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CAMEL CODE 3s Triple!?!

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Treichel: Hey everyone, this is Mark Treichel with another episode of With Flying Colors. I'm going to focus this episode on some of what was said at the N2A board meeting last week. It was a short agenda. It was publicly much shorter than, unless you were actually there much shorter than they even had publicized because they had technical difficulties.

I think, I'm trying to remember when they went, when when I [00:01:00] was there, when we shifted to being able to go. And do these over the Internet. I think it started the investigation of that started under Debbie mats. And I think it was Rick Metzger as a board chair who really pushed for that that development and that improvement.

And I don't recall them ever having a real technical difficulty, but they did this past Thursday. And the YouTube video does not have anything about the MDI rule because their video crashed. And it has missing pieces of what they talked about on the share insurance fund briefing. I've done a little bit of work.

To look at what the video said, and then compare that to what they publicly said their statements were. And which is on NCWA's website, which is nice. I can get a little bit of more of what for example, what new board member Tanya Otska said because she was virtually fully cut off on the video.

There was A decent amount of what Chairman Harper had to say and Vice Chairman Kyle [00:02:00] Houtman, but none of them had their full statements on the video. And so I'll do a little bit of recon to pull a few sentences from each of those as we highlight what was said relative to the insurance fund. And of course.

Why do I like to do a podcast on the insurance fund briefing? Because it is the only glimpse of public camel code data and you, and they've had trends of camel code threes going up from 21 to 22, 22 to 20 March of 23, June of 23, September of 23 camel codes. Freeze kept going up in large institutions.
They stayed about the same rough justice wise for less complex credit unions less than 500 million. But the numbers I predicted by the way, I did a poll on LinkedIn. I think it was about five out of six people polled felt that camel codes. The camel codes Threes would deteriorate in the fourth quarter.

And if [00:03:00] you voted and you were one of the five out of six And five out of six, I say that because it was 84 percent 84 percent of the many votes. Were that camel codes would deteriorate and they did deteriorate camel code. Shares in camel codes went up from 6. 4 percent to 7. 8%. Now Even more importantly than that, it's happening in some large credit unions and what Chairman Harper, one of the things Chairman Harper said was that he is concerned by the fact that over the last year, Camel Code threes have tripled.

So chairman Harper followed that up with a question of the chief financial officer about what was driving these camel code three downgrades and the answer that the CFO gave was that the primary reasons were liquidity risk, which which I'm discussing here and interest rate risk. But in addition, so looking at what happened in the last quarter, but in [00:04:00] addition to that, several factors that have been seen in recent downgrades also include concerns over. overall risk management at credit unions, as well as concentration risk, information technology risk, elevated expenses, and finally commercial lending. So when you know that question's coming, you look at the downgrades of that happened in that quarter.
So staff looked at those institutions that added, that were added to the pool of code threes in the fourth quarter and the problems they had there. , are some that we've seen a lot liquidity and interest rate risk. But the references that caught my eye the most are overall risk management at the credit unions, which means and saying management.

, is not doing a good job, and. whether that means accounting problems, , regulatory problems, et cetera, et cetera. , that's a general statement related to the management code specifically. Concentration risk, I'm seeing [00:05:00] that in a lot of my conversations with credit unions that NCOA is being aggressive on concentration risk.

And the commercial lending, I'm also seeing that. Now, the interesting one that caught my eye or my ear was the reference to elevated expenses. So, And very rarely questions expenses, they will, they won't question them individually. They'll say you need to have. You need to make money, you need to make ample money to to meet your well, capitalized goals or whatever your capitalized capitalization goals are.
They're very rare that they'll talk about elevated expenses. And so for the CFO to specifically stated as a reason for a downgrade. Definitely, , catches, , and peaks my interest. I might need to go dig around on some and see who has the highest operating expense ratios in that category.

Treichel: I'm seeing that in my conversations with credit unions that NCUA is being very aggressive on liquidity, on [00:06:00] sensitivity, on management codes, and I'm expecting that this will probably Continue as delinquency has gone up. They're concerned about delinquency. Of course, I've talked here about their priority letters and the priority letters have interest rate risk, credit risk and liquidity risk as three of the six concerns.

And as those three things percolate throughout the year, you can expect. I believe camel code threes to further deteriorate. Now one glass half full approach to that is the camel code fours and fives have not really gone up substantially. So it really isn't that you see losses to the insurance fund until you see fours and fives.

