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© Copyright 2015, Trepp LLC
Introduction to Stress TestingFor Community Banks
EDR / Trepp WebinarSeptember 17, 2015
© Copyright 2015, Trepp LLC2
Speakers
Matt AndersonManaging DirectorApplied Data & Research, Trepp
Mike BenzAssociate Vice PresidentBank Solutions, Trepp
© Copyright 2015, Trepp LLC3
Goals for Today
Introduction to Stress Testing
Look at Some
Solutions
© Copyright 2015, Trepp LLC4
What is Stress Testing?
© Copyright 2015, Trepp LLC5
Stress Testing
• Specific Applications– Credit Loss / Loan Losses– Interest Rate Sensitivity – Asset Liability Management
• Comprehensive– Capital Adequacy– Scenario-based, Regulator-defined– Required for larger institutions (CCAR and DFAST)
© Copyright 2015, Trepp LLC6
Regulators’ Definition
• Stress testing is a forward-looking quantitative evaluation of stress scenarios that could impact a banking institution’s financial condition and capital adequacy. – based on assumptions about potential adverse external events,
such as changes in real estate or capital markets prices– most useful when it reflects the characteristics particular
to the institution and its market area– can be used to evaluate credit risk in the overall loan
portfolio, segments of portfolios, or individual loans
Source: FDIC Supervisory Insights
© Copyright 2015, Trepp LLC7
Regulators’ Definition
• Stress tests can be used to evaluate whether existing financial (such as capital and liquidity) and operational (such as staffing and internal systems) resources are sufficient to withstand an economic downturn or unexpected event.
Source: FDIC Supervisory Insights
8 © Copyright 2015, Trepp LLC
The Current State of Stress Testing
Macroeconomic variables Forward looking Multiple
scenarios
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Stress Testing Background
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Stress Testing Evolution
CCARComprehensive CapitalAnalysis and Review
- Began as SCAP (2009), expanded to CCAR (2011)
- Large Banks: over $50bn
- Review of banks’ capital plans (dividends)
DFASTDoddFrank Act Stress Testing
- Banks over $10bn
- Enterprise-wide capital adequacy
- Public reporting requirement
CECLCurrentExpectedCreditLoss
- FASB “life of loan” loss standard
- Will change how banks reserve for future losses
11 © Copyright 2015, Trepp LLC
Stress Test Concepts
1998: OCC Loan Portfolio Management Handbook
1990s: Interagency Statement on Interest Rate Risk Issued
2006: Joint Guidance on Concentrations in CRE Lending, Sound Risk Management Practices
2010: Interagency Statement Re-stated
Interagency Policy on Funding and Liquidity Risk Management
Stress Testing is NOT a new concept!
2011: Comptroller’s Handbook Concentrations of Credit Booklet
2012-16: OCC Bulletin, Guidance for Evaluating Capital Planning an Adequacy
12 © Copyright 2015, Trepp LLC
What are Regulators’ Expectations?
© Copyright 2015, Trepp LLC13
Regulator Expectations
1. Repeatable, defensible• Won’t fly anymore: “We think using 1.5x our loss experience
during the downturn will be sufficient.”
2. Forward-looking, scenario-based forecasts tied to macro-economic inputs
• Usually means quantitative/regression models
3. Management and Board buy-in• Board is “ultimately responsible”
4. Documented and Tested• Process is as important as the results• If it’s not in writing, it doesn’t exist
14 © Copyright 2015, Trepp LLC
"... stress testing has fundamentally changed the way we think about capital adequacy. The need to specify scenarios, loss estimates, and revenue assumptions--and to apply these specifications on a dynamic basis--has immeasurably advanced the regulation of capital adequacy and, thus, the safety and soundness of our financial system."
“… the single most important advance in prudential regulation since the crisis.”
The Regulator Perspective
Federal Reserve Governor Daniel K. Tarullo "Stress Testing after Five Years" - June 25, 2014
15 © Copyright 2015, Trepp LLC
Scenarios
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What Macroeconomic Variables Go into the Projections?
Macroeconomic indicators:• GDP growth (real, nominal)• Disposable income growth
(real, nominal)• Unemployment rate• CPI inflation
17 © Copyright 2015, Trepp LLC
What Macroeconomic Variables Go into the Projections?
Market Volatility Indices• Dow Jones Total Stock Market Index • Market Volatility Index (VIX) • Home Price Index • Commercial Real Estate Price Index
18 © Copyright 2015, Trepp LLC
Benchmark Yields• 3-month Treasury Yield• 5-year Treasury Yield• 10-year Treasury Yield• BBB Corporate Yield• Mortgage Rate• Prime Rate
What Macroeconomic Variables Go into the Projections?
19 © Copyright 2015, Trepp LLC
Unemployment Rate
0.0
2.0
4.0
6.0
8.0
10.0
12.0
1Q05 1Q06 1Q07 1Q08 1Q09 1Q10 1Q11 1Q12 1Q13 1Q14 1Q15 1Q16 1Q17
Actual Baseline Adverse Severely Adv.
