Has your credit union's lending department learned its lesson from Lehman Brothers? At a very high level, the demise of Lehman Brothers is simple: The company took on an extraordinary amount of mortgage loans, a good portion of them in the Alt-A market. Whereas subprime mortgages are considered extremely high risk loans due to the poor credit history (or lack thereof) of the borrower, Alt-A is a classification of mortgages where the risk profile falls between prime and subprime. The borrowers behind Alt-A mortgages typically have clean credit histories, but features of the mortgage itself (higher loan-to-value and debt-to-income ratios, or inadequate documentation of the borrower's income) will generally have some issues that increase its risk profile. However, the higher interest rates the bank garnished from these loans made them especially appealing, and Lehman Brothers took on the risk in extraordinary numbers.
From 2004 to 2006, Lehman accumulated such large volumes of these higher risk loans, that when the real estate market bubble collapsed in the summer of 2006, and the riskier borrowers started to default, rather than curtail their mortgage portfolio, Lehman made the detrimental mistake of pushing forward. In 2007, Lehman underwrote more mortgage-backed securities than any other firm, accumulating an $85 billion portfolio, or four times its shareholders' equity.1 It wasn't long before these risks, and the failed recovery of the housing market, forced Lehman to file for bankruptcy.
Is Your Credit Union Lending Software Ready for New Standards?
Perhaps the above synopsis is over simplifying the situation, which is no doubt a very well documented and researched series of missteps by executive management. But the bottom line boils down to risk and having the lending software in place to collect and analyze the data in order to calculate risk. The Financial Accounting Standards Board (FASB), in response to Lehman and other banks involved in the subprime mortgage scandal, issued new standards in June of 2016 to prevent a repeat. These new standards will go into effect in 2020 for financial institutions registered with the SEC, and 2021 for those that aren't. The new standards replace the current “incurred loss” accounting model with an “expected loss” model, or CECL (Current Expected Credit Loss). In very simplistic terms, this means financial institutions will have to account for events that have not yet occurred, and assess the risk of these events occurring, versus accounting for actual losses incurred. There is little doubt that credit union regulators believe CECL is the biggest change ever to financial accounting.
Your credit union core technology will play a major role in preparing for CECL. These new standards will require banks and credit unions to significantly change the way they collect and analyze data in order to asses the potential risk. According to the American Bankers Association Mike Gullette, bankers, regulators, and auditors are in agreement that more granular data and analysis will be required and new performance metrics will be needed.2 Now is the time to ask your core technology provider what they are doing to prepare for these sweeping changes. Does the credit union lending software you use collect the needed data and analyze the risk that will be required in just a few short years?