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Recent Uncertainty Highlights The Importance of Evaluating Strategic Net Worth Requirements

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The rapidly changing competitive environment and recent natural disasters are reminders of the importance of evaluating strategic net worth requirements.

Natural disasters, like the recent string of hurricanes that impacted the country, contribute to uncertainty and highlights the need to evaluate strategic net worth requirements.

A key component to understanding strategic net worth requirements is taking a deliberate approach to understanding aggregate risk.  In a previous blog post we outlined an approach to help with this process.

Two types of risks that should be included in any effective aggregate risk process are interest rate risk and credit risk.  While these two key risks need to be addressed, growing concerns on strategic risks to future earnings streams should also be discussed and incorporated into the aggregate risk estimate.

For instance, think about the potential reduction in future earnings as consumer usage of real-time financial management self-service alerts that can curb their spending increases.  And options for how consumers pay for their purchases continue to rapidly expand beyond the traditional financial services industry – Amazon could be the next big player in this space.

The Current Expected Credit Losses (CECL) standard is another example of how the environment is changing.  CECL should not be viewed as just an accounting issue because it has the potential to impact both earnings and net worth.  While 2021 may seem like a lifetime away, it is critical that decision-makers understand their credit union’s capacity to handle the impact of CECL.

Remember that being within individual risk limits does not necessarily indicate that the credit union is safe and sound.  As history repeatedly teaches us, bad things don’t usually happen in isolation.  The few pressures described above can occur while an unforeseen event comes out of left field, such as the Equifax data breach.

Another example of an unforeseen event is the string of natural disasters that have impacted the country in the past few months.  For those affected, it is still too early to understand the fallout from these events.  However, it is an unfortunate reminder that the unexpected can happen, and the net worth needs to be able to handle multiple risks happening simultaneously or bear the brunt of cascading events.

None of the risks above are easy to quantify, but that doesn’t mean risks should not be aggregated to gain an understanding of the aggregate risks relative to net worth.  Starting with a list of your management teams’ top concerns is a great way to get the ball rolling.  Keep in mind that the chance of being “exactly right” on your credit union’s aggregate risks is slim to none.  The value is in the strategic discussions and the allocation of net worth to strategic threats and unforeseen events.

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CECL: Takeaways and Considerations from Recent Workshops

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CECL is much more than an accounting issue and being focused only on compliance is shortsighted. The effects of CECL will transcend every area of credit unions and the implications, if they are understood, can be anticipated and prepared for. Communication with senior management is crucial to gain buy-in to these implications.

C. myers has been working tirelessly with credit unions and credit risk simulation vendors to help the industry better prepare for changes that will happen due to CECL. The objective of this work has been to not only help individual credit unions, but also, to gather learnings that can help all credit unions. This process has included one-on-one work with credit unions over the last six months and focus group workshops of large credit unions. The two workshops included a dozen credit unions with an average asset size above $4 billion. CECL can impact all institutions, large and small, but the intent of starting with large credit unions is to get takeaways from credit unions with more resources to devote to solutions. Following, you will find ideas from the interactive workshops in Phoenix, Arizona and Tampa, Florida.

Making Sense of CECL Working from their unique, institution-specific data, the workshop participants collaborated with other credit union representatives to bring the various aspects of CECL into focus and explored different methodologies and implications to the credit union business model. Discussions, walk-through exercises, and examples helped link implementation with strategic outcomes in these interactive sessions. The workshops helped participants become better equipped to consider the strategic implications, reduce pitfalls, make the most of opportunities, and to find additional decision-making opportunities through the journey of implementing CECL.

An attending CFO from a credit union with assets greater than $5 billion said, “I figured the hard work was already done as we already contracted with a vendor to do the calculations. I am realizing that this is just the beginning and there will be a lot of important decisions and work to do going forward.” That sentiment represented the overall view of the attendees as the data gathering and getting a number is just the beginning.

Attendees noted that c. myers’ independence was an added benefit. They were able to work with each credit union on understanding the implications of CECL, regardless of the vendor and methodology being used.

Gail Wean, Senior Vice President/Chief Financial Officer, Grow Financial FCU of Tampa, Florida, commented on her c. myers CECL workshop experience, “The presenters exceeded my expectations. This was one of the best presentations of complex information in my career. Exceptional knowledge base, and organization, and communication of CECL.” Much of the focus of the workshop was not only to gain knowledge, but to be positioned to use tools and examples to communicate potential strategic implications to others when attendees are back at the credit union.

