How does individual loan stress testing fit into an institution’s overall loan portfolio management program?
Stress testing principles should also be incorporated into loan underwriting practices. Stress testing individual loans provides insights into a borrower’s ability to withstand adversity, thereby facilitating more constructive underwriting and more accurate pricing commensurate with the risk. Decisions on loan originations and major servicing actions for large loans should be supported by loan specific stress testing analysis. Individual loan stress tests should assess the borrower’s ability to withstand adversity from factors such as changes in commodity prices, input costs, interest rates, government payments, and production levels and yields. Items such as off-farm income and income from contracts (e.g., integrator/contract growers) should also be stressed if the borrower’s repayment capacity is reliant on this income. On loans to borrowers in distressed industries, current prices and production costs already reflect highly stressed conditions. In these situations, stress testing ma
