We have developed a methodology which captures interest rate, revenue reduction, and industry/collateral type risk in a stress test scenario. This methodology is generally deployed while completing the Loan Review; this is a cost-effective approach to completing a stress test. It can be completed on a stand-alone basis.
The parameters of this stress scenario are derived from a combination of collaboration with the Client, as well as using a risk-based approach to assign risk to the industry/collateral type. The results are used to create a migration analysis to apply these findings in a “bottoms-up“ approach. Using a migration analysis derived from the loans included in the Stress Test, these results are applied to the entire commercial loan and commercial mortgage portfolio to ascertain the pro-forma impact of the stress scenario on Asset Quality. The Clients ALLL model is updated with the results of the Stress Test, and a pro-forma provision is calculated lending to a pro-forma Earnings calculation. The Earnings calculations then flow through to the balance sheet to obtain the pro-forma impact on Capital.
This tool provides a quantitative outcome, which can be updated and adjusted for changing circumstances. This flexibility allows the model to also be used for Strategic Planning and to provide quantitative support for portfolio concentrations.