According to the Bank for International Settlements (BIS), which overseas the implementation of Basel Capital levels for international banks, Stress Testing is "a generic term describing various techniques used by financial firms to gauge their potential vulnerability to exceptional but plausible events."  Stress tests in the past have been almost exclusively undertaken within the parameters of a bank's interest rate sensitivity.  Thus, a stress test historically measured the impact of a 200 basis point swing in interest rates on the firm's capital position, represented by Value at Risk (Var).  Basel II is calling for a more stringent stressing of not merely interest rate sensitivity but also credit risk.  To date, there has been little quantitative and statistical advancement in stress testing for credit portfolios. 

Nonetheless, recent interagency regulatory guidance on CRE concentrations specifically calls for a stress test of the CRE portfolio.  The manner of the stress test is not delineated.  We believe that a valid stress test should be able to stress individual loans within the portfolio as well as the entire CRE portfolio.  Factors that should be stressed include components of Net Operating Income or NOI  (Potential Gross Income, Vacancy Rate, Effective Gross Income, Operating Expenses); components of Debt Coverage Ratios (NOI, Debt Payment, Interest Rate, Amortization); and components of Loan-to-Value (capitalization rate).

In alliance with Bankers Toolbox, we have developed a comprehensive CRE stress test software application that determines the impact on your institution's capital of varying assumptions about commercial real estate variables - vacancy rates, cap rates, rent rolls, expenses, interest rates and loan terms.