Credit Union Exam Solutions Presents With Flying Colors

Hey everyone.

This is mark Treichel with another episode
of, with flying colors today, I'm going

to chat with Todd Miller of my team.

And this episode is
called outgo in practice.

Essential reports analysis
and risk management.

Todd has tremendous background in
this, including being a director

of special actions that examiner.

A capital market specialist
and supervising the entire west

coast one-third of the countries.

Capital market specialists at NCUA.

So Todd, last week we discussed Alco
governance, essentials and building an

effective committee structure who should
be on the committee, et cetera, et cetera.

Now we're going to pivot to ALM or
Alco reporting and policies, et cetera.

So with that, , I'm going to give
you free reign to share your wisdom.

Todd Miller: So this should
be all laid out in policies.

I'm going to go through some general
things and that I think should be

part of most ALCO report packages
and part of most ALCOs functionings.

This shouldn't be intended to
be an inclusive list that this

is the only things you need.

If you want to add other
reports, feel free to do that.

Some of this is, how do you
lay out your business plan?

And how does the board layout
performance key performance

indicators and key risk indicators.

So this can change it a little bit, but
I'm going to lay out what I think is

should be in a typical Elko package.

And some of what I lay out here might
not be in the package every month.

It might be in once a quarter.

We'll even talk about model validations.

That might only have to occur a
couple times a year, but we'll

go through just some general
things that I think should be in.

Most Elko packages out there,
even though it's not in an

exhaustive, all inclusive list.

1st, 1, credit unions operate
in an environment out there.

So somewhere within our Elko and our
organization, we should have some basic

economic data that we're keeping track of.

What's going on nationally and
more important, what's going on

locally, and especially with managing
credit risk, what's happening

in our local housing market.

If you're a business lender, what's
happening in our local commercial real

estate market, what are employment trends
within our local area and our fields

of membership, there should be just
some general economic information that

shared across the committee, because
they're going to be determining tactics.

Thanks.

And while credit unions should not
make huge bets on the economy, they

do have to take a position and make
reasonable decisions on how they're

going to operate their lending and
investment programs, their deposit

gathering programs, and that's going to
be influenced by their local economic

factors or their expectations of which
direction the economy is going to go.

You can't really manage any risk out
within the organization unless you

have some basic information about your
financial statements and your budgets.

And how are you doing on budgets
and comparisons along that line?

They're the biggest ones that responsible.

How do we address
variances in our budgets?

Do we need to change strategy?

Do we need to change tactics?

Do we need to change pricing if things
aren't going as the board expects?

I'm a big believer in compliance
dashboards and within this,

there's lots of things.

So there's key performance indicators, key
risk indicators, gives you an exam report.

It has key ratios.

I do think each board, as they lay
out their business plans, they should

lay out what are the key performance
indicators and key risk indicators

for them and that strategic plan.

You can get really carried away with
these and maybe overburden the committee,

but you also need to have enough where,
what's going on with each of those risk

areas in the organization and have a
way to measure your performance against

your strategic and business plans
within those performance indicators.

Risk indicators.

I'm a big believer that
especially concentration risk is

important for most organizations.

And, I think a lot of organizations,
they will have these types of

ratios, but they're spread out.

I really think to be effective with an
outgo and even for boards of directors,

and, we've talked about board governance
before that these 1 spot where

people can see them all in 1 place.

Liquidity reports, and there's
different kinds of liquidity reports.

A lot of people use historical
measures for liquidity, and I think

that's fine for compliance purposes.

For an ALCO type, someone
who's responsible for managing

liquidity and interest rate risk,
they need cash flow forecasts.

And especially they need to
be looking at them out there

three to six months from now.

How are we going to be deploying
the funds available to us

into loans and investments?

How are we going to be
gathering up those deposits?

What's our risk of deposits leasing?

What's going on with our borrowed money?

Those become very important indicators.

And I'll just throw
something else out here.

Some ALCOs, they will get reports like
this from various places, so they might

generate an in house cash flow forecast.

Their ALM vendor might
give them another one.

And you'll see some of this with
interest rate risk reports too.

They'll get them from multiple vendors.

I'm a big believer there needs
to be one version of the truth

though in the organization.

And which of these reports
are you going to use?

