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Hey, everyone.

This is Mark Treichel with another
episode of With Flying Colors.

I'm excited today to be here
with Steve Farr and Todd Miller.

You've heard them here often and
guys, how are you doing today?

Doing good.

Doing good.

Still doing good.

Glad to hear it.

Doing well as well.

Doing well.

All right.

And so some listeners may have not heard
They may be new but as a refresher for

the old time listeners or the the new
listeners, Steve, why don't you give

a little bit of your background and
what you did at NCUA before retiring

from NCUA and then changing teams with
Todd and I and helping credit unions.

Okay.

Yeah, I can break my 30 year career
at NCA into to two separate pieces.

The first 15 years I was in the field
predominantly as a problem case officer

working with credit unions primarily
on the west coast, but got involved

in projects throughout the nation.

Then I spent the next basically
15 years in the central office in

the division of risk management.

Involved in multiple projects there that
get me very interested and engaged doing

the enforcement manual, the corporate
resolution risk based capital which

I finished up right before I retired.

And it took forever for
that to come into place.

Then in retirement I did get called
in and worked at a conservatorship

for NCOA as a chief financial officer.

That was kinda my changing over from
being an NCOA to being on the side of

the, working with the credit unions
closely and then have been working

with Mark since we started his agency.

Very good.

And Todd?

So I spent right at 34 years with N.

C.

U.

A.

I can break my career into maybe
three pieces as opposed to Steve's to

I spent the 1st decade roughly as a.

Examiner and problem case
officer in the western region.

That middle third of my career, I
spent it as a regional capital market

specialist in the western region that
also involved a lot of training of

the examiners on interest rate, risk,
liquidity and investments involved writing

policies for NCUA's interest rate, risk,
and liquidity reviews at that time.

And then the last 11 years of my
career, I spent it as a director of

special actions in the Western region,
supervising problem case officers and

supervising regional capital market
specialists, sat on more than a few

committees during that time frame
that were internal to NCUA, including

their supervisory review committee.

All in all, it was an enjoyable 34 years.

I retired and Martin gave me
about three months off and called

me and said, Hey, can you come
back to work for the other side?

I said, that sounds fun.

And it has been.

And we've been having fun ever since.

Some of our best war stories, some
of our greatest accomplishments, some

of our proudest moments in credit
unions was when a credit union Would

have to became troubled, right?

And went into special actions
or as a principal examiner,

you work with the credit union.

They have some issues.

You get a good working relationship going.

Credit union takes it serious.

And lo and behold, they
might come out stronger.

But to get to that point, you
have to have a setback first.

Your code, your camel code one to
forever Some bad luck comes along or

some bad decisions come along and gets
a little bit more aggressive code.

You a three.

We did a podcast on that.

We published last week on that.

Now we're in a credit union that
has transitioned from a 3 to a 4

or from a 2 to a 4, which happens
on occasions when stuff goes awry.

And that's what this podcast is about.

It's about becoming a camel code for, and
I'll never say camels it's camel to me.

You, they added the yes, but in my
mind, it's camel camel, you'll be

your camel code for, and so your
camel code for, so now what does

that mean for the credit union?

What does it mean for NCUA?

What should a credit union be expecting?

What are your thoughts relative to
a downgrade just happened today?

What does that mean?

From NCOA's perspective, once you
become a CAMEL 4 they generally see you

as a cretine that's exhibiting unsafe
and unsound practices or conditions.

They think risk management practices
are unacceptable relative to

the cretine size and complexity.

They may even have some concerns
whether management is willing and

able to correct the nature of these
problems, which they consider severe.

And as such, it informs their
entire supervision process and

their administrative record process.

At this point, they are building
an administrative record.

So if things continue to go south, it
enables them to take other actions.

So they're starting that whole building
block of a formal administrative record.

So the first thing as a code for what
it means is you're going to be under

some form of administrative action.

In most cases, that's an unpublished
letter of understanding and agreement.

If a board doesn't agree to that, they can
end up with a preliminary warning letter.

Generally, these are unpublished,
although they may be published.

There's reputation risk
if they're published.

For some of the state chartered credit
unions, publication of these are

required, depending on state statutes.

There's not a lot of states, but
there is a few states out there

that do require these administrative
actions to be published.

