What some people consider random facts can really be significant indicators. During a recent conversation with a colleague, I described myself as an “Encyclopedia of Useless Random Facts.” What is seemingly trivial information to others is often of interest to me. Take for example that a higher percentage of U.S. presidents were left handed than the general population. I’m sure that most of us are not really concerned with what hand our president signs legislation with unless, of course, we were running for president.
But, what if that random fact pointed to a more meaningful piece of information? What if a person’s dominate hand somehow correlated to their leadership skills? What if being left-handed helped individuals cope with the disadvantages of living in a right-hand dominate world and those coping skills translate to a higher self-awareness? Sometimes, what seems meaningless on the surface could be significant if correlated with another important indicator. Malcolm Gladwell addresses these “Outliers” in his book of the same title, published in 2008.
In his book, Gladwell proves that a person’s birthdate highly correlates to how successful they are in sports. But, the date a person is born really doesn’t contribute to their athletic ability in any way. What Gladwell found was that children whose birthdates fell around the cutoff date for entry into the first grade were often held back one year and as a result would end up being the oldest in their class the following year. Because they were older, and ostensibly more mature, these older students were better prepared for learning and tended to do better in class.
As these individuals progressed through their education and into sports, they were often better performers on the field due, again, to their one-year extra maturity. Coaches tend to give more time and attention to the better performing players, so these older, more mature kids would get more attention from coaches than the younger less mature players. All of this translated into these children with seemingly insignificant birthdates outperforming their peers on and off the field. Parents who read this book began holding their children back from first grade to give them that extra edge. It was called “red-shirting” kindergartners.
In 2005, Dr. Michael Burry was one of a handful of people who predicted the collapse of the mortgage industry based on insignificant indicators that he observed in mortgage backed securities. Very few people believed him and some thought he was completely daft. He put over $1 Billion on the line betting against the U.S. economy and in favor of something that had not happened in decades, wide-spread mortgage defaults. As it turns out, he was right and became even richer, capitalizing on others’ unwillingness to believe the insignificant random facts he had discovered.
Over the last year, CU Direct’s Advisory Services has been assisting credit unions across the country in identifying some of these seemingly insignificant data points that actually turn out to be highly predictive in the way their loan portfolios perform. In fact, many of these factors are more predictive than even the credit score at origination. For instance, the existence of a co-borrower of any type decreases the probability of default by 300% for one credit union.
CU leaders often feel that their hands are tied when it comes to accurately predicting risk, especially when it comes to new CECL rules. Many are fearful that changing loss estimate calculations may have a negative impact on ROA, and this may, in fact, be true. However, one will not know for sure until they have conducted the exercise.
For those that are waiting for the magic wand for making these calculations, you should know that it already exists — in the form of custom default predictive models. These models can help prepare your credit union for the requirements of more accurately predicting losses, well before the requirements take effect. Like the sports stars with the right birthdates, you are in a position, today, to improve your credit union’s odds for success, and our Advisory Services is prepared to help you make that happen.