It's not let's use this one today,
this other one tomorrow, which

everyone makes us look good.

Let's lay out in policy which
of these reports, Is going to

be our decision making tool.

We can use other reports as a model
validation type thing and other

source of information, but you do
have to be careful that you have

1 version of the truth going on.

We've seen clients written
up for this, especially with.

In their loan portfolio and their
credit risk management where they

have different systems, giving them
different versions of the truth.

What does that say
about your organization?

When you have different
versions of the truth?

It's not looks well.

It doesn't necessarily look very well
when you have different versions of

the truth inside the organization.

It's cashflow reports.

Very important interest rate risk reports.

This is traditionally
the role of the Alco.

How, what does our net interest
income and what does our NAV numbers

look like under various scenarios?

Cardings typically don't do these
every month unless you're really

large but quarterly is quite common.

Along the lines with the interest
rate risk report, at the ELCO

level, ELCO members need to have a
good general understanding of the

model assumptions in those reports.

Do they need to see all 2, 000
of them that are in a report?

No, but they do need to have a good
general understanding of which assumptions

move the numbers the most and at
least occasionally they need to have

some good documentation of what those
numbers and those assumptions look like.

And that ELCO should be actively
involved in establishing change

control procedures for those numbers.

Now it's an important piece and
examiners will criticize credit unions

at the ELCO level if they don't have
a good Handle around what those model

assumptions might be investment portfolios
and see ways regulation lays out.

Here's required investment reports.

Typically those flow to Elko.

It's pretty common for Elko
to actually be the party that.

Sets investment strategy inside
that business plan based on

other things that are going on.

There should be some good reports
related to that whole investment

portfolio and their analysis.

Another piece of this and
credit unions will hear this

all the time from examiners.

They want scenario and sensitivity
testing of their models.

Backtesting of liquidity models.

I think that scenario and sensitivity
analysis is an important piece of this.

Like I said, members of the ALCO
committee, they should know which

variables will move these numbers the
most and which ones they need to pay

attention to in terms of their member
behavior, the scenario analysis, it's

really important for your capital planning
and building your, whole strategic plan.

What does our results look like
if A happens or if B happens?

Do we want to have our loan
portfolio be 60 percent real

estate and 40 percent consumer?

Or do we want to be a business lender
where it's 60 percent business loans

and 20 percent consumer loans and
20 percent residential real estate?

Those things make a difference,
and credit unions need to build

those into scenario analysis.

What happens if, what happens if all
these CDs that we've gathered up in

the last couple years walk back out
the door and we can't replace them?

What happens if our whole
deposit structure changes?

Those types of things should be laid
out in scenario analysis, especially as

we're building up our business plans.

Increasingly, we're seeing
examiners ask credit unions to

stress test their loan portfolios.

This is a new thing to credit unions.

It's not a new thing.

In fact, the first time I've seen a
stress test was way back in the 1990s.

They had an egg lender where they had
an in house database where they could

actually just change the price of
commodities and it would spit out, here's

all your farmers that were not going
to make money or make money under this.

And that was way back in 1990.

So it's not a new thing, but it's new
that examiners are increasingly asking

credit unions to do these stress and
scenario analysis on their loan portfolio,

especially if they have concentrations
of member business loans, because

everyone's reading that commercial real
estate buildings are empty or less full

than they used to be in certain markets.

So that scenario type
of testing and analysis.

It informs your decision
making in a very positive way.

Another key part of Elko, and sometimes
Elko re delegates this, but I think Elko

really needs to stay on top of it, and
that's your pricing decisions support.

How do we price our assets and our,
and liabilities, and what are we

going to use to base that pricing on?

Now, just about every credit union will
have surveys of what competitors have for

loan and share rates, but If you follow
competitors, you're going to get their

results and their expenses and capital
might be very different than yours.

So I think you need just a
little bit more than that.

And it's, where here's an analysis of the
yields and returns on our loan portfolio.

Here's analysis of our cost of funds.

Here's our analysis of our
borrowing and deposit structure.

You don't see this very often, but I
think it's very critical is what's our

marginal costs and marginal yields so
many times as a problem case officer

and a director of special actions, you
get into institutions that have earnings

problems and what you really find out
is they've mispriced things that price

things to meet the competition, but it
doesn't meet the needs of the institution.

