NCUA Indicates CAMEL Codes Keep Getting Worse

What is more concerning for me, however, is the rapid rise in total assets for composite Campbell's code 3 billion plus credit unions. If not addressed quickly by the credit union management. These problems could escalate into CamelScope 4 and 5 ratings and even failures. And it's the billion dollar plus credit unions that pose the greatest risks to the shared insurance fund.

So that snippet came from the NCUA board meeting, and chairman Harper was being briefed on the state of the chair insurance fund. the. board presentation on the shared insurance fund. it's one of my favorite, quarterly events that happens at NCUA. And you might ask why? The reason why is that it's the only time they publicly do any type of disclosure on what's happening in Campbell code trends. Now I put a post on LinkedIn. Let me pull it up here.

Indicating that if you took the amount of dollars in, in complex credit unions, and as a reminder, complex credit unions are those over 500 million dollars in assets based on NCUA's definition. If you took the dollars in code 3s, they increased from 47. 7 billion, with a B, in June to 80. 8 billion. That's an increase annualized. If you take the results, multiply it by 4 and divide by what you had coming into the quarter, that's an increase of 277%.

Now, if you go back and look at the number a year ago, they actually made reference to that in The budget briefing, which happened later in the day, and when they made reference to that, they indicated there were like 11 or 12 and now there are 51. So that was like a 500 percent increase in the number of large credit unions with a code 3.

Now, that impacts the insurance fund, which we'll get to a little bit later. And the reality is N. C. U. A. Is nervous about the economy. They. That is trickling into camel codes, and I'm going to now go back to NCUA Board Chairman Todd Harper with some questions and answers that he also poses to Chief Financial Officer Eugene Sheed at NCUA.

In today's report, we see that stress firsthand, especially in large, complex credit unions with more than 500 million in assets.

In fact, as shown on slide 9, the number of large, complex credit unions I'm going to talk a little bit about credit unions with composite Camel's Code three rating increased by nine credit unions to a total of 51 credit unions in the third quarter assets in the Camel's Code three group for credit unions of all sizes also increased to 131. 7 billion dollars as shown in the bottom right hand corner of slide nine. That is nearly 45 percent higher than the previous quarter's results.

The rising risks within the credit union system also demonstrate why the NCUA Board must ensure the agency's 2024 budget has sufficient resources to examine, supervise, and mitigate these growing risks. Some may not like the size of the increase proposed in the staff draft budget, but it is our job to protect credit union members and the system.

Other issues, including the reinstatement of federal student loan repayments, rising costs for property and casualty insurance, and consumers drawing down the last of their pandemic era savings will also affect already strained household finances going forward. And those household level issues could eventually roll on to the credit union's books as delinquencies and charge offs.

So the NCUA Credit unions and the public should be prepared for further impact on the asset distribution of the system's CAMEL's ratings. It will get worse before it gets better. That brings me to my first question, Eugene. On slide 8, we see a 275 basis point increase in the percentage of insured shares held in PASA CAMEL 3 code credit unions since the end of 2022. This brisk pace of increase concerns me.

How rapid is the growth of insured shares in Camel's Code 3 credit unions compared to what we have experienced in prior business cycles? So as

The NCOA will continue to monitor credit union performance and mitigate risk in the examination process, off site monitoring, and tailored supervision. The NCOA board will also closely watch credit union and share insurance fund performance in the quarters ahead and act to protect the system as needed.

Additionally, and I cannot emphasize this enough, credit union executives, supervisors, and boards of directors must remain diligent in managing the potential risks on their balance sheet and when monitoring economic conditions and the interest rate environment. Today's economic environment requires active, not passive, management by all. Additionally, the NCUA must ensure the share insurance fund remains healthy and fortify the system's defenses.

For potential risks ahead with the rising camel code three credit unions, the share insurance funds general reserve balance increased by 10. 2 million in the third quarter, as shown on slide for at the end of the quarter, the reserve balance total of 214. 3 million with 7. 3 million set aside for specific reserves and 207 million set aside for general reserves.

Eugene, when you look at the number of credit union failures and the cost to the share insurance fund, as we saw on slide five, the actual cash losses have been small, about 1. 4 million a year to date. Would you elaborate on why general reserves are high when actual cash losses have been so small? And please discuss the NCUA's methodology for reserving for potential losses for the share insurance

fund. For example, I've long had concerns that the share insurance fund's current reserving methodology. does not consider black swan events.

And the modeling that we do for the general reserve does attempt to take into consideration the totality of the current situation that we see within the industry. It does not, I would say, unlike some modeling that we sometimes talk about, it does not exclude, per se, black swan events. The modeling kind of takes into account.

The current state of the credit unions same, similar factors to the CAML ratings, which is why they often move in tandem with each other as well as macroeconomic data that we're seeing. And again the purpose of that is to get a systemic look at essentially a financial risk to the SIF based on current economic performance of credit unions in the industry. And then we have the specific reserves where when we know something... More particular is probable estimable.

We can value it then we create that specific reserve. Looking at slide I think you mentioned slide five. I did. So let's take a one thing I want to point out on slide five, if we can bring that one up is this discrepancy that you see in actual cash losses in any particular year. So on slide five, that this is a five year. I just actually, we got six years of data up there. In 2018 there were $784 million, $785 million of losses.

Whereas in the, two years later we're down to a million 0.6 in was so huge variability in terms of what happens. In terms of actual losses in any particular year. So the general reserve model is trying to guess where you're going to be between some events that are, extreme at one end and extreme at the other end. You're generally not going to nail the upper and the lower ends perfectly.

