Stress Testing: The Secret Weapon for Managing Commercial Real Estate Risk

According to the FDIC, during the past few decades, insured institution CRE loan exposures credit have increased considerably. This growth has been most prevalent among mid-tier commercial banks, which typically hold assets of $1 billion to $10 billion.

Because of the shift in the usage of commercial buildings, specifically in urban centers due to the pandemic, the concerns around higher percentages CRE loan risk for portfolios loom large. CBRE recently reported that the share of U.S. office buildings with an occupancy rate over 95% declined to 60% in Q2 of 2023 from 63% in Q1 of 2020, which was pre-pandemic. Additionally, the Associated General Contractors of America’s 2024 outlook survey report states that 64% of contractors named rising interest rates and financing costs as one of their biggest concerns. This points to risks in construction lending, which can have a ripple effect on commercial real estate.

As defined by the FDIC agency, various levels of real estate loan risk are broken into profiles. Strong commercial real estate portfolios are ones with:

The FDIC outlines firms with the following criteria as Satisfactory:

Commercial Real Estate loan risk increases with fewer checks and balances in place. The FDIC assesses those with a higher concentration of CRE development loans and a high volume of past-due loans as “fair.” Those with a larger volume of high-risk loan types paired with weakness in risk management and high levels of adversely classified assets are categorized as “unsatisfactory.” Neither of these profiles are ones you want to be associated with your institution or commercial real estate portfolio.

One way to remain in the above-average category is to employ a high-quality commercial loan risk monitoring solution. This tool combined with expert advice can help you make confident and smart decisions regarding real estate loan risk.

Understanding the Mechanics of Stress Testing Tools

Stress testing services are becoming more and more popular in the financial industry. Using this technology, institutions can better track their portfolios on an ongoing basis with less margin for error. DXScore® from DebtX Analytics, a credit rating system for commercial real estate loans, is a premium platform.

Using our stress testing models enables commercial real estate lenders, warehouse lenders, and regulators to uncover credit strengths and weaknesses that otherwise may go unnoticed when originating new loans or monitoring existing loan portfolios. DXScore® is calibrated to calculate a loan’s total credit risk based on the relationships among multiple risk variables observed over the long term.

Our stress testing process distills these risks into a single numeric credit score that enables lenders and regulators to evaluate relative risk across otherwise heterogeneous assets.

Stress Testing is an Essential CRE Loan Risk Assessment Method

Regular market monitoring and commercial real estate risk assessment are essential to sound CRE risk management. These insights are truly valuable when they inform swift shifts in commercial real estate concentration limits and exposures in response to fluctuating market conditions.

DXScore® is objective, repeatable, and auditable and provides critical missing information in loan risk assessment. This commercial loan risk monitoring solution measures risk independent of financial factors such as required market yield. DXScore® the first and only credit rating system of its kind.

Identifying signs that suggest CRE markets are at or near a peak is critical to protecting portfolios and mitigating risk. Since our stress testing analytics are based on more than 15 years of trade data and origination data captured on tens of thousands of loans through the DebtX Analytics platform, it can recognize potential triggers more quickly and accurately than other platforms.

Key Advantages of Stress Testing for Commercial Real Estate Lenders

Our highly specialized and proprietary commercial loan risk monitoring models have several features that set them apart from competitors, including:

Incorporating Stress Testing into Commercial Real Estate Loan Risk Strategies

Regulators have recommended institutions with 100% of total capital in loans tied to construction and development or total CRE loans of 300% or more risk-based capital conduct an annual stress test. Even if an institution doesn’t meet those thresholds for required Commercial Real Estate loan risk assessment, regulators still expect lenders to manage CRE loan portfolios closely.

Regardless of portfolio size, DebtX Analytics solutions for stress testing can be affordably integrated into your stress testing and portfolio management processes seamlessly to help you avoid risk and maximize profitability.

Learn more about how this commercial loan risk monitoring model can work for your institution when you schedule a free demo today.

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