And if you go back to the
last recession in 2008.

Before it hit, a lot of the folks had
problems is because they followed the

market in terms of pricing loans and
the entire market underpriced for risk.

And do you want to have control
of that decision or not?

And, cost accounting
systems come into this.

It really depends on size and complexity.

But in general, you need a good pricing
decision support set of reports, whatever

that might be for your organization that
you need to understand, because pricing

decisions, even through the last little
bit here, when interest rates shot up, a

lot of cratings got into some earnings.

issues for a short period of time.

Most of them adjusted pretty well
and have adjusted today, but there's

still some that are still having
some challenging issues with earnings

because they made poor pricing decisions
in the past before that even hit.

This isn't in all ALCOs, but I do think
more and more it's becoming a big piece

of ALCO, is they need a comprehensive
set of credit risk management reports.

Now, do they need to be having discussions
at ALCO about individual borrowers?

No.

Should they have a general idea of
what's going on in their Loan portfolios.

Absolutely.

Yes.

How do you build that out so
you don't cross the line into

getting into the weeds, so to
speak, that becomes an individual

credit union's kind of challenge.

But I do think in general, it's
very hard for a credit union to

manage liquidity and interest rate
risk without assessing credit risk.

I just don't see how you
can manage those two without

having a handle on credit risk.

But that's Todd Miller's take on
ELCO and that they need to have.

control of that credit
risk assessment as well.

Agendas in minutes are really a key
thing and the way I would lay out

what does your agenda in minutes
do and what should they accomplish.

They should make it really transparent
what you're using to make decisions, the

decisions you made, why decisions were
made And if you've got adverse trends,

why are you not doing nothing about it?

So I'm trying to see things
not going the way they're at.

And I okay, we'll just watch
that for a while, but we're

not going to change anything.

Your minutes should really be transparent
that you made that decision intentionally

and did so for specific reasons.

And I think a lot of places miss this.

They have their agenda.

They don't put a thought into it.

I think trender reporting is a big
piece of this in getting it right.

We have one, we have more than one
client, they'll rate their risk categories

and you should put that on the agenda.

Liquidity risk this month,
right on the agenda.

Moderate increasing, moderate
stable, high increasing, high stable.

Really where you spend your time
should get dictated by, where your risk

is at and where your risk is going.

So those are critical things to me.

And a lot of times when you get
issues with examiners, questioning

a credit union's decision, it's
because as they go through their exam

process, and they read your minutes,
and they look at your reports, it's

not clear and transparent to them.

What decisions you made
and why you made them.

So it's critical that you lay out in
your minutes, your Elko minutes that we

made these decisions for these reasons,
and we weren't operating in a vacuum.

You can avoid a lot of issues
with your examiners and from a

board governance perspective.

It should be clear and transparent.

So if your board picks up these
minutes and looks through it.

They should be able to understand
why you did what you did with the

authority they've given you as well.

So you don't do it just for the examiners.

You do it for the benefit of the
organization and it's the way you

keep everyone on the same page.

It's really unfortunate.

There's a few times we've been
involved with credit unions that

end up in court with the vendor.

They end up in court because of accuso.

They end up in court because of, some
investment broker did something to

them and you start deposing people.

And it's they don't remember why
and they look at their own minutes

and it's why did you do that?

I don't remember.

I don't know.

That's really not a good place to be in as
an organization when you don't understand

why you made the decisions you made.

So that kind of covers the reporting.

I just want to talk about model risk a
little bit in line with the reporting,

because a lot of what Elko's does and
bases their decision on are based on

forward looking models, be that cash
flow forecast, interest rate risk models.

All the scenario stuff we talked about
in sensitivity testing, those are all

done as part of forward looking models,
credit stresses on your loan portfolio.

That's all models.

Model risk is something that
is a challenge for everyone.

I do think for ALCO committees, committee
members needed general understanding of

key assumptions in all of these models.

If they're basing decisions on them,
they should have a basic understanding.

Do they need to be an expert on
the model and know everything?

No, but they should have a
good general understanding.

The second piece of this is model
validations, and this happens in different

places and different size credit unions,
and some really large credit unions.

It's a whole separate function
of internal audit and the.

