©2015 RSM US LLP. All Rights Reserved. ©2015 RSM US LLP. All Rights Reserved.
BUILDING BLOCKS FOR EFFECTIVE LOAN PORTFOLIO STRESS TESTINGJohn P. Behringer, CPA
Partner
November 17, 2015
©2015 RSM US LLP. All Rights Reserved.
Housekeeping Items
• Ask questions throughout
the session using the
GoToWebinar control
panel
• The slides and the
recording will be sent out
to attendees after today’s
session
1
©2015 RSM US LLP. All Rights Reserved.
About Sageworks
• Financial information company that provides credit and risk
management software solutions to thousands of financial
institutions
− Stress Testing, ALLL, Credit Analysis, Loan Administration, Workflow,
Risk Rating, TDR, Loan Pricing, Accounting for Purchased Loans
• Awards
− Named to Inc. 500 list of fastest growing privately held companies in
the U.S.
− Named to Deloitte’s Technology Fast 500
− NC Tech Awards: Excellence in Customer Service
2
©2015 RSM US LLP. All Rights Reserved.
About RSM
• After 50 years of operating as a member of the RSM International network, our firm (formerly McGladreyLLP) united with these fellow firms, effective October 26, 2015, under a common name and global brand: RSM.
• RSM US LLP is the leading provider of audit, tax and consulting services focused on the middle market, with more than 8,000 people in 80 offices nationwide. We are a licensed CPA firm and the U.S. member of RSM International, a global network of independent audit, tax and consulting firms with more than 37,000 people in over 110 countries. RSM uses its deep understanding of the needs and aspirations of clients to help them succeed.
3
©2015 RSM US LLP. All Rights Reserved.
About the Presenter
− Great Lakes Financial Institutions Practice Leader
− National Leader for Credit Risk Services
− Over 15 years experience providing Risk and Advisory Services to Financial Institutions
− Experience assisting clients implement loan portfolio stress testing methodology
• Model selection
• Governance
• Reporting
John P. Behringer
Risk Advisory Partner
4
©2015 RSM US LLP. All Rights Reserved.
Agenda
• Business Case for Stress Testing
• Regulatory Expectations
• Stress Testing Methodology Basics
• Basic Stress Testing Example
• Stress Testing Governance Considerations
• Open Discussion
5
©2015 RSM US LLP. All Rights Reserved.
Polling Question
In your opinion how strong is your institution’s
current loan portfolio stress testing program?
• Best in class
• Overall effective but could be enhanced
• Work in progress
• What’s loan portfolio stress testing?
6
©2015 RSM US LLP. All Rights Reserved.
Common Attitudes Toward Stress Testing
• Why bother?
• We ran the stress test but now what?
• We implemented a model but these results do
not make any sense.
• How do I use the results in an effective manner?
• We do it at the loan level in credit presentations.
7
©2015 RSM US LLP. All Rights Reserved.
Can you answer these questions?
• How does a 100 or 200 BPS rate shock impact your borrowers ability to repay?
• Drop in commodity prices impact on marginal borrowers debt service ability?
• How does a negative change in capitalization rates on multi-family or non-owner occupied CRE impact NOI for your borrowers?
• Are we effectively monitoring concentrations and how a negative event in any one industry or vertical may impact the asset quality of our loan portfolio?
• How would a stress event impact the aggregate loan portfolio and in turn how does that impact capital?
8
©2015 RSM US LLP. All Rights Reserved.
Stress Testing Benefits
• Early warning on potential problem loans
• Broader perspective on overall level of loan portfolio credit risk
• More precise scenarios for use in capital stress testing
• Assist in eventual implementation of CECL
• Data point for consideration in ALLL adequacy analysis
• Provides Board of Directors ability to establish and monitor portfolio risk against established risk appetite (think ALCO)
• Comply with regulatory expectations
9
©2015 RSM US LLP. All Rights Reserved.
Polling Question
Did we convince you why stress testing is
important and beneficial for your institution?
• Yes I’m on board let’s keep the train moving!
• Maybe but would like to know specific regulatory
expectations.
• Not sure . . . . Keep going . . . .
• Nope I’m just here for the CPE
10
©2015 RSM US LLP. All Rights Reserved. ©2015 RSM US LLP. All Rights Reserved.
REGULATORY EXPECTATIONS
©2015 RSM US LLP. All Rights Reserved.