And so far that has not started happening. But when you go to the actual statements made by the board members Chairman Harper said a couple of things that did catch my ear
okay, so one of the things that definitely caught my ear, and I generally [00:07:00] agree with, although I do want to point out in Chairman Harper, if you're, if you if you listen to this episode you might want to pay attention to this next portion, but Chairman Harper said in his public statement published on the website, I cannot emphasize enough the importance of liquidity planning for financial institutions of all sizes, especially following the Federal Reserve Board's decision to close the bank term funding program as scheduled on March 11th.

Chairman Harper said credit unions will need to ensure they have ready sources of liquidity available should they need it. In fact, access to the NCA central liquidity facility on the Federal Reserve discount window should be part of participating credit unions, broader liquidity risk management plans for a variety of contingencies, not just during times of crisis.
Generally, I agree with that. Now, when you go and watch the actual video of what Chairman he said before closing, I cannot emphasize enough of the importance of liquidity planning for financial [00:08:00] institutions of all sizes. So that's very similar. This program helped to stabilize the bank and financial system after the collapse last year of Silicon Valley, Signature and First Republic Banks.

With the sunset of this temporary program, credit unions will need to ensure they have the ready resources of liquidity available should they need it. In fact, access to the central liquidity facility and the Federal Reserve discount window should be part of participating credit unions broader liquidity risk management plans for a variety of contingencies and not just during emergencies.

So he, his public statement is the same as what he said in his written statement, but he added this paragraph or this sentence. Also, credit unions should not be concerned about using the central liquidity facility for fear of negative consequences as part of the examination. And as a reminder, the more [00:09:00] members in capital stock that the central liquidity facility has, the better it can serve the liquidity needs of credit unions.

I'm glad he said this. But it's actually not what happens. He indicates that credit unions should not be concerned about using the central liquidity facility for fear of negative consequences. Now, you could read this a couple different ways as part of the examination. Is he saying if you use it, you won't be criticized in the exam?

Treichel: Or is he saying, don't worry about being criticized because you should have it as one of your tools in the toolbox. Now, the latter, I would agree with, but NCOA If you utilize the ability to tap into your borrowings at the CLF, you cannot use those borrowings for making loans to your members. So it is really a crisis type situation.

Now, does that mean it's. a bad source to have? Absolutely not. I would encourage anybody to join, raise the [00:10:00] capital stock for the industry collectively, which will help smaller credit unions. He made statements about how about 15 years ago, this helped us get through the CLF to help us get through crises.

It definitely did, but it was crises. Anybody who's ever really used the borrowings of the CLF, when you use it, there's a lot of tentacles to it, which makes it hard to use it. It's just what's in the law and what's in the federal credit union act. That doesn't mean it shouldn't be part of your tools, but to say that you won't be, not to worry about the negative consequences of it as part of an exam is wishful thinking, and I'm seeing credit unions in the conversations I'm having, credit unions are being criticized aggressively on use of non member deposits, aggressively on use of the federal home loan bank, aggressively on use of the discount window, And no one uses the CLF unless they have to, and it's the last tool in your toolbox.
Should it be a tool in your toolbox? [00:11:00] Yes. Is this an opportunity to talk about camel codes and talk about the fact that the NCOA board unanimously believes the CLF That should have broader authority. Yes, I think it's smart to take advantage of the situations and highlight this to Congress. Hopefully, eventually, that will get fixed.

But when I was at N. C. U. A., when I be approached by credit unions when I led N. C. U. A. as the executive director, there was concerns at the board level sometimes that, What they wanted to happen would not trickle down to the examiner level. Now, could that be what's happening here that Chairman Harper is saying, Hey, I want to get this message out to my staff that the, you should not criticize them for use of the CLF.

If that's the case, they're going to have to back off on liquidity. And in the same token, Chairman Harper is talking about liquidity. In virtually all of his speeches, he did it at the Brookings Institute recently, and they came out with a letter and guidance specifically [00:12:00] on liquidity.

I didn't go back and compare that to this statement, but it did catch my ear that he said it publicly and that it was not in the. published statement that he made. That always catches, I like to compare what they publicly say versus what they publicly publish, because that's really where the nuance is.

They have these prepared statements. By the way in my other podcast, which is called Credit Union Regulatory Guidance, hosted by Samantha Shares which is an audiobook style podcast, and I'll put a link in the show notes We have a an episode coming out looking at those statements of the three board members and in it.

You can see that they'll ask questions. Those are questions that are listed in the prepared marks remarks they have, but there's no answer in what they publish because those answers, while they are also generally scripted. 99 percent of the time scripted they're not included there. You have to watch [00:13:00] the actual board meeting to hear what staff said.