20 © Copyright 2015, Trepp LLC
Commercial Real Estate Price Index
100120140160180200220240260280300
1Q05 1Q06 1Q07 1Q08 1Q09 1Q10 1Q11 1Q12 1Q13 1Q14 1Q15 1Q16 1Q17
Actual Baseline Adverse Severely Adv.
21 © Copyright 2015, Trepp LLC
Stress Testing Results
© Copyright 2015, Trepp LLC22
What Do Stress Test Results Look Like?
Stress Testing must
produce information
that will:
Project income (9 quarters into the future)
Project balance
sheets (9 quarters into the future)
Project Loan Loss (9
quarters into the future for 15 loan
types)
Project capital
Project operational
risk
© Copyright 2015, Trepp LLC23
What Do Stress Test Results Look Like?
24 © Copyright 2015, Trepp LLC
What Do Stress Test Results Look Like?
25 © Copyright 2015, Trepp LLC
15.5%
7.4%
-3.8%
-1.9%-0.8%
0.0% 0.1%
-2.7%
13.9%
0.0%
5.0%
10.0%
15.0%
20.0%
25.0%
9/30/2014 PPNR NCO Change inALLL
Taxes Dividends Other RWA 12/31/2016
Capital Ratio Drivers - Tier 1 Capital Ratio
Stressed Capital Drivers
© Copyright 2015, Trepp LLC26
Stress Testing Applications
1. Regulatory Compliance
2. Budgeting / Business Planning
3. Strategic Planning
4. Return Optimization– Right-sizing the capital base to achieve higher ROE
© Copyright 2015, Trepp LLC27
Stress Testing Value Goes Well Beyond Compliance
Compliance Review
Loss Minimization
Risk Measurement
Risk Management
Strategic Integration
Return Optimization
Enterprise Risk Management evolves in organizations
Regulatory Compliance is just the first step
Risk Control Balance Sheet Protection
Risk/ReturnOptimization
Value Creation
28 © Copyright 2015, Trepp LLC
Loan Modeling
29 © Copyright 2015, Trepp LLC
Credit Loss / Loan Modeling
Top Down
Portfolio Segmentation
Historical Loss Rate Application
Bottom Up
Probability of Default (PD)
Risk Rating Migration
- Loss Given Default (LGD) - Expected Loss (EL)
© Copyright 2015, Trepp LLC30
Loan Models: PD, LGD, EL
• Probability of Default– Likelihood ranging from 0% to 100%, over time– Cumulative PD from 0% to 100%
• Loss Given Default – Loss severity– How large is the loss in the case of default
• Expected Loss– PD * LGD * Outstanding Loan Balance, over time.
31 © Copyright 2015, Trepp LLC
PD vs LTV and DSCR
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Loan Data Input
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Loan Level Results
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Portfolio Summary
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Portfolio Summary
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Data download and interactivity allow for further analysis
Customized Output
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CECL
© Copyright 2015, Trepp LLC38
CECL: Current Expected Credit Loss Model
• FASB: Proposed Accounting Standards Update (Subtopic 825-15), announcement expected in Q3 2015
• Transition period through January 2018
• Loss Reserve based on forward-looking, "life of loan" assessment
• Acceptable methods include probabilities of default, historical loss rate averages, discounted cash flows
© Copyright 2015, Trepp LLC39
CECL Impacts
• Audit and disclosure needs will increase
• Preparation: Data collection and aggregation across multiple platforms
• Implementation of a model or system that can account for analytics, compliance, and reporting
• OCC has estimated ALLL increases of 30 to 50%
• Bankers tend to believe 50% increase
© Copyright 2015, Trepp LLC40
Getting Started
41 © Copyright 2015, Trepp LLC
How Do I Get Started?
Since regulators will be redefining stress scenarios over time, you want your solution to be flexible, allowing for a wide range of scenarios and assumptions
All capital adequacy models should be treated as a long-term and integral part of any strategic planning process
All capital adequacy models should be aligned with bank management’s forward looking business assumptions
© Copyright 2015, Trepp LLC42
How Do I Get Started?
Make sure you have access to your
internal data
If building your own models, make sure you have access
to the right external data
What data do I need? Is the data reliable?
43 © Copyright 2015, Trepp LLC
• Time can be a resource or a constraint
• Starting early opens more options
• Determine needs
• Develop and stay within budget
When Should I Start?
© Copyright 2015, Trepp LLC44
Trepp Overview
45 © Copyright 2015, Trepp LLC
• Bank Navigator / T-CAST
• TreppDM Loan Model
• CRE Data Feed
• TreppLoan
Trepp Products for Banks
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TreppDM – Loan Modeling
47 © Copyright 2015, Trepp LLC
CRE Data Feed
• Over 100,000 commercial and multifamily mortgages
• Monthly loan data, quarterly property financials• History to late-1990s• More than 250 data elements per loan• Uses include loan modeling and benchmarking /
score cards
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TreppLoan – Source Deals
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Questions
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www.trepp.com
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