Commercial Real Estate Stress Testing

What Is It

CRE Stress Testing is the testing of a credit’s ability to pay under varying market conditions. The most commonly stress variable are:

Capitalization rate

Vacancy/occupancy rate

Interest rate

Operating expenses

NOI

Lease rates

The other, and in some instances most important variable, is the property value. Although a credit manager may input and assume their own “what-if” property value, a reasonable estimate of fair value (FASB #157 Level 3) can be obtained by using the presumed cap rate and NOI.

The idea of Commercial Real Estate Stress Testing is to test the various variables and determine if, at what point, the property is unable to support the debt service. A Stress Test may be conducted at the time of underwriting to allow the lender to understand future risk embedded within the credit, and on a continuing basis as the ever shifting market conditions impact the income of the property.

CRE Stress Testing is strongly encouraged by regulators. The alarm was first sounded in 2000, with the FDIC stepping up their recommendations in 2006 through the FIL channel. In April of 2008 John Dugan, Comptroller of the Currency, in a presentation before the Exchequer Club in Washington, DC, also promoted the use of CRE Stress Testing.

The very next day Federal Reserve Vice-Chair Donald Kohn also publicly encouraged it usage. The cap things off, just a few days later the Western District Office of the OCC released their results of a Horizontal Examination of commercial real estate credits. Within that document was also a plea for Stress Testing.

At FIMAC Solutions LLC we are bringing you the first practical CRE Stress Test Model in the industry. The model will conduct all required stresses and provide the user with an estimate of Loss Given Default if the credit fails a stress. The model is also constructed to provide a “Stress Grade” to each credit to supplement the lenders internal Credit Grade.

An additional benefit of Commercial Real Estate Stress Testing is the ability to analyze a portfolio for concentrations of credit. Since the entire portfolio is loaded into the model, concentration analysis may be conducted by loan type, borrower, guarantor, region or local, and so forth. The user may then look a work case stress by concentration.

CRE Stress Testing is an excellent tool for commercial real estate portfolio management and may be conducted easily and quickly by a member of the support staff with results provided to individual lenders and senior credit administration.

We will begin marketing Version 1.0 of our CRE Stress Analytics Model in early June. Pricing will be for a software license with an annual maintenance fee. Call or e-mail Randall Corwin now to get on the list for our reduced early user discount. rcorwin@fimacsolutions.com  or 877-789-5905, Ext. 739.