The next biggest thing that's going
to happen is you're going to see

your examiners every 120 days.

So they're going to be doing an exam.

They're going to do follow
ups a couple times a year.

So you're going to get to know your
examiner very well because you're going

to be seeing them very frequently.

They're probably going to spend six
to eight to 12 weeks a year with you.

So that's a good chunk of the year
that you're going to have examiners

involved with your operation then.

It's a huge burden just to deal with
that aspect of it, but from NCOA's

perspective, that needs to occur.

They need to know that you're resolving
problems and they're going to make

themselves a bee in your bonnet until
problems are resolved or they know

they have to take some other action.

Other things that go with the Code 4
when NCOA codes a credit unit for the

Federal Reserve is known, let known,
and so usually you're going to lose

access to your daylight overdrafts.

They may actually ask you to, if
you're borrowing from the Fed or have

borrowing agreements with the Federal
Reserve, they may start asking you

for more collateral, or they may ask
you to put your collateral on site.

I've seen that in a number of different
places with the Federal Reserve Bank.

Most Code 4 credit unions are not
borrowing from the Federal Reserve,

but it does occur on occasion.

If you're a larger credit union,
you're likely to get assigned to

the Division of Special Actions.

If you're one of the worst problems in the
region, that can be a good or bad thing.

Actually, a lot of troubled credit unions
find it's a good thing because those

Problem case officers have more experience
than regular examiners and there tend

to be a little bit more open minded
and have a broader set of experiences

as to what works and doesn't work.

So in many cases, that turns out to
be a good thing for the credit union.

But the big thing for writing under a
code for You're going to be spending

that 12, 18, 20 weeks a year with your
PCO examiner because they're going to be

doing exams or follow ups every 120 days.

And did you say did I don't know if
I caught you talk about the Federal

Reserve, but the Federal Home Loan
Bank also becomes aware of the camel

cone for eventually the Federal Home
Loan Bank, with the Federal Reserve

NCA tells the Federal Reserve when
we go to place the floor so they know

within a couple days of when the exam
is completed, the Federal Reserve.

Federal Home Loan Bank, we don't actually
tell them, but the Federal Home Loan

Bank has their own credit reviews.

Once a year, they typically ask NCUA for
an exam report, and they pay us whatever

they, NCUA charges them nowadays for that.

They do charge the FHLB
for those exam reports.

So eventually, the FHLB is going to find
out because as part of their credit review

processes, they tend to ask for those exam
reports once a year or every 18 months.

And so eventually, they will find out
and it may affect how you deal with them.

A lot of the FHLB credit processes are net
worth driven, though, as opposed to CAMEL.

I'm sure you get a higher risk rating
when FHLB finds out you're a code 4,

but if you still have decent net worth,
it doesn't seem in my history with

as a PCO and a DSA, it doesn't seem
to impact your borrowing authority to

getting a camel 4 if your net worth is
still up at those regulatory levels.

As soon as your net worth starts dropping
down into PCA and stuff then it can impact

your borrowing ability with the FHLBs.

They will start shortening the
length of terms that you can borrow.

So instead of long term advances that
are going to cut you down to shorter

term time periods, they may start asking
you to they'll put haircuts on your

collateral when net worth starts getting
down under that five percent range.

It's not Unusual for the FHLB to say
haul those loan files over to our

office or some other designated third
party where we want them stored.

And there's a huge operational expense
involved in that too because now you

don't have your original files and people
refinance and things of that nature.

You're checking them
back out of the facility.

It becomes A burdensome and basically
if you get a code four as a credit union

for the board and management your life
is going to become more burdensome.

It's a little bit more problematic,
which reminds me of a post I did

when I first started taking a country
western song that was called, How

Can I Miss You If You Won't Go Away.

And they don't go away.

It seems like they're always there.

You said 20 weeks.

Your examiners come visit for a long time.

And I got a question for Steve as
it relates to what Todd just said,

and the central liquidity facility.

So let's say you're downgraded
to a, from a 3 to a 4.

There are, Some liquidity challenges.

The federal home loan bank
says, yeah, you know what?

We're going to give you more
haircuts on this, or we're going to

cut your line because of capital.