Brett Fisher, Vice President of Asset & Liability Management, Founders FCU stated, “Participation in the CECL workshop has our credit union not only much better prepared to tackle CECL, but their wisdom set the foundation for utilizing CECL data analytics to improve business decisions.”

10 Takeaways

Below are 10 of the many key takeaways identified during the workshops:

  1. CECL should not be viewed as just an accounting issue because the potential earnings and net worth impact, especially if a credit union grows loans, can have strategic implications for which all the decision-makers at the credit union will want to be prepared.
  2. The potential impact of CECL can vary greatly by credit union and expected environment.
  3. As there is no single right answer, conquering CECL with excellence is better done together by discussing trade-offs of various paths in order to better see potential short- and long-term implications of CECL decisions.
  4. The point at which you address the problem is directly related to the number of viable options available to solve it. The sooner credit unions begin exploring different methods of calculating expected losses, the more agile they will be in understanding it. Credit unions need time to compare methods to feel good about their estimates.
  5. Within each of the various methods, there are many assumptions and settings for the credit union to consider. These settings can materially change the loss estimate.
  6. Focusing on improved business intelligence as a part of the work for CECL can be a material benefit to credit unions in the future.
  7. Return on Assets (ROA) will no longer be a clear measure of success, especially with loan growth.
  8. Clarity on the objectives an institution has when building a CECL implementation plan is a key to success.
  9. Understanding the correlations between different economic indicators and the credit risk of various account types is an important step in deciding which indicators to forecast. This process can be easy or may take several rounds of additional research based on the unique history of the institution.
  10. Staying focused on the net yield over the life of the loan will help avoid shortsighted decisions that could hurt relevancy.

 

Currently, institutions have been so focused on the data gathering that they haven’t had a chance to look beyond the data to the strategy. CECL will change the way earnings, net worth and the impact of growth, and risk in the future will be measured.

No one has managed an institution using CECL rules. The manner in which financials will become disconnected from an institution’s financial strength will differ greatly from the rules that all have applied when managing an institution. It will take time to adjust to this change. Starting now and working with others will better prepare institutions.

C. myers will be holding additional CECL workshops in 2018. For more information, please call 800.238.7475.

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AICPA: Buzz About CECL

We had the benefit of speaking at the AICPA conference on one of our favorite topics, how to use ALM for actionable business intelligence. In this case, the focus was on how a credit union can support changes to remain relevant.

Another topic that also had a lot of buzz at the conference was CECL, which can also impact relevancy. Based on the discussions, we thought it would be a good idea to repost the blog from May 19, 2016.

CECL’s Threats To Your Business Model:  Six Questions To Consider</font size>

CECL is a new set of rules that every credit union eventually will have to play by. While it may not be in effect until 2021, many credit unions could find that they need all that time to reposition their business models to prepare for its impact. Keep in mind that the impact being discussed currently is in a good credit environment. How does the exposure to CECL change in a bad credit environment?

At the end of 2015, the nearly 500 credit unions with assets over $500 million had an average net worth ratio of 10.9% and an ALLL of 0.9%. If the impact of CECL causes ALLL to increase 50%, or even what some refer to as a worst case of 100%, the net worth will be reduced but not dramatically for most.

For those same credit unions, if you were to go back to the Great Recession, what potential impact could CECL have created?

CECL Graph

While many experienced a reduction to ALLL in the years following, what would have happened to the credit unions that would have had materially lower net worth? How could this impact business models and strategic decisions going forward?

Every credit union should be asking:

  • Because CECL will be extremely volatile in changing economic conditions, how much net worth do we need to have to prepare for that potential additional volatility?
  • How should our business model be repositioned so that we have enough net worth in volatile, bad case scenarios?
  • If our current target markets are susceptible to credit risk and could wipe out significant amounts of net worth under the new CECL rules, do we need to adjust who we target in the future?
  • After CECL is in place, loan growth, especially strong loan growth, will come at much lower initial profitability. How does this impact our business model?
  • What changes should we be making, if any, to our concentration risk policy?
  • If the battle for prime paper increases materially, will we choose to increase our presence in that battlefield, and how will we differentiate ourselves in order to remain relevant?

