Stress Testing Credit Risk At Community Banks
Stress Testing Credit Riskat Community BanksThe recent banking crisis illustrates how rapidly marketconditions can deteriorate andsubject banks to considerable strain.One result of this experience is thatstress testing has come to occupy amore prominent place in the supervision of large banks. The Supervisory Capital Assessment Program,its successor the ComprehensiveCapital Adequacy Review, and thestress-testing requirements of Section165 of the Dodd-Frank Wall StreetReform and Consumer ProtectionAct are, collectively, an important setof supervisory expectations for largebanking organizations.Stress-testing expectations forcommunity banks are more discreteand limited.1 Existing supervisoryguidance states that banks with significant concentrations in commercialreal estate (CRE) or subprime lendingshould conduct portfolio stress testsof these exposures as part of theirongoing risk management activities(see text box on page 10). Outsidethe credit risk arena, standard assetliability management techniques suchas analyzing the effect of interest-rateshocks, or other interest-rate simulations, amount to a form of stresstesting. Finally, interagency guidancestates that all institutions should planfor ways to meet their funding needsunder stressed conditions.Community banks looking to conductCRE stress tests in accordance withsupervisory guidance, or otherwiseconsidering the use of stress tests forrisk management, may find that it ishard to know where to start. Confusionis understandable: some stress-testingapproaches can be complex, and thereare a variety of analytical approachesfrom which to choose.These difficulties notwithstanding, there are simple approaches tocredit-risk stress testing that canbe implemented by a communitybank. While not a substitute forstrong loan underwriting and grading, credit administration, risk limitsand governance of the credit-grantingprocess, stress testing can help institutions evaluate lending risks andcapital adequacy under stressed butplausible scenarios. Some community banks have used stress teststo develop a more comprehensiveunderstanding of potential loss exposure and incorporated the results intotheir risk management and capitalplanning processes. Experience frombank examinations suggests thatcommunity banks that proactivelymanage their lending function andattempt to plan for, measure andcontrol their vulnerability to adverseevents have been better able to makeadjustments and improve performance over time.This article describes the creditrelated stress-testing process andexplains how community bank boardsof directors and senior management can use this process to bettermanage risk. The article emphasizesthat smaller community banks caneffectively perform stress testing in asimple and straightforward manner toachieve the goals of outstanding supervisory guidance. The article includestwo simple examples of stress-testingmethodologies. These are offered asan informational resource only, not asa supervisory directive.See FDIC Press Release 54-2012, Agencies Clarify Supervisory Expectations for Stress Testing by CommunityBanks, issued May 14, 2012 html).1Supervisory Insights Summer 20129
Stress Testing Credit Riskcontinued from pg. 9Outstanding Supervisory Guidance for Stress Testing Credit ExposuresThe 2006 Guidance on Concentrations in Commercial Real Estate Lending, Sound RiskManagement Practices and the 2001 Expanded Guidance for Evaluating SubprimeLending Programs state that institutions with CRE and subprime lending concentrations should perform portfolio-level stress tests or sensitivity analyses to quantify theimpact of changing economic conditions on asset quality, capital, and earnings. Theseissuances recommend that institutions consider the sensitivity of the performance ofportfolio segments with common risk characteristics to prospective changes in marketconditions. Importantly, the guidance emphasizes that the sophistication of stress testing should be consistent with the size, complexity, and risk characteristics of the portfolios and balance-sheet structure.Definition of a Stress TestStress testing is a forward-lookingquantitative evaluation of stressscenarios that could impact a bankinginstitution’s financial condition andcapital adequacy. These risk assessments are based on assumptions aboutpotential adverse external events, suchas changes in real estate or capitalmarkets prices, or unanticipated deterioration in a borrower’s repaymentcapacity. Stress tests are most usefulwhen customized to reflect the characteristics particular to the institutionand its market area, and can be used toevaluate credit risk in the overall loanportfolio, segments of portfolios, orindividual loans. Stress tests also canbe used to evaluate whether existingfinancial (such as capital and liquidity)and operational (such as staffing andinternal systems) resources are sufficient to withstand an economic downturn or unexpected event.The FDIC does not endorse aprescribed method for stress testing, and outstanding stress-testingexpectations for large institutions arenot required for community banks.2Rather, the extent and depth of aninstitution’s credit-related stress testing should be commensurate with itsunique business activities, portfoliosize, and concentrations. Stress testscan be performed effectively by bankstaff or, at the institution’s discretion, a competent third party, usingmethods ranging from simple spreadsheet computations to more complexsoftware applications. For example,some smaller community banks havesuccessfully implemented relativelysimple, yet effective, CRE loan stresstesting processes while larger institutions have created similarly effective stress assessments with greatersophistication and complexity.Community banks and other institutions with total assets of less than 10 billion are not subject to the stresstesting requirements established in Section 165 of the Dodd-Frank Wall Street Reform and Consumer ProtectionAct or the Supervisory Guidance on Stress Testing for Banking Organizations with More Than 10 Billion In TotalConsolidated Assets, issued May 14, 2012.210Supervisory Insights Summer 2012