And then lo and behold you've got a line,
the last line that you can utilize is

at the corporate, the local corporate
there's a thing called a lot of credit

unions don't know about it, but a
guaranteed line of credit at the corporate

and the CLF gets involved in that.

Can you share?

Now, this isn't directly linked to a
4, but I would say there's a strong

correlation that code 4s might end up
at the doorstep of their corporate.

And then the corporate may
make a phone call to N.

C.

U.

A.

Could you expand upon what I
just tiptoed into there, Steve?

Yeah, and there's always.

Mistakes made on that.

And yes, you do have the option of
joining the central liquidity facility,

but that the central liquidity isn't
really a lender of last resort in that.

You still have to be credit
worthy to get a loan from the

central liquidity facility.

And then there's this whole, you have to
do the deposit and all that kind of stuff.

So it is a source.

Of liquidity that's out there
in addition to the other ones

that are receiving the reports.

Mark talked about a guaranteed line
of credit, which is a type of to

assistance under Section 208 of the
Federal Credit Union Act, and that

the insurance fund would basically be
guaranteeing payment to the we usually

work with the corporate credit union
on doing guaranteed lines of credit.

Now, they used to be used more often
when we had credit unions that were

operating with lower levels of capital.

But since PCA, they're really
rare that we would do those.

And you might see it in terms of
if you were in conservatorship.

Now, the other thing that I wanted
to bring up on that is, is, as credit

unions get to be a camel four, and
they're larger, it can start to have.

Some impact on the N.

C.

U.

S.

I.

F.

equity ratio because the math is there
is the same as your credit unions is your

delinquency on your portfolio increases.

You have to have more money set aside for.

The expected losses on that.

So the same thing happens is
that credit unions camo codes

become worse and they're larger.

You can start seeing that the insurance
fund is starting to have to put more money

in the reserve for losses, which reduces
the equity of the insurance fund, which.

Can lead to reduction in the equity
level and potential premiums that

have to be paid to recover from that.

So that all plays into
that equation on that.

So I thought it would bring that up.

That's a great point.

And when we talked about code 3s in
our code 3 podcast, we talked about

trends of large code 3s increasing and
that the smaller code 3s in number.

the same, adjusting for mergers, but that
the growth seemed to be That the average

size of a code three was going up because
when a few big credit unions fall into

that category, it can impact the numbers.

And of course, if they slip into code
fours, as you're saying that can increase

the map on math on the calculation.

On what needs to be in the insurance
fund so far, the code 3 code for

data doesn't seem to reveal too much.

I don't know if you have that
there in front of you, but

are there any trends in code?

4 is that you've seen?

Or is that maybe what's
coming around the band?

On the short run there, they
haven't increased the number.

It's been 125.

Gamma fours in December
and again in March.

It was the same number, but the
assets and their increase from 5.

5 billion to 7 billion.

But if you look at like FBI, see,
sometimes runs a little bit ahead

of recognizing potential problems
a little bit faster than in two.

It is in the same time period.

They went from 52 institutions that
are the problem bank, which is four

and five from 52 to 63, but their
assets went from 66 billion in

those institutions to 82 billion.

And that's what we're always concerned
about is, now that this, the delinquency

is coming up and we're seeing more losses
that are occurring on the credit side.

And the credit side is where the
insurance fund gets its losses.

We can ride through liquidity
and interest rate risk might

cause an institution to fail.

It doesn't generally cost
the insurance fund money.

Credit losses cause the
insur insurance fund money.

So that's that's why, people get
really concerned once you're a Camel

4, and that it needs to be fixed
quickly, so it doesn't turn out to

be a loss to the insurance fund.

Because I was always that, the NFL
for the football league has protect

the shield and I was always out there.

My job is to protect the fun And that was
a real cheerleader on that when I was in

ncua And then at the end of the day when
all the people at ncua gather at the bar

They would toast to the fund because the
fund was paying their salary you hung

out with different examiners than I did

That was an east coast thing.

That was a There's a, there's someone
who may or may not be in the office

of the national exam and supervision
who was who started not saying at what

level and not at the top, not at the
tippy top, but there was someone that,

that came up with toasting to the fund.

And if they're, I don't know if
they're a listener, but there are,

they're probably smiling right now.

All right.

And.

So go ahead, Todd.

There's one more thing we didn't
talk about that applies to camel

fours is they're officially a
troubled credit union under section

seven Oh one 14 of the regulations.

