1. Liz Williams, Managing Director, CEIS Review
Mike Lubansky, Director of Consulting Services, Sageworks

2. To ask a question during the webinar, feel free to enter it into the chat box
along the right hand side of your screen. Slides are available there, too. We
will email you if we can’t get to your question during the presentation.
Link to download slides
Area to enter questions or
write-in poll answers

3. 

An Independent consulting firm serving lending institutions
regarding their loan portfolios since 1989
Experience providing the following services:
◦ Loan Review Programs
◦ Loan Loss Reserve Methodology Validation or Refinement
◦ Loan Portfolio Stress Testing
◦ Consulting
 Credit Risk Process Review
 Loan Policy Maintenance
 Loan and Credit Seminars

4. 



Financial information company that provides credit and risk
management solutions to financial institutions
Data and applications used by thousands of financial
institutions and accounting firms across North America
Provides banking industry resources including whitepapers,
webinars, templates and videos on SageworksAnalyst.com
Awards
◦ Named to Inc. 500 list of fastest growing privately held companies
◦ Named to Deloitte’s Technology Fast 500

5. 
Elizabeth (Liz) Williams
Elizabeth is Managing Director of Special Projects & “Complex”
Reviews at CEIS Review, Inc., where she is responsible for various
projects for clients involving “complex” portfolios, process and
procedure, loan loss reserve methodology, stress testing and other
specific needs.

Mike Lubansky
Mike is a director of consulting services at Sageworks, where he
oversees product development, research and implementation in the
banking market. He often presents on risk management, most
recently to the FFIEC on stress testing methodologies.

6. 

Does your institution currently perform any of the following
stress tests?
When evaluating capital adequacy, have examiners cited your
stress testing results?

7. 





What is Stress Testing
Stress Testing & Capital Adequacy Regulations
CRE Stress Tests
Top Down Stress Tests
Expected Thresholds
Basel III Implications

8. 




Perform loan-, portfolio- or institution-level analysis
Develop scenarios of stressed environments: baseline,
adverse and severely adverse
Apply stress scenarios and calculate estimated impairment
View potential impact on the financial institution’s earnings
and capital
Determine complexity of stress tests according to bank size,
loan portfolio characteristics and risk appetite

9. 
“Bottom up” Analysis
1.
2.
3.
4.

Apply set of assumptions to a sample of individual transactions
Determine impact on key ratios for each transaction
Aggregate results at the portfolio level
Extrapolate results across portfolio (depending on sample size)
“Top down” Analysis
1. Segment the portfolio into homogeneous pools
2. Evaluate impact of a scenario(s) on each pool
3. Aggregate results for each pool at total portfolio

10. 
Individual Transactional Analysis
o Typically performed at underwriting / approval
o Sensitize cash flow or other indicators
o Assess impact on risk of migration to criticized / classified
/default
o Not focus of today’s discussion

11. • Interagency Guidance on CRE Concentrations
2006
• Portfolio stress testing key “in establishing a risk management framework that
effectively identifies, monitors and controls CRE concentration risk.”
• “…sophistication …should be consistent with the size, complexity, and risk
characteristics of its [the bank’s] CRE loan portfolio.”
• Primarily describes “bottom-up” analysis
• CCAR Requirements for 19 Largest Banks
2009
• Annual “top down” analysis - assess capital adequacy under adverse economic
conditions
• Dodd-Frank – Requirements for Banks > $10 Billion in assets
2011
• Expands CCAR-like “top down” process to larger number of banks
• Implementation deferred to 2013 ($10 billion to $50 billion in assets)

12. • OCC Comptroller’s Handbook - “Concentrations of Credit” – Update
2011
• “Banks of all sizes will benefit by supplementing stress testing of significant
individual loans with portfolio and firm-wide stress testing. The overall goal is to
quantify loss potential and the impact on earnings and capital adequacy.”
• Combination of “bottom-up” and “top-down” analysis
• Interagency Expectations for Stress Testing by Community Banks
2012
• Confirmed that Dodd-Frank and CCAR requirements would not apply
• Reiterated that “all banking organizations, regardless of size, should have the
capacity to analyze the potential impact of adverse outcomes on their financial
condition….The agencies note that such existing guidance, including that covering
interest rate risk management, commercial real estate concentrations, and funding
and liquidity management (among others), continues to apply.”
• Combination of “bottom-up” and “top down” analysis
• Other Agency-Specific Publications
2012
• FDIC –Supervisory Insights – “Stress Testing Credit Risk at Community Banks”
• OCC – “New Stress Testing Guidance and CRE Stress Test Tool”
• More specific comments regarding processes

