Stress Testing and Vintage Analysis are Key to Managing CRE Concentration Issues

June 2016

Stress Testing and Vintage Analysis are Key to Managing CRE Concentration Issues

Appropriate stress testing is essential to showing examiners that your bank is managing its commercial real estate concentrations appropriately – but most community banks are using stress tests the wrong way. That’s the message from a recent Bank Insights webinar featuring Invictus Consulting Group co-founder Adam Mustafa.

Examiners across the country are ratcheting up the pressure on banks with growing CRE loan portfolios, Mustafa warned, and in some cases they are writing MRAs for banks with no capital plans and CRE concentrations above recommended thresholds.

OCC examiners told Suffolk Bancorp in New York that it had to curtail lending and increase capital because of its CRE concentrations – an example Mustafa highlighted in the presentation. The bank announced it was being acquired at the end of June, a sure sign that not dealing with CRE concentrations can have significant consequences for community banks.

Banks think they can solve the CRE problem with stress testing alone, but Mustafa outlined five reasons why that’s not working:

Only the CRE loan portfolio is being stress tested, which does a disservice to parts of the bank that are strong.

Data gathering for loan-level stress tests is a nightmare. Most banks don’t have it centralized. (This will be an issue for banks when CECL is implemented as well).

Banks are treating the stress tests as a ‘check-the-box’ exercise, without including top management to guide the process or use the results to position the bank for success.

Management doesn’t understand the results, so they are not in a position to have effective conversations with examiners.  “They rubber stamp it and give it to the regulators. It won’t work,” Mustafa warned. “If regulators don’t think management understands it, the mission fails.”

Most banks are not applying the stress test results toward strategic and capital planning.  “Think of it as a strategic exercise, not a compliance one. If you do that, it will be worth the reward,” Mustafa said.  Banks should and can use stress test results “for offense, as well as defense.”

“Stress testing is the right tool for the job. It’s the tool, not the job,” Mustafa said. “Most banks think of it as an end game. Think of it instead as a tool to provide insights and the ability to show regulators that you can handle CRE concentrations.”

Mustafa showed banks how they can use a combination of top-down and bottom-up stress testing to demonstrate to examiners that they “can be trusted with elevated levels of CRE concentration.”  Key to that analysis is using loan-level data to analyze the portfolio by vintage – another lesson that will be important for banks when they implement CECL.  Mustafa said you cannot underestimate the importance of vintage, since it identifies the economic and competitive conditions on the day the loan was originated.

Banks must be able to show regulators they have risk management and capital planning infrastructure and skill-set to manage their portfolios, regardless of their CRE concentrations. “If they get that sense of comfort from you, believe me, you will be able to operate well above the thresholds.”

Mustafa urged banks to see the big picture and understand what regulators are really thinking. “If you can read between the lines, and not just the rules itself, then you can see the spirit of what is happening and use sophisticated techniques to achieve the end result,” Mustafa said.

Editor’s Note: If you want more information about the webinar, “Powerful and Practical Techniques to Manage CRE Concentrations amid Regulatory Scrutiny,” please contact George Dean Callas at