Now staff likes getting the scripted questions, but not all board members historically have done that. The only one currently that from watching the videos that does off the cuff questions is vice chairman Kyle Holtman. And you can see, looking at his statement, there are no questions. that have no answers on, on, on their website because he doesn't give the questions in advance.

The other two board members do, and NCOA board members historically do, and that's because they want to control the narrative. Of the meeting, they want it to go well and that's one way that they achieve that. All right. By the way at the end of the board action bulletin which summarizes the actions of the board, they indicated there will be no board meeting in March for the NCWA board meeting.

So historically, NCUA has had 11 board meetings for as long as I can remember, as long as I was an executive at NCUA, which started in 2000, and I was there [00:14:00] till 2020. So those 20 years, I don't ever recall NCUA skipping other than August. There was never an August board meeting, so they would do a board meeting every month.

Other than August, I did hear a rumor from good sources at NCUA last year that there were some discussions that the executives thought maybe they should have less frequent board meetings, something more closely aligned with what FDIC does, which is more along the lines of a quarterly board meeting.

So the fact that they're skipping March, I'm going to predict that over time, Chairman Harper will move this to a quarterly board meeting. Now. The other thing is you'll hear board members refer to the fact that it was at last, the last board meeting was Tanya Otsuka's first board meeting and Kyle Hauptman mentioned that he met her and had coffee with her and he did it before she was appointed.

And that was because under the Sunshine Act, they cannot meet. [00:15:00] Unless it's in the public, they have to have their executives do their bidding. So for example, you want to have the budget, you have the budget before you don't the budget increase. You want 2 percent cut. The board member has to have their executive go meet with the other board members, executive and cut deals that way.

And everything needs to be in the public. However, there is an exception to it being in the public. They have what's called a notation vote. And I'm going down a rabbit hole here, but the fact that they're not having a board meeting in March, the fact that I've heard rumors that they want to go to have less board meetings.

Now, if I was on staff, I would love that because the board meetings are very very stressful for staff because a lot can go right, but a lot can go wrong and, you've got egos, everybody's got an ego and when things go wrong board members can get unhappy. So if there's less of those events, if I was a staff member, I would be going, that's great from a perspective of.

Are less things being done in the public are less things being done in the sunshine. I would have a little bit of concern. And the reason I bring up a [00:16:00] notation vote is there are procedures in place in law and in ensues delegations that allows the board to vote by notation vote. And that can be a personnel action that can be a, an appeal.

And appeals will be done in what's called a closed board meeting. Now, it used to be that every other board meeting probably had something that wasn't the closed agenda and they would close it and say why it couldn't be public there, there's federal laws and there's into a rules and it has to be, either like a personnel type action or a policy type action that was, that would relate to personnel or a credit union.
You're talking about a credit union being conserved or cease and desist order, and there are other things that fall into that category. I don't recall the last time NCUA had a closed board meeting. And I guarantee you there are things that are being acted on, which means they're being done via notation vote.

And the way the delegations work is any board member [00:17:00] Any of the three board members and say, no, I want this to be done in the sunshine. First, the general counsel has to say it's okay to do it by notation vote and it meets the rules, but any one board member can veto it being done not in the sunshine and being done by notation vote.

Now what happens is if you're going to select a promotion and you don't, that. That you don't want to have any debate on it. And you're going to pick someone to be, for example, the new E& I director. There's no reason to bring it to the table and have a dialogue, but it does create a record.

And they're minimizing those records by doing most of these things by notation vote and probably some public things are being done. That could have been done publicly or being done via notation vote in any event. They're going this. This means something they don't. They're not having a board meeting, which means Chairman Harper is okay.

Not having a board meeting, which means the other two board members are comfortable with it. Now, Tonya Otsuka. She's new, so she's going to go with the flow. That tends to be what happens [00:18:00] as they get their sea legs, but I'm predicting that will be a trend. I also think they must be doing some things via notation vote that they're not.

Probably making public. Now most of those, again, are gonna be things you wouldn't find out about anyway, but it does minimize the record and minimizing the records is a, a little bit less transparent about what's going on. But again, I'm sure staff is pleased with the less is more approach.

Now, I might do a podcast where I'd say, Hey, if you had a board March board meeting, here's some things that you might want to consider or that maybe you'll be having on the agenda. By the way, another reason to maybe skip March is that they've got GAC coming up, and we would always embargo anything you wouldn't want anything controversial right before GAC, and you wouldn't want anything real controversial right after GAC, because you wouldn't want to be having, getting briefings on those intense things while they're preparing for the biggest speech that they have to give in front of four or 5, 000 people, and this will be Tanya Otsuka's first one.

