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Wednesday, December 9, 2009

Part II

National Administration 12 CFR Parts 702, 703, 704, et al. Corporate Credit Unions; Proposed Rule

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NATIONAL CREDIT UNION • Mail: Address to Mary Rupp, The corporate system offers a broad ADMINISTRATION Secretary of the Board, National Credit range of support to NPCUs. The Union Administration, 1775 Duke products and services provided by U.S. 12 CFR Parts 702, 703, 704, 709, and Street, Alexandria, Virginia 22314– Central to retail corporates, and by retail 747 3428. corporates to NPCUs, include: • Hand Delivery/Courier: Same as Investment/deposit services, wire RIN 3133–AD58 mail address. transfers, share draft processing and Corporate Credit Unions Public inspection: All public imaging, automated clearinghouse comments are available on the agency’s transactions (ACH) processing, AGENCY: National Credit Union Web site at http://www.ncua.gov/ automatic teller machine (ATM) Administration (NCUA). RegulationsOpinionsLaws/comments as processing, bill payment services and ACTION: Proposed rule. submitted, except as may not be security safekeeping. The volume of possible for technical reasons. Public payment systems-related transactions SUMMARY: NCUA is issuing proposed comments will not be edited to remove throughout the system annually runs amendments to its rule governing any identifying or contact information. into the millions and the dollar amounts corporate credit unions contained in Paper copies of comments may be associated with those transactions are in part 704. The major revisions involve inspected in NCUA’s law library at 1775 the billions each month. Corporates also corporate credit union capital, Duke Street, Alexandria, Virginia 22314, serve as liquidity providers for NPCUs. investments, asset-liability management, by appointment, weekdays between 9 Natural person credit unions invest governance, and credit union service a.m. and 3 p.m. To make an excess liquidity in a corporate when the (CUSO) activities. The appointment, call (703) 518–6540 or NPCU has lower demand and draw amendments would establish a new send an e-mail to [email protected]. down the invested liquidity when loan capital scheme, including risk-based FOR FURTHER INFORMATION CONTACT: demand increases. In sum, corporates capital requirements; impose new Richard Mayfield, Capital Markets provide NPCUs with convenient and prompt corrective action requirements; Specialist, Office of Corporate Credit quality services and expertise, all at a place various new limits on corporate Unions, at the address above or fair price. For many NPCUs, this is a investments; impose new asset-liability telephone: (703) 518–6642; Ross combination that makes the corporate management controls; amend some Kendall, Staff Attorney, Office of system a valuable resource and, for corporate governance provisions; and General Counsel (OGC), at the address some smaller NPCUs, an essential limit a corporate CUSO to categories of above or telephone (703) 518–6540; Paul resource. services preapproved by NCUA. In Peterson, Director, Applications Federally-chartered corporates are addition, this proposal contains Section, OGC, at the address above or governed by federal law and state conforming amendments to part 702, telephone (703) 518–6540; or Todd chartered corporates by state law. In Prompt Corrective Action (for natural Miller, Regional Capital Market addition, all corporates that are person credit unions); part 703, Specialist, Region V, at telephone (703) federally-insured, or that accept share Investments and Deposit Activities (for 409–4317. deposits from NPCU members that are federal credit unions); part 747, SUPPLEMENTARY INFORMATION: federally insured, must comply with Administrative Actions, Adjudicative The NCUA’s primary mission is to NCUA’s part 704 corporate credit union Hearings, Rules of Practice and ensure the safety and soundness of rule. 12 CFR part 704; § 704.1, and 12 Procedure, and Investigations; and part federally-insured credit unions. NCUA U.S.C. 1766(a). This proposal contains 709, Involuntary Liquidation of Federal performs this important public function significant changes to part 704 and Credit Unions and Adjudication of by examining all federal credit unions, conforming changes to other parts of Creditor Claims Involving Federally participating in the examination and NCUA’s rules. The changes include new Insured Credit Unions. These supervision of federally-insured state investment limitations, asset-liability amendments will strengthen individual chartered credit unions in coordination management requirements, capital corporates and the corporate credit with state regulators, and insuring standards, prompt corrective action union system as a whole. federally-insured credit union members’ requirements, corporate governance accounts. In its statutory role as the requirements, and CUSO requirements. DATES: Comments must be received on Prior to drafting this proposal, the or before March 9, 2010. administrator of the National Credit Union Share Fund (NCUSIF), Board considered all of the existing part ADDRESSES: You may submit comments the NCUA insures and supervises 704, but ultimately concluded that the by any of the following methods (Please approximately 7,740 federally-insured rule provisions addressed in this send comments by one method only): credit unions, representing 98 percent of proposal, and discussed below, were the • Federal eRulemaking Portal: http:// all credit unions and approximately 89 provisions that needed modification. www.regulations.gov. Follow the million members.1 These modifications are intended not instructions for submitting comments. Over 95 percent of natural person only to avert a repeat of the recent • NCUA Web site: http:// credit unions (NPCUs) belong to, and problems encountered in the corporate www.ncua.gov/ receive services from, corporate credit system but also to anticipate new RegulationsOpinionsLaws/ unions (corporates). There are 27 retail problems that might occur. For example, proposed_regs/proposed_regs.html. corporates that provide services directly while the recent corporate problems Follow the instructions for submitting to NPCUs, and there is one wholesale were caused in part by spread widening comments. corporate, U.S. Central Federal Credit associated with perceptions of credit • E-mail: Address to Union (U.S. Central), that provides risk, the proposal requires a corporate [email protected]. Include ‘‘[Your services to many of the 27 retail conduct a new spread widening test that name] Comments on Part 704 Corporate corporates. should demonstrate sensitivity to both Credit Unions’’ in the e-mail subject credit risk and other potential market

line. 1 risks. Likewise, increased capital • Within the fifty states, approximately 155 state- Fax: (703) 518–6319. Use the chartered credit unions are privately insured and requirements and well-defined subject line described above for e-mail. are not subject to NCUA regulation or oversight. concentration limits protect not only

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against the types of risk that a corporate that best met the needs of yield over traditional investments in materialized in the past but also each NPCU in serving its members. The other asset-backed securities (e.g., different risks that might materialize anticipated level of competition was securitized credit card and auto suddenly in the future. expected to spur consolidation within receivables). The vast majority of MBS This preamble is organized in four the industry to build scale and improve had high credit ratings (AA equivalent sections as follows. Section I discusses efficiencies. In turn, this would build or above) and interest rates that reset on the historical background leading up to capital through increased earnings. a monthly or quarterly basis, which the need for this rulemaking. Section II While a few mergers occurred, one of closely matched the corporates’ need to summarizes affected portions of the the primary consequences of fund on member shares.3 current corporate rule and the proposed competition was to reduce margins on These features made MBS highly changes to those portions. Section III services and put pressure on the marketable and thus provided adequate contains a more complete analysis of the corporates to seek greater yields on their liquidity to the corporates so they, in proposed changes with references to investments. turn, could provide liquidity to their particular sections and paragraph NPCU members. I.B. Corporate System: 2000 Through numbers within part 704. Section IV U.S. Central and Western Corporate Mid-2007 discusses various statutory requirements Federal Credit Union (WesCorp) had the applicable to the rulemaking process. The investment provisions of NCUA’s highest concentrations of MBS in the Section III, with its analysis of each corporate regulation, located at 12 CFR entire corporate system.4 The advent of proposed change to part 704, is part 704, have for many years permitted national FOMs produced the particularly important. Included in corporates to purchase private label competition that may, in turn, have subsection III.E are illustrations of how mortgage-backed and mortgage-related helped generate these MBS the various provisions of this proposal, securities (collectively referred to as concentrations. WesCorp was able to if they had been applied to the corporate MBS). Part 704, however, restricts most attract new NPCU members in part by system in the past, would have corporates (those without expanded offering rates higher than other drastically reduced the recent corporate investment authority) to investing in corporates. Consequently, it maintained losses. Section III looks not only to the only the highest credit quality rated an aggressive earnings strategy achieved past, but also the future. Specifically, securities by at least one Nationally by acquiring higher yielding (i.e., subsection III.D. includes a discussion Recognized Statistical Rating riskier, though still highly rated) MBS of how a hypothetical corporate might Organization (NRSRO).2 Historically, with greater amounts of credit risk. In structure its balance sheet so as to highly rated securities have experienced direct response to WesCorp’s market achieve the proposed new capital minimal defaults and have been very share success, other corporates likely requirements while at the same time liquid. Under NCUA rules, some pressured U.S. Central, their wholesale complying with the various proposed corporates were permitted to exercise corporate, to pay higher, more investment and asset-liability expanded investment authority and to competitive dividends which those limitations. The Board encourages purchase investment grade securities corporates could pass along to their commenters to take a very close look at rated down to BBB because they had NPCU members. As a result, U.S. the discussion in III.D. This discussion higher capital ratios, more highly Central changed its portfolio strategy will help commenters to understand trained personnel, and more capacity in and also invested heavily in higher how the Board envisions the various their systems to monitor and model yielding MBS. elements of the proposal, working their portfolios. Even those corporates NCUA communicated to corporates together, can permit the corporate that had expanded credit risk authority, the need to establish reasonable system to return to a position of however, used it sparingly. In addition concentration limits in their board providing necessary services to natural to being limited to securities with very policies. In January 2003, NCUA issued person credit unions while ensuring the high NRSRO ratings, corporates were Corporate Credit Union Guidance Letter system operates within appropriate required to perform a comprehensive 2003–01, which expressly highlighted safety and soundness constraints. The credit analysis of the underlying the risks associated with credit Board invites comment on all aspects of collateral supporting the marketable concentrations and specifically Section III, including the viability of the security. addressed the need for corporates to assumptions employed by NCUA. Either through direct purchase, or establish appropriate limitations within indirectly through investments at U.S. their credit risk management policies. I. History of Current Issues in the Central, the corporate system became During this timeframe, NCUA was Corporate System heavily invested in privately issued also beginning to focus efforts on I.A. Corporate System: Prior to 2000 MBS. Between 2003 and mid-2007, the identifying and educating NPCUs on percentage of investments in MBS grew emerging risks associated with proper Up until the late 1990s, federally from 24 percent to 37 percent. At credit risk management of lending, chartered corporates had a defined field purchase, these securities provided the including real estate lending, because of of membership (FOM) serving a specific corporates with a modest increase in a nation-wide increase in alternative state or geographic region. Most state lending arrangements. Over the next few chartered corporates had national FOMs 2 The term nationally recognized statistical rating years, NCUA and the federal banking but primarily serviced the state in organization (NRSRO) is used in federal and state agencies worked cooperatively to which they were incorporated. In 1998, statutes and regulations to confer regulatory provide numerous pieces of industry the NCUA Board began to approve benefits or prescribe requirements based on credit ratings issued by credit rating agencies identified by national FOMs for federal corporates, in the Securities and Exchange Commission (SEC) as 3 Overnight share dividends repriced daily. Fixed part to provide requested parity with NRSROs. The Credit Rating Agency Reform Act of rate share certificates were funded by investing in state charters. Within a few years most 2006 requires a credit rating agency seeking to be swaps. The swaps converted the corporates had a national FOM. treated as an NRSRO to apply for, and be granted, variable rates paid by the MBS to fixed rates that registration with the SEC. See final SEC Rule, could be used to pay the certificate dividends. NCUA’s intention in allowing Oversight of Credit Rating Agencies Registered as 4 NCUA placed both USC and WesCorp into national FOMs was to provide NPCUs Nationally Recognized Statistical Rating conservatorship in March 2009, as discussed further with the ability to select membership in , at 72 FR 33564 (June 18, 2007). below.

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guidance on non-traditional mortgage Some MBS were backed by them less attractive. NPCUs began to products. NCUA warned of the potential underlying that had imprudent invest part of their excess liquidity adverse impact these types of loans underwriting. These alternative elsewhere, further increasing corporate could have on consumers and credit mortgage loans were aggressively made liquidity concerns. union balance sheets. Natural person to buyers in high-price home markets as In response to these concerns, NCUA credit unions have responded favorably a means to address home affordability.6 directed corporates to consider a to the supervision oversight of NCUA; to The weak credit fundamentals of the number of steps to ensure adequate date, these types of mortgage loans underlying mortgages, the inherent risk sources of liquidity, including: represent less than 4 percent of all first of the MBS structures, and the declining encouraging the establishment of mortgage loans outstanding in the credit home market combined to severely commercial paper and medium-term union industry. affect the performance of MBS holdings note programs; encouraging additional In April 2007, several months before of some corporates. liquidity sources (both advised and the distress in the mortgage market MBS prices and marketability committed); encouraging an increase in surfaced, NCUA issued Corporate Credit declined significantly. Even bonds that the number of repo transaction Union Guidance Letter No. 2007–02, held AA ratings or higher were unable counterparties; encouraging focusing on the various risks associated to be sold at prices close to par, membership in a Federal Home Loan with MBS. This letter addressed MBS discouraging investors, including (FHLB); requiring independent credit risk, liquidity risk, market value corporates, from selling them. third party stress test modeling of risk, and concentration risk, and by Corporates increasingly looked to mortgage-related securities to determine mid-2007 corporates had, by-and-large, borrowings to meet liquidity demands. if the securities would continue to cash ceased the purchase of private label By pledging their MBS assets as flow; assisting U.S. Central to gain MBS. Still, by the summer of 2007 the security, corporates were able to obtain access to the Federal Reserve Board’s MBS at the heart of the corporate financing from external lenders. discount window; and encouraging problem were already on the books of In hindsight, it would have been education and communication with U.S. Central and WesCorp. At that time, preferable for the corporates to have their members about what was all their investments, including MBS, sold their problem MBS in 2007. occurring in the financial market and were still rated investment grade, and However, any sale following the MBS how it was affecting their balance 98 percent were rated AA or higher. It market dislocation in the summer of sheets. Corporates have done a good job was not until a year later (June 2008) 2007 would have forced unrealized of communicating these issues with that these corporates’ MBS credit ratings losses to become realized losses at a their members and this did assist in began migrating downward, and even time when actual credit impairment of preventing significant outflows of funds then 96 percent were still investment the underlying assets was viewed by from the corporate system. grade and 92 percent were still rated AA many as unlikely. Absent a market of On August 11, 2008, the Wall Street or better. willing buyers, private label MBS Journal published an article on the increasingly could only be sold at a very unrealized losses on available-for-sale I.C. Corporate System: Mid-2007 severe discount (distressed prices)— Through Mid-2008 securities in the corporate system. The causing losses even more significant article generated additional questions Beginning mid-year 2007, real estate than the accumulated unrealized losses and concerns throughout the credit values declined across many markets in on available-for-sale securities reflected union industry and increased the the U.S. and greater numbers of on the financial statements. The possibility of a run on corporate shares. mortgages became delinquent leading to conventional market wisdom at the time A run would have forced some a greater number of foreclosures. The was that the problems in the MBS corporates to sell their MBS at severely higher number of foreclosures further markets were temporary and it did not depressed prices, leading to loss of not eroded housing prices, resulting in make economic sense to sell securities only all the member capital in the lower recovery of principal and even until market liquidity and counterparty affected corporates but also most higher losses when the foreclosed trust improved. member shares.7 The loss of these properties were liquidated. This Conditions did not improve and as shares would have likely caused the resulted in sharp price declines for MBS the MBS markets became more failure of many member NPCUs and and a corresponding shallowing of the distressed and illiquid, the margin required numerous recapitalizations of market as a flight to quality arose. requirements set by lenders for MBS the NCUSIF, with catastrophic effects Initially, market participants believed collateral pledged by their corporate on the credit union system as a whole. the market disturbance was limited to credit union borrowers increased. The Also in that August 2008 timeframe the subprime market and would be cost of primary borrowing sources the media publicized problems with short-lived, and the performance of the available to corporates became Fannie Mae, Freddie Mac, Bear Stearns, senior credit positions in MBS, such as prohibitively expensive as a result. Due Countrywide, and numerous other those primarily held by corporates, to the continued price devaluation of financial entities. Liquidity in the global would not be at risk; however, that has MBS, the ability to borrow by pledging markets froze: liquidity had become not proven not to be the case. By the end of corporate investment portfolios only expensive, but almost impossible 2007 and early into 2008, what started diminished significantly, thereby to obtain. Unfortunately, these events out as problems with sub-prime increasing liquidity pressures. In turn, coincided with seasonal liquidity mortgages spread to Alt-A loans, option this reduced leverage diminished the demands placed by NPCUs on their ARM loans, and finally to prime yields paid by the corporates and made corporates. Traditionally, NPCUs 5 mortgage loans. withdraw funds during August and between different payment options period to September, and funds begin to flow 5 Alt-A loans are between subprime and prime. period. Prime mortgage loans are considered high Generally, the borrowers have good credit histories, quality, with highly rated borrowers and other back into the corporates in October. The but pay higher interest because of some other risk criteria indicating relatively low risk. factor, such as low documentation or high loan-to- 6 Very few, if any, of these problem loans that 7 The vast majority of shares in corporates are value ratio. Option ARM loans (option adjustable found their way into MBS pools were originated by uninsured because the account balances are well rate mortgages) allow the borrower to choose credit unions. above the $250,000 federal insurance limit.

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tightening liquidity environment was of HARP and CU SIP, NCUA provided the need to determine the actual loss significant concern to NCUA and the about $8 billion of additional funding to exposure of the NCUSIF. corporate system, because corporates corporates to pay down external • Announced that losses to the must maintain adequate liquidity to borrowings.8 NCUSIF associated with corporates ensure the uninterrupted functioning of The unrealized losses in the corporate would be several billion dollars, the payment systems. system grew to nearly $18 billion by exceeding the NCUSIF’s entire retained The potential loss of member year-end 2008. The severity of the MBS earnings and impairing each credit confidence in their corporates, ever- price declines and credit downgrades, union’s one percent capitalization increasing concerns about the credit along with the erosion of subordinated deposit. quality of MBS, and the seasonal classes within the MBS structures held • Issued an Advance Notice of Public liquidity outflows all created the by corporates, required reconsideration Rulemaking (ANPR) on restructuring the ‘‘perfect storm’’ for the corporate by some corporate credit unions that all corporate rule. The sixty-day comment system. NCUA was concerned that some such fair value declines were period expired in April 2009. NCUA corporates would be unable to meet the temporary.9 In January, 2009, several received almost five hundred comment liquidity demands of their members in corporates reported major realized letters, providing suggestions on the short-term or be unable to fund losses and significant capital depletion, possible regulatory reforms for payment systems activity. In addition, and it became apparent that the NCUA’s corporates and the corporate system. NCUA had indications of an exodus of liquidity assistance efforts by In March 2009, due to huge operating NPCU funds from the corporate system themselves would not be sufficient to losses at U.S. Central and WesCorp, lack due to a lack of confidence. stabilize the corporates. The NCUA of sufficient capital, and for other Accordingly, in the fall of 2008 it Board continued its consideration of reasons, the NCUA Board was forced to became critical for NCUA to initiate issues including corporate capital and place these two corporates into dramatic action to bolster confidence in corporate restructuring and, at its conservatorship. The action protected the corporates and ensure the January 28, 2009, meeting, the NCUA retail credit union share deposits and continuing flow of liquidity in the credit Board took the following actions in the interests of the NCUSIF and helped union system. The NCUA’s initial furtherance of corporate stabilization: clear the way for NCUA to take public actions involved liquidity • Approved issuance of a $1 billion additional mitigating actions as they support, while the Board intensified its NCUSIF capital note to U.S. Central as might become necessary. contingency planning on related issues, a result of pending realized losses on As of May 2009, NCUA estimated that including corporate capital and MBS and other asset-backed securities. losses to the NCUSIF associated with corporate restructuring. This action was necessary to preserve the troubles in the corporate system During the last half of calendar year confidence in U.S. Central, given its exceeded the entire equity in the Fund 2008 NCUA took several actions, in pivotal role in the corporate system, and and impaired approximately 69 percent tandem with the Central Liquidity maintain external sources of funding. of the capitalization deposit that all Facility (CLF), to increase liquidity • Approved the Temporary Corporate federally insured credit unions maintain throughout the entire credit union Credit Union Share Guarantee Program with the NCUSIF. These losses system, especially within the (TCCUSGP), which guarantees necessitated premium and deposit corporates. These pro-liquidity actions uninsured shares at participating replenishment assessments that would, included: corporates through September 30, 2011. in total, cost insured credit unions an • Encouraging corporates with large This program was vital in maintaining amount equal to almost one percent of unrealized losses on holdings of MBS to NPCU confidence in the corporate their insured shares. Though the credit make application to the Federal Reserve system. union system as a whole had the net Discount Window. • Authorized the engagement of worth to absorb these costs and remain • Converting loans made by Pacific Investment Management well capitalized, the legal structure of corporates to NPCUs to CLF-funded , L.L.C. (PIMCO), an the NCUSIF would have required that loans using funds borrowed by the CLF independent third party, to conduct a credit unions take all these insurance from the U.S. Treasury. comprehensive analysis of expected expense charges at once, which would • Announcing and implementing the non-recoverable credit losses for result in a contraction of credit union Temporary Corporate Credit Union distressed securities held by corporates. lending and other services. This would Liquidity Guarantee Program This information served to augment come at a particularly difficult time, (TCCULGP) on October 16, 2008. The NCUA’s previous analysis of potential when it was vital that credit unions be TCCULGP is similar to the FDIC’s losses to the NCUSIF and provided an a source of consumer confidence and Temporary Liquidity Guarantee Program independent assessment of the continue to make credit available to announced by the FDIC on October 14, reliability of information provided by support an economic recovery. In fact, 2008. The TCCULGP provides a 100 the corporates. The focus on non- the NCUA Board realized that such a percent guarantee on certain new recoverable credit losses rather than the large, sudden impact on credit unions’ unsecured debt obligations issued by higher and more volatile losses due to financial statements could further eligible corporates. other market factors was consistent with destabilize consumer confidence. • Announcing and implementing the The Board was committed to seeking Credit Union System Investment 8 The SIP and HARP programs were key in the lowest cost option for stabilizing the Program (CU SIP) and the Credit Union providing liquidity to the corporates and the credit corporate system, while also minimizing Homeowners Affordability Relief union system at this critical juncture. These two the adverse impact on natural person programs, and other CLF lending, would not have Program (CU HARP). Both programs been possible without NCUA’s advocacy the credit unions and their members so that allow participating NPCUs to borrow previous September for lifting the CLF cap. credit unions could remain a vibrant funds from the CLF and invest those 9 The term ‘‘subordinated’’ means that the and healthy sector of the U.S. financial funds in CU SIP notes issued by security will absorb credit losses in the underlying system. In pursuit of these ends, the pool of loans before other, more senior, securities corporates, injecting additional liquidity absorb credit losses. In general, the principal of the Board drafted legislation to create a into the corporates and the entire credit subordinated security will be exhausted before the Temporary Corporate Credit Union union system. With the launch of CU more senior securities absorb any loss. Stabilization Fund (CCUSF). The

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proposed CCUSF would borrow money I.D. The Advance Notice of Proposed Although Prompt Corrective Action from the Treasury for up to seven years Rulemaking (ANPR) (PCA) applies to NPCUs and to banking and use the money to pay expenses In January 2009, NCUA solicited entities, PCA does not currently apply 11 associated with the ongoing problems in public comment on whether to corporates. The current rule also the corporate credit union system, such comprehensive changes to the structure provides that retail corporates with a as the capital injection into U.S. Central. of the corporate system were warranted. retained earnings ratio of less than two The primary purpose of this new 74 FR 6004 (Feb. 4, 2009). This percent must increase their retained CCUSF would be to spread over corporate credit union ANPR sought earnings by a certain amount each multiple years the costs to insured comment on how best to define and quarter, but this reserving requirement credit unions associated with the structure the role of corporates in the only applies to a wholesale corporate corporate credit union stabilization credit union system, whether to modify credit union if its retained earnings ratio effort, and to ensure that the payment by the level of required capital for falls below one percent. insured credit unions of those costs was corporates, whether to modify or limit II.B. Proposed Amendments to Part 704 anti-cyclical, and not pro-cyclical. the range of permissible investments for Capital Rules The Board sought Congressional corporates, whether to impose new NCUA intends to change the support and passage of the CCUSF. On standards and limits on asset-liability corporate capital requirements to make May 20, 2009, Congress enacted and the management and credit risk, and them stronger and more consistent with President signed into law the Helping whether to make modifications in the the requirements of the banking Families Save Their Homes Act of 2009 area of corporate governance. (Helping Families Act), Public Law 111– NCUA received some 445 comments regulators. For example, the other 22. Section 204 of the Helping Families in response to the ANPR. More than 370 regulators employ three different Act created the sought-after CCUSF and of these comments came from natural minimum capital ratios, not one ratio provided NCUA with other helpful person credit unions (NPCUs). Eighteen like NCUA. The current corporate tools, such as increasing the authority of corporates, 27 state credit union minimum capital ratio is also calculated the NCUSIF and CCUSF to borrow from leagues, four national trade associations, differently from any of the three ratios the Treasury and permitting the NCUSIF and the National Association of State employed by the other regulators. The proposal replaces the current four to assess premiums over as much as 8 Credit Union Supervisors also percent total capital ratio with a four years to rebuild the equity ratio should commented. the ratio fall below 1.20 percent. NCUA reviewed these public percent leverage ratio, and limits the Immediately following passage of this comments closely and considered them capital that can be used to calculate the legislation, the NCUA Board took a carefully in drafting this proposed rule. leverage ratio to core, or Tier 1, capital, series of actions establishing and Certain specific comments received in which would include only the more implementing the CCUSF. On June 18, response to the ANPR are discussed in permanent forms of corporate capital. 2009, the Board obligated the CCUSF to Section C below as they relate to The proposal also includes new accept assignment from the NCUSIF of particular proposed amendments. minimum risk-based capital ratios that the $1 billion capital note extended to are calculated based on risk-weighted U.S. Central executed on January 28, II. Summary of Current Rule and assets. Failure to meet these minimum 2009. The Board also determined to Proposed Changes ratios will trigger a capital restoration legally obligate the CCUSF for any This proposal contains numerous plan requirement, potential capital liability arising from the TCCUSGP changes to the current corporate rule. restoration directives, and other, new (share guarantee) and TCCULGP Some of these changes are short and prompt corrective action (PCA) (liquidity guarantee) programs. These straightforward, while others are more provisions. The new PCA provisions are steps effectively spread the cost of the lengthy and complex. This Section II similar to those currently applicable to corporate stabilization program for briefly summarizes the current part 704 . The due process associated with insured credit unions over multiple provisions, and the proposed changes. the new PCA provisions is set out in a years. Section III describes each proposed new subpart to part 747 of NCUA’s For more than a year, then, going back change in more detail. rules. to the summer of 2008, the NCUA Board The proposal also refines the has worked a number of avenues to II.A. Current Part 704 Capital Rules acceptable elements of corporate capital. stabilize the corporate system, involving Currently, corporates have only one For example, after an appropriate phase- liquidity improvement and protection, mandatory minimum capital in period a certain percentage of core capital injections, and spreading the requirement: They must maintain total costs to NPCUs of the stabilization capital—retained earnings, paid-in 11 Section 216 of the Federal Credit Union Act program out over multiple years. These capital (PIC), and membership capital establishes a PCA scheme for natural person credit unions. 12 U.S.C. 1790d. Paragraph (m) of § 216 actions were critical to the near- and accounts (MCAs)—in an amount equal states specifically that the provisions of § 216 are mid-term survival of the corporate to or greater than 4 percent of their not applicable to corporate credit unions. Since system and to minimizing the potential moving daily average net assets.10 corporate credit unions are different in form, costs to the NCUSIF and to the insured Failure by a corporate to meet this function, and mission than natural person credit unions, the PCA scheme set forth in this proposal NPCUs obligated to the fund the minimum capital ratio triggers the differs from that contained in § 216 and its NCUSIF. For the longer term, however, requirement to file a capital restoration implementing regulation, 12 CFR Part 702. The the Board believes it needs to address plan with NCUA and may cause NCUA legal authority for this proposed corporate PCA the structure of corporates and the to issue a capital restoration directive scheme is found in two different places. Section 120(a) of the Act, states, in pertinent part, that corporate system and the investment, and take other administrative action. ‘‘[A]ny central credit union chartered by the Board capital, and governance standards by shall be subject to such rules, regulations, and which corporates operate. Accordingly, 10 12 CFR 704.3(d). Corporates have other capital- orders as the Board deems appropriate * * * .’’ 12 the Board has turned its attention to part related requirements, such as a core capital ratio U.S.C. 1766(a). Section 201(b)(9) of the Act also and a retained earnings ratio, but failure to meet requires that federally insured credit unions 704, NCUA’s corporate rule, and to the these requirements only triggers future earnings ‘‘comply with the requirements of this [share public comments that the Board retention requirements and does not trigger a insurance] title and of regulations prescribed by the solicited in response to its ANPR. capital restoration plan requirement. Board thereto.’’ 12 U.S.C. 1781(b)(9).

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capital must be in the form of retained apply if the rating is subsequently described below, will reduce reliance on earnings. The timing and amount of this lowered. Certain investment types, such NRSRO ratings. retained earnings requirement is as U.S. government securities and CUSO The proposal will eliminate the discussed in detail in Section III below. investments, are exempt from the current Part II expanded investment The proposal will also toughen the NRSRO requirement. authority, modify the current Part IV requirements for Tier 2 capital accounts • Specifically prohibits certain types expanded authority on derivatives, and (i.e., MCAs) that can be used in part to of investments, including most impose increased capital requirements satisfy the new total risk based capital derivatives, most stripped MBS (e.g., to qualify for Part I and II expanded ratio. Specifically, the current minimum interest only strips and principal only investment authorities. three year requirement for MCAs will be strips), mortgage servicing rights, and II.E. Current Part 704 ALM Provisions lengthened to five years, and the residual interests in asset-backed adjustable balance type of MCA securities (ABS). The current part 704 requires that accounts will be eliminated. • Does not address investments that corporates maintain an internal ALM The proposal also renames the two are structured to be subordinate, in policy. The rule requires that as part of types of contributed capital accounts terms of potential credit losses, to other that policy the corporate do Net (PIC and MCA) to render the names securities. Economic Value (NEV) modeling to more descriptive of what they actually II.D. Proposed Amendments to Part 704 measure interest rate risk, but the rule are. PIC is renamed as perpetual Investment Limitations does not have any other specific contributed capital (PCC), and MCAs are requirements relating to the risks of renamed as nonperpetual capital The proposal will impose specific mismatches between asset and liability accounts (NCAs). The proposal further concentration limits by investment cash flows. The current part 704 permits corporates to issue PCC and sector. Sectors include residential requires that any corporate permitting NCAs to both members and mortgage-backed securities, commercial early withdrawals on share certificates nonmembers. mortgage-backed securities, student loan ‘‘assess a market-based penalty The proposal will eliminate the asset-backed securities, automobile sufficient to cover the estimated current prohibition on corporates loan/lease asset-backed securities, credit replacement cost of the certificate requiring credit unions to contribute card asset-backed securities, other asset- redeemed.’’ The current rule does not capital to obtain membership or receive backed securities, corporate debt establish any minimum amount of cash, services. It will also permit members to obligations, municipal securities, or cash equivalents, that a corporate transfer corporate capital instruments registered investment , and must, for liquidity purposes, maintain they hold to third parties and will an all others category to account for the on hand at all times. The current rule require corporates to facilitate such development of new investments types. limits a corporate’s borrowing to the transfers. The proposal further restricts the greater of 10 times capital or 50 percent The proposal also eliminates the purchase of high-risk structured of shares and capital, but does not place special treatment that wholesale instruments that concentrate, and thus any additional limits on secured corporates receive with regard to multiply, market risk exposures, such as borrowings. retained earnings reserving investments that return a multiple of a requirements. All corporates will be particular market interest rate. These II.F. Proposed Amendments to Part 704 subject to the same requirements with limits would be in addition to current ALM Provisions regard to retained earnings. limits on derivatives. The proposal The proposal would: Finally, the proposal permits a would also limit subordinated positions • Establish a maximum limit on the corporate, at its option, to give new in all sectors. This limit will reduce a weighted average life of a corporate’s contributed capital priority over existing corporate’s credit risk by restricting its aggregate assets. contributed capital. ability to purchase mezzanine • Establish limits on cash flow residential mortgage-backed securities, mismatches so as not to exceed an II.C. Current Part 704 Investment as some corporates did, or other acceptable gap between the average life Limitations subordinated structured securities that of assets and liabilities. Among other investment provisions, are not the most senior security in terms • Require additional testing for the current part 704: of credit risk. spread widening and net interest • Requires that a corporate maintain The proposed changes would prohibit income (NII) modeling; including an internal investment policy that additional investment types that have testing standards. includes reasonable and supportable proven problematic, such as • Further limit a corporate’s ability to concentration limits, including limits by collateralized debt obligations (CDOs) pay a market-based redemption price to investor type and sector, but does not and Net Interest Margin (NIM) no more than par, thus eliminating the prescribe standards for determining the securities. ability to pay a premium on early reasonableness of those limits. The proposed changes would require withdrawals. • Requires that the aggregate of all that a corporate get multiple ratings • Require a corporate maintain a investments in any single obligor is from different NRSROs, and only use minimum amount of cash or cash limited to the greater of 50 percent of the lowest of the ratings, and require equivalents to ensure sufficient liquidity capital or $5 million. that ratings be used only to exclude an protection for payment system • Specifies, for permissible investment, not as authorization to operations. investment types, that the investment include one. Credit ratings will not be • Restrict the use of secured must be rated no lower than AA—by at a substitute for pre-purchase due borrowings for purposes other than least one Nationally Recognized diligence and ongoing risk monitoring. liquidity needs. Statistical Rating Organization (NRSRO) Downgrades below the minimum rating The effects of these new, proposed at time of purchase. The required rating threshold will continue to trigger ALM provisions, as well as the may be lower for certain investment investment action plans. These investment provisions discussed in types if the corporate has expanded provisions, along with the asset-liability paragraph E. above, are illustrated in authorities. Additional requirements management (ALM) provisions more detail in subsection III.D. below.

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II.G. Current Part 704 Corporate • Require that all compensation • Removes § 704.19, which provided Governance Provisions agreements between a corporate and its wholesale corporates with a lower senior executives and directors be retained earnings requirement than The current part 704 places disclosed to the members of the retail corporates. limitations on board representation, corporate upon request and at least once • Restricts the total amount of including limits on the number of trade annually to the entire membership. organization representatives. The • Provide for disclosure of material investments and loans a corporate may current rule does not, however, place increases in compensation related to accept from any single member. any experience or knowledge corporate mergers. • Requires that corporate CUSOs requirements on individual corporate • Prohibit certain golden parachute restrict their services to brokerage directors. The current rule does not payments and related indemnification services, investment advisory services, require any disclosure of executive provisions. and other categories of services as • compensation to the members of a Require that a majority of all preapproved by NCUA. corporate, nor does it place any limits corporate boards (including USC) • on golden parachute severance packages consist of representatives from natural Expands the current requirement for senior executives.12 The current part person credit unions. that corporate CUSOs agree to give 704 does not limit the representation of • Establish term limits on both NCUA access to books and records to corporate executives and officials on the corporate members and individuals include access to the CUSO’s personnel boards of other corporates. serving as representatives of corporate and facilities. members. II.H. Proposed Amendments to Part 704 • Prohibit an individual from serving III. Discussion and Analysis of Corporate Governance Provisions on the boards of more than one Particular Proposed Amendments corporate at a time and prohibit an The proposed changes, after This proposed rule contains organizational entity from having two or appropriate phase-in periods, would: 13 amendments to different sections and more individual representatives on the appendices in part 704. The following • Require that corporate directors board of a single corporate. currently hold a Chief Executive Officer table summarizes the current (CEO), Chief Financial Officer (CFO), or II.I. Miscellaneous Proposed organization of part 704, and where, Chief Operating Officer (COO) position, Amendments to Part 704 when, and how the Board intends to at their credit union or member entity. The proposal: amend that organization and substance.

Current part 704 Rule Provision Amended?

704.1 Scope ...... No. 704.2 Definitions ...... Yes. First amendment effective upon publication of final rule. Second amendment effective one year after publication of final rule. 704.3 Corporate credit union capital ...... Yes. Removed and replaced effective one year after publication of final rule. 704.4 Board responsibilities ...... Yes. Effective one year after publication of final rule, current Board responsibilities moved to 704.13. Effective one year after publication of final rule, new 704.4 (Prompt corrective action) added. 704.5 Investments ...... Yes. 704.6 Credit risk management ...... Yes. 704.7 Lending ...... No. 704.8 Asset and liability management ... Yes. 704.9 Liquidity management ...... Yes. 704.10 Investment action plan ...... No. 704.11 Corporate CUSOs ...... Yes. 704.12 Permissible services ...... No. 704.13 [Reserved] ...... Effective one year after publication of final rule, current 704.4, Board responsibilities, moved to 704.13. No change to substance. 704.14 Representation ...... Yes. 704.15 Audit requirements ...... No. 704.16 Contract/written agreements ...... No. 704.17 State-chartered corporate credit No. unions. 704.18 coverage ...... No. 704.19 Wholesale corporate credit Yes. Current 704.19 removed. New 704.19, Disclosure of executive and director compensation, unions. added. 704.20 None...... Yes. New 704.20, Golden parachute and indemnification payments, added. Appendix A—Model Forms ...... Yes. Renamed Capital Prioritization and Model Forms. Appendix B—Expanded Authorities and Yes. Requirements. Appendix C—None ...... Yes. Effective one year after publication of final rule, new Appendix C, Risk-Based Capital Credit Risk-Weight Categories, added.

This section of the preamble discusses organization of part 704, that is, starting investments (§ 704.5) and credit risk each of these proposed amendments in with the proposed capital (§ 704.3) and (§ 704.6), then asset and liability detail. This section generally follows the PCA (§ 704.4) amendments, then management (§ 704.8), then corporate

12 The Internal Revenue Code, and state law, may 13 Some of these proposals are phased-in over require some disclosure for state chartered time. corporates, but not for federal charters.

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board representation § (704.14), and years. In addition, part 704 permits Commenters advocating greater then the new sections relating to adjustable balance membership capital capital requirements generally disclosure of executive and director accounts; while banking regulators do supported a phase-in period before any compensation (§ 704.19) and golden not recognize any sort of adjustable new requirements become effective. The parachutes and indemnification balance accounts as capital. corporate trade association and many corporates suggested that all corporates (§ 704.20). Public Comment on the ANPR Many of the proposed amendments should attain a minimum Tier 1 core require new definitions that appear in The ANPR discussed various capital ratio of four percent using 12 § 704.2, and the discussion of these approaches that NCUA is considering month daily average net assets (DANA) definitions appears with the discussion with respect to capital requirements for by the end of 2010 and higher minimum of the associated substantive change to corporates and solicited comment on core capital levels in the future based on the corporate rule. The proposal several aspects of this issue. For Basel.14 These commenters also said the includes amendments to the example, the agency asked whether it use of DANA is necessary to account for Appendices A and B, and adds a new should establish a new leverage ratio fluctuations in assets due to the cash Appendix C. Since Appendix B relates consisting only of more permanent flow seasonality of credit unions, to investment authority, the proposed (core) capital and excluding MCAs; although there were different views amendments to that appendix are increase the required capital ratio to among the commenters about the discussed as part of the discussion of more than four percent; and implement appropriate length of DANA, ranging § 704.5. Since Appendices A and C (on changes that would result in redefining from three months to three years. model forms and the risk-weighting of MCAs in line with accepted banking Some commenters took the opposing assets, respectively) relate to corporate notions of capital. The agency asked view, suggesting that current capital capital, the changes to these appendices whether it should establish new requirements are adequate with proper are discussed as part of the discussion minimum capital ratios based on risk- oversight and risk management. One of the proposed § 704.3. The proposed weighted asset classifications, which commenter noted that an increased addition of subpart L to part 747 could include the use of some form of capital contribution requirement would provides the due process associated membership capital. Another question limit the flexibility of credit unions in with the new PCA provision, and so is presented for comment and discussion dealing with the corporate system. discussed as part of the § 704.4 in the ANPR was whether natural Another commenter indicated that, with discussion. person credit unions should maintain an appropriate limitation on the The proposed changes to capital contributed capital as a prerequisite to investment authority and range of terminology in part 704 also necessitate obtaining services from a corporate. permissible services offered by a Comments about capital and capital conforming amendments to parts 702, corporate in a consolidated corporate requirements were wide ranging, 703, and 709, as discussed below. network, current capital rules should be reflecting the importance and difficulty adequate. III.A. Amendments to Part 704 of this issue. Many commenters believe Other commenters advocated that Relating to Capital there is a need for greater capital within NCUA require mandatory capital the corporate system and for more Current Part 704 Capital Requirements contributions by natural person credit sensitive measures of the necessary unions as a condition of receiving Adequate capital is essential to the capital. services from a corporate. One corporate safe and sound operation of a corporate. Ninety-seven commenters addressed that supported mandatory capital for It ensures that the corporate has a buffer the question of whether the agency services stated that such a requirement against the losses associated with all the should establish a new required capital would likely drive the regionalization of various risks associated with the ratio consisting of core capital only and corporates as natural person credit investments and activities of a excluding membership capital accounts. unions would limit their corporate corporate. Sixty-four favored such a new capital relationships to one nearby corporate. Currently, part 704 contains only one ratio while 33 opposed it. One hundred Some commenters, however, took the mandatory, minimum capital sixteen commenters discussed whether opposite view, believing mandatory requirement: that corporates achieve a corporate should be permitted to capital contributions to be too limiting and maintain a ratio of capital to provide services only to members who on the ability of credit unions to choose moving daily average net assets of at contributed tier 1 capital; 82 favored the corporate they want to do least four percent. Part 704 defines this restriction while 34 opposed it. with; these commenters suggested that capital, generally, to include retained Regarding the question of whether the the corporate simply charge higher earnings, paid-in capital (PIC), and required capital ratio should be service fees for members not membership capital accounts (MCAs). increased, the vast majority of contributing capital. The current capital requirements in part commenters—80 of 93—favored Many of those commenters who 704 differ in certain respects from the increasing the required capital ratio to discussed the issue of membership capital requirements that banking more than four percent. capital accounts (MCAs) supported the Of the 58 commenters who addressed regulators impose on banks. For idea of making MCA conform to the the topic of whether the agency should example, part 704 does not include any accepted banking standard of Tier 2 change the rules regarding the manner capital calculations based on risk- capital, e.g., to require that it be a in which membership capital can be weighted assets. Part 704 also permits minimum of five year term or, if of adjusted, 44 favored and 14 opposed certain membership capital accounts to indefinite term, subject to at least five rule changes in this area. On the qualify as corporate capital where those years notice of withdrawal. Many question of whether the corporates same accounts would not satisfy the commenters suggested that MCA should be subject to risk-based capital bank regulators’ definition of capital. contributions be tied to asset size and Part 704 permits membership capital standards, the commenters were nearly accounts with terms as short as three unanimous, with 173 of 185 comments 14 The definitions of DANA, and moving DANA, years, while banking regulators require favoring risk-based capital standards for are laid out and discussed further on in this such capital to have terms of at least five corporates. preamble.

