Commercial Loan Stress Tests

Collections Training Resource
June 26, 2012 — 1,149 views  
Become a Bronze Member for monthly eNewsletter, articles, and white papers.

New risk management measurements are constantly developing in order to evaluate investments following the Great Recession. The evolving implementation of commercial loan stress tests is allowing business institutions to better determine which investments will do well and which will fail by examining a variety of alternative elements. While the risk mitigator is used by a number of organizations, the commercial real estate industry seems particularly fond of employing it.


According to Money Library, various elements are applied to a portfolio to determine how fast and far an investment could fall if a perfect storm developed. In addition, it enables a business to identify whether it can cope if certain scenarios were to develop and put plans of action together.


In the commercial real estate industry, the integration of loan stress testing has become popular with lenders that all-too frequently were left holding the paperwork from defaults. Loan stress testing allows a lender to conduct scenario applications for common external impacts such as economic shifts, falling real estate values, increased property demand and rising interests, according to Hardland Financial Solutions.


The rising popularity of this tool is in part caused by commercial real estate’s vulnerability in today’s unstable market. The Federal Reserve Bank of Philadelphia states the connection between commercial and residential housing development, including land acquisition and development, construction, conversion rates and any other emerging market conditions make each industry exposed to negative influences.


The source claims that the likelihood of a stress test being done on a particular sector relies heavily on the size of the portfolio relative to another and the geographic market trends of the areas in question. The slow growth rate of the commercial market and the great impact of negative influences make commercial lenders less inclined to ignore any poor scores found on impact performance reports through stress testing.


Commercial loan stress tests should consider the regional impacts of the local economy as well as the national. The varying degrees at which these will change the scenario are dependent on the location of the market in question. Areas such as the Northeast featured little residential housing trials in comparison to areas such as the Midwest.


The application of loan stress testing allows a commercial lender to dissect the results to determine how best to invest. Commercial lenders looking to strengthen their portfolios can integrate loan stress tests.

Collections Training Resource