In its description of "stress testing," Wikipedia notes that stress testing is sometimes called "torture testing."
But at Opus Bank in Irvine, Calif., the notion of stress testing is embraced rather warmly.
"It not only gives us portfolio perspective, it gives us accounting and finance perspective as well," says Michael Allison, co-president of the bank, which was founded in September 2010 and so far has suffered no losses on loans it has originated (it has acquired some troubled loan portfolios on which it has taken losses). The bank serves major West Coast population centers such as Seattle that are seeing economic expansion.
At $3.2 billion in assets, Opus is not large enough to be held to the stress-testing requirements Dodd-Frank imposes on large banks. It uses the tests as a risk mitigant and management tool and a precaution, knowing that regulators informally expect it.
Large banks are given dire scenarios to play against their loan portfolios, to see how they would perform, say, if another mortgage crisis occurred.
Smaller banks that don't receive such scenarios need to imagine the worst case on their own. Because many of its loans are commercial real estate and commercial and industrial, Opus looks at factors like unemployment, spending levels, and interest rate movements, and the impact they have on occupancy and such.
"It is hard, there are as many variables as there are people trying to design how best to stress a portfolio," says Allison. "We can look at past economic cycles so we can model in our stress perspective the repeat experience of what's happened before. Economic cycles do tend to repeat themselves."
The bank relies on Moody's downturn and severe downturn scenarios, says Nicole Carrillo, chief financial officer. It obtains loan delinquency data from SNL. It uses FDIC data on loss rates.
The Primatics software models the impact of a downturn on loan performance factors like occupancy and rental rates.
"We don't just do interest rate shocks on our loans like we used to," Carrillo says. "We break it down to a much more granular level of, what will make this default, what will drive that?"
To feed the stress tests, the bank uploads its entire loan portfolio at loan-level detail. "We think that creates a lot more flexibility with the stress scenarios and more accuracy in the results when you can see how variable and fixed rate loans moved," says Carrillo. "It enables us to slice and dice the results to drill down and see trends."
The software generates cash flow projections, interest income projections, loan valuations, forecasted allowances and provisions. "The interest income forecast is very helpful in our budgeting and forecasting," Carrillo notes.
If the software indicates an asset category will be at risk at some point in the future, the bank can reduce that exposure by selling some of those loans or asking for early repayment. (Although salespeople don't typically want to hear that a loan that looks perfectly good at the moment bears future risk, having supportable data lends credibility to the idea that issues may arise.) The software can also point out opportunities for growth in certain asset categories because of strong expected performance.
No risk model is perfect the mortgage crisis proved that. Gut instinct still counts.
"That's a weakness of this whole stress effort the design of how you stress is still fairly subjective, even though it's influenced by economic data," Allison acknowledges. "Unfortunately, old and gray still has its place."
Still, both Carrillo and Allison see value in the exercise.
"We can meet with the regulators with confidence that we're ahead of their expectations," Allison points out.
Over time, Opus plans to split its C&I portfolio by industry (primarily manufacturing, health care and retail), then apply specific industry data on loss probability to those groups of loans. "This is stress testing 2.0 for us," Carrillo says.
Where does the name Opus come from?
"An Opus is your greatest masterpiece," says Carrillo.
"Your life's work," says Allison.
"Our CEO considers this bank his greatest masterpiece," Carrillo explains.