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Comprehensive Credit Risk Management at Credit UnionsRandy Thompson, PHDCEO, TCT Risk SolutionsBrad BaugesstCEO, 1 Community Credit Union
Key Elements/Tools2Comprehensive and CompliantComprehensive and Compliant Policies PoliciesRisk Based LendingCredit MigrationRisk Based Loan PricingCredit Migration
Credit Risk ManagementCredit risk policies describe the amount of riskthe credit union will tolerate in its portfolio aswell as how the credit union will identify creditproblems early and respond to those problems.Credit Risk Management policies should alsodescribe the tools the credit union will use tomanage credit risk and describe how those toolswill aid in carrying out policy.Credit Risk Management policy should supportother loan policies including Loan ConcentrationRisk, IRR and Liquidity Policies.3Community development financialinstitutions (CDFIs) are privatefinancial institutions that are 100%dedicated to delivering responsible,affordable lending to help lowincome, low-wealth, and otherdisadvantaged people andcommunities join the economicmainstream.
Creating Compliant and Useful PolicyMaking sure policies provideguidance to management andreflect the credit union’s riskmanagement philosophy.Loan policies have become muchmore detailed and encompassing asa result of regulations and thegrowing complexity in loanportfolios.Community development financialinstitutions (CDFIs) are privatefinancial institutions that are 100%dedicated to delivering responsible,affordable lending to help lowincome, low-wealth, and otherdisadvantaged people andcommunities join the economicmainstream.4
5Loan Process ManagementLoan process policies describe: the credit union’s overall lending philosophy,instructions for loan officers, and so forth. Many credit unions have individual loan policiesfor business loans, consumer loans, collectionpractices, mortgage loans, etc. Loan process-type policies have grown muchmore descriptive and complex as a result ofregulatory requirements.
6What is Risk Based Lending?Risk Based Lending consists of:Underwriting (Do you want to make thisloan?)Pricing (What rate must I charge toaccount for the risk?)
Underwriting7Credit Unions create criteria formaking loan decisionsIdentify criteria that affect riskCriteria must be valid, reliable andfair
Underwriting8Validity- are you measuring whatyou intend to measureReliable- do you get the sameresults from repeated applicationsFair- do all similar people get thesame outcomes
Risk Based Lending - Guidance9 NCUA Guidance Letter - 174 “Risk-based lending allows credit union management to assessthe risks involved in different types of loan products and pricethese products based upon the inherent risk associated withindividual borrowers. The end result is a more diversified loan portfolio mixinglower-yielding, lower risk loans with higher-yielding, but riskierloans.” “Prior to beginning a risk-based lending program, it is importantthat the credit union board determine the parameters for theriskier loans based on the credit union's financial condition,business plan, lending and collection history, and asset liabilitymanagement (ALM) program.”August 1995Central missionof ellopportunities
Underwriting10Purpose of Risk Based Lending Diversify loan portfolio Extend loans to underserved Make loans we would otherwiseavoid
Risk Based Lending - Definition11 NCUA Guidance Letter - 174 “Prior to beginning a risk-based lending program, it isimportant that the credit union board determine theparameters for the riskier loans based on the creditunion's financial condition, business plan, lending andcollection history, and asset liability management (ALM)program.”August 1995Central missionof ellopportunities
12UnderwritingProfile CriteriaEmploymentMax D/IUnsecured D/IDelinquency30 current Del. On Home or Car60 current Del. In pastMax Times Del. In Pst YearOpen Coll. Accts in 24 mthsProductsSecured LoansMin/Max AmtMax MileageMax TermLTVSignature LoansMin/Max AmtProfile A (A & A )1 Year4535IdentifiestoextendNone24 mths/NoneincreasedcredittoNoneRate Bump 2,500.00 - 100,000.00120,00096120 / 150 GapA 500.00 - 15,000.00A 500.00 - 25,000.00