And NC way now gets a say in
change of senior management

officials and elected officials.

So there's an approval process and
they have a right to veto various

management changes or board changes.

And that That's just another
administrative burden of putting the

people in putting their resume and whether
it's a board member or an official.

Now, refresh my memory.

Some of them can serve temporarily.

Is it so if you have a board
election, they can serve for

30 days without that approval.

I'd have to go back and read the reg.

I think you have to send notice into
NCA like by the third business day

or something that air here's a change
in our election and I don't know,

you got until day seven or something
where somewhere in there to actually

send in the change in approval,
you'd have to go look up the reg.

I don't remember it exactly,
but elected officials can serve.

For that 30 day period while NCOA
processes that approval form, or

senior executives, they need approval
from NCOA before they can serve.

And and the obviously the reason
there is there's risk to the fund.

They want to make sure who's ever put
in place at an institution coded a four

as the skill sets to help reposition
and reduce the risk to the credit union.

And then, of course, thereby
reducing the risk to the insurance

does say no to some of those.

They do.

They do.

Indeed.

I think we've all been
involved in a few of those.

More often than not, if you've done a
good search and there's no skeletons per

se in the closet of who you've selected,
you'll see approval so you can get them on

board and start dealing with the issues.

Now code ones and twos can
get document resolutions.

Code threes.

You're definitely going to
have a document resolution.

So now you're a code for You got You're
going to have document resolutions,

but those document resolutions
might also then turn into what?

In most places if NCUA's preferred
path is they turn into an unpublished

letter of understanding and agreement.

That's the preferred and the path
that happens most of the time.

Some cardines prefer not to enter into
letters of understanding and agreement.

So NCUA will issue you a preliminary
warning letter if you refuse to sign

that letter of understanding agreement.

It will say essentially
all of the same items.

Increasingly NCOA is reserving
the right to publish letters

of understanding and agreement.

Historically, they do
that in only rare cases.

And like we mentioned earlier in
the podcast, there are some states

that have statutes that require
them to publish those letters

of understanding and agreement.

Now, usually they bury it on their
webpage, they don't issue a press release

to the newspapers or anything because
they would rather the public not know

and create reputation risk for the credit
union, but there are some states that will

publish those letters of understanding
agreement because they have no choice.

Their statutes require it.

If you're a state charter, just
know what your state regulations

require if you fall into this task.

There's a special thing too, so we've
talked about code fours in general, but

there's code fours that start having
challenges to capital, and once your

net worth starts falling below those
regulatory limits and you have that code

four, There's other implications too.

You start finding out all your
letters want, lenders want collateral.

If you're doing mortgage, selling
mortgages on the secondary market,

this gets very problematic.

And especially with Bannie Mae and
choosing to not want to buy your

mortgages, Bannie Mae will often take
your servicing rights away from you.

Bannie Mae will often
make you post collateral.

to retain those servicing rights.

So there's other implications that come
into play if your capital starts falling

at the same time you get that code four.

Got it.

Yeah.

So it's not a good place to be.

You might get assigned to special
actions, generally speaking,

after the shock and awe of getting
assigned to special actions is over.

Generally speaking, I think our history
has been that the credit union Likes the

better staff, the more educated, longer
term staff the not so risk averse staff

that are in special actions because
sometimes they've seen so much more

that they have a better context because
of the journey that they've been on.

At least a better resolution
for the credit union.

So anything else on code for us before
we do a short chat about code fives.

We talked about this in
our Code 3 podcast too.

There's a higher expectation on the board
that they're going to hold management

accountable and monitor progress on
these DOORS and administrative actions.

There's an expectation that management's
going to keep their board informed as

to progress on resolving these issues.

In general, though, for board members,
NCUA is going to put more pressure on

them to hold their management accountable
and understand the nature of the

problems and what is needed for progress.

There's going to be some expectation that
the board will authorize the resources

necessary to address these problems,
because generally when you get down

to the Code 4, it involves additional
people, additional third parties, lots

of overtime expense levels will go up.

Even though NCOA might give you a door
that says reduce expenses, the corrective

actions are going to usually require
you to spend a fair amount of money.

And there's going to be some
expectations that board are

going to authorize the resources
necessary to resolve these problems.

