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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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Focusing on Branch Profitability, Solely, Misses the Mark: 4 Things to Consider

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As consumers’ preferences continue to evolve, it is becoming painfully clear that focusing solely on branch profitability will provide an incomplete or even misleading picture for decision-makers.

Think of it this way.   Traditional branch profitability analyses often reward branches for living off the past. 

Consider a branch that has a large loan portfolio, creating a lot of revenue, ultimately leading to today’s high ROA for that branch.  However after taking a closer look, it may turn out that this branch hasn’t produced many loans over the past year.  In fact, they are one of the lower ranked branches in terms of loan production.  However, the high ROA shown in a traditional branch profitability analysis is the result of living off loan production from years ago.

Evaluation in terms of current ROA alone may result in missed opportunities to realign resources today in order to have intentional focus on strategic objectives and evolving trends.

The following outlines 4 things to consider that is guaranteed to enhance business intelligence with respect to delivery channel effectiveness.

1.  Expand the evaluation to all delivery channels.  Credit unions are investing heavily in self-service options for members.  Effective adoption of these options is key to remaining relevant for many credit unions.  A focus during on-boarding has proven to help with adoption and engagement of new self-service options

2.  Align measures of success for each delivery channel with the credit union’s strategy.  This requires decision-makers to be intentional about the purpose of each branch, the contact center, and digital delivery channels

3.  Take a holistic approach to metrics.  Rank them to align with the credit union’s strategy.  For example:

  • Membership Growth
    • Not all growth is created equal.  This can be evaluated by segments if there is a strategic emphasis on the type of membership growth
    • Assigning indirect autos to the closest branch can significantly skew results.  Consider evaluating and managing the indirect channel as a stand-alone delivery channel
    • The same holds true for membership acquired digitally.  If a branch is credited, decision-makers will not have clarity with respect to the effectiveness of their digital delivery strategy or the physical branch
  • Value-Add vs. Routine Transactions
    • Work with your team to distinguish value-add from routine transactions, then rank delivery channels accordingly.  For example, many are revamping branches to remove routine transactions so that value-add and complex transactions can be effectively and efficiently handled.  In this case, the metric would evolve around reducing routine in-branch transactions and increasing value-add transactions
  • Member Engagement & Feedback
    • Comprehensive delivery channel evaluations should incorporate what the members are saying about their experiences with the different touch-points.  Credit unions are investing heavily in digital delivery.  It is not uncommon to hear that member satisfaction with digital delivery is lower than that provided in branches.  If this is true for your credit union, ask yourself how this can impact member engagement and how the gap in member satisfaction can be narrowed
    • If the credit union has strategic emphasis on particular demographic segments, consider establishing metrics that align with this focus
  • Loan Growth
    • Rank current balance, short-term, intermediate-term, and long-term performance independently.  This addresses a common flaw of profitability studies that can focus too heavily on older loans
    • Rank major segments of lending by balance and recent production.  This provides an early warning if production is falling off
  • Share Growth
    • Consider category evaluations.  Delivery channels that rank high for regular shares or checking may benefit the credit union differently than those with a heavy reliance on money markets or CDs

4.  Weighting Is Key

  • Each of the above can be important to monitor, but not all of them will contribute equally to the credit union’s performance or strategy.  Consider the credit union’s strategic objectives and then use these objectives to help weight the importance of each category.  This intentional view of production and member experience, connected to strategy, creates better business intelligence for decision-makers than a traditional branch profitability analysis

Having a broader understanding of delivery channels in terms of contribution to strategic objectives and the trends exhibited is the first step.  This can then be combined with profitability estimates if desired.

As the financial services industry becomes more complex, it is important for decision-makers to have the right type of business intelligence so they can take action and make necessary course corrections, timely.

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Making “No” Decisions

One of the key characteristics of a high-functioning credit union is the ability to make “no” decisions in order to stay focused on the credit union’s strategic direction. As this year starts and the project list grows, it will be important to keep a laser-like focus on the projects that the management team has determined are the most important for achieving the credit union’s strategic objectives.

With 100% certainty, there will be many “shiny new objects” throughout the year that will be highly tempting or considered “must haves.” Before committing to those “shiny new objects,” it will be critical to take the time to filter them through the credit union’s strategic direction and objectives to see if or how they fit.

If they truly fit, then deliberately consider the timing of taking on more. Are these “shiny new objects” really top priorities or would the credit union be better served by delaying the start date so as not to distract from current strategic objectives?

Mastering the skill of strategically allocating resources is exceedingly important because technology innovations are happening at lightning speed. In the meantime, distractions will need to be put in the “no” or “not right now” column.

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What If The Fed Rate Projection Is Right?

This is a question credit unions should try to answer as part of their ongoing long-term forecasting process.  The FOMC reaffirmed on Wednesday (December 12) that they do not anticipate raising rates until 2015.

Source:  Federal Reserve

So what happens to earnings and net worth if rates stay at historic lows for two more years, and then start to rise? Instinctively, the net interest margin should be squeezed over the next two years as assets continue to reprice down without a corresponding reduction in the cost of funds. The big unknown is: how much and how fast will rates rise?

Credit unions may need to run a series of “what-ifs” to understand the impact. “What-ifs” should include rates rising over different time periods (i.e., 12 months, 24 months, etc.) and increase to different levels (i.e., 100bps, 200bps, 300bps).  It would also be prudent to test changes in balance sheet mix, as rates may rise for different reasons.  If the economy is booming, then the credit union may be able to originate more loans.  This would help the bottom line and possibly mitigate the impact of the lower-yielding assets brought on in 2013 and 2014.  However, if the economy is stagnant, loan growth could be an issue—which would hurt earnings and net worth.

Decision-makers should review the series of “what-ifs” and discuss any areas of concern.  Credit unions should run additional “what-ifs” that address their concerns—particularly in cases where success measures would not be met or the credit union’s ability to deliver on its strategic objectives is threatened.

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Evaluating Investments

This post is a continuation of Investing At “Record” Low Rates… published February 10, 2012.

Investments with complex optionality are increasingly being added to credit union investment portfolios.  As such, it is critical that credit unions have a solid understanding of what they may be purchasing, before the transaction is executed.

First, make sure your broker is providing you with a complete picture of the characteristics of the investment in question.  In general, most brokers provide market value, and cash flow information for the current environment and a +300 basis point (bp) rate change.  However, some investments (in particular some CMOs) may look “okay” if rates go up 300bp, but have the potential for extreme extension risk if market rates go up 400 or 500bp.  Credit unions should ask their broker for cash flow and market value shock data for the +400 and/or +500bp rate change, particularly for investments with optionality.  Remember that short-term market rates were 500bp higher than they are today as recently as 2007.

In addition to cash flows, other optionality features can be very important as well.  For example, if the investment is variable rate, make sure that all of the repricing parameters are clearly understood: repricing frequency, margin, caps, floors, etc.  When the first repricing can occur is particularly important, especially with rates being so low.  For callables and step ups, consider call dates and potential repricing dates.  For step up investments consider if the future step protection warrants the lower starting coupon rate compared to a bullet or callable with the same final maturity.

Working with a trustworthy broker certainly helps in this process, but that does not absolve decision-makers of completing their own due diligence and ensuring an investment fits within their overall strategic objectives.  Keep asking questions until there is clarity on the investment and its structure, consider the other pertinent decision drivers (for example, policy, impacts to aggregate risk position, etc.) and consider the unexpected in the decision-making process.