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also that NCUA mandate that corporates should be permitted to operate with a reputational risk.16 The U.S. banking implement MCA with uniform lower minimum capital requirement, regulators compensated for the capital characteristics, so that there would be consistent with protection of the requirements associated with these less competition among the corporates insurance fund and the long-term safety additional risks by imposing a separate for capital from NPCUs. Some of the credit union industry and the capital ratio, the leverage ratio, which commenters also stated that MCA individual corporate. was not based on the credit risk- withdrawals should only be permitted if Unfortunately, it is not easy to weighted assets but was based on total the corporate would be in compliance develop a capital scheme that accounts assets. Another criticism of Basel I was with applicable capital standards after for all possible risks and that requires that the risk-weightings were too broad withdrawal. Some commenters only as much capital as is necessary to and general, and that within a particular expressed the opposite view, with one cover the potential losses associated asset class individual assets should not suggesting that withdrawal within six with such risks. The Board has closely all be risk-weighted at, say, 50 percent, months of notice should be sufficient. examined the efforts of the other but should be classified with more Commenters who supported the idea regulators to develop a risk-based specificity. For example, loans to of a risk-based approach to capital capital scheme. Those efforts are based, corporations are of varying credit indicated that they believed that in large part, on the Basel Accords. A quality and should not all carry the appropriately designed risk-based short discussion of those Accords and same risk-weighting. Again, the leverage capital requirements would encourage the related efforts of the banking ratio helps compensate for this lack of corporates to monitor and control their regulators follows. granularity in credit-risk weighting. more risky investments and activities. Also, Basel I did not account for new Some of these commenters, however, Summary of the Basel Accords asset classes, such as the securitizations stated that if NCUA restricts investment A group of eleven industrialized that were first making an appearance or other authorities of corporates nations, including the U.S., formed the during the 1980s. through regulatory changes, then capital Basel Committee to harmonize banking Due in part to the criticisms of Basel requirements should be less than that standards and regulations among the I, the Basel Committee set to work on required of other institutions under member nations. One of the another agreement, the International Basel standards. Another commenter Committee’s tasks was to design Convergence of Capital Measurement expressed doubt about the effectiveness standards that would provide a bank and Capital Standards: A Revised of a risk-based system, noting that it did with sufficient capital in relation to the Framework, which was finalized in not alleviate or prevent the current risks undertaken by the bank. In July of 2006. This New Accord, also known as difficulties being experienced in the 1988, the Committee issued the Basel II, greatly expands the scope, banking sector. International Convergence of Capital technicality, and depth of Basel I. Basel Discussion of Proposed Capital Measurements and Capital Standards, II provides for new approaches to credit Regulations known informally as Basel I. risk; adapts to the securitization of bank Basel I created a risk-based capital assets; covers market, operational, and A corporate’s capital levels must be scheme based on four pillars. The first interest rate risk; and incorporates consistent with the risks associated with pillar, constituents of capital, defined market based surveillance (market the activities in which a corporate the elements of Tier 1 and Tier 2 capital. discipline) and regulation. engages. Linking the amount of a credit The second pillar, asset risk weighting, Basel II has three pillars. Pillar one, union’s capital requirement to the provided for risk-weighting of asset minimum capital requirements, created overall riskiness of its assets is a more classes into four categories: zero a formula for risk-based capital that accurate method of ensuring that the translates roughly into Reserves (capital) credit union can afford to cover losses percent, 20 percent, 50 percent, and 100 percent. The third pillar, target standard = (.08)(Risk-Weighted Assets) + that may arise from such activities (Operational Risk Reserves) + (Market without becoming insolvent. The other ratio, imposed an eight percent minimum risk-weighted capital ratio, at Risk Reserves). Basel II provided federal banking regulators have adopted alternative ways to calculate credit-risk this risk-based approach to capital in a least half of which (four percent) must weights and operational reserves.17 manner consistent with the be Tier 1. Pillar 4, or transitional and Pillar two, the supervisory review international framework for capital implementing agreements, urged process, required that banking standards established by the Basel banking regulators to support these regulators provide significant oversight Committee on Banking Supervision capital requirements with strong and enforcement of capital standards. (commonly referred to as the Basel surveillance and enforcement. All of the Pillar three, market discipline, required Supervisors Committee) in July, 1988 major U.S. banking regulators (Basel I), and as subsequently expanded subsequently adopted capital requirements based on Basel I.15 16 ‘‘Operational risk’’ includes risks such as loss upon in 2006 (Basel II). due to fraud and legal/compliance risk. ‘‘Market Activities that potentially have higher Basel I, however, was subject to risk’’ includes losses due to general economic returns generally have such potential significant domestic and international downturns and market fluctuations, but also because of their higher risk of loss. criticism. One criticism was that the sometimes includes the other enumerated risks (e.g., reputational and interest rate risk). Because higher risk/return activities can risk-weightings only accounted for credit risk. In other words, Basel I did 17 The other banking agencies, in their July 2008 exhaust a corporate’s capital faster than proposed rulemaking, listed six different Basel II lower risk/return activities, the Board not provide a capital buffer for potential methods for calculating the reserve requirements believes corporates engaging in higher loss from other risks, such as associated with credit and operational risk: risk activities should hold more capital operational risk, market risk, interest Credit-Risk Weighting Methods: to protect the National Credit Union rate risk, legal risk, currency risk, and Standardized Foundation Internal ratings based Share Insurance Fund and to provide Advanced internal ratings based appropriate incentives for prudent 15 References to banking regulators here mean the Federal Reserve (Fed), Office of the Comptroller of Operation Risk Reserve Methods: management. Likewise, institutions that the Currency (OCC), Office of Thrift Supervision Standarized engage in lower risk activities do not (OTS), and the Federal Deposit Insurance Basic Indicator Approach (BIA) need as large a capital cushion and Corporation (FDIC). Advanced Measurement (AMA)

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that banks make significant public would more appropriately address the corporate capital rule based on the disclosure of their investments and industry’s economic concerns regarding existing general risk-based capital rules activities to help control risk through domestic and international of the other regulators, that is, the Basel market discipline. competitiveness.’’ Under this proposed I rules. The Basel I standards, when The primary criticism of Basel II is the Basel II Standardized Framework banks combined with investment and ALM complexity associated with its more that are not required to use the Basel II requirements that limit noncredit risk comprehensive, and more complex, risk Advanced approach have the option of and a robust leverage ratio requirement, and risk-weighting scheme. either continuing with existing (pre- should ensure corporates have the Basel IA) general risk-based capital rules Status of the Capital Schemes of the capital they need to cover noncredit or opting into the new Basel II Banking Regulators risks and to reserve for weaknesses in Standardized Framework. Also, the Basel I credit risk methodology. The As noted above, the primary banking regardless of whether a bank opts to Board believes use of the existing Basel regulators have adopted capital schemes continue under the Basel I rules or the I format provides the best synthesis of based on Basel I, referred to here as the Basel II Standardized Framework rules, capital requirements and ease of ‘‘general risk-based capital rules.’’ Since the banking regulators indicated that application.21 the completion of Basel II these they will continue to require a In crafting the proposed capital rule, regulators have published three minimum leverage ratio as well as risk- NCUA closely examined the capital important rulemakings related to based capital ratios. As of October 2009, rules of the federal banking regulators. capital. the banking regulators, however, had In particular, NCUA looked to the • In September 2006, the banking not adopted a final Basel II capital rules of the Office of the regulators issued a proposed rule with Standardized rulemaking. Comptroller of the Currency (OCC) and Advanced Basel II risk standards and In determining how to amend the the Office of Thrift Supervision (OTS), measurements. Generally, the proposal existing capital requirements of part 704 the primary regulators of federally- would have permitted banks to adopt to meet the needs of corporates, NPCUs, chartered banks.22 The NCUA also their own methodology for calculating and the NCUSIF, the Board concluded looked to the capital rules of the Federal credit and operation risks, so long as the that the ideal would be a corporate Deposit Insurance Corporation (FDIC) methodology complied with the three capital scheme that provides sufficient for state chartered nonmember banks, pillars of Basel II and the banks could capital protection against risk without since both the NCUA and the FDIC justify the methodology to the undue complexity. The scheme needs to function as federal account insurers.23 regulators. In December 2007, the take into account the capital schemes of The Board adapted these rules, as much regulators finalized this Advanced Basel the banking regulators, so as to give as possible, to the capital needs of 18 II rulemaking. Compliance with this external entities some comfort with the corporates, in consonance with the Advanced methodology is mandatory scheme, while including capital differences between credit unions and for large banks (i.e., above $250 billion), elements that account for the unique banks and with a view toward and optional for all other banks. nature of corporate as member-owned • simplification wherever possible. In December 2006, the banking serving other member- The NCUA also looked to the OTS’ regulators published proposed owned cooperatives. The capital scheme PCA regulations, and Section 38 of the improvements to the general risk-based must also account for the fact that Federal Deposit Insurance Act (FDIA), capital rules, which they labeled as the corporates have limited means to raise in drafting proposed regulations for 19 Basel IA NPR. This Basel IA NPR capital because, for example, they corporates on the consequences of stated: ‘‘A banking organization would cannot issue stock. having inadequate capital.24 The be able to elect to adopt these proposed The Advanced Basel II approach proposed PCA regulations are discussed revisions or remain subject to the appears inappropriate for corporates at later in this preamble. Agencies’ existing risk-based capital this time. The Advanced approach is The NCUA believes that corporates rules, unless it uses the Advanced more complex than necessary, and the operating with adequate capital have Capital Adequacy Framework proposed other regulators do not require it for more incentive and are better positioned in the notice of proposed rulemaking banks with less than $250 billion in to evaluate the potential risks and published in September 2006.’’ The assets. The Standardized Basel II rewards inherent in various activities. banking regulators, however, never approach also appears inappropriate for Thus, a corporate operating with more adopted these proposed improvements. corporates because the other regulators than minimum amounts of capital may • In July 2008, the banking agencies have not yet finalized their be permitted a wider range of activities published a proposed Basel II Standardized methodology and could rulemaking called the Standardized make significant changes to that 21 To understand the length and complexity of the Framework.20 The preamble to this NPR methodology. In addition, even when Basel I capital rules alone, the OTS Basel I capital noted that the ‘‘[a]gencies have decided the other regulators do finalize their provisions fill up 35 full pages in the Code of not to finalize the Basel IA NPR and to Basel II Standardized Framework, they Federal Regulations (CFR), and the OTS Prompt Corrective Action provisions fill up another 10 full propose instead a new risk-based capital will permit banks smaller than $250 CFR pages, for a total of 45 pages. These two OTS framework that would implement the billion in size to elect to continue under rulemakings together are twice as long as NCUA’s Standardized Framework for credit risk, the Basel I rules. If NCUA adopted a entire corporate rule, Part 704, which fills up about the Basic Indicator Approach for Basel II Standardized Framework, 23 CFR pages. The proposed Basel II Standardized NCUA would need to have both a Basel and the final Basel II Advanced rules are even operational risk, and related disclosure longer. requirements,’’ and ‘‘[m]any II and a Basel I rule for corporates to be 22 See 12 CFR part 567 (OTS Capital Rules) and commenters felt the Basel II consistent with the rules of the other 12 CFR part 3 (OCC Capital Rules). The OTS rules Standardized Framework is more risk regulators—which would add an were of particular interest the mutual savings banks sensitive than the Basel IA NPR and additional level of complexity to the regulated by the OTS, like credit unions, are pending NCUA rulemaking. The Board structured as mutual organizations. 23 See 12 CFR part 325 (FDIC capital rules). 18 72 FR 69288 (Dec. 7, 2007). has determined that, given this fact and 24 12 CFR 565 (OTS’ Prompt Corrective Action 19 71 FR 77446 (Dec. 26, 2006). the relative size of corporates and their rules); and 18 U.S.C. 1831o (FDIA Prompt 20 73 FR 43983 (July 29, 2008). activity base, the NCUA should adopt a Corrective Action).

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without as much direct regulatory significant.25 Accordingly, a minimum five years or that have an indefinite term (i.e., restriction, subject only to supervisory leverage ratio requirement is essential. no maturity) with a minimum withdrawal review. These proposed capital measurements notice of five years; are available to cover and associated minimums are similar to losses that exceed retained earnings and Structure of Proposed Capital those described in Basel I and adopted perpetual contributed capital; are not insured Regulations by the NCUSIF or other share or deposit by the federal banking regulators. There insurers; and cannot be pledged against The proposed changes to the capital are some minor differences, reflecting borrowings. In the event the corporate is requirements of part 704 affect three the mutual organization of corporates liquidated, the holders of nonperpetual different sections. and the unique role they play in the capital accounts (NCAs) will claim equally. Proposed § 704.3 establishes new risk- credit union system. For example, this These claims will be subordinate to all other proposal employs average asset claims (including NCUSIF claims), except based and leveraged capital ratios and that any claims by the holders of perpetual standards. The credit risk categories that calculations in the capital ratio denominators, and not the period-end contributed capital (PCC) will be subordinate are used in determining a corporate’s to the claims of holders of NCAs. assets employed by the banking risk-weighted assets appear in a The currently permissible three-year proposed new Appendix C to part 704. regulators. This reflects the corporate’s unique role as a liquidity provider, as term MCAs, and MCAs that are Proposed amendments to § 704.2 discussed further below. The proposal adjustable balance over a short period of contain revised definitions of terms also does not include a tangible capital time, are insufficiently permanent to used in the capital standards. The or tangible equity requirement.26 On the meet the definition of capital as permissible components of a corporate’s other hand, the proposal does require described in the Basel accords and as capital base, including which items that corporates build and maintain a adopted by the federal banking qualify as core capital, which items certain amount of retained earnings to regulators.28 To qualify as capital, the qualify as supplementary capital, and satisfy their minimum leverage ratio proposal requires that hybrid debt which items must be deducted in requirement. instruments such as nonperpetual determining the corporate’s capital base contributed capital accounts (NCAs) be for purposes of the risk-based and Elements of Capital term instruments of an initial maturity leverage ratio standards are set forth in As discussed above, the current part of at least five years or, if structured as proposed § 704.2. 704 sets forth three different categories indefinite notice (or ‘‘no maturity’’) Proposed § 704.4, prompt corrective of capital: retained earnings, PIC, and accounts, must have a notice period of action, outlines the potential MCAs. These elements of capital are at least five years. consequences of a corporate’s failure to divided by moving DANA to obtain the Accounts that can adjust meet any of its regulatory capital capital ratio. A corporate must maintain automatically as permitted under the requirements. a minimum four percent capital ratio. current rule on a periodic basis are also MCAs are currently defined in part of insufficient permanency. A member Proposed § 704.3 Corporate Credit 704 as: Union Capital can rapidly manipulate its share [F]unds contributed by members that: are balances in a corporate, so NCA Overview adjustable balance with a minimum adjustments based on share balances withdrawal notice of 3 years or are term have little permanency—and a member The proposed rule establishes three certificates with a minimum term of 3 years; standards that a corporate must satisfy can even manipulate its asset size to are available to cover losses that exceed some extent and so that measure also in order to meet its capital requirement: retained earnings and paid-in capital; are not a leverage ratio of adjusted core capital insured by the NCUSIF or other share or does not ensure the necessary capital to moving daily average net assets deposit insurers; and cannot be pledged permanency. The proposed redefinition (DANA), a tier 1 risk-based capital ratio against borrowings. of NCAs to eliminate adjustable balance accounts helps ensure permanency and of that same adjusted core capital over 12 CFR 704.2. The proposed rule so ensure that NCAs reflect the basic moving daily average net risk-based changes the nomenclature for MCAs, requirements of true capital. Although assets (DANRA), and a total risk-based renaming them with a more descriptive the proposal eliminates adjustable capital standard expressed as a title: nonperpetual contributed capital balance capital accounts, a corporate percentage of total capital to moving accounts (NCAs). This proposed may enter into an agreement with a DANRA. retitling summarizes the substantive member where the member commits to The two risk-based capital standards difference between MCAs and PIC and providing additional capital if the address the credit risk inherent in the reflects that fact that the proposal will member uses certain services or assets in a corporate’s investment permit corporates to issue NCAs to both increases its shares at the corporate portfolio and activities. Of course, there members and nonmembers.27 The above a certain level. are other risks that are inherent in proposal specifically defines NCAs as The current part 704 permits a corporates and their portfolios and follows: corporate to issue paid-in capital to both activities, such as market risk, interest Nonperpetual capital means funds members and nonmembers, but the rate risk, liquidity risk, and the risk of contributed by members or nonmembers that: membership capital account, as fraud. The leverage ratio requirement is are term certificates with a minimum term of suggested by its name, is currently intended to ensure that no matter how available only to members of the free from credit risk a corporate may be, 25 For example, the interest rate sensitivity analysis required by § 704.8(d) of the current corporate. Corporates may, of course, it must maintain a minimum amount of borrow funds from various entities capital measured in terms of its total corporate rule controls for, but does not eliminate, interest rate risk. Likewise, the provisions in this under various terms, and the Board assets as protection against risks other proposed rule that would control the mismatch in believe that if a corporate issues long- than credit risk. While there are other, the duration of a corporate’s assets and liabilities would limit, but not eliminate, the risk of spread term subordinate debt to nonmembers important provisions of the existing under terms and conditions identical to corporate rule and the proposal that widening. 26 See, e.g., 12 CFR 567.2(a)(3). place limits around these noncredit 27 PIC will also be retitled as perpetual 28 See, e.g., 12 CFR 3.100(f) (OCC requires risks, these risks still exist and are contributed capital, as discussed further below. minimum five year term).

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the current membership capital, the Principles (GAAP) retained earnings, stable forms of capital. Furthermore, it is corporate should be able to treat such PCC, the retained earnings of any intended that the loan loss reserves which nonmember subordinated debt as acquired credit union if the acquisition qualify for inclusion as Tier 2 capital will be general in nature. That is, any portion of the capital in the same manner it treats was a mutual combination, and certain allowance for loan and lease losses which is membership capital accounts. minority interests in the equity accounts ascribed to particular assets that have been Accordingly, the proposal permits both of CUSOs that are fully consolidated. identified as possessing a reasonable members and nonmembers to invest in This definition is the same as the probability of some loss is not to be included nonperpetual contributed capital current § 704.2 definition, with the as Tier 2 capital * * *. Beyond the clearly accounts (NCAs). addition of any minority interests in the identified specific loan loss reserves, it is Currently, Part 704 Defines Paid-In equity accounts of CUSOs that are fully difficult to distinguish between the portion of Capital (PIC) as Follows: consolidated with the corporate. So, for the loan loss reserve that is freely available to absorb future losses within the portfolio Paid-in capital means accounts or other example, if a corporate owned 90 and the portion that reflects likely losses on interests of a corporate that: are perpetual, percent of the equity in a CUSO, with existing problem or troubled loans. However, non-cumulative dividend accounts; are 10 percent equity owned by third a bank that maintains a relatively large available to cover losses that exceed retained parties, and the corporate consolidated allowance for loan and lease losses usually earnings; are not insured by the NCUSIF or its financials with the CUSO, the has a relatively greater incidence of other share or deposit insurers; and cannot be corporate could include the remaining identified asset quality problems in its loan pledged against borrowings. 10 percent minority interest in its Tier and lease portfolio, and in this situation the entire allowance for loan and lease losses 12 CFR 704.2. The proposal does not 1 capital. This treatment is consistent make any change to the definition of PIC cannot be considered to be a true general with the treatment afforded such reserve for the purposes of risk-based capital. except to rename PIC as perpetual minority interests by the other Therefore, a standard percentage limitation, contributed capital (PCC). To ensure regulators.29 based on total risk-weighted assets, is the that a corporate can function as a viable Also, the terms core capital and Tier most reasonable method of eliminating the entity, it must be clear to creditors, both 1 capital are used synonymously in this bulk of the non-qualifying loan loss reserves current and future, that capital in the proposal. from banks’ capital calculations. The figure form of PCC and NCAs protect the The proposal further defines of 1.25 percent of risk-weighted assets was creditors against any losses borne by the supplementary capital as including determined on the basis of historical data corporates. Capital instruments, to certain portions of its NCAs, GAAP * * *. perform their function as capital, must allowance for loan and lease losses, and 54 FR 4168 (Jan. 27, 1989). be depleted when needed to cover net unrealized gains on available-for- The proposal also provides that a corporate losses. sale equity securities with readily corporate may include 45 percent of its Accordingly, the proposal also adds determinable fair values. During the last unrealized gains on available-for-sale the following definition of available to five years of an nonperpetual equity securities in supplementary cover losses in § 704.2 to clarify the contributed capital account, the amount capital. Unrealized gains are unrealized meaning of that phrase: that may be considered supplementary holding gains, net of unrealized holding Available to cover losses that exceed capital is reduced, on a monthly basis, losses, calculated as the amount, if any, retained earnings means that the funds are until the amount reaches zero when the by which fair value exceeds historical available to cover operating losses realized, account has only one year of life cost. The proposal further provides that in accordance with generally accepted remaining, all as described in paragraph NCUA may disallow such inclusion in accounting principles (GAAP), by the 704.3(b)(3). This reduction is consistent the calculation of supplementary capital corporate credit union that exceed retained with the current corporate rule and the if the NCUA determines that the earnings. Likewise, available to cover losses capital regulations of the other securities are not prudently valued. that exceed retained earnings and perpetual Again, this is similar to how the other contributed capital means that the funds are regulators. A corporate may also include available to cover operating losses realized, its allowance for loan and lease losses regulators define supplementary 30 in accordance with GAAP, by the corporate in supplementary capital, up to a capital. Although it is unlikely that credit union that exceed retained earnings maximum of 1.25 percent of risk- corporates will hold much in the way of and perpetual contributed capital. Any such weighted assets. This is also consistent equity securities, they might have some losses must be distributed at the with the capital regulations of the other equity securities in CUSOs. Because the time the loss is realized first among the regulators. As noted by the OCC: 45 percent limitation used by the holders of perpetual contributed capital banking regulators includes the effects accounts (PCC), and when all PCC is The allowance for loan and lease losses is intended to absorb future losses. Although of possible taxation upon sale, and exhausted, then pro rata among all corporates are not subject to income nonperpetual contributed capital accounts future losses may not be identified (NCAs), all subject to the optional specifically at the time a provision is made, taxation, the Board invites comment on prioritization in Appendix A of this Part. To a presumption exists that losses are inherent the proposed 45 percent limitation.31 the extent that any contributed capital funds in the loan and lease portfolio. The obvious The terms supplementary capital and are used to cover losses, the corporate credit link between the allowance and inherent Tier 2 capital are used synonymously in union must not restore or replenish the losses in the loan and lease portfolio this preamble and the proposal. affected capital accounts under any precludes it from qualifying as Tier 1 capital, circumstances. In addition, contributed which encompasses only the purest and most 30 See, e.g., 12 CFR 567.5(a) (OTS capital rule). capital that is used to cover losses in a fiscal 31 ‘‘The Basel Accord also permits institutions to year previous to the year of liquidation has 29 See, e.g., 12 CFR 567.5(a)(1)(iii) (OTS definition include up to 45 percent of the pretax net no claim against the liquidation estate. of Tier 1 capital); 12 CFR part 3, Appendix A, unrealized gains on equity securities in § 2(a)(3) (OCC definition of Tier 1 capital). supplementary capital. As explained in the Basel This language is similar to that used ‘‘[M]inority interests in the equity accounts of Accord, the 55 percent discount is applied to the to define the phrase available to cover consolidated subsidiaries * * * [are] accorded Tier unrealized gains to reflect the potential volatility of losses as it relates to secondary capital 1 treatment because, as a general rule, [they] this form of unrealized capital, as well as the tax in NCUA’s low income credit union represent equity that is freely available to absorb liability charges that generally would be incurred if losses in operating subsidiaries.’’’ Todd Eveson, the unrealized gain were realized or otherwise rule. 12 CFR 701.34(b)(7). ‘‘Financial and Bank Issuance of taxed currently.’’ 63 FR 46518 (Sept. 1, 1998) The proposal defines core capital as Trust Preferred Securities,’’ 6 N.C. Banking Inst. (Discussion of joint FDIC, OTS, and OCC capital Generally Accepted Accounting 315, 321 (2002). rulemaking).

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Nonperpetual contributed capital is a offsetting are met. Also, any amounts the capital calculation. However, form of Tier 2 capital. deducted from core capital in intangibles above this de minimus The use of core capital and calculating adjusted core capital are also amount must be deducted from both supplementary capital, and their deducted from net assets. core capital (the numerator of the incorporation into the proposed This is virtually the same capital ratios) and assets (the minimum capital ratios, is discussed denominator employed in the current denominator). This treatment of further in the following paragraph-by- part 704 for the total capital ratio. The intangibles is similar to the treatment paragraph summary of the proposed proposal includes a slight modification given intangibles by the other § 704.3. to make clear that any asset deducted regulators.33 from core capital to obtain adjusted core The proposal, however, provides Paragraph-by-Paragraph Analysis of capital (i.e., the leverage ratio some flexibility on the treatment of § 704.3 numerator) should likewise be deducted intangibles. The NCUA, on its own Paragraph 704.3(a) Capital from the denominator. initiative or upon application from a Requirements The proposed leverage ratio differs corporate, may direct that a particular This proposed paragraph (a) requires from that of the banking regulators in corporate add some or all of these a corporate to maintain, at all times, that the proposal uses a moving 12- excess intangibles back into the three minimum capital ratios. Paragraph month average of assets where the other corporate’s adjusted core capital and (a)(1) requires all corporates maintain a regulators use period-end assets. The associated assets. In making this leverage ratio of 4.0 percent or greater, Board believes that the corporates, in determination, the NCUA will consider a Tier 1 risk-based capital ratio of 4.0 their role as liquidity providers and the volatility and permanency of the percent or greater, and a total risk-based liquidity managers for natural person particular intangible and the overall capital ratio of 8.0 percent or greater. credit unions, need some flexibility to financial condition of the particular Each of these ratios are further defined handle seasonal variations in total corporate. in § 704.2 as discussed below. Paragraph assets—and moving DANA provides Second, the corporate must deduct 704.3(a)(2) continues the existing that flexibility. Proposed paragraph investments, both equity and debt, from requirement that a corporate have a 704.3(e), however, empowers the consolidated CUSOs. To include these capital plan in place to achieve and NCUA, in appropriate cases, to direct investments would overstate the amount maintain the necessary capital. that a particular corporate use period- of capital available to absorb losses in Paragraph (a)(3) requires that the end assets in its capital ratio the consolidated entity. This treatment corporate prepare and submit a retained calculations rather than moving DANA. of these investments is similar to the earnings accumulation plan if, under treatment given these investments by Leverage Ratio Numerator: Adjusted 34 certain circumstances described below, Core Capital the other regulators. the corporate is not making sufficient Third, if the corporate credit union, As discussed above, core capital progress in building the necessary on or after twelve months following the generally means the sum of a corporate’s retained earnings to satisfy its future publication of the final rule, contributes retained earnings, as calculated under minimum leverage ratio requirements. new capital or renews existing capital to GAAP, and perpetual contributed another corporate credit union, the Leverage Ratio capital.32 To obtain adjusted core corporate must deduct an amount equal The proposed leverage ratio is defined capital, the proposal requires the to the aggregate of such new or renewed in the proposal as the adjusted core corporate to make several modifications capital. Because the corporate universe capital divided by moving DANA. As to core capital. is so small, and may get even smaller in discussed above, the leverage ratio First, the corporate must deduct an the future, the Board is concerned that ensures that the corporate has adequate amount equal to the amount of the capital investment between two or more capital to provide for losses other than corporate’s intangible assets that exceed corporates can endanger the stability of credit losses. Paragraph 704.3(a) one half percent of the corporate’s the entire corporate system and, requires a minimum leverage ratio of 4.0 moving DANA. Generally, intangible ultimately, the stability of the entire percent. The capital numerator, and the assets are difficult to value and highly credit union system. Accordingly, this asset denominator, of the leverage ratio volatile. In addition, many forms of proposed deduction from corporate are discussed below. intangible assets, such as goodwill, capital discourages capital investment decline in value if an entity suffers between corporates. For example, Leverage Ratio Denominator: Moving losses, which is the point in time that without the deduction corporate A DANA the permanency of capital is most might place significant capital in The proposal employs moving DANA important. The other regulators have corporate B, which then, in turn, might recognized these problems with as the leverage ratio denominator. place significant capital in corporate C. intangible assets and so generally Moving DANA means the average of Losses in corporate C might then cause require banks to deduct problematic DANA for the month being measured corresponding losses in corporates A intangibles from both assets and capital and the previous eleven (11) months. and B which, in turn, may have to pass when calculating core capital ratios. DANA means the average of net assets some of those losses to their natural Corporates, however, do not generally calculated for each day during the person credit union members. The maintain intangibles on their books. The period (which would be the previous Board invites comment on this proposed Board, therefore, is proposing that month). deduction from capital, including intangibles of a de minimus amount Net assets means total assets less whether there should be an exception (one half of one percent of total assets) loans guaranteed by the NCUSIF and for de minimus member capital may be treated just like other assets in member reverse repurchase contributions between corporates and, if transactions. For its own account, a so, how that exception should be corporate’s payables under reverse 32 For a corporate that acquires another credit union in a mutual combination, core capital also repurchase agreements and receivables includes the retained earnings of the acquired credit 33 See, e.g., 12 CFR 567.5(a)(2) (OTS capital rule). under repurchase agreements may be union, or of an integrated set of activities and 34 See, e.g., 12 CFR 567.5(a)(2)(iv) (OTS capital netted out if the GAAP conditions for assets, at the point of acquisition. rule).

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defined. The Board notes that corporates mark and thus be adequately mandatory for a corporate that fails to will have some time to adapt to this capitalized, the corporate must have at meet its REAP requirements. deduction, since it will not be effective least 200 bp of retained earnings. The In addition to the REAP provision in for 12 months and, even then, will not remaining 200 bp in the ratio numerator paragraph 704.8(a)(3) above, the apply to preexisting capital accounts may consist of PCC. Similarly, to have proposal contains other tools to deal unless the account is renewed in some a five percent leverage ratio at the ten with corporates that are either unable, fashion (e.g., renewal of an NCA year mark and thus be adequately or unwilling, to build retained earnings instrument upon maturity). capitalized, a corporate must have 250 at an adequate pace during the phase-in The current part 704 encourages bp of retained earnings, and the period. For example, proposed corporates to achieve and maintain remaining 250 bp in the ratio numerator § 704.3(d), discussed further below, retained earnings at 2 percent of assets, may consist of PCC. permits the Board to establish different but does not actually require them to do Although the first explicit retained minimum capital requirements for so. The Board believes that some earnings requirement will not become individual corporates ‘‘upon a regulatory mechanism to force effective for six years, the Board determination that the corporate credit corporates to build retained earnings is recognizes that corporates must work union’s capital is or may become necessary. In the long run, contributed hard during the entire six year period to inadequate in view of the credit union’s capital like PCC is a supplement to build retained earnings. Accordingly, circumstances.’’ Proposed § 704.3(d)(2) retained earnings, but PCC is not an paragraph 704.3(a)(3) provides that, (emphasis added). This provision also entirely adequate replacement for beginning with the first call report provides that ‘‘higher capital levels may retained earnings. As demonstrated in submitted by the corporate three years be appropriate when NCUA determines the recent corporate crisis, the depletion after the date of the final rule: that * * * the credit union has failed to of the contributed capital at corporates [A] corporate credit union must calculate properly plan for, or execute, necessary put severe, procyclical stress on their retained earnings growth.’’ Proposed member natural person credit unions. and report the ratio of its retained earnings to its moving daily average net assets. If this § 704.3(d)(2)(ix). NCUA could use this While this situation cannot be entirely particular tool, and other PCA tools, to avoided in the future, it can be ratio is less than 0.45 percent, the corporate credit union must, within 30 days, submit a address capital inadequacies, if any— mitigated through retained earnings retained earnings accumulation plan to the even before the third anniversary of the growth. Accordingly, the proposal NCUA for NCUA’s approval. The plan must final rule and the associated requires that, after an appropriate phase- contain a detailed explanation of how the requirement to prepare a REAP. in period, a certain percentage of core corporate credit union will accumulate capital consist of retained earnings. earnings sufficient to meet all its future Tier 1 Risk-Based Capital Ratio The initial adjustment to core capital, minimum leverage ratio requirements, effective six years after the date of including specific semiannual milestones for The proposal defines the Tier 1 risk- publication of the final rule, will require accumulating retained earnings. If the based capital ratio (T1RBCR) to mean that a corporate deduct from core capital corporate credit union fails to submit a plan the ratio of adjusted core capital to the any amount of PCC that causes PCC acceptable to NCUA, or fails to comply with moving daily average net risk-weighted minus retained earnings, all divided by any element of a plan approved by NCUA, assets. NCUA intends this ratio, along the corporate will immediately be classified with the total risked-based capital ratio moving daily average net assets as significantly undercapitalized or, if (DANA), to exceed two percent. The (TRBCR), to ensure that the corporate already significantly undercapitalized, as has sufficient capital to handle the effect of this provision is to require that, critically undercapitalized. The corporate for a corporate to achieve the minimum credit union will be subject to all the credit risk associated with its four percent leverage ratio necessary for associated prompt corrective actions under investments and activities. The adequate capitalization, it must have at § 704.4 of this part. combination of the T1RBCR, and the least 100 bp of retained earnings at the TRBCR ratio discussed below, ensures six year mark. The remaining 300 bp in The intent of this retained earnings that at least half of the capital used for the ratio numerator may consist of accumulation plan (REAP) provision is purposes of protecting against losses either PCC or retained earnings. to ensure that corporates strive for, and associated with credit risk is the more Similarly, to have a five percent attain, retained earnings growth rates permanent capital (i.e., core capital). leverage ratio at the six year mark and that are adequate to achieve 100 bp of The other portion of capital used to thus be well capitalized, a corporate retained earnings by the end of year six protect against credit risk may be Tier 2 must have 150 bp of retained earnings, and 200 bp of retained earnings by the capital, also called supplementary and the remaining 350 bp in the ratio end of year ten. capital, as discussed below in numerator may consist of PCC. This Adequate retained earnings are connection with the TRBCR. critical to the health of the corporate adjustment to core capital will, then, T1RBCR Numerator: Adjusted Core system going forward. It is the Board’s force corporates to work toward Capital building their retained earnings. intent that, if a corporate is subject to a The Board, however, believes that, REAP and fails to meet any of the The capital numerator for the T1RBCR ideally, a corporate should continue to established retained earnings is adjusted core capital, the same as the increase its retained earnings and milestones, NCUA will take decisive numerator for the leverage ratio reduce its reliance on contributed action under the prompt corrective discussed above. capital. The second adjustment to core action authorities of 704.4. Included T1RBCR Denominator: Moving Daily capital, effective ten years after the date among those authorities are replacement Average Net Risk-Weighted Assets of publication of the final rule, will of the board and senior management, (DANRA) require that a corporate deduct from and liquidation, conservatorship or core capital any amount of PCC that consolidation of the corporate. These The moving DANRA means the causes PCC to exceed retained earnings. actions are discretionary on NCUA’s average of daily average net risk- The effect of this provision is to require part under 704.4, however, and the weighted assets for the month being that, for a corporate to have a four NCUA Board requests comment on measured and the previous eleven (11) percent leverage ratio at the ten year whether any such actions should be months.

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DANRA means the average of net risk- Paragraph 704.3(b) Requirements for securities in nonperforming status or on weighted assets calculated for each day Nonperpetual Contributed Capital which borrowers fail to comply with during the period (which would be the repayment terms; This proposed paragraph describes • previous month). the NCA account terms and the various Has inadequate underwriting Net risk-weighted assets means risk- disclosure, transfer, and release policies, standards, or procedures for its loans and investments; weighted assets less CLF stock requirements. This paragraph is similar • Has failed to properly plan for, or subscriptions, CLF loans guaranteed by to the existing 704.3(b), taking into execute, necessary retained earnings the NCUSIF, U.S. Central CLF account the change in NCA terms described above. The proposal also growth; or certificates, and member reverse • protects against the premature release of Has a record of operational losses repurchase transactions. For its own that exceeds the average of other, account, a corporate’s payables under NCAs with the addition of the following new paragraph (b)(5): similarly situated corporates; has reverse repurchase agreements and management deficiencies, including receivables under repurchase A corporate credit union may redeem failure to adequately monitor and nonperpetual contributed capital prior to agreements may be netted out if the control financial and operating risks, GAAP conditions for offsetting are met. maturity or the end of the notice period only with the prior approval of the NCUA. particularly the risks presented by Also, any amounts deducted from core concentrations of credit and capital in calculating adjusted core Paragraph 704.3(c) Requirements for nontraditional activities; or has a poor capital are also deducted from net risk- Perpetual Contributed Capital record of supervisory compliance. weighted assets. To this point, this is This paragraph describes the PCC When the NCUA determines that a similar to the moving DANA calculation account terms and the various different minimum capital requirement in the denominator of the leverage ratio. disclosure, transfer, and release is necessary or appropriate for a However, the moving DANRA requirements. Again, this paragraph is particular corporate, including calculation required the use of risk- similar to the existing 704.3(c). As with minimum capital relating to weighted assets, which are calculated as NCA, the proposal protects against the classification as significant or critically provided for in the proposed Appendix premature release of PCC by permitting undercapitalization, the NCUA will C of part 704. This risk-weighting a corporate to call PCC only with notify the corporate in writing of its process is described in detail in the NCUA’s prior approval. proposed minimum capital section of the preamble devoted to requirements; the schedule for Paragraph 704.3(d) Individual Appendix C. compliance with the new requirement; Minimum Capital Requirements and the specific causes for determining Total Risked-Based Capital Ratio Paragraph 704.3(d) provides that the that the higher individual minimum capital requirement is necessary or The total risk-based capital ratio NCUA may establish increased individual minimum capital appropriate for the corporate. The means the ratio of total capital to requirements for a particular corporate NCUA will forward the notifying letter moving DANRA. upon a determination that the to the appropriate state supervisor if a The denominator, moving DANRA, is corporate’s capital is or may become state-chartered corporate would be the same as the denominator for the inadequate in view of the credit union’s subject to an individual minimum T1RBCR, as discussed above. The circumstances. capital requirement. numerator, ‘‘Total capital’’ means the The proposal provides several The responses of the corporate and sum of a corporate’s adjusted core examples where a greater minimum appropriate state supervisor must be in capital and its supplementary capital capital requirement may be appropriate, writing and must be delivered to the less the corporate’s equity investments such as where a corporate: NCUA within 30 days after the date on not otherwise deducted when • Is receiving special supervisory which the notification was received. calculating adjusted core capital. attention; The NCUA may extend or shorten the • Supplementary capital, or Tier 2 Has or is expected to have losses time period for good cause. resulting in capital inadequacy; The corporate’s response must capital, generally means the sum of all • the corporate’s NCAs, except that at the Has a high degree of exposure to include any information that the credit interest rate risk, prepayment risk, union wants the NCUA to consider in beginning of each of the last five years credit risk, concentration risk, certain deciding whether to establish or to of the life of an NCA instrument the risks arising from nontraditional amend an individual minimum capital amount that is eligible to be included as activities or similar risks, or a high requirement for the corporate, what the supplementary capital is reduced by 20 proportion of off-balance sheet risk; individual capital requirement should percent of the original amount of that • Has poor liquidity or cash flow; be, and, if applicable, what compliance instrument (net of redemptions). While, • Is growing, either internally or schedule is appropriate for achieving as discussed above, the proposal adjusts through acquisitions, at such a rate that the required capital level. the definition of NCAs to make these supervisory problems are presented that After expiration of the response accounts more permanent and bring are not dealt with adequately by other period, the NCUA will decide whether them in line with the Basel NCUA regulations or other guidance; or not the proposed individual requirements for supplementary capital, • May be adversely affected by the minimum capital requirement should be the value of these NCAs as a buffer activities or condition of its CUSOs or established for the corporate, or whether against losses as the NCAs approach other persons or credit unions with that proposed requirement should be their maturity or withdrawal date. The which it has significant business adopted in modified form, based on a proposed amortization schedule tracks relationships, including concentrations review of the corporate’s response and the amortization used by the banking of credit; other relevant information. Failure to regulators for supplementary capital • Has a portfolio reflecting weak provide an adequate response will that takes this hybrid debt instrument credit quality or a significant likelihood constitute a legal basis for prompt form. of financial loss, or that has loans or corrective action under § 704.4.

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Paragraph 704.3(e) Reservation of sheet item. This reservation of authority proposal amends the forms so that they Authority explicitly recognizes NCUA’s retention are consistent with the proposed Financial organizations are constantly of sufficient discretion to ensure that definitions of PCC and NCAs. These developing innovative transactions that corporates, as they become involved form changes include changing the may not fit well into the various risk- with new types of financial assets and notice and term of NCAs from three weight categories in Appendix C to part activities, will be treated appropriately years to five years, eliminating 704. New investment activities may under the regulatory capital standards. references to adjustable balance NCAs, nominally fit into a particular risk- Applicable State Regulator and describing in more detail the weight category or credit conversion meanings of the phrase ‘‘available to Several paragraphs of this proposed factor, but impose risks on the holder at cover losses.’’ Because this new option § 704.3 on capital, and the proposed levels that are not commensurate with will be available to corporates before the § 704.4 on prompt corrective action, the nominal risk-weight or credit other new capital provisions go into refer to the applicable state regulator in conversion factor for the asset, exposure effect, including the nomenclature connection with potential actions or instrument. Accordingly, the changes (that is, from PIC to PCC, and involving state chartered corporates. proposal clarifies NCUA’s authority from MCAs to NCCs), the proposal The proposal amends § 704.2 to define over corporates, on a case-by-case basis, expands the number of model forms in applicable state regulator as the to determine the appropriate risk-weight Part II from the two current forms to prudential state regulator of a state for assets and credit equivalent amounts eight forms. chartered corporate. and the appropriate credit conversion The current paragraph (6) in the factor for off-balance sheet items in Appendix A to Part 704—Capital model forms reads as follows: these circumstances. Specifically, the Prioritization and Model Forms Where the corporate credit union is NCUA may: The current Appendix A to part 704, liquidated, membership capital accounts are • Disregard any transaction entered entitled Model Forms, contains forms payable only after satisfaction of all liabilities into by a corporate primarily for the that members provide the corporate on of the liquidation estate including uninsured purpose of reducing the minimum an annual basis acknowledging the obligations to shareholders and the NCUSIF. required amount of regulatory capital or terms and conditions of the members’ otherwise evading the requirements of PIC and MCA accounts. The proposal It is possible, for example, that a this section; solvent corporate could be voluntarily • renames Appendix A as Capital Require a corporate to compute its Prioritization and Model Forms. The liquidated and that there could be some capital ratios on the basis of period-end, new Appendix A has two parts. Part II funds remaining after payment to rather than average, assets when it is contains amended model disclosure creditors, uninsured shareholders, and appropriate to carry out the purposes of forms. Part I is new, and reads as the NCUSIF. It is also possible (although part 704; follows: unlikely) that the value of the assets of • Notwithstanding the definitions of an insolvent, involuntarily liquidated Part I—Optional Capital Prioritization core and supplementary capital in the corporate credit union could increase corporate rule, find that a particular Notwithstanding any other provision in between the date of liquidation and the asset or core or supplementary capital this chapter, a corporate credit union, at its date the assets are sold, and there could option, may determine that capital component has characteristics or terms then be some funds in the liquidation that diminish its contribution to a contributed to the corporate on or after [DATE 60 DAYS AFTER DATE OF estate remaining after payment to the corporate’s ability to absorb losses and PUBLICATION OF FINAL RULE IN creditors, uninsured shareholders, and require the discounting or deduction of FEDERAL REGISTER] will have priority, for the NCUSIF. In both of these cases, the such asset or component from the purposes of availability to absorb losses and NCA holders, and possibly the PCC computation of core, supplementary, or payout in liquidation, over capital holders, would receive a total capital; contributed to the corporate before that date. distribution 35—but this is only true to • Notwithstanding Appendix C of The board of directors at a corporate credit the extent that the NCAs and PCCs were this section, look to the substance of a union that desires to make this determination not used in a previous fiscal year to must: transaction, find that the assigned risk- cover losses. Once used to cover losses, weight for any asset, or credit equivalent (a) On or before [DATE 60 DAYS AFTER DATE OF PUBLICATION OF FINAL RULE the NCAs and PCC are gone to the amount or credit conversion factor for IN FEDERAL REGISTER], adopt a resolution extent so used, and all possible claims any off-balance sheet item does not implementing its determination. related to those accounts, including appropriately reflect the risks imposed (b) Inform the credit union’s members and liquidation-based claims, are on the corporate, and may require the NCUA, in writing and as soon as practicable extinguished. Accordingly, the proposal corporate to apply another risk-weight, after adoption of the resolution, of the adds the following clarifying language credit equivalent amount, or credit contents of the board resolution. to the end of each paragraph (6): conversion factor that the NCUA deems (c) Ensure the credit union uses the appropriate; and appropriate initial and periodic Model Form However, [NCAs or PCCs] that are used to • If Appendix C does not specifically disclosures in Part II below. cover losses in a fiscal year previous to the assign a risk-weight, credit equivalent This option, if implemented by a year of liquidation has no claim against the amount, or credit conversion factor to a corporate’s board of directors, will give liquidation estate. particular asset or activity of the those entities that contribute new The proposal also adds a conforming corporate, assign any risk-weight, credit capital to the corporate starting 60 days amendment to NCUA’s involuntary equivalent amount, or credit conversion after the publication of the final rule liquidation rule, 12 CFR 709.10, to factor that it deems appropriate. priority—in terms of availability to reflect the option to give new Exercise of this authority by NCUA absorb losses and payout in contributed capital payout priority. may result in a higher or lower risk- liquidation—over those capital weight for an asset or credit equivalent contributions made before that date. The 35 This possibility is recognized in NCUA’s amount or a higher or lower credit purpose of this provision is to provide involuntary liquidation rule. 12 CFR 709.5(b)(7) and conversion factor for an off-balance a tool for facilitating capital growth. The (9).

