The Strategic Benefits and Challenges of Stress-Testing Your Loan Portfolio

by. Mary Ellen Biery

As the recent NCUA guidance shows, credit unions should be start looking into a methodology for stress-testing their loan portfolio and identifying concentrations with potential risk. According to the NCUA’s Supervisory Letter on Concentration Risk Credit Unions need to “demonstrate their understanding of the risk” for their specific loan concentrations and the services they offer. This guidance has helped many financial institutions better understand what examiners will expect, but there is still some ambiguity and challenges around how to begin. One place to start is identifying how credit union leaders most hope to benefit from stress testing.

For many credit unions, stress testing is a best practice and something they should be progressively implementing in a structured manner, according to Mike Lubansky, director of consulting for Sageworks. That way, they can make the most out of the process.

“Credit unions may be trying to do this to satisfy the regulators and check a box,” he said. “However, if they can implement an effective stress-testing program, institutions have found they can manage the risks better.”
“Stress testing should help management identify pockets of the portfolio that may be vulnerable to changes in short-term interest rates or deteriorating real estate market conditions,” said CEIS managing director of special projects Elizabeth Williams. “Hopefully that gives them a chance to make some changes today or prior to experiencing the actual stress.”

For example, a credit union might change its loan pricing on certain types of real estate to attract or discourage loans in those areas. Or it might modify its marketing efforts to target one sector or another. Indeed, executives at financial institutions are finding that an effective stress-testing program can help them:

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