If you don’t think these questions are relevant, consider that in today’s good credit environment, 22% of all existing auto loans are to subprime borrowers (Wall Street Journal). How much could this increase in a recession due to credit migration?

As you wrestle with the mechanics of implementing CECL, it is even more important to think about the business model implications. In addition to the current economic environment, think through what could happen in a recessionary environment when loan losses can mount rapidly and the impact of CECL can be magnified.

The point is not to dissuade you from taking credit risk, but rather to stress that the rules have changed; everyone will need to be much more deliberate with their business models, strategic plans, and the execution of those plans to be well-positioned for CECL.

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Interest Rate Risk in an Auto Loan – Really?

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The competitive landscape for auto loans has fundamentally changed over the last 15 years.  There are more non-traditional lenders vying for autos and non-credit union lenders have been saturating the indirect lending market.

These trends put pressure on pricing and take a bite out of the auto lending pie.  As a result, financial institutions are getting creative with pricing and terms.  As this occurs, questions to consider need to evolve.

One example is the increase in 10-year auto loans, which we are seeing as we conduct interest rate risk simulations.

Consider:

  • How might prepayments differ from a shorter-term auto loan?
  • Is it reasonable to assume that a consumer wanting a 10-year auto will prepay the loan at the same rate as a 5-year auto loan?

There is not an abundant amount of prepayment data on this type of loan to answer the questions above, so, test the impact.  In the table below, notice the escalation in average life as well as the balance remaining after three years and five years.  If the prepayment rate on this term of auto loan is 10% then more than half of the balance would remain after three years, and nearly one-third would remain after five years.

10 Year Auto Loan Table SM 080416

So yes, these loans bring more interest rate risk.  If these types of loans become more prevalent, it will be important to change mindsets with respect to interest rate risk and auto loans, not to mention the risk of negative equity that comes hand in hand with the extended term.

Consider the potential impact of CECL on longer-term auto loans.  For example:

  • What if the auto loan is actually underwater for a material portion of the time it is outstanding?
  • Do the potential risks mean financial institutions should not do long-term auto loans?  There is no easy answer or one-size-fits-all response.  Each executive team needs to decide their product offering in light of their value proposition, appetite for risk, and financial strength.

What we do know is that the questions need to evolve to appropriately identify and manage the risk.

Events

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Making Sense of CECL: An Interactive Workshop

During this hands-on workshop (limited availability), attendees will navigate the uncharted waters of CECL together, using tools designed to explore various methodologies and implications to the credit union business model.  You’ll work with your unique data and collaborate with other credit unions as you bring the various aspects of CECL into focus.

  • Understand CECL requirements, methodologies, and data considerations
  • Strategize the impact to your business model
  • Discuss various options to calibrate forecasts and assumptions
  • Plan your implementation

By design, FASB has not prescribed the “right answer.”  As a result, there are opportunities for you to consider and many decisions for you to make.  The sooner you start thinking about how to implement CECL at your credit union, the better off you’ll be.

You’ll participate in discussions and walk through exercises and examples to help you link implementation with strategic outcomes.

  • What are the strategic implications of various loss estimate methodologies for your credit union?
  • How could CECL impact business models and strategic decisions going forward?
  • What are things to consider regarding different methodologies?
  • What factors should be considered in forecasts and how much forecasting is enough?
  • How well do forecasted losses connect with your credit union’s unique experience?

In preparation for the session, we’ll work with you on the types of data to collect so you can arrive at the workshop ready to hit the ground running.

It’s much more than covering minimum requirements; this workshop will help participants be better equipped to consider strategic implications, reduce pitfalls, make the most of opportunities, and implement CECL in a meaningful way.

Participants will earn up to 16 CPE credits

Content level: Intermediate

Instructional Delivery Method: Group Live

Location:  Course is in sunny Phoenix, Arizona at our headquarters next to the South Mountain Preserve, the nation’s largest municipal park, with 51 miles of trails for hiking, biking, and horseback riding. You may even want to make a long weekend of it and visit Sedona or the Grand Canyon. We also are near several local favorites like the Desert Botanical Garden and the Phoenix Zoo.