Types of Stress TestingFinancial institutions can create a variety of stress tests toevaluate credit portfolio risk and the potential impact oncapital. These types of generalized stress tests can be usedby community banks to meet supervisory expectations (e.g.,expectations contained in the 2006 CRE Guidance) or byinstitutions seeking to complement and enhance their otherrisk management activities. As suggested by this list, there isno one right way to conduct stress tests.Transactional Sensitivity Analysis – Before making acommitment for financing a commercial property or project,an institution can analyze financial and market assumptionsprovided by the borrower or through the appraisal processto determine the degree to which the cash flows generatedby the property or project can withstand market fluctuationsand service the loan per contractual terms. For example,a bank could assume the departure of a key tenant in acommercial real estate project and measure the resultingeffect on loan performance. The results of such stress analyses can help an institution determine whether to make a loanand if so, formulate a more appropriate loan structure, pricing, or other prudential terms to mitigate credit risk. Further,individual stress tests can be aggregated and studied toassess the impact on the portfolio.Stressed Portfolio Loss Rates – Applying a set of portfolio orportfolio-segment loss rates that might be expected duringdownturn conditions can help community banks identifyExamples of Credit-RelatedStress Tests that Can Be Usedby Community BanksExamples of credit-related stresstests are presented below for illustrative purposes.3 These relativelynon-complex stress tests can produceuseful information about a community bank’s vulnerability to adversecircumstances and provide insightsfor boards of directors and manage-the extent to which capital might be at risk given the bank’sbalance-sheet structure and loan mix. For example, a bankcould use portfolio loss rates from a previous economicrecession and apply those to their current portfolio.Scenario Analysis – An institution may want to evaluatehow a certain portfolio or portfolio segment (e.g., second lienmortgages) may respond to different levels in a key performance metric (e.g., housing prices or interest rates).Loan Migration Analysis – Institutions with larger portfoliosand more comprehensive internal databases can evaluatehow a downward migration in internal loan ratings, consistent with migrations that might be expected during adversefinancial conditions, would impact asset quality and capital.This analysis would also assist institutions in determiningpossible actions to address potential migration or deterioration in the portfolio.Reverse Stress Testing – With reverse stress testing, aninstitution assumes a known adverse outcome, such assevere credit losses that reduce regulatory capital ratios tobelow satisfactory levels, and determines the loss event andassociated circumstances that could lead to that outcome.This type of analysis helps institutions quantify the level ofcapital and earnings buffer it has to absorb financial shocksand helps identify those circumstances that, either singularlyor in combination, would have the greatest adverse impact.ment to consider when determiningif action should be taken to mitigateoutsized risks.Portfolio-level example usingstressed loss ratesThe first example illustrates a portfolio-level stress test using stressedloss rates in two scenarios corresponding to moderate and severe levels ofstress. For each scenario, a set of portfolio loss rates and average balances3These examples are not intended to be viewed as a standard stress-testing format or methodology endorsed orexpected by the FDIC. They are presented to illustrate that simple, straightforward stress tests can provide usefulinsight into concentrated credit portfolios held by community banks.Supervisory Insights Summer 201211
