By Ray Birch
ATLANTA—New pricing structures and new approaches to lending will likely result from the Financial Accounting Standards Board’s (FASB) new Current Expected Credit Loss model (CECL), predicts one analyst, who acknowledges many lenders are still trying to fully understand the new rules.
“CECL changing how financial institutions must reserve for future loan losses will certainly impact lending pricing,” said Amy Graybill VP of enterprise insights and core data products at Equifax. “So we might begin to see different pricing structures for any loan type, including auto, once banks, credit unions and other lenders get their arms wrapped around how to implement CECL and what it means to their reserves for future losses.”
Financial industry trade groups have voiced their opposition to CECL, saying the rules will limit lenders’ ability to make loans and deny credit to more borrowers. Credit union trade groups have argued CUs should not fall under the new rules, while numerous credit union events have featured full sessions at which attendees have sought to get their arms around CECL.
Graybill reminded that the key accounting change from CECL is that lenders must now set aside reserves for future losses based on the life of the loan.
Effect on Short-Term Forecasts
“Today, lenders are doing short-term forecasts for their loan-loss reserves,” noted Graybill. “They wait for borrowers to show signs of stress—say, become delinquent—and then they start setting aside some of that money in reserves. It’s a short-term, easy model. However, when the economy starts changing it really impacts how those short-term forecasts perform.”
With CECL’s requirement that lenders perform life-of-loan loss forecasting, Graybill said that means as soon as a lender says yes to a loan, it must begin reserving for potential losses on that loan. She said that requirement means the lender must have a much better understanding of the borrower’s financial condition when they make the loan.
“They now really have to understand they are making a loan to this borrower, in this region, with this risk score, on this type of auto, for example, with this LTV…,” she said.
Impact on Loan Pricing
Graybill expects that kind of analysis will impact loan pricing, sending some rates up and others down, depending on the borrower and collateral. Adjustments will come across the entire credit spectrum, she added.
If a lender is heavily into subprime or high LTV auto loans, for example, that would lead to much higher reserves and then possibly higher loan prices.
“We will probably see a mix of pricing changes,” said Graybill, who said that some loan rates could drop. “For instance, a bank may now be capturing higher loss reserves for really well performing loans than they will under CECL. So they may not have to do that, and reserve less.”
She said that terms may be adjusted, as well.
“If a borrower buys an expensive car and does not put a lot down, perhaps lenders will extend those terms from 24 to 36 months to keep the payment down to make it easier for the borrower to repay,” she said, adding that she does not see auto loan terms extending out for the 80-plus month deals.
Greater Income Validation Needed
Graybill stressed that lenders will likely require greater income validation up front and possibly higher downpayments.
Prior to the first quarter of 2020, however, when adherence to CECL policy is expected to be required, a lot will be figured out by banks and credit unions, which Graybill emphasized are still trying to fully understand CECL.
“They are figuring out a lot in the next 18 months—how does this impact my pricing model? Do I need to price differently? Are my margins high enough? Do I still need to offer some loans because they now have become too expensive?” she said.
Graybill, however, does not believe CECL will effect the availability of any particular type of loan, saying that as some lenders may pull back from certain loans others will take up the slack with the right pricing model.
“I don’t see any loan type drying up as a result of CECL,” she said.
Forgetting the Past?
Asked if CECL is arriving at a time when many lenders are forgetting the past, including the practices that led to the severity of the Great Recession, Graybill told CUToday.info CECL does force lenders to look more critically at the past and the future.
“When you think about what CECL is requiring, it’s requiring that lenders look at the past, incorporate historical data, to help set aside future dollars for losses,” she said. “So there should be some inherent, do I really want to do this type of thing, thinking. I believe that CECL will help lenders understand that maybe there should be a way to tighten safely. Not go to no more often, but find better ways to say yes.”