Makes sense.

Steve, any last thoughts on force?

Yeah, and those documents or
resolutions for fours often become

really voluminous and it becomes
a big project management issue.

And what part of that project management
is that reporting that Todd talked about.

Very good.

The worst code it's the functional
equivalent of an F in school, right?

If a 4 is a D and a 3 is a C, and
NCOA doesn't really look at it in

that mind, but I always did when I was
there because it's an easy translation.

If you get an F in school You might
have to withdraw from the class.

We might have to redo the class.

Code fives are rare, but any
thoughts on, and I can always

remember it's okay it's good.

It's a four, it's going to be a five.

You start.

Coding it a five, we're thinking of
further administrative actions and

sometimes you think you're writing
a code five and before you deliver

the report, you actually end up
conserving the credit union because

the risks are identified are so bad.

But general thoughts on the death wish
code also known as a camel code five.

Yeah, failure is usually imminent and
you're either going to be, they're

going to be quickly trying to find a
merger partner for you, but it'll be a

merger partner with NCOA or in the state
regulator, highly involved in that process

and your choices will be very limited.

They'll take the least cost option
to resolve the credit union quickly.

Excellent point.

In other words, what Steve is
saying is the regulator is going to

pick your merger partner, not you.

Self determination is out
the window at that juncture.

At that point, as an NCUA employee,
you're just trying to reduce the cost

of the insurance fund to the lowest
dollar possible by any means possible.

Well said.

Said.

All right, guys, we'll go ahead.

Todd, looks like you were
going to say something.

No, we do NCUA.

Really for code fives, and you mentioned
it already, you're getting ready to write

a report to issue a code five and quite
often it turns into a conservatorship.

Especially in recessionary area periods,
that's very much a true statement.

We talked about fun stuff that we've
had as examiners and probably the

most gratifying thing is, taking a
conservatorship and actually fixing

it and returning it to the members.

Prior to the credit union membership
act, there was lots of easy ways

for NCUA to provide cash assistance
for credit unions to keep them open.

And I know Steve did a lot
of that early in his career.

I did a little bit of it.

The credit union membership act took
away NCUA's ability to provide assistance

to keep a failing credit union open.

It, came back to NCUA in 2010 2011,
but it's very much limited to capital

notes, no other form of assistance.

And so they're done pretty rarely,
although we did do a couple

of them at the last recession.

NCUA did save a couple conservatorships
by recapitalizing them.

Those were always the most rewarding
parts of the job, though, is when

you take a trouble crediting and
actually resolve those issues and

see it returned to the members.

Yeah, that's a great point.

It reminds me of an act,
an old acronym, right?

The P.

U.

E.

D.

the prior undivided earnings deficit
for what Todd's alluding to is you N.

C.

U.

A.

could guarantee a deficit.

So where we have prompt
corrective action now.

That says you have to do this at 7%,
you have to do this at 6, you have to

do this at 4, you fall under 4, NCOA is
pushing you to merge and or having other

corrective action and a plan for you to
merge at some point in time in there,

is it at 2 or 4, they have to conserve.

We used to let credit unions run
if they put a plan together to get

back to zero within four, within
24 months, if I remember right.

That was the general timeframe.

I did two or three PUE Ds.

Steve probably did a dozen or more.

It's.

I understand the public policy point of
view of why they can no longer do that.

But I can also just actually look around
today and see at least five credit unions

that we saved that way that it would
have otherwise been closed in the early

1990s that are still here today in 2024.

They were successful ways
to preserve a credit union.

It's unfortunate that statutes by Congress
no longer give NCUA that option anymore.

Agree.

I agree.

Those were good tools to be able to use
in the right situations and they took

flexibility out of staff's hands because
public policy required that to happen.

All right, guys, any last
thoughts here before we wrap

up today on fours and fives?

Very good.

As always, this was fun.

Brings back triggers, some synapses.

I hadn't thought of the acronym
P U E D in, in a few years.

That's always fun to, to make my
brain think of a long lost acronyms.

Thanks so much guys.

Take care.

Have a good day.

You too.

And listeners, as always,
I appreciate you listening.

I hope you'll listen again soon.

Mark Treichel signing
off with Flying Colors.

Thank you for joining us on this episode
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