Regulatory Expectations
• FDIC – Supervisory Insights Summer 2012
− Stress testing expectations are more limited and discrete for banks under $1 billion
− Existing guidance requires banks with CRE or subprime concentrations should perform portfolio-level or sensitivity analysis to evaluate impact on asset quality, capital and earnings
− No specific method recommended and expectations for larger institutions not expected of community banks
− Extent and depth of stress testing should be consistent with the organization’s risks, i.e. portfolio size, concentrations and type of lending
• OCC – Bulletin 2012-33− Considers some form of stress
testing or sensitivity analysis on at least an annual basis of the loan portfolio necessary to maintain a sound risk management program
− No specific method recommended
− Effective elements in a stress test identified include:
• Consider plausible “what-if” questions about vulnerabilities
• Provide reasonable (i.e. directionally consistent) results regarding impact on earnings and capital from stress event
• Incorporate results into overall risk management (i.e. ERM) activities – ALCO, Capital Stress-test/planning, etc.
12
©2015 RSM US LLP. All Rights Reserved.
Regulatory Expectations
• Supervisory Guidance on Model Risk Management− Stress test methodology should be developed consistent with regulatory
guidance on Model Risk Management
− Stress test model should be identified and captured in model universe
− Key areas that require consideration based on guidance• Model Development, Implementation and Use
− Model selection and methodology
− Appropriate use of model and results
• Model Validation
− Independent from model users
− Three keys
• Evaluate conceptual soundness of model
• On-going monitoring
• Outcomes analysis – includes back-testing
• Governance, Policies and Controls
− Policies and procedures
− Roles and responsibilities
− Model inventory
− Remediation monitoring
− Vendor management
− Internal Audit role13
©2015 RSM US LLP. All Rights Reserved. ©2015 RSM US LLP. All Rights Reserved.
STRESS TESTING METHODOLOGY BASICS
©2015 RSM US LLP. All Rights Reserved.
Stress Testing Methodology Basics
• Stress testing methodologies− Transactional sensitivity analysis/Transaction stress testing
• Considers impact of adverse event at loan level
• Typically completed during underwriting and annual review process
• Usually tailored to specific borrower
− Stressed portfolio loss rates/Portfolio stress testing• Utilizes various adverse scenarios at the portfolio level to evaluate impact on
earnings and capital
• Identifies potential problem loans under different scenarios
− Scenario analysis• Similar to Stressed portfolio loss rates/Portfolio stress testing
• Focuses on portfolio segment based on industry/vertical, concentration, etc.
− Enterprise-level stress testing• Integrated approach to stress testing
• Considers multiple variables in scenario to provide a more precise result
− Loan migration analysis• Focuses on estimated impact to earnings from downward migration in risk ratings
− Reverse stress testing
15
©2015 RSM US LLP. All Rights Reserved.
Stress Testing Methodology Basics
• Community Banks
− Two methods most common and beneficial
• Transactional
• Portfolio level
16
©2015 RSM US LLP. All Rights Reserved.
Stress Testing Methodology Basics
• Transactional − Assumptions stressed as part of adverse scenario
should be credit specific • CRE Non-Owner Occupied example
− Loss of key tenant
− Increase in real estate taxes
− Change in Cap Rate
− Promotes consistency in sensitivity analysis completed for both underwriting and on-going monitoring
• Constant assumptions to consider regardless of borrower
− Increase in interest rates
− Decline in collateral value
17
©2015 RSM US LLP. All Rights Reserved.
Stress Testing Methodology Basics
• Portfolio
− Need to segment portfolio
• CALL report categories
• Concentrations
• ALLL segments
− Assumptions
• Will vary by segment
• Consider data points available
18
©2015 RSM US LLP. All Rights Reserved.
Stress Testing Methodology Basics
• Probability of Default
(PD)
− Key assumptions
• Interest rate
• Net operating income
(NOI)
− Revenues
− Expenses
• Loss Given Default
(LGD)
− Key assumptions
• Cap rate
• Collateral value
• Coverage ratios
19
©2015 RSM US LLP. All Rights Reserved.
Stress Testing Methodology Basics
• Key Data Points
− PD
• Revenue
• Expenses
• NOI
• DSC
• Interest rate
− LGD
• Collateral value
• Note balance
• LTV
20
©2015 RSM US LLP. All Rights Reserved.