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Appendix C to Part 704—Risk-Based requirement. Items that are deducted central government of an OECD country; Capital Ratios and Asset Risk- from a corporate’s asset base in and Weightings determining its assets are also deducted • Certain claims on a qualifying A corporate’s risk-based capital from its capital. securities firm that are collateralized by cash on deposit in the corporate or by requirement is calculated based on the On-Balance Sheet Assets credit risk presented by both its on- securities issued or guaranteed by the The proposed amendments sets forth balance sheet assets and off-balance United States Government or its a system of risk-weighted assets similar sheet commitments and obligations. agencies, or the central government of to that used by the other federal banking With certain limited exceptions, the an OECD country. regulators. Assets, in general, will be asset base of a corporate is determined Twenty percent weighting (Category assigned to risk categories based on the on a consolidated basis, i.e., including 2). This category contains items viewed degree of credit risk associated with the its consolidated CUSOs. Assets are as presenting a significantly lower level obligor or nature of the obligation. The assigned a credit-risk weighting based of risk than standard risk assets. It categories include risk-weights of 0, 20, upon their relative risk. Risk-weights are includes: 50, and 100 percent. • Cash items in the process of generally tied to the nature of the The 100 percent category is the collection; underlying obligor. standard risk category. Assets not • Assets conditionally guaranteed by The risk-weightings range from zero specifically included in another the United States Government or its percent for assets backed by the full category fall within this category. Items agencies, or the central government of faith and credit of the United States or that are less risky than a ‘‘standard risk an OECD country, or collateralized by that pose no credit risk to the corporate asset’’ because of the traditional securities issued or guaranteed by the to 100 percent as the standard risk- financial strength of the obligor, the United States government or its weighting. default history of the asset type, or the Off-balance sheet commitments are agencies, or the central government of guarantee or security backing the asset converted to a ‘‘credit equivalent’’ an OECD country; are assigned to a lower risk category. • Certain securities issued by the U.S. amount by using a conversion factor This reflects the Board’s determination, Government or its agencies which are intended to estimate the likelihood that mirroring in many ways the implicit not backed by the full faith and credit the contingent obligation will result in determinations made by the market, that of the United States Government; an actual obligation of the corporate and such assets present lower risks. • Certain securities issued by United the potential size of loss such items may Risk-weighted assets are determined States Government-sponsored agencies; result in. That amount is then risk- by taking the book value of each asset • Assets guaranteed by United States weighted according to the risk and multiplying it by the risk-weight Government-sponsored agencies; associated with the underlying obligor, assigned to it. Ownership interests in • Assets collateralized by the current just as an on-balance sheet asset would investment companies such as mutual market value of securities issued or be. The amount of risk-weighted assets funds are assigned risk-weights based guaranteed by United States will then be multiplied by a credit risk upon the composition of the investment Government-sponsored agencies; capital requirement to determine the company’s underlying portfolio of • Claims guaranteed by a qualifying minimum amount of capital required for assets. The resulting values are added securities firm, subject to certain that corporate. together to arrive at total risk assets. The conditions; The rule also sets forth the items that amount of total risk assets is the amount • Claims representing general count as capital and that may be used against which the minimum capital obligations of any public-sector entity in to satisfy the risk-based capital requirement is applied. an OECD country, and that portion of requirement. ‘‘Core capital,’’ or ‘‘tier 1 any claims guaranteed by any such capital,’’ includes items of a more Summary of Risk-Weights for On- public-sector entity; permanent nature, such as PCC and Balance Sheet Assets • Balances due from and all claims on GAAP retained earnings. Certain other Zero percent weighting (Category 1). domestic depository institutions. items provide a somewhat lesser degree This category, presenting, in the Board’s • The book value of paid-in Federal of protection, often because of their estimation, a nearly non-existent level Home Loan Bank stock; nonpermanent nature or their of credit risk, includes: • Deposit reserves at, claims on, and imposition of fixed obligations. These • Cash; balances due from the Federal Home items are considered ‘‘supplementary • Securities issued by and other Loan Banks; capital,’’ or ‘‘tier 2 capital,’’ and include direct claims on the U.S. Government or • Assets collateralized by cash held NCAs. Together, the sum of core and its agencies or the central government of in a segregated by the supplementary capital equal a an Organization for Economic reporting corporate; corporate’s ‘‘total capital.’’ Cooperation and Development (OECD) • Claims on, or guaranteed by, official Although both core and country; multilateral lending institutions or supplementary capital may be used in • Notes and obligations issued by or regional development institutions in meeting the risk-based capital guaranteed by the Federal Deposit which the United States Government is requirement, the amount of Insurance Corporation or the National a shareholder or contributing supplementary capital that may be Credit Union Share Insurance Fund and member; 36 counted toward that requirement is backed by the full faith and credit of the • Assets collateralized by the current limited to the amount of the credit United States Government; market value of securities issued by union’s core capital through the use of • Deposit reserves at, claims on, and the T1RBC ratio. Additional limits are balances due from Federal Reserve 36 These institutions include, but are not limited placed upon certain types of Banks; the book value of paid-in Federal to, the International Bank for Reconstruction and supplementary capital. These limits Reserve Bank stock; Development (World Bank), the Inter-American • Development Bank, the Asian Development Bank, may restrict the extent to which these Assets directly and unconditionally the African Development Bank, the European forms of supplementary capital may be guaranteed by the United States Investments Bank, the International Monetary Fund used to satisfy the corporate’s capital Government or its agencies, or the and the Bank for International Settlements.

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official multilateral lending institutions • Equity investments; obligation of a depository institution). or regional development institutions in • The prorated assets of subsidiaries For certain off-balance sheet contracts, which the United States Government is (except for the assets of consolidated however, including interest and a shareholder or contributing member; CUSOs) to the extent such assets are exchange rate contracts, credit • All claims on depository included in adjusted total assets; equivalent amounts are determined by institutions incorporated in an OECD • All repossessed assets or assets that summing two amounts: the current country, and all assets backed by the are more than 90 days past due; and exposure and the estimated potential full faith and credit of depository • Intangible assets not specifically future exposure. institutions incorporated in an OECD weighted in some other category. Summary of Conversion Factors for Off- country; The term ‘‘prorated assets’’ means the • Claims on, or guaranteed by total assets (as determined in the most Balance Sheet Items depository institutions other than the recently available GAAP report) of a Conversion factors—Group A—100 central bank, incorporated in a non- consolidated CUSO multiplied by the Percent. Direct credit substitutes are OECD country, with a remaining corporate credit union’s percentage of assigned to Group A. Direct credit maturity of one year or less; and ownership of that consolidated CUSO. substitutes are any irrevocable • Local currency claims conditionally Corporates may take indirect obligations in which a corporate has guaranteed by central governments of ownership of assets, such as through a essentially the same credit risk as if it non-OECD countries, to the extent the mutual fund. The proposal provides that had made a direct loan to the obligor or corporate has local currency liabilities investments representing an indirect account party. Direct credit substitutes in that country. holding of a pool of assets are assigned include guarantees (or guarantee-type Fifty percent risk-weighting (Category to risk-weight categories based upon the instruments) backing financial claims, 3). This category contains assets risk-weight that would be assigned to such as outstanding securities, loans, considered to present a moderate level each category of assets in the pool, and and other financial obligations of credit risk as compared to standard described various methods for achieving including those on behalf of CUSOs. risk assets. It includes: that result. In no case, however, will any Direct credit substitutes also include • Revenue bonds issued by any such investment be assigned a total risk- standby letters of credit, equivalent public-sector entity in an OECD country weight of less than 20 percent. obligations, and forward agreements for which the underlying obligor is a The proposal also recognizes that that are legally binding agreements public-sector entity, but which are certain transactions or activities, such as (contractual obligations) to purchase repayable solely from the revenues derivatives transactions, may appear on assets with certain drawdowns at generated from the project financed corporate’s balance sheet but are not specified future dates. through the issuance of the obligations; specifically described in the Section Asset sales with recourse, if not • Qualifying mortgage loans and II(a) on-balance sheet risk-weight already included on the balance sheet, qualifying multifamily mortgage loans; categories. These items will be assigned are treated in the same way as direct • Certain privately-issued mortgage- risk-weights as described in Section II(b) credit substitutes. Such sales will be backed securities; and or II(c) below, generally relating to off- treated as if they did not occur. Capital • Qualifying residential construction balance sheet items. will be required against the full amount loans. sold for assets sold with recourse. One hundred percent risk-weighting Off-Balance Sheet Items Retention of the subordinated portion of (Category 4). All assets not classified The Board is also proposing to a senior/subordinated loan participation elsewhere or deducted from calculations incorporate off-balance sheet items in its or package of loans will be treated in the of capital pursuant to §§ 704.2 and 704.3 calculation of risk-weighted assets, same manner as an asset sale with are assigned to this category, which using a method similar to that used by recourse. The minimum amount of comprises standard risk assets. This the federal banking regulators. capital required against loans sold to an category includes: Under the proposal, off-balance sheet institution with full recourse is • Consumer loans; items are incorporated into risk- determined by the type of obligor. • Commercial loans; weighted assets by first determining the Group B—50 percent. This group • Home equity loans; on-balance sheet credit equivalent includes transaction-related • Non-qualifying mortgage loans; • amounts for the items and then contingencies and unused commitments Non-qualifying multifamily assigning the credit equivalent amounts not falling within Group E. Transaction- mortgage loans; to the appropriate risk category related contingencies include • Residential construction loans; • Land loans; according to the obligor, or if relevant, performance bonds, performance • Nonresidential construction loans; the guarantor or the nature of the standby letters of credit, warranties, and • Obligations issued by any state or collateral. standby letters of credit related to any political subdivision thereof for the For many types of off-balance sheet particular transactions. These benefit of a private party or enterprise transactions, the risk-weight is instruments are different from financial where that party or enterprise, rather determined by a two-step process. First, guarantee-type standby letters of credit than the issuing state or political the notional principal, or face value, in that they concern performance of subdivision, is responsible for the amount of the off-balance sheet item is nonfinancial or commercial contracts or timely payment of principal and interest multiplied by a credit conversion factor undertakings. These instruments on the obligations; to arrive at a balance sheet ‘‘credit- generally involve guaranteeing the • Debt securities not specifically risk- equivalent amount.’’ The conversion account party’s obligation to deliver a weighted in another category; factor is based upon the relative service or product in the conduct of its • Investments in fixed assets and likelihood that a credit obligation will day-to-day business. premises; result from the commitment. The credit- A commitment is defined as any • Servicing assets; equivalent amount is then assigned to arrangement between an institution and • Interest-only strips receivable, other the appropriate risk category depending its customer that legally obligates the than credit-enhancing interest-only upon the obligor (e.g., to the 20 percent institution to extend credit to the strips; risk category if guaranteeing an customer in the form of loans or leases.

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It also includes such undertakings as Group F—Off balance sheet contracts; zero is also assigned to a contract with overdraft transactions. Normally, a interest rate and foreign exchange a market value of zero, since neither commitment involves a written contract contracts. Credit equivalent amounts for party would suffer a loss in the event of or agreement, a commitment fee, or these contracts, including interest-rate contract termination. In summary, the some other form of consideration. swaps, futures, over-the-counter current exposure of a rate contract Commitments are included in risk- options, interest-rate options purchased equals either the positive market value weighted assets regardless of whether (caps, floors and collars), foreign of the contract or zero. they contain ‘‘material adverse change’’ exchange rate contracts, and forward The second part of the credit clauses or other similar provisions. rate agreements are determined by equivalent amount for rate contracts, the Commitments with material adverse summing two amounts: the current estimated potential future exposure change clauses are included in this exposure and the estimated potential (often referred to as the add-on), is an category (rather than in a category future exposure. amount that represents the potential carrying a smaller conversion factor) The current exposure (sometimes future credit exposure of a contract over because they represent obligations that referred to as replacement cost) of a its remaining life. This exposure is may involve risk if an institution funds contract is derived from its market calculated by multiplying the notional the commitment before the customer’s value. In most instances the initial principal amount of the underlying condition deteriorates, or before the market value of a contract is zero.37 A contract by a credit conversion factor deterioration is recognized. Moreover, corporate should mark all of its rate that is determined by the remaining while the Board does not wish to contracts to market to reflect the current maturity of the contract and the type of discourage the use of material adverse value of the transaction in light of contract. change clauses, some court decisions changes in the market price of the The potential future credit exposure is suggest that the presence of a material contracts or in the underlying interest or calculated for all contracts, regardless of adverse change clause cannot exchange rates. Unless the market value whether the mark-to-market value is necessarily be relied on to relieve an of a contract is zero, one party will zero, positive, or negative. For interest institution of its obligations pursuant to always have a positive mark-to-market rate contracts with a remaining maturity a commitment. value for the contract, while the other of one year or less, the credit conversion Only the unused portion of a party (counterparty) will have a negative factor is 0 percent and for those over commitment is treated as an off-balance mark-to-market value. one year, the factor is .5 percent. For sheet item. Amounts that are already An institution holding a contract with exchange rate contracts with a maturity drawn and outstanding under a a positive mark-to-market value is ‘‘in- of one year of less, the factor is 1 commitment appear on the balance the-money,’’ that is, it would have the percent and for those over one year the sheet; such amounts, therefore, will not right to receive payment from the factor is 5 percent. Because exchange be included as commitments for counterparty if the contract were rate contracts involve an exchange of purposes of computing the risk-asset terminated. Thus, an institution that is principal upon maturity and are ratio. in-the-money on a contract is exposed to generally more volatile, they carry a Group C—20 percent. Group C counterparty credit risk, since the higher conversion factor. No potential includes short-term, self-liquidating, counterparty could fail to make the future credit exposure is calculated for trade-related contingencies that arise expected payment. The potential loss is single-currency interest-rate swaps in from the movement of goods, including equal to the cost of replacing the which payments are made based on two commercial letters of credit and other terminated contract with a new contract floating indices (basis swaps). documentary letters of credit that would generate the same expected The potential future exposure is then collateralized by the underlying cash flows under the existing market shipments. added to the current exposure to arrive conditions. Therefore, the in-the-money 38 Group D—10 percent. Group D institution’s current exposure on the at a credit equivalent amount. Each includes unused portions of eligible contract is equal to the market value of credit equivalent amount is then Asset-backed Commercial Paper (ABCP) the contract. assigned to the appropriate risk liquidity facilities with an original An institution holding a contract with category, according to the counterparty maturity of one year or less. The ABCP a negative mark-to-market value, on the or, if relevant, the guarantor or the risk-weighting treatment is similar to other hand, is ‘‘out-of-the-money’’ on nature of the collateral. The maximum the risk-weighting employed by the that contract, that is, if the contract were risk-weight applied to such rate other regulators. The proposal adds key terminated, the institution would have contracts is 50 percent. terms related to the ABCP risk- an obligation to pay the counterparty. Netting and Risk-Based Capital weighting to the definitions section. 12 The institution with the negative mark- Treatment of Off-Balance Sheet CFR 704.2. to-market value has no counterparty Contracts Group E—Zero Percent. Group E credit exposure because it is not entitled includes unused commitments that are to any payment from the counterparty in Netting arrangements are a means of less than one year in maturity or that the the case of counterparty default. improving efficiency and reducing corporate can, at its option, Consequently, a contract with a negative counterparty credit exposure. Often unconditionally (without cause) cancel. market value is assigned a current referred to as master netting contracts, Facilities that, at the institution’s exposure of zero. A current exposure of these arrangements typically provide for option, are unconditionally cancelable both payment and close-out netting. at any time are not considered to be 37 An options contract has a positive value at Payment netting provisions permit an commitments, provided that the inception, which reflects the premium paid by the institution to make payments to a purchaser. The value of the option may be reduced counterparty on a net basis by offsetting institution makes a separate credit due to market movements but it cannot become decision before each drawdown under negative. Therefore, unless an option has zero payments it is obligated to make with the facility. Unused retail credit card value, the purchaser of the option contract will 38 lines are deemed to fall under this group always have some credit exposure, which may be This method of determining credit equivalent greater than or less than the original purchase price, amounts for rate contracts is known as the current if the corporate has the unconditional and the seller of the option contract will never have exposure method, which is used by most banks option to cancel the card at any time. credit exposure. under $250 billion in assets.

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payments it is entitled to receive and, defaulter is a net creditor under the securitization programs involve assets thus, to reduce its costs arising out of contract. that are not Federally supported in any payment settlements. Close-out netting Certain off-balance sheet rate way. Sellers of these privately provisions permit the netting of credit contracts are not subject to the above securitized assets therefore often exposures if a counterparty defaults or calculation, and therefore, are not part provide other forms of credit upon the occurrence of another event of the denominator of a corporate’s risk- enhancement—that is, they take first or such as insolvency or bankruptcy. If based capital ratio. These include a second dollar loss positions—to reduce such an event occurs, all outstanding foreign exchange rate contract with an investors’ credit risk. original maturity of 14 calendar days or contracts subject to the close-out A seller may provide this credit provisions are terminated and less; any interest rate or foreign enhancement itself through recourse accelerated, and their market values are exchange rate contract that is traded on arrangements. The proposed rule uses determined. The positive and negative an exchange requiring the daily the term ‘‘recourse’’ to refer to the credit market values are then netted, or set off, payment of any variations in the market risk that a banking organization or credit against each other to arrive at a single value of the contract; and certain asset- union retains in connection with the net exposure to be paid by one party to backed commercial paper programs. transfer of its assets. Banks and credit the other upon final resolution of the Recourse Obligations, Direct Credit unions have long provided recourse in default or other event. Substitutes, and Certain Other Positions connection with sales of whole loans or The potential for close-out netting The proposed rule provides loan participations; today, recourse provisions to reduce counterparty credit additional risk-weighting provisions for arrangements frequently are also risk, by limiting an institution’s recourse obligations, direct credit associated with asset securitization obligation to the net credit exposure, substitutes, and certain other positions. programs. Depending on the type of depends upon the legal enforceability of These terms generally relate to asset securitization transaction, the sponsor securitization and associated securities. the netting contract, particularly in of a securitization may provide a A discussion of asset securitization insolvency or bankruptcy. portion of the total credit enhancement Accordingly, the proposal permits a follows. Asset securitization is the process by internally, as part of the securitization corporate, in determining its current which loans or other credit exposures structure, through the use of excess credit exposure for multiple off-balance are pooled and reconstituted into spread accounts, overcollateralization, sheet rate contracts executed with a securities, with one or more classes or retained subordinated interests, or other single counterparty, to net off-balance positions, that may then be sold. similar on-balance sheet assets. When sheet rate contracts subject to a bilateral Securitization provides an efficient these or other on-balance sheet internal netting contract by offsetting positive mechanism for depository institutions enhancements are provided, the and negative mark-to-market values, to buy and sell loan assets or credit enhancements are ‘‘residual interests’’ provided that the netting contract meets exposures and thereby to increase the for regulatory capital purposes. Such certain requirements, including that the organization’s liquidity.40 residual interests are a form of recourse. bilateral netting contract creates a Securitizations typically carve up the single, enforceable legal obligation for A seller may also arrange for a third risk of credit losses from the underlying party to provide credit enhancement in all individual off-balance sheet rate assets and distribute it to different an asset securitization.41 If the third- contracts covered by the contract.39 A parties. The ‘‘first dollar,’’ or most party enhancement is provided by bilateral netting contract that contains a subordinate, loss position is first to walkaway clause is not eligible for absorb credit losses; the most ‘‘senior’’ another banking organization, that netting for purposes of calculating the investor position is last to absorb losses; organization assumes some portion of current credit exposure amount. A and there may be one or more loss the assets’ credit risk. In this final rule, walkaway clause is a provision in a positions in between (‘‘second dollar’’ all forms of third-party enhancements, netting contract that permits the non- loss positions). Each loss position i.e., all arrangements in which a banking defaulting counterparty to make only functions as a credit enhancement for organization assumes credit risk from limited payments, or no payments at all, the more senior positions in the third-party assets or other claims that it to the estate of the defaulter even if the structure. has not transferred, are referred to as For residential mortgages sold ‘‘direct credit substitutes.’’ 42 The 39 The Basel Supervisors’ Committee issued a through certain Federally-sponsored economic substance of the credit risk consultative paper on April 30, 1993, proposing an mortgage programs, a Federal from providing a direct credit substitute expanded recognition of netting arrangements in government agency or Federal can be identical to its credit risk from the regulations based on Basel I. The paper is entitled ‘‘The Prudential Supervision of Netting, government-sponsored enterprise (GSE) retaining recourse on assets transferred. Market Risks and Interest Rate Risk.’’ The section guarantees the securities sold to Many asset securitizations use a applicable to netting is subtitled ‘‘The Supervisory investors and may assume the credit combination of recourse and third-party Recognition of Netting for Capital Adequacy risk on the underlying mortgages. Purposes.’’ Specifically, the Basel proposal states enhancements to protect investors from However, many of today’s asset that netting for risk-based capital purposes is credit risk. When third-party permissible if (1) In the event of a counterparty’s failure to perform due to default, bankruptcy or 40 For purposes of this discussion, references to enhancements are not provided, the liquidation, the corporate’s claim (or obligation) ‘‘securitization’’ also include structured finance transferring entity often retains credit would be to receive (or pay) only the net value of transactions or programs and synthetic transactions risk on the assets transferred. the sum of unrealized gains and losses on included that generally create stratified credit risk positions, transactions; (2) the banking entity has obtained which may or may not be in the form of a security, written and reasoned legal opinions stating that in whose performance is dependent upon a pool of 41 As used in this proposed rule, the terms ‘‘credit the event of legal challenge, the netting would be loans or other credit exposures. Synthetic enhancement’’ and ‘‘enhancement’’ refer to both upheld in all relevant jurisdictions; and (3) the transactions bundle credit risks associated with on- recourse arrangements, including residual interests, entity has documentation and procedures in place balance sheet assets and off-balance sheet items and and direct credit substitutes. to ensure that the netting arrangements are kept resell them into the market. For examples of 42 For purposes of this rule, purchased credit- under review in light of changes in relevant law. synthetic securitization structures, see Banking enhancing interest-only strips are also ‘‘residual These criteria are contained in the proposed rule. Bulletin 99–43, November 15, 1999 (OCC). interests.’’

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Risk Management of Exposures Arising The proposal generally defines conversion factor. The corporate will From Securitization Activities recourse obligations as a corporate’s then assign this credit equivalent While asset securitization can retention, in form or in substance, of amount to the risk-weight category enhance both credit availability and any credit risk directly or indirectly appropriate to the obligor in the profitability, managing the risks associated with an asset it has sold (in underlying transaction, after associated with this activity can pose accordance with Generally Accepted considering any associated guarantees significant challenges. The risks Accounting Principles) that exceeds a or collateral, in accordance with the involved, while not new to banking pro rata share of that corporate’s claim risk-weight categories in Section II(a) of organizations and credit unions, may be on the asset. A recourse obligation the Appendix. The proposal states that, less obvious and more complex than the typically arises when a corporate for a direct credit substitute that is an risks of traditional lending. Specifically, transfers assets in a sale and retains an on-balance sheet asset (e.g., a purchased securitization can involve credit, explicit obligation to repurchase assets subordinated security), a corporate must liquidity, operational, legal, and or to absorb losses due to a default on use the amount of the direct credit reputational risks in concentrations and the payment of principal or interest or substitute and the full amount of the forms that may not be fully recognized any other deficiency in the performance asset it supports, i.e., all the more senior by management or adequately of the underlying obligor or some other positions in the structure). This means, incorporated into a credit union’s risk party. Recourse may also exist for example, that if a corporate invests management systems. implicitly if a corporate provides credit in a senior mezzanine security that enhancement beyond any contractual supports a more senior tranche, the Risk-Weighting of Direct Credit obligation to support assets it has sold.44 corporate must use the full amount of Substitutes and Recourse Obligations As stated above, the primary the supported tranche, without regard (Including Residual Interests and Credit difference between direct credit for the existence or not of tranches Enhancing IO Strips) substitutes and recourse obligations is subordinate to the mezzanine tranche. The proposal defines four key terms: that recourse obligations involve the This can result in a risk-weighting direct credit substitute, recourse assumption of credit risk associated several times greater than the risk- obligations, residual interests, and with assets that the corporate once weighting for the most senior tranche. credit enhancing interest only (IO) owned but transferred, while direct There are two subsets of recourse strips. The proposal defines a direct credit substitutes involve the obligations that receive special credit substitute as any arrangement in assumption of credit risk related to treatment for risk-weighting purposes: which a corporate assumes, in form or assets that the corporate does not own. residual interests and credit enhancing in substance, credit risk associated with Both direct credit substitutes and interest only strips. In addition, in some an on-balance sheet or off-balance sheet recourse obligations, however, can asset transfers the transferring entity asset or exposure that was not involve similar, and significant, credit might retain two or more different previously owned by the corporate risk. Accordingly the proposal outlines recourse obligations on the same (third-party asset) and the risk assumed the same general process (with some transferred assets, and the rule provides by the corporate exceeds the pro rata exceptions) for risk-weighting both for a special risk-weighting calculation share of the corporate’s interest in the direct credit substitutes and recourse in this case. These situations are third-party asset.43 obligations. discussed further below. The proposal requires that the The proposal defines residual 43 If a corporate has no claim on the third-party corporate multiply the full amount of interests, a form of recourse obligation, asset, then the corporate’s assumption of any credit the credit-enhanced assets for which the as any on-balance sheet asset that: risk is a direct credit substitute. As stated in the corporate directly or indirectly retains (1) Represents an interest (including a definition, direct credit substitutes include: or assumes credit risk by a 100 percent beneficial interest) created by a transfer (1) Financial standby letters of credit that support that qualifies as a sale (in accordance financial claims on a third party that exceed a corporate’s pro rata share in the financial claim; 44 As stated in the definition, recourse obligations with Generally Accepted Accounting (2) Guarantees, surety arrangements, credit include: Principles) of financial assets, whether derivatives, and similar instruments backing (1) Credit-enhancing representations and through a securitization or otherwise; financial claims that exceed a corporate’s pro rata warranties made on transferred assets; (2) Loan servicing assets retained pursuant to an and share in the financial claim; (2) Exposes a corporate to credit risk (3) Purchased subordinated interests that absorb agreement under which the corporate will be more than their pro rata share of losses from the responsible for losses associated with the loans directly or indirectly associated with the underlying assets, including any tranche of asset serviced. Servicer cash advances as defined in this transferred asset that exceeds a pro rata backed securities that is not the most senior section are not recourse obligations; share of that corporate’s claim on the tranche; (3) Retained subordinated interests that absorb asset, whether through subordination (4) Credit derivative contracts under which the more than their pro rata share of losses from the corporate assumes more than its pro rata share of underlying assets; provisions or other credit enhancement credit risk on a third-party asset or exposure; (4) Assets sold under an agreement to repurchase, techniques. (5) Loans or lines of credit that provide credit if the assets are not already included on the balance Residual interests generally include enhancement for the financial obligations of a third sheet; credit-enhancing interest-only strips, party; (5) Loan strips sold without contractual recourse spread accounts, cash collateral (6) Purchased loan servicing assets if the servicer where the maturity of the transferred portion of the is responsible for credit losses or if the servicer loan is shorter than the maturity of the commitment accounts, retained subordinated makes or assumes credit-enhancing representations under which the loan is drawn; interests (and other forms of and warranties with respect to the loans serviced. (6) Credit derivatives that absorb more than the overcollateralization), and similar assets Servicer cash advances as defined in this section corporate’s pro rata share of losses from the that function as a credit enhancement. are not direct credit substitutes; transferred assets; (7) Clean-up calls on third party assets. However, (7) Clean-up calls on assets the corporate has Residual interests further include those clean-up calls that are 10 percent or less of the sold. However, clean-up calls that are 10 percent or exposures that, in substance, cause the original pool balance and that are exercisable at the less of the original pool balance and that are corporate to retain the credit risk of an option of the corporate are not direct credit exercisable at the option of the corporate are not asset or exposure that had qualified as recourse arrangements; and substitutes; and a residual interest before it was sold. (8) Liquidity facilities that provide support to (8) Liquidity facilities that provide support to asset-backed commercial paper (other than eligible asset-backed commercial paper (other than eligible While residual interests generally do not ABCP liquidity facilities). ABCP liquidity facilities). include assets purchased from a third

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party, the definition does include a TABLE A based risk-weighting treatment in credit-enhancing interest-only strip that accordance with Table C below if the is acquired in any asset transfer as a Long-term rating category Risk-weight asset is not rated by an NRSRO, is not residual interest. (in percent) a residual interest, and meets one of The proposal provides that a three different, alternative standards for Highest or second highest in- internal ratings described below. corporate must maintain risk-based vestment grade ...... 20 capital for a residual interest equal to Third highest investment TABLE C the face amount of the residual interest, grade ...... 50 Lowest investment grade ..... 100 even if the amount of risk-based capital Risk-weight that must be maintained exceeds the full One category below invest- Rating category ment grade ...... 200 (in percent) risk-based capital requirement for the assets transferred. For residual interests Investment grade ...... 100 in the form of credit enhancing interest TABLE B One category below invest- only strips, the rule further provides ment grade ...... 200 that a corporate must maintain risk- Risk-weight Short-term rating category A direct credit substitute, but not a based capital equal to the remaining (in percent) purchased credit-enhancing interest- amount of the strip (emphasis added) Highest investment grade ..... 20 only strip, is eligible for the a ratings even if the amount of risk-based capital Second highest investment based risk-weighting under Table C if that must be maintained exceeds the full grade ...... 50 the asset is created in connection with risk-based capital requirement for the Lowest investment grade ..... 100 an asset-backed commercial paper assets transferred. program sponsored by the corporate and Where a corporate transfers assets, The proposal also permits certain the rating is generated by an appropriate and holds both a residual interest asset-backed securities (ABS), direct internal credit risk rating system.47 (including a credit-enhancing interest- credit substitutes, and recourse A recourse obligation or direct credit only strip) and another recourse obligations that do not meet the substitute, but not a residual interest, is obligation in connection with that definition of ‘‘traded position’’ to be eligible for a ratings based risk- transfer, the corporate must maintain risk-weighted based on NRSRO ratings weighting under Table C if the asset is risk-based capital equal to the greater of category under certain circumstances.46 created in connection with a structured the risk-based capital requirement for Use of Ratings Based Approach to finance program and an NRSRO has the residual interest or the full risk- Assets That Are Not Specifically Rated reviewed the terms of the program and based capital requirement for the assets by an NRSRO stated a rating for positions associated transferred. with the program.48 If the program has The proposal provides that, in certain Ratings-Based Approach to Risk- circumstances, a corporate may use the 47 The proposed rule provides that such internal Weighting ratings based approach for asset-backed credit risk rating systems typically: securities, direct credit substitutes, or (1) Are an integral part of the corporate’s risk In lieu of the general risk-weighting residual interests that are not management system that explicitly incorporates the approach described above, the proposal specifically rated by an NRSRO. full range of risks arising from the corporate’s would allow a corporate to employ a participation in securitization activities; If the asset is senior or preferred in all (2) Link internal credit ratings to measurable ratings based approach to certain asset- features to a particular traded position, outcomes, such as the probability that the position backed securities, direct credit including collateralization and maturity, will experience any loss, the expected loss on the substitutes, or residual interests. the corporate may risk-weight the face position in the event of default, and the degree of variance in losses in the event of default on that To apply a ratings based approach to amount of the senior position under the position; one of these particular assets, the asset ratings based approach using Tables A (3) Separately consider the risk associated with must generally be a traded position, and and B above based on the NRSRO rating the underlying loans or borrowers, and the risk if a long term position, must be rated by of the traded position, subject to associated with the structure of the particular supervisory guidance. The corporate securitization transaction; an NRSRO as one grade below (4) Identify gradations of risk among ‘‘pass’’ assets investment grade or better or, if a short- must satisfy NCUA that this treatment is and other risk positions; term position, must be publicly rated by appropriate. (5) Use clear, explicit criteria to classify assets an NRSRO as investment grade or An asset created in connection with a into each internal rating grade, including subjective better.45 To obtain the risk-weighted securitization is eligible for a ratings- factors; (6) Employ independent credit risk management asset amount, the corporate will or loan review personnel to assign or review the multiply the face amount of the asset by 46 A position that is not traded is eligible for the credit risk ratings; the appropriate risk-weight determined ratings based risk-weighting if: (7) Include an internal audit procedure to in accordance with Table A or B below: (1) The position is a recourse obligation, direct periodically verify that internal risk ratings are credit substitute, residual interest, or asset- or assigned in accordance with the corporate’s mortgage-backed security extended in connection established criteria; 45 The proposal defines a traded position as a with a securitization and is not a credit-enhancing (8) Monitor the performance of the assigned position retained, assumed, or issued in connection interest-only strip; internal credit risk ratings over time to determine with a securitization that is rated by a NRSRO, (2) More than one NRSRO rate the position; the appropriateness of the initial credit risk rating where there is a reasonable expectation that, in the (3) All of the NRSROs that provide a rating rate assignment, and adjust individual credit risk ratings near future, the rating will be relied upon by: a long term position as one grade below investment or the overall internal credit risk rating system, as (1) Unaffiliated investors to purchase the security; grade or better or a short term position as needed; and or investment grade. If the NRSROs assign different (9) Make credit risk rating assumptions that are (2) An unaffiliated third party to enter into a ratings to the position, the corporate must use the consistent with, or more conservative than, the transaction involving the position, such as a lowest rating to determine the appropriate risk- credit risk rating assumptions and methodologies of purchase, loan, or repurchase agreement. weight category; NRSROs. Also, if two or more NRSROs assign ratings to a (4) The NRSROs base their ratings on the same 48 Under the proposal, a corporate may use a traded position, the corporate must use the lowest criteria that they use to rate securities that are rating obtained from a rating agency for unrated rating to determine the appropriate risk-weight traded positions; and direct credit substitutes or recourse obligations (but category. (5) The ratings are publicly available. Continued

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options for different combinations of Other Limitations on Risk-Based Capital Federal Credit Union Act (12 U.S.C. assets, standards, internal or external Requirements 1790d) (Section 216) contains a similar credit enhancements and other relevant The proposal contains some PCA provision, and NCUA has factors, and the NRSRO specifies ranges miscellaneous limitations on the risk- implemented Section 216 through of rating categories to them, the based capital requirements. There is a regulations in part 702. 12 CFR part 702. corporate may apply the rating category low-level exposure provision that limits Section 216 of the FCUA, however, is applicable to the option that the maximum risk-based capital not applicable to corporates, and neither corresponds to the corporate’s position. requirement to the maximum is part 702. 12 U.S.C. 1790d(m); 12 CFR To rely on this sort of program rating, contractual loss exposure, even where 702.1(c). The Board has determined, the corporate must demonstrate to risk-based capital requirement as however, that some sort of regulatory NCUA’s satisfaction that the credit risk calculated under Appendix C might PCA regime is appropriate for rating assigned to the program meets the exceed that amount. There is a corporates, and this proposal sets forth same standards generally used by provision that limits the amount of risk- such a regime. Corporates have a wider variety of NRSROs for rating traded positions. The based capital to support mortgage- powers than natural person credit corporate must also demonstrate to related securities or participation unions, including some powers that are NCUA’s satisfaction that the criteria certificates retained in a more like bank powers. Accordingly, underlying the assignments for the swap. There is a provision that this proposed PCA rule, to be located at program are satisfied by the particular eliminates double counting of assets for § 704.4 of NCUA’s corporate rule, position. purposes of risk-weighting. Finally, A recourse obligation or direct credit contains elements from both Section 38 there is a provision that requires the substitute, but not a residual interest, is of the FDIA and Section 216 of the corporate to risk-weight recourse eligible for a ratings based risk- FCUA, and their various implementing weighting under Table C if the asset is obligations and direct credit substitutes regulations. Part 747 of NCUA’s rules created in connection with a structured retained or assumed by a corporate on describes the rules and procedures for financing program and the corporate the obligations of CUSOs in which the various hearings and recommendations, uses an acceptable credit assessment corporate has an equity investment in and subpart L sets forth the procedures computer program to determine the accordance with this Section II(c), for the issuance, review, and rating of the position. An NRSRO must unless the corporate’s equity investment enforcement of orders imposing PCA on have developed the computer program is deducted from credit union’s capital natural person credit unions. The and the corporate must demonstrate to and assets under § 704.2 and § 704.3. proposal contains a new subpart M in NCUA’s satisfaction that the ratings III.B. Amendments to Part 704 Relating part 747 that contains similar under the program correspond credibly to Prompt Corrective Action procedures for corporate PCA. and reliably with the rating of traded The proposal establishes five positions.49 Proposed § 704.4 Prompt Corrective categories of corporate capital Action classification: well capitalized, not residual interests) in structured finance Section 38 of the Federal Deposit adequately capitalized, programs that satisfy specifications set by the rating Insurance Act (12 U.S.C. 1831o) undercapitalized, significantly agency. The corporate would need to demonstrate that the rating meets the same rating standards (Section 38) contains a framework that undercapitalized, and critically generally used by the rating agency for rating traded applies to every insured banking undercapitalized. The proposal deems a positions. In addition, the corporate must also institution a system of supervisory corporate, generally, to be ‘‘well demonstrate to the NCUA’s satisfaction that the actions indexed to the capital level of capitalized’’ if the institution criteria underlying the rating agency’s assignment of ratings for the program are satisfied for the the individual institution. The purpose significantly exceeds the required particular direct credit substitute or recourse of this ‘‘prompt corrective action’’ (PCA) minimum level for each relevant capital exposure. statutory provision is to ‘‘resolve the measure; ‘‘adequately capitalized’’ if the To use this approach, a corporate must problems of insured depository institution meets the required minimum demonstrate to the NCUA that it is reasonable and level for each relevant capital measure; consistent with the standards of this final rule to institutions at the least possible long- rely on the rating of positions in a securitization term loss to the [Federal Deposit ‘‘undercapitalized’’ if the institution structure under a program in which the corporate Insurance Corporation’s] deposit fails to meet the required minimum participates if the sponsor of that program has insurance fund.’’ Section 216 of the level for any relevant capital measure; obtained a rating. This aspect of the final rule is ‘‘significantly undercapitalized’’ if the most likely to be useful to corporates with limited involvement in securitization activities. In addition, To qualify for use by a corporate for risk-based institution is significantly below the some banking entities extensively involved in capital purposes, a computer program’s credit required minimum level for any securitization activities already rely on ratings of assessments must correspond credibly and reliably relevant capital measure; or ‘‘critically the credit risk positions under their securitization to the rating standards of the rating agencies for undercapitalized’’ if the institution is programs as part of their risk management practices. traded positions in securitizations. A corporate Such corporates also could rely on such ratings must demonstrate the credibility of the computer critically below the required minimum under this final rule if the ratings are part of a program in the financial markets, which would level for any relevant capital measure. sound overall risk management process and the generally be shown by the significant use of the Capital ratios alone, of course, are not ratings reflect the risk of non-traded positions to the computer program by investors and other market fully indicative of the capital strength of participants for risk assessment purposes. A corporates. an institution. In particular, in This approach can be used to qualify a direct corporate must also demonstrate the reliability of credit substitute or recourse obligation (but not a the program in assessing credit risk. proposing these minimum capital residual interest) for a risk-weight of 100 percent or A corporate may use a computer program for levels, the NCUA is aware that a 200 percent of the face value of the position under purposes of applying the ratings-based approach corporate can have capital ratios above the ratings-based approach, but not for a risk-weight under this final rule only if the corporate satisfies of less than 100 percent. NCUA that the program results in credit the specified minimums for the well 49 The NCUA will also allow corporates, assessments that credibly and reliably correspond capitalized and adequately capitalized particularly those with limited involvement in with the ratings of traded positions by the rating categories while still exhibiting unsafe securitization activities, to rely on qualifying credit agencies. The corporate should also demonstrate to and unsound characteristics. One reason assessment computer programs that the rating the NCUA’s satisfaction that the program was for this dichotomy is that capital is a agencies have developed to rate otherwise unrated designed to apply to its particular direct credit direct credit substitutes and recourse obligations substitute or recourse exposure and that it has lagging indicator of problems of insured (but not residual interests) in asset securitizations. properly implemented the computer program. depository institutions, and use of

