Current Expected Credit Losses: Data and Tools Required


By Shana Richardson, CEO, Ser Technology

When I discuss Current Expected Credit Losses (CECL) with credit unions, about one-third say they are confident and already parallel testing methodologies; another third is nervously becoming aware of CECL’s impact and feeling unprepared. The remaining third is somewhat in Pollyanna mode, and think the regulation won’t be as onerous due to their asset size or don’t feel they have the resources to comply in full.

Here’s the reality though—the NCUA has been clear about the need for credit unions and their boards to become familiar with the new accounting standard and take the proper steps toward implementation.

The first step is a basic gap analysis. Most credit unions must review their balance sheets and the assets they have, asking the question, “Is this a CECL asset?” If the credit union doesn’t have a model, it has a gap to fill.

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The second step is determining how to generate loss estimates. Creating life of instrument loss estimates for most credit unions will be new, so they must understand how they are going to achieve this. Will they invest in real econometric models, or will they have more of an analytical process? Will they build or purchase models, or use a combination of both? How can they generate the estimates in a controlled, efficient way that supports the required analysis? These are all questions that must be addressed to help ensure a smooth transition.

Credit unions will also want to think about what kind of data they will need to satisfy this new process. For many, changes will need to be made to their loss estimation methodologies. Smaller credit unions, in particular, will have to perform forward-looking estimates for the first time, and that’s not just going to be an operational change but also a significant mindset change.

Data is at the heart of the matter. In an ideal scenario, data from disparate systems, applications and service providers is clean, collated and balanced to the general ledger. Then the fog of the written regulations will lift, and finding the right methodology for your credit union becomes clearer.

Finally, analytics and disclosures must be examined to ensure the regulators, auditors, board, and senior management are all comfortable with the results.

The NCUA has been clear about the need for credit unions and their boards to become familiar with the new accounting standard and take the proper steps toward implementation. –Shana Richardson

One thing is certain: copious historical data is needed to both protect capital and account for expected loan losses. CECL will require lenders to create detailed Allowance for Loan and Lease Losses (ALLL) pools based on the vintages of the loans, terms of loans, and loss accumulation periods, or the relative position on the loss curve. 

Calculating risk in the new CECL environment is going to be tricky without adept data and CECL tools. I can personally vouch for that. SerTech has been delivering a data analytics service called ProAct since 2005.

In early 2007, I distinctly remember the day we demonstrated our findings to a client and the CEO said, “If we charge off the amount your analysis is showing, we’ll be out of business.” Sure enough, within 24-months the client had charged off the amount our calculations had shown— within $5,000. The ProAct analysis was so aligned to the actual charge-off amount because we had worked closely with the client’s team to clean, collate, and replace data. At that point, we could determine what the right algorithms and visual reporting tool best suited to their lending model. It was a painstaking endeavor, but one that proved how critical data and tools are to a robust credit risk management program.

Credit unions that have started refining and automating their processes are finding it’s no easy task. Interpretations of the standards and their lack of prescriptiveness leave credit unions to muddle their way through—and the effects of implementation decisions can be huge. ProAct further offers portfolio stress testing to consider hypothetical changes in the economic environment and their effect on risk. Stress testing allows credit unions to adjust and project credit score and property value movements as well as loss severity within loan portfolios. ProAct's risk analysis options are also proven tools for compliance, audits and setting reserve levels.

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Credit unions’ back-end processes for ALLL calculations will change over the next several years. I hope these tips are helpful, if you need tools to get your credit union prepared for CECL, we can help with that too.