UnderwritingProfile CriteriaEmploymentMax D/IUnsecured D/IDelinquency30 current Del. OnHome or Car60 current Del. In pastMax Times Del. In PstYearOpen Coll. Accts in 24mthsProductsSecured LoansMin/Max AmtMax MileageMax TermLTVSignature LoansMin/Max Amt13Profile A (A & A )Profile B (B & C)Profile C (D & E)1 Year45356 Months452560 Days4520None24 mths/NoneNone12 mths/NoneNone6 mths/None3 or 46Rate BumpRate Bump 2,500.00 - 100,000.00120,00096120 / 150 Gap 2,500.00 - 50,000.00100,00072 Month100 2,500.00 20,000.00100,00060 Months90A 500.00 - 15,000.00A 500.00 - 25,000.00C 500.00 - 5,000.00B 500.00 - 7,500.00E 500.00 - 1,000.00D 500.00 - 2,500.00NoneRate BumpIdentifies to extendincreased credit to
Risk Based Lending - Considerations14 NCUA Guidance Letter - 174Risk-based lending involves setting a tiered pricingstructure that assigns loan rates based upon anindividual's credit risk.Through a carefully planned risk-based lendingprogram, credit unions may be able to make loans tosomewhat higher-risk borrowers, as well as betterserve their more credit-worthy members.”August 1995Central missionof ellopportunities
NCUA Guidance Letter - 174“ The key to successful risk-based lending is toensure that prices (rates) correctly reflect therisk and costs involved.”August 199515Central missionof ellopportunities
Risk Based PricingWe define risk, in relation to the loan portfolio, as the likelihood thatmoney that has been expended or extended by the credit union will notreturn. Money expended includes cost of funds, loan operations andcollections.16Central missionof helpingmembersTargetedmarketing Money extended includes charge-offs of principle balances.IncreasedLoyaltyThese items are identified as costs and as such can be statistically(stochastically) quantified and measured.UpsellopportunitiesThe consistent and complete measurement of these costs is foundationalto an accurate and effective loan pricing system.
Credit Migration17Many names for the same concept Credit Migration Multi-dimensional portfolio management On-going decisioning Migration AnalysisCentral missionof ellopportunities
Credit Migration No matter what name you use it is animportant tool for managing the risk in yourloan portfolio;18Central missionof helpingmembers Loan losses are directly tied to it;Targetedmarketing Examiners are asking for, and in cases,requiring it; andIncreasedLoyalty It provides a valid and understandablemethod to identify expected credit lossesUpsellopportunities
Credit Migration19Vital Statistic 60% to 80% of all losses come fromloans that were made in higher gradesand then experienced a falling FICOscore.Central missionof ellopportunities
Utilize Credit Migration Identify in policy what you willSetmonitorand howup specificprocedures to\complywithpolicy Set up specific procedures tocomplywithpolicy Document your actionDocument youraction Report to Board20
21Understanding Credit ScoresCredit Agencies continually monitor multiplerisk indicators to calculate credit scores: Payment historyAmount of creditAvailable creditEmployment historyRepossessionsBankruptciesForeclosuresUsing these variables they employ regressionbased models to predict loan losses
Understanding Credit ScoresEach of these variables is dynamicSet up specificprocedures to\complypolicy Changes in variables mayaffectwithcredit Credit changes affect riskDocument youraction Changes in risk may affect memberperformance22
Credit MigrationUnderstanding your Loan PortfolioCredit risk can Increase or DecreaseWhich risk pools are improving impairing?Set up specificIdentifying Potential Problemsprocedures to\Isolate impaired loans and react to them earlycomply with policyUnderstand the risk in your pools and adjust lendingpracticesIdentifying Emerging OpportunitiesRecognize Members that are making smart decisionsProactively offer ways to help your membersUnderstand which pools of loans to take on more riskDocument youractionApplying Precision in Allowance CalculationStatistically based calculationComplying to regulations23
Understanding Your Credit Portfolio24 Createmigrationmatrix fortotalportfolio OriginalFICO andCurrent FICO
Understanding Your Credit Portfolio25Createmigrationmatrix foreach riskpool
Understanding Your Credit Portfolio26It is alsoimportant topartitionloans by riskpools andapply thesameanalysisindividuallyto each pool.
