NAFCU Journal May June 2021

30 THE NAFCU JOURNAL May–June 2021 INSIDE NAFCU SERVICES W e keep hearing words like “unprecedented” and “unpre- dictable” in reference to this pandemic. That can be really overwhelming to a credit union looking to complete stress testing with a future so volatile. So, I’ve compiled some answers here to frequently asked questions—and questions I want you to be asking at your institution—about stress testing processes, challenges, best practices and more. Q: What advice do you have for keeping our institution focused and aligned while setting out on the first steps of stress testing? A: Stress testing and loan underwriting foundations are built on risk assessments. In order to do either well, you need current risk data such as loan-to-value (LTV) or FICO at the date of underwrit- ing and at the time of applying stress. All institutions need to understand the credit risk data they have and apply that knowledge to the risk analysis process. Take your time to understand what your data is telling you, update your data if possible, and apply consistent logic. Q: Beyond the impacts of COVID, what other socioeconomic factors should our credit unions be considering as we perform stress testing for the next 3–5 years? A: I believe there are many future issues to pay attention to. Two predominant things to watch out for: ■ Commercial real estate values after COVID-19. Companies will probably use less office/retail space and more people will work from home, thus having effects on available space and possible reduction in collat- eral values. ■ Generational wage disparities. It is forecast that 12,000 Baby Boomers are retiring each day between now and 2030. The labor participation rate of younger people (under 30, specifically) needs to increase dramatically; more young people need to be employed as fewer high-paid Baby Boomers are in the workforce. The wage dispar- ity between these groups may also become a consumer spending issue as well. In general, these younger workers entering the labor force earn less. Q: Are there any macroeconomic variables we should be talking about within those factors, too? A: These are the factors we are paying close attention to because they tend to have higher correlation to credit risk in our clients’ data historically: 1. Labor participation rate 2. Consumer price index (CPI) 3. Inflation rate 4. Commercial real estate value indexes 5. Housing Prices 6. Unemployment Q: How can we predict if our allowance is overstated? Or if we need additional allowances for COVID-19? Does this also support additional allowances? A: Yes. However, you must understand your current risk profile. This means you need to have credit quality indicators such as current FICO for consumer loans, LTV for real estate loans and debt service coverage ratio (DSCR) for commercial loans. You also need to understand which loans have additional risk because of forbearances or by industry type. Without this, you really are guessing. We recommend you create a baseline of your allowance based on current loan risk factors and then stress those factors. Many institutions have kept the allow- ance high before the COVID crisis and for many, not much additional allowance is necessary. Creating a baseline gives you a good starting point for your analysis. Q: What about loan growth and interest rates? How should our credit union account for the new loans? A: In a time such as this, all under- writings should be viewed differently. Because of the uncertainty, reducing your overall risk may be wise. But it can be difficult. Take the current residential real estate market: rates are low, and demand is high. The average price of a home has increased dramatically over the past year. Home prices in most areas are way above the peak in 2008; can prices still go up EXPERT ANSWERS TO YOUR STRESS TESTING QUESTIONS By Mike Umscheid, president and CEO, ARCSys