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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 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, check out our services at marktreichel. com.