Oh, one other thing [00:19:00] going back to chairman's Harper chairman Harper's comment on credit unions should not be concerned for negative consequences. Now there used to be some language. I pulled this up from something I did research on camel code for a client back during COVID. There was a statement in an interagency policy statement. Here it is. , the interagency policy statement for COVID relief said examiners will not criticize an institution for appropriate use of the discount window or other Federal Reserve lending programs or the NQA central liquidity facility. Similarly, examiners will not criticize an institution's prudent use of its liquidity buffer to support economic recovery in accordance with the institution's liquidity risk management framework.

So that, that guidance has evaporated because there is. No, all the guidance tied to COVID relief is gone. Now, maybe chairman Harper was referring to that. I did a Google search, search the other documents I have relative to [00:20:00] camel. And I don't believe there's any public statement other than what Chairman Harper just said at the board table that says that you won't be criticized for using the Federal Reserve Lendings Programs or the CLF.

If anybody is aware of anything out there that I'm missing, please let me know. Chairman Harper, if you're listening and I want to clarify that would be great as well. All right. Moving on to board member, a few of the board members. All three of the board members talked about, the fun being healthy, but we need to be on guard because of camel code three is going up.

And succinctly Kyle Hauptman talked about the fact that it went up from 1. 27 to 1. 30, which is a good thing for credit unions. They talked about what the normal operating level is, which is 1. 33. By the way, NSUA can only make it go above 1. 30 from retained earnings, meaning they cannot assess to go above 1.
30, which is good for credit unions that it's at 1. 30. But how did it go up? It went up because losses have been low. It went up because share growth has [00:21:00] been low, and it went up because NCUA has earned more money, as have credit unions on investments, because of where interest rates are at. So they have more income, they have less losses, and they have less share growth, which was the perfect storm for the NCUSIF equity position to go up and improve, which again, is a good thing for credit unions, as long as there's no big losses that come out of the economic challenges that NCUA refers to as happening.

In other parts of the board agenda. All right, then there's a discussion about the fact that N. C. U. A. can earn more money if they just put the money in overnight, but that now that they've put 5 billion in the fund and overnight that they're going to start going back to their ladder, which will ladder out their investments and the fact that they want to do that.

Because rates are eventually going to go down and they're explaining why it makes sense to buy something that's one, two or three years out. That will have a [00:22:00] lower rate than the Fed funds rate, but it will make more sense once the Fed starts reducing rates and the board members talk about rates going down.

Eugene Schied, the chief financial officer, talks about rates going down and I find it a little ironic from what I'm hearing some credit unions have to deal with NCUA because Credit unions are being criticized on their net economic value after rates have gone up 500 basis points. And then NCOA comes in and says, Hey, I think rates are going to go up another 300 basis points, or you need to stress it as if rates are going to go up another 300 basis points, which yes, you do need to stretch it.

But anticipating that it's going to actually happen right now is probably even more than a black swan event when you hear what everybody's saying publicly. And credit unions, I think are unjustly being criticized for their NEV in that regard, particularly because NEV only looks at one piece.[00:23:00]
It only looks at the asset size. It doesn't give you credit for having good earnings. It doesn't give you credit for having low operating expenses. It doesn't give you credit for how your shares are reacting. And oh, by the way, NCOA says you need to update your share studies. Guess what? Credit union share studies are showing that the shares did not move.

And I'm seeing instances where NCOA doesn't like the fact that credit unions are able to relax or improve their liquidity ALM data based on these studies that NCOA said they had to go get. It's ironic that NCUA realizes they need to go a little bit longer on investments when they're encouraging credit unions who have, in the credit union's opinion, enough liquidity where they're preventing some credit unions from actually going out a little bit on that curve because NCUA wants them to build up a little bit more liquidity, and as you know better than I, liquidity is an art and not a science, but I did note [00:24:00] that NCUA wants to go a little longer term on their Insurance fund portfolio, which I think would be good for the insurance fund.

That's all I've got today. There was an item on the Minority Depository Institution rules that go into effect in 30 days. As I mentioned, our other podcast is called Credit Union Regulatory Guidance and it's an episode.

And there is an episode that walks through the entire presentation that NCWA did, all the verbiage that's in that rule that goes out that's effective in 30 days. As always, I want to thank you for listening. We've got some exciting episodes coming up. This is Mark Treichel signing off with flying colors.

Thank you for joining us on this episode of with flying colors, subscribe on your favorite podcast app to hear future episodes where subject matter experts of all varieties will provide tips on how to achieve success with NCUA. If you would like to learn more about how we assist credit unions, [00:25:00] check out our services at marktreichel.
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