Talking CECL — Success is a Process, Not a Destination
According to the American Bankers Association, CECL (Current Expected Credit Loss) represents “the biggest change to bank accounting, ever.” The reality of these sweeping changes in the way we have done business for the last three to four decades, for some, is daunting. Don’t make the mistake of believing that the five years given before implementation is plenty of time to prepare your credit union. There are some fundamental steps that have to be taken, just to be ready for implementation.
I’m sure you have heard this phrase many times, “You have to walk before you can run,” and intuitively it makes sense to us. But, what does it really mean? Do you really have to walk before you can run, or has anyone been able to run before they walk? The truth is, that in any given scenario, there are always outliers. There have been instances where a person has done what no one else can do with little preparation. However, for the rest of us, we simply can’t cheat the system. We have to learn and implement the fundamentals before we can tackle the advanced techniques. Success is a process, not a destination.
If you’re a Dallas Cowboys fan, like me, you have weathered almost two decades of mediocre football, always hoping for a better season next year. For the last 20 years, each season has begun with a ray of hope. Either we had a new quarterback, running back or wide receiver who promised to be the best in the game, or new coaches were brought on to fix a weakness that existed the year prior. Yet, these promises failed to take us back to the glory days of the nineties, when the common greeting in the Big D was, “How ‘bout them Cowboys?” The reason that these quick-fix solutions failed, as my dad would point out, is because they ignored the basics of football – blocking and tackling. You can have the best quarterback in the league, but without an offensive line, your quarterback will get sacked. You can have the best receiver in the league, but unable to execute a running game, your receiver will be ineffective. These are the fundamentals of football.
The same is true when it comes to offering financial services to credit union members. You can create unique and clever marketing gimmicks, an awesome mobile presence, and have the flashiest new branch facilities, but if you fail to execute on the basics of lending and retail operations, your promise of success will be fleeting. You can have all the appearances of being ready to play the game, but weaknesses in the operations, as a whole, can leave you vulnerable to failure. The new CECL guidelines for accounting for future losses is a game changer that presents a risk to all financial institutions’ success, not just credit unions. Many are comforted by the fact that implementation of these rules is still half a decade away. The delayed implementation of the rules is not due to lack of importance to the survival of credit unions and banks, but rather because of the amount of work and effort it will take to implement these new financial strategies. In a sense, we have been given five years to learn to walk before we will have to run — or practice the fundamentals so that we are ready for the big game.
Here are some steps we recommend you and your credit union take to successfully prepare for what is being described as the biggest change in the financial services industry in recent memory.
Data Acquisition and Management (6-12 months)
Don’t be careless with your data. I’m not talking about data security; I’m talking about understanding the value of the data you are collecting. At CU Direct, we’ve been helping credit unions manage their data for almost ten years using our Lending Insights program. We help credit unions collect data from disparate sources, cleanse the data to ensure that it is accurate, and construct data models to make it easy to extract and formulate insights. As you may have heard, the first step is the hardest. Data Management is the hardest part of this process. There are resources available in the credit union space today, like Lending Insights, to help with this part of the process, but you have to invest both time and money in this step, or you will never get to the next step.
We have worked with over 200 credit unions in the last decade and only a few were able to initially provide us with clean and accurate data. You will need to have at least 24 months of robust data to move to the analysis stage, and if you have only begun to collect some of that data, it’s not hard to see that you may already be behind. In some cases, you will need to work with third parties or extract data from archived data storage, all while pursuing your normal course of business. Simply put, this will take time, so you need to start now.
Analysis (12-24 months)
CECL is highly dependent upon your knowledge of how your portfolio performs at a granular level, well beyond simply the credit score. In order to predict how future loans will perform, you have to look back at how loans with diverse parameters have performed differently in the past. How does a 740 borrower with a 50% debt to income compare to a 740 with a 25% debt to income? They are different and you need to know why. How do economic changes affect these two borrowers differently? Studying static pools of loans with different criteria will help you understand that. Again, CU Direct’s Lending Insights is a great tool that goes beyond observing static reports to analyzing cause and effect.
Once you have clean data, you will begin to slice and dice that data. With the multitude of variables that can affect a loan portfolio’s performance, you may go down one path that leads to a dead end and then have to try a different path. Simply put, this takes time. If you have never played the role of analyst, you can fall victim to many of the fallacies associated with analytics and for this reason, it takes time to learn from one’s own mistakes.
Predictive Modeling (6-12 months)
Once you understand how loans have performed in your portfolio, you can build models that predict the performance of future loans. This is the key to getting reliable CECL projections. It’s not that hard to predict the chances of your favorite team winning a particular game against a particular opponent, for example. That’s because you have reliable statistics that can be used in different scenarios to come up with the probability of a win. Modeling loan portfolio performance is no different, but just as an amateur gambler would only be lucky to correctly predict the outcome of the championship game, without having worked with loan portfolio data in the past, it will be difficult to accurately predict loan losses in the future. CU Direct’s Advisory Services has been working with credit unions over the last 18 months to begin creating predictive models, and the results have been highly accurate and informative. Having accurate models, based upon your credit union’s data, will help you not only conquer the CECL beast, but will help your credit union be a better lender.
For this part of the process, you may need to seek outside assistance. You will want to consider that the world of analytics and data modeling is the fastest growing segment of business technology. Data Scientists are in high demand and if you start the process today, you will most likely already stand in line for results. This is not an area where an “easy-button” approach will work. One size doesn’t fit all. Just as teams in the NFL don’t use the same playbook; one credit union can’t use another credit union’s predictive model as their own. Be leery of magic software solutions that promise turn-key results.
Testing (12-24 months)
Even the best athletes cannot take the field without practice. Every year, your favorite teams go to camp to learn new strategies, and test them in a real world environment – before it counts! In the same way, you will need time to test your models against real world scenarios and make changes to ensure that your game plan is as reliable as it can be.
So, one can see, adding up the cumulative time that it takes to prepare for CECL, you may only have about a twelve-month window to safely hesitate before doing something. That is only if you can confidently say that your credit union is good at executing on long-term projects. If not, you need to start this process today.