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Planning For PLL

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Given the economic experience of the past couple of years, many credit unions were forced to beef up their loan loss reserves.  Now, as things appear to be getting better, we are seeing that some credit unions feel they are “overfunded” and are not adding to their reserves.  While this may provide some temporary relief to earnings, credit unions cannot plan their long-term business models on the fact that there is no PLL expense or, in some cases, that the expense is negative.

Credit unions have worked hard in this environment to define their target markets, focus their efforts toward them and have learned to do things more efficiently. They should enjoy this brief reprieve.  However, credit unions should not become complacent.  Rather, they need to continue efforts to position themselves to be better and stronger in the future.

As far as modeling goes, assume that the PLL expense is at the level expected after the allowance for loan loss reaches an adequately funded level.  This will provide a more realistic picture of long-term earnings.  From a risk-management perspective, consider the experiences from the last couple years in making assumptions about worst-case credit risk exposure, not only from loans but also from investments.

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Do Lower PLL Ratios Mean The Credit Crisis Is Over?

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On the surface, recent credit union provision for loan loss (PLL) trends seem encouraging; industry-wide through second quarter 2010, the ratio of PLL to average assets has declined by 31 basis points to an annualized ratio of 0.81%.  However, delinquencies and charge-offs as a percent of loans have only decreased by 11 basis points and 5 basis points respectively for the same period.
Of course every situation and institution is unique, but as we look toward 2011, credit unions might want to consider:

  • Is the improvement in PLL sustainable?  Or, could it be a function of allowance accounts being over-funded?  As noted above, recent delinquency and charge-off trends do not look as positive as the industry PLL trend
  • Do the unemployment outlook, real estate values and the trends in member credit scores support the assumption that PLL will continue to decrease through 2011?
  • What if many of our usually dependable borrowers lose their jobs and, at a certain point, run out of savings?
  • What if strategic defaults become more commonplace?  Consider that strategic defaults are currently blamed for as much as 25% of foreclosure activity
  • Could commercial real estate woes trickle down to further impact the economy and cause broader loan losses?

Is 2011 the year that we’ll see sustainable improvements in PLL?  Hopefully it is, but with all of the uncertainty out there, we may not want to count on it just yet.