ERM process in smaller credit
unions, it actually falls a lot of

times to the ALCO committee itself
to validate their own models.

And sometimes it's even down to the
finance department to just validate

their own cash flow forecast.

It doesn't really.

There's right, there's different
answers to who handles model validation

and different size organizations.

The point I want to make is community
members should be comfortable with the

efforts made to validate their models.

How frequently do we do it, within
an organization from a governance

perspective, it can be happening
in different departments and

be driven by different people.

But at the end of the day, the
folks using those models to make

decisions should be comfortable.

With what their organization has done
to validate those critical models

and make sure they're accurate.

That covers most of what I have to say.

I think that gives people a good
general understanding of things.

Maybe 1 of these days, you
can get another person to.

Do a podcast just on the whole credit
risk reporting piece of it because

it can be as big as the other pieces.

And I think it's a ever
growing important piece.

And we see more and more examiners
want justification for concentration

risks, whether that's in your investment
portfolio, loan portfolio, and CUA

hasn't really talked about liability
concentrations, but I guarantee you it

will be coming in the future on their
part as they get comfortable with.

Their whole concentration risk on the
asset side of the balance sheet today,

Treichel: Todd, as you're talking
through that I'm envisioning a couple

different listeners, not specific
people, but someone out, for a walk,

listening to this on their iPhone.

Versus someone sitting at their laptop
versus someone driving in their car.

And there, you had so much
information packed in there.

I know that some of the listeners
are going to go when I get to my

laptop, I need to relisten to this
and I need to take some notes.

And when I get to my laptop, I
need to forward this episode to my

committee, et cetera, because there
was just tons of information there.

I wrote a lot of different things down.

And the listeners can't see this, but you
might not even be able if I hold it here,

you can see I got two different pens.

I got a black one and a red one.

And as you were talking on some
things that I wanted to, I didn't

want to interrupt you because I don't
want to break your flow because that

was fabulous, but I wrote a couple
different things down that link to

things that it triggered for me.

I'm going to walk through.

Some of those, I'm going to ramble with
some of those and then you can pivot

and see if there's anything that I
said that that you want to respond to.

So you talked about, stress testing and,
everybody's hearing that there's empty

buildings and that's a type of commercial
loan risk and that you need to have better

tools that are doing stress testing.

And I believe we've given
guidance and, or NCOA.

Has criticized credit unions that when
you're doing that stress testing, you

don't want to just stress commercial
over here and then stress real estate,

residential real estate over here and
then stress your visa over here and

then stress your deposits over here.

There needs to be some sort of
cascading effect where you might.

You might stress two
factors or three factors.

That was one thing I wanted to mention.

And there, we, I also want to
mention that we have a separate,

you and I did a separate podcast
with the sole topic of model risk.

And so if someone is listening and you
want to hear more about what Todd said

relative to model risk, I think we
probably have a 20 Or 30 minute podcast

that we did specifically on model risk.

Scenario and sensitivity analysis.

I think if I'm linking this right
to some of our conversations.

We've had situations where a document
resolution or an examiner finding was

given to a credit union where they said
that you need to update those and you

need to be reevaluating those things.

And careful what you ask for and is
what we've seen because people have

come through this cycle and they have.

Re evaluated what the reality is
and then projecting that forward.

And I'm going to get some of this
wrong, but I think you're going to

get the point I'm trying to make here.

But when NCOA asks you to do some
backtesting, that backtesting

sometimes will actually work the
opposite of what NCOA thought.

And your assumptions might show
that your deposits are more sticky.

So that's something that I
wanted to throw out there.

To governance, many of these things,
if any NCA, you hit on governance

and a couple different points.

We have a separate podcast on governance.

We are seeing NCUA almost link every
examiner finding, maybe not examiner

finding, but document resolution.

If NCUA is unhappy about something
that happened since the last exam,

they seem to always now link it
back to corporate governance.

Which makes some sense in most instances,
but it just Impresses upon me that

the corporate governance is even
more important that it's ever been.

I've said another podcast.

It almost seems has done training
on a national level or pointed out

that they need to do this because
we're seeing it so consistently.

And then here's my last comment,
and then I'll let you respond

to any of these that you might.

Might want to when I'm going back to
when I was actually doing exams, you

go in and so he doesn't do an audit.

There's the supervisory committee
or the CPA audit, but you'd

have your regular trial balance.

And, loans totaled up to 15.

24179 million dollars.

And you'd compare that to the
regular loan trial balance.

Then you'd have the visa trial
balance, which was different.

Then you'd have the commercial loan trial
balance, which might have been different.

Then you might have the real
estate loan trial balance.

And then on top of that, you've got
these big systems that credit union

seems to have sometime where they where
they're doing analysis and loss analysis.

And I don't want to name particular
companies, but there are other

vendors out there that will
provide these other analyses.

And we saw in some situations
where an examiner said, Hey, you

have all this ALM stuff that says.

That this loan type is X at the end
of March and it's off by, 4, 000 on a

multimillion dollar program because it's
purpose isn't to be that trial balance.

And.

In that instance, we gave some guidance
to this credit union that they might

want to get those ALM reports as
of April instead of as of March so

that the examiner doesn't try and
link it back to their call report.

And there's no requirement that
those ALM reports be linked.

And I think you might have said
even, you've seen some situations

so there's a lot of workload
tied to that for that vendor.

The vendor might give you a discount.

Not only do you have the added
advantage of NSUA, not trying to link

it to something that it shouldn't.

And that doesn't happen that often.

That was really more of a one off.

But, alright, that's those are the
brain dump of what I wrote and read on

different things I wanted to mention
relative to the notes I have here.

Did that, any of that trigger any
clarification or follow ups from what I

said that you might want to add there?

Todd Miller: Think I'll respond
to all of them just briefly.

And we'll do the last 1
1st balancing reports.

And this is back to my 1
version of the truth type thing.

You do need within your organization
processes to reconcile reports.

Now, you might run credit risk
things, that might be done at

a mid month or not a quarter.

And you build this workflow in there
and, most organizations now have large

data warehouses, information is lodged
in a couple of different places.

It might be off a little bit from
your accounting reports, and it's

probably okay for them to be off a
little bit, but examiners just want

to reconcile things to the penny.

And that's just.

A waste of their time when you're
in, a 1 or 2 or a 5 billion dollar

organization, or even a 500 million dollar
organization, but ratings themselves

should have internal controls to reconcile
these different reports and make sure

they're appropriate reports here.

People capital markets.

Who's ever looking at a lamb?

I always looked at them and
tied them to a balance sheet.

The, these roughly look good.

Okay.

Within, and this happens almost all
the time, within your loan type codes

and your vendors, ALM type codes,
sometimes things just don't map exactly.

Small errors never bothered me.

Simple things were investment
securities, where you know exactly what

the balance is on exactly that day.

Those should tie exactly every time.

And it didn't happen often in
my career, but it did happen

once or twice, where there were
material errors in an ALM model.

And some of this was intentional on the
part of the credit he not giving their

vendor actually accurate information
about items on their balance sheet.

And see way tends to want to reconcile
this stuff to the penny, because

even though they don't catch very
much fraud, it's usually caught.

or otherwise by internal audit or
an employee writing out another

employee, or caught by accident.

But a lot of times when NCAA does catch
fraud, it is because these reports don't

reconcile or they'll see strange things
they get their share alone download and

that's not tying with a general ledger.

Or there's a funky account
within that trial balance.

That's been used to hide errors.

So that's why MCUA is sensitive
to that issue is because

the frauds they have caught.

It's been caught for that reason.

Not the point of our thing here today.

We'll go back to sensitivity
scenario analysis.

You see this a lot in exam reports.

They want you to beef up
sensitivity scenario analysis.

As an ALCO, though, you need to keep
in mind those are two totally separate

things, even though examiners often use
the words interchangeably, sensitivity

analysis is about determining which
factors move those model results

the most and which assumptions
move it the most scenario analysis.

You're trying to figure out what could or
might happen under different conditions.

It's not related to, those
core basic assumptions at all

two very different purposes.

We go back to this credit modeling and
you mentioned, we stress this credit

portfolio, real estate differently
from the consumer differently from the

residential real estate and yeah, they're.

But more and more, you're seeing
for credit unions to really

justify their capital adequacy.

They're almost going down
to a capital planning path.

And, so you get into the ones credit
unions and they're over 10 billion.

They're required to do
this combined stress test.