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moving DANA and DANRA exacerbates directives, orders, and other supervisory the tier 1 risk-based capital ratio, and this lag. directives. In the case of a state- the leverage ratio. The paragraph then Accordingly, a corporate might be chartered corporate credit union, the defines the five PCA capital categories subject to a written order or directive proposal provides that NCUA will in terms of these ratios. that establishes higher capital levels for consult with, and seek to work The proposal provides that a that institution. NCUA is proposing that cooperatively with, the appropriate corporate is ‘‘well capitalized’’ if it has for a corporate to be well capitalized, it State official before taking any a total risk-based capital ratio of 10.0 must not be subject to any written discretionary PCA actions. percent or greater, a Tier 1 risk-based capital order or directive.50 This capital ratio of 6.0 percent or greater, a Paragraph 704.4(b) Scope proposal reflects the view that a leverage ratio of 5.0 percent or greater, corporate that is subject to a written This paragraph establishes that the and is not subject to any written capital directive does not have capital PCA section applies to corporates, agreement, order, capital directive, or that significantly exceeds the required including officers, directors, and prompt corrective action directive minimum level for the relevant capital employees. The paragraph clarifies that issued by NCUA to meet and maintain measures. the section does not limit the authority a specific capital level for any capital The proposal also gives the NCUA of the NCUA in any way to take measure. A corporate must satisfy all discretion to downgrade, where supervisory actions to address unsafe or four of these criteria to be considered appropriate, a ‘‘well capitalized’’ unsound practices, deficient capital well capitalized. corporate by one category and require levels, violations of law, unsafe or The proposal provides that a an ‘‘adequately capitalized’’ or unsound conditions, or other practices. corporate is ‘‘adequately capitalized’’ if ‘‘undercapitalized’’ corporate to comply It generally prohibits a corporate from the corporate has a total risk-based with supervisory actions as if it were in stating in any advertisement or capital ratio of 8.0 percent or greater, a the next lower category. Additionally, promotional material its capital category Tier 1 risk-based capital ratio of 4.0 the NCUA may, for good cause, modify or that the NCUA has assigned the percent or greater, a leverage ratio of 4.0 the minimum capital ratio percentages corporate to a particular category. The percent or greater, and does not meet for purposes of determining the proposal also requires newly chartered the definition of a well capitalized appropriate PCA capital category for a corporates to submit to NCUA a draft corporate. A corporate must satisfy all particular corporate credit union. The plan that sets forth how the corporate four of these criteria to be considered proposal further clarifies that NCUA will solicit contributed capital and build adequately capitalized. continues to have available all other retained earnings. The proposal provides that a non-PCA supervisory tools traditionally corporate is ‘‘undercapitalized’’ if the Paragraph 704.4(c) Notice of Capital corporate has a total risk-based capital used to supervise corporates, and the Category agency intends to use these tools as ratio that is less than 8.0 percent, or has appropriate in supervising corporates. This paragraph describes the effective a Tier 1 risk-based capital ratio that is less than 4.0 percent, or has a leverage These tools include appropriate date of change in capital category, ratio that is less than 4.0 percent. enforcement actions and supervisory which is important in terms of triggering Failure to achieve any one of these three follow-up measures based upon the various time-sensitive actions. The minimum percentages will cause the corporate’s overall condition and the paragraph provides that that the corporate to be undercapitalized. existence of any financial, operational, effective date will be the most recent The proposal provides that a or other supervisory weaknesses, date that a 5310 Financial Report is corporate is ‘‘significantly irrespective of the corporate’s capital required to be filed with the NCUA; a undercapitalized’’ if the corporate has a category for purposes of the prompt final NCUA report of examination is total risk-based capital ratio that is less corrective action provisions of the delivered to the corporate; or written than 6.0 percent, or a Tier 1 risk-based proposal. notice is provided by the NCUA to the capital ratio that is less than 3.0 percent, Finally, the proposal prohibits a corporate that its capital category has or a leverage ratio that is less than 3.0 corporate from disseminating to third- changed. The rule also provides that a percent. Again, failure to achieve any parties its capital category, except where corporate must provide the NCUA with one percentage will cause the corporate permitted by NCUA or otherwise written notice that an adjustment to the to be significantly undercapitalized. provided by statute or regulation. This corporate’s capital category may have The proposal provides that a also prohibits corporates from occurred no later than 15 calendar days corporate is ‘‘critically advertising their capital category. undercapitalized’’ if the corporate has a A paragraph-by-paragraph summary following the date that any material total risk-based capital ratio that is less of the PCA proposal follows. event has occurred that would cause the corporate to be placed in a lower capital than 4.0 percent, or a Tier 1 risk-based Paragraph 704.4(a) Purpose category from the category assigned to capital ratio that is less than 2.0 percent, This proposed paragraph establishes the corporate on the basis of the or a leverage ratio that is less than 2.0 that the principal purpose of PCA is to corporate’s most recent call report or percent. Again, failure to achieve any define, for corporates that are not report of examination. After receiving one of percentages will cause the adequately capitalized, the capital this notice, or on its own initiative, the corporate to be critically measures and capital levels that are NCUA will determine whether to undercapitalized. The proposal provides NCUA with used for determining appropriate change the capital category of the authority to reclassify a corporate’s supervisory actions. The proposal also corporate and will notify the corporate capital category based on supervisory establishes procedures for submission of the NCUA’s determination. criteria other than capital. One such and review of capital restoration plans Paragraph 704.4(d) Capital Measures criteria is a determination by NCUA that and for issuance and review of capital and Capital Category Definitions the corporate received a less-than- 50 This would include capital orders, capital This paragraph restates the relevant satisfactory rating (i.e., three or lower) directives, and cease and desist orders related to capital measures from proposed § 704.3, for any rating category (other than in a capital. that is the total risk-based capital ratio, rating category specifically addressing

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capital adequacy) under the Corporate capitalized corporate that has been including payment of dividends on Risk Information System (CRIS) rating reclassified for supervisory reasons is perpetual contributed capital or system and has not corrected the not, however, required to submit a nonperpetual contributed capital conditions that served as the basis for capital restoration plan solely by virtue accounts if, after making the the less than satisfactory rating. In this of the reclassification. Also, a corporate distribution, the institution would be case, the NCUA may reclassify a well that has already submitted and is undercapitalized. capitalized corporate as adequately operating under a capital restoration capitalized, and may require an plan is not required to submit an Provisions Applicable to adequately capitalized or additional capital restoration plan based Undercapitalized, Significantly undercapitalized corporate to comply on a revised calculation of its capital Undercapitalized, and Critically with certain mandatory or discretionary measures or a reclassification unless the Undercapitalized Corporates supervisory actions as if the corporate NCUA requests one. Upon being categorized as were in the next lower capital category. A corporate that is undercapitalized undercapitalized, significantly NCUA may also downgrade the capital and that fails to submit a timely, written undercapitalized, or critically category of a well capitalized, capital restoration plan will be subject undercapitalized, a corporate will be adequately capitalized, or to all of the provisions of this section subject to the following conditions and undercapitalized corporate by one applicable to significantly restrictions. category if the NCUA determines that undercapitalized corporates. The corporate must submit an the corporate is otherwise in an unsafe Within 60 days after receiving a acceptable capital restoration plan to the or unsound condition. capital restoration plan under this NCUA. The corporate must not permit In both situations, however, the section, the NCUA will provide written its DANA during any calendar month to NCUA must offer the corporate notice notice to the corporate of whether it has exceed its moving DANA unless the and opportunity to be heard before approved the plan. The NCUA may NCUA has accepted the corporate’s carrying out such a supervisory extend this time period. capital restoration plan and any increase downgrade. The procedures, which If NCUA does not approve a capital in total assets is consistent with the include the opportunity for a hearing, restoration plan, the corporate must plan. The corporate also must not, are described in paragraph 704.4(h) and submit a revised capital restoration directly or indirectly, acquire any the proposed subpart M of part 747. plan, when directed to do so and within interest in any entity, establish or the time specified by the NCUA. An Paragraph 704.4(e) Capital Restoration acquire any additional branch office, or undercapitalized corporate is subject to Plans engage in any new line of business the provisions of § 704.4 applicable to unless the NCUA determines that the The proposal requires that any significantly undercapitalized credit proposed action is consistent with and corporate that is downgraded to unions until it has submitted, and will further the achievement of the plan. undercapitalized, or a lower capital NCUA has approved, a capital category, must file a capital restoration The NCUA will also closely monitor restoration plan. If NCUA directs that the corporate for compliance with plan with the NCUA. the corporate submit a revised plan, it The capital restoration plan must capital standards, capital restoration must do so in time frame specified by plans and activities. include all of the information required NCUA. to be filed under paragraph (k)(2)(ii). Additional provisions applicable to Any undercapitalized corporate that significantly undercapitalized This information includes the steps the fails in any material respect to corporate will take to become corporates and undercapitalized implement a capital restoration plan corporates that fail to submit and adequately capitalized; the levels of will be subject to all of the provisions capital to be attained during each year implement acceptable capital of § 704.4 applicable to significantly restoration plans. in which the plan will be in effect; how undercapitalized corporates. A If a corporate is significantly the corporate will comply with the other corporate that has filed an approved undercapitalized, or is undercapitalized PCA restrictions or requirements then in capital restoration plan may, after prior and has failed to submit and implement effect under this section; the types and written notice to and approval by the a capital restoration plans acceptable to levels of activities in which the NCUA, amend the plan to reflect a the NCUA, the corporate is prohibited corporate will engage; and other change in circumstance. Until such time from doing any of the following without information as the NCUA may require. as NCUA has approved a proposed the prior written approval of the NCUA: All financial data in the plan must be amendment, the corporate must • Paying any bonus or profit-sharing prepared in accordance with the implement the capital restoration plan to any senior executive officer. instructions provided on the call report. as approved prior to the proposed • Providing compensation to any A corporate required to submit a capital amendment. restoration plan as the result of a senior executive officer at a rate reclassification of the corporate for Paragraph 704.4(f) Mandatory and exceeding that officer’s average rate of supervisory reasons must also include a Discretionary Supervisory Actions compensation (excluding bonuses and description of the steps the corporate The proposal provides for certain profit-sharing) during the 12 calendar will take to correct the unsafe or mandatory supervision actions months preceding the calendar month unsound condition or practice. depending on a corporate’s capital in which the corporate became The capital restoration plan must be category. Many of these provisions are undercapitalized. filed with the NCUA within 45 days of incorporated by cross reference to The NCUA will not grant approval the date that the corporate receives paragraph 704.4(k). with respect to a corporate that has notice or is deemed to have notice that failed to submit an acceptable capital the corporate is undercapitalized, Provisions Applicable to All Corporates restoration plan. significantly undercapitalized, or Paragraph (k)(1) provides that a If a corporate is significantly critically undercapitalized, unless the corporate is prohibited, unless it obtains undercapitalized, or is undercapitalized NCUA notifies the corporate of a NCUA’s prior written approval, from and has failed to submit and implement different filing period. An adequately making any capital distribution, a capital restoration plans acceptable to

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the NCUA, the NCUA may also take one corporates that are critically after a corporate becomes critically or more of the following actions: undercapitalized are subject to undercapitalized, whether NCUA • Requiring recapitalization, through additional requirements and should liquidate or conserve the requiring the corporate to seek and restrictions. institution. obtain additional contributed capital, A critically undercapitalized requiring the corporate to increase its corporate must not, beginning 60 days Paragraph 704.4(g) Directives To Take rate of earnings retention, or requiring after becoming critically Prompt Corrective Action the corporate to combine with another undercapitalized, make any payment of The proposed rule states that the insured depository institution, if one or dividends on contributed capital or any NCUA will provide an undercapitalized, more grounds exist for appointing a payment of principal or interest on the significantly undercapitalized, or conservator or liquidating agent for the corporate’s subordinated debt unless the critically undercapitalized corporate institution. NCUA determines that the exception • prior written notice of the NCUA’s Further restricting the corporate’s would further the purpose of this intention to issue a directive requiring transactions with affiliates. section. Interest, although not payable, • such corporate to take actions or to Restricting the interest rates that the may continue to accrue under the terms follow restrictions described in this corporate pays on shares and deposits to of any subordinated debt to the extent part. Proposed § 747.3002 of this the prevailing rates of interest on otherwise permitted by law. Dividends chapter, discussed below, prescribes the deposits of comparable amounts and on contributed capital do not, however, notice content and associated process. maturities in the region where the continue to accrue. institution is located, as determined by The NCUA will, by order, restrict the Paragraph 704.4(h) Procedures for the NCUA. activities of any critically Reclassifying a Corporate Based on • Restricting the corporate’s asset undercapitalized corporate and prohibit Criteria Other Than Capital growth more stringently than required any such corporate from doing any of under paragraph (k)(2)(iii), or requiring the following without the NCUA’s prior This provides that when the NCUA the corporate to reduce its total assets. written approval: intends to reclassify a corporate or • Requiring the corporate or any of its • Entering into any material subject it to the supervisory actions CUSOs to alter, reduce, or terminate any transaction other than in the usual applicable to the next lower activity that the NCUA determines course of business, including any capitalization category based on an poses excessive risk to the corporate. investment, expansion, acquisition, sale unsafe or unsound condition or practice • Ordering a new election for the of assets, or other similar action. the NCUA will provide the credit union corporate’s board of directors. • Extending credit for any highly with prior written notice of such intent. • Requiring the corporate to dismiss leveraged transaction. Proposed § 747.3003 of this chapter, from office any director or senior • Amending the corporate’s charter or discussed below, prescribes the notice executive officer who had held office for bylaws, except to the extent necessary to content and associated process. more than 180 days immediately before carry out any other requirement of any Paragraph 704.4(i) Order To Dismiss a the corporate became undercapitalized. law, regulation, or order. Director or Senior Executive Officer • Requiring the corporate to employ • Making any material change in qualified senior executive officers (who, accounting methods. This provides that when the NCUA • if the NCUA so specifies, will be subject Paying excessive compensation or issues and serves a directive on a to approval by the NCUA). bonuses. • corporate requiring it to dismiss from • Requiring the corporate to divest Paying interest on new or renewed office any director or senior executive itself of or liquidate any interest in any liabilities at a rate that would increase officer, the NCUA will also serve upon CUSO or other entity if the NCUA the corporate’s weighted average cost of the person the corporate is directed to determines that the entity is in danger funds to a level significantly exceeding dismiss (Respondent) a copy of the of becoming insolvent or otherwise the prevailing rates of interest on directive (or the relevant portions, poses a significant risk to the corporate. insured deposits in the corporate’s where appropriate) and notice of the • Conserve or liquidate the corporate normal market areas. Respondent’s right to seek if NCUA determines the corporate has With regard to the phrase reinstatement. Proposed § 747.3004 of no reasonable prospect of becoming ‘‘significantly exceeding the prevailing this chapter, discussed below, adequately capitalized. rates,’’ the prevailing effective yields of prescribes the content of the notice of • Requiring the corporate to take any interest are the effective yields on right to seek reinstatement and the other action that the NCUA determines insured deposits (or shares) of associated process. will better carry out the purpose of this comparable maturities offered by other section than any of the actions insured depository institutions in the Paragraph 704.4(j) Enforcement of described in this paragraph. market area in which the corporate is Directives The NCUA may also impose one or soliciting shares. A market area is any more of the restrictions applicable to readily defined geographic area in This proposed paragraph cross critically undercapitalized corporates, which the rates offered by any one references proposed § 747.3005, discussed below, if the NCUA insured depository institution operating discussed below, on the process for determines that those restrictions are in the area may affect the rates offered enforcement of directives. necessary to carry out the purpose of by other institutions operating in the Paragraph 704.4(k) Remedial Actions this section. same area. For a corporate, the market Towards Undercapitalized, Significantly could be a national market. Additional Provisions Applicable to Undercapitalized, and Critically The NCUA may also, at any time, Undercapitalized Corporates Critically Undercapitalized Corporates conserve or liquidate a critically In addition to the provisions undercapitalized corporate or require This proposed paragraph describes described above for undercapitalized such a corporate to combine, in whole the various PCA remedial actions, and significantly undercapitalized or part, with another institution. NCUA discussed in detail in the section of corporates, the proposal provides that will consider, not later than 90 days paragraph 704.4(f) above.

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Proposed Subpart M of Part 747— § 747.3002(f) the safeguard that if NCUA to those which § 747.3003 prescribes in Issuance, Review and Enforcement of fails to decide a request to modify or cases of reclassification, with two Orders Imposing Prompt Corrective rescind an existing DSA within 60 days, exceptions. First, the dismissed person Action on Corporates that DSA will be deemed modified or bears the burden of proving that his or Proposed subpart M of part 747 rescinded. her continued employment would materially strengthen the corporate’s provides an affected corporate, and its Section 747.3003 Reclassification to ability to become ‘‘adequately officials and employees, with due Lower Capitalization Category capitalized’’ or to correct an unsafe or process related to certain NCUA actions The NCUA is authorized to reclassify unsound condition, as the case may be. taken under proposed § 704.4 a corporate to the next lower capital 12 CFR 747.3004(e)(4). Second, if the establishing PCA for corporates. category on grounds of an unsafe or NCUA’s final decision is to deny Proposed subpart M is similar to the unsound practice or condition, provided reinstatement, it must provide reasons current subpart L, which sets forth the the corporate is first given notice and an for its decision. 12 CFR 747.3004(f). applicable due process for natural opportunity for a hearing. 12 CFR person credit union PCA under part 702 704.4(d)(3). In such cases, therefore, Section 747.3005 Enforcement of of NCUA’s rules. 12 CFR part 702. A § 747.3003 requires the NCUA to give Orders Imposing Prompt Corrective section-by-section analysis of subpart M notice of the NCUA’s intention to Action follows. reclassify a corporate, 12 CFR When a corporate fails to comply with Section 747.3001 Scope 747.3003(a), and describe the practice(s) a mandatory supervisory action (MSA) and/or condition(s) justifying or DSA, the NCUA Board may apply to Section 747.3001 establishes an reclassification. 12 CFR 747.3003(b). the appropriate U.S. District Court to independent process for appealing The corporate may then challenge the enforce that action. 12 CFR 747.3005(a). certain NCUA decisions to impose PCA reclassification, provide evidence Alternatively, the NCUA Board may under part 704.4. In the case of state supporting its position, and request an assess a civil money penalty against a charted corporates seeking independent informal hearing and the opportunity to corporate (and any institution-affiliated review under subpart M, this section present witnesses. 12 CFR 747.3003(c). party acting in concert with it) which provides that the parties (i.e., NCUA and If the corporate requests a hearing, an violates or fails to comply with an MSA corporate and/or a dismissed director or informal hearing will be conducted by or DSA, or fails to implement an officer) will serve upon the appropriate a presiding officer designated by the approved capital restoration plan. 12 State official the documents filed or NCUA. 12 CFR 747.3003(d). At the CFR 747.3005(b). Finally, subpart M issued in connection with a proceeding hearing, the corporate or its counsel allows the NCUA Board to enforce an under subpart M. may introduce relevant documents, MSA or DSA under § 704.4 ‘‘through Section 747.3002 Discretionary present oral argument, and, if any other judicial or administrative Supervisory Actions (DSAs) authorized, present witnesses. 12 CFR proceeding authorized by law.’’ 12 CFR 747.3003(e). The presiding officer then 747.3005(c). Section 747.3002 provides for prior makes a recommended decision to the notice and an opportunity to be heard NCUA, 12 CFR 747.3003(e)(4), who then Phase-in of Proposed Capital and PCA before a DSA is imposed. The NCUA issues a final decision whether to Requirements Board must give advance notice of its reclassify the corporate. 12 CFR The Board intends to phase-in the intention to impose a DSA, 12 CFR 747.3003(f). proposed capital and PCA requirements 747.3002(a)(1), except when necessary over time. Details about the proposed to further the purpose of PCA. 12 CFR Section 747.3004 Dismissal of Director or Senior Executive Officer phase-in are contained in subsection 747.3002(a)(2). The corporate may then III.D. below. challenge the proposed action in writing The NCUA is authorized to issue a and request that the DSA not be DSA directing a corporate to dismiss a III.C. Amendments to Part 704 Relating imposed or be modified. 12 CFR director or senior executive officer. 12 to Corporate Investments and Asset- 747.3002(c). The corporate, however, is CFR 704.4(k)(3)(ii)(F). In such cases, Liability Management not entitled to a hearing. The NCUA, or § 747.3004 requires the NCUA Board to The proposal contains amendments to an independent person designated by serve the dismissed person with a copy the part 704 investment authorities. the NCUA, may then decide not to issue of the directive issued to the corporate, These proposed amendments work in the directive or to issue it as proposed accompanied by a notice of the right to conjunction with the asset-liability or as modified, 12 CFR 747.3002(d); and seek reinstatement by the NCUA Board. management provisions of the that decision is final. A corporate which 12 CFR 747.3004(a)–(b). That person regulation to prevent excessive already is subject to a DSA may request may then challenge the dismissal and concentrations of risk. By limiting reconsideration and rescission due to request for reinstatement, and may investment types and concentrations in changed circumstances. 12 CFR request an informal hearing and the combination with more comprehensive 747.3002(f). opportunity to present witness risk assessment requirements, the In general, this system avoids testimony.51 12 CFR 747.3004(c). The proposal establishes a more rigorous involving panels or councils in the dismissal remains in effect while the framework for identifying, measuring, appeal process, and expanding it request for reinstatement is pending. 12 monitoring, and controlling a beyond an opportunity to be heard in CFR 747.3004(g). corporate’s balance sheet risks—and writing, because this would undermine If a hearing is requested, an NCUA- does so in a manner consistent with the the overall objective of PCA, that is, to designated presiding officer conducts avowed conservative principles of take prompt action. On the other hand, the hearing under procedures identical corporate credit union mission. a time limit, as contained in the In formulating the proposed changes proposal, for the NCUA to decide on 51 The corporate directed to dismiss a director or to investment authorities and asset- officer may not seek reinstatement of the dismissed requests to modify, to not issue, or to director or officer under § 747.3004, but that liability management, NCUA rescind DSAs is appropriate. corporate may challenge the directive under incorporated lessons learned from both Accordingly, the rule includes in § 747.3002. its recent experience with corporate

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investment portfolios and their authority for natural person federal excessive risk characteristics of other associated losses, as well as comments credit unions. CDOs, are permissible investments received from the ANPR. NCUA One hundred thirty eight commenters provided they fall within the other determined that three major risk responded to the ANPR question on investment and asset-liability conditions were the primary whether corporate investments should restrictions of the rule. be limited to those permissible for contributors to the current losses in the Mortgage-Related Securities corporate system: (1) Excessive natural person credit unions. Thirty- investment sector concentrations; (2) four commenters were in favor of the The proposal eliminates the phrase excessive average-life mismatches proposal, but 104 were opposed. The mortgage-related security (MRS) from between assets and liabilities; and (3) NCUA Board agrees with the part 704 because it is unnecessary and excessive concentrations in commenters opposed to limiting potentially confusing. The current part subordinated securities, including corporate credit union investment 704 permits corporates to invest in mezzanine securities. authorities to those provided to natural domestic asset backed securities, a term The proposed revisions to the person credit unions. Corporate credit which includes mortgage-backed investment and asset-liability provisions unions and natural person credit unions securities (MBS), that is, a type of of the corporate rule restrict these risk have different balance sheet dynamics security backed by first or second conditions in the aggregate through the and business models and serve different mortgages on real estate upon which is use of limits tied to a corporate credit types of members. As such, an located a dwelling, mixed residential union’s capital. The intent of the alignment of investment authorities for and commercial structure, a residential proposed revisions is to provide a the sake of parity may not be prudent. manufactured home, or a commercial structure. 12 CFR 704.5(c)(5), 704.2 framework that allows for a level of risk- Ninety-four commenters discussed the (definition of ABS and MBS). MRS are taking necessary to support the question of prohibiting specific a limited subset of MBS, and so profitability of a corporate but which investment authorities. Sixty-three references to MBS, and not MRS, are will be continuously and adequately supported some prohibitions, while 31 appropriate in the corporate rule.52 Of supported by the corporate’s capital. did not. The NCUA Board concurs with course, a corporate may not invest in Sufficient capital prevents losses from the commenters that some investment any MBS, or any other ABS, unless the adversely affecting corporate members types that are permissible under the security satisfies the other requirements and the entire credit union industry. As current regulation are not appropriate of part 704, including the minimum illustrated in more detail in subsection for corporate credit unions. Accordingly, the proposal amends NRSRO rating requirements and the III.E. below, the proposed revisions, had paragraph 704.5(h) to prohibit corporate prohibitions on certain investments, they been in place prior to 2007, would credit unions from making investments such as strips, residuals, CDOs, and have significantly reduced the current in collateralized debt obligations and NIMs. 12 CFR 704.5(h). losses in the corporate system. net interest margin securities. Expanded Investment Authorities NCUA believes that placing Collateralized debt obligations (CDOs) restrictions on investment authorities are defined in § 704.2 as a debt security The current part 704 provides that without concomitant limits on asset- collateralized by mortgage- and asset- corporates that meet certain liability management could still result backed securities or corporate requirements may qualify for expanded in corporate credit unions assuming obligations in the form of loans or debt. investment authorities. Those expanded excessive risk positions. Accordingly, Net interest margin securities (NIMs) are authorities, currently labeled as Base- members of the public are encouraged to defined in § 704.2 as securities plus, Part I, Part II, Part III, Part IV, and consider the combined effects of the collateralized by residual interests in (1) Part V, are described in Appendix B of revised investment and asset-liability collateralized mortgage obligations, (2) part 704. Base-plus expanded authority management authorities and restrictions real estate mortgage investment permits slightly greater declines in NEV when submitting comments to NCUA. conduits, or (3) asset-backed securities. when subjected to interest rate shocks. In addition to the amendments to part Residual interests are further defined in Part I expanded authority allows for the 704 investment authorities, NCUA also § 704.2 as the ownership interest in purchase of certain investments with intends to revise corporate credit union remainder cash flows from a CMO or lower NRSRO ratings, provides for reporting requirements on the 5310. The ABS transaction after payments due additional categories of permissible goal of the additional reporting bondholders and trust administrative investments, and permits greater requirements will be for readers to have expenses have been satisfied. declines in NEV when subject to interest a clear and comprehensive view of the Both CDOs and NIMs have rate shocks. Part II expanded authority financial condition of corporate credit concentrated risk attributes (i.e., they is similar to Part I, but provides even unions. Likely additions and are highly leveraged by design) and more leeway. Parts III, IV, and V relate modifications to the current 5310 will complex cash flow rule structures that to foreign investments, derivative include: (1) Credit ratings and sector make them susceptible to excessive transactions, and loan participation concentrations by book and market losses. These high-risk investments are authority, respectively. value; (2) average lives and durations, also inherently less liquid and more The ANPR sought comments on the spread and effective, of a corporate price volatile than other investments continued need for expanded credit unions assets and liabilities; and backed by similar collateral, making authorities for corporate credit unions. (3) additional disclosure on pricing them inappropriate investments for Of the 164 commenters who discussed sources and pricing level. corporate credit unions. the topic of expanded authorities, 110 Although Re-REMICs are technically deemed expanded authorities Section 704.5 Investments collaterized debt obligations, the appropriate and necessary for corporate The current § 704.5 describes proposal excludes senior tranches of Re- credit unions, while 54 commenters permissible corporate investments and REMICs consisting of senior mortgage- the limits on those investments. and asset-backed securities from the 52 Natural person federal credit unions may invest in MRS, as permitted by 12 U.S.C. 1757(15), but are Corporate investment authority is CDO definition. Accordingly, these Re- generally not permitted to invest in ABS or MBS somewhat different than the investment REMICs, which do not have the that are not also MRS.

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thought the expanded authorities of, Base-plus and Part I authority, and IV, respectively. Also, a corporate that should be reduced or eliminated. eliminates the current Part II authority. currently qualifies for a particular Seventy-five of these commenters To qualify for Part I authority, the expanded authority may continue to use discussed whether NCUA should proposal adds a requirement that a that authority without seeking change the eligibility requirements and/ corporate achieve and maintain a requalification if the corporate meets the or require periodic requalification for leverage ratio of at least six percent, new requirements in the final rule. For expanded authorities, with 68 meaning that its tier 1 capital, divided Parts I and II, those new requirements commenters favoring changes and seven by its moving DANA, must equal or include a six percent minimum total opposed. exceed six percent. capital ratio, and, one year after Many commenters opposed to Part I currently permits investments publication of the final rule in the expanded authorities suggested that with lower NRSRO ratings, and, to Federal Register, a six percent reliance on the authorities is a large control for credit risk, proposed minimum leverage ratio. paragraph (e) limits the aggregate contributor to the current problems Investments in Investment Companies facing corporate credit unions. Many of investments purchased under the these commenters believe the authority of Part I to the lower of 500 Paragraph (f) currently permits a authorities are no longer beneficial or percent of capital or 25 percent of corporate credit union to invest in an necessary. Other commenters argued assets. Paragraph (b) of Part I also investment company registered with the that the current economic problems currently permits qualifying corporates Securities and Exchange Commission confronting the corporate system were to engage in repurchase and securities under the Investment Company Act of not, in fact, caused by reliance on lending agreements in an amount up to 1940 where the prospectus restricts the expanded authorities. 300 percent of capital with any one investment portfolio to investments and counterparty, but the proposal removes Supporters of expanded authorities investment transactions that are this provision, thus limiting all such noted that corporates must be allowed permissible for that corporate credit transactions to 200 percent of capital. 12 to earn a return on their investments union to engage in directly. The CFR 704.6(c)(2)(i). proposal amends the paragraph to above their cost of funds and the use of The current rule further also provides expanded authorities, when properly permit investment in collective that, as part of the interest rate shock investment funds maintained by a done, facilitates this level of return and test, a Part I corporate’s NEV may benefits the entire credit union system. national bank or a decline as much as 28 percent if the subject to the same requirement that the Some of these commenters suggested corporate has a minimum capital ratio that NCUA should consider even fund limit its investment and of at least five percent and as much as investment transactions to those that are broader investment authorities for 35 percent if the corporate has a corporate credit unions. These permissible direct investments for minimum capital ratio of at least six corporates. commenters argue that the current percent. The proposal, after a 12 month limits on corporate credit union phase-in, replaces the capital ratio with Miscellaneous Revisions to Investment investment authority require a corporate the new leverage ratio, and replaces 5 Definitions to overexpose itself to securities backed and 6 percent with 7 and 8 percent, The proposal contains several by mortgages, auto loans, and credit respectively. The proposal makes miscellaneous revisions, and additions, card receivables, which forces similar changes to Part I authority with to the investment definitions. concentration into the same products regard to the new Asset-Liability NEV The proposal adds a definition of that natural person credit unions are test, discussed further in connection Nationally Recognized Statistical Rating exposed to and increases risk with the amendments to § 704.8 below. Organization (NRSRO) that recognizes throughout the credit union industry. The proposal also eliminates Part II that NRSROs are designations made by Many of those supporting the authority (which permits investments the United States Securities and continuation of expanded authorities down to the lowest investment grade) in Exchange Commission. The proposal stated that NCUA should adopt stronger its entirety. In the past, corporates did amends the definitions of derivatives capital requirements and more not use much of the Part II authority contract, equity investment, and equity conservative concentration limits to they had, and those corporates that did security so that they stand alone without help manage the associated risks. use the authority generally used it only external cross-references. The proposal Additional suggestions included to continue to hold downgraded eliminates references to regular way enhanced safety and soundness investments and avoid divestiture. settlement, and the definition of that oversight, establishment of education Prices of securities also tend to drop term, in favor of a simpler reference to and experience standards for corporate precipitously once an investment’s investment settlement. The proposal staff who oversee investments, and credit rating falls to non-investment amends the definition of residual ongoing requalification of corporates grade, so it is prudent to avoid the threat interest to clarify that it represents the that have been approved for expanded that a further single credit category ownership interest in certain cash flows. authority. Commenters strongly downgrade might lead to additional Section 704.6 Credit Risk Management supported risk-based capital levels impairment of asset values. commensurate with any additional The proposal also modifies the The current § 704.6 includes a single investment risk associated with the use current Part IV authority on derivatives obligor concentration limit. The rule of expanded authorities. to ensure that corporates do not use also requires that a corporate have a The NCUA Board agrees that derivatives to take on additional risk, credit risk management policy that expanded authorities for corporate but only use derivatives to mitigate addresses certain concentrations of risk, credit unions do offer benefits to the interest rate and credit risk or to create but does not dictate sector entire credit union system. The Board structured products equivalent to what concentrations. Additionally, the does, however, believe stronger controls a corporate could purchase directly. current rule requires that all corporate in this area are appropriate. Due to the elimination of Part II, the investments, other than in another Accordingly, the proposed rule revises proposal renumbers the current Parts III, corporate or a CUSO, have a credit the qualification criteria, and elements IV, and V authorities as Parts II, III, and rating from at least one NRSRO of no

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lower than AA—for long term ratings The maximum amount of a various portfolio mixtures and changing and A–1 for short term ratings. corporate’s investment in each of these market factors. While the limits allow There was strong support among the ten sectors is limited to a certain for significant portions of the ANPR commenters for additional multiple of capital: Either the lower of investment portfolio to be placed in a regulation of concentration limits. 500 percent of capital or 25 percent of specific asset type, they are restrictive Seventy-nine of 89 commenters favored assets, or the lower of 1,000 percent of enough to force any particular corporate adoption of stronger concentration capital or 50 percent of assets. In to hold multiple asset types at all times. limits. Some commenters, however, formulating the proposed sector These sector concentration limits— expressed concern about the possibility concentration limits, the Board when combined with the tighter single that sector limits could actually force considered various factors. For example, obligor, short weighted average life, and corporates to over-diversify into the the Board wanted to ensure adequate limited subordinated securities more risky sectors and thus increase diversification of investments across a restrictions—substantially reduce the risk. range of asset types considered threat of excessive credit risk to The current rule generally limits appropriate for the stable liquidity, NEV corporate earnings and capital. investments in any single obligor to 50 and capital levels expected to be The Board invites comment on percent of capital or $5 million, maintained by corporates. The Board whether there should be additional whichever is greater. 12 CFR 704.6(c). also wanted to ensure, however, that the concentration sublimits in any of these The proposed rule reduces this 50 sectors and sector limits did not force a sectors. For example, the Board is percent single obligor limit to 25 corporate to ‘‘overdiversify.’’ In other interested in whether it should impose percent. words, the Board wanted to permit a further limits on corporate debt The Board believes the current, corporate to concentrate in two or three obligations by industry of the obligor. general limit of 50 percent of capital is less risky sectors, or to avoid investing In addition to the 1,000 percent of too high and presents excessive in certain sectors altogether, if that was capital or 50 percent of assets for potential risk to corporate credit unions. the corporate’s desired course of action. registered investment companies (i.e., The 25 percent limit encourages risk Accordingly, the rule places a lower mutual funds), the corporate must diversification, alleviates excessive of 1,000 percent of capital limitation or identify the underlying assets in each concentration of risk exposure with any 50 percent of assets on each of these fund. The corporate must then one obligor, and protects corporate three sectors: corporate debt obligations, categorize each asset into one of the credit unions’ ongoing ability to serve as municipal securities, FFELP student other nine sectors and include those liquidity providers. loan asset-backed securities, and assets when calculating compliance The Board also believes that the registered investment companies, and with those sector limits. If current data current rule has not resulted in effective places a more restrictive limit of the on the underlying assets is not readily corporate policies on sector investment lower of 500 percent of capital or 25 available, the corporate can use the most concentrations. Accordingly, the percent of assets on the other sectors. recent available data. Also, a corporate proposed rule adds a new paragraph The higher limits for corporate debt may only invest in a registered 704.6(d) establishing explicit regulatory obligations and municipal securities investment if the fund’s prospectus concentration limits by discreet allow a corporate the flexibility and limits the fund to investments otherwise investment sector. option to invest away from securitized permissible for direct corporate The proposed sector concentration bonds, if they choose to do so. The investment. limits are divided into ten asset classes: higher limit for FFELP student loan The proposal also includes a catchall (1) Residential mortgage-backed asset-backed securities is appropriate sector in paragraph 704.6(d)(2). A securities; (2) commercial mortgage- since the U.S. Department of Education corporate credit union must limit its backed securities; (3) Federal Family reinsures a vast majority of the aggregate holdings in any investments Education Loan Program (FFELP) underlying student loan balances. The that do not fall within one of the ten student loan asset-backed securities; (4) lower of 500 percent of capital limits or sectors above to the lower of 100 private student loan asset-backed 25 percent of assets for the remaining percent of capital or five percent of securities; (5) auto loan/lease asset- sectors ensure that a corporate has assets. To provide flexibility for the backed securities; (6) credit card asset- prudent diversification when investing development and use by corporates of backed securities; (7) other asset-backed in non-government securities. Both USC new investment types, the NCUA may securities; (8) corporate debt obligations; and WesCorp, the two conserved approve a higher limit in appropriate (9) municipal securities; and (10) corporates, would have had cases. registered investment companies. The substantially less losses if non- The proposal excludes certain assets proposal also adds several related government residential mortgage-backed entirely from both the proposed sector definitions to § 704.2. Mortgage-backed securities had been limited to the lower concentration limits and the single security (MBS) means a security backed of 500 percent of capital or 25 percent obligor concentration limit, including by first or second mortgages secured by of assets, working in conjunction with fixed assets, loans, investments in real estate upon which is located a the proposed subordinated security CUSOs, investments issued by the dwelling, mixed residential and limitations prior to 2007. The United States or its agencies or its commercial structure, residential hypothetical effect of this concentration government sponsored enterprises, and manufactured home, or commercial limit, and other aspects of the proposed investments fully guaranteed or insured structure. Commercial MBS means an rule, on U.S. Central’s and WesCorp’s as to principal and interest by the MBS collateralized primarily by multi- historical balance sheets is discussed in United States or its agencies. family and commercial property loans. more detail in subsection III.E. below. Investments in other federally-insured Residential MBS means an MBS Sector concentration limits ensure credit unions, deposits in other collateralized primarily by residential that the composition of the investment depository institutions, and investment mortgage loans. The proposal also portfolio is consistently more repurchase agreements are also modifies the existing definition of asset- diversified across various asset types. excluded from the sector concentration backed security (ABS) to clarify that, The asset classes and concentration limits but not the single obligor generally, MBS are a type of ABS. limits are necessarily broad to allow for concentration limit.

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The proposal amends paragraph explained in greater detail in subsection establish an asset and liability 704.6(d)(4), renumbered to 704.6(f)(5), III.E. below. management committee, charge a to clarify that if any investment group The current paragraph 704.6(d) market-based penalty on early or asset class fails the single obligor, or provides that all corporate investments, withdrawals sufficient to cover sector, concentration limit, at the time other than in a corporate credit union or replacement cost of a redeemed of purchase or after the time of CUSO, must have an applicable credit certificate, adopt a written ALM policy purchase, then all the investments of rating from at least one nationally that includes modeling for interest rate that obligor, or in that asset class, are recognized statistical rating organization risk (IRR) sensitivity and affect on net subject to the investment rule’s (NRSRO). Many ANPR commenters economic value (NEV), and assess on an investment action plan requirements. 12 expressed support for decreased annual basis whether the corporate CFR 704.10. Although the new sector reliance on NRSRO ratings, with 89 of should do additional NEV modeling. 12 concentration limits and changes to the 122 commenters in favor of tighter CFR 704.8. single obligor concentration limit are regulation in this area. Some of these The ANPR proposed a number of effective immediately, they will not commenters suggested requiring a possible actions to further reduce the require automatic divestiture of any consensus of three NRSROs, and some level of risk in corporate credit union existing asset held by a corporate credit suggested requiring that ratings only be balance sheets, including the union on the effective date of the rule. used for the purpose of excluding implementation of cash flow duration Accordingly, the Board does not believe investments, not including them, in an requirements and additional, mandatory that corporate credit unions need a investment portfolio. stress testing. Of the 104 comments transition period before the sector The Board believes that credit ratings directed to this issue, 94 supported concentration limits become effective. constitute potentially useful information some action in this area. The NCUA In addition to the new obligor and about credit risk, but expects corporates Board generally agrees with these sector concentration limits, the proposal to avoid reliance on individual ratings commenters and is proposing several adds a new paragraph 704.6(e) that or NRSROs as a primary criterion of new ALM requirements in an effort to further limits a corporate’s investments purchase suitability. Several provisions better identify, measure, monitor and in subordinated securities. Holders of of this proposal act to reduce the effect control future risk. subordinated debt are accorded a low of NRSRO reliance, including the new sector concentration limits and the Maximum Redemption Value for Share priority in the event of insolvency and Certificates liquidation. Subordinated securities limits on subordinated securities, discussed above, and the restrictions on While not specifically addressed in present greater credit risk, liquidity risk, average-life mismatches discussed later the ANPR, the Board recognizes the price volatility, and ratings volatility in this section. need for more stability within the than more senior securities. All these The proposal also amends the current liabilities on a corporate credit union’s factors combine to make any significant paragraph 704.5(d), and renumbers it as balance sheet. While the current rule concentration in subordinated securities 704.5(f), to place two new, specific requires market-based early withdrawal inappropriate for a corporate’s portfolio. limits on the use of NRSROs. First, the penalties, the liquidity problems faced Accordingly, the proposal limits a proposal requires a corporate use the by corporates can be exacerbated by corporate’s aggregate investment in lowest available NRSRO rating for permitting members to redeem subordinated securities to the lower of compliance purposes. NRSRO rating certificates a premium, that is, a price 400 percent of capital or 20 percent of changes may lag changes in the higher than book value. Accordingly, assets and the amount of subordinated financial condition of the entity or the proposal amends paragraph 704.8(b) securities in any single asset sector to instrument being rated, particularly in to permit redemption at the lesser of the lower of 100 percent of capital or 5 the case of downgrades, and so the book value plus accrued dividends or percent of assets. corporate should be required to respond the value based on a market-based The proposal includes the following to the first such NRSRO downgrade. penalty sufficient to cover the estimated definition of subordinated security to Second, the proposal requires that a replacement cost of the certificate § 704.2: minimum of 90 percent of a corporate’s redeemed. Subordinated security means a security investment holdings, by book value, that has a junior claim on the underlying Limiting the Average-Life Mismatches must be rated by at least two NRSROs. Between Assets and Liabilities collateral or assets to other securities in the This will ensure ratings diversification, same issuance. If a security is junior to only will further reduce reliance on To the extent that a corporate to money market fund eligible securities in individual NRSROs, and will result in a maintains a mismatch between the the same issuance, the former security is not average life of its assets and liabilities, subordinated for purposes of this definition. more timely identification of credit problems with particular investments. it becomes exposed to several forms of This definition covers all support The proposal also requires that a market risk. A corporate credit union tranches, including senior mezzanine corporate monitor any new post- that buys floating rate securities may tranches. The definition also includes purchase NRSRO ratings on investments have minimal exposure to changes in securities with performance ‘‘triggers’’ it holds. the level of the Treasury yield curve but that could cause the security to assume Finally, the proposal requires that a may have significant risk exposure to a junior claim position. corporate address, in its policies, the changes in credit spreads (a change in The proposed limitations on treatment of concentration risk related yields on non-Treasury instruments subordinated securities, working in to servicers of receivables, collateral relative to market Treasury yields). For conjunction with the proposed sector type, and tranche priority. example, when a depository invests its limitations on non-government assets in a long-term, floating rate residential MBS, would have—assuming § 704.8 Asset and Liability security rather than in a short-term both limits had been in effect prior to Management security, and the depository is funded 2007—prevented a substantial amount The current § 704.8 contains several with overnight deposits, it is exposed to of the current MBS losses experiences asset-liability management (ALM) additional credit spread risk whenever by U.S. Central and WesCorp. This is provisions. The rule requires a corporate the market spread relationship on that

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instrument changes vis-a`-vis Treasury its absolute NEV and the volatility of its mismatches as a corporate’s base case securities. Short of default, the price NEV (how much NEV changes for a NEV level moves higher, just as with the decline of a long-term security is likely given stress) in a manner similar to the current IRR NEV modeling. to be greater than that of a short-term current § 704.8(d) IRR NEV modeling. The proposed rule employs a security, given a deteriorating credit Specifically, a corporate must limit its conservative approach when NEV outlook for the issuer. risk so that, when the spread widening testing for dealing with assets and The Board intends to restrict any shock is applied, its NEV ratio does not liabilities with embedded options. The mismatch between the principal cash decline below 2 percent and the NEV rule imposes conservative treatment of flows of assets and liabilities so as to itself does not decline more than 15 non-mandatory issuer options, i.e., limit the degree of credit spread percent. The proposal specifies that all issuer call options, by assuming they are duration to which a corporate credit investments must be tested, excluding not exercised. Additionally, the union is exposed. In lieu of capturing derivatives and equity investments, and proposed rule balances this conservative the repricing risk, the Board decided to that all borrowings and shares must be approach against the lack of a limit the base case average-life tested, but not contributed capital. requirement for a corporate to shorten mismatch between assets and liabilities The proposed rule will also add a new liabilities based on anticipated or as well as the change in base case paragraph 704.8(f) with a separate potential early redemption of share mismatch for given changes in market spread widening test that assumes a 50 certificates. The NCUA, however, will spreads. percent slowdown in prepayment Net economic value (NEV) has be monitoring the issuance of liabilities speeds. This additional test will force a traditionally been used by the NCUA to with long maturities and short calls to corporate to structure its assets and measure interest rate risk (IRR) on a determine if they are issued to liabilities so that, when the spread corporate credit union’s balance sheet. manipulate NEV measures and may, widening shock is applied, its NEV ratio NCUA adopted the IRR NEV among other things, mandate a greater does not decline below 1 percent and measurement requirement in response capital requirement. See the proposed to excessive interest rate risks taken in the NEV itself does not decline more § 704.3(e). the early to mid 1990’s by corporate than 25 percent. This additional test New paragraphs (e)(2) and (f)(2) also credit unions. IRR NEV proved to be an will help determine if a potential require corporates to measure the effect effective tool of measuring interest rate extension of a corporate’s average life that failed triggers, e.g., delinquency risk during periods of relative asset mismatch is within an acceptable limit. triggers and cumulative loss triggers, price stability, prior to mid-2007, while For example, consider a corporate have on average-life NEVs. Many non- providing a less effective measurement with a five percent base case NEV. government mortgage-backed securities, of credit spread risk when market values Applying the § 704.8(e) base AL NEV and other securitized securities, redirect of assets suffered from the systemic test, the proposed regulatory limits— cash-flows if delinquencies or losses shock that began in mid-2007. that is, that the NEV ratio not decline increase to a predetermined level Accordingly, the Board is now below two percent and the NEV itself because of a failed trigger. The effects of proposing a new paragraph 704.8(e) to not decline more than 15 percent—will the redirected cash-flows should be require average life (AL) mismatch NEV permit this corporate to operate with an measured and understood by corporate modeling in addition to the existing IRR approximate average-life mismatch of credit unions. up to 0.25 years. Applying the § 704.8(f) NEV modeling. The new AL NEV Below are two examples that illustrate AL NEV test with its 50 percent modeling will help ensure appropriate both the current IRR NEV calculation slowdown in prepayment speeds, the matching of asset and liability cash-flow and the proposed, new average life (AL) proposed regulatory limits—that is, that durations. NEV calculation using a simplified Proposed paragraph 704.8(e) requires the NEV ratio not decline below 1 corporate balance sheet. These examples an AL NEV stress test to measure the percent and the NEV itself not decline are intended to provide the reader with economic impact on capital resulting more than 25 percent—will permit this a better understanding the current and from a credit spread widening of 300 bp. corporate an additional mismatch proposed rules. These spread increases would be extension of up to 0.2 years. These applied to both assets and liabilities. proposed AL NEV tests, of course, are Sample Corporate Credit Union ‘‘A’’ The corporate will examine the effect on designed to permit greater average-life Balance Sheet 53

Weighted average life Modified Par value Market value (years) duration

Assets: Private Label MBS (2) ...... 2 0.083 $1,000,000 $1,000,000 ABS (3) ...... 1.5 0.8 2,000,000 2,000,000 Corporate Bonds & Member Loans (3) ...... 1.5 0.90 3,000,000 3,000,000 Cash and Cash Equivalent Investments (1) ...... 0.1 0.1 3,850,000 3,850,000 Capital Instruments (PCC or NCA) (2) ...... 3 0.083 50,000 50,000 Property ...... N/A N/A 50,000 50,000 CUSO Equity ...... N/A N/A 50,000 50,000

53 This is a simplified balance sheet and simplified examples. Each corporate credit union will likely, depending on its particular balance sheet, need to employ more granular information and sophisticated modeling.

