As regulators grow increasingly concerned with the outlook for the commercial real estate market, a Denver software company is set to launch a product that would help community banks gauge the strength of commercial real estate loans in their portfolios.
This month Fimac Solutions LLC is releasing its commercial real estate stress test, modeling software that promises to help banks determine whether a borrower will generate enough net income on a property to meet loan obligations. The software can also be used to test the overall commercial real estate loan portfolio, as well as to stress-test various concentrations such as office buildings, shopping centers, or hotels.
The off-the-shelf software lets bankers tweak variables such as occupancy levels, capitalization ratios, rental rates, and interest rates, giving a picture of potential risk. For instance, it can model how a slowdown in travel would affect hotel rental rates or how inflation might affect occupancy rates at strip malls.
Regulators first issued guidance on the need for stress testing in CRE lending in 2006. Stress testing gives the institutions a way "to quantify the impact of changing economic scenarios on asset quality, earnings, and capital," according to interagency guidance offered in January 2006. It is viewed as one way for banks to anticipate risk ahead of time and mitigate it by taking steps such as scaling back in one concentration, diversifying portfolios, increasing reserves, or restructuring loans.
In an interview last week, Steve Fritts, the associate director of risk management policy at the Federal Deposit Insurance Corp., said that commercial real estate "by its nature is economically sensitive. Any concentration you have is an additional risk. We are expecting … stress testing to be one part of the overall analytical processes."
Community banks are especially vulnerable to a commercial real estate downturn because they generally have much larger concentrations of CRE loans on their books than big banks do.
But unlike their larger counterparts, community banks lack the resources to do sophisticated stress testing, said Gregory W. Doner, the chairman and chief executive of Fimac and a former chief financial officer at an Ohio community bank.
Fimac, a software company that focuses on risk and profitability management, declined to disclose the price of its stress-testing product but said it is in line with its other banking software products. The cost to community banks is dependent on the size of their CRE portfolios.
Mr. Doner said the product has no immediate competition in the marketplace but that he has heard of similar products in the pipeline, as well as other software companies including stress testing in their commercial loan management models. The product's likely customers, he added, are small banks in metropolitan markets that have more than 20 commercial real estate loans.
The 2006 regulatory guidance, Mr. Fritts said, does not really call for community banks to come up with complex systems. Rather, it is purposely vague and says only that a system's sophistication should reflect the portfolio's size and complexity.
Still, many apparently are not heeding regulators' advice to do more stress testing.
John C. Dugan, the comptroller of the currency, said in an April speech, "Right now too many community bankers are having too hard a time coming to grips with the problems that have emerged in their commercial real estate portfolios. … ." Though "this resistance to recognizing problems at the beginning of an economic downturn may be human nature, it's not healthy because denial is not a strategy."
Ann Grochala, the director of lending and accounting policy for Independent Community Bankers of America, said the new Fimac program could be useful to community banks, as long as it is not too expensive or too labor-intensive.
