Are You Concentrating on Concentration?

According to the OCC’s Concentrations of Credit - Comptroller’s Handbook, excessive concentrations of credit can be a major factor in banking failures.  Many banks review individual borrowers and neglect to implement a proper portfolio concentration management program that can make banks aware of their portfolio concentrations that may cause additional risk.  

In the handbook, the OCC writes:
“Because a concentration of credit tends to perform like a single large exposure, concentrations have the potential to pose risk to earnings and capital. Depending on how broadly a bank defines its common pools of credit exposures, nearly all banks will have concentrations in their credit portfolios. Historically, concentrations of commercial real estate loans, … have played major roles in the failure or material weaknesses of a large number of banks.”

Stress testing portfolio concentration is a way to assess the vulnerabilities of the bank to specific concentrations.  It is a key exercise for banks which provides important guidance about potential risk exposure by testing the ability to withstand market changes within portfolio concentration categories within their portfolios. Unlike individual loan stress testing typically performed during underwriting, the results of the portfolio stress test are not intended to be a transactional analysis of the creditworthiness of individual loans, nor do they create a specific number or adjustment factor that can be applied quantitatively to credits.  Instead, the information can help direct the bank to selected concentration groups that may be at risk, and serve as a “compass” to help inform a bank of risk direction.  

Using commercial real estate (CRE) as an example, simple concentration analysis can begin by breaking the CRE portfolio into segments including property type by owner occupied status, project location, risk rating and product.  Once these segments have been defined, local market conditions and institution-specific lending patterns can be incorporated as determining factors of which concentrations should be used for stress testing.  

After CRE concentrations have been identified for stress testing, reasonable scenarios of “shocks” need to be established for testing against these concentration segments. These tests are likely to be variable-based on the intensity of shock, such as low, moderate and severe, and utilize a number of market/economic indicators like NOI, cap rate and debt service amount. The results of these tests will be reports that will show the aggregate impact of the various stress scenarios on the loan concentration segment loan values. Meaningful measurements showing changes in loan value including LTV and DSC are compared pre- and post-stress to evaluate the impact of the test. 

This resulting information may suggest heightened exposure for certain portfolio concentration segments under times of market stress, and could lead a bank to do further analysis of the condition of the underlying credits in that sector, or look closer at the current market conditions that influence borrower/loan performance in that sector.  At a minimum the bank will be better aware of where credit deterioration may develop more quickly within their CRE portfolio and be able to take proactive steps to limit their exposure. 
Ardmore Banking Advisors’ set of Credit Quality reports, generated from our web-hosted data platform, myCreditInsight, were designed based on the OCC’s Handbook, referenced above, to meet regulatory expectations and exhibit your bank’s proactive monitoring of concentration trends and key risk indicators - a best practice in credit risk management.  

Reports are ready “out of the box” in HTML, Excel, Word, and PDF formats, with drill-to-detail capabilities. They demonstrate your bank’s ability to meet or exceed all concentration management capabilities.  For more information about our concentration reporting and stress testing capabilities, please contact Peter Cherpack at