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Weighted average life Modified Par value Market value (years) duration

Total (Capital Notes and Property not included in WAL and dura- tion) ...... 1.01 0.48 10,000,000 10,000,000

Liabilities: Overnight and Short-Term Deposits (1) ...... 0.1 0.1 7,500,000 7,500,000 Long-Term Certificates (1) ...... 1.0 0.95 1,500,000 1,500,000 Borrowings (2) ...... 2.0 0.24 450,000 450,000

Total ...... 0.34 0.24 9,500,000 9,500,000

Base Case NEV ...... 500,000 Capital Instruments (PCC or NCA) (2) ...... 3 0.083 50,000 50,000 Retained Earnings ...... N/A N/A 450,000 450,000 1—Fixed Rate, 2—Floating Rate, and 3—both Fixed and Floating Rate.

The sample balance sheet is for a minus 100, 200, and 300 bp on its IRR than 15 percent (expanded authorities corporate credit union with NEV ratio NEV ratio and IRR NEV volatility. allow for greater NEV volatility). A (base case NEV/Fair market value of Corporate credit unions must consider corporate credit union must also assets) of 5 percent. The current IRR the effects on prepayment speeds when include the effects of interest rate NEV requires the corporate credit union performing the rate shocks. Results of derivative exposure when performing to evaluate the impact of an the rate shocks must not result in NEV the rate shocks. instantaneous, permanent, and parallel ratio declining below 2 percent or a Corporate Credit Union A: 300 bp shock of the yield curve of plus and decline of NEV (NEV volatility) of more Increase in Interest Rates

Weighted average life Modified Par value Market value (years) duration

Assets: Private Label MBS (2) ...... 3.00 0.083 $1,000,000 $997,510 ABS (3) ...... 1.70 0.900 2,000,000 1,946,000 Corporate Bonds & Member Loans (3) ...... 1.50 0.900 3,000,000 2,919,000 Cash and Cash Equivalent Investments (1) ...... 0.10 0.100 3,850,000 3,838,450 Capital Instruments (PCC or NCA) (2) ...... 3.00 0.083 50,000 49,876 Property ...... N/A N/A 50,000 50,000 CUSO Equity ...... N/A N/A 50,000 50,000

Total (Capital Notes and Property not included in WAL and dura- tion) ...... 1.16 0.500 10,000,000 9,850,836

Liabilities: Overnight and Short-Term Deposits (1) ...... 0.10 0.10 7,500,000 7,477,500 Long-Term Certificates (1) ...... 1.00 0.95 1,500,000 1,457,250 Borrowings (2) ...... 2.00 0.24 500,000 496,400

Total ...... 0.34 0.24 9,500,000 9,431,150

+300 Basis Point NEV ...... 419,686 Capital Instruments (PCC or NCA) (2) ...... 3.00 0.083 50,000 50,000 Retained Earnings ...... N/A N/A 450,000 450,000 1—Fixed Rate, 2—Floating Rate, and 3—both Fixed and Floating Rate.

In the example above, Corporate A is The plus 300 bp shock above assumed shares, certificates, and borrowings. A shocked with a 300 basis point (bp) that prepayment speeds for amortizing 300 basis point credit spread widening, increase in interest rates. Its IRR NEV securities would slow in an up rate as opposed to changes in interest rates, ratio falls to 4.26 percent ($419, 686/ scenario. The slowdown in prepayment is used to shock the portfolio and $9,850,836) and the plus 300 basis point speeds would account for the extended determine if the average life mismatch IRR NEV volatility is 14.80 percent average lives and durations in the MBS between assets and liabilities is ([5.00% ¥ 4.26%]/5.00%). Corporate A and ABS holdings. excessive for the corporate credit would have been within regulatory The proposed AL NEV measure uses union’s base net economic value. The compliance since its IRR NEV ratio still the framework of the IRR NEV, but proposal requires that the spread exceeds 2 percent and its NEV volatility modifies it to measure and limit the widening not result in NEV ratio was lower than 15 percent. mismatch of average lives of the assets declining below 2 percent or the NEV and liabilities related to a corporate’s volatility of more than 15 percent

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(expanded authorities allow for greater a 50 percent slowdown in prepayment Corporate Credit Union A: 300 bp IRR NEV volatility). The proposal also speeds to determine if a corporate has Spread Widening requires a secondary AL NEV test with excessive average life extension risk.

Weighted average life Modified Par value Market value (years) duration

Assets: Private Label MBS (2) ...... 2.00 0.083 $1,000,000 $943,600 ABS (3) ...... 1.50 0.80 2,000,000 1,915,200 Corporate Bonds & Member Loans (3) ...... 1.50 0.90 3,000,000 2,872,700 Cash and Cash Equivalent Investments (1) ...... 0.10 0.10 3,850,000 3,838,450 Capital Instruments (PCC or NCA) (2) ...... N/A N/A 50,000 50,000 Property ...... N/A N/A 50,000 50,000 CUSO Equity ...... N/A N/A 50,000 50,000

Total (Capital Notes and Property not included in WAL and dura- tion) ...... 1.01 0.48 10,000,000 9,719,950

Liabilities: Overnight and Short-Term Deposits (1) ...... 0.10 0.10 7,500,000 7,477,500 Long-Term Certificates (1) ...... 1.00 0.95 1,500,000 1,457,250 Borrowings (2) ...... 2.00 0.24 450,000 425,000

Total ...... 0.34 0.24 9,500,000 9,359,750

+300 Basis Point NEV ...... 360,200 Capital Instruments (PCC or NCA) (2) ...... 3.00 0.083 50,000 50,000 Retained Earnings ...... N/A N/A 450,000 450,000 1—Fixed rate, 2—Floating Rate, and 3—both Fixed and Floating Rate.

In the example above, we see that, because they do not have principal cash declines sharply due to external market after a 300 bp spread widening, flows. Capital instruments are also shocks. Accordingly, the proposal adds Corporate A’s AL NEV ratio is 3.71 excluded from AL NEV calculations a new paragraph 704.8(g) requiring NII percent ($360,200/$9,719,950) and its unless the associated cash inflows or modeling. Corporates must model NII at AL NEV volatility is 25.80 percent outflows have a fixed date, i.e., they are least once each quarter, using multiple ([5.00% ¥ 3.71%]/5.00%). So Corporate without rolling or perpetual maturities. interest rate environments extended A would have been within regulatory The Board specifically invites over a period of at least two years. compliance with regard to its AL NEV comment on the proposed AL NEV Two-Year Average Life ratio, but the corporate would have limits as well as the assumptions used failed the AL NEV volatility portion of by NCUA in creating the hypothetical In addition to the proposed spread the proposed requirement. corporate portfolio used to model the widening and NII modeling, the Board This secondary AL NEV measurement effect of those limits. is proposing a new paragraph 704.8(h) that assumes a 50 percent slowdown in that will limit the weighted average life Net Interest Income Modeling prepayment speeds helps model the (WAL) of a corporate’s assets to two effect of extension risk on the average The ANPR asked about additional years. A corporate credit union must life mismatches between assets and testing by corporate credit unions to test its assets at least once a month for liabilities. Slower prepayment speeds ensure adequate monitoring of the compliance with this WAL limitation will extend securities that amortize impact of changing market conditions and report noncompliance to the NCUA based on the payments of the on the overall balance sheet. For immediately. In calculating its average underlying collateral. Securities with example, the ANPR asked about net life, the proposal requires that a more sensitivity to changes in interest income (NII), that is, the corporate assume that issuer options prepayment speeds will suffer greater difference between a corporate’s will not be exercised. declines in value when applying the revenues on its assets and the cost of The Board believes that an excessive spread widening and prepayment speed servicing its liabilities, and how NII is asset average life is inconsistent with a slowdown, all else being equal. The affected by changing interest rates. A corporate’s primary mission and proposal permits additional volatility in large majority of commenters who subjects the corporate to unnecessary this particular AL NEV test, from 15 addressed this issue supported risks. The Board proposes to use a two percent to 25 percent (expanded incorporating NII modeling into the year limit because that should give authorities allow for greater AL NEV corporate rule. corporate adequate flexibility to manage volatility in the 50 percent slowdown in The Board believes that NII modeling their business while maintaining a risk prepayment speed measure), and also adds an additional, needed profile consistent with the corporate allows for a lower minimum NEV ratio measurement of projected future mission. requirement of 1 percent. earnings in multiple interest rate Calculation of Duration at the These new AL NEV measurements, scenarios. Proper and realistic NII Individual Asset/Liability Level unlike the IRR NEV measurement, do modeling will assist corporate not include the effect of interest rate management with its budgeting process The proposal adds a new paragraph derivatives and capital note assets. and will provide an interest rate risk 704.8(i) that requires a corporate Interest rate derivatives are excluded measurement tool if base case NEV calculate the effective duration and

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spread duration for each of its assets The proposal treats violation of the sources of internal and external and liabilities where the values of these two-year average asset life requirement, liquidity and that they keep a sufficient are affected by changes in interest rates and the NII testing requirement, in a amount of cash and cash equivalents on or credit spreads. While the NEV tests similar fashion. Violations that persist hand to support their payment systems described above implicitly require such for ten or more days must be reported obligations. calculation at the individual asset or as described above, and violations that The current rule places the following liability level, the Board believes it persist for 30 or more days require the aggregate limitation on corporate important to state this requirement submission of an action plan to NCUA borrowing: explicitly. This information about and a potential downgrade in PCA A corporate credit union may borrow up to individual assets and liabilities will capital category. 10 times capital or 50 percent of shares enable the credit union’s auditors, board Limitations on Investments From Single (excluding shares created by the use of of directors, and NCUA examiners to member reverse repurchase agreements) and Member or Other Entity determine if the corporate is performing capital, whichever is greater. CLF borrowings these granular calculations correctly, The Board is concerned about risks to and borrowed funds created by the use of particularly for those assets and both individual corporates and member reverse repurchase agreements are liabilities that have embedded individual natural person credit unions excluded from this limit * * *. optionality resulting in more complex that arise from placing undue reliance 12 CFR 704.9(b). The proposal calculations. on a single entity. For example, if a modifies this aggregate limit to restrict corporate relies too heavily on corporate borrowing to the lower of ten Violations of NEV and NII Tests or investments from one member, that times capital or 50 percent of capital Limits on Average Life of Assets member might decide to remove its and shares. Proposed paragraph 704.8(j) has funds which could cause severe The Board also believes that specific requirements pertaining to liquidity problems at the corporate. corporates should be limited in their violations of the NEV and NII testing Similarly, if a natural person credit ability borrow on a secured basis for and the requirement to maintain an union (NPCU) has too much money other than liquidity purposes. As average asset life of two years or less. invested in a particular corporate, the demonstrated by recent events, secured If a corporate’s decline in NEV, base NPCU is exposed to credit risk and, borrowing can create additional risks for case NEV ratio, or any other NEV ratio potentially, liquidity risk from that lack the corporate and the NCUSIF. Secured resulting from the IRR and AL NEV tests of diversification. lenders require collateral to be valued at in 704.6 violates the associated Accordingly, the proposal adds a new market and they impose an additional regulatory limits, and the corporate paragraph (k) to § 704.8 that prohibits haircut (margin) to ensure the borrowing cannot adjust its balance sheet so as to the corporate from accepting from a is fully and continuously collateralized. satisfy those limits within ten calendar member or other entity any investment, Market shocks can create short-term days after detecting the violation, then including shares, loans, PCC, or NCAs, market values that are below long-term operating management of the corporate if, following that investment, the intrinsic values and which can magnify credit union must immediately report aggregate of all investments from that potential losses if collateral were to be this information to its board of directors, entity in the corporate would exceed ten seized and sold as permitted by the supervisory committee, and the NCUA. percent of the corporate’s moving daily lending agreements. If the corporate’s regulatory violation average net assets. The purpose of this Accordingly, the proposal permits persists for 30 or more calendar days, provision is to prevent a corporate from secured borrowing for nonliquidity the corporate must submit an action being too exposed to any particular purposes only if the corporate is well plan to NCUA and is also subject to PCA member or other entity in the event that capitalized, that is, its core capital reclassification. Immediately following the entity should suddenly decide to exceeds five percent of its moving the 30th day the corporate must submit reduce its investments in the corporate. DANA. The proposal further restricts a detailed, written action plan to the The concentration limit in proposed such borrowing to an amount equal to NCUA that sets forth the time needed paragraph (j) will not become effective the difference between the corporate’s and means by which the corporate for 30 months so as to allow affected core capital and five percent of its intends to correct the violation and, if corporates a deliberate and orderly moving DANA. the NCUA determines that the plan is transition. At the conclusion of this 30- Beyond the aggregate borrowing limit, unacceptable, the corporate must month phase-in, an affected entity may the proposal does not restrict the immediately restructure its balance not make new investments or new amount of secured borrowing a sheet to bring the exposure back within loans, or renew existing loans, or corporate may do for liquidity purposes. compliance or adhere to an alternative reinvest shares or dividends in the The proposal does, however, restrict the course of action determined by the corporate, if the aggregate of all the maturity of any secured borrowing for NCUA. If the corporate is currently entity’s investments in the corporate liquidity purposes to a maximum of 30 categorized as adequately capitalized or immediately following such a days. This maturity limit will not well capitalized for purposes of § 704.4 transaction would exceed the 10 percent preclude a corporate from renewing (prompt corrective action), the corporate limit. liquidity-related borrowings on a rolling will be immediately recategorized as § 704.9 Liquidity Management basis. undercapitalized until the violation is These limits on aggregate borrowing corrected. If the corporate is already in The corporate system provides and secured borrowing should help some undercapitalized category, the essential payment systems support to mitigate the consequences of future corporate will be reclassified as one many NPCUs, but the current corporate adverse market events for the corporates category lower. The corporate must rule says nothing about maintaining and the NCUSIF. comply with all the PCA provisions adequate liquidity to support the relating to undercapitalization until corporate’s payment systems III.D. Phase-in of Part 704 Capital and such time as the corporate demonstrates obligations. The proposal amends PCA Requirements to the satisfaction of the NCUA that the paragraph 704.9(a) to require that The Board understands that the regulatory violation is corrected. corporates demonstrate accessibility to proposed amendments to Part 704

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capital regulations are complex and that constitute a specified minimum part of weights in certain corporates. NCUA many corporates would not meet the core capital for purposes of the capital also made some assumptions with targets upon issuance of the final rule. ratios.54 Corporates will have several respect to the risk-weights of derivative Instead of an immediate methods, or combination of methods, to portfolios. An accurate risk-weight in implementation, the Board proposes to satisfy this new minimum leverage ratio these cases requires the assignment of a phase-in the new capital and PCA prior to the seventh anniversary, risk-weight at the transaction level. requirements over a ten-year period of including decreasing assets or Under the proposed capital standards, time. Most of the new provisions will be increasing PCC or retained earnings. only two of the 28 corporates would be effective after one year, the minimum Beginning with the sixth anniversary, considered well capitalized or leverage ratio requirement will become corporates will be subject to, and must adequately capitalized today, while 16 effective after three years, and the be in compliance with, the retained of 28 corporates would be considered provisions related to minimum retained earnings part of the various capital critically undercapitalized. Only two earnings will become effective in the ratios. Most importantly, the corporates corporates would currently meet the sixth through tenth years. This must have at least 100bp of retained minimum four percent leverage ratio subsection III.D. discusses the phase-in earnings to satisfy the adequately- requirement. and demonstrates how a hypothetical capitalized four percent minimum The 18 retail corporates that have zero corporate might, while complying with leverage ratio, and 150bp of retained retained earnings will face a significant the proposed investment and asset earnings to achieve a five percent challenge in meeting the four percent liability limitations described above, leverage ratio and be considered well leverage ratio requirement. At the end of generate sufficient earnings to meet the capitalized. Corporates can only achieve year six they will need to have retained capital requirements by the end of the this retained earnings requirement by earnings equal to 1.0 percent of DANA. phase-in periods. decreasing assets or increasing retained This will require earnings in the range None of the new provisions related to earnings. of 0.15–0.2 percent of DANA, capital and PCA will be effective for a In proposing this phase-in plan the depending on asset growth. This will period of one year following the Board analyzed (1) the current capital require adjustments to business plans publication of the final rule in the position of the various corporates, (2) and will limit the ability of these Federal Register. During this time the earning ability of the corporates, and corporates to grow. period, corporates must continue to (3) the impact and uncertainty NCUA created a number of scenarios comply with the existing § 704.3 capital associated with the existing, troubled for recapitalization of the corporate ratio requirement and its associated MBS (discussed further below). The system over this period. In all capital definitions, within the guidance Board believes this phase-in period will recapitalization scenarios, retained provided by NCUA. Also, while the encourage corporates to improve their earnings growth is critical, particularly Board will delay the effective date of the capital base without encouraging overly given the new investment and ALM proposed capital and PCA requirements, aggressive strategies to accumulate limitations contained in the proposal. the Board expects each corporate to retained earnings or solicit high cost The ability to grow retained earnings is begin calculating and reporting its new capital. The Board invites comment on so critical that, before proceeding with capital ratios upon publication of the the reasonableness of the proposed the capital phase-in discussion, it is final rule. phase-in plan and the following important to first discuss the ability of Beginning with the first anniversary analysis. a corporate to grow its retained earnings of the final rule publication corporates under the proposal. Results—Current Capital Positions will be subject to, and must be in Ability to Grow Retained Earnings compliance with, all of the new risk- NCUA analyzed each corporate’s Under the Proposed Investment and based capital provisions and PCA current capital under the proposed ALM Limitations provisions and their associated capital standards based upon 5310 data definitions. Between the first and third from August 2009. NCUA adjusted retail As discussed above, to be adequately anniversaries, the corporate will corporate credit union capital levels capitalized under the new capital rules continue to comply with the existing based on known losses at U.S. Central. will require a minimum leverage ratio of minimum total capital ratio in addition After this adjustment, 18 retail four percent (400 bp), consisting of a to the new risk-based capital ratios. The corporates have zero retained earnings. combination of PCC and retained proposal accomplishes this transition to Nine of the 18 face a complete earnings and measured in relation to the new leverage ratio by employing an elimination of PCC accounts and a 12-month DANA. One hundred of these interim definition of leverage ratio in partial elimination of existing NCA. 400 bp must, by the end of year six, § 704.2, from the first to the third Additional Other Than Temporary consist of retained earnings. While anniversaries, that tracks the current Impairment (OTTI) losses at U.S. NCUA believes it is essential to build rule’s minimum total capital ratio. Central may increase the number of retained earnings as a component of Corporates will have several methods, corporates that fall into this category. capital, it also considered whether this or combination of methods, to achieve In certain cases, the data in the prescribed target was reasonable and compliance with these new capital current 5310 reports do not contain the attainable. Accordingly, NCUA staff requirements prior to the third precision necessary to make an exact analyzed the ability of a hypothetical anniversary, including decreasing calculation. For example, the private corporate to obtain 100 bp of retained aggregate assets or portfolio risk or label mortgage securities lack details to earnings within six years (measured in increasing NCAs, PCC, or retained determine the precise risk-weight. relation to 12-month DANA). earnings. NCUA used 50 percent, but a portion of Assuming no retained earnings to Beginning with the third anniversary, these instruments will carry higher risk- start, and no asset growth, the corporate corporates will be subject to, and must would have to earn about 17 bp of net be in compliance with, the new leverage 54 Beginning on the third anniversary, corporates income each year to reach this target. that are not making adequate progress in ratio; however, corporates will not yet accumulating retained earnings will have to submit There are many variables that can need to comply with the additional a retained earnings accumulation plan, as described impact actual earning, and there will be requirement that retained earnings in proposed § 704.3(a)(3). variability in specific corporate credit

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unions’ abilities to meet this target. the minimum annual earnings necessary portfolio of investments adheres to the Nonetheless, NCUA determined that, to reach the retained earnings target. proposed limits for investment within reasonable assumptions for The table below presents a sample concentrations and weighted average future earnings and expenses, a corporate portfolio with one possible asset life (WAL).55 corporate credit union could generate investment mix. This particular

INVESTMENTS

Total weighted Sector Portfolio average life LIBOR/EDSF percentage (years) spread

FFELP Student Loan ABS ...... 20 1.000 25 Private Student Loan ABS ...... 10 0.500 200 Auto ABS ...... 20 0.600 25 Credit Card ABS ...... 10 1.000 30 Other ABS ...... 10 0.300 10 Overnight Investments ...... 30 0.003 0

Total ...... 100 0.501 34

In structuring this table, NCUA Wall Street contacts for mid-October In preparing this analysis, NCUA also estimated interest income from current 2009. assumed the following corporate investment market data. Additionally: • All ABS spreads are for AAA senior liabilities. Funding costs were bonds. approximated using a sample of current • Spreads were obtained from Wall • Overnight Investments include corporate credit union offerings. Street research, dealer offerings and excess Fed Reserves, Repo and Overnight Corporate Deposits.

LIABILITIES

Total weighted Type Total average life LIBOR/EDSF percentage (years) spread

Overnight Shares ...... 30 0.003 0 Term Certificates ...... 70 0.500 0

Total ...... 100 0.351 0

This liability mix, when combined PRO FORMA INCOME USING JANUARY– that can positively affect a corporate’s with the assets above and assuming the JUNE 2009 SYSTEM AVERAGES— ability to build retained earnings. For corporate has 4 percent NEV and total Continued example, a modest assumption of capital, also satisfies the proposed asset interest rate risk usually generates a liability cash flow mismatch sensitivity Percent stable and positive return. A slight test.56 mismatch between the modified As demonstrated in the two tables Other Income ...... 0.17 duration of assets and liabilities can above, this asset-liability mix is capable generate a source of positive spread Total Operating Income 0.51 between sources and uses of funds of generating a net interest income of 34 Total Operating Ex- bp a year under the limitations of the penses ...... 0.30 without creating an excessive exposure proposed regulation. Using June 2009 Net Income From Oper- of earnings or capital at risk or assuming corporate system averages for pro forma ations ...... 0.21 too much interest rate risk. Investments income and expenses would produce purchased during periods of upward the following net income from The pro forma income projections sloping yield curves (i.e., when longer operations: 57 above indicate that a corporate can, in maturities have a higher yield than fact, grow retained earnings at or above shorter maturities) usually generate PRO FORMA INCOME USING JANUARY– 20 bp a year and so achieve income additional earnings consistent with a JUNE 2009 SYSTEM AVERAGES from operations sufficient to build 100 modest level of interest rate risk. To the bp of retained earnings in five to six extent that the yield curve maintains its Percent years (assuming no asset growth). slope over the life of the investment, net In addition to the considerations interest income improves as investment Net Interest Income ...... 0.34 discussed above, there are other factors average lives shorten and the book yield

55 The investment concentration limits appear in of about 0.16 years (0.501 minus 0.351) equates to particular limit is discussed in more detail earlier proposed § 704.6(d). The two-year limit on about two months. At four percent NEV, this two- in this preamble. weighted average asset life appears in proposed month mismatch satisfies the requirement that the 57 NCUA derived the non-interest income and § 704.8(h). These limits are discussed in greater NEV ratio not decline below two percent, and the expenses from recent aggregate corporate system detail earlier in this preamble. percentage decline in NEV not exceed fifteen 5310 data. 56 The cash flow mismatch limit appears in percent, when spread widens 300 bp as specified proposed § 704.8(e). In the example, the mismatch in paragraphs 704.8(e)(1)(ii) and (iii). Again, this

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is higher versus current market yields Results: Projected Capital Positions zero growth beyond recapitalization for comparable securities with the same Having established that it is possible deposits, and annual earnings equal to remaining average life. This ‘‘roll down’’ for a corporate to fashion a balance 0.1 percent of DANA (10 bp). NCUA effect can also occur due to lower sheet that facilitates earnings growth also assumed that existing natural benchmark yields and/or tighter credit under the proposed investment and person credit unions would voluntarily spreads. Corporates also have some ALM limitations, NCUA used a mix of recapitalize the corporate system at pricing power in service pricing or earnings, growth, and capital historical rates of 0.4 percent of assets. dividends paid that can positively affect contribution assumptions to build 3. ‘‘C’’ Case Assumptions—NCUA the building of retained earnings. scenarios further analyzing the ability of assumed that natural person credit Conversely, there are factors that may corporates to reach adequate unions would not voluntarily negatively affect a corporate’s ability to capitalization by year seven. recapitalize the corporate system at The different mix types lead NCUA to build retained earnings. Future net historical rates. This scenario assumes four scenarios, entitled A through D (for that natural person credit unions would interest investment income may be analysis cataloging only). In all limit capital investments in the diminished by tighter credit spreads if scenarios, NCUA assumed that PCC and corporate system to 0.2 percent of a corporate doesn’t have the ability to NCA would be used only to the extent lower the dividend rates it pays, and an that they qualify for inclusion in the assets. In the case of U.S. Central, the inverted yield curve may also have proposed capital measures. In assumption was that other corporates negative implication on a corporate’s determining the pool of available PCC would invest in capital accounts at one- ability to build retained earnings. and NCA investments available, NCUA half of historical levels. In this scenario, Finally, NCUA realizes that some used an average asset size for natural DANA and risk-weighted assets were corporates may have difficulty at first in person credit unions and applied that to reduced by 4 percent of each year, and earnings are 0.2 percent of DANA. restructuring their existing portfolios to the number of current members in each meet the requirements of the new corporate. NCUA also assumed an equal 4. ‘‘D’’ Case Assumptions—NCUA regulation, particularly with regard to amount of PCC and NCA accounts in all assumed that corporates would have the new cash flow mismatch and WAL of the scenarios. zero growth beyond recapitalization limitations. NCUA has the authority, in The scenario assumptions and results deposits for the first 3 years. Annual are summarized below. appropriate cases and within the earnings would equal 0.2 percent of 1. ‘‘A’’ Case Assumptions—NCUA DANA and natural person credit unions context of a carefully crafted investment assumed that corporates would have action plan, to permit individual would voluntarily recapitalize the zero growth beyond recapitalization corporate system at historical rates of corporates to operate outside these deposits and annual earnings equal to 0.4 percent of assets. In year 4, DANA limitations while illiquid legacy 0.2 percent of DANA (20 bp). NCUA was immediately reduced by one third. investments amortize. Of course, to the assumed that natural person credit extent that legacy investments have unions would voluntarily recapitalize The table below illustrates the credit issues, and the corporate is forced the corporate system at historical rates number of corporates that would to recognize OTTI, this OTTI will have of 0.4 percent of assets. achieve adequate capitalization, by year, a negative effect on the corporate’s 2. ‘‘B’’ Case Assumptions—NCUA over the next 7 years, under the various retained earnings growth. assumed that corporates would have case assumptions.

Year Year Year Year Year Year Year one two three four five six seven

‘‘A’’ Case...... 5 6 7 8 24 25 25 ‘‘B’’ Case...... 5 5 5 7 7 7 8 ‘‘C’’ Case...... 4 5 6 6 18 21 24 ‘‘D’’ Case ...... 5 6 7 23 24 24 26

A discussion about the results of each Under the B case assumptions, 21 availability of capital instruments. scenario follows. corporates (i.e., 28 minus seven) are Seven of the 28 corporates are unable to The A case scenario would result in unable to reach an adequate reach adequate capital levels in the first 25 of the 28 corporates reaching an capitalization level within six years and six years. This scenario illustrates that adequate level of capitalization within 20 are unable to reach an adequate at least a majority of corporates may still six years. With zero growth and .2 capitalization level within seven years. reach adequate capital levels even if percent of earnings each year, a These institutions will need to further natural person credit unions reduce the corporate’s retained earnings reaches adjust assets, or adjust earnings to historic amount of capital invested in the minimum 100 bp requirement by insure that return on DANA is the corporate system. On the other year five. Three of the corporates fail to significantly in excess 0.1 percent, or hand, some corporates may find it meet the aggregate capital requirements obtain member capital investments at difficult to achieve adequate capital by year six because their current assets amounts greater than historical industry levels if their natural person credit and numbers of members produce a averages. unions refuse to provide near historic pool of available PPC and NCA accounts The C case assumes a 0.2 percent levels of capital funding. The alternative that is inadequate for these three earnings level but also assumes that for these corporates is to reduce assets. corporates. It is possible that one or natural person credit unions will not be The ‘‘D’’ case scenario represents more of these three corporates would willing to recapitalize the corporates at another possible strategy. A corporate become adequately capitalized if they historical levels. In this scenario DANA may attempt to maintain current assets, are able to obtain an appropriate level shrinks by four percent each year, to generate retained earnings on the of PPC accounts. correspond with the reduced current asset base for several years and

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then shrink the balance sheet before the minimum leverage ratio will be the most need to shrink their balance sheets, look final leverage ratio requirement becomes difficult ratio for corporates to achieve for potential merger partners, or both. effective. All but four corporates would because improvements in this ratio In addition to general comments on reach adequate capitalization under this require the corporate credit union to the proposed capital phase-in, NCUA scenario by the end of year six. both solicit permanent capital and build invites individual corporates to provide Implementation of this scenario may be retained earnings. But if corporates were additional modeling information related challenging as it is difficult to shrink limited to earnings only, and not able to to the effect of the proposed phase-in assets by this magnitude on the basis of solicit capital, many would not be able period on that corporate. rates alone. The corporate’s members to reach the adequately capitalized level would need to actively assist the for a significant number of years—in III.E. Proposed Rule: Hypothetical Effect corporate for it to succeed in this some cases, twenty or more years. on Recent Losses at WesCorp and U.S. strategy. Central These particular scenarios do not Phase-In of Capital Provisions reflect NCUA’s classification of any (Conclusion) As discussed above, the primary specific corporate or its expected capital The most likely capital outcome for purpose of these proposed changes to position during the phase-in period. each corporate will depend on a number part 704 is to mitigate future risks to the Each corporate will need to complete a of factors unique to that corporate. corporate system so that the system can similar analysis with assumptions more These factors include the ability to raise continue to provide valuable services to specific to its own business plans and capital from existing members and the NPCUs in a safe and sound manner. based on its own members’ potential level of earnings that the corporate is Although the focus of the proposal is PCC and NCA contributions. Also, this able to achieve. Achieving these new forward looking, NCUA realizes that it analysis only goes out to seven years, capital requirements may also require a cannot avoid, to some extent, a look and does not incorporate the final corporate make significant changes in backwards. Accordingly, this subsection leverage requirement, effective at ten historic business plans and in the way III.E. illustrates the hypothetical effects years, that PCC count only to the extent it prices its services and deposit of the proposed rule on the balance it is matched dollar for dollar by products. sheets of WesCorp and U.S. Central as retained earnings. Corporates that meet Still, NCUA believes that well- those entities existed in June 2007. the six year leverage requirement should managed corporates that have financial NCUA chose WesCorp and U.S. Central be well-positioned to meet the ten year support from their members can in fact for this illustration since their risk requirement, but numerical projections reach their capital targets within the positions account for the vast majority beyond six or seven years rely on too proposed phase-in period. For a of projected losses in the corporate many assumptions to carry significant corporate that lacks good management system. meaning. or significant member support, however, The following chart illustrates the These scenarios also make clear that these capital goals may not be effect of the proposed investment sector many corporates will struggle to achieve achievable. Those corporates that limits on the permissible amount of the minimum capital ratios over the struggle to grow their earnings or to total non-agency residential mortgage proposed phase in period. The convince members to invest capital will backed securities (RMBS): 58

Non-agency Proposed rule RMBS limit as 59 Corporate percent of percent of Exposure reduction under proposed rule capital (2007) capital

WesCorp ...... 990% 500% Approximately 50%. U.S. Central 60 ...... 1,040% 500% More than 50%.

Non-agency RMBS produced almost Central. Using projected losses and the The following chart illustrates the 100 percent of projected losses and assumption that security selection effect of the proposed limit on the OTTI in the corporate credit union would have been comparable in quality permissible amount of subordinated system. Had it been in effect, the to what they hold now, WesCorp and non-agency residential mortgage backed proposed rule would have limited the U.S. Central losses would have been cut securities: 61 exposure to this sector by approximately in half. 50 percent for WesCorp and U.S.

Proposed rule Subordinated non-agency RMBS limit as Corporate as percent of capital (2007) percent of Exposure reduction under proposed rule capital

WesCorp ...... More than 600% ...... 100% More than 80%. U.S. Central ...... More than 150% ...... 100% More than 30%.

58 Proposed § 704.6(d). NCUA used post-June 59 The proposed § 704.5(h) also prohibits Net related to OTTI taken on non-agency RMBS at U.S. June 2007 statistics where the June 2007 statistics Interest Margin securities (NIMs) and collateralized Central. were not available. The use of more recent statistics debt obligations (CDOs), and these are included in 60 Sandlot Funding assets are included due to the understates loss exposure and, therefore, the loss projections and exposure reductions. subsequent reconsolidation on U.S. Central’s understates the effects the proposed rule would Additionally, contributed capital by corporate balance sheet and recent accounting changes related have had on projected losses if it had been in effect. credit unions in U.S. Central is excluded from the to ABCP conduits. projected loss number since the losses are directly 61 Proposed § 704.6(e).

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Subordinated non-agency RMBS the assumption that security selection the CDO and NIM prohibitions, produced approximately 70 percent of would have been comparable in quality, aggregate WesCorp losses would have the combined projected losses and OTTI WesCorp’s losses would have been been reduced by approximately 80 in WesCorp and U.S. Central.62 The reduced by more than 75 percent and percent and U.S. Central losses would proposed rule would have lowered the U.S. Central’s losses would have been have been reduced by approximately 45 exposure to subordinated non-agency reduced by more than 15 percent. percent. The following chart illustrates RMBS by more than 80 percent in Combining the effects of the non- the effect of the proposed cash flow WesCorp and more than 30 percent in agency RMBS sector limitations, the weighted average life (WAL) mismatch U.S. Central. Using projected losses and subordinated non-agency RMBS, and limit under the proposed rule: 63

Minimum estimated Investment portfolio Estimated asset and Proposed rule’s WAL reduction of Corporate WAL (2007) Liability WAL liability WAL approximate limit on investment WAL mismatch WAL mismatch under proposed rule

WesCorp ...... 2.88 years ...... 0.97 years ...... 1.91 years ...... 0.40 years ...... 1.51 years. U.S. Central ...... 2.93 years ...... 0.93 years ...... 2.00 years ...... 0.30 years ...... 1.70 years.