Stress Testing Credit Riskcontinued from pg. 11are estimated in step #1, covering atwo-year period of projections. Theseloss estimates could be derived, forexample, from the bank’s own experience during stress periods or from peerportfolio performance. Projections thatassume historical or peer loss rateswill be more informative and relevantif potential losses are adjusted, evenif only judgmentally, to reflect therisk in the bank’s own portfolio. Theloss rate estimates are then appliedto portfolio balances to produce anestimate of aggregate losses. The nextsteps (step #2 and step #3) estimatethe impact of these portfolio losses onearnings (which also are estimated)and capital. In this example, the bank’sconstruction and development lending concentration and other exposurescould affect the capital position in theassumed severe scenario.1. Estimate Portfolio Losses Over the Stress-Test HorizonStress Period Loss RatesOver Two YearsStress Period Losses OverTwo YearsEstimatedPortfolioBalances, in ModerateCase StressSevereCase StressModerateCaseStress, in SevereCaseStress, in 12414.0%25.0%1731222.5%5.0%11Residential Mortgage3722.9%6.5%1124Other Loans1255.0%10.0%613Totals6433569Construction & DevelopmentCommercial Real Estate2. Estimate Revenues and Impact of Stress on EarningsModerateCaseStress, in SevereCaseStress, in Pre-provision net revenue (over twoyears)3125Less Provisions (e.g., set to equalestimated losses from step 1)3569Less Tax Expense (Benefit)(1)(13)Net After-Tax Income(3)(31)3. Estimate Impact of Stress on CapitalModerateCaseStress, in SevereCaseStress, in Beginning Tier 1 Capital8888Net Change in Tier 1 Capital(e.g., set to equal Net After-TaxIncome from step 2)(3)(31)Ending Tier 1 Capital8557850816Estimated Average AssetsEstimated Tier 1 Leverage Ratio12Supervisory Insights 10%7%Summer 2012
Risk-Stratification Matrix for aCRE Loan PortfolioAnother relatively simple analysisis a risk-stratification matrix basedon debt-service coverage (DSC) andloan-to-value (LTV). In this three-stepexample, an institution could:1. Stratify and aggregate a segmentof CRE loans that represents ameaningful sample of the portfoliobased on current DSC and LTV,and slot the results in the matrixas a percentage of total risk-basedcapital. For a smaller institution,the largest 10 or 20 CRE loan exposures may be sufficiently representative. The intensity of potentiallyhigher risk exposures is highlightedin pink (elevated risk) and red(more severe).2. Devise plausible assumptions aboutadverse trends in cash flows andcollateral values for the 10 or 20exposures, and then re-slot theresults to create a stressed scenario.In some cases, this may be as simpleas applying a uniform “haircut” (forexample, 20 percent) to the currentcash flows and collateral values.3. Compare the pre-and post-stresstest results to assess the portfolio’svulnerability to certain realisticstress events that could impact theinstitution. Portfolios with strongDSCs and LTVs may show limitedmigration to problem-credit status,while the opposite may be evidentfor portfolios with a large volumeof loans originated at or near theinstitution’s minimum acceptableunderwriting standards.Institutions embarking on a stresstesting process may want to prioritizework based on the largest exposuresor portfolio concentrations, theriskiest segments of the portfolio, andSupervisory Insights watch-list credits. Insight gained frominitial stress testing can provide thefoundation for more expansive testsif this is deemed necessary. Consistent with outstanding supervisoryguidance, stress testing of concentrated non-owner occupied CRE andsubprime lending portfolios should bea primary focus. However, communitybanks seeking to enhance their riskmanagement processes may find valuein evaluating risks in owner-occupiedCRE and other concentrated lendingcategories (such as C&I or residential loans) given a downward adjustment in regional and local economiccircumstances or collateral lue60-69%70-79%80-89%90 % 1.75x5.0%45.5%38.0%7.5%1.51x to 1.75x19.0%74.0%53.0%15.0%1.26x to 1.50x22.5%58.0%60.0%12.5%1.16x to 1.25x7.5%35.0%17.5%0.0%1.01x to 1.15x0.0%5.0%25.0%0.0% 1.0x0.0%0.0%0.0%0.0%Note: Cell data represent the volume of loans, as a percentage of totalrisk-based capital, that meet the LTV and DSC criteria for that ue60-69%70-79%80-89%90 % 1.75x0.0%5.0%15.0%7.5%1.51x to 1.75x0.0%7.5%45.0%12.5%1.26x to 1.50x5.0%12.5%20.0%25.0%1.16x to 1.25x0.0%20.0%17.5%12.5%1.01x to 1.15x0.0%50.0%125.0%70.0% 1.0x0.0%10.0%35.0%5.0%Note: Cell data represent the volume of loans, as a percentage of totalrisk-based capital, that meet the LTV and DSC criteria for that cell.Summer 201213
Stress Testing Credit Riskcontinued from pg. 13Common Risk Measures for Developing Stress Tests for Individual CRE LoansThese risk measures have been used to assess the effect of financial, economic, andmarket factors on CRE loan repayment. Many of these measures also apply to other loancategories. Institutions may find it beneficial to conduct stress tests using one or a combination of these risk factors: debt-service coverage loan-to-value ratios and capitalization rates property net operating income collateral value depreciation (regional and local) CRE sector performance (office, retail, multi-family, warehouse/industrial, lodging) interest-rate levels on variable-rate loans contractual terms (amortization, balloon payments) that may introduce refinancing orrepayment risk occupancy status lease rates unit absorption rates for real estate developments economic factors such as changes in local employment and house pricesUsing Stress-Test ResultsBanks gain the most benefit fromstress-testing exercises when theyare incorporated into the overall risk management and strategicplanning processes. For example,results of portfolio-level stress testscan be reviewed by boards of directors and senior management as onecomponent of their analysis of lending concentrations, the adequacy ofcapital and the allowance for loanand lease losses, and the overall riskfacing the institution. Additionally,stress-test results for individual loanscan be used by loan officers andcredit committees to better understand a borrower’s or property’s riskcharacteristics and position the