On the surface, it would have seemed like Michael Burry, the hedge fund manager whose story is featured in the “Big Short,” could predict the future. He foresaw what many people could not see back in 2003-2004, that the housing market was extremely unstable and on its way toward a collapse. Burry wasn’t a psychic — he meticulously analyzed and researched patterns and irregularities, which pointed him toward seeing the eventual 2008 housing market crash. Staying ahead of the curve and being better prepared during current economic conditions is a page worth taking out of Burry’s playbook.
For community financial institutions (CFIs), the current rate environment is putting sustained pressure on margins, deposit pricing, and commercial real estate (CRE) portfolios. Following one of the most rapid tightening cycles in decades, balance sheets are more exposed to rate sensitivity, deposit volatility, and valuation risk. Resilience will depend less on trying to time the cycle and more on routinely testing credit, liquidity, and capital under severe but plausible scenarios.
The immediate task for management is to distinguish resilient borrowers, segments, and structures from those that will not perform under stress, while continuing to support core relationships and local growth. The seven disciplines below are practices leadership teams should institutionalize to strengthen resilience and sustain growth.
Here are seven practical strategies to strengthen resilience and sustain growth:
1. Reassess portfolio concentrations against current risk drivers.
Begin with a fresh look at concentrations across your loan and investment books, focusing on segments most exposed to rate and valuation shocks. For example, office and higher‑end multifamily CRE remain under pressure in many markets, while some sectors tied to e‑commerce logistics or essential services appear more resilient but may still face refinancing risk as legacy low‑rate debt matures. It may be useful to look beyond broad asset classes and consider breaking exposures down by property type, geography, borrower profile, and debt structure (such as interest-only, balloon, amortizing, or variable versus fixed), which can offer clearer insight into where localized downturns or rate shifts might have an outsized impact on capital and earnings.
2. Increase borrower reporting and quality.
Rising funding costs and slowing cash‑flow growth mean that yesterday’s underwriting no longer guarantees tomorrow’s performance. Annual financial updates for commercial borrowers are increasingly insufficient when margins are under pressure and refinancing risk is elevated. Consider moving higher‑risk or higher‑balance relationships to semiannual or quarterly refresh cycles. You can also make greater use of AI in reviewing transaction history highlighting behavioral indicators such as deposit balance trends, payment patterns, line utilization, and covenant compliance, as early warning signals. Integrating this data into a simple, transparent risk dashboard assists senior credit and finance leaders spot emerging stress earlier.
3. Embed refinancing and valuation risk into CRE underwriting and reviews.
Regulators have highlighted the growing risk that some commercial borrowers may struggle to refinance maturing debt on reasonable terms, especially in office and other underperforming segments. For CFIs with CRE concentrations, maturity profiles and exit strategies are as important as current debt‑service coverage ratios. It may be worth incorporating into portfolio and transaction reviews an assessment of refinance timing, projected loan-to-value ratios under stressed cap rates, and borrowers’ capacity to contribute additional equity, as scenario analyses combining higher cap rates, modest NOI declines, and increased refinancing costs can help highlight loans that could migrate to criticized or classified status and give boards and senior management better visibility into potential impacts on capital planning and earnings.
4. Tie credit stress testing to capital and earnings planning.
Formal supervisory stress tests apply to the largest institutions, but the core disciplines of well‑defined scenarios, documented methodologies, and clear capital implications are equally important for CFIs. Start with a small set of institution‑specific scenarios that combine macro variables (unemployment, interest rates, CRE prices) with local factors (employer concentration, industry mix, housing trends). Stress testing criteria should provide insight into projected charge‑offs, provision expense, and risk‑weighted asset changes across major portfolios. For leadership teams, stress testing should guide timely adjustments in growth targets, pricing, and capital actions before conditions deteriorate.
5. Elevate liquidity and portfolio stress testing alongside credit.
Recent years showed how quickly deposit flows can change when rates move and confidence is tested. Community banking organizations initially experienced slower deposit repricing but later accelerated increases as competition intensified and runoff emerged, pushing deposit betas higher. This dynamic directly affects net interest margin and can interact with credit risk if funding constraints limit the ability to work constructively with stressed borrowers. It may be helpful to complement loan-focused scenarios with a portfolio level approach, a top down stress tests that quickly models the portfolio while also evaluating the adequacy and usability of contingent liquidity sources, like borrowing lines, available collateral, and unencumbered securities, to give CFOs and treasurers a more integrated, active view of how a downturn could affect both sides of the balance sheet.
6. Refresh risk-rating practices and watchlist governance.
In an environment with persistent sectoral stress and rising refinance risk, timely and consistent risk ratings become even more important. Review whether your internal rating definitions, downgrade triggers, and watchlist criteria adequately capture forward‑looking indicators such as lease rollover risk, updated valuations, or shifts in sponsor liquidity. Strong governance around watchlists, such as regular cross‑functional reviews between credit, lending, finance, and special assets, helps ensure that emerging problem loans receive early attention and tailored action plans. This discipline may support more reliable reserve methodologies, CECL modeling assumptions, and regulatory communications, all of which influence earnings volatility and capital flexibility.
7. Integrate CECL, planning, and stress testing into a single risk narrative.
For most CFIs, CECL is now embedded in financial reporting, but its full strategic value is realized when it is integrated with stress testing and capital planning. Management can use scenario‑based loss estimates to challenge and refine CECL assumptions around prepayments, qualitative factors, and portfolio segmentation. When credit, liquidity, and capital teams use shared scenarios and data, they can offer a consistent view of performance under stress and management’s response, helping community banks and credit unions make more confident decisions on growth, pricing, and capital deployment.
CFIs can’t rely on forecasting alone in today’s volatile environment. Resilience depends on continuously stress-testing credit, liquidity, and capital under realistic downside scenarios. By sharpening portfolio visibility, improving borrower monitoring, and integrating CECL with forward-looking risk analysis, leadership teams can identify emerging vulnerabilities earlier and make more informed decisions on growth, pricing, and capital allocation. Institutions that operationalize these disciplines will be better positioned to navigate margin pressure, deposit volatility, and CRE uncertainty while continuing to support their communities.