The proposal also limits the WAL of wholesale corporate that provides marketplace. Some of these commenters the aggregate investment portfolio to products and services only to the retail felt that the existence of U.S. Central two years. Had they been in place, these corporates. The ANPR discussed this created efficiencies in the system and proposed restrictions on the maximum configuration and solicited comment that U.S. Central had the greatest level average WAL mismatch and the about whether this two-tier structure of investment expertise available to the absolute maximum investment WAL continues to make sense in the current system. Supporters of the status quo, would have reduced the amount of marketplace. The ANPR asked what the however, typically felt greater regulatory liquidity risk and credit risk in the role of the wholesale corporate should oversight, risk mitigation, and higher WesCorp and U.S. Central portfolios. be and whether there should be any capital standards for corporates were The shorter average lives would have differentiation in powers and authorities still necessary. produced much quicker principal between retail and wholesale Existing § 704.19—Wholesale Corporate paydowns and shorter maturities than corporates. Credit Unions WesCorp and U.S. Central experienced A slight majority of the commenters since June 2007, strengthening system believe the two-tiered corporate system, The Board believes that having a third liquidity. Furthermore, the resulting with a network of retail corporates and tier in the credit union system presents shorter average lives, combined with the a single wholesale corporate, U.S. both an element of inefficiency and a limits on WAL extension risk, would Central, is outdated and unnecessary. systemic risk multiplier effect. The have lowered the risk in the allowable Many commenters believe this two-tier inefficiency arises from the added cost RMBS portfolio due to more stable cash structure has resulted in an aggregation of having two layers of intermediation flow characteristics.64 of excessive risk at the top tier and that for the goods and services extended by NCUA is comfortable that these U.S. Central duplicates the investment the wholesale corporate through its provisions of the proposed rule, taken and payment services that large retail retail corporate members to their natural together, would have resulted in corporates can provide at competitive person credit union members. The significantly lower corporate losses had cost and with greater diversification of multiplier on risk results from the fact they been in effect prior to the recent risk. Some commenters stated the that each dollar of loss in excess of credit crisis. The reduced losses would wholesale tier is redundant, inefficient, retained earnings at the wholesale level have protected corporate credit unions led to too much concentrated risk, and can result in as much two additional with capital in U.S. Central from some, has resulted in the creation of an entity dollars of loss for the rest of the system: if not all, of the losses from depleted that has become ‘‘too big to fail.’’ Others One dollar lost at the retail corporate capital. Additionally, WesCorp’s stated that elimination of the two-tiered level and one at the natural person members would have seen lower write- system may lead to a necessary credit union level.65 Accordingly, the downs of their capital in Wescorp, and consolidation of the corporate credit Board is moving towards eliminating WesCorp would have not caused any union system, resulting in a system in regulatory and policy distinctions loss to the NCUSIF—and thus no losses which corporates are more economically between wholesale and retail to credit unions that were not WesCorp viable. corporates. members. Other commenters, predominantly The existing § 704.19 provides that III.F. Amendments to Part 704 Related smaller credit unions, believe that the wholesale corporates must strive to to the Structure of the Corporate System wholesale tier is beneficial and obtain a one percent retained earnings necessary. Smaller credit unions believe ratio, as opposed to the existing At present, the corporate system that the level of services and support § 704.3(i), which requires that all other consists of twenty-seven corporates that they receive from corporates, including corporates strive to retain a two percent provide retail service and support to investment expertise, is not readily retained earnings ratio. The proposed natural person credit unions and one available to them in the outside capital revisions to § 704.3 eliminate the

62 Subordinated securities include senior requires WALs be measured assuming: (1) issuer corporate to assume a 50% slowdown in payment mezzanine tranches. options are not exercised; and (2) further tests and speeds. 63 Proposed § 704.8(e). As discussed above, the limits for a slowdown in prepayment speeds are 65 See, e.g., Retail Corporates Apply U.S. Central proposed rule also limits WAL mismatches based conducted. Capital Losses, Credit Union Times, August 3, 2009, on three factors: (1) Current base net economic 64 As discussed above, proposed § 704.8(f) at www.cutimes.com. value (NEV); (2) Investment authorities, and; (3) Total capital. Furthermore, the proposed rule contains an mismatch test that requires the

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need for any earnings retention NCUA wants to ensure it has some confidence in corporate leadership, requirement. To ensure that the new oversight and control of these activities. thereby supporting and strengthening capital requirements apply equally to Accordingly, the proposal amends the corporate system. As more fully both wholesale and retail corporates, the § 704.11 to require that, generally, a developed below, the proposed rule sets proposal eliminates both the current corporate CUSO must agree that it will out new provisions in the following paragraph 704.3(i) and current § 704.19. limit is services to brokerage services, areas: The proposal also eliminate the investment advisory services, and other • Qualifications for corporate unnecessary term ‘‘wholesale corporate categories of services as preapproved by directorship, including term limits and credit union’’ from the definitions in NCUA and published on NCUA’s Web NPCU representation; § 704.2. site. A CUSO that desires to engage in • Transparency of senior executive To further facilitate the elimination of an activity not preapproved by NCUA and director compensation the third tier, the proposal also amends can apply to NCUA for that approval. arrangements; and the existing part 704 provisions on The current paragraph 704.11(e) • Restrictions on certain severance board representation to require that the prohibits a corporate CUSO from and indemnification payments for board of every corporate have a majority acquiring control, directly or indirectly, senior executive officers. of its members comprised of of another depository financial representatives of natural person credit institution or to invest in shares, stocks, § 704.14 Representation unions. As a result, no corporate in the or obligations of an insurance company, Qualifications of Directors system will ever again be captive to trade association, liquidity facility, or Corporate credit unions are complex other corporates. This amendment, and similar organization. The proposal entities that can, and do, have a the associated transition period, are retains this prohibition, but moves it significant impact on the functioning of discussed in more detail below in paragraph 704.11(g), which sets forth the entire credit union system. The connection with the proposed corporate the contents of the mandatory written ANPR solicited comment on whether governance amendments applicable to agreement between ever corporate and changes to the corporate rule are all corporates. its CUSOs. The proposal also adds two The Board has also directed OCCU to other requirements to this mandatory necessary to ensure a corporate credit eliminate any distinctions between agreement. First, the proposal requires union’s governing board possesses the corporates in field of membership the CUSO agree to expanded access for requisite degree of knowledge and (FOM) policy, and so retail corporates auditors, the corporate’s directors, and expertise. One hundred fifty-seven will be allowed to offer services to other NCUA. Currently, the CUSO must agree commenters responded to NCUA’s corporates and U.S. Central will be to permit access to the CUSO’s ‘‘books, request for comment on this subject, and allowed to provide services to natural records, and other pertinent nearly three-quarters of these person credit unions. documentation,’’ and the proposal commenters—112—supported expands this access to: ‘‘personnel, additional qualification standards for III.G. Amendments to Part 704 Related facilities, equipment, books, records, corporate directors. to Corporate CUSOs and any other documentation that the Sophisticated corporate investment Part 704 currently permits corporates auditor, directors, or NCUA deem and operation strategies require to invest in and lend to credit union pertinent.’’ Second, the proposal directors with adequate levels of service organizations (corporate prescribes that the CUSO specifically knowledge and experience to CUSOs). A corporate CUSO is defined agree to abide by all the requirements understand and provide oversight for as an entity that is at least partly owned set forth in § 704.11. these strategies. NCUA believes that the by a corporate credit union; primarily The current paragraph 704.11(b) recent crisis in the corporate system was serves credit unions; restricts its places limits on the aggregate amount of attributable, in part, to a failure on the services to those related to the normal a corporate’s investments in, and loans part of the some corporate boards to course of business of credit unions; and to, a CUSO. The proposal does not understand the extent of the risk is structured as a corporation, limited contain any changes to these limits. embedded in their balance sheets. liability company, or limited Still, data available to NCUA indicates Those commenters who supported partnership under state law. 12 CFR that the level of corporate investment in regulatory director qualifications 704.11(a). Part 704 does not list the CUSOs is significantly less than these thought such qualifications would permissible activities for corporate 704.11(b) limits would allow, based on ensure corporates are governed by CUSOs, unlike part 712, which does list November 2008 corporate capital levels. knowledgeable individuals who are up- the permissible activities for the CUSOs The Board invites comment on whether, to-date on the most recent developments of natural person FCUs. 12 CFR in the final rule, it should reduce the in the credit union system. Some 712.5(b). CUSO investment and loan limits in the commenters said that board candidates The Board believes it is appropriate to current 704.11(b). should be limited to either chief tighten NCUA oversight over the executive officers (CEOs) or chief activities of corporate CUSOs. A III.H. Amendments to Part 704 Related financial officers (CFOs) of member corporate CUSO may serve hundreds or to Corporate Governance credit unions. There was also some even thousands of natural person credit As noted in the ANPR, corporate support that directors be required to unions, and so its activities can affect management requires a high level of obtain periodic training or continuing the entire credit union system. sophistication and expertise. Successful education. Other commenters suggested Additionally, as the corporate credit corporate management also requires that the issue of director qualification be union system evolves in the coming performance and practices that instill left to the discretion of the individual years, some of the services that are and inspire confidence by the corporate and not be mandated by currently accomplished in-house at a membership in the integrity of those in regulation. Some commenters said that, corporate may migrate to a corporate positions of leadership and with respect to state charters, this issue CUSO. The movement of these activities responsibility. With this proposal, is a function of state law and regulation. could increase the systemic risk NCUA intends to improve corporate Others said that nothing presently associated with corporate CUSOs, and governance standards and elevate prevents a board of directors from

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retaining outside experts to assist its In today’s environment directors must have Generally, corporate directors serve understanding on any issue that board considerable knowledge and devote for staggered three-year terms, as may determine. sufficient time to have an adequate provided in Art. VII, § 2, Corporate Some of those opposed to imposing understanding of a corporate’s operations. In Credit Union Bylaws (2003), and the minimum director qualifications stated many cases directors may need extensive training in the corporate’s unique operations Board intends, for sitting directors, to that an emphasis on education may (i.e., sophisticated investments and asset phase in this new term limit disqualify certain persons who have liability management). The information requirement without undue disruption. valuable experience, skills, or talents provided by management is normally Accordingly, the proposal would not not attributable to formal education. extensive and complex. Directors need to require any current director to step Others opposed to regulatory dedicate a significant amount of effort to down before the current term ends, qualifications noted that such becoming familiar with these concepts. regardless of the length of time served qualifications are no assurance against Corporate Credit Union Guidance before the rule became effective. the recurrence of the current corporate Letter 2005–02 (April 5, 2005). These Instead, the proposal provides that no system problems, with one noting that training principles are just as valid individual may stand for election to the all of the various proposed today as back in 2005. The standard board if, at the end of the term for which qualifications existed on a voluntary FCU bylaws also state that FCUs will the individual seeks election, he or she basis at one or more corporates, and establish ‘‘a policy to address training would have served for more than six those governance techniques had not for newly elected and incumbent consecutive years as a director. protected those corporates from the directors and volunteer officials in areas Corporates should ensure that directors effects of the current economic such as ethics and fiduciary who run for reelection following the downturn. responsibility, regulatory compliance, effective date of this rule will, in fact, Corporates have evolved into complicated entities with key roles in and accounting * * *.’’ Standard FCU be able to complete their entire term the credit union system. The Board Bylaws, Art. VI, § 6(d)(2006). Although without exceeding the six-year term believes, therefore, that individuals corporates are not governed by these limit. seeking a position on a corporate board FCU bylaws, the Board could The rule also clarifies that, for should exhibit a minimum level of incorporate similar language into the purposes of calculating term limits, knowledge and expertise. Accordingly, standard corporate bylaws. The Board service on the board is determined by the proposal adds a new paragraph solicits comment as to whether such a reference to the corporate member on 704.14(a)(2) to require, as qualification change to the corporate bylaws would whose behalf the individual is serving, for directorship, that all candidates be appropriate. and not simply by the number of years must currently hold the equivalent of a Term Limits and Other Board the particular individual has served. CEO, CFO, or chief operating officer Restrictions. The ANPR also solicited Thus, for example, if the CEO of an (COO) position at the member comment on whether NCUA should NPCU has served on the board of a institution (typically, though not impose term limits for service on a corporate for six years, the CFO or COO always, a natural person credit union). corporate board. The majority of those of that NPCU may not follow on to the The proposal phases this requirement in who offered a comment, on this issue, board in the next succeeding term. For by applying it only to candidates at the 80 out of 145, supported the concept of purposes of the rule, all individuals time of election or reelection, and corporate term limits. Those supporting representing a single member are treated making the effective date of the proposal term limits generally stated this would as a single individual. some four months after the effective help to eliminate complacency on boards and ensure that corporates were Given the importance of the role date of the rule. corporate directors fulfill in establishing In lieu of such an experience run by the best qualified individuals. the overall policy and direction for requirement, the Board considered Others, in opposition to the idea, corporate credit unions, the Board is proposing that directors of corporates be advocated that NCUA not impose concerned that those individuals who required to obtain formal training on an mandatory term limits by regulation. are chosen for this role be in a position annual or other periodic basis as a One corporate opposed director term condition of service on a corporate limits but supported term limits on to devote the degree of time and board. The Board determined not to officer positions within the board to attention necessary to effectively include that requirement in the proposal ensure ‘‘adequate change in leadership discharge their responsibilities. for a couple of reasons. First, as noted while retaining experienced directors.’’ Accordingly, the proposed rule would above, the Board believes limiting Others who opposed term limits establish that no individual may be director eligibility to persons currently generally felt that this disrupted elected or appointed to the board of one holding a CEO, CFO or COO position continuity and reduced efficiency by corporate while serving at the same time will help ensure qualified candidates creating a continuous need to train new as a member of any other corporate are chosen for board positions. In directors. credit union board. This restriction will addition, the Board does not believe it The Board has determined that some help ensure that directors are undivided a good use of examiner resources to form of term limit will be beneficial. in their loyalty to the corporate for analyze training attendance records, the New directors are more likely, generally, which they are serving and are not sufficiency of a particular corporate’s than old directors to ask questions about distracted from attending to the needs of training standards, or the effectiveness existing policies and to generate their institution because of competing of the training. suggestions for improvement. This, in demands arising from another corporate. Although the Board has determined turn, should help ensure that corporate The proposal would also prohibit any not to impose by regulation a specific, policies are subject to continuous member of a corporate from having and mandatory, training requirement, review and evaluation. Accordingly, the more than one of its officers sitting on the Board believes director training is proposal adds a new paragraph the board of the corporate at one time. important and corporates should 704.14(a)(3) to impose a six-year limit This provision will prevent a corporate encourage such training. In 2005, NCUA on continuous service as a corporate from being dominated by any single stated: director. member.

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Representation by Natural Person Credit which recommended NCUA consider the manager or official has for the Unions alternatives requiring FCUs to make performance of the corporate and for the As discussed above, the Board intends periodic disclosure of executive attendant protection of the financial to eliminate the distinction between compensation to their members. interests of the corporate’s owners. In Soon after the issuance of the MSAP, wholesale and retail corporates. sum, the Board believes the interests GAO also recommended ‘‘the Chairman Accordingly, the proposal adds a new that corporate members have in this of NCUA take action to ensure that paragraph 704.14(a)(4) requiring that a compensation information outweighs information on federal credit union majority of a corporate’s directors, any privacy interests the senior executive compensation is available to managers may have in that including the chair of the board, must credit union members and the public for information.66 serve on the board as representatives of review and inspection.’’ GAO, Credit Accordingly, the proposal contain a natural person credit union members. Unions: Transparency Needed on Who new § 704.19 requiring corporates to Retail corporates should already satisfy Credit Unions Serve and on Senior provide to its members certain this governance requirement. The Executive Compensation Arrangements information about the compensation proposal, however, delays the effective (GAO–07–29) (2006). The Board created and benefits of senior executive officers date of this provision for three years to an outreach task force which, although and directors. Given the importance allow U.S. Central, the only wholesale not focused specifically on corporate Congress and GAO placed on the corporate, time to meet this new issues, did consider and make some disclosures required in IRS Form 990 governance requirement. recommendations focused on (an annual informational filing required Because of the addition of the new compensation transparency and related of many tax-exempt entities, including subparagraphs 704.14(a)(2), (3), and (4), issues. One OTF recommendation was state chartered credit unions), much of as discussed above, the proposal that NCUA ‘‘promulgate a regulation § 704.19 mirrors the Form 990 renumbers the remaining subparagraphs requiring federal credit unions and information and access process. For of paragraph 704.14(a). federal corporate credit unions to purposes of the rule, however, the Board § 704.19 Disclosure of Executive and annually disclose individual senior has concluded that completion of the Director Compensation executive officer compensation to their Form 990 is not sufficient. The IRS members.’’ Report to the NCUA Board determines the form and content of the As noted in the ANPR, part 704 does from the Outreach Task Force, p. 71, Form 990 disclosure and so that may not currently require any disclosure by available at http://www.ncua.gov/ change in the future. In addition, even a corporate to its members of senior ReportAndPlans/plans-and-reports/ though Form 990 data is publicly executive compensation arrangements. 2008/OutreachTFReport-022608.pdf. available, the affirmative disclosure The response to the ANPR contained a Addressing compensation disclosure required by this proposal provides for few comments on compensation requires a balancing of privacy interests greater transparency to members. transparency. Some who commented against the ownership and financial A paragraph-by-paragraph discussion noted that disclosure of corporate interests of members. The basic question of the new § 704.19 follows. compensation should be subject to the presented is whether an increased level Proposed paragraph 704.19(a) requires same guidance as applies to natural of transparency would strengthen each corporate to prepare and maintain person credit unions. One commenter principles and the annual disclosure of executive and said corporates should provide accountability, and if so, whether those director compensation. As currently transparency through existing filing benefits outweigh the damage to proposed, the rule would allow a requirements, such as the Internal individual privacy interests of the corporate to choose the disclosure Revenue Service Form 990—required affected executives. In the corporate format it considers most appropriate, for for state charters, but not federal context particularly, the Board believes example, through the use of a narrative, charters. Another commenter argued this balance can and should be struck in table, or chart. NCUA solicits comment that executive compensation and favor of increased transparency and on the question of whether the rule disclosure of salary and benefit disclosure to members. The member- should specify the form that the information have no bearing on the owners of a corporate credit union have disclosure should take, including, for current crisis. This commenter stated a strong financial interest in the example, the identification of specific that a number of publicly traded corporate. The typical corporate categories that must be used, such as companies, each with their management member has large investments in the direct salary, bonus, deferred compensation packages fully disclosed corporate and much of this investment compensation, etc. In any case, the to the public, have gone bankrupt is at risk, either in the form of perpetual disclosure must specifically identify during this current crisis. contributed capital, nonperpetual senior executive personnel by name, job Debate over disclosure of credit union contributed capital, or uninsured shares. title, and compensation. To the extent compensation has been ongoing for The corporate member needs to have that members of the board of directors years. For example, in November 2005, this investment properly managed and also receive compensation in exchange Congress and the Government protected. Accordingly, the member for or as an incident to their service on Accountability Office (GAO) raised wants the corporate to provide proper the board, the rule specifies that the questions about the lack of transparency financial incentives to its managers and corporate must disclose that regarding credit union senior executive official to do a good job while ensuring compensation as well. compensation. In response, the NCUA that the corporate is also properly As discussed more fully below, the undertook the Member Service expending its funds—and both these definition of compensation Assessment Pilot Program to study, interests are affected by compensation among other issues, the transparency of paid to corporate executives and 66 The financial interests of corporate members in senior executive compensation. On officials. Corporate managers and their corporate are likely to be more significant than November 3, 2006, NCUA completed its officials, of course, do have privacy the financial interests of natural person members in their natural person credit union, because natural study and issued the Member Service interests in their compensation, but persons are less likely to have significant amounts Assessment Pilot Program: A Study of those interests diminish the more senior of at-risk investments in their credit union than are Federal Credit Union Service (MSAP), the manager and the more responsibility members of corporates.

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encompasses all benefits provided by where a corporate is considering a Compensation also includes expense the corporate to its senior executives or merger with another corporate, any accounts and other allowances (for example, directors. The Board believes that, to be arrangement resulting in a material the value of the personal use of housing, accurate, the disclosure must ascribe a increase in compensation (i.e., an automobiles or other assets owned by the dollar value to each component of corporate credit union; expense allowances increase in current compensation of or reimbursements that recipients must compensation, and the proposed rule more than 15 percent or $10,000, report as income on their separate specifically requires this. The proposal whichever is greater) for any senior return; payments made under contemplates each corporate will executive officer or director of the indemnification arrangements; and payments prepare the disclosure at approximately merging corporate must be included in made for the benefit of friends or relatives). the same time each year, much like an the annual disclosure form. In addition, In calculating required compensation annual tax filing. If senior executive or the proposal specifies that corporates disclosures, reasonable estimates may be director compensation changes during must describe in the merger plan used if precise cost figures are not readily the course of a year, a corporate will not submitted to the NCUA any financial available. be required to prepare a new or arrangements providing for a material The Board is also concerned about the amended disclosure. In some instances increase in compensation for any senior possibility of ‘‘reverse’’ mergers, where requiring only an annual disclosure may executive officer or director. The Board a larger credit union merges into a result in some lag in updated intends that all arrangements, formal smaller credit union and the officers information, but such a disclosure and informal, be covered by this and directors of the merging entity requirement more closely resembles the disclosure requirement. The scope of assume control of the continuing entity. reporting made in annual tax filings for disclosure includes both arrangements Accordingly, the Board invites comment state chartered credit unions and lessens that are written and those not about whether, and under what the disclosure burden on the corporate. immediately reduced to writing, as well circumstances, the requirement to Proposed paragraph 704.19(b) as arrangements involving the deferred disclose merger-related compensation provides that any member may obtain a receipt of compensation. should be extended to the officers and copy of the most current disclosure, and Where a merging credit union is directors of the continuing credit union all disclosures for the previous three federally chartered, the proposal would as well as the merging credit union. years, on request made to the corporate also require an affirmative disclosure of § 704.20 Limitations on Golden in person or in writing. The corporate the existence of a material increase in Parachute and Indemnification must provide the disclosure(s), at no compensation to its members before Provisions cost to the requesting member, within their vote on the merger. State law five business days of receiving the governs whether members of a state- Section 2523 of the Comprehensive request. In addition, the corporate must chartered credit union are entitled to Thrift and Bank Fraud Prosecution and distribute the most current disclosure to vote; therefore, NCUA is only proposing Taxpayer Recovery Act of 1990 67 all its members at least once a year, this latter requirement for federally (Fraud Act) amended the Federal Credit either in the annual report or in some chartered corporate credit unions. Union Act (Act) by adding a new other manner of the corporate’s Section 704.2 contains two proposed section 206(t). Public Law 101–647, choosing. definitions relating to the scope of the section 2523(b) (1990). Section 206(t) The Board considered whether to § 704.19 disclosures. First, the proposal provides that ‘‘[t]he Board may prohibit impose some type of non-disclosure eliminates the current definition of or limit, by regulation or order, any requirement on members as a condition senior management employee, a term no golden parachute payment or to receiving the information, but longer used in part 704, and replaces indemnification payment.’’ 12 U.S.C. ultimately determined not to impose that definition with a definition of 1786(t)(1). such a condition, given the difficulty in senior executive officer as: Accordingly, the proposal adds a new enforcing such a requirement. The § 704.20 to NCUA’s corporate rule that compensation information, however, is [A] chief executive officer, any assistant prohibits golden parachutes, that is, likely to be of interest only to members, chief executive officer (e.g., any assistant payments made to an institution and the Board anticipates that members president, any vice president or any assistant affiliated party (IAP) that are contingent will not likely disseminate the treasurer/manager), and the chief financial officer (controller). This term also includes on the termination of that person’s information to nonmembers. employees of any entity hired to perform the employment and received when the Proposed paragraph 704.19(c) clarifies functions described above. that a corporate may supplement the corporate making the payment is required disclosure, at its option, with This definition is similar to that troubled, undercapitalized, or insolvent. information may put the disclosures in currently used in § 701.14 of NCUA’s The proposal also prohibits a corporate, appropriate context. For example, a rules. 12 CFR 701.14. Second, since the regardless of its financial condition, corporate could provide members with Board believes it is important for from paying or reimbursing an IAP’s salary surveys, a discussion of complete accuracy to require disclosure legal and other professional expenses compensation in relation to other credit of all forms of executive compensation, incurred in administrative or civil union expenses, or compensation the proposal defines compensation as: proceedings instituted by NCUA or the information from similarly sized credit [A]ll salaries, fees, wages, bonuses, appropriate state regulatory authority. unions or financial institutions. severance payments paid, current year The new § 704.20 will be effective In the case of merger, the Board is contributions to employee benefit plans (for immediately upon the finalization of concerned that prospective merger example, medical, dental, , and this rule. These limitations will apply to partners may seek to improperly disability), current year contributions to all new employment contracts entered influence the deliberations of deferred compensation plans and future into on or after that date, as well as severance payments, including payments in management or the board at a corporate connection with a merger or similar seeking to merge. One way to deal with 67 The Comprehensive Thrift and Bank Fraud combination (whether or not funded; Prosecution and Taxpayer Recovery Act of 1990 is the potential for improper activity is whether or not vested; and whether or not title XXV of the Crime Control Act of 1990, S. 3266, transparency. Accordingly, proposed the deferred compensation plan is a qualified which was passed by Congress on October 27, 1990 paragraph 704.19(d) provides that, plan under Section 401(a) of the IRS Code). and signed into law on November 29, 1990.

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existing contracts that are renewed or assessed a civil money penalty, removed • The IAP has committed any modified in any way after that date. from office, prohibited from fraudulent act or omission, breach of A paragraph-by-paragraph summary participating in the conduct of the trust or fiduciary duty, or insider abuse of the proposed § 704.20 follows: affairs of an insured credit union, or with regard to the corporate credit Paragraph 704.20(a) Definitions required to cease and desist from or take union that has had or is likely to have any affirmative action described in § 206 a material adverse effect on the This proposal contains several of the FCU Act. 12 U.S.C. 1786. corporate credit union; definitions. The key definitions are Accordingly, the proposed paragraph • The IAP is substantially responsible discussed further below. 704.20(d) generally prohibits a for the insolvency of, the appointment Paragraph 704.20(b) Golden Parachute corporate, regardless of its financial of a conservator or liquidating agent for, Payments Prohibited condition, from paying or reimbursing or the troubled condition of the an IAP’s legal and other professional corporate credit union; The proposal provides, generally, that expenses incurred in proceedings • The IAP has materially violated any no corporate credit union will make or instituted by NCUA or the appropriate agree to make any golden parachute applicable federal or state banking law state regulatory authority. Paragraph or regulation that has had or is likely to payment, that is, a payment to an 704.20(e), discussed below, describes institution-affiliated party (IAP) that is have a material effect on the corporate when a corporate can proceed to credit union; or contingent on the termination of that indemnify an IAP. • person’s employment and received The IAP has violated or conspired when the corporate making the payment Paragraph 704.20(d) Permissible to violate certain specified criminal is troubled, as defined in § 701.14(b)(4) Golden Parachute Payments provisions of the United States Code. In determining whether to grant an of NCUA’s rules. 12 CFR 701.14(b)(4); The Board has determined that in application for any of these exceptions, see also 12 U.S.C. 1790a; 12 U.S.C. certain, limited circumstances payments the Board may also consider: 1786(r) (definition of IAP). The proposal that otherwise satisfy the definition of • also prohibits golden parachute golden parachute payments should be Whether, and to what degree, the payments in the event a corporate has permitted. The proposal includes three IAP was in a position of managerial or become insolvent or ‘‘undercapitalized’’ fiduciary responsibility; exceptions to the general prohibition on • for prompt corrective action purposes. golden parachutes: The length of time the IAP was See proposed § 704.4. This prohibition • One exception permits the insertion affiliated with the corporate credit is intended to prevent IAPs who are of a golden parachute payment union, and the degree to which the substantially responsible for the provision into an employment contract proposed payment represents a troubled condition of a corporate from when a corporate which is already in reasonable payment for services receiving an unwarranted benefit. troubled condition needs to hire a rendered over the period of The proposed definition of golden senior manager with expertise to help employment; and • parachute would also exclude certain put the corporate back on a sound Any other factors or circumstances payments pursuant to certain bona fide financial footing (the ‘‘white knight’’ which would indicate that the proposed deferred compensation plans. Although exception). Without this white knight payment would be contrary to the intent the rule text is necessarily complex, the exception, a troubled corporate may not of section 206(t) of the Act. proposal provides that, in general, a be able to attract qualified senior Paragraph 704.20(e) Permissible plan funded by earned but deferred management. Before employing the Indemnification Payments compensation is allowed. Also, certain white knight exception to make a types of elective plans are allowed if payment, a corporate must notify and Broadly speaking, Congress intended they are funded, were in effect more obtain the written permission of the through the Fraud Act to limit the than one year prior to any of the events Board. ability of IAPs who are responsible for described in § 701.14(b)(4) of NCUA • Another exception permits losses sustained by an insured rules, and the party is vested in the reasonable severance arrangements in depository institution to avoid the plan. For example, payments made the context of a merger for the consequences of that responsibility. pursuant to qualified retirement plans; management of the merging corporate. Where, however, that responsibility has nondiscriminatory severance pay plans; The merger must be unassisted, that is, not yet been finally established, the benefit plans required by state statute, at no cost to the NCUA; and any Board does not intend to categorically and death benefit arrangements would severance payments made cannot prohibit corporates from advancing not be prohibited. Payments made exceed twelve months salary. In funds to pay or reimburse IAP’s for pursuant to these exclusions, however, addition, the NCUA Board must review reasonable legal or other professional are generally limited in amount to 12 and approve the payment in advance. expenses incurred in defending against months of base salary. • Finally, there is a general exception an administrative or civil action brought that permits severance arrangements on by NCUA. Accordingly, paragraph Paragraph 704.20(c) Prohibited an exceptional basis where the NCUA 704.20(e) prescribes certain Indemnification Payments Board determines the payment is circumstances under which Section 206(t) of the Act authorizes appropriate. indemnification payments may be NCUA to prohibit or limit In applying to NCUA for any of the made. indemnification payments. 12 U.S.C. three exceptions above, the corporate The proposed rule provides that 1786(t)(5). The Act defines a prohibited credit union must assert to NCUA its indemnification payments may be made indemnification payment as a payment belief that the IAP does not bear any where the corporate’s board of directors by a corporate for the benefit of an IAP responsibility for the troubled condition makes a good faith determination, after for any liability or legal expense of the corporate. Specifically, the due investigation, that: sustained in connection with an corporate must demonstrate that it does • The IAP acted in good faith and in administrative or civil enforcement not possess, and is not aware of, any a manner he/she believed to be in the action that results in a final order or information that provides a reasonable best interests of the corporate credit settlement pursuant to which the IAP is basis to believe that: union;

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• The payment of such expenses will corporates, and not to natural person referred to as information collections. not materially adversely affect the credit unions.68 The Office of Management and Budget corporate credit union’s safety and The Board also notes that its (OMB) has approved the current soundness; proposals (i.e., on disclosure of information collection requirements in • The indemnification payments compensation and prohibition of golden part 704 and assigned them control ultimately do not become prohibited parachutes and indemnification number 3133–0129. indemnification payments as defined in arrangements) differ from the The proposed changes to part 704 704.20(a), that is, the administrative requirements in the Treasury’s recent modify existing information collection action does not result in a civil money final rule applicable to entities receiving requirements and impose new penalty, removal order, or cease and federal assistance under the Troubled information collection requirements. As desist order against the IAP; and Asset Relief Program (TARP) program. required by the PRA, NCUA is • The IAP agrees in writing to 74 FR 28394 (June 15, 2009). The submitting a copy of this proposed reimburse the corporate credit union, to Treasury rule imposes several regulation to the Office of Management the extent not covered by payments substantive limits on senior executive and Budget (OMB) for its review and from insurance, for that portion of the compensation, including limits on approval. Persons interested in advanced indemnification payments, if bonuses and the use of compensation submitting comments with respect to any, which subsequently becomes plans that would encourage earnings the information collection aspects of the prohibited indemnification payments. manipulation to enhance executive proposed rule should submit them to The proposed rule does permit a compensation. The Treasury rule also the OMB at the address noted below. corporate to purchase commercial requires affected entities establish a compensation committee comprised of Estimated PRA Burden: Capital and insurance policies or fidelity bonds, at PCA Requirements a reasonable cost, to pay the future independent directors, prepare a written potential cost of defending an policy on luxury expenditures, disclose NCUA has determined that the administrative proceeding or civil certain types of perquisites, and following capital and PCA aspects of the eliminate tax gross ups. The Board does action. Such insurance cannot pay for proposed rule either modify or create not believe adoption of the Treasury any penalty or judgment against an IAP new information collection approach for all corporate credit unions but may pay restitution to the corporate requirements: is necessary or desirable at this time, or its liquidating agent. • The current rule imposes an although the Board reserves the right to obligation on a corporate to prepare and Paragraph 704.20(f) Filing Instructions impose similar conditions in the future submit a capital restoration plan in the on any credit union that receives This paragraph provides procedures event the corporate’s capital falls below assistance from the NCUSIF. for corporate credit unions to request certain specified measures. The Board permission to make IV. Regulatory Procedures proposed rule creates several new nondiscriminatory severance plan capital standards and requirements, and IV.A. Regulatory Flexibility Act payments and golden parachute thereby increases the potential for payments described in paragraph The Regulatory Flexibility Act additional circumstances under which a 704.20(d). requires NCUA to prepare an analysis to capital restoration plan, or revisions to describe any significant economic a plan already submitted, may be Paragraph 704.20(g) Applicability in impact any proposed regulation may required. the Event of Liquidation or have on a substantial number of small • Beginning with the first call report Conservatorship entities (those under $10 million in submitted by a corporate three years This paragraph clarifies how the assets). The proposal only applies to after the date of the final rule, if the ratio restrictions in this section function in corporates, all but one of which has of the corporate’s retained earnings to the event of conservatorship or assets well in excess of $10 million. moving daily average net assets is less liquidation. Any consent or approval of Accordingly, the proposed amendments than .45 percent, the corporate must a golden parachute payment granted will not have a significant economic prepare and submit to NCUA a retained under the provisions of this part by the impact on a substantial number of small earnings accumulation plan. The plan Board will not in any way bind any credit unions and, therefore, a must explain how the corporate intends liquidating agent or conservator for a regulatory flexibility analysis is not to accumulate earnings sufficient to failed corporate credit union and will required. meet the minimum leverage ratio not in any way obligate the liquidating IV.B. Paperwork Reduction Act requirements established by the rule agent or conservator to pay any claim or within the time frames set forth in the obligation pursuant to any golden The Paperwork Reduction Act of 1995 rule. (PRA) applies to rulemakings in which parachute, severance, indemnification • The proposal generally requires a an agency by rule creates a new or other agreement. corporate to obtain the prior approval of paperwork burden on regulated entities NCUA before permitting the early Compensation Disclosure and or modifies an existing burden. 44 redemption of any contributed capital. Prohibition of Golden Parachutes: U.S.C. 3507(d). For purposes of the • The proposal requires a corporate to Application to Natural Person Credit PRA, a paperwork burden may take the notify NCUA within fifteen days after Unions; Consideration of TARP form of a either a reporting or a any material event has occurred that Limitations recordkeeping requirement, both would cause the corporate to be placed At this time, the Board is primarily in a lower capital category from the 68 Natural person federal credit unions may concerned with recent problems provide for indemnification of officers and directors category assigned to it on the basis of exposed by the corporate financial as set forth at § 701.33 of NCUA. To the extent that the corporate’s most recent call report or crisis, including corporate governance this proposed § 704.20 conflicts with § 701.33 or report of examination. problems. Accordingly, the Board any other federal law or regulation, or state law or regulation (for state-chartered corporates), the The NCUA estimates the burden intends to apply the requirements of corporate must comply with § 704.20. See 12 CFR associated with these capital and PCA proposed § 704.19 and 704.20 only to 704.1. information collections as follows.

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The new capital standards will apply effective and spread durations for approval may take four hours: 4 uniformly to all twenty-eight corporates. individual assets and liabilities to corporates × 4 hours = 16 hours. NCUA estimates that approximately support the test results. NCUA estimates Summary of Collection Burden twenty corporates will be required to that burden hours associated with prepare new or revised capital compliance with this requirement NCUA estimates the total information restoration plans in the coming year, would be as follows: collection burden represented by the and that the effort to prepare or revise 28 corporates × 168 hours (total for proposal, calculated on an annual basis, a plan will involve fifty hours: 20 the four new tests per year) = 4,704 as follows: corporates × 50 hours = 1,000 total hours. Capital restoration plans: 20 corporates × 50 hours = 1,000 hours. hours. Estimated PRA Burden: New CUSO NCUA estimates that three corporates Retained earnings accumulation Procedures will be required to prepare retained plans: 3 corporates × 50 hours = 150 earnings accumulation plans, and that The current rule does not set out hours. the effort to prepare such a plan will categories of approved CUSO activity Notice of intent to redeem contributed involve fifty hours: 3 corporates × 50 for corporate CUSOs, but instead simply capital: 10 corporates × 1 hour = 10 hours = 150 total hours. indicates that CUSOs must primarily hours. NCUA estimates ten corporates may serve credit unions and may engage in Notice of PCA category change: 10 have to notify NCUA about requests to activity that is related to the business of corporates × 1 hour = 10 hours. × redeem contributed capital, but that the credit unions. Under the proposal, a Ratings procurement: 28 corporates burden of preparing and sending such a corporate will be required to obtain the 2 hours = 56 hours. notice would be minimal: 10 corporates approval from the NCUA for proposed Investment action plans: 10 × CUSO activities, except for brokerage corporates × 20 hours = 200 hours. 1 hour = 10 hours. × Similarly, NCUA anticipates that ten services and investment advisory ALM testing: 28 corporates 168 corporates may be required to notify services, which are specifically pre- hours = 4,704 hours. NCUA about changes affecting their approved. Once an activity has been CUSO approval requests: 12 × category under the prompt corrective approved, NCUA will publish that fact corporates 2 hours = 24 hours. Compensation disclosures: 28 action provisions of the rule; again, the on its Web site and the activity will × burden of preparing the notice is thereafter be considered pre-approved corporates 10 hours = 280 hours. × Merger related disclosures: 4 minimal: 10 corporates 1 hour = 10 for other CUSOs. NCUA estimates that × hours. two hours will be sufficient for corporates 5 hours = 20 hours. corporates to prepare approval requests, Requests to make golden parachute Estimated PRA Burden: Investment × and NCUA anticipates that twelve such and severance payments: 4 corporates Requirements requests will be made. 4 hours = 16 hours. With respect to investments, the Total Burden Hours: 6,470 hours. proposal requires that at least 90 percent Estimated PRA Burden: Corporate NCUA previously estimated the of a corporate’s investments have Governance Requirements burden associated with the current rule, NRSRO ratings, increasing the With respect to corporate governance, and approved by OMB under control associated PRA burden. the proposal requires: number 3133–0129, at about 2,434 The change applies to all corporates, • Corporates prepare and disseminate hours per corporate, and, for 31 and NCUA estimates that all twenty- to members a disclosure document corporates, a total burden of 75,454 eight will be required to acquire outlining the compensation hours. The number of corporates has additional ratings as part of their due arrangements for senior level since dropped from 31 to 28, reducing investment due diligence. This effort employees. the estimated burden under the current should entail a minimal expenditure of • Merging corporates include certain rule to about 68,152 hours. As discussed time: 28 corporates × 2 hours = 56 compensation information in their above, the proposal would add about hours. filings with the NCUA and their notices 6,470 hours to the current burden, Given the change in how NRSRO to their members. bringing the total burden covered by ratings are used, NCUA estimates that • Corporates obtain NCUA approval OMB control number 3133–0129 to approximately ten corporates will before making certain golden parachute about 74,622 hours. encounter downgrades affecting their payments. NCUA does not anticipate that investments, which will trigger new These information collections would compliance with any of the new investment action plans or amended apply to all twenty-eight corporates. information collection aspects of the investment action plans. Developing an NCUA estimates that compliance with proposed rule will require that investment action plan can take as the annual compensation disclosure corporates purchase any additional much as twenty hours, with the requirement will take approximately ten equipment or hire any additional staff. following burden: 10 corporates × 20 hours: 28 corporates × 10 hours = 280 Accordingly, existing maintenance and hours = 200 hours. hours. service costs to corporates are likewise NCUA estimates that four corporates unaffected, and there should be no Estimated PRA Burden: ALM will merge with other corporates each additional depreciation expense, since Requirements year, with another entity, and that all corporates should be able to With respect to asset and liability preparing the required notice and implement the new requirements using management, the proposal requires new disclosure forms will take 5 hours: 4 existing systems, equipment, and spread widening and net interest corporates × 5 hours = 20 hours. personnel. The proposal may require income testing, which are information NCUA also estimates that four some corporates to incur additional collections. The additional testing, corporates will need to solicit NCUA marginal costs associated with the which must be done at least quarterly, approval in advance of making a enhanced ALM testing requirements, to will be required of and affect all severance or golden parachute payment the extent that they are not already corporates. The proposal also requires a within the scope of the proposed rule, conducting these tests, and a few corporate to calculate and record the and that preparing the request for corporates will incur additional expense

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associated with obtaining required shall be taken only where there is By the National Credit Union credit ratings for certain investments. constitutional and statutory authority Administration Board on November 19, 2009. NCUA estimates the labor cost for the action and the national activity Mary F. Rupp, associated with this compliance at is appropriate in light of the presence of Secretary of the Board. approximately $50 per hour. a problem of national significance.’’ Accordingly, NCUA proposes to Multiplying this figure by the number of NCUA has plenary statutory authority to amend 12 CFR parts 702, 703, 704, 709, additional hours estimated for these regulate corporate credit unions. 12 and 747 as follows: burden categories yields an additional U.S.C. 1766(a). Further, the risk of loss financial burden associated with the to federally-insured credit unions and PART 702—PROMPT CORRECTIVE proposed rule of $8,500 per corporate. the NCUSIF due to corporate activities ACTION The NCUA considers comments by are concerns of national scope. The the public on this proposed collection of 1. The authority citation for part 702 proposed rule, if adopted, would apply continues to read as follows: information in: to all corporates that accept funds from • Evaluating whether the proposed federally-insured credit unions, Authority: 12 U.S.C. 1766(a), 1790d. collection of information is necessary including some state chartered credit 2. Effective [DATE 12 MONTHS for the proper performance of the unions. NCUA believes that the AFTER DATE OF PUBLICATION OF functions of the NCUA, including protection of corporate credit unions, FINAL RULE IN THE FEDERAL whether the information will have a federally-insured credit unions, and REGISTER], revise paragraph (d) of practical use; ultimately the NCUSIF, warrants § 702.105 to read as follows: • Evaluating the accuracy of the application of the proposed rule to all § 702.105 Weighted-average life of NCUA’s estimate of the burden of the corporates. proposed collection of information, investments. The proposed rule does not impose including the validity of the * * * * * additional costs or burdens on the states methodology and assumptions used; (d) Capital in mixed-ownership or affect the states’ ability to discharge • Enhancing the quality, usefulness, Government corporations and corporate traditional state government functions. and clarity of the information to be credit unions. For capital stock in NCUA has determined that this collected; and mixed-ownership Government • Minimizing the burden of collection proposal may have an occasional effect corporations, as defined in 31. U.S.C. of information on those who are to on the states, on the relationship 9101(2), and perpetual and respond, including through the use of between the national government and nonperpetual contributed capital in appropriate automated, electronic, the states, or on the distribution of corporate credit unions, as defined in 12 mechanical, or other technological power and responsibilities among the CFR 704.2, the weighted-average life is collection techniques or other forms of various levels of government. However, defined as greater than one (1) year, but information technology; e.g., permitting the potential risk to the NCUSIF without less than or equal to three years; the proposed changes justifies any such electronic submission of responses. * * * * * The Paperwork Reduction Act effects. requires OMB to make a decision IV.D. The Treasury and General PART 703—INVESTMENTS AND concerning the collection of information Government Appropriations Act, 1999— DEPOSIT ACTIVITIES contained in the proposed regulation Assessment of Federal Regulations and 3. The authority citation for part 703 between 30 and 60 days after Policies on Families publication of this document in the continues to read as follows: Federal Register. Therefore, a comment The NCUA has determined that this Authority: 12 U.S.C. 1757(7), 1757(8), to OMB is best assured of having its full proposed rule will not affect family 1757(15). effect if OMB receives it within 30 days well-being within the meaning of 4. Effective [DATE 12 MONTHS of publication. This does not affect the section 654 of the Treasury and General AFTER DATE OF PUBLICATION OF deadline for the public to comment to Government Appropriations Act, 1999, FINAL RULE IN THE FEDERAL the NCUA on the proposed regulation. Public Law 105–277, 112 Stat. 2681 REGISTER], revise paragraph (b) of Comments should be sent to: Office of (1998). § 703.14 to read as follows: Information and Regulatory Affairs, List of Subjects OMB, New Executive Office Building, § 703.14 Permissible investments. Washington, DC 20503; Attention: 12 CFR Part 702 * * * * * NCUA Desk Officer, with a copy to (b) Corporate credit union shares or Credit unions, Reporting and Mary Rupp, Secretary of the Board, deposits. A Federal credit union may recordkeeping requirements. National Credit Union Administration, purchase shares or deposits in a 1775 Duke Street, Alexandria, Virginia 12 CFR Part 703 corporate credit union, except where the 22314–3428. NCUA Board has notified it that the Credit unions, Investments. corporate credit union is not operating IV.C. Executive Order 13132 12 CFR Part 704 in compliance with part 704 of this Executive Order 13132 encourages chapter. A Federal credit union’s independent regulatory agencies to Credit unions, Corporate credit aggregate amount of perpetual and consider the impact of their actions on unions, Reporting and recordkeeping nonperpetual contributed capital, as state and local interests. In adherence to requirements. defined in part 704 of this chapter, in fundamental federalism principles, 12 CFR Part 709 one corporate credit union is limited to NCUA, an independent regulatory two percent of the federal credit union’s agency as defined in 44 U.S.C. 3502(5), Credit unions, Liquidations. assets measured at the time of voluntarily complies with the executive 12 CFR Part 747 investment or adjustment. A Federal order. The executive order states that: credit union’s aggregate amount of ‘‘National action limiting the Credit unions, Administrative contributed capital in all corporate policymaking discretion of the states practices and procedures. credit unions is limited to four percent

