By Ray Birch
CLAWSON, Mich.—If a credit union is cutting back on lending because its CECL number has spiked, one analyst is suggesting it might be time to gain a better understanding of the CECL model it is using.
The concerns at many CUs and resulting policy changes are coming about as credit unions begin to phase in the CECL accounting standard.
Charley McQueen, president and CEO of McQueen Financial Advisors, which provides consulting services around current expected credit losses (CECL) to credit unions, said he has seen credit unions look to reduce lending in response to an increase in their CECL numbers as they have also moved to quickly increase their corresponding reserves.
But when that happens, he said, it’s a warning sign the CECL model itself may be the reason for the increase. He cautioned against CECL models that are often termed a “black box”—where the assumptions, decisions and rules within the model are not transparent.
“CECL is being slowly phased in over a number of years, so a credit union shouldn't have had an equity hit from it,” said McQueen.
McQueen said if a credit union is taking a hit to its equity ratio, then the credit union is either implementing CECL incorrectly or it’s not charging enough for the loans that have gone delinquent.
“They might be doing some really bad lending by not putting in a good enough yield and are therefore making a negative return,” he observed.
‘Doubled for No Apparent Reason’
McQueen said he is personally not aware of any credit unions that have reported reducing their lending volume as a result of CECL, but CUToday.info has received a report from a credit union leader who asserts the issue is occurring among a number of credit unions in his area.
“We've had a number of clients come over to our CECL model, leaving other providers that have what they call a black box model,” explained McQueen. “People are calling us and saying ‘Our CECL number doubled for no apparent reason last month, and the service provider we use can't explain to us why it doubled’.”
Charley McQueen
McQueen’s response is that “is not logical. CECL is very mathematical. You have your historical losses. You have your forward economic projections and your current economic projections, and you put it all together and should be able to trace back every single modification to your CECL number.”
No Surprises
He stressed there should be no surprises with CECL. And yet, the surprises continue.
“But we have more and more people coming over to us because of these black box models,” he said. “They are just causing significant problems. CECL should not be a big problem. It's a known quantity. So, we're really surprised by some people's response to some of the problems they’re saying they’re having.”
McQueen shared the example of a client who had a $1.5-million CECL reserve.
“Their report came out one month and said they suddenly needed to have a $3-million CECL reserve,” McQueen said. “That would be a direct hit to income. They don't make a million half dollars a month. It turned out they simply had a CECL model that was faulty, causing them to put significantly bigger numbers in (than was necessary). If CECL (reserves) are going up for unknown reasons, something is wrong.”
The Need for Quantifiable Numbers
However, if the CU’s economic forecast is looking worse going forward, that could cause CECL numbers to go up, McQueen noted.
“But, it all should be quantifiable,” he said. “One of the best predictors of losses historically has been the unemployment rate. If you don't have a job you can’t pay your bills. That's where we look right now. The Fed’s projected unemployment rate is really quite low. So, while you know maybe a little bit of uncertainty is coming down the road, we're not seeing that hitting unemployment predictions, yet. Again, I don't see why CECL numbers would be going up substantially. You shouldn't see massive swings unless there is a significant problem within the credit union or if all of a sudden the unemployment rate jumps to 5%, 6% or 7%.”
McQueen said one exception would be any credit union with a sizeable commercial real estate portfolio, which could very well be experiencing an increase in its CECL number.
Finding a New Provider
McQueen stressed if certain questions can’t be answered, a credit union needs to find a new vendor.
“Every CECL provider should be able to explain to you the changes in any month, what happened and why,” he said.