Migration analysis may be the answer
Beth Carr, CEO of Santa Cruz Community Credit Union, may have more concerns than most about the impact of the Current Expected Credit Losses implementation. Santa Cruz Community is a $120 million low-income designated, community development financial institution.
“Because CECL takes a different look at loan risk, we expect – like everyone I think – for provisions for loan losses to increase, and therefore, our income will decrease. As a small CDFI, low-income designated credit union, what we do for our community is based on our resources,” Carr explained. “Therefore, this change could take away income that will further tighten our abilities to serve our underserved and unbanked populations.”
Santa Cruz Community CU’s field of membership comprises Santa Cruz and a sliver of Monterey. Within its field of membership, and a key focus for them, is Watsonville. The community is the second poorest in the country and is 80% to 90% Latino. Overall, California has been experiencing a housing crisis, but, Carr pointed out, some of the manufactured home mortgages they work on are reaching $600,000, a ludicrous amount for such a low-income community. The credit union spends a lot of time with consumers who’ve been turned away from banks and other credit unions in the community. Very recently Santa Cruz Community CU made one mortgage to six different homebuyers, all making about $25,000. Most institutions wouldn’t bother to figure out how to make that happen, she lamented. Now all six are homeowners.
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That’s one of many services and programs that could be affected when CECL takes effect. The credit union does a lot of nonprime lending, ITIN lending and small business lending. “The point is to give access to people who can’t get access anywhere else,” she explained. Other services targeting the low-income, but not affected by CECL, include providing savings for people without Social Security Numbers and offers share-secured Visa cards.
“I also have some concerns that inadvertently, credit unions will rethink their loan offerings and provide lower-risk loans or change underwriting to the point where actions can potentially limit access to our low-income communities. This, of course, is probably more fear than reality since the industry has yet to establish the results of the models we are all evaluating. We are currently evaluating a CECL model that shows we are over reserved if we adopted today, because there are some variables. However, we plan to thoroughly validate that model.”
Randy Thompson, CEO of TCT Risk Solutions, explained that some consultants are saying allowances could go up as much as 70%-80% for some credit unions under CECL, which requires credit unions to account for potential loan losses for the life of the loan rather than incurred losses. That means net worth would decline, and credit unions running in the 7% range could be in for PCA trouble. That’s true with a regression analysis, which tends to only look at deteriorating accounts. Using migration analysis, however, some credit unions, like Santa Cruz, could be looking better.
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“I understand credit unions seem to be hesitant to lend in a low-income environment, but with migration analysis that can be mitigated by the members moving up,” Thompson said. Migration analysis accounts for not only the credit scores that are going down, but also the credit scores that are going up. Santa Cruz does a lot of financial and credit education work with its members and offers programs to improve their scores, he pointed out. At some credit unions (TCT is currently working with 65) that serve a lot of low-income members and provide educational and other support, 35%+ credit scores might be moving upward. “That movement mitigates the impact CECL would have on the balance sheet,” he explained.
Thompson said he suspects that other than some of the very large credit unions, many are not ready for CECL’s financial implications, much less the indirectly related potential field of membership-related potholes. That belief was reinforced when FASB recently proposed delaying implementation.