A Unique CECL Modeling Exercise for a Rapidly Growing Consumer Lender

The Challenge

A financial institution specializing in consumer lending approached VBC for assistance in estimating the financial impact of transitioning to CECL.  The institution was expected to double in size by Q1 2023 and adding to the complexity of their situation, they were focused on lending to near-prime and subprime customers who could not obtain credit from more traditional bank players in this space. 

With their credit profile, credit losses would be expected to be much higher than at a more conservative financial institution.  Scrutiny on their reserve levels and modeling process was expected to be high as a result.  Initial internal expectations were for the CECL reserve to be significantly higher than the current ALLL reserve and they were seeking expertise to assess this estimate.  

Our Approach

VBC addressed this challenge by forming a working team that included one of our partners, one of our CECL experts with 20+ years of credit modeling experience, the institution’s CFO, and their Head of Credit Risk.  Over a three-month period, VBC identified the available data, analyzed options for portfolio segmentation, and proposed a model methodology – PD/LGD – that allowed the Client to benefit from applying DCF to the CECL calculation.  VBC then built a working CECL model for the Client using loan-level data and aligning FICO bands with industry loss rates and recovery rates.  Given that the portfolio was growing so fast, and that the institution was < 5 years old, we recommended industry rates that would likely be more defendable with auditors and regulators.   We incorporated an entire credit cycle of data in our analysis to ensure that stress losses aligned with peak losses in 2008-11.  We then prepared two calculations: one based on their current position as of Q2 2021, and a second based on their forecasted position as of Q4 2022.  

The Result

Based on our robust quantitative modeling approach, we were able to justify a CECL reserve that was not significantly higher than their current ALLL reserve with a process that was entirely quantitatively driven and completely transparent.  

In this example, as with all of our clients, VBC customizes solutions to meet the institution’s specific needs.  We become a valued partner and an extension of the institution’s team and are present at board meetings and C-level meetings when needed.  We focus Client attention on the most important assumptions to ensure they have a sense of ownership of the process, and we provide the best tools and techniques available in the marketplace.  

As a result of this engagement, the Client has extended our relationship and asked that we lead the full implementation of CECL in 2022 and 2023.  Our mission is to position your financial institution for success by engaging with you in a collaborative partnership, enriching you with valuable expertise and useful data and insights, and empowering you to make impactful decisions.

Learn more about VBC’s CECL service.