13. 
Bottom up stress tests typically focus on CRE portfolio, using
one or a combination of these factors:
o
o
o
o
o
o
o
o
o
o
„debt-service coverage
„loan-to-value ratios and capitalization rates
„property net operating income
„collateral value depreciation (regional and local)
„CRE sector performance
„interest-rate levels on variable-rate loans
„contractual terms that may introduce refinancing or repayment risk
„occupancy status and„lease rates
„unit absorption rates for real estate developments
„economic factors such as changes in local employment and house prices

14.  234 Loans in sample as of
1/31/2012
 65% of Pass-rated CRE,
Multifamily & Construction
 C&I loans with real estate
collateral treated as CRE
 Includes loans reviewed
between Dec. 2010 and March
2012
 Coverage increases every
quarter
 Income properties (263 loans,
84% of exposure):
o 154 Multifamily
o 23 Retail
o 22 Industrial
o 35 Office & Other
Stress Segments
Other Income
Properties 31%
(% Total Exposure)
Construction
9%
(Retail 11%;
Industrial
OwnerOccupied
4%
10%;
Guarantor
3%
Office & Other
9%)
Income - MF
(State 1)
25%
Income - MF
(Elsewhere)
11%
Income - MF
(State 2)
17%

15. Grade Migration Assumptions
Assumed Migration Depends on Recourse, LTV and DSCR
Full Recourse
Grade
LTV < Benchmark %
LTV ≥ Benchmark %
Pass
Marginal Pass
Special Mention
(Appropriate DSCR Thresholds)
(Appropriate DSCR Thresholds)
Classified (Substandard or Doubtful)
Less Than Full Recourse
Grade
LTV < Benchmark %
LTV ≥ Benchmark %
(Appropriate DSCR Thresholds)
(Appropriate DSCR Thresholds)
Pass
Marginal Pass
Special Mention
Classified (Substandard or Doubtful)

16.  DSC recalculated with higher
rates
 Up to +300 bps by 50 bps steps
 Apply standard grade migration
assumptions to adjusted DSC
and current LTV
 122 loans maturing or resetting
by 3/31/17 treated as interest
sensitive
 53% of exposure (26 loans)
reset after 2014
 93% of exposure (101 loans)
remain Pass up to +150 bps
 Falls to 63% Pass (70 loans) at
+300 bps
 Over half the migration is to
Special Mention rather than
Classified
 No potential impairments
estimated
Scenario I - Interest Rate Sensitivity
Potential Grade Migration
100%
80%
60%
40%
+50 bps
+100
+150
+200
+250
+300
bps
bps
bps
bps
bps
Classified
0%
0%
2%
6%
9%
17%
SM
2%
2%
4%
7%
9%
21%
98%
97%
93%
88%
81%
63%
Pass

17. Flexible scenario
Impact at loan and
summary level

18. Capital levels

19. “For most community banks, a simple stressed loss-rate analysis
based on call report categories may provide an acceptable
foundation to determine if additional analysis is necessary.”
OCC Supervisory Guidance– Community Bank Stress Testing– 10/18/2012


Segment the portfolio into pools with similar risk characteristics
Develop “stressed” loss rates for each segment; consider:
◦ Bank’s historical loss rates over several stress periods
◦ Peer / market loss rates over several stress periods
◦ Results of any “bottom up” stress testing


Calculate Stress Period Loss amounts (2-year timeframe)
Estimate Earnings impact, apply to Tier 1 Capital ratios