What you want is to have a model that as conditions start to deteriorate, the reserve starts to go up in anticipation of those potential cash payouts. And then as economic conditions improve the reserve income's down because the general reserve model goes both ways. It goes up some quarters, it comes down in others.

And then they go on with a big discussion about the insurance fund and how the essentially the equivalent of Cecil for credit unions is the allowance for credit union losses at the NCUSIF level. And they have a general reserve, they have a specific reserve. And when the specific reserve is, is code fours and code fives where they expect that they're shopping a credit union and they might have a loss. The general reserve is, is.

Essentially, materially based upon the camel codes and credit unions. So when you have camel code threes going up, pick a number, quite a bit, substantially, increasing velocity, you're going to see increases in what needs to be set aside, for losses. And they indicated they set aside 10 million, during the quarter. If you annualize that 10 million, that's 40 million on a base. Of 21 million. So that's about a 20 percent increase as this number keeps going up. If it keeps going up.

And oh, by the way, Chairman Harper predicts that it will go up. What does that mean? That means that they're probably are aware of some other large credit unions that became code 3s during the month of October. We're in November as I sit here speaking, it's November 18th on a Saturday. And yeah, so camel code 3s are going to go up. So, what happens when you

become a Code 3? NCUA comes and visits you at least twice as often, every six months. I've said this before, and I'll say it again. Best way to stay out of NCUA's crosshairs is to never become a Code 3. They have the authority when they come back at that six month, visit to upgrade you back to a Code 3. But they don't very frequently do that. Sometimes they don't do it because they don't bring enough resources to do something closer to a full exam.

Sometimes they don't do it because they don't feel the credit union has done enough to be upgraded. And even if you're squeaky clean, oftentimes they'll just say, Hey, you're doing great. If you keep doing it, when we come back in another six months we will do, quote, a full exam. And we will upgrade you at that point in time. So you become a code three, you're stuck in their crosshairs 99 times out of a hundred for, the next full year. And you'll see them, they, they depart.

Let's say they depart in January. You'll see them again in July and you'll see them again the following January. Gets worse. If you become a code four, you'll see them every four months. And it's almost as if they never leave. which reminds me, of a funny, A funny country western song. How can I miss you if you don't go away?

Well, if you're a code 4, NSUA tends to not go away, and it's a constant drip, a constant reminder, that you need to manage a little bit towards what the insurer, what the regulator wants. And again, your goal should be to stay out of being a code 4, stay out of being a code 3. and I've seen a lot of code 3s downgrades. We've, assisted in some credit unions getting upgrades, But it's a challenging time out there nonetheless.

So one other thing that's brought up in the budget briefing, I did a separate podcast on their budget document, the staff budget document, which is about 60 page, a lot of transparency. they just did a budget briefing Thursday at two o'clock testifying it. That was NASCS, the Virginia league, the Washington, Oregon league, which I believe is now called go west CUNA and NAFCU, who've now decided to merge into America's credit unions.

So there were five, 5 organizations, 5 trade associations, they're making statements to NCUA, they generally every year come up with some broad statements that the budget's getting too high, and that, NCUA, should, should reduce the budget. But they did provide some constructive criticism. Now, one thing that, Chairman Harper and I disagree on quite a bit. And I've talked about it here in the podcast.

He's actually referenced the podcast statements I've made on this is that it's not a zero sum game to move something from. Tip to move resources from safety and soundness to consumer compliance, implying that there is a nexus between the 2. there is somewhat of a nexus between the 2. however, when they are not increasing. Full time equivalence, but they are taking staff from.

regular examinations from safety and soundness exams, and they are turning them into specialists that deal only with consumer compliance. That's a reduction in resources that go to safety and soundness at the same time as they're saying, we think there's going to be more problem in credit unions. So, quite frankly, I think it would be more appropriate for them to ask for more staff, keep the examiner staff.

And add these consumer compliance folks, but to pretend that, when you move resources, from. From 1 area into another area that the area that you took them from, is not. Position. More poorly, it's just not accurate in my opinion. So I disagree with him on that. I, I do in general, I think their budget is reasonable. Yes, they've got some pay increases, but yes, so have credit unions had pay increases. So have other people in industry had pay increases.

And one thing that you'll never hear NCUA or have not yet heard NCUA say publicly is if you take the combined payments that credit union make to trade associations. The cost of those is more than the cost of NCUA in its entirety. So, and both of them are immaterial. I'm not saying that you shouldn't join a trade association, but, the trade associations like to make a big issue about NCUA's budget. And the reality is.

a similar size credit union sees less hours spent on them than a similar size bank, meaning NCUA is more efficient and NCUA, I believe, has a very prudent budget process. All

right. So, in summary, NCUA is, nervous about the economy. They're nervous that the insurance fund. may need more increases in the future for their allowance for loan losses for or their allowance for credit union failures. Why? Because camel codes are getting worse and they predict more to come. That means when they come in they're going to be more aggressive as opposed to less aggressive and that's something that I've seen from my conversations with credit unions out there.

So you need to be ready for that. You need to be ready for them to be Pushing harder on your camel codes and pushing harder on your asset quality and pushing harder on your liquidity and pushing harder on your capital. Uh, you name it. They are going to push on it. Again, and again and again over these next years exams. All right. That's it. I appreciate, your listening today. Hope you'll listen again in the future, and I hope you have a fabulous Thanksgiving with your family.

One of my favorite, holidays of the year is Thanksgiving, and we will be spending it with family this year as well. Mark Treichel, signing off with Flying Colors.