NCUA Indicates CAMEL Codes Keep Getting Worse
Download MP3Todd H: This sudden rise may
be startling for some, but
it should have been expected.
After all the continued high levels of
interest rate risk have increased credit
union liquidity risks contributed to
asset quality deterioration and capital
erosion and placed pressure on earnings.
What is more concerning for me,
however, is the rapid rise in total
assets for composite Campbell's
code 3 billion plus credit unions.
If not addressed quickly by
the credit union management.
These problems could escalate
into CamelScope 4 and 5
ratings and even failures.
And it's the billion dollar plus
credit unions that pose the greatest
risks to the shared insurance fund.
Microphone (USB PnP Audio Device)-1:
Hey, everyone.
This is Mark Treichel with another
episode of With Flying Colors.
That voice before the intro
to the podcast, which normally
starts an episode, is that of
NCUA Board Chairman Todd Harper.
He did not appear on the show.
Let me clarify that right out of the
gate, especially if anybody at NCUA
is listening and by the way, people
at NCUA do listen, I have a separate
episode on that, but I digress.
All right.
So that snippet came from the
NCUA board meeting, and chairman
Harper was being briefed on the
state of the chair insurance fund.
the.
board presentation on the
shared insurance fund.
, it's one of my favorite, , quarterly
events that happens at NCUA.
And you might ask why?
The reason why is that it's the only time
they publicly do any type of disclosure on
what's happening in Campbell code trends.
Now I put a post , on LinkedIn.
Let me pull it up here.
Indicating , that if you took the amount
of dollars in, in complex credit unions,
, and as a reminder, complex credit unions
are those over 500 million dollars
in assets based on NCUA's definition.
If you took the dollars in code
3s, they increased from 47.
7 billion, with a B, in June to 80.
8 billion.
That's an increase annualized.
If you take the results, multiply it by
4 and divide by what you had coming into
the quarter, that's an increase of 277%.
Now, if you go back and look at the
number a year ago, they actually
made reference to that in The budget
briefing, which happened later in
the day, and when they made reference
to that, they indicated there were
like 11 or 12 and now there are 51.
So that was like a 500 percent
increase in the number of large
credit unions with a code 3.
Now, that impacts the insurance fund,
which we'll get to a little bit later.
And the reality is N.
C.
U.
A.
Is nervous about the economy.
They.
That is trickling into camel codes, and
I'm going to now go back to NCUA Board
Chairman Todd Harper with some questions
and answers that he also poses to Chief
Financial Officer Eugene Sheed at NCUA.
Todd: The Share Insurance Fund's
performance in the third quarter of
2023 mirrors the industry's financial
performance over the last year.
Like the credit union system, the Share
Insurance Fund is performing well overall.
But there are some flashing
cautionary lights that we
should all heed and act upon.
For several months, the NCUA has
reported signs of growing liquidity,
interest rate, and credit risks
within the credit union system.
In today's report, we see that
stress firsthand, especially in
large, complex credit unions with
more than 500 million in assets.
In fact, as shown on slide 9, the number
of large, complex credit unions I'm
going to talk a little bit about credit
unions with composite Camel's Code three
rating increased by nine credit unions
to a total of 51 credit unions in the
third quarter assets in the Camel's
Code three group for credit unions
of all sizes also increased to 131.
7 billion dollars as shown in the
bottom right hand corner of slide nine.
That is nearly 45 percent higher
than the previous quarter's results.
The rising risks within the credit
union system also demonstrate why
the NCUA Board must ensure the
agency's 2024 budget has sufficient
resources to examine, supervise,
and mitigate these growing risks.
Some may not like the size of the
increase proposed in the staff draft
budget, but it is our job to protect
credit union members and the system.
Other issues, including the reinstatement
of federal student loan repayments,
rising costs for property and casualty
insurance, and consumers drawing down
the last of their pandemic era savings
will also affect already strained
household finances going forward.
And those household level issues could
eventually roll on to the credit union's
books as delinquencies and charge offs.
So the NCUA Credit unions and the
public should be prepared for further
impact on the asset distribution
of the system's CAMEL's ratings.
It will get worse before it gets better.
That brings me to my
first question, Eugene.
On slide 8, we see a 275 basis point
increase in the percentage of insured
shares held in PASA CAMEL 3 code
credit unions since the end of 2022.
This brisk pace of increase concerns me.
How rapid is the growth of insured
shares in Camel's Code 3 credit
unions compared to what we have
experienced in prior business cycles?
So as
Eugene: compared to prior business
cycles, we first went back and took
a look at the last 10 years, which
would include the taxicab period.
And we found no evidence of any
cycle that saw this kind of increase.
So then we went back a bit further, and
you have to go back to the Great Recession
in the 2010, 2007 to 2010 period.
Where we did see instances of quarter
over quarter increases that were larger
than what we've seen this quarter.
