Stress Testing and Projects Help Forecast Problem Credits

A part of reviewing a borrower’s credit is forecasting “what could happen next?”  In the next several weeks, borrowers will be providing their updated tax returns as we approach the July 15th filing deadline, and community financial institutions will have their credit analysts waiting to receive and analyze changes from the prior year.

Once the data has been entered and the current financial year reviewed, we then turn to the “what happens next?” question.  The Square 1 Credit Suite has several key areas that can help with answering that question.

1. Transaction Stress Testing:  Current financial data and current debts of the borrower are used to stress different scenarios.  What happens if interest rates increase or decrease, affecting the repayment of the loan(s)?  What happens if the cash flow available for debt service changes?  What impact do these factors have on the debt service coverage ratio?
2. Projections:  Multiple projection scenarios can be created on both the income statement and balance sheet of a borrower’s financial statement.  The analyst can make adjustments for particular line items, increasing or decreasing by a dollar amount or percentage.

As community banks and credit unions face the ongoing challenges of their borrowers in a post-COVID world, stress testing and projections will become an integral part of the review process.  Understanding the impact on the borrower’s cash flow projecting into the coming months and year will be critical in managing risk.