bank(as lender) for unexpected adversecircumstances. Also, institutions withsound risk management practices14Supervisory Insights surrounding stress testing, includingboard oversight and direction, appropriate policy guidance, and an effective internal control and validationprocess, will have greater confidencein the reliability of stress-test results.The strategic value of stress testingmay be greatest during the expansionary phase of business cycles. Duringtimes when losses are minimal andproperty values are rising, stresstesting assessments of riskier assetsand concentrated positions can helpmanagement anticipate potential risksarising from lower-than-expected obligor cash flows, deteriorating local orregional economic circumstances, ordeclining real estate values. Directorates can use stress-test results as partof establishing risk tolerances andensuring that remedial or mitigatingaction is taken when elevated risksbecome evident. If a board determinesSummer 2012
that the institution’s current riskprofile exceeds tolerable levels, it maywant to review credit-exposure limits,loan underwriting standards, the needfor additional capital or staffing, orother financial, operational, or administrative measures.ConclusionCommunity banks can implementan effective stress-testing process ina straightforward manner to help theboard of directors and senior management understand the potential impactof adverse scenarios. Clearly, institutions with total assets of less than 1billion tend to have less complex creditportfolios and a particularly intimateunderstanding of their borrowers andlocal economic conditions. Therefore,when an institution is subject to asupervisory expectation to conductstress tests (as with the 2006 CREguidance) or otherwise wishes toconduct stress tests, it may be sufficient for such institutions to analyzethe portfolio in a simple spreadsheetto simulate base-case and severe stressscenarios. To the extent loan portfoliosinclude speculative, risky, or concentrated elements, an institution canstress test these exposures to identifySupervisory Insights potential vulnerabilities to enable theboard of directors to make informedstrategic decisions. Used in this way,stress testing can be a valuable toolto assist institutions in strengtheningcredit-risk management practices.This article should not be construedas supervisory guidance or establishing regulatory expectations.William R. BaxterSenior Examination Specialistwbaxter@fdic.govThomas F. LyonsActing Chief, Policy andProgram Developmenttlyons@fdic.govThe authors thank Steven Burton,Chief; Margaret Hanrahan, SeniorExamination Specialist; and JohnWeier, Chief for their valuablecontributions to this article.Summer 201215
and service the loan per contractual terms. For example, a bank could assume the departure of a key tenant in a commercial real estate project and measure the resulting effect on loan performance. The results of such stress analy-ses can help an institution determine whether to make a loan and if so, formulate a more appropriate loan structure .
113.credit 114.credit 115.credit 116.credit 117.credit 118.credit 119.credit 12.credit 120.credit 121.credit 122.credit 123.credit 124.credit 125.credit 1277.credit
1.4 importance of human resource management 1.5 stress management 1.6 what is stress? 1.7 history of stress 1.8 stressors 1.9 causes of stress 1.10 four major types of stress 1.11 symptoms of stress 1.12 coping with stress at work place 1.13 role of human resource manager with regard to stress management 1.14 stress in the garment sector
Executive Summary 6 . Company Overview 7 . Basel III Overview 7 . Capital Requirements and Management 12 . Capital Summary 14 . Credit Risk 16 . Overview 16 . Wholesale Credit Risk 18 . Retail Credit Risk 20 . Counterparty Credit Risk 22 . Securitization Credit Risk 26 . Equity Credit Risk 30 . Operational Risk 33 . Market Risk 35 .
1. Stress-Strain Data 10 2. Mohr Coulomb Strength Criteria and 11 Stress Paths 3. Effect of Different Stress Paths 13 4. Stress-Strain Data for Different Stress 1, Paths and the Hyperbolic Stress-Strain Relationship 5. Water Content versus Log Stress 16 6. Review 17 B. CIU Tests 18 1. Stress-Strain Data 18 2.
2D Stress Tensor x z xx xx zz zz xz xz zx zx. Lithostatic stress/ hydrostatic stress Lithostatic stress Tectonic stress Fluid Pressure-Hydrostatic-Hydrodynamic Lithostatic Stress Due to load of overburden Magnitude of stress components is the same in all
required to have the Credit Card Credit permission to access the Apply Credit Card Credit. The patient transactions that appear in the Credit Card Credit page are limited to charges with a credit card payment. This can be any credit card payment type, not just Auto CC. To apply a credit card credit: 1.
Θ. Typical stress distributions in a welded connection with fi llet welds are shown in Figure 2 b). These various stress a) The overall geometry b) The stress state at the weld toe Figure 1 – Stress state in the weld toe region of a welded joint a) Stress fi elds in an unwelded plate b) Stress fi elds in a plate with non-load carrying one .
use of the stress path method in solving stress-strain problems in soil mechanics. Some examples of stress paths are shown in Fig. 7.5. Fig. 7.5(a) shows a number of stress paths that start on the p axis ( σ1 σ3), the stress paths going in different directions depending on the relative changes to σ1 and σ3. Fig. 7.5(b) shows stress paths .