But again, you have to go
back to the Great Recession.
Todd: Thank you, Eugene.
That's a bit sobering to hear.
The NCOA will continue to monitor credit
union performance and mitigate risk
in the examination process, off site
monitoring, and tailored supervision.
The NCOA board will also closely watch
credit union and share insurance fund
performance in the quarters ahead and
act to protect the system as needed.
Additionally, and I cannot emphasize
this enough, credit union executives,
supervisors, and boards of directors
must remain diligent in managing the
potential risks on their balance sheet
and when monitoring economic conditions
and the interest rate environment.
Today's economic environment requires
active, not passive, management by all.
Additionally, the NCUA must ensure the
share insurance fund remains healthy
and fortify the system's defenses.
For potential risks ahead with the
rising camel code three credit unions,
the share insurance funds general
reserve balance increased by 10.
2 million in the third quarter, as shown
on slide for at the end of the quarter,
the reserve balance total of 214.
3 million with 7.
3 million set aside for specific
reserves and 207 million set
aside for general reserves.
Eugene, when you look at the number
of credit union failures and the cost
to the share insurance fund, as we
saw on slide five, the actual cash
losses have been small, about 1.
4 million a year to date.
Would you elaborate on why general
reserves are high when actual
cash losses have been so small?
And please discuss the NCUA's
methodology for reserving for potential
losses for the share insurance fund.
For example, I've long had concerns
that the share insurance fund's
current reserving methodology.
does not consider black swan events.
Eugene: Okay.
So thank you for that question and
I would guess there's several parts
to that and I'd start with the part
about the black swan events where
the methodology as I've mentioned
in my statement includes two parts.
There's a specific reserve
and a general reserve.
The general reserve really is there
to ensure that we've got sufficient
funds to cover probable losses.
At any given time.
And the modeling that we do for the
general reserve does attempt to take into
consideration the totality of the current
situation that we see within the industry.
It does not, I would say, unlike
some modeling that we sometimes
talk about, it does not exclude,
per se, black swan events.
The modeling kind of takes into account.
The current state of the credit unions
same, similar factors to the CAML
ratings, which is why they often move
in tandem with each other as well as
macroeconomic data that we're seeing.
And again the purpose of that is to
get a systemic look at essentially
a financial risk to the SIF based
on current economic performance
of credit unions in the industry.
And then we have the specific reserves
where when we know something...
More particular is probable estimable.
We can value it then we
create that specific reserve.
Looking at slide I think
you mentioned slide five.
I did.
So let's take a one thing I want to point
out on slide five, if we can bring that
one up is this discrepancy that you see in
actual cash losses in any particular year.
So on slide five, that
this is a five year.
I just actually, we got
six years of data up there.
In 2018 there were $784
million, $785 million of losses.
Whereas in the, two years later we're
down to a million 0.6 in was so huge
variability in terms of what happens.
In terms of actual losses
in any particular year.
So the general reserve model is trying
to guess where you're going to be
between some events that are, extreme
at one end and extreme at the other end.
You're generally not going to nail the
upper and the lower ends perfectly.
What you want is to have a model that
as conditions start to deteriorate, the
reserve starts to go up in anticipation
of those potential cash payouts.
And then as economic conditions improve
the reserve income's down because the
general reserve model goes both ways.
It goes up some quarters,
it comes down in others.
Todd: We're trying to get to
that proverbial just right.
Correct.
Yeah.
Microphone (USB PnP Audio Device)-2:
Okay, you heard a little bit there from
Chief Financial Officer Eugene Sheed.
There's a lot to unpack here.
We haven't seen this big of increases in
camel code velocity of camel code threes
increasing, particularly large camel
code threes since the Great Recession.
Chairman Harper found that sobering, and
he said if management does not act quickly
and boards do not act quickly, you could
become a code four and you could become
a code five, which could lead to failure.
And then they go on with a big discussion
about the insurance fund and how the
essentially the equivalent of Cecil
for credit unions is the allowance for
credit union losses at the NCUSIF level.
And they have a general reserve,
they have a specific reserve.
And when the specific reserve is, is
code fours and code fives where they
expect that they're shopping a credit
union and they might have a loss.
The general reserve is, is.
Essentially, , materially based upon
the camel codes and credit unions.
So when you have camel code threes
going up, pick a number, , quite a bit,
, substantially, , increasing velocity,
you're going to see increases in what
needs to be set aside, , for losses.
And they indicated they set aside
10 million, during the quarter.
If you annualize that 10 million,
that's 40 million on a base.
Of 21 million.
So that's about a 20 percent increase
as this number keeps going up.
If it keeps going up.
And oh, by the way, Chairman
Harper predicts that it will go up.
What does that mean?
That means that they're probably
are aware of some other large
credit unions that became code
3s during the month of October.
We're in November as I sit here speaking,
it's November 18th on a Saturday.