Understanding Your Credit Portfolio27Create a netcredit changecalculation
Understanding Your Credit Portfolio28Net RiskChange
Understanding Your Credit Portfolio29Delinquencyby ChangeGroup
Understanding Your Credit Portfolio30Charge-Offsby ChangeGroup
Credit MigrationUnderstanding your Loan PortfolioCredit risk can Increase or DecreaseWhich risk pools are improving impairing?Set up specificIdentifying Potential Problemsprocedures to\Isolate impaired loans and react to them earlycomply with policyUnderstand the risk in your pools and adjust lendingpracticesIdentifying Emerging OpportunitiesRecognize Members that are making smart decisionsProactively offer ways to help your membersUnderstand which pools of loans to take on more riskDocument youractionApplying Precision in Allowance CalculationStatistically based calculationComplying to regulations31
Identify Potential Problems in the Portfolio32Drop of 2 ormore creditgardes in animpaired FICO60%-80% ofDelinquenciesand Charge-offscome fromimpaired FICOscore loansBy respondingearly you canminimize losses
Identifying Impaired LoansRE33Post-EvaluationHH IDACCT TYPEOriginal FICO forLoan Pool ReportOrig. GradeSEP11 FICOCurrent FICO For1211M CURRReportCurr. Grade BAL1211M CREDIT1211M ORIG BAL LIMIT200027920L35RE745A 674674B 16,689.00 105,000.00 00.00% -200055284L38RE765A 644644C 89,083.00 100,000.00 00.00% -200033992L45RE759A 648648C 3,848.00 39,542.00 00.00% -200018742L45RE724A657657C 68,223.00 111,846.00 00.00% -200018574L45RE736A649649C 75,500.00 92,000.00 606000.00% -200018420L45RE727A632632C 31,206.00 40,000.00 400000.00% -200018222L45RE722A654654C 41,932.00 45,915.00 450000.00% -200017570L38RE702A635635C 15,072.00 21,200.00 00.00% -200033876L45RE699A539539E 44,300.00 52,859.00 00.00% -200051416L45RE678B599599E 38,382.00 42,129.00 400000.00% -200033010L52RE672B525525E 463,065.00 467,025.00 00.00% -200025234L38RE686B553553E 9,521.00 12,000.00 00.00% -200023090L45RE671B622622D 64,079.00 98,774.00 680000.00% -200019506L45RE668B535535E 96,517.00 114,638.00 524000.00% -200044060L45RE643C531531E 53,248.00 111,250.00 00.00% -200044028L52RE654C573573E 329,286.00 330,000.00 00.00% -200030580L45RE648C583583E 11,000.00 13,505.00 110000.00% -200020462L45RE654C539539E 35,556.00 43,702.00 00.00% -200016786L45RE644C598598E 209,856.00 257,346.00 00.00% -200006168L45RE641C607607D 6,700.00 0.00% -8,333.00 10000Current Value LTVAmount At Risk
Identifying Impaired Loans34Central missionof helpingmembersLoan TypeBalanceUnsecured eOpenDate759A 617D2/8/2013TargetedRatemarketingLimit14.99% 5,000IncreasedLoyaltyUpsellopportunities
Bankruptcy Narrative35Act early and minimize exposure Quality cash flow and lifestyle Trauma to cash flow Switch from cash flow to unsecureddebt Declare Bankruptcy
Credit MigrationUnderstanding your Loan PortfolioCredit risk can Increase or DecreaseWhich risk pools are improving impairing?Set up specificIdentifying Potential Problemsprocedures to\Isolate impaired loans and react to them earlycomply with policyUnderstand the risk in your pools and adjust lendingpracticesIdentifying Emerging OpportunitiesRecognize Members that are making smart decisionsProactively offer ways to help your membersUnderstand which pools of loans to take on more riskDocument youractionApplying Precision in Allowance CalculationStatistically based calculationComplying to regulations36
Identifying Emerging OpportunitiesDollar37Original FICO GradesCurrent FICOA ABCDENot ReportedGrand TotalA 740 33,886,855 4,911,282 1,696,945 425,522 105,543 63,014 3,184,419 44,273,580A690-739 7,886,015 11,359,190 5,212,544 857,840 146,917 147,464 1,828,060 27,438,030B660-689 1,857,191 4,601,064 10,527,101 2,055,535 1,333,417 158,714 537,630 21,070,652C630-659 910,286 910,852 2,541,847 2,547,064 886,367 848,199 268,658 8,913,273D600-629 17,970 123,766 1,503,642 2,480,152 715,706 525,812 526,391 5,893,438E 600 91,237 610,842 1,026,951 2,088,359 717,708 643,272 563,043 5,741,413Not Reported 75,089 29,047 481,778 - 300 472,982 1,248,632Grand Total 44,724,643 22,546,043 7,381,182 114,579,017189,43722,990,809 10,643,908 3,905,658 2,386,776Central missionof ellopportunities
