The examiner sat across the desk from me, polite but persistent. “How do you know?” was the question he kept asking. We were discussing our Allowance for Loan and Lease Loss (ALLL) account. “How do you know your balance is sufficient? How do you know your methodology is adequate? How do you know?” I explained the method we used to calculate our required ALLL balance. I described the Qualitative and Environmental factors we used. I showed him our current delinquency reports, loss estimates, and collection notes. He nodded politely, then repeated, “Yes, but how do you know?”
At this point, I was getting exasperated. I know because I know! I’ve been doing this for nearly two decades, and some things you just know. Then inspiration struck. I smiled and said, “I know because we use a third party vendor to provide a wide array of loan analytics for us, including validating our ALLL methodology.” Taking a deep breath, I continued, “Visible Equity performs a Monte Carlo simulation on our entire loan portfolio. Using current LTV and credit score data, combined with migrations in both factors, they estimate a probability of default for each loan in our portfolio. Then they run 1,000 iterations on our data to identify the distribution of expected losses, assuming a 75% recovery rate on secured loans. Based on this independent analysis, our ALLL account is adequately funded at a 95% confidence interval.”
The examiner paused for a few seconds, nodded, and made a small check mark on his paper. “Okay,” he said, “now let’s talk about BSA…”
The ability to analyze a loan portfolio has historically been limited to large institutions who have the resources to hire:
- Smart people who know what questions to ask;
- More smart people to write the programs to find the answers to those questions;
- Even more smart people who know what to do with the answers they find.
Smaller institutions like ours have smart people too; we’re just focused on the day-to-day challenges of serving members, maintaining compliance, and taking out the trash. The luxury of data analytics has been just that – a luxury. Sure we would like it, but not badly enough to dedicate the resources to have it.
Times change, and what was once considered a luxury is now considered a standard feature. Consider how automobiles have changed: Air conditioning; seat belts; air bags; anti-lock brakes… All of these features at one time were not standard; today it would be difficult to find a new vehicle that does not include all of these and much more to make the drive more comfortable and safe. Although automobiles are more expensive than they were 25 years ago, we get so much more value from each dollar we spend.
In today’s world, the ability to see both the “big picture” in our loan portfolio, and then be able to drill down to individual loans is rapidly becoming expected as a standard feature. And just as the automotive industry has changed to provide greater value and convenience per dollar spent, loan analytics is benefiting from increased computing power, ease of manipulating data, and economies of scale. As a small credit union partnering with Visible Equity, we now have access to answers that we didn’t even know to ask before.
The smart folks at Visible Equity have taken care of the programming, and they offer lots of resources to help us know what questions to ask. They have taken care of two of the three “smart” needs my credit union has, leaving me to focus on just one area – what should I do with what I now know? That’s still a daunting challenge, but one that I can deal with.
Next time my examiners or Board want to know ______________ about our loan portfolio, I have the resources to find the answer.
Now, whose turn is it to take out the trash?
Freedom Credit Union is a $27 million credit union in Provo, Utah serving 3,300 members. We started in 1956 as the Provo School District Credit Union. With a small staff and a focus on using technology to serve our members with exceptional personal service, we have roughly doubled in size in the past ten years.