And yeah, so camel code
3s are going to go up.
So, what happens when you become a Code 3?
NCUA comes and visits you at least
twice as often, every six months.
I've said this before,
and I'll say it again.
Best way to stay out of NCUA's
crosshairs is to never become a Code 3.
They have the authority when they
come back at that six month, , visit
to upgrade you back to a Code 3.
But they don't very frequently do that.
Sometimes they don't do it because
they don't bring enough resources to
do something closer to a full exam.
Sometimes they don't do it because
they don't feel the credit union
has done enough to be upgraded.
And even if you're squeaky
clean, oftentimes they'll just
say, Hey, you're doing great.
If you keep doing it, when we
come back in another six months
we will do, quote, a full exam.
And we will upgrade you
at that point in time.
So you become a code three, you're
stuck in their crosshairs 99 times out
of a hundred for, , the next full year.
And you'll see them, they, they depart.
Let's say they depart in January.
You'll see them again in July and you'll
see them again the following January.
Gets worse.
If you become a code four, you'll
see them every four months.
And it's almost as if they never leave.
, which reminds me, , of a funny, , A
funny country western song.
How can I miss you if you don't go away?
Well, if you're a code 4, NSUA tends to
not go away, and it's a constant drip,
a constant reminder, , that you need
to manage a little bit towards what
the insurer, what the regulator wants.
And again, your goal should
be to stay out of being a code
4, stay out of being a code 3.
, and I've seen a lot of code 3s downgrades.
We've, , assisted in some credit
unions getting upgrades, But it's a
challenging time out there nonetheless.
So one other thing that's brought up in
the budget briefing, I did a separate
podcast on their budget document,
the staff budget document, which is
about 60 page, a lot of transparency.
, they just did a budget briefing
Thursday at two o'clock testifying it.
That was NASCS, the Virginia league,
the Washington, Oregon league, which
I believe is now called go west CUNA
and NAFCU, , who've now decided to
merge into America's credit unions.
So there were five, 5 organizations,
5 trade associations, they're making
statements to NCUA, they generally
every year come up with some
broad statements that the budget's
getting too high, and that, , NCUA,
should, should reduce the budget.
But they did provide some
constructive criticism.
Now, one thing that, Chairman Harper
and I disagree on quite a bit.
And I've talked about
it here in the podcast.
He's actually referenced the
podcast statements I've made
on this is that it's not a zero
sum game to move something from.
Tip to move resources from safety and
soundness to consumer compliance, implying
that there is a nexus between the 2.
there is somewhat of
a nexus between the 2.
however, when they are not increasing.
Full time equivalence, but
they are taking staff from.
regular examinations from safety
and soundness exams, and they are
turning them into specialists that
deal only with consumer compliance.
That's a reduction in resources that go
to safety and soundness at the same time
as they're saying, we think there's going
to be more problem in credit unions.
So, , quite frankly, I think it would
be more appropriate for them to ask for
more staff, keep the examiner staff.
And add these consumer compliance
folks, but to pretend that,
when you move resources, from.
From 1 area into another area that the
area that you took them from, , is not.
Position.
More poorly, , it's just
not accurate in my opinion.
So I disagree with him on that.
I, I do in general, I think
their budget is reasonable.
Yes, they've got some pay
increases, but yes, so have
credit unions had pay increases.
So have other people in
industry had pay increases.
And one thing that you'll never hear NCUA
or have not yet heard NCUA say publicly
is if you take the combined payments that
credit union make to trade associations.
The cost of those is more than
the cost of NCUA in its entirety.
So, and both of them are immaterial.
I'm not saying that you shouldn't
join a trade association, but, the
trade associations like to make
a big issue about NCUA's budget.
And the reality is.
, a similar size credit union sees
less hours spent on them than a
similar size bank, meaning NCUA is
more efficient and NCUA, I believe,
has a very prudent budget process.
All right.
So, , in summary, , NCUA
is, , nervous about the economy.
They're nervous that the insurance fund.
may need more increases in the future for
their allowance for loan losses for or
their allowance for credit union failures.
Why?
Because camel codes are getting
worse and they predict more to come.
That means when they come in they're
going to be more aggressive as opposed
to less aggressive and that's something
that I've seen from my conversations
with credit unions out there.
So you need to be ready for that.
You need to be ready for them to be
Pushing harder on your camel codes and
pushing harder on your asset quality
and pushing harder on your liquidity
and pushing harder on your capital.
Uh, you name it.
They are going to push on it.
Again, and again and again
over these next years exams.
All right.
That's it.
I appreciate, , your listening today.
Hope you'll listen again in the
future, and I hope you have a fabulous
Thanksgiving with your family.
One of my favorite, , holidays of the
year is Thanksgiving, and we will be
spending it with family this year as well.
, Mark Treichel, signing
off with Flying Colors.