CPE Field of Study: Accounting                                               

Prerequisite Education or Experience: Basic familiarity with credit union financial statements and a basic understanding of credit loss reserve determination

Advance Preparation Requirements: In preparation for the session, we’ll work with you on the types of data to collect so you can arrive at the workshop ready to hit the ground running

Who Should Attend: A team of up to 4 people per credit union that includes the CFO. The CLO and CIO are encouraged to attend and others, such as the CEO and CRO, are welcome

Fees, Refund, and Course Cancellation Policy

Fee: $2,500 per credit union

Refunds will not be given for cancellations received less than 30 days prior to the session; however, a substitute from your credit union is welcome.

In the rare case that a class must be cancelled, c. myers will make every effort to do so 30 days or more in advance of the class, in which case we are not responsible for travel costs or penalties incurred.

Complaint Resolution Policy

c. myers will make every effort to resolve complaints regarding NASBA compliance within a reasonable amount of time and in a confidential manner. A formal complaint must be submitted in writing and must set forth a statement of the facts and the specific remedy sought. Submit complaints to:

c. myers corporation
Attn: CPE Program Administrator
8222 South 48th Street
Suite 275
Phoenix, AZ 85044

CPE Program Administrator: 800.238.7475

National Registry of CPE Sponsors, A/LM Education

c. myers corporation is registered with the National Association of State Boards of Accountancy (NASBA) as a sponsor of continuing professional education on the National Registry of CPE Sponsors. State boards of accountancy have final authority on the acceptance of individual courses for CPE credit. Complaints regarding registered sponsors may be submitted to the National Registry of CPE Sponsors through its website: www.NASBARegistry.org

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CUES Directors Conference

CECL: A Board’s-Eye View

Monday, December 11, 2017

Breakout Session 1: 11:00 a.m. – 12:15 p.m.   |   Breakout Session 2: 2:45 – 4:00 p.m.

Speakers: John Myers, President/Principal  |  Tim Busby, Vice President

The Current Expected Credit Loss model (CECL) is imminent, yet implementation and strategic consequences are unclear. While CECL is an accounting standard, its effects will be felt far beyond the accounting department. The objective of this session is to discuss board-level considerations related to CECL so that board members can support management as they explore the uncharted waters of CECL.

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Making Sense of CECL: An Interactive Workshop – Full

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During this hands-on workshop, attendees will navigate the uncharted waters of CECL together, using tools designed to explore various methodologies and implications to the credit union business model.  You’ll work with your unique data and collaborate with other credit unions as you bring the various aspects of CECL into focus.

  • Understand CECL requirements, methodologies, and data considerations
  • Strategize the impact to your business model
  • Discuss various options to calibrate forecasts and assumptions
  • Plan your implementation

By design, FASB has not prescribed the “right answer.”  As a result, there are opportunities for you to consider and many decisions for you to make.  The sooner you start thinking about how to implement CECL at your credit union, the better off you’ll be.

You’ll participate in discussions and walk through exercises and examples to help you link implementation with strategic outcomes.

  • What are the strategic implications of various loss estimate methodologies for your credit union?
  • How could CECL impact business models and strategic decisions going forward?
  • What are things to consider regarding different methodologies?
  • What factors should be considered in forecasts and how much forecasting is enough?
  • How well do forecasted losses connect with your credit union’s unique experience?

In preparation for the session, we’ll work with you on the types of data to collect so you can arrive at the workshop ready to hit the ground running.

It’s much more than covering minimum requirements; this workshop will help participants be better equipped to consider strategic implications, reduce pitfalls, make the most of opportunities, and implement CECL in a meaningful way.

Participants will earn up to 16 CPE credits

Content level: Intermediate

Instructional Delivery Method: Group Live

Location:  Course is in sunny Phoenix, Arizona at our headquarters next to the South Mountain Preserve, the nation’s largest municipal park, with 51 miles of trails for hiking, biking, and horseback riding. You may even want to make a long weekend of it and visit Sedona or the Grand Canyon. We also are near several local favorites like the Desert Botanical Garden and the Phoenix Zoo.

CPE Field of Study: Accounting                                               

Prerequisite Education or Experience: Basic familiarity with credit union financial statements and a basic understanding of credit loss reserve determination

Advance Preparation Requirements: In preparation for the session, we’ll work with you on the types of data to collect so you can arrive at the workshop ready to hit the ground running

Who Should Attend: A team of up to 5 people per credit union that includes the CFO. The CLO and CIO are encouraged to attend and others, such as the CEO and CRO, are welcome

Fees, Refund, and Course Cancellation Policy

Fee: $1,000 per credit union

Refunds will not be given for cancellations received less than 30 days prior to the session; however, a substitute from your credit union is welcome.

