Stress Testing Simplified

Kamakura Corporation Approach to Stress Testing
Kamakura is well positioned to assist its constituent clients in a number of ways to comply with the stringent regulatory endeavour required through a series of action steps: 

Stress Testing Models
The Kamakura Risk Manager suite of products is equipped with a state of the art stress test builder than can take into consideration today’s regulation and any forecast strictures that may be imposed by the regulatory authorities. This ensures that the solution is scalable, and can cope with not just present regulations, but also anything conceivable that regulators may impose upon the sector over time. The solution, being fully integrated, can apply the impact of macro factor changes on market factors, idiosyncratic customer behaviour, and therefore, impact cashflows to produce results with unparalleled accuracy. 

Model Validation
Kamakura is well positioned to undertake a model validation exercise for its clients, through: 

  • A review of the model documentation
  • A review conceptual framework underpinning the model for appropriateness and assumptions
  • A review of data source quality and relevance
  • A review of model calibration approach and performance
  • A review of model results for predictive power, statistical fit, etc.
  • An identification of potential model deficiencies  
  • Documentation and presentation of findings of the model validation process

The Kamakura approach to model validation can potentially reduce organisational expenses through: 

  • Providing complete, succinct, and current model documentation
  • Producing standard data analysis and model calibration metrics
  • Identifying potentially inappropriate model assumptions
  • Using the same model validation team for repetitive validation projects

The Challenger Model
A guiding principle for managing model risk is "effective challenge" of models, that is, critical analysis by objective, informed parties that can identify model limitations and produce appropriate changes. Effective challenge depends on a combination of incentives, competence, and influence

  • Kamakura offers challenger models which replicate the Dodd-Frank Act stress tests (“DFAST”) based on independent financial industry data and internally developed models
  • Kamakura can load client data for challenger testing directly from the requisite call reports and FR Y-16 forms already finalized by the Fed
  • Kamakura can use client assumptions as to prepayments, recovery rates, rollovers, etc. and can vary these to add further insight into models
  • Kamakura can produce fully compliant Fed SR11-7 model test documentation with formulae and coefficients

Engagement Enhancers

  • Kamakura can combine client loan data with its own database to align our default models with a client bank’s actual loss histories.
  • Clients can elect to stress test additional variables beyond the standard twenty-six. Such variables may reflect special regional or industry exposures and may be included in separate schedules.
  • Outputs can be delivered to the client on a loan by loan basis for close-up analysis in addition to delivery by asset class and type.
  • In addition to the standard scenarios provided by the Fed., Kamakura can generate scenarios at any level of statistical confidence using its powerful simulation engine.
  • The analysis horizon can optionally be extended beyond the peremptory nine quarters and adjusted to monthly or annual intervals to increase/reduce granularity.

A Timely Response

  • Kamakura offers a comprehensive suite of managed services and will coordinate and execute supervisory stress tests: from data capture and model calibration to scenario generation and interpretation of outputs supplementing the work of internal bank personnel.
  • Our expertise in loss modeling and stress testing leverages three long-standing Kamakura business lines: Enterprise Risk Management software, outsourcing of risk management services, and default model research and development.
  • Kamakura default models predate the Fed’s stress test scenarios by more than a decade and have been continuously tested, re-tested, and refined over that time.
  • Kamakura has on hand challenger models in all the major loan classifications and the requisite depth of staff to apply them and evaluate test results on behalf of supervised institutions.

Representative Assignments
A large US Bank required validation of their non-maturing deposit (NMD) balance and rate models provided by a third-party vendor, and Kamakura assisted them by:
Reviewing the adequacy of the model documentation

  • Reviewing remediation steps taken by model owner to address issues
  • Reviewing exploratory data analysis performed by model owner
  • Reviewing data analysis processes for model calibration data
  • Reviewing NMD model framework
  • Testing robustness of NMD model variable selection and calibration
  • Testing robustness of NMD model dimensionality/co-linearity
  • Testing robustness of NMD model pruning method
  • Evaluating appropriateness of resampling/cross validation approach
  • Reviewing appropriateness of NMD model assumptions
  • Review and analysing model outcomes for predictive power, out-of sample fit, and other model evaluation criteria

A $14 billion asset bank required validation of other than temporary impairment (OTTI) of structured credit exposures. This engagement was concluded through an engagement that involved 11 private-label CMO tranches from different CMO deals. 

  • Kamakura Risk Manager (KRM) and supporting securitization cash flow generator was used to simulate future principal cash flows
  • Cash flow simulation incorporated potential defaults on loans in the asset pool underlying each CMO deal
  • Loan defaults were simulated using a dynamic default model appropriate to each loan
  • Default and cash flow simulations were performed across a range of potential risk factor paths generated by stochastic process models
  • Expected principal losses were estimated based on the simulated cash flow results across the risk factor paths
  • Expected principal losses were compared with client impairment estimates

A large US Bank required validation of prepayment models provided by a third-party vendor.

  • Engagement covered prepayment models for MBS and HE/HELOC loans provided by the third-party vendor
  • Model validation requirements included Bank Model Governance Program, Basel II, and OCC guidelines
  • Reviewed completeness, accuracy, integrity, and reasonability of data used to develop the prepayment models
  • Reviewed conceptual soundness of the prepayment modelling approaches, including logic, structure, integration of assumptions
  • Reviewed completeness and accuracy of the computer-based processes implementing the prepayment models
  • Reviewed and analysed model outcomes for predictive power, out-of sample fit, and other model evaluation criteria
  • Compared model outcomes with those obtained from alternative, best practice prepayment models

An $85 billion bank required validation of capital adequacy models for a range of loan classes 

  • Engagement covered capital requirement models for ten different loan classes including C&I, commercial RE, and residential RE loans
  • Eight common macroeconomic factors affecting capital requirements were selected and risk factor models for these factors were developed
  • Econometric models relating the common risk factors to net charge-off behaviour of each loan class were developed
  • Sample paths for the common risk factors were simulated over a multi-period time horizon
  • Simulated sample paths were applied to the econometric models to generate net charge-off distributions for each future simulation period
  • Survival probabilities were simulated for the future simulation periods and applied to simulated net charge-offs to obtain capital requirements
  • Capital requirement results were compared to the results from the client’s existing capital requirement models

Regulatory Consulting Clients
Kamakura regularly engages with key financial services institutions to provide a range of regulatory-driven services. Kamakura's clients include banks, insurance companies, investment managers, and government and regulatory agencies. 

  • Kamakura offers these services to clients in the United States and worldwide through our offices in major countries
  • Kamakura has performed several previous model development and validation consulting engagements
  • Kamakura also has performed model development and validation consulting for regulators including the OCC, Federal Reserve, NCUA
  • Clients look to Kamakura for these services because we offer –
  • Thought leadership in quantitative finance and risk analysis
  • Industry experience in banking and other financial services
  • Subject matter experts to efficiently perform engagements
  • Advanced valuation and risk analysis technology supporting model development and validation

Reporting
Kamakura provides transaction level reporting on all its results, and this includes the full spectrum of CCAR/DFAST reporting as specified in the various templates provided by the regulators. Over and above the mandated regulatory reports, the solution is capable of producing all relevant management and executive information reporting for the organisation. Some key reports are encapsulated hereinbelow: