Credit Union Exam Solutions Presents With Flying Colors

Speaker: Hey everyone, this
is Mark TriCal with another

episode of With Flying Colors.

NCUA is in a deregulatory mode.

I've done a couple podcasts relative
to some of the earlier deregulations.

They've been coming out and
they've been coming out in waves.

I they just came out with seven or
eight and the one I'm gonna talk about.

Wave seven or eight.

That is, and the one I'm gonna talk
about here today is going to be the

most recent one that came out went into
the Federal Register on March 25th.

And it has to do with taking the
guardrails off on participation loans or

the regulation that creates guardrails.

And that's why this podcast is
called When the Guardrails come off.

So again, it relates to
indirect vehicle loans.

I'm gonna touch on whether or not
Inwe still has the tools that it

needs when this regulation comes off.

And by the way, I'm going to
refer to this rule as a rule.

It's actually a proposed rule, but
when you only have one board member

and that board member proposes a rule,
odds are eventually it'll go final.

Although with the caveat of does, can
one board member act when will there

be a replacement to that board member?

And I'm hearing some rumblings
that there could be a change

soon at the NCA board level.

Stay tuned for that.

When that does happen, I'll also
have a podcast relative to that.

So again if you want to comment
on this proposal which in

general I'll steal the lead.

I think it's a good proposal.

It's a better one than some of the past
ones, which I've framed as changing.

Happy to glad.

And there's a little bit of happy
to glad here, but I think it does

do some real deregulation here.

So NCOA has had a rule it's been in place
on participation loans for 20 years.

They put that rule in place
in 2020, excuse me, in 2006.

And of course it is 2026.

Easy math, 20 years.

So what the rule said when it was put
in place in 2006, indirect lending

at the time was growing very fast.

In the mid two thousands, credit unions
were partnering with auto dealers and

bringing in third party servicers.

Often at that juncture without
adequate due diligence or with

the controls in place to manage
the related concentration risk.

So NCO a's concern at the time is
that institutions were walking into

these programs without fully actually
understanding what was going on.

So it made bright line caps.

What were the bright line caps?

The bright line cap was a 50% of net
worth limit for the first 30 months

of a program and a hundred percent of
net worth limit after the 30 months.

And a waiver from the regional director
was required if you wanted to go above.

A hundred percent.

This applied to both federal credit
unions and federally insured state

charters from different regs.

NCS was 7 0 1 2 1 H for the
feds and for the states.

It was linked to 7 41 0.203

C.

The rule was simple, but it was
blunt, and it worked as a trip wire.

And NCA by the way as most
likely NCA for commercial loans,

they used to do waivers, right?

If you wanted to go over 80% LTV, you
had to write the regional director.

And they've got, they got away
from requesting waivers there.

They used to have
waivers for fixed assets.

If you wanted to go over 5%, that
got away from creating waivers and

bright line caps and went to more
principled based principles based.

Okay, principles based regulations.

So what is NCA proposing now?

So what it's planning on doing,
again, proposing to do, is deleting

the, that entire framework,
it's going to remove 7 0 1 2.

H for federal credit unions, and
it's going to remove 7 41 0.203

for federally insured state
chartered credit unions.

The waiver process will be gone
similarly to how they got rid of other

waiver processes and, the appeals
provision of course, you can't appeal

these things if the rules go away,
so they'll clean that up, right?

So what will replace it?

The board of directors will set
its own policies, similar to,

again the comparison of LTVs.

If you want to do a commercial
LTV of 90%, you just have to

explain why it makes sense.

How much of you'll do,
et cetera, et cetera.

Here will be the same.

If you wanna do more than a
hundred percent concentration

risk, you'll just have to ex.

Explain it based on your credit union
size, complexity, and risk profile.

So again, pr, so the justification
is it's principle-based supervision.

It replaces the bright line with
exam-based judgments calibrated to

each credit union, it reduces the
regulatory burden in theory board the

boards know their credit unions best
governance is what they need to do.

We don't need to prescribe.

NCA does not need to prescribe
what you need to do, and it's

being driven by President Trump's.

Executive order 1 4 1 9 2, which
creates a 10 to one deregulation

mandate to eliminate costs of 10 rules
for every new one that is proposed.

Part two, the tools that remain
and why they're more powerful than

than what this reg created anyway.

So this is where you get
into the happy to glad.

It's bigger and better than happy
to glad because this is a rule that

really doesn't need to exist because
they have other ways currently have

already taken care of that there.

They're said another way.

NCAA's best tool was never
that bright line cap.

What's the best tool?

It's NCAA's concentration risk
letter to credit unions, which

is current active a guidance,
which is current active guidance.

Okay.

But in that guidance, it talks
about board approved limits.

You need to create specific concentration
limits tied to net worth by policy, not

by regulatory default risk rating systems.

Quantified documented frameworks
for assessing individual.

And aggregate exposure.

And we see a lot of this coming
up, by the way, concentration

risk and what's your risk?

Appetite?

Seeing a lot of that in our conversations
with credit unions scenario and

sensitivity analysis, you need to
do stress testing on concentration

positions under adverse conditions.

So again the bright line goes
away, but you still need to do all

these things as it relates to the.

Co concentration risk letter.

It talks about data warehousing creating
an infrastructure to track migration,

vintage analysis and servicer performance.

Regular board reporting, periodic
reporting on the individual and aggregate

exposures, not just annual reviews.

By the way, we have a great
podcast on what should be in

the perfect credit union annual.

Monthly report, and again, perfect.

From an NCOA perspective.

Of course, there's what the
CEO wants in the report.

There's what the board thinks they want,
and there's what NCOA thinks they want.

And sometime, sometimes board reporting
can get quite cumbersome because

every time you layer something on
the report gets longer and again,

the board members are, unless you're
in a state charter, that allows.

In a state that allows boards to be
paid, the boards tend to be volunteers

and you can overwhelm them, but board
reporting is required on concentration,

risks, et cetera, et cetera.

The a hundred percent threshold
concentrations exceeding a hundred

percent of net worth require
documented board rationale.

So it's there in the concentration
risk letter but they're

getting rid of the regulation.

Maybe they'll tweak the
concentration risk letter.

Although it's been my argument
that they have some really good old

ladder that they don't wanna touch.

And the reason they don't wanna
touch is that if they touch

them, it gets fingers on it.

And you can, it is kinda like going
to Congress and you wanna get, the

back when the Federal Credit Union Act
was changed to resolve the field of

membership issue in order to get the
field of membership issue resolved the

member business loan cap came in because
banks were successful in lobbying that.

So same holds true if you at NCOA,
if a staff member wants to get a

letter to credit unions changed.

They risk it actually going away, right?

That you bring it up to an
NCA board member and say, Hey,

we need to tweak this letter.

They go, what letter?

I didn't even know we had that letter.

Let's get rid of it.

Or they'll say, that's great, but
we're gonna water it down so you can

end up losing ground from a safety and
soundness perspective as a regulator.

But again, this is a pretty good letter.

And I think it is one they maybe
over rely on some instances or don't

necessarily ha have enough consistency on.

But the principles created by
the concentration risk letter

generally work quite well.

And then there's always, the catchall
safety and soundness authority, which

is more powerful than a fixed cap.

A lot of times when I'm having
conversations with credit unions,

they'll say this is the regulation they
referred to, and I could look at it

and glance at it and go, yeah, that's
their general safety and soundness.

Authority regulation, which is what
they have to link things to now because

they've been under a mandate from
the past couple of NCA boards to not

rely overly on guidance, even though
I'm telling you that they have this

guidance that they will be relying on
as it relates to concentration risk.

They, the guidance is out there.

They don't want to say in a.

Dora that you need to do it for that
reason, so they'll link it back to

the safety and soundest authority.

So why calibration beats a hard stop
Because, if you've got a $200 million

credit union that has a hundred percent
of net worth in a certain type of

loan, but doesn't have a lot of capital
and doesn't have a concentration risk

policy, and you have a $2 billion
institution that has runs a best in

class indirect program for 15 years.

There, there's a substantial
difference in the safety and

soundness of those two examples.

And by getting rid of that regulation,
which really doesn't mean a lot,

and focusing more on safety and
soundness and the principles from

the letter to credit unions, NCUA
can still do what they need to do.

So what so what?

Examiner corrective actions
are in their toolkit.

They can require reduced
concentration limits.

And they do that by saying you
need a concentration limit and you

need to explain why you need that.

But they might not necessarily accept that
until they get to a number that they think

is they won't tell you a number, but they
will tell you that you need to tweak it.

And oh, by the way.

There is an internal NCOA instruction
that says if your net worth concentration

risk of a certain product exceeds
X percent you need to get the

regional director's approval on that.

If it re, if it.

Exceeds why percent You need to
get the office of examination

of insurance approval.

And guess what?

If you have to go get higher levels
approval internally at NCUA for

someone to bless a program, the
examiners are less likely to bless

that program without a very robust
concentration risk policy program,

risk appetite, et cetera, et cetera.

So all these things bleed together.

And they could require you to
red reduce your current exposure.

Whether that's member business loans,
whether that's indirect auto loans,

whether that's signature loans.

I've seen this frequently
in the last few years.

And they could require you to cease
lending until, don't cease doing

this until you have a better program.

Cease doing this until you comply
with the commercial loan rule.

All these tools still remain in
place for the examiners, which

is why this regulation going
away really doesn't harm them.

Now, where does this get
a little bit complicated?

And where does NC a's proposal?

What does NCA.

Proposal not necessarily addressed?

There's a sophistication gap.

I mentioned different credit unions have
different programs, different credit

unions have different levels of expertise.

The 2006 rule wasn't targeted at
large, sophisticated credit unions.

It was a trip wire for smaller
institutions, those without management

depth experience or concentration risk
frameworks, removing that trip wire.

And tho those credit unions must
fill that void on their own.

The bet is at NCA that they will and that
they'll do it in a safe and sound manner.

The challenge is, NCA will only catch
problems when an examiner is in the

building or is asking to review things.

Not every credit union is
examined every year by the time

a concentration issue surfaces.

In an exam, an ex, an
exposure may already exist.

Now they have, trends that they
look at and that'll determine whe

when and where they go places.

But as I've talked a lot about here, a lot
recently, they've lost 27% of their staff.

They didn't lose 27% of the new people.

They lost 20% of the seasoned
people, the most experienced people.

And in c, a staff will fill those voids.

They will rise to the occasion, but the.

Body of work of someone who's been at
NCA for 35 years, 30 years, 25 years, and

their understanding of exams and their
comfortable and their comfortableness,

if that's a word with risk, is
different than someone who's been on

two years, five years, 10 years, right?

The longer term folks see more
gray and have more experience the

younger term, see more black and
white and may miss some things.

They may overreact to some things.

They will grow into their roles and
they've got a lot of talented people.

But that is an issue that.

Theoretically and in reality will
create some issues for credit

unions that are dealing with this.

And then there's the consistency question.

Principal.

Principal based supervision
is only as good as the

consistency of its application.

NCUA has three regions with varying
examiner experience and as I mentioned,

and the bright line rule eliminated
a little bit of that regional

variability, although it still came up.

Through these other areas that I'm
talking about on the safety and

soundness, and it came up through
concentration risk requirements

via the letter to credit unions.

So what should a credit
union consider doing now?

There's four steps.

Really in my mind, regardless of
where you're at, if you are not

already doing that, you should take a
look at re review your board policy.

If your current indirect vehicle policy
references the old 50 and a hundred

percent net worth limits as a ceiling,
that policy, when this proposed rule

becomes final will need to be tweaked.

Run a concentration risk letter checklist.

Pull out the NCA guidance.

And look at it and say, have
you done all these things?

It's always good to take
a look at your policies.

NCOA has a really good webpage
where they say, here's the

policies that are required.

Here's how frequently you
are required to update them.

But when this rule is finalized, it
would be a great opportunity to take a

look at the concentration risk letter
and compare it to your policies.

And then probably most importantly,
document your rationale.

What are you basing your
concentration risk limits on?

Why are you comfortable with it?

Building it into your policies, building
it into your strategic planning, and.

Lastly if you like these changes,
consider submitting a comment letter.

NCUA takes these very seriously and
comment letters are due by May 26th.

If you like the rule, tell 'em if you
think the rule shouldn't be canceled.

And you think that maybe NCOA
should get rid of the concentration.

Letter to credit unions
in addition to this.

Tell them that, or,
'cause NCA does listen.

They could be, as I mentioned
earlier, they could be at some sort

of transition point, leadership wise.

If Halman goes to the
job that he's accepted.

And if Trump and Congress approve
the person who is rumored to

be coming in as chair, there's
gonna be a transition there.

And this could possibly get slowed down.

By a new person coming in like that.

But I do believe that this one has an
extremely high probability of being

finalized, which is why I've taken the
time to talk about it here on the podcast.

Bottom line, the tools remain the same.

Exam authority and concentration
risk guidance letter.

Are more flexible and sophisticated
than the older bright line cap

for well-managed credit unions.

This change is appropriate.

The regulatory floor was constraining
institutions, credit unions that

had outgrown the need for it.

The risk is at the margins.

Smaller credit unions, less
experienced management.

We're are gonna have thinner exam coverage
and UAS exam coverage is thin anyway.

So again, in closing, keep your
policies updated, take a look at them,

and as always we're here to answer
any questions that you might have.

And I've got some other podcasts
on some of the other deregulation

efforts that NSU has, that'll be
coming out here in the next few weeks.

I want to thank you for listening.

Thank you for watching if you're
on YouTube and stay tuned.

For more to come soon on the
other deregulation efforts.

This is mark Kel signing
off with flying colors.