Stress Testing Credit Losses for Commercial Real Estate Loan Portfolios

Jun Chen

This chapter will discuss the estimation of credit losses for commercial real estate (CRE) loans under the stressful macroeconomic scenarios formulated by the regulators in conducting stress-testing programmes. The focus is to provide a coherent analytical framework where the top-down macro view can be married with bottom-up, loan-level specifics to derive accurate credit loss estimates for CRE loans.

CRE loans constitute a large share of the loan portfolios for most commercial banks. Approximately one-fifth of the loan book in the commercial banking universe is CRE loans. The investment risk and return characteristics of CRE loans differ from commercial and industrial (C&I) loans, and the unique features of this asset class warrant specialised analytics to address stress-testing needs. Due to the high-risk nature in CRE lending, particularly construction loans, regulators have long been wary of the risks of possessing too much CRE in a single bank’s loan book. Even before real estate helped trigger the 2007–08 financial crisis, in December 2006 the Office of the Comptroller of the Currency (OCC), the Board of Governors of the Federal Reserve System and the Federal Deposit

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