Basic Stress Testing Example
21
Commercial Real Estate Revenue Expenses NOI Change in NOI
Non-owner occcupied Base -10 -20 -30 Base -10 -20 -30 Base -10 -20 -30 Base -10 -20 -30
Owner occupied Base -10 -20 -30 Base -10 -20 -30 Base -10 -20 -30 Base -10 -20 -30
Commercial and Industrial Revenue Expenses NOI Change in NOI
Lines of credit Base -10 -20 -30 Base -10 -20 -30 Base -10 -20 -30 Base -10 -20 -30
Equipment Base -10 -20 -30 Base -10 -20 -30 Base -10 -20 -30 Base -10 -20 -30
Floor plans Base -10 -20 -30 Base -10 -20 -30 Base -10 -20 -30 Base -10 -20 -30
BPS Change BPS Change Change in Debt Service Coverage
BPS Change BPS Change Change in Debt Service Coverage
Basic PD Analysis - Commercial
Commercial Real Estate Collateral Value LTV
Non-owner occcupied Base -10 -20 -30 Base -10 -20 -30
Owner occupied Base -10 -20 -30 Base -10 -20 -30
Commercial and Industrial Collateral Value LTV
Lines of credit Base -10 -20 -30 Base -10 -20 -30
Equipment Base -10 -20 -30 Base -10 -20 -30
Floor plans Base -10 -20 -30 Base -10 -20 -30
BPS Change
BPS Change
Change in LTV
Change in LTV
Basic LGD Analysis – Commercial
Residential Real Estate Payment Collateral
ARMs Base +50 +100 +200 Base -10 -20 -30 +50 +100 +200 +50 +100 +200 -10 -20 -30
HELOCs Base +50 +100 +200 Base -10 -20 -30 +50 +100 +200 +50 +100 +200 -10 -20 -30
Change in LTVInterest Rate Change BPS Change in Collateral Change in payment Change in DTI
Basic Residential Analysis
©2015 RSM US LLP. All Rights Reserved.
Corporate Governance Considerations
• Who owns the model and process?
− Risk Management Function
• How are the results utilized and how are they
reported?
− Parameters established consistent with risk appetite
− Actionable items and on-going monitoring if out of
tolerance
• Third party model
− How is model risk management addressed?
− Vendor management activities?
22
©2015 RSM US LLP. All Rights Reserved.
Polling Question
Do you feel prepared to discuss stress testing
with key stakeholders?
• Yes – this was excellent and I’m now a stress
testing expert.
• Maybe – could benefit from some examples
specific to my institution.
• No – Still not going to do any stress testing at
the portfolio level.
23
©2015 RSM US LLP. All Rights Reserved. ©2015 RSM US LLP. All Rights Reserved.
©2015 RSM US LLP. All Rights Reserved.
Polling Questions
Learn more about Sageworks Stress Testing?
Learn more about RSM?
25
26
• Increases consistency in pricing decisions• Ensures the institution meets performance targets (e.g., ROE,
ROA, NIM)• Accounts for cost of funds, risk premiums and other expenses • Builds justification/documentation for prices• Can be as simple or complex as the bank needs• Allows for multiple scenario comparisons to find the optimum
loan agreements• Offers pricing benchmarks from proprietary Sageworks
database• Integrates with other Sageworks solutions for data efficiency
BENEFITS OF THE SOLUTION
©2015 RSM US LLP. All Rights Reserved.
Contact Information, Additional Resources
John BehringerPartner, Great Lakes Region Financial
Institutions Practice Leader
RSM US LLP
312.634.5905
Additional Resources
• www.sageworksanalyst.com
− CECL Countdown Webinar on Thursday
− web.sageworks.com/CECL-Countdown-webinar/
• www.rsmus.com
27
Billy BurnetMarketing Manager
Sageworks
984.242.2619
©2015 RSM US LLP. All Rights Reserved.
This document contains general information, may be based on authorities that are subject to change, and is not a substitute for professional
advice or services. This document does not constitute audit, tax, consulting, business, financial, investment, legal or other professional
advice, and you should consult a qualified professional advisor before taking any action based on the information herein. RSM US LLP, its
affiliates and related entities are not responsible for any loss resulting from or relating to reliance on this document by any person.
RSM US LLP is a limited liability partnership and the U.S. member firm of RSM International, a global network of independent audit, tax and
consulting firms. The member firms of RSM International collaborate to provide services to global clients, but are separate and distinct legal
entities that cannot obligate each other. Each member firm is responsible only for its own acts and omissions, and not those of any other
party. Visit rsmus.com/aboutus for more information regarding RSM US LLP and RSM International.
RSM® and the RSM logo are registered trademarks of RSM International Association. The power of being understood® is a registered
trademark of RSM US LLP.
© 2015 RSM US LLP. All Rights Reserved.