If you can't rely on historic correlations, is it time for a fresh approach to stressing your portfolio?

Michael van Miert

March 9, 2023

As we go into 2023, there is much being said about the global outlook. Having reviewed outlook reports from the leading financial institutions globally, and factoring in the discussions we are having with CEOs, CFOs, and other key senior execs at US banks on their commercial lending activities, there is a clear consensus that at minimum, the US will enter a mild recession. Even through an optimistic lens, the upside cases are looking to be a reduction in growth rate, narrowly avoiding a recession. However, the drivers are different than before. 


There is a clear difference between historical trends and what we are seeing today with lenders in the US having to rethink their approach to analyzing their portfolios as consensus is growing that their historical models can’t accurately predict future portfolio performance.  

Due to excess savings from the Covid era depleting, a split view on interest rates increasing to 5% or 5.5%, and with supply chains starting to normalize (they still have a long way to go) there are different corelations to what we have seen in past cycles.  Goldman Sachs has outlined very clearly in its report, “This Cycle is Different” that this largely stems from the post-pandemic job market; we had an extremely heated job market with an unprecedented volume of new role openings during 2020/21. However, there was no excessive employment that took hold, and as we’ve seen over the last 12 months, many companies are having to re-assess hires they made during the pandemic, making mass redundancies as pandemic peaks have troughed. It is clear we cannot simply take previous models based on historical correlations to look at how the future economy will perform. How businesses will perform needs to be looked at in a more real-time and forward-looking manner. 

Another critical element HSBC raises in its report Q1 2023 Investment Outlook – Looking for the Silver Lining is the expected increase in digitization and automation to combat the inflationary market. Although the need stems from a different problem statement, this is something that we are talking to several institutions about. Automation, the need to bring in operational leverage, the ability to deliver the same value to clients, and have the same view of risk in the portfolio if not a deeper view, but with greater efficiency, are all key. The annual review process for example is becoming an increasing burden and one of the key areas of concentration. As we are thinking through where we can further develop and deploy our product set, this will be a clear and core area of concentration. How can we further enable institutions to deploy their resources in the right places at the right times, rather than spreading them in a way they know is not sustainable or efficient?  

One thing is clear in the forecasted outlook - the need for banks to have a more robust way to stress their commercial portfolio at a granular, borrower level is essential. As we see further forecasted interest rate rises driving refinancing risk, changes of impacts to the supply chain from the situation in China, and growing geo-political tension, there is a need for this to be a dynamic system of analysis with levers which can be pulled as needed and re-run as situations change. This will deliver a best-in-class service to clients, a hardened reporting structure to regulators, efficiency, and an unparalleled depth of understanding within commercial portfolios to reduce losses and improve bottom lines by supporting clients through the cycle. 

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