20. 1. Estimate Portfolio Losses Over the Stress-Test Horizon
Stress Period Loss Rates, Two Yrs
Est. Portfolio
Balances, in $
Construction & Development
Moderate Case
Stress
Severe Case
Stress
Stress Period Losses, Two Yrs
Moderate Case
Stress, in $
Severe Case
Stress, in $
124
14.0%
25.0%
17
31
22
2.5%
5.0%
1
1
Residential Mortgage
372
2.9%
6.5%
11
24
Other Loans
125
5.0%
10.0%
6
13
Totals
643
35
69
Commercial Real Estate
2. Estimate Revenues and Impact of Stress on Earnings
Moderate Case
Stress, in $
Severe Case
Stress, in $
Pre-provision net revenue (over two years)
31
25
Less Provisions
35
69
Less Tax Expense (Benefit)
-1
-13
Net After-Tax Income
-3
-31
Moderate Case
Stress, in $
88
-3
85
850
10%
Severe Case
Stress, in $
88
-31
57
816
7%
3. Estimate Impact of Stress on Capital
Beginning Tier 1 Capital
Net Change in Tier 1 Capital
Ending Tier 1 Capital
Estimated Average Assets
Estimated Tier 1 Leverage Ratio
Capital levels

23. 


Easier to pull together a top down stress test, requires little
loan-level data
Requires market data to assess possible range of loss rates
loan type
Could consider Reverse Stress Test
 Institution back-solves to see what loss rates scenarios cause the
institution to breach capital thresholds
 Management considers how likely those conditions are, makes contingency
plans, or takes other steps to mitigate the identified risks

24. 
With capital levels under stress calculated, the institution can
estimate appropriate ratios
 Tier 1 capital ratio = (Total Equity - Revaluation Reserves) / Risk Based
Assets
 Total capital ratio = (Tier 1 Capital + Tier 2 Capital) / Risk Based Assets
Minimum
Well
Capitalized
Adequately
Capitalized
Undercapitalized
Significantly
Undercapitalized
Tier 1 capital
ratio
4.0%
≥ 6.0%
≥ 4.0%
< 4.0%
< 3.0%
Total capital
ratio
8.0%
≥ 10.0%
≥ 8.0%
< 8.0%
< 6.0%
Current

25. 
If stress tests indicate capital ratios could fall below
thresholds, the institution would have to make a plan that
might include:
1.
2.
3.
4.
5.
6.
7.
closer monitoring of market information,
adjusting strategic and capital plans to mitigate risk,
changing risk appetite and risk tolerance levels,
limiting or stopping loan growth or adjusting the portfolio mix,
adjusting underwriting standards,
raising more capital,
selling or hedging loans to reduce the potential impact from such stress
events.

26. 
“The Basel Committee is raising the resilience of the banking
sector by strengthening the regulatory capital framework…
The reforms raise both the quality and quantity of the regulatory capital base
and enhance the risk coverage of the capital framework. They are
underpinned by a leverage ratio that serves as a backstop to the risk-based
capital measures, is intended to constrain excess leverage in the banking
system and provide an extra layer of protection against model risk and
measurement error.”
Basel III: A global regulatory framework for more resilient banks and banking systems

27. 
Community banks will start transitioning on January 1, 2015
Year (as of Jan 1)
Now
2015
2016
2017
2018
2019
Minimum common equity tier 1 capital ratio
N/A
4.5%
4.5%
4.5%
4.5%
4.5%
Common equity tier 1 capital conservation
buffer
N/A
N/A
0.625
%
1.25%
1.875
%
2.5%
Minimum common equity tier 1 capital ratio plus
capital conservation buffer
N/A
4.5%
5.125
%
5.75%
6.375
%
7.0%
Phase-in of most deductions from common
equity tier 1 (including 10 percent & 15 percent
common equity tier 1 threshold deduction items
that are over the limits)
N/A
40%
60%
80%
100%
100%
Minimum tier 1 capital ratio
4.0%
6.0%
6.0%
6.0%
6.0%
6.0%
Minimum tier 1 capital ratio plus capital
conservation buffer
N/A
N/A
6.625
%
7.25%
7.875
%
8.5%
Minimum total capital ratio
8.0%
8.0%
8.0%
8.0%
8.0%
8.0%
Minimum total capital ratio plus conservation
buffer
N/A
N/A
8.625
%
9.25%
9.875
%
10.5%
Leverage ratio
4.0%
4.0%
4.0%
4.0%
4.0%
4.0%

29. Liz Williams
Managing Director-Special Projects, CEIS Review, Inc.
888-967-7380
lwilliams@ceisreview.com
http://ceisreview.com/
Mike Lubansky
Director of Consulting Services, Sageworks
866.603.7029 ext. 651
mike.lubansky@sageworks.com
www.sageworksanalyst.com