Identifying Improved Loans38Central missionof ellopportunities
Identifying Improved LoansLoanTypeNew AutoBalance 7CurrentGradeA Central missionof 12 6.50%IncreasedLoyaltyUpsellopportunities
Improved FICO OpportunitiesAdditionalServicesExtended toMemberVISAImpact forCredit Union 37,500 in newloan balancesHELOCDEBIT CARD 1,000 interchangeincome fordebit transactions40Imact forMemberReduced interest rateand interest cost onloansEnhanced ability toaccess effective loans
Credit MigrationUnderstanding your Loan PortfolioCredit risk can Increase or DecreaseWhich risk pools are improving impairing?Set up specificIdentifying Potential Problemsprocedures to\Isolate impaired loans and react to them earlycomply with policyUnderstand the risk in your pools and adjust lendingpracticesIdentifying Emerging OpportunitiesRecognize Members that are making smart decisionsProactively offer ways to help your membersUnderstand which pools of loans to take on more riskDocument youractionApplying Precision in Allowance CalculationStatistically based calculationComplying to regulations41
ALLL- Homogeneous Pools42Traditional PooledALLL Approach
Risk Based ALLL W/Credit MigrationMaintain existing poolsSet up specificDivide pool balances into creditgraderangesprocedures to\comply with policyCreate unique loss ratios for each grade within each poolMonitor changing credit scores for movement in poolsDocument youractionCalculated ALLL requirement for each grade within eachpool43
ALLL- Homogeneous Pools44Risk Based CECLCompliantApproach
ConsiderationsEarly planning makes a huge differenceSet up specificUnderstand the impacts on initialtransferto\procedurescomply with policyUnderstand the impacts from growth and operationsPlan for increases in ALLL requirementsDocument youractionAssure your pricing accurately measures CECL impact45
How CreditCDFIWhatare theMigrationbottom Enhancesline impacts?Facilitates static poolanalysis to assess andimprove underwritingCredit Migration Users are able tolend deeper.46
How CreditCDFIWhatare theMigrationbottom Enhancesline impacts?Net Credit Scores are nearly93% higher! Credit Migration Users Non-CM Users 7.3% 4.1%Credit Migration users are ableto lend more effectively.Facilitates static poolanalysis to assess andimprove underwriting47
How CreditCDFIWhatare theMigrationbottom Enhancesline impacts?Average Credit Union ROA increased nearly 95% Credit Migration Users Non-CM Users0.700.41Credit Migration users are able tolend more profitably.Facilitates static poolanalysis to assess andimprove underwriting48
How CreditCDFIWhatare theMigrationbottom Enhancesline impacts? Loan yields increase by 34 basis pointsby enhancing C,D and E lending Delinquencies declined to 0.35% Charge-off ratio declined to 0.16% Loan to share increased to 83%These factors combine to enhanceincome and strengthen equityFacilitates static poolanalysis to assess andimprove underwriting49
50Final notes of caution Credit Migration system must bestatistically valid to achieve maximumbenefit Simply tracking scores will not providemaximum benefits A statistically valid model establishesaccurate score ranges and risk analyses
FOR MORE INFORMATION OR TO SCHEDULE A DEMOContact Dr. Randy C. Thompson, 1
well as how the credit union will identify credit problems early and respond to those problems. Credit Risk Management policies should also describe the tools the credit union will use to manage credit risk and describe how those tools will aid in carrying out policy. Credit Risk Management policy should support