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of assets measured at the time of corporate credit union that acquires calculated at the point of acquisition, if investment or adjustment. another credit union in a mutual the acquisition was a mutual * * * * * combination, capital includes the combination. retained earnings of the acquired credit Core capital ratio means the corporate PART 704—CORPORATE CREDIT union, or of an integrated set of credit union’s core capital divided by its UNIONS activities and assets, at the point of moving daily average net assets. acquisition. 5. The authority citation for part 704 Corporate credit union means an Capital ratio means the corporate continues to read as follows: organization that: credit union’s capital divided by its (1) Is chartered under Federal or state Authority: 12 U.S.C. 1762, 1766(a), 1781, moving daily average net assets. law as a credit union; and 1789. Collateralized debt obligation (CDO) (2) Receives shares from and provides 6. Revise § 704.2 to read as follows: means a debt security collateralized by loan services to credit unions; mortgage-backed securities, asset- § 704.2 Definitions. (3) Is operated primarily for the backed securities, or corporate purpose of serving other credit unions; Adjusted trading means any method obligations in the form of loans or debt. (4) Is designated by NCUA as a or transaction whereby a corporate Senior tranches of Re-REMIC’s corporate credit union; credit union sells a security to a vendor consisting of senior mortgage- and asset- (5) Limits natural person members to at a price above its current market price backed securities are excluded from this the minimum required by state or and simultaneously purchases or definition. federal law to charter and operate the commits to purchase from the vendor Collateralized mortgage obligation credit union; and another security at a price above its (CMO) means a multi-class mortgage- current market price. (6) Does not condition the eligibility backed security. of any credit union to become a member Asset-backed security (ABS) means a Core capital means the sum of the security that is primarily serviced by the on that credit union’s membership in corporate credit union’s retained any other organization. cashflows of a discrete pool of earnings and paid-in capital. Daily average net assets means the receivables or other financial assets, Commercial mortgage-backed security average of net assets calculated for each either fixed or revolving, that by their (CMBS) means a mortgage-backed day during the period. terms convert into cash within a finite security collateralized primarily by Derivatives means a financial contract time period plus any rights or other multi-family and commercial property whose value is derived from the values assets designed to assure the servicing loans. or timely distribution of proceeds to the Compensation means all salaries, fees, of one or more underlying assets, security holders. Mortgage-backed wages, bonuses, severance payments reference rates, or indices of asset values securities are a type of asset-backed paid, current year contributions to or reference rates. Derivative contracts security. employee benefit plans (for example, include interest rate derivative Available to cover losses that exceed medical, dental, life insurance, and contracts, exchange rate derivative retained earnings means that the funds disability), current year contributions to contracts, equity derivative contracts, are available to cover operating losses deferred compensation plans and future commodity derivative contracts, credit realized, in accordance with generally severance payments, including derivative contracts, and any other accepted accounting principles (GAAP), payments in connection with a merger instrument that poses similar by the corporate credit union that or similar combination (whether or not counterparty credit risks. exceed retained earnings. Likewise, funded; whether or not vested; and Dollar roll means the purchase or sale available to cover losses that exceed whether or not the deferred of a mortgage-backed security to a retained earnings and paid-in capital compensation plan is a qualified plan counterparty with an agreement to resell means that the funds are available to under Section 401(a) of the IRS Code). or repurchase a substantially identical cover operating losses realized, in Compensation also includes expense security at a future date and at a accordance with GAAP, by the accounts and other allowances (for specified price. corporate credit union that exceed example, the value of the personal use Embedded option means a retained earnings and perpetual of housing, automobiles or other assets characteristic of certain assets and contributed capital. Any such losses owned by the corporate credit union; liabilities which gives the issuer of the must be distributed pro rata at the time expense allowances or reimbursements instrument the ability to change the the loss is realized first among the that recipients must report as income on features such as final maturity, rate, holders of paid-in capital accounts their separate income tax return; principal amount and average life. (PIC), and when all PIC is exhausted, payments made under indemnification Options include, but are not limited to, then pro rata among all membership arrangements; and payments made for calls, caps, and prepayment options. capital accounts (MCAs), all subject to the benefit of friends or relatives). In Equity investments means the optional prioritization described in calculating required compensation investments in real property and equity Appendix A of this Part. To the extent disclosures, reasonable estimates may securities. that any contributed capital funds are be used if precise cost figures are not Equity security means any security used to cover losses, the corporate credit readily available. representing an ownership interest in an union must not restore or replenish the Contributed capital means either enterprise (for example, common, affected capital accounts under any paid-in capital or membership capital preferred, or other capital stock) or the circumstances. In addition, contributed accounts. right to acquire (for example, warrants capital that is used to cover losses in a Core capital means the sum of: and call options) or dispose of (for fiscal year previous to the year of (1) Retained earnings as calculated example, put options) an ownership liquidation has no claim against the under GAAP; interest in an enterprise at fixed or liquidation estate. (2) Paid-in capital; and determinable prices. However, the term Capital means the sum of a corporate (3) The retained earnings of any does not include convertible debt or credit union’s retained earnings, paid-in acquired credit union, or of an preferred stock that by its terms either capital, and membership capital. For a integrated set of activities and assets, must be redeemed by the issuing

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enterprise or is redeemable at the option Membership capital means funds deposit, or the borrower of funds in a of the investor. contributed by members that: Are federal funds transaction. Obligor does Exchangeable collateralized mortgage adjustable balance with a minimum not include an originator of receivables obligation means a class of a withdrawal notice of 3 years or are term underlying an asset-backed security, the collateralized mortgage obligation certificates with a minimum term of 3 servicer of such receivables, or an (CMO) that, at the time of purchase, years; are available to cover losses that insurer of an investment. represents beneficial ownership exceed retained earnings and paid-in Official means any director or interests in a combination of two or capital; are not insured by the NCUSIF committee member. more underlying classes of the same or other share or deposit insurers; and Paid-in capital means accounts or CMO structure. The holder of an cannot be pledged against borrowings. other interests of a corporate credit exchangeable CMO may pay a fee and Mortgage-backed security (MBS) union that: Are perpetual, non- take delivery of the underlying classes means a security backed by first or cumulative dividend accounts; are of the CMO. second mortgages secured by real estate available to cover losses that exceed Fair value means the amount at which upon which is located a dwelling, retained earnings; are not insured by the an instrument could be exchanged in a mixed residential and commercial NCUSIF or other share or deposit current, arms-length transaction structure, residential manufactured insurers; and cannot be pledged against between willing parties, as opposed to home, or commercial structure. borrowings. a forced or liquidation sale. Quoted Moving daily average net assets Pair-off transaction means a security market prices in active markets are the means the average of daily average net purchase transaction that is closed out best evidence of fair value. If a quoted assets for the month being measured or sold at, or prior to, the settlement or market price in an active market is not and the previous eleven (11) months. expiration date. available, fair value may be estimated Mutual combination means a Quoted market price means a recent using a valuation technique that is transaction or event in which a sales price or a price based on current reasonable and supportable, a quoted corporate credit union acquires another bid and asked quotations. market price in an active market for a credit union, or acquires an integrated Repurchase transaction means a similar instrument, or a current set of activities and assets that is transaction in which a corporate credit appraised value. Examples of valuation capable of being conducted and union agrees to purchase a security from techniques include the present value of managed as a credit union. a counterparty and to resell the same or estimated future cash flows, option- Nationally Recognized Statistical any identical security to that pricing models, and option-adjusted Rating Organization (NRSRO) means counterparty at a specified future date spread models. Valuation techniques any entity that has applied for, and been and at a specified price. should incorporate assumptions that granted permission, to be considered an Residential properties means houses, market participants would use in their NRSRO by the United States Securities condominiums, cooperative units, and estimates of values, future revenues, and and Exchange Commission. manufactured homes. This definition future expenses, including assumptions NCUA means NCUA Board (Board), does not include boats or motor homes, about interest rates, default, unless the particular action has been even if used as a primary residence, or prepayment, and volatility. delegated by the Board. timeshare properties. Federal funds transaction means a Net assets means total assets less Residential mortgage-backed security short-term or open-ended unsecured loans guaranteed by the NCUSIF and (RMBS) means a mortgage-backed transfer of immediately available funds member reverse repurchase security collateralized primarily by by one depository institution to another transactions. For its own account, a residential mortgage loans. depository institution or entity. corporate credit union’s payables under Residual interest means the Foreign bank means an institution reverse repurchase agreements and ownership interest in remainder cash which is organized under the laws of a receivables under repurchase flows from a CMO or ABS transaction country other than the United States, is agreements may be netted out if the after payments due bondholders and engaged in the business of banking, and GAAP conditions for offsetting are met. trust administrative expenses have been is recognized as a bank by the banking Net economic value (NEV) means the satisfied. supervisory authority of the country in fair value of assets minus the fair value Retained earnings means the total of which it is organized. of liabilities. All fair value calculations the corporate credit union’s undivided Immediate family member means a must include the value of forward earnings, reserves, and any other spouse or other family member living in settlements and embedded options. appropriations designated by the same household. Paid-in capital, and the unamortized management or regulatory authorities. Limited liquidity investment means a portion of membership capital, that is, For purposes of this part, retained private placement or funding agreement. the portion that qualifies as capital for earnings does not include the allowance Member reverse repurchase purposes of any of the total capital ratio, for loan and lease losses account, transaction means an integrated is excluded from liabilities for purposes accumulated unrealized gains and transaction in which a corporate credit of this calculation. The NEV ratio is losses on available for sale securities, or union purchases a security from one of calculated by dividing NEV by the fair other comprehensive income items. its member credit unions under value of assets. Retained earnings ratio means the agreement by that member credit union Net interest margin security means a corporate credit union’s retained to repurchase the same security at a security collateralized by residual earnings divided by its moving daily specified time in the future. The interests in collateralized mortgage average net assets. For a corporate credit corporate credit union then sells that obligations, residual interests in real union that acquires another credit union same security, on the same day, to a estate mortgage investment conduits, or in a mutual combination, the numerator third party, under agreement to residual interests in other asset-backed of the retained earnings ratio also repurchase it on the same date on which securities. includes the retained earnings of the the corporate credit union is obligated Obligor means the primary party acquired credit union, or of an to return the security to its member obligated to repay an investment, e.g., integrated set of activities and assets, at credit union. the issuer of a security, the taker of a the point of acquisition.

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Section 107(8) institution means an Trade date means the date a corporate net average assets, to exceed two institution described in Section 107(8) credit union originally agrees, whether percent; and of the Federal Credit Union Act (12 orally or in writing, to enter into the (5) Beginning after [DATE 120 U.S.C. 1757(8)). purchase or sale of a security. MONTHS AFTER DATE OF Securities lending means lending a Trigger means an event in a PUBLICATION OF FINAL RULE IN security to a counterparty, either securitization that will redirect cash- THE FEDERAL REGISTER], deduct any directly or through an agent, and flows if predefined thresholds are amount of PCC that causes PCC to accepting collateral in return. breached. Examples of triggers are exceed retained earnings. Senior executive officer mean a chief delinquency and cumulative loss Adjusted total capital means total executive officer, any assistant chief triggers. capital modified as follows: To the executive officer (e.g., any assistant Weighted average life means the extent that nonperpetual contributed president, any vice president or any weighted-average time to the return of a capital accounts are included in total assistant treasurer/manager), and the dollar of principal, calculated by capital, and the sum of those NCAs chief financial officer (controller). This multiplying each portion of principal exceeds the aggregate of the corporate’s term also includes employees of any received by the time at which it is PCC and retained earnings, the entity hired to perform the functions expected to be received (based on a corporate will exclude the excess from described above. reasonable and supportable estimate of adjusted total capital. Settlement date means the date that time) and then summing and Adjusted trading means any method originally agreed to by a corporate credit dividing by the total amount of or transaction whereby a corporate union and a counterparty for settlement principal. credit union sells a security to a vendor of the purchase or sale of a security. When-issued trading means the at a price above its current market price Short sale means the sale of a security buying and selling of securities in the and simultaneously purchases or not owned by the seller. period between the announcement of an commits to purchase from the vendor Small business related security means offering and the issuance and payment another security at a price above its a security as defined in section 3(a)(53) date of the securities. current market price. of the Securities Exchange Act of 1934 Applicable state regulator means the 7. Effective [DATE 12 MONTHS (15 U.S.C. 78c(a)(53)), e.g., a security prudential state regulator of a state AFTER PUBLICATION OF FINAL RULE that is rated in 1 of the 4 highest rating chartered corporate credit union. categories by at least one nationally IN THE FEDERAL REGISTER], revise Asset-backed commercial paper recognized statistical rating § 704.2 to read as follows: program (ABCP program) means a organization, and represents an interest § 704.2 Definitions. program that primarily issues in one or more promissory notes or Adjusted core capital means core commercial paper that has received a leases of personal property evidencing capital modified as follows: credit rating from an NRSRO and that is the obligation of a small business backed by assets or other exposures held (1) Deduct an amount equal to the concern and originated by an insured in a bankruptcy-remote special purpose amount of the corporate credit union’s depository institution, insured credit entity. The term sponsor of an ABCP intangible assets that exceed one half union, insurance company, or similar program means a corporate credit union percent of the corporate credit union’s institution which is supervised and that: moving daily average net assets, but the examined by a Federal or State (1) Establishes an ABCP program; NCUA, on its own initiative, upon authority, or a finance company or (2) Approves the sellers permitted to petition by the applicable state leasing company. This definition does participate in an ABCP program; regulator, or upon application from a not include Small Business (3) Approves the asset pools to be corporate credit union, may direct that Administration securities permissible purchased by an ABCP program; or a particular corporate credit union add under Sec. 107(7) of the Act. (4) Administers the ABCP program by State means any one of the several some or all of these excess intangibles monitoring the assets, arranging for debt states of the United States of America, back to the credit union’s adjusted core placement, compiling monthly reports, the District of Columbia, Puerto Rico, capital; or ensuring compliance with the and the territories and possessions of (2) Deduct investments, both equity program documents and with the the United States. and debt, in consolidated credit union program’s credit and investment policy. Stripped mortgage-backed security service organizations (CUSOs); Asset-backed security (ABS) means a means a security that represents either (3) If the corporate credit union, on or security that is primarily serviced by the the principal-only or interest-only after [DATE 12 MONTHS AFTER DATE cashflows of a discrete pool of portion of the cash flows of an OF PUBLICATION OF FINAL RULE IN receivables or other financial assets, underlying pool of mortgages. THE FEDERAL REGISTER], contributes either fixed or revolving, that by their Subordinated security means a new capital or renews an existing terms convert into cash within a finite security that has a junior claim on the capital contribution to another corporate time period plus any rights or other underlying collateral or assets to other credit union, deduct an amount equal to assets designed to assure the servicing securities in the same issuance. If a the aggregate of such new or renewed or timely distribution of proceeds to the security is junior only to money market capital; security holders. Mortgage-backed fund eligible securities in the same (4) Beginning on [DATE 72 MONTHS securities are a type of asset-backed issuance, the former security is not AFTER DATE OF PUBLICATION OF security. subordinated for purposes of this FINAL RULE IN THE FEDERAL Available to cover losses that exceed definition. REGISTER], and ending on [DATE 120 retained earnings means that the funds Total assets means the sum of all a MONTHS AFTER DATE OF are available to cover operating losses corporate credit union’s assets as PUBLICATION OF FINAL RULE IN realized, in accordance with generally calculated under GAAP. THE FEDERAL REGISTER], deduct any accepted accounting principles (GAAP), Total capital means the sum of a amount of perpetual contributed capital by the corporate credit union that corporate credit union’s core capital and (PCC) that causes PCC minus retained exceed retained earnings. Available to its membership capital accounts. earnings, all divided by moving daily cover losses that exceed retained

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earnings and perpetual contributed payments made under indemnification (1) Represents the contractual right to capital means that the funds are arrangements; and payments made for receive some or all of the interest due available to cover operating losses the benefit of friends or relatives). In on transferred assets; and realized, in accordance with GAAP, by calculating required compensation (2) Exposes the corporate credit union the corporate credit union that exceed disclosures, reasonable estimates may to credit risk directly or indirectly retained earnings and perpetual be used if precise cost figures are not associated with the transferred assets contributed capital. Any such losses readily available. that exceeds its pro rata share of the must be distributed pro rata at the time Consolidated Credit Union Service corporate credit union’s claim on the the loss is realized first among the Organization (Consolidated CUSO) assets whether through subordination holders of perpetual contributed capital means any corporation, partnership, provisions or other credit enhancement accounts (PCC), and when all PCC is business trust, joint venture, association techniques. exhausted, then pro rata among all or similar organization in which a NCUA reserves the right to identify nonperpetual contributed capital corporate credit union directly or other cash flows or related interests as accounts (NCAs), all subject to the indirectly holds an ownership interest a credit-enhancing interest-only strip. In optional prioritization described in (as permitted by § 704.11 of this Part) determining whether a particular Appendix A of this Part. To the extent and the assets of which are consolidated interest cash flow functions as a credit- that any contributed capital funds are with those of the corporate credit union enhancing interest-only strip, NCUA used to cover losses, the corporate credit for purposes of reporting under will consider the economic substance of union must not restore or replenish the Generally Accepted Accounting the transaction. affected capital accounts under any Principles (GAAP). Generally, Daily average net assets means the circumstances. In addition, contributed consolidated CUSOs are majority-owned average of net assets calculated for each capital that is used to cover losses in a CUSOs. day during the period. Contributed capital means either fiscal year previous to the year of Daily average net risk-weighted assets perpetual or nonperpetual contributed liquidation has no claim against the means the average of net risk-weighted capital. liquidation estate. assets calculated for each day during the Capital means the same as total Core capital means the sum of: (1) Retained earnings as calculated period. capital, defined below. Derivatives means a financial contract Capital ratio means the corporate under GAAP; whose value is derived from the values credit union’s capital divided by its (2) Perpetual contributed capital; of one or more underlying assets, moving daily average net assets. (3) The retained earnings of any Collateralized debt obligation (CDO) acquired credit union, or of an reference rates, or indices of asset values means a debt security collateralized by integrated set of activities and assets, or reference rates. Derivative contracts mortgage-backed securities, asset- calculated at the point of acquisition, if include interest rate derivative backed securities, or corporate the acquisition was a mutual contracts, exchange rate derivative obligations in the form of loans or debt. combination; and contracts, equity derivative contracts, Senior tranches of Re-REMIC’s (4) Minority interests in the equity commodity derivative contracts, credit consisting of senior mortgage- and asset- accounts of CUSOs that are fully derivative contracts, and any other backed securities are excluded from this consolidated. However, minority instrument that poses similar definition. interests in consolidated ABCP counterparty credit risks. Collateralized mortgage obligation programs sponsored by a corporate Dollar roll means the purchase or sale (CMO) means a multi-class mortgage- credit union are excluded from the of a mortgage-backed security to a backed security. credit unions’ core capital or total counterparty with an agreement to resell Commercial mortgage-backed security capital base if the corporate credit union or repurchase a substantially identical (CMBS) means a mortgage-backed excludes the consolidated assets of such security at a future date and at a security collateralized primarily by programs from risk-weighted assets specified price. multi-family and commercial property pursuant to Appendix C of this Part. Eligible ABCP liquidity facility means loans. Core capital ratio means the corporate a legally binding commitment to Compensation means all salaries, fees, credit union’s core capital divided by its provide liquidity support to asset- wages, bonuses, severance payments moving daily average net assets. backed commercial paper by lending to, paid, current year contributions to Corporate credit union means an or purchasing assets from any structure, employee benefit plans (for example, organization that: program or conduit in the event that medical, dental, life insurance, and (1) Is chartered under Federal or state funds are required to repay maturing disability), current year contributions to law as a credit union; asset-backed commercial paper and that (2) Receives shares from and provides deferred compensation plans and future meets the following criteria: loan services to credit unions; severance payments, including (3) Is operated primarily for the (1)(i) At the time of the draw, the payments in connection with a merger purpose of serving other credit unions; liquidity facility must be subject to an or similar combination (whether or not (4) Is designated by NCUA as a asset quality test that precludes funding funded; whether or not vested; and corporate credit union; against assets that are 90 days or more whether or not the deferred (5) Limits natural person members to past due or in default; and compensation plan is a qualified plan the minimum required by state or (ii) If the assets that the liquidity under Section 401(a) of the IRS Code). federal law to charter and operate the facility is required to fund against are Compensation also includes expense credit union; and assets or exposures that have received a accounts and other allowances (for (6) Does not condition the eligibility credit rating by a Nationally Recognized example, the value of the personal use of any credit union to become a member Statistical Rating Organization (NRSRO) of housing, automobiles or other assets on that credit union’s membership in at the time the inception of the facility, owned by the corporate credit union; any other organization. the facility can be used to fund only expense allowances or reimbursements Credit-enhancing interest-only strip those assets or exposures that are rated that recipients must report as income on means an on-balance sheet asset that, in investment grade by an NRSRO at the their separate income tax return; form or in substance: time of funding; or

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(2) If the assets that are funded under about interest rates, default, for the month being measured and the the liquidity facility do not meet the prepayment, and volatility. previous eleven (11) months. criteria described in paragraph (1) of Federal funds transaction means a Mutual combination means a this definition, the assets must be short-term or open-ended unsecured transaction or event in which a guaranteed, conditionally or transfer of immediately available funds corporate credit union acquires another unconditionally, by the United States by one depository institution to another credit union, or acquires an integrated Government, its agencies, or the central depository institution or entity. set of activities and assets that is government of an Organization for Foreign bank means an institution capable of being conducted and Economic Cooperation and which is organized under the laws of a managed as a credit union. Development OECD country. country other than the United States, is Nationally Recognized Statistical Embedded option means a engaged in the business of banking, and Rating Organization (NRSRO) means characteristic of certain assets and is recognized as a bank by the banking any entity that has applied for, and been liabilities which gives the issuer of the supervisory authority of the country in granted permission, to be considered an instrument the ability to change the which it is organized. NRSRO by the United States Securities features such as final maturity, rate, Immediate family member means a and Exchange Commission. principal amount and average life. spouse or other family member living in NCUA means NCUA Board (Board), Options include, but are not limited to, the same household. unless the particular action has been calls, caps, and prepayment options. Intangible assets means assets delegated by the Board. considered to be intangible assets under Net assets means total assets less Equity investment means an loans guaranteed by the NCUSIF and investment in real property and equity GAAP. These assets include, but are not limited to, core deposit premiums, member reverse repurchase securities. transactions. For its own account, a Equity security means any security purchased credit card relationships, favorable leaseholds, and servicing corporate credit union’s payables under representing an ownership interest in an reverse repurchase agreements and enterprise (for example, common, assets (mortgage and non-mortgage). Interest-only strips receivable are not receivables under repurchase preferred, or other capital stock) or the agreements may be netted out if the right to acquire (for example, warrants intangible assets under this definition. Leverage ratio means, before [DATE GAAP conditions for offsetting are met. and call options) or dispose of (for 36 MONTHS AFTER DATE OF Also, any amounts deducted from core example, put options) an ownership PUBLICATION OF FINAL RULE IN capital in calculating adjusted core interest in an enterprise at fixed or THE FEDERAL REGISTER], the ratio of capital are also deducted from net determinable prices. However, the term adjusted total capital to moving daily assets. does not include convertible debt or average net assets. Net economic value (NEV) means the preferred stock that by its terms either Leverage ratio means, on or after fair value of assets minus the fair value must be redeemed by the issuing [DATE 36 MONTHS AFTER DATE OF of liabilities. All fair value calculations enterprise or is redeemable at the option PUBLICATION OF FINAL RULE IN must include the value of forward of the investor. THE FEDERAL REGISTER], the ratio of settlements and embedded options. Exchangeable collateralized mortgage adjusted core capital to moving daily Perpetual contributed capital, and the obligation means a class of a average net assets. unamortized portion of nonperpetual collateralized mortgage obligation Limited liquidity investment means a contributed capital that is, the portion (CMO) that, at the time of purchase, private placement or funding agreement. that qualifies as capital for purposes of represents beneficial ownership Member reverse repurchase any of the minimum capital ratios, is interests in a combination of two or transaction means an integrated excluded from liabilities for purposes of more underlying classes of the same transaction in which a corporate credit this calculation. The NEV ratio is CMO structure. The holder of an union purchases a security from one of calculated by dividing NEV by the fair exchangeable CMO may pay a fee and its member credit unions under value of assets. take delivery of the underlying classes agreement by that member credit union Net interest margin security means a of the CMO. to repurchase the same security at a security collateralized by residual Fair value means the amount at which specified time in the future. The interests in collateralized mortgage an instrument could be exchanged in a corporate credit union then sells that obligations, residual interests in real current, arm’s-length transaction same security, on the same day, to a estate mortgage investment conduits, or between willing parties, as opposed to third party, under agreement to residual interests in other asset-backed a forced or liquidation sale. Quoted repurchase it on the same date on which securities. market prices in active markets are the the corporate credit union is obligated Net risk-weighted assets means risk- best evidence of fair value. If a quoted to return the security to its member weighted assets less Central Liquidity market price in an active market is not credit union. Facility (CLF) stock subscriptions, CLF available, fair value may be estimated Mortgage-backed security (MBS) loans guaranteed by the NCUSIF, U.S. using a valuation technique that is means a security backed by first or Central CLF certificates, and member reasonable and supportable, a quoted second mortgages secured by real estate reverse repurchase transactions. For its market price in an active market for a upon which is located a dwelling, own account, a corporate credit union’s similar instrument, or a current mixed residential and commercial payables under reverse repurchase appraised value. Examples of valuation structure, residential manufactured agreements and receivables under techniques include the present value of home, or commercial structure. repurchase agreements may be netted estimated future cash flows, option- Moving daily average net assets out if the GAAP conditions for offsetting pricing models, and option-adjusted means the average of daily average net are met. Also, any amounts deducted spread models. Valuation techniques assets for the month being measured from core capital in calculating adjusted should incorporate assumptions that and the previous eleven (11) months. core capital are also deducted from net market participants would use in their Moving daily average net risk- risk-weighted assets. estimates of values, future revenues, and weighted assets means the average of Nonperpetual capital means funds future expenses, including assumptions daily average net assets risk-weighted contributed by members or nonmembers

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that: are term certificates with a flows from a CMO or ABS transaction not include Small Business minimum term of five years or that have after payments due bondholders and Administration securities permissible an indefinite term (i.e., no maturity) trust administrative expenses have been under Sec. 107(7) of the Act. with a minimum withdrawal notice of satisfied. State means any one of the several five years; are available to cover losses Retained earnings means the total of states of the United States of America, that exceed retained earnings and the corporate credit union’s undivided the District of Columbia, Puerto Rico, perpetual contributed capital; are not earnings, reserves, and any other and the territories and possessions of insured by the NCUSIF or other share or appropriations designated by the United States. deposit insurers; and cannot be pledged management or regulatory authorities. Stripped mortgage-backed security against borrowings. In the event the For purposes of this part, retained means a security that represents either corporate is liquidated, the holders of earnings does not include the allowance the principal-only or interest-only nonperpetual capital accounts (NCAs) for loan and lease losses account, portion of the cash flows of an will claim equally. These claims will be accumulated unrealized gains and underlying pool of mortgages. subordinate to all other claims losses on available for sale securities, or Subordinated security means a (including NCUSIF claims), except that other comprehensive income items. security that has a junior claim on the any claims by the holders of perpetual Risk-weighted assets means a underlying collateral or assets to other contributed capital (PCC) will be corporate credit union’s risk-weighted securities in the same issuance. If a subordinate to the claims of holders of assets as calculated in accordance with security is junior only to money market NCAs. Appendix C of this part. fund eligible securities in the same Obligor means the primary party Section 107(8) institution means an issuance, the former security is not obligated to repay an investment, e.g., institution described in Section 107(8) subordinated for purposes of this the issuer of a security, the taker of a of the Federal Credit Union Act (12 definition. deposit, or the borrower of funds in a U.S.C. 1757(8)). Supplementary Capital means the federal funds transaction. Obligor does Securities lending means lending a sum of the following items: not include an originator of receivables security to a counterparty, either (1) Nonperpetual capital accounts, as underlying an asset-backed security, the directly or through an agent, and amortized under § 704.3(b)(3); servicer of such receivables, or an accepting collateral in return. (2) Allowance for loan and lease insurer of an investment. Securitization means the pooling and losses calculated under GAAP to a Official means any director or repackaging by a special purpose entity maximum of 1.25 percent of risk- committee member. of assets or other credit exposures that weighted assets; and Pair-off transaction means a security can be sold to investors. Securitization (3) Forty-five percent of unrealized purchase transaction that is closed out includes transactions that create gains on available-for-sale equity or sold at, or prior to, the settlement or stratified credit risk positions whose securities with readily determinable fair expiration date. performance is dependent upon an values. Unrealized gains are unrealized Perpetual contributed capital (PCC) underlying pool of credit exposures, holding gains, net of unrealized holding means accounts or other interests of a including loans and commitments. losses, calculated as the amount, if any, corporate credit union that: are Senior executive officer mean a chief by which fair value exceeds historical perpetual, non-cumulative dividend executive officer, any assistant chief cost. The NCUA may disallow such accounts; are available to cover losses executive officer (e.g., any assistant inclusion in the calculation of that exceed retained earnings; are not president, any vice president or any supplementary capital if the NCUA insured by the NCUSIF or other share or assistant treasurer/manager), and the determines that the securities are not deposit insurers; and cannot be pledged chief financial officer (controller). This prudently valued. against borrowings. In the event the term also includes employees of any Tier 1 capital means adjusted core corporate is liquidated, any claims made entity hired to perform the functions capital. by the holders of perpetual contributed described above. Tier 2 capital means supplementary capital will be subordinate to all other Settlement date means the date capital. claims (including NCUSIF claims). originally agreed to by a corporate credit Tier 1 risk-based capital ratio means Quoted market price means a recent union and a counterparty for settlement the ratio of Tier 1 capital to the moving sales price or a price based on current of the purchase or sale of a security. daily average net risk-weighted assets. bid and asked quotations. Short sale means the sale of a security Total assets means the sum of all a Repurchase transaction means a not owned by the seller. corporate credit union’s assets as transaction in which a corporate credit Small business related security means calculated under GAAP. union agrees to purchase a security from a security as defined in section 3(a)(53) Total capital means the sum of a a counterparty and to resell the same or of the Securities Exchange Act of 1934 corporate credit union’s adjusted core any identical security to that (15 U.S.C. 78c(a)(53)), e.g., a security capital and its supplementary capital, counterparty at a specified future date that is rated in 1 of the 4 highest rating less the corporate credit union’s equity and at a specified price. categories by at least one nationally investments not otherwise deducted Residential properties means houses, recognized statistical rating when calculating adjusted core capital. condominiums, cooperative units, and organization, and represents an interest Total risk-based capital ratio means manufactured homes. This definition in one or more promissory notes or the ratio of total capital to moving daily does not include boats or motor homes, leases of personal property evidencing net risk-weighted assets. even if used as a primary residence, or the obligation of a small business Trade date means the date a corporate timeshare properties. concern and originated by an insured credit union originally agrees, whether Residential mortgage-backed security depository institution, insured credit orally or in writing, to enter into the (RMBS) means a mortgage-backed union, insurance company, or similar purchase or sale of a security. security collateralized primarily by institution which is supervised and Trigger means an event in a residential mortgage loans. examined by a Federal or State securitization that will redirect cash- Residual interest means the authority, or a finance company or flows if predefined thresholds are ownership interest in remainder cash leasing company. This definition does breached. Examples of triggers are

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delinquency and cumulative loss NCUA, or fails to comply with any maturity or prior to the end of the notice triggers. element of a plan approved by NCUA, period only with the prior approval of Weighted average life means the the corporate will immediately be the NCUA and, for state chartered weighted-average time to the return of a classified as significantly corporate credit unions, the approval of dollar of principal, calculated by undercapitalized or, if already the appropriate state regulator. multiplying each portion of principal significantly undercapitalized, as (6) Sale. A member may transfer its received by the time at which it is critically undercapitalized. The interest in a nonperpetual contributed expected to be received (based on a corporate credit union will be subject to capital account to a third party member reasonable and supportable estimate of all the associated prompt corrective or nonmember. that time) and then summing and actions under § 704.4. (7) Merger. In the event of a merger of dividing by the total amount of (b) Requirements for nonperpetual a corporate credit union, nonperpetual principal. contributed capital accounts (NCA)—(1) capital will transfer to the continuing When-issued trading means the Form. NCA funds may be in the form of corporate credit union. The minimum buying and selling of securities in the a term certificate or a no-maturity notice five-year notice period for withdrawal of period between the announcement of an account. no-maturity capital remains in effect. offering and the issuance and payment (2) Disclosure. The terms and (c) Requirements for perpetual date of the securities. conditions of a nonperpetual contributed capital (PCC)—(1) 8. Effective [DATE 12 MONTHS contributed capital account must be Disclosure. The terms and conditions of AFTER DATE OF PUBLICATION OF disclosed to the recorded owner of the any perpetual contributed capital FINAL RULE IN THE FEDERAL account at the time the account is instrument must be disclosed to the REGISTER], revise § 704.3 to read as opened and at least annually thereafter. recorded owner of the instrument at the follows: (i) The initial NCA disclosure must be time the instrument is created and must signed by either all of the directors of be signed by either all of the directors § 704.3 Corporate credit union capital. the member credit union or, if of the member credit union or, if (a) Capital requirements. (1) A authorized by board resolution, the authorized by board resolution, the corporate credit union must maintain at chair and secretary of the board; and chair and secretary of the board. all times: (ii) The annual disclosure notice must (2) Release. Perpetual contributed (i) A leverage ratio of 4.0 percent or be signed by the chair of the corporate capital may not be released due solely greater; credit union. The chair must sign a to the merger, charter conversion or (ii) A Tier 1 risk-based capital ratio of statement that certifies that the notice liquidation of a member credit union. In 4.0 percent or greater; and has been sent to all entities with NCAs. the event of a merger, the perpetual (iii) A total risk-based capital ratio of The certification must be maintained in contributed capital transfers to the 8.0 percent or greater. the corporate credit union’s files and be continuing credit union. In the event of (2) To ensure it meets its capital available for examiner review. a charter conversion, the perpetual requirements, a corporate credit union (3) Five-year remaining maturity. contributed capital transfers to the new must develop and ensure When a no-maturity NCA has been institution. In the event of liquidation, implementation of written short- and placed on notice, or a term account has the perpetual contributed capital may be long-term capital goals, objectives, and a remaining maturity of less than five released to facilitate the payout of strategies which provide for the years, the corporate will reduce the shares with NCUA’s prior written building of capital consistent with amount of the account that can be approval. regulatory requirements, the considered as nonperpetual contributed (3) Callability. A corporate credit maintenance of sufficient capital to capital by a constant monthly union may call perpetual contributed support the risk exposures that may amortization that ensures the capital is capital instruments only with the prior arise from current and projected fully amortized one year before the date approval of the NCUA and, for state activities, and the periodic review and of maturity or one year before the end chartered corporate credit unions, the reassessment of the capital position of of the notice period. The full balance of applicable state regulator. Perpetual the corporate credit union. an NCA being amortized, not just the contributed capital accounts are callable (3) Beginning with the first call report remaining non-amortized portion, is on a pro-rata basis across an issuance submitted on or after [DATE 36 available to absorb losses in excess of class. MONTHS AFTER DATE OF the sum of retained earnings and (4) Perpetual contributed capital. PA PUBLICATION OF THE FINAL RULE perpetual contributed capital until the corporate credit union may issue IN THE FEDERAL REGISTER], a funds are released by the corporate perpetual contributed capital to both corporate credit union must calculate credit union at the time of maturity or members and nonmembers. and report to NCUA the ratio of its the conclusion of the notice period. (5) The holder of a PCC instrument retained earnings to its moving daily (4) Release. Nonperpetual contributed may freely transfer its interests in the average net assets. If this ratio is less capital may not be released due solely instrument to a third party member or than 0.45 percent, the corporate credit to the merger, charter conversion, or nonmember. union must, within 30 days, submit a liquidation of the account holder. In the (d) Individual minimum capital retained earnings accumulation plan to event of a merger, the capital account requirements. the NCUA for NCUA’s approval. The transfers to the continuing entity. In the (1) General. The rules and procedures plan must contain a detailed event of a charter conversion, the capital specified in this paragraph apply to the explanation of how the corporate credit account transfers to the new institution. establishment of an individual union will accumulate earnings In the event of liquidation, the corporate minimum capital requirement for a sufficient to meet all its future may release a member capital account to corporate credit union that varies from minimum leverage ratio requirements, facilitate the payout of shares, but only any of the risk-based capital including specific semiannual with the prior written approval of the requirement(s) or leverage ratio milestones for accumulating retained NCUA. requirements that would otherwise earnings. If the corporate credit union (5) Redemption. A corporate credit apply to the corporate credit union fails to submit a plan acceptable to union may redeem NCAs prior to under this part.

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(2) Appropriate considerations for concentrations of credit and corporate credit union, what the establishing individual minimum nontraditional activities; or has a poor individual capital requirement should capital requirements. Minimum capital record of supervisory compliance. be, and, if applicable, what compliance levels higher than the risk-based capital (3) Standards for determination of schedule is appropriate for achieving requirements or the leverage ratio appropriate individual minimum the required capital level. The responses requirement under this part may be capital requirements. The appropriate of the corporate credit union and appropriate for individual corporate minimum capital levels for an appropriate state supervisor must be in credit unions. The NCUA may establish individual corporate credit union writing and must be delivered to the increased individual minimum capital cannot be determined solely through the NCUA within 30 days after the date on requirements, including modification of application of a rigid mathematical which the notification was received. the minimum capital requirements formula or wholly objective criteria. The The NCUA may extend the time period related to being either significantly and decision is necessarily based, in part, on for good cause. The time period for critically undercapitalized for purposes subjective judgment grounded in agency response by the insured corporate credit of § 704.4 of this part, upon a expertise. The factors to be considered union may be shortened for good cause: determination that the corporate credit in NCUA’s determination will vary in (A) When, in the opinion of the union’s capital is or may become each case and may include, for example: NCUA, the condition of the corporate inadequate in view of the credit union’s (i) The conditions or circumstances credit union so requires, and the NCUA circumstances. For example, higher leading to the determination that a informs the corporate credit union of capital levels may be appropriate when higher minimum capital requirement is the shortened response period in the NCUA determines that: appropriate or necessary for the notice; (i) A corporate credit union is corporate credit union; (B) With the consent of the corporate receiving special supervisory attention; (ii) The exigency of those credit union; or (ii) A corporate credit union has or is circumstances or potential problems; (C) When the corporate credit union expected to have losses resulting in (iii) The overall condition, already has advised the NCUA that it capital inadequacy; management strength, and future cannot or will not achieve its applicable (iii) A corporate credit union has a prospects of the corporate credit union minimum capital requirement. high degree of exposure to interest rate and, if applicable, its subsidiaries, (iv) Failure by the corporate credit risk, prepayment risk, credit risk, affiliates, and business partners; union to respond within 30 days, or concentration risk, certain risks arising (iv) The corporate credit union’s such other time period as may be from nontraditional activities or similar liquidity, capital and other indicators of specified by the NCUA, may constitute risks, or a high proportion of off-balance financial stability, particularly as a waiver of any objections to the sheet risk including standby letters of compared with those of similarly proposed individual minimum capital credit; situated corporate credit unions; and requirement or to the schedule for (iv) A corporate credit union has poor (v) The policies and practices of the complying with it, unless the NCUA has liquidity or cash flow; corporate credit union’s directors, provided an extension of the response (v) A corporate credit union is officers, and senior management as well period for good cause. growing, either internally or through as the internal control and internal audit (v) After expiration of the response acquisitions, at such a rate that systems for implementation of such period, the NCUA will decide whether supervisory problems are presented that adopted policies and practices. or not the proposed individual are not dealt with adequately by other (4) Procedures—(i) In the case of a minimum capital requirement should be NCUA regulations or other guidance; state chartered corporate credit union, established for the corporate credit (vi) A corporate credit union may be NCUA will consult with the appropriate union, or whether that proposed adversely affected by the activities or state regulator when considering requirement should be adopted in condition of its CUSOs or other persons imposing a new minimum capital modified form, based on a review of the or entities with which it has significant requirement. corporate credit union’s response and business relationships, including (ii) When the NCUA determines that other relevant information. The NCUA’s concentrations of credit; a minimum capital requirement is decision will address comments (vii) A corporate credit union with a necessary or appropriate for a particular received within the response period portfolio reflecting weak credit quality corporate credit union, it will notify the from the corporate credit union and the or a significant likelihood of financial corporate credit union in writing of its appropriate state supervisor (if a state- loss, or has loans or securities in proposed individual minimum capital chartered corporate credit union is nonperforming status or on which requirement; the schedule for involved) and will state the level of borrowers fail to comply with compliance with the new requirement; capital required, the schedule for repayment terms; and the specific causes for determining compliance with this requirement, and (viii) A corporate credit union has that the higher individual minimum any specific remedial action the inadequate underwriting policies, capital requirement is necessary or corporate credit union could take to standards, or procedures for its loans appropriate for the corporate credit eliminate the need for continued and investments; union. The NCUA shall forward the applicability of the individual minimum (ix) A corporate credit union has notifying letter to the appropriate state capital requirement. The NCUA will failed to properly plan for, or execute, supervisor if a state-chartered corporate provide the corporate credit union and necessary retained earnings growth, or credit union would be subject to an the appropriate state supervisor (if a (ix) A corporate credit union has a individual minimum capital state-chartered corporate credit union is record of operational losses that exceeds requirement. involved) with a written decision on the the average of other, similarly situated (iii) The corporate credit union’s individual minimum capital corporate credit unions; has response must include any information requirement, addressing the substantive management deficiencies, including that the credit union wants the NCUA comments made by the corporate credit failure to adequately monitor and to consider in deciding whether to union and setting forth the decision and control financial and operating risks, establish or to amend an individual the basis for that decision. Upon receipt particularly the risks presented by minimum capital requirement for the of this decision by the corporate credit

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union, the individual minimum capital appropriately reflect the risks imposed civil money penalties, or any other requirement becomes effective and on the corporate credit union. The actions authorized by law. binding upon the corporate credit NCUA may require the corporate credit (2) Unless permitted by the NCUA or union. This decision represents final union to apply another risk-weight, otherwise required by law, no corporate agency action. credit equivalent amount, or credit credit union may state in any (4) Failure to comply. Failure to conversion factor that NCUA deems advertisement or promotional material satisfy any individual minimum capital appropriate. its capital category under this part or requirement, or to meet any required (iii) If Appendix C does not that the NCUA has assigned the incremental additions to capital under a specifically assign a risk-weight, credit corporate credit union to a particular schedule for compliance with such an equivalent amount, or credit conversion category. individual minimum capital factor to a particular asset or activity of (3) Any group of credit unions requirement, will constitute a basis to the corporate credit union, the NCUA applying for a new corporate credit take action as described in § 704.4. may assign any risk-weight, credit union charter will submit, as part of the (5) Change in circumstances. If, after equivalent amount, or credit conversion charter application, a detailed draft plan a decision is made under paragraph factor that it deems appropriate. In for soliciting contributed capital and (b)(3)(iv) of this section, there is a making this determination, NCUA will building retained earnings. The draft change in the circumstances affecting consider the risks associated with the plan will include specific levels of the corporate credit union’s capital asset or off-balance sheet item as well as contributed capital and retained adequacy or its ability to reach its other relevant factors. earnings and the anticipated timeframes required minimum capital level by the (4) Where practicable, the NCUA will for achieving those levels. The Board specified date, the NCUA may amend consult with the appropriate state will review the draft plan and modify it the individual minimum capital regulator before taking any action under as necessary. If the Board approves the requirement or the corporate credit this paragraph (e) that involves a state plan, the Board will include any union’s schedule for such compliance. chartered corporate credit union. necessary waivers of this section or part. The NCUA may decline to consider a (c) Notice of capital category. (1) corporate credit union’s request for such § 704.4 [Redesignated as § 704.13] Effective date of determination of changes that are not based on a 9. Redesignate § 704.4, Board capital category. A corporate credit significant change in circumstances or responsibilities, as § 704.13. union will be deemed to be within a that are repetitive or frivolous. Pending given capital category as of the most the NCUA’s reexamination of the 10. Effective [DATE 12 MONTHS recent date: original decision, that original decision AFTER THE DATE OF PUBLICATION (i) A 5310 Financial Report is and any compliance schedule OF THE FINAL RULE IN THE required to be filed with the NCUA; established in that decision will FEDERAL REGISTER], add a new (ii) A final NCUA report of continue in full force and effect. § 704.4 to read as follows: examination is delivered to the (e) Reservation of authority. § 704.4 Prompt Corrective Action. (1) Transactions for purposes of corporate credit union; or evasion. The NCUA may disregard any (a) Purpose. The principal purpose of (iii) Written notice is provided by the transaction entered into primarily for this section is to define, for corporate NCUA to the corporate credit union that the purpose of reducing the minimum credit unions that are not adequately its capital category has changed as required amount of regulatory capital or capitalized, the capital measures and provided in paragraphs (c)(2) or (d)(3) of otherwise evading the requirements of capital levels that are used for this section. this section. determining appropriate supervisory (2) Adjustments to reported capital (2) Period-end versus average figures. actions. This section establishes levels and category— The NCUA reserves the right to require procedures for submission and review (i) Notice of adjustment by corporate a corporate credit union to compute its of capital restoration plans and for credit union. A corporate credit union capital ratios on the basis of period-end, issuance and review of capital must provide the NCUA with written rather than average, assets when the directives, orders, and other supervisory notice that an adjustment to the NCUA determines appropriate to carry directives. In the case of a state- corporate credit union’s capital category out the purposes of this part. chartered corporate credit union, NCUA may have occurred no later than 15 (3) Reservation of authority. (i) will consult with, and seek to work calendar days following the date that Notwithstanding the definitions of core cooperatively with, the appropriate state any material event has occurred that and supplementary capital in paragraph regulator before taking any discretionary would cause the corporate credit union (d) of this section, the NCUA may find actions under this section. to be placed in a lower capital category that a particular asset or core or (b) Scope. This section applies to from the category assigned to the supplementary capital component has corporate credit unions, including corporate credit union for purposes of characteristics or terms that diminish its officers, directors, and employees. this section on the basis of the corporate contribution to a corporate credit (1) This section does not limit the credit union’s most recent call report or union’s ability to absorb losses, and the authority of NCUA in any way to take report of examination. NCUA may require the discounting or supervisory actions to address unsafe or (ii) Determination by the NCUA to deduction of such asset or component unsound practices, deficient capital change capital category. After receiving from the computation of core, levels, violations of law, unsafe or notice pursuant to paragraph (c)(1) of supplementary, or total capital. unsound conditions, or other practices. this section, or on its own initiative, the (ii) Notwithstanding Appendix C of The NCUA may take action under this NCUA will determine whether to this Part, the NCUA will look to the section independently of, in change the capital category of the substance of a transaction and may find conjunction with, or in addition to any corporate credit union and will notify that the assigned risk-weight for any other enforcement action available to the corporate credit union of the asset, or credit equivalent amount or the NCUA, including issuance of cease NCUA’s determination. credit conversion factor for any off- and desist orders, approval or denial of (d) Capital measures and capital balance sheet item does not applications or notices, assessment of category definitions. (1) Capital

