PASADENA, Calif.-Tools that take a "top-down" approach to assess credit risk in the entire loan portfolio are available for the first time to credit unions.
That's according to Anna Mendez, chief credit officer at Wescom CU here, who believes most credit unions are missing the bigger picture when it comes to credit risk in that typically managers use tools that fail to scrutinize the loan portfolio as a whole in light of broader economic variables. The tools are limited to considering risk at the individual loan level devoid of economic variables, or from the "bottom up," she said.
The bottom-up method produces an incomplete analysis of the portfolio, and, therefore, "an unrealistic picture of what's coming your way," she said. "Wescom's approach to managing credit risk is two-pronged," Mendez continued. "We look at performance from the portfolio level as well as the loan level. It's both top -down and bottom-up."
Early last year, the $3.5-billion CU modeled its approach after standards set by the Basel II Accord of banking regulations - but it couldn't put the approach into practice with the tools that were available in the marketplace, she said. "When I first started looking for technologies to support our envisioned two-pronged approach to credit- risk management, I didn't find anything out there for an organization our size," said Mendez. "While there were some solutions for the bottom-up analysis, credit unions just didn't have access to top-down analysis. Larger organizations have always utilized these systems and find them critical for their business planning, as well as their daily operations."
That changed when Wescom teamed up with Cary, N.C.-based SAS for loan analytics at the portfolio level, said Mendez. SAS provides business intelligence software. Together, Wescom and SAS created a top-down system appropriate for small financial institutions, Mendez said. The SAS modules include Forecast Server, Enterprise Miner and SAS Base.
"The SAS system forecasts losses by looking at the past performance of the portfolio and correlating it to various economic variables provided by the source of your choice," she said. "Wescom currently uses Moody's as our source for this data. We can then see what the economic variables are expected to do and how our portfolio should perform as a result."
The econometric-fueled forecasts go a step beyond the widespread practice of scenario-shocking, she said. "We are actually considering forecasted economic trends. So, for example, if Moody's indicates that we'll have, among other variables, a huge unemployment rate next year, we know what our delinquency rates and foreclosures in our portfolio look like in that scenario."
Wescom has used SAS since April, and "our performance has been very close to our forecast," said Mendez. For the bottom-up approach at the loan level, Wescom teamed with Ser Technology to help build the ProAct risk analysis software. Dallas-based Ser Technology (SerTech) delivers credit services to credit unions.
"ProAct considers the FICO and bankruptcy score of each loan and, from that, is able to predict how the loans will perform over a 24-month period," said Mendez. "We can then combine the loan level analysis from ProAct with the portfolio level analysis from SAS to get a true picture of what our performance will be," said Mendez. Wescom forecasts data for 12-month periods and refreshes the analysis each quarter, said Mendez. Management can view the forecasts on a digital dashboard and respond by making adjustments to origination guidelines as necessary, she said.
The two-pronged approach also informs collections practices, she added. "The systems identify the riskiest loans so that we can collect on them in a much more proactive manner." Wescom - reporting more than $32-million in losses in the first three quarters of 2008 - didn't need to adopt such a comprehensive approach to controlling credit risk in previous years, Mendez said. "In the past, tools available to credit unions were adequate for the market environment," Mendez said. "But Wescom recognized the climate was changing and that we would need even better forecasting and risk management tools."
CUs should expect to pay less than $100,000 per year for both the SAS and SerTech systems, said Mendez. "Even the smaller credit unions can afford this and will need it, especially when considering the cost of credit losses in general."
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For info on this story:
* www.wescom.org
* www.sas.com
* www.sertech.com
