it is evident that most loans can absorb substantial changes in income and cap rates. It also shows the guarantors can substantially reduce the potential for losses.

Loan Scoring

Loan scoring is an excellent way to complement a loan by loan stress test by measuring and grading various attributes of a loan to determine its collectability. Just as consumer loans are measured and graded according to different factors, commercial loans are measured and graded according to factors typically measured in commercial loans. In this example, it would appear that two loans have a potential for loss and require the support of guarantors to offset or reduce those losses.

-->Back to top

Portfolio Stress Test

A portfolio stress test shows how changes in specific loans can affect the portfolio as a whole. This example analyzed changes to income, collateral values and cost of funds. It showed that the median loan in the portfolio had a 1.49 debt service coverage ratio (DSCR) and 66% loan to value (LTV). Although the DSCR appeared satisfactory, a 20% decrease in borrowers’ income would cause the ratio for the median loan to fall to 1.19 which was below the underwriting standard for this bank. A 20% decline in collateral values would increase the LTV for the median loan to 82% which was still within underwriting standards. The cost of funds analysis showed the impact of changes in funding rates to the net interest income on the bank’s fixed rate loan portfolio. Even moderate hanges in funding costs could significantly erode this bank’s net interest earnings.

-->Back to top

High-Level Stress Test

The high level stress test analyzes and stresses the components which comprise the bank’s balance sheet. In this example, the stress test suggests that the bank has sufficient capital to fund operations and absorb projected loan losses.

-->Back to top