September 30, 2022
A Letter from Trez Capital’s Chief Risk Officer
The current global economy is highly uncertain. Many indicators are warning of continued volatility. Inflation continues to plague Canada and the United States after growing to over 8% and 9%, respectively, by the third quarter. This is a 40-year high, the highest since November 1981.
The invasion of Ukraine has disrupted the global economy and remnants of the pandemic continue to affect the global supply chain. With central banks acting hawkish, these factors add up to a North American recession, which is the current consensus among analysts.
When bearish uncertainty is the driving factor of the economy, stress testing helps optimize decision-making and position investments to succeed as markets shift.
Stress Testing Overview & Insights
A stress test is a risk management tool to gain an understanding of the strengths and weaknesses in a portfolio. This allows for planning to manage market uncertainty and adjust accordingly.
Portfolio-level stress testing will determine the potential financial impact on earnings and capital flows. It can identify portfolio concentration issues and assess the impact of adverse events or changing economic conditions, especially when related to credit quality. All these metrics assist in analyzing a portfolio’s long-term strength.
Importance of Stress Tests
At Trez Capital, rigorous risk management processes have overseen our investment decisions for 25 years. Every loan undergoes a diligent multi-factor risk analysis. With the insight of macroeconomic forecasts, the risk management team identifies underlining factors and scenarios that will potentially impact our portfolio. Scenario impact stress tests are applied to understand potential impacts on our portfolio, including bearings on specific assets and asset classes. This approach is utilized for our annual audited credit loss provisioning, which ensures adequate provisions are taken to withstand potential losses given the current forecasted economic and industry outlooks. More recently, given the rapidly rising interest rates, we have assessed interest budget adequacy through a sensitivity framework to understand potential outcomes and impact to the portfolio. The test confirmed the expected declines in interest budget coverage, but that Sponsors had adequate resources to support debt service. In select cases, Borrowers have funded capital to balance project interest budgets. The stress tests and sensitivity outcomes are continuously assessed and used to shape Trez Capital’s risk appetite and credit decisions.
Anticipating the Future for Optimal Returns
By using this forward-looking process, every part of the portfolio is looked at in relation to projected future conditions to understand multiple scenarios and evaluate potential investments. By understanding the risk profile and opportunities for mitigation, proactive steps can be taken – whether tactical, controls-based, or intervention – to create optimal investment outcomes.
Risk Management at Trez Capital
Trez Capital continuously monitors the emerging risk horizon, portfolio segments, project-level progress and evaluates resilience to macro- and micro-risk factors through stress testing. Even under current macroeconomic headwinds, Trez Capital believes profitable opportunities remain in select under-supplied regions of the real estate market with strong fundamentals and with stronger borrowers.
Overall, stress testing is a key building block to the risk management at Trez Capital and we continue to monitor economic shifts, global events, and changes in specific asset classes, so we can continue to best serve our investors and protect their investments.
Chief Risk Officer
About Trez Capital
Founded in 1997, Trez Capital is a diversified real estate investment firm and preeminent provider of commercial real estate debt financing solutions in Canada and the United States. Trez Capital offers private and institutional investors strategies to invest in a variety of opportunistic, fully secured, mortgage investment funds, syndication and joint-ventures and provides property developers and owners with quick approvals on flexible short- to mid-term financing.
With offices across North America, Trez Corporate Group has over $5.3* billion CAD in assets under management and has funded over 1,700 transactions totaling more than $16.5 billion CAD since inception. For more information, visit www.trezcapital.com. (*Trez Corporate Group AUM includes assets held by all Trez related entities as well as $2.9 billion Manager AUM (Trez Capital Fund Management Limited Partnership)).