And, the Federal Reserve even sets
the conditions for those stress tests.

Here's what the interest rate
scenario is going to look like.

Here's what the economy
is going to look like.

And those are very technical and very
precise, but I think for a lot of

credit unions, the scenario analysis
and different concentration levels.

They can do that on a less precise
way and probably need to do a

combined analysis of some of these
stresses to determine if they're.

capital is adequate.

You have regulatorily
required capital levels.

The reality is in many marketplaces
and depending on the way your balance

sheet structured is, those regulatory
capital levels are probably not

sufficient for you to be competitive
and optimally serve your members.

You're going to need more capital than
that regulatory capital in the real world.

And as your competitors have more
capital, you're going to need

more capital to keep up with them.

Yeah, capital planning is Unnecessary
part of every organization and, I can see

a day where these required tests for 10
billion get moved down to credits at 5

billion and examiners are going to start
wanting people at 1 billion to do it,

even though the reg might not require it.

It's just an evolution that
examiners go through where.

Best practices, they tend to
filter it down to smaller and

smaller organizations, and I don't
necessarily see that as a bad thing.

In many ways, it's a good thing.

And I just started out the whole thing.

Large organizations have
committee charters and small

organizations put it in policy.

And I said it's Even these small
organizations, you should think

about having committee charters.

So it's just a natural
evolution of things.

So I think more and more you're
going to see examiners push

organizations of all size to.

Go to a comprehensive capital
planning type, and, we help

people out with some of that.

You see it consistently in exam reports.

They want support for concentration
risk, which is really another way to say,

prove you have enough capital to do this.

It's just the other side of the coin.

Which words do you use?

Prove you have enough capital or prove
you can support your concentration risk.

It's the same question.

Just different sides to it.

Did I hit all the points
you had written down there?

You

Treichel: did.

You did fabulous.

Yeah, you hit them all.

I have different

Todd Miller: color pens too and
I have notes and I always say I'm

going to check off on my notes.

When I address something, but
I get talking and I never do.

So I make it and then I just don't really
look at him very much during our podcast

Treichel: that that
just makes me smile too.

Cause it reminds me of my dad.

I used to go to a lot of
race horse races with my dad.

And he had the daily racing form, and he
had four different colored highlighters,

and he had three different colored
pens and every one meant something,

and, and then you'd get there you'd do
all your handicapping, which is almost

as fun as going to the race, and then
you'd get there, and you'd see the

odds, and you'd do something different.

And then you'd go back and you'd look at
in blue, he said he wanted blue as his

top horse, for example, in each race.

And then you only went with that, like
half the time you'd go home and you'd

do the debrief of the, all that color
coding and and you'd realize that you

were onto something you just needed
to follow with your convictions and

the assumptions you had going in.

So that's a total non sequitur
to this, but all that color

code made me think of that.

So that made my heart smile.

All right, Todd.

So what else as we wrap this up, is
there any final thoughts you want to make

relative to what we've discussed here?

Todd Miller: No, I think we'll just go
reiterate something at the beginning.

There's no one right
answer for all of this.

You're trying to accomplish the
same general things, but really

you make all this fit and work
within your corporate culture.

It's all part of your corporate culture.

You build this around the knowledge,
skills and abilities of your

staff and a good reason to do it.

Do this and have this in a very formal
way is it improves the knowledge, skills

and abilities of the rest of your staff.

And I guess that kind of leads to 1
thing that examiners do bring this up.

Occasionally is it's important to continue
the training of all your staff that

they have ongoing training and various
areas that they're responsible for.

Listening to our podcast
as part of that, but

Treichel: that's right.

That's

Todd Miller: right that is an
important piece for committee members

and it's an important piece for
any organization that you Dedicate

resources to improving those knowledge
skills abilities of your staff members

Treichel: Fantastic, this is going to
be an instant classic episode I got

a feeling that that people are again
going to want to listen to this more

than once There's a lot of really good
Advice and counsel in this and I want

to thank you for your time today, Todd.

Todd Miller: It was my pleasure mark.

I enjoy doing these

Treichel: These are fun.

These are very fun.

And listeners, I want to
thank you for listening.

I hope you'll listen again soon.

This is Mark Treichel signing
off with Flying Colors.