In the rare case that a class must be cancelled, c. myers will make every effort to do so 30 days or more in advance of the class, in which case we are not responsible for travel costs or penalties incurred.

Complaint Resolution Policy

c. myers will make every effort to resolve complaints regarding NASBA compliance within a reasonable amount of time and in a confidential manner. A formal complaint must be submitted in writing and must set forth a statement of the facts and the specific remedy sought. Submit complaints to:

c. myers corporation
Attn: CPE Program Administrator
8222 South 48th Street
Suite 275
Phoenix, AZ 85044

CPE Program Administrator: 800.238.7475

National Registry of CPE Sponsors, A/LM Education

c. myers corporation is registered with the National Association of State Boards of Accountancy (NASBA) as a sponsor of continuing professional education on the National Registry of CPE Sponsors. State boards of accountancy have final authority on the acceptance of individual courses for CPE credit. Complaints regarding registered sponsors may be submitted to the National Registry of CPE Sponsors through its website: www.learningmarket.org

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Making Sense of CECL: An Interactive Workshop – Full

During this hands-on workshop, attendees will navigate the uncharted waters of CECL together, using tools designed to explore various methodologies and implications to the credit union business model.  You’ll work with your unique data and collaborate with other credit unions as you bring the various aspects of CECL into focus.

  • Understand CECL requirements, methodologies, and data considerations
  • Strategize the impact to your business model
  • Discuss various options to calibrate forecasts and assumptions
  • Plan your implementation

By design, FASB has not prescribed the “right answer.”  As a result, there are opportunities for you to consider and many decisions for you to make.  The sooner you start thinking about how to implement CECL at your credit union, the better off you’ll be.

You’ll participate in discussions and walk through exercises and examples to help you link implementation with strategic outcomes.

  • What are the strategic implications of various loss estimate methodologies for your credit union?
  • How could CECL impact business models and strategic decisions going forward?
  • What are things to consider regarding different methodologies?
  • What factors should be considered in forecasts and how much forecasting is enough?
  • How well do forecasted losses connect with your credit union’s unique experience?

In preparation for the session, we’ll work with you on the types of data to collect so you can arrive at the workshop ready to hit the ground running.

It’s much more than covering minimum requirements; this workshop will help participants be better equipped to consider strategic implications, reduce pitfalls, make the most of opportunities, and implement CECL in a meaningful way.

Participants will earn up to 16 CPE credits

Content level: Intermediate

Instructional Delivery Method: Group Live

Location:  Course will be hosted by and held at Suncoast Credit Union in Tampa, Florida

CPE Field of Study: Accounting                                               

Prerequisite Education or Experience: Basic familiarity with credit union financial statements and a basic understanding of credit loss reserve determination

Advance Preparation Requirements: In preparation for the session, we’ll work with you on the types of data to collect so you can arrive at the workshop ready to hit the ground running

Who Should Attend: A team of up to 5 people per credit union that includes the CFO. The CLO and CIO are encouraged to attend and others, such as the CEO and CRO, are welcome

Fees, Refund, and Course Cancellation Policy

Fee: $1,500 per credit union

Refunds will not be given for cancellations received less than 30 days prior to the session; however, a substitute from your credit union is welcome.

In the rare case that a class must be cancelled, c. myers will make every effort to do so 30 days or more in advance of the class, in which case we are not responsible for travel costs or penalties incurred.

Complaint Resolution Policy

c. myers will make every effort to resolve complaints regarding NASBA compliance within a reasonable amount of time and in a confidential manner. A formal complaint must be submitted in writing and must set forth a statement of the facts and the specific remedy sought. Submit complaints to:

c. myers corporation
Attn: CPE Program Administrator
8222 South 48th Street
Suite 275
Phoenix, AZ 85044

CPE Program Administrator: 800.238.7475

National Registry of CPE Sponsors, A/LM Education

c. myers corporation is registered with the National Association of State Boards of Accountancy (NASBA) as a sponsor of continuing professional education on the National Registry of CPE Sponsors. State boards of accountancy have final authority on the acceptance of individual courses for CPE credit. Complaints regarding registered sponsors may be submitted to the National Registry of CPE Sponsors through its website: www.learningmarket.org