New stress-testing applications intended to help banks develop more detailed diagnoses of potential problems in their commercial real estate portfolios are finding customers.

To prepare for regulatory exams, Pacific Commerce Bank is deploying stress-testing software from Banker's Toolbox Inc. to locate weaknesses in its CRE portfolio.

Cliff Nielsen, a vice president and Pacific Commerce Bank's chief technology officer, said the $187 million-asset bank's portfolio has not been designated as having a high concentration of CRE loans, a distinction usually made at banks with outstanding CRE loan value of more than 300% of Tier 1 capital.

However, the Los Angeles bank is concerned about how continuing weakness in the economy could affect the retail sector, and how this would be felt downstream in its CRE portfolio.

"It's always in our best interest to be doing [stress testing] to make sure we're in good working order and not in a problematic situation," said Nielsen. The bank's CRE loans are mostly in California and Arizona.

The Banker's Toolbox software, called Crest, analyzes potential changes in criteria such as vacancies, capitalization rates, interest rates and gross income. It produces reports on loan-to-value, debt service coverage ratios and net operating income, letting the bank determine hypothetical net collateral shortfalls, note hazardous concentration areas or forecast complications with borrowers facing refinancing.

Crest also allows for analysis of specific asset classes such as apartment loans or retail or business properties. "You can paint multiple pictures and look at your portfolio from different angles," Nielsen said.

About 15 financial companies have started using Crest in the year since it was introduced.

Harland Financial Solutions Inc. also offers a CRE stress-testing product, called Portfolio Manager, which is offered as part of its CreditQuest commercial credit risk management suite or as a stand-alone product.

"It is critical to have a dependable mechanism to quickly and accurately monitor our portfolio," said Julie Jennette Barnes, an executive vice president and the chief credit officer at American Bank in Texas, a $1.5 billion-asset company that recently deployed Harland's software to test for concentrations of different types of CRE loans, such as land and commercial development loans, as well as diagnostics to take interest rate shocks, occupancy levels and appraisal values into account.

Samir Kamat, a senior manager at Capgemini, said advances in stress testing and broader data sourcing allow assessments to graduate from loan-level stress testing to diagnostics of an entire geographic region or type of loan. "The traditional [loan-level] stress-testing approach still exposes you to systemic threats," he said.

An additional business case that technology vendors make for automated CRE stress testing is that banks, particularly community banks, are so busy working out residential loans that they lack the time or staff to run hypothetical numbers on outstanding CRE loans or to manually track indirect drags.

"We have big-box retailers, such as Circuit City and Linens N' Things, that have filed for Chapter 11. The smaller businesses that surround those stores suffer because there's less traffic. That affects the vacancy rate, which affects a CRE portfolio," said Michelle Lucci, a risk management consultant at Banker's Toolbox. Lucci said many banks are still using capitalization rates — which move inversely with loan values — too low for the economic climate; these can be easily recalculated with automated stress testing.

Marketwide risks also argue for strong stress testing. The Real Estate Roundtable said about $400 billion of commercial mortgages will come due through the end of 2009. And Foresight Analytics said total recession-related commercial mortgage losses could rise as high as $250 billion. "There's a huge deleveraging that has to occur," said Tino Korologos, a managing director of distressed debt at Deloitte Corporate Finance LLC.

Community and midsize banks are particularly vulnerable, given their lack of portfolio diversity. "These banks don't have a market outside of their own area, so they can get blindsided by a downturn," said Joel Pruis, director of advisory services at Experian PLC's Experian Decision Analytics unit.