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measures. For purposes of this section, next lower capital category, in the that it must submit a new or revised the relevant capital measures are: following circumstances: capital restoration plan must file the (i) The total risk-based capital ratio; (i) Unsafe or unsound condition. The plan in writing with the NCUA within (ii) The Tier 1 risk-based capital ratio; NCUA has determined, after notice and 45 days of receiving such notice, unless and opportunity for hearing pursuant to the NCUA notifies the corporate credit (iii) The leverage ratio. paragraph (h)(1) of this section, that the union in writing that the plan is to be (2) Capital categories. For purposes of corporate credit union is in an unsafe or filed within a different period. this section, a corporate credit union is: unsound condition; or (2) Contents of plan. All financial data (i) Well capitalized if the corporate (ii) Unsafe or unsound practice. The submitted in connection with a capital credit union: NCUA has determined, after notice and restoration plan must be prepared in (A) Has a total risk-based capital ratio an opportunity for hearing pursuant to accordance with the instructions of 10.0 percent or greater; and paragraph (h)(1) of this section, that the provided on the call report, unless the (B) Has a Tier 1 risk-based capital corporate credit union received a less- NCUA instructs otherwise. The capital ratio of 6.0 percent or greater; and than-satisfactory rating (i.e., three or restoration plan must include all of the (C) Has a leverage ratio of 5.0 percent lower) for any rating category (other information required to be filed under or greater; and than in a rating category specifically paragraph (k)(2)(ii) of this section. A (D) Is not subject to any written addressing capital adequacy) under the corporate credit union required to agreement, order, capital directive, or Corporate Risk Information System submit a capital restoration plan as the prompt corrective action directive (CRIS) rating system and has not result of a reclassification of the issued by NCUA to meet and maintain corrected the conditions that served as corporate credit union pursuant to a specific capital level for any capital the basis for the less than satisfactory paragraph (d)(3) of this section must measure. rating. Ratings under this paragraph include a description of the steps the (ii) Adequately capitalized if the (d)(3)(ii) refer to the most recent ratings corporate credit union will take to corporate credit union: (as determined either on-site or off-site correct the unsafe or unsound condition (A) Has a total risk-based capital ratio by the most recent examination) of or practice. of 8.0 percent or greater; and which the corporate credit union has (3) Failure to submit a capital (B) Has a Tier 1 risk-based capital been notified in writing. restoration plan. A corporate credit ratio of 4.0 percent or greater; and (4) The NCUA may, for good cause, union that is undercapitalized and that (C) Has: modify any of the percentages in fails to submit a written capital (1)A leverage ratio of 4.0 percent or paragraph (d)(2) of this section as restoration plan within the period greater; and described in § 704.3(d). provided in this section will, upon the (2) Does not meet the definition of a (e) Capital restoration plans. (1) expiration of that period, be subject to well capitalized corporate credit union. Schedule for filing plan— all of the provisions of this section (iii) Undercapitalized if the corporate (i) In general. A corporate credit applicable to significantly credit union: union must file a written capital undercapitalized credit unions. (A) Has a total risk-based capital ratio restoration plan with the NCUA within (4) Review of capital restoration that is less than 8.0 percent; or 45 days of the date that the corporate plans. Within 60 days after receiving a (B) Has a Tier 1 risk-based capital credit union receives notice or is capital restoration plan under this ratio that is less than 4.0 percent; or deemed to have notice that the section, the NCUA will provide written (C) Has a leverage ratio that is less corporate credit union is notice to the corporate credit union of than 4.0 percent. undercapitalized, significantly whether it has approved the plan. The (iv) Significantly undercapitalized if undercapitalized, or critically NCUA may extend this time period. the corporate credit union has: undercapitalized, unless the NCUA (5) Disapproval of capital plan. If the (A) A total risk-based capital ratio that notifies the corporate credit union in NCUA does not approve a capital is less than 6.0 percent; or writing that the plan is to be filed restoration plan, the corporate credit (B) A Tier 1 risk-based capital ratio within a different period. An adequately union must submit a revised capital that is less than 3.0 percent; or capitalized corporate credit union that restoration plan, when directed to do so, (C) A leverage ratio that is less than has been required pursuant to paragraph within the time specified by the NCUA. 3.0 percent. (d)(3) of this section to comply with An undercapitalized corporate credit (v) Critically undercapitalized if the supervisory actions as if the corporate union is subject to the provisions corporate credit union has: credit union were undercapitalized is applicable to significantly (A) A total risk-based capital ratio that not required to submit a capital undercapitalized credit unions until it is less than 4.0 percent; or restoration plan solely by virtue of the has submitted, and NCUA has (B) A Tier 1 risk-based capital ratio reclassification. approved, a capital restoration plan. If that is less than 2.0 percent; or (ii) Additional capital restoration the NCUA directs that the corporate (C) A leverage ratio that is less than plans. Notwithstanding paragraph submit a revised plan, it must do so in 2.0 percent. (e)(1)(i) of this section, a corporate time frame specified by the NCUA. (3) Reclassification based on credit union that has already submitted (6) Failure to implement a capital supervisory criteria other than capital. and is operating under a capital restoration plan. Any undercapitalized Notwithstanding the elements of restoration plan approved under this corporate credit union that fails in any paragraph (d)(2) of this section, the section is not required to submit an material respect to implement a capital NCUA may reclassify a well capitalized additional capital restoration plan based restoration plan will be subject to all of corporate credit union as adequately on a revised calculation of its capital the provisions of this section applicable capitalized, and may require an measures or a reclassification of the to significantly undercapitalized adequately capitalized or institution under paragraph (d)(3) of this institutions. undercapitalized corporate credit union section unless the NCUA notifies the (7) Amendment of capital plan. A to comply with certain mandatory or corporate credit union that it must corporate credit union that has filed an discretionary supervisory actions as if submit a new or revised capital plan. A approved capital restoration plan may, the corporate credit union were in the corporate credit union that is notified after prior written notice to and

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approval by the NCUA, amend the plan (f)(1)(ii) and (f)(1)(iii) of this section, notice of right to seek reinstatement and to reflect a change in circumstance. immediately upon receiving notice or the associated process. Until such time as NCUA has approved being deemed to have notice that the (j) Enforcement of directives. Section a proposed amendment, the corporate corporate credit union is critically 747.3005 of this chapter prescribes the credit union must implement the capital undercapitalized, the corporate credit process for enforcement of directives. restoration plan as approved prior to the union will become subject to these (k) Remedial actions towards proposed amendment. additional provisions of paragraph (k) of undercapitalized, significantly (f) Mandatory and discretionary this section: undercapitalized, and critically supervisory actions. (1) Mandatory (A) Restricting the activities of the undercapitalized corporate credit supervisory actions.— corporate credit union ((k)(5)(i)); and unions. (1) Provision applicable to all (i) Provisions applicable to all (B) Restricting payments on corporate credit unions. A corporate corporate credit unions. All corporate subordinated debt of the corporate credit union is prohibited, unless it credit unions are subject to the credit union ((k)(5)(ii)). obtains NCUA’s prior written approval, restrictions contained in paragraph (2) Discretionary supervisory actions. from making any capital distribution, (k)(1) of this section on capital In taking any action under paragraph (k) including payment of dividends on distributions. of this section that is within the NCUA’s perpetual and nonperpetual contributed (ii) Provisions applicable to discretion to take in connection with a capital accounts if, after making the undercapitalized, significantly corporate credit union that is deemed to distribution, the institution would be undercapitalized, and critically be undercapitalized, significantly undercapitalized. undercapitalized corporate credit undercapitalized or critically (2) Provisions applicable to unions. Immediately upon receiving undercapitalized, or has been undercapitalized corporate credit notice or being deemed to have notice, reclassified as undercapitalized, or unions. as provided in paragraph (c) or (e) of significantly undercapitalized; or an (i) Monitoring required. The NCUA this section, that the corporate credit action in connection with an officer or will— union is undercapitalized, significantly director of such corporate credit union; (A) Closely monitor the condition of undercapitalized, or critically the NCUA will follow the procedures any undercapitalized corporate credit undercapitalized, the corporate credit for issuing directives under paragraphs union; union will be subject to the following (g) and (i) of this section. (B) Closely monitor compliance with provisions of paragraph (k) of this (g) Directives to take prompt capital restoration plans, restrictions, section: corrective action. The NCUA will and requirements imposed under this (A) Restricting capital distributions provide an undercapitalized, section; and (paragraph (k)(1)); significantly undercapitalized, or (C) Periodically review the plan, (B) NCUA monitoring of the condition critically undercapitalized corporate restrictions, and requirements of the corporate credit union (paragraph credit union prior written notice of the applicable to any undercapitalized (k)(2)(i)); corporate credit union to determine (C) Requiring submission of a capital NCUA’s intention to issue a directive requiring such corporate credit union to whether the plan, restrictions, and restoration plan (paragraph (k)(2)(ii)); requirements are achieving the purpose (D) Restricting the growth of the take actions or to follow proscriptions described in this part. Section 747.3002 of this section. corporate credit union’s assets (ii) Capital restoration plan required. of this chapter prescribes the notice (paragraph (k)(2)(iii)); and (A) Any undercapitalized corporate content and associated process. (E) Requiring prior approval of certain credit union must submit an acceptable (h) Procedures for reclassifying a expansion proposals (paragraph capital restoration plan to the NCUA. (k)(2)(iv)). corporate credit union based on criteria (B) The capital restoration plan will— (iii) Additional provisions applicable other than capital. When the NCUA (1) Specify— to significantly undercapitalized, and intends to reclassify a corporate credit (i) The steps the corporate credit critically undercapitalized corporate union or subject it to the supervisory union will take to become adequately credit unions. In addition to the actions applicable to the next lower capitalized; requirement described in paragraph capitalization category based on an (ii) The levels of capital to be attained (f)(1) of this section, immediately upon unsafe or unsound condition or practice during each year in which the plan will receiving notice or being deemed to the NCUA will provide the credit union be in effect; have notice that the corporate credit with prior written notice of such intent. (iii) How the corporate credit union union is significantly undercapitalized, Section 747.3003 of this chapter will comply with the restrictions or or critically undercapitalized, or that the prescribes the notice content and requirements then in effect under this corporate credit union is subject to the associated process. section; and provisions applicable to corporate credit (i) Order to dismiss a Director or (iv) The types and levels of activities unions that are significantly senior executive officer. When the in which the corporate credit union will undercapitalized because the credit NCUA issues and serves a directive on engage; and union failed to submit or implement in a corporate credit union requiring it to (2) Contain such other information as any material respect an acceptable dismiss from office any director or the NCUA may require. capital restoration plan, the corporate senior executive officer under (C) The NCUA will not accept a credit union will become subject to the paragraphs (k)(3) of this section, the capital restoration plan unless the provisions of paragraph (k)(3)(iii) of this NCUA will also serve upon the person NCUA determines that the plan— section that restrict compensation paid the corporate credit union is directed to (1) Complies with paragraph to senior executive officers of the dismiss (Respondent) a copy of the (k)(2)(ii)(B) of this section; institution. directive (or the relevant portions, (2) Is based on realistic assumptions, (iv) Additional provisions applicable where appropriate) and notice of the and is likely to succeed in restoring the to critically undercapitalized corporate Respondent’s right to seek corporate credit union’s capital; and credit unions. In addition to the reinstatement. Section 747.3004 of this (3) Would not appreciably increase provisions described in paragraphs chapter prescribes the content of the the risk (including credit risk, interest-

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rate risk, and other types of risk) to institution, if one or more grounds exist other action that the NCUA determines which the corporate credit union is under this section or the Federal Credit will better carry out the purpose of this exposed; and Union Act for appointing a conservator section than any of the actions (iii) Asset growth restricted. An or liquidating agent. described in this paragraph. undercapitalized corporate credit union (B) Restricting any ongoing or future (iii) Senior executive officers’ must not permit its daily average net transactions with affiliates. compensation restricted. assets during any calendar month to (C) Restricting interest rates paid. (A) In general. The corporate credit exceed its moving daily average net (1) In general. Restricting the rates of union is prohibited from doing any of assets unless— dividends and interest that the the following without the prior written (A) The NCUA has accepted the corporate credit union pays on shares approval of the NCUA: corporate credit union’s capital and deposits to the prevailing rates on (1) Pay any bonus or profit-sharing to restoration plan; and shares and deposits of comparable any senior executive officer. (B) Any increase in total assets is amounts and maturities in the region (2) Provide compensation to any consistent with the plan. where the institution is located, as senior executive officer at a rate (iv) Prior approval required for determined by the NCUA. exceeding that officer’s average rate of acquisitions, branching, and new lines (2) Retroactive restrictions prohibited. compensation (excluding bonuses and of business. An undercapitalized Paragraph (k)((3)(ii)(C) of this section profit-sharing) during the 12 calendar corporate credit union must not, does not authorize the NCUA to restrict months preceding the calendar month directly or indirectly, acquire any interest rates paid on time deposits or in which the corporate credit union interest in any entity, establish or shares made before (and not renewed or became undercapitalized. acquire any additional branch office, or renegotiated after) the date the NCUA (B) Failing to submit plan. The NCUA engage in any new line of business announced the restriction. will not grant approval with respect to unless the NCUA has accepted the (D) Restricting asset growth. a corporate credit union that has failed corporate credit union’s capital Restricting the corporate credit union’s to submit an acceptable capital restoration plan, the corporate credit asset growth more stringently than in restoration plan. union is implementing the plan, and the paragraph (k)(2)(iii) of this section, or (iv) Discretion to impose certain NCUA determines that the proposed requiring the corporate credit union to additional restrictions. The NCUA may action is consistent with and will reduce its total assets. impose one or more of the restrictions (E) Restricting activities. Requiring further the achievement of the plan. prescribed by regulation under the corporate credit union or any of its (v) Discretionary safeguards. The paragraph (k)(5) of this section if the CUSOs to alter, reduce, or terminate any NCUA may, with respect to any NCUA determines that those restrictions activity that the NCUA determines undercapitalized corporate credit union, are necessary to carry out the purpose poses excessive risk to the corporate take one or more of the actions of this section. described in paragraph (k)(3)(ii) of this credit union. (F) Improving management. Doing one (4) More stringent treatment based on section if the NCUA determines those other supervisory criteria. actions are necessary to carry out the or more of the following: (1) New election of Directors. (i) In general. If the NCUA purpose of this section. determines, after notice and an (3) Provisions applicable to Ordering a new election for the opportunity for hearing as described in significantly undercapitalized corporate corporate credit union’s board of subpart M of part 747 of this chapter, credit unions and undercapitalized Directors. that a corporate credit union is in an corporate credit unions that fail to (2) Dismissing Directors or senior unsafe or unsound condition or deems submit and implement capital executive officers. Requiring the the corporate credit union to be restoration plans. corporate credit union to dismiss from engaging in an unsafe or unsound (i) In general. This paragraph applies office any Director or senior executive practice, the NCUA may— with respect to any corporate credit officer who had held office for more (A) If the corporate credit union is union that— than 180 days immediately before the (A) Is significantly undercapitalized; corporate credit union became well capitalized, reclassify the corporate or undercapitalized. credit union as adequately capitalized; (B) Is undercapitalized and— (3) Employing qualified senior (B) If the corporate credit union is (1) Fails to submit an acceptable executive officers. Requiring the adequately capitalized (but not well capital restoration plan within the time corporate credit union to employ capitalized), require the corporate credit allowed by the NCUA under paragraph qualified senior executive officers (who, union to comply with one or more (e)(1) of this section; or if the NCUA so specifies, will be subject provisions of paragraphs (k)(1) and (2) Fails in any material respect to to approval by the NCUA). (k)(2) of this section, as if the corporate implement a plan accepted by the (G) Requiring divestiture. Requiring credit union were undercapitalized; or NCUA. the corporate credit union to divest (C) If the corporate credit union is (ii) Specific actions authorized. The itself of or liquidate any interest in any undercapitalized, take any one or more NCUA may take one or more of the entity if the NCUA determines that the actions authorized under paragraph following actions: entity is in danger of becoming (k)(3)(ii) of this section as if the (A) Requiring recapitalization. insolvent or otherwise poses a corporate credit union were (1) Requiring the corporate credit significant risk to the corporate credit significantly undercapitalized. union to seek and obtain additional union; (ii) Contents of plan. Any plan contributed capital. (H) Conserve or liquidate the required under paragraph (k)(4)(i) of this (2) Requiring the corporate credit corporate credit union if NCUA section will specify the steps that the union to increase its rate of earnings determines the credit union has no corporate credit union will take to retention. reasonable prospect of becoming correct the unsafe or unsound condition (3) Requiring the corporate credit adequately capitalized; and or practice. Capital restoration plans, union to combine, in whole or part, (I) Requiring other action. Requiring however, will not be required under with another insured depository the corporate credit union to take any paragraph (k)(4)(i)(B) of this section.

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(5) Provisions applicable to critically average cost of funds to a level daily assessment of the market value of undercapitalized corporate credit significantly exceeding the prevailing the repurchase securities and maintains unions. rates of interest on insured deposits in adequate margin that reflects a risk (i) Activities restricted. Any critically the corporate credit union’s normal assessment of the repurchase securities undercapitalized corporate credit union market areas. and the term of the transaction; and must comply with restrictions 11. Revise § 704.5 to read as follows: (4) The corporate credit union has prescribed by the NCUA under entered into signed contracts with all § 704.5 Investments. paragraph (k)(6) of this section. approved counterparties and agents, and (ii) Payments on contributed capital (a) Policies. A corporate credit union ensures compliance with the contracts. and subordinated debt prohibited. A must operate according to an investment Such contracts must address any critically undercapitalized corporate policy that is consistent with its other supplemental terms and conditions credit union must not, beginning no risk management policies, including, necessary to meet the specific later than 60 days after becoming but not limited to, those related to credit requirements of this part. Third party critically undercapitalized, make any risk management, asset and liability arrangements must be supported by tri- payment of dividends on contributed management, and liquidity party contracts in which the repurchase capital or any payment of principal or management. The policy must address, securities are priced and reported daily interest on the corporate credit union’s at a minimum: and the tri-party agent ensures subordinated debt unless the NCUA (1) Appropriate tests and criteria for compliance; and determines that an exception would evaluating investments and investment (e) Securities Lending. A corporate further the purpose of this section. transactions before purchase; and credit union may enter into a securities Interest, although not payable, may (2) Reasonable and supportable lending transaction provided that: continue to accrue under the terms of concentration limits for limited (1) The corporate credit union, any subordinated debt to the extent liquidity investments in relation to directly or through its agent, receives otherwise permitted by law. Dividends capital. written confirmation of the loan, obtains (b) General. All investments must be on contributed capital do not, however, a first priority security interest in the U.S. dollar-denominated and subject to continue to accrue. collateral by taking physical possession the credit policy restrictions set forth in (iii) Conservatorship, liquidation, or or control of the collateral, or is § 704.6. other action. The NCUA may, at any recorded as owner of the collateral (c) Authorized activities. A corporate time, conserve or liquidate any critically through the Federal Reserve Book-Entry credit union may invest in: undercapitalized corporate credit union Securities Transfer System; or require the credit union to combine, (1) Securities, deposits, and obligations set forth in Sections 107(7), (2) The collateral is a legal investment in whole or part, with another for that corporate credit union; institution. NCUA will consider, not 107(8), and 107(15) of the Federal Credit Union Act, 12 U.S.C. 1757(7), 1757(8), (3) The corporate credit union, later than 90 days after a corporate directly or through its agent, receives credit union becomes critically and 1757(15), except as provided in this section; daily assessment of the market value of undercapitalized, whether NCUA collateral and maintains adequate should liquidate, conserve, or combine (2) Deposits in, the sale of federal funds to, and debt obligations of margin that reflects a risk assessment of the institution. the collateral and terms of the loan; and (6) Restricting activities of critically corporate credit unions, Section 107(8) institutions, and state banks, trust (4) The corporate credit union has undercapitalized corporate credit entered into signed contracts with all unions. To carry out the purpose of this companies, and mutual savings banks not domiciled in the state in which the agents and, directly or through its agent, section, the NCUA will, by order— has executed a written loan and security (i) Restrict the activities of any corporate credit union does business; agreement with the borrower. The critically undercapitalized corporate (3) Corporate CUSOs, as defined in corporate or its agent ensures credit union; and and subject to the limitations of (ii) At a minimum, prohibit any such § 704.11; compliance with the agreements. corporate credit union from doing any (4) Marketable debt obligations of (f) Investment companies. A corporate of the following without the NCUA’s corporations chartered in the United credit union may invest in an prior written approval: States. This authority does not apply to investment company registered with the (A) Entering into any material debt obligations that are convertible into Securities and Exchange Commission transaction other than in the usual the stock of the corporation; and under the Investment Company Act of course of business, including any (5) Domestically-issued asset-backed 1940 (15 U.S.C. 80a), or a collective investment, expansion, acquisition, sale securities. investment fund maintained by a of assets, or other similar action. (d) Repurchase agreements. A national bank under 12 CFR 9.18 or a (B) Extending credit for any corporate credit union may enter into a mutual savings bank under 12 CFR transaction NCUA determines to be repurchase agreement provided that: 550.260, provided that the company or highly leveraged. (1) The corporate credit union, fund prospectus restricts the investment (C) Amending the corporate credit directly or through its agent, receives portfolio to investments and investment union’s charter or bylaws, except to the written confirmation of the transaction, transactions that are permissible for that extent necessary to carry out any other and either takes physical possession or corporate credit union. requirement of any law, regulation, or control of the repurchase securities or is (g) Investment settlement. A corporate order. recorded as owner of the repurchase credit union may only contract for the (D) Making any material change in securities through the Federal Reserve purchase or sale of an investment if the accounting methods. Book-Entry Securities Transfer System; transaction is settled on a delivery (E) Paying compensation or bonuses (2) The repurchase securities are legal versus payment basis within 60 days for NCUA determines to be excessive. investments for that corporate credit mortgage-backed securities, within 30 (F) Paying interest on new or renewed union; days for new issues (other than liabilities at a rate that would increase (3) The corporate credit union, mortgage-backed securities), and within the corporate credit union’s weighted directly or through its agent, receives three days for all other securities.

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(h) Prohibitions. A corporate credit interests in one or more IO CMOs or PO (including accumulated dividends and union is prohibited from: CMOs as an asset associated with an interest) by the NCUSIF or the Federal (1) Purchasing or selling derivatives, investment repurchase transaction or as Deposit Insurance Corporation. except for embedded options not collateral in a securities lending (c) Issuer Concentration limits— required under GAAP to be accounted transaction. When the exchangeable (1) General rule. The aggregate of all for separately from the host contract or CMO is associated with one of these two investments in any single obligor is forward sales commitments on loans to transactions, it need not conform to the limited to 25 percent of capital or be purchased by the corporate credit conditions in paragraphs (h)(5)(i)(A) or $5 million, whichever is greater. union; (B) of this section. (2) Exceptions. (2) Engaging in trading securities (i) Conflicts of interest. A corporate (i) Aggregate investments in unless accounted for on a trade date credit union’s officials, employees, and repurchase and securities lending basis; immediate family members of such agreements with any one counterparty (3) Engaging in adjusted trading or individuals, may not receive pecuniary are limited to 200 percent of capital; short sales; and consideration in connection with the (ii) Investments in non-money market (4) Purchasing mortgage servicing making of an investment or deposit by registered investment companies are rights, small business related securities, the corporate credit union. Employee limited to 50 percent of capital in any residual interests in collateralized compensation is exempt from this single obligor; mortgage obligations, residual interests prohibition. All transactions not (iii) Investments in money market in real estate mortgage investment specifically prohibited by this paragraph registered investment companies are conduits, or residual interests in asset- must be conducted at arm’s length and limited to 100 percent of capital in any backed securities; and in the interest of the corporate credit single obligor; and (5) Purchasing net interest margin union. (iv) Investments in corporate CUSOs securities; (j) Grandfathering. A corporate credit are subject to the limitations of § 704.11. (6) Purchasing collateralized debt union’s authority to hold an investment (3) For purposes of measurement, obligations; and is governed by the regulation in effect at each new credit transaction must be (7) Purchasing stripped mortgage- the time of purchase. However, all evaluated in terms of the corporate backed securities (SMBS), or securities grandfathered investments are subject to credit union’s capital at the time of the that represent interests in SMBS, except the requirements of §§ 704.8 and 704.9. transaction. An investment that fails a as described in subparagraphs (i) and 12. Revise § 704.6 to read as follows: requirement of this section because of a (iii) below. subsequent reduction in capital will be (i) A corporate credit union may § 704.6 Credit risk management. deemed non-conforming. A corporate invest in exchangeable collateralized (a) Policies. A corporate credit union credit union is required to exercise mortgage obligations (exchangeable must operate according to a credit risk reasonable efforts to bring CMOs) representing beneficial management policy that is nonconforming investments into ownership interests in one or more commensurate with the investment risks conformity within 90 calendar days. interest-only classes of a CMO (IO and activities it undertakes. The policy Investments that remain nonconforming CMOs) or principal-only classes of a must address at a minimum: for 90 calendar days will be deemed to CMO (PO CMOs), but only if: (1) The approval process associated fail a requirement of this section, and (A) At the time of purchase, the ratio with credit limits; the corporate credit union will have to of the market price to the remaining (2) Due diligence analysis comply with § 704.10. principal balance is between .8 and 1.2, requirements; (d) Sector Concentration Limits. (1) A meaning that the discount or premium (3) Maximum credit limits with each corporate credit union must establish of the market price to par must be less obligor and transaction counterparty, set sector limits that do not exceed the than 20 points; as a percentage of capital. In addition to following maximums: (B) The offering circular or other addressing deposits and securities, (i) Residential mortgage-backed official information available at the time limits with transaction counterparties securities—the lower of 500 percent of of purchase indicates that the notional must address aggregate exposures of all capital or 25 percent of assets; principal on each underlying IO CMO transactions including, but not limited (ii) Commercial mortgage-backed should decline at the same rate as the to, repurchase agreements, securities securities—the lower of 500 percent of principal on one or more of the lending, and forward settlement of capital or 25 percent of assets; underlying non-IO CMOs, and that the purchases or sales of investments; and (iii) FFELP student loan asset-backed principal on each underlying PO CMO (4) Concentrations of credit risk (e.g., securities—the lower of 1000 percent of should decline at the same rate as the originator of receivables, servicer of capital or 50 percent of assets; principal, or notional principal, on one receivables, insurer, industry type, (iv) Private student loan asset-backed or more of the underlying non-PO sector type, geographic, collateral type, securities—the lower of 500 percent of CMOs; and and tranche priority). capital or 25 percent of assets; (C) The credit union investment staff (b) Exemption. The limitations and (v) Auto loan/lease asset-backed has the expertise dealing with requirements of this section do not securities—the lower of 500 percent of exchangeable CMOs to apply the apply to certain assets, whether or not capital or 25 percent of assets; conditions in paragraphs (h)(5)(i)(A) and considered investments under this part, (vi) Credit card asset-backed (B) of this section. including fixed assets, individual loans securities—the lower of 500 percent of (ii) A corporate credit union that and loan participation interests, capital or 25 percent of assets; invests in an exchangeable CMO may investments in CUSOs, investments that (vii) Other asset-backed securities not exercise the exchange option only if all are issued or fully guaranteed as to listed in paragraphs (ii) through (vi)— of the underlying CMOs are permissible principal and interest by the U.S. the lower of 500 percent of capital or 25 investments for that credit union. government or its agencies or its percent of assets; (iii) A corporate credit union may sponsored enterprises (excluding (viii) Corporate debt obligations—the accept an exchangeable CMO subordinated debt), and investments lower of 1000 percent of capital or 50 representing beneficial ownership that are fully insured or guaranteed percent of assets; and

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(ix) Municipal securities—the lower (3) All rating(s) relied upon to meet (5) The modeling of indexes that serve of 1000 percent of capital or 50 percent the requirements of this part must be as references in financial instrument of assets. identified at the time of purchase and coupon formulas; and (2) Registered investment must be monitored for as long as the (6) The tests that will be used, prior companies—A corporate credit union corporate owns the investment. to purchase, to estimate the impact of must limit its investment in registered Corporate credit unions must identify investments on the percentage decline investment companies to the lower of and monitor any new post-purchase in NEV compared to base case NEV. The 1000 percent of capital or 50 percent of NRSRO ratings on investments they most recent NEV analysis, as assets. In addition to applying the limit hold. determined under paragraph (d)(1)(i), in this paragraph (d)(2), a corporate (4) Investments are subject to the (e)(1)(i), and (f)(1)(i) of this section may credit union must also include the requirements of § 704.10 if: be used as a basis of estimation. underlying assets in each registered (i) An NRSRO that rates the (b) Asset and liability management investment company in the relevant investment downgrades that rating, after committee (ALCO). A corporate credit sectors described in paragraph (d)(1) of purchase, below the minimum rating union’s ALCO must have at least one this section when calculating those requirements of this part; or member who is also a member of the sector limits. (ii) The investment is part of an asset board of directors. The ALCO must (3) A corporate credit union will limit class or group of investments that review asset and liability management its aggregate holdings in any exceeds the sector or obligor reports on at least a monthly basis. investments not described in paragraphs concentration limits of this section. These reports must address compliance (d)(1) or (d)(2) to the lower of 100 (g) Reporting and documentation. (1) with Federal Credit Union Act, NCUA percent of capital or 5 percent of assets. At least annually, a written evaluation Rules and Regulations (12 CFR chapter The NCUA may approve a higher of each credit limit with each obligor or VII), and all related risk management percentage in appropriate cases. transaction counterparty must be policies. (4) The following investments are also prepared and formally approved by the (c) Penalty for early withdrawals. A excluded from the concentration limits board or an appropriate committee. At corporate credit union that permits early in paragraphs (d)(1), (d)(2), and (d)(3): least monthly, the board or an share certificate withdrawals must Investments in other federally insured appropriate committee must receive an redeem at the lesser of book value plus credit unions, deposits in other investment watch list of existing and/or accrued dividends or the value based on depository institutions, and investment potential credit problems and summary a market-based penalty sufficient to repurchase agreements. credit exposure reports, which cover the estimated replacement cost of (e) Subordinated securities. A demonstrate compliance with the the certificate redeemed. This means the corporate credit union may not hold corporate credit union’s risk minimum penalty must be reasonably subordinated securities in excess of the management policies. related to the rate that the corporate lower of 100 percent of capital or 5 (2) At a minimum, the corporate credit union would be required to offer percent of assets in any single credit union must maintain: to attract funds for a similar term with investment sector described in (i) A justification for each approved similar characteristics. (d) Interest rate sensitivity analysis. paragraphs (d)(1) and (d)(2) or in excess credit limit; (ii) Disclosure documents, if any, for (1) A corporate credit union must: of the lower of 400 percent of capital or all instruments held in portfolio. (i) Evaluate the risk in its balance 20 percent of assets in all investment Documents for an instrument that has sheet by measuring, at least quarterly, sectors described in paragraph (d). been sold must be retained until the impact of an instantaneous, (f) Credit ratings.—(1) All completion of the next NCUA permanent, and parallel shock in the investments, other than in another examination; and yield curve of plus and minus 100, 200, depository institution, must have an (iii) The latest available financial and 300 bp on its NEV and NEV ratio. applicable credit rating from at least one reports, industry analyses, internal and If the base case NEV ratio falls below 3 nationally recognized statistical rating external analyst evaluations, and rating percent at the last testing date, these organization (NRSRO). At a minimum, agency information sufficient to support tests must be calculated at least monthly 90 percent of all such investments, by each approved credit limit. until the base case NEV ratio again book value, must have a rating by at 13. Revise § 704.8 to read as follows: exceeds 3 percent; least two NRSROs. Corporate credit (ii) Limit its risk exposure to levels unions may use either public or § 704.8 Asset and liability management. that do not result in a base case NEV nonpublic NRSRO ratings to satisfy this (a) Policies. A corporate credit union ratio or any NEV ratio resulting from the requirement. must operate according to a written tests set forth in paragraph (d)(1)(i) of (2) At the time of purchase, asset and liability management policy this section below 2 percent; and investments with long-term ratings must which addresses, at a minimum: (iii) Limit its risk exposures to levels be rated no lower than AA– (or (1) The purpose and objectives of the that do not result in a decline in NEV equivalent) by every NRSRO that corporate credit union’s asset and of more than 15 percent. provides a publicly available long-term liability activities; (2) A corporate credit union must rating on that investment, and (2) The maximum allowable assess annually if it should conduct investments with short-term ratings percentage decline in net economic periodic additional tests to address must be rated no lower than A–1 (or value (NEV), compared to base case market factors that may materially equivalent) by every NRSRO that NEV; impact that corporate credit union’s provides a publicly available short-term (3) The minimum allowable NEV NEV. These factors should include, but rating on that investment. If the ratio; are not limited to, the following: corporate credit union obtains a (4) Policy limits and specific test (i) Changes in the shape of the nonpublic NRSRO rating, that rating parameters for the NEV sensitivity Treasury yield curve; must also be no lower than AA–, or A– analysis requirements set forth in (ii) Adjustments to prepayment 1, for long-term and short-term ratings, paragraphs (d), (e), and (f) of this projections used for amortizing respectively. section; securities to consider the impact of

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significantly faster/slower prepayment (3) A corporate credit union must also immediately be recategorized as: speeds; and test for the effects of failed triggers on Undercapitalized until the violation is (iii) Adjustments to volatility its NEV and NEV while testing the cash corrected, and assumptions to consider the impact that flow sensitivity analysis. (iii) If presently less than adequately changing volatilities have on embedded (g) Net interest income modeling. A capitalized, immediately be option values. corporate credit union must perform net downgraded one additional capital (e) Cash flow mismatch sensitivity interest income (NII) modeling to category. analysis. project earnings in multiple interest rate (k) Overall limit on business (1) A corporate credit union must: environments for a period of no less generated from individual credit unions. (i) Evaluate the risk in its balance than 2 years. NII modeling must, at On or after [DATE 30 MONTHS AFTER sheet by measuring, at least quarterly, minimum, be performed quarterly. DATE OF PUBLICATION OF FINAL the impact of an instantaneous spread (h) Weighted average asset life. The RULE IN THE FEDERAL REGISTER], a widening of both asset and liabilities by weighted average life (WAL) of a corporate credit union is prohibited 300 basis points, assuming that issuer corporate credit union’s investment from accepting from a member or other options will not be exercised, on its portfolio, excluding derivative contracts entity any investment, including shares, NEV and NEV ratio. If the base case and equity investments, may not exceed loans, PCC, or NCAs if, following that NEV ratio falls below 3 percent at the 2 years. A corporate credit union must investment, the aggregate of all last testing date, these tests must be test its investments at least quarterly for investments from that member or entity calculated at least monthly until the compliance with this WAL limitation. in the corporate would exceed 10 base case NEV ratio again exceeds 3 When calculating its WAL, a corporate percent of the corporate credit union’s percent; credit union must assume that no issuer moving daily average net assets. (ii) Limit its risk exposure to levels options will be exercised. 14. Revise § 704.9 to read as follows: (i) Effective and spread durations. A that do not result in a base case NEV § 704.9 Liquidity management. ratio or any NEV ratio resulting from the corporate credit union must measure at (a) General. In the management of tests set forth in paragraph (e)(1)(i) of least once a quarter the effective liquidity, a corporate credit union must: this section below 2 percent; and duration and spread durations of each of (1) Evaluate the potential liquidity (iii) Limit its risk exposures to levels its assets and liabilities, where the values of these are affected by changes needs of its membership in a variety of that do not result in a decline in NEV economic scenarios; of more than 15 percent. in interest rates or credit spreads. (j) Regulatory violations. (1) (i) If a (2) Regularly monitor and (2) All investments must be tested, corporate credit union’s decline in NEV, demonstrate accessibility to sources of excluding derivatives and equity base case NEV ratio or any NEV ratio internal and external liquidity; investments. All borrowings and shares resulting from the tests set forth in (3) Keep a sufficient amount of cash must be tested, but not contributed paragraphs (d), (e), and (f) of this section and cash equivalents on hand to support capital. violate the limits established in those its payment system obligations; (3) A corporate credit union must also paragraphs, or the corporate credit (4) Demonstrate that the accounting test for the effects of failed triggers on union is unable to satisfy the tests in classification of investment securities is its NEV and NEV ratios while testing the paragraphs (g) and (h) of this section; consistent with its ability to meet cash flow sensitivity analysis. and potential liquidity demands; and (f) Cash flow mismatch sensitivity (ii) The corporate cannot adjust its (5) Develop a contingency funding analysis with 50 percent slowdown in balance sheet so as to satisfy the plan that addresses alternative funding prepayment speeds. (1) A corporate requirements of paragraph (d), (e), (f), strategies in successively deteriorating credit union must: (g), or (h) of this section within 10 liquidity scenarios. The plan must: (i) Evaluate the risk in its balance calendar days after detecting the (i) List all sources of liquidity, by sheet by measuring, at least quarterly, violation, then: category and amount, that are available the impact of an instantaneous spread (iii) The operating management of the to service an immediate outflow of widening of both asset and liabilities by corporate credit union must funds in various liquidity scenarios; 300 basis points, assuming that issuer immediately report this information to (ii) Analyze the impact that potential options will not be exercised and its board of directors, supervisory changes in fair value will have on the prepayment speeds will slow by 50 committee, and the NCUA. disposition of assets in a variety of percent, on its NEV and NEV ratio. If the (2) If any violation described in interest rate scenarios; and base case NEV ratio falls below 2 paragraph (j)(1)(i) persists for 30 or more (iii) Be reviewed by the board or an percent at the last testing date, these calendar days, the corporate credit appropriate committee no less tests must be calculated at least monthly union: frequently than annually or as market or until the base case NEV ratio again (i) Must immediately submit a business conditions dictate. exceeds 2 percent; detailed, written action plan to the (b) Borrowing limits. A corporate (ii) Limit its risk exposure to levels NCUA that sets forth the time needed credit union may borrow up to the that do not result in a base case NEV and means by which it intends to lower of 10 times capital or 50 percent ratio or any NEV ratio resulting from the correct the violation and, if the NCUA of capital and shares (excluding shares tests set forth in paragraph (f)(1)(i) of determines that the plan is created by the use of member reverse this section below 1 percent; and unacceptable, the corporate credit union repurchase agreements). (iii) Limit its risk exposures to levels must immediately restructure its (1) Secured borrowings. A corporate that do not result in a decline in NEV balance sheet to bring the exposure back credit union may borrow on a secured of more than 25 percent. within compliance or adhere to an basis for liquidity purposes, but the (2) All investments must be tested, alternative course of action determined maturity of the borrowing may not excluding derivatives and equity by the NCUA; and exceed 30 days. Only a credit union investments. All borrowings and shares (ii) If presently categorized as with core capital in excess of five must be tested, but not contributed adequately capitalized or well percent of its moving DANA may capital. capitalized for PCA purposes, borrow on a secured basis for

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nonliquidity purposes, and the the corporate credit union will not (1) At least a majority of directors, outstanding amount of secured reasonably be held liable for the including the chair of the board, must borrowing for nonliquidity purposes obligations of the corporate CUSO. This serve on the board as representatives of may not exceed an amount equal to the opinion must address factors that have member credit unions; difference between core capital and five led courts to ‘‘pierce the corporate veil,’’ (2) On or after [DATE 4 MONTHS percent of moving DANA. such as inadequate capitalization, lack AFTER DATE OF PUBLICATION OF (2) Exclusions. CLF borrowings and of corporate identity, common boards of FINAL RULE IN THE FEDERAL borrowed funds created by the use of directors and employees, control of one REGISTER], only individuals who member reverse repurchase agreements entity over another, and lack of separate currently hold the position of chief are excluded from this limit. books and records. executive officer, chief financial officer, 15. Revise § 704.11 to read as follows: (e). Permissible activities. A corporate or chief operating officer at a member CUSO must agree to limit its activities may seek election or re-election to the § 704.11 Corporate Credit Union Service to: board; Organizations (Corporate CUSOs). (1) Brokerage services, (3) No individual may be elected to (a) A corporate CUSO is an entity that: (2) Investment advisory services, and the board if, at the expiration of the term (1) Is at least partly owned by a (3) Other categories of services as to which the individual is seeking corporate credit union; approved in writing by NCUA and election, the individual will have served (2) Primarily serves credit unions; published on NCUA’s Web site. as a director for more than six (3) Restricts its services to those (f) An official of a corporate credit consecutive years. For purposes of related to the normal course of business union which has invested in or loaned calculating the six-year period, any of credit unions as specified in to a corporate CUSO may not receive, consecutive prior service on the board paragraph (e) of this section; and either directly or indirectly, any salary, by representatives of the same corporate (4) Is structured as a corporation, commission, investment income, or member must be counted as though the limited liability company, or limited other income, compensation, or individual seeking election had fulfilled partnership under state law. consideration from the corporate CUSO. that service. Accordingly, a corporate (b) Investment and loan limitations. This prohibition also extends to member may not circumvent the term (1) The aggregate of all investments in immediate family members of officials. limit provisions by putting forward a member and non-member corporate (g) Prior to making an investment in new candidate for directorship after one CUSOs must not exceed 15 percent of a or loan to a corporate CUSO, a corporate or more of its prior representatives has corporate credit union’s capital. credit union must obtain a written served on the board for six consecutive (2) The aggregate of all investments in agreement that the CUSO: years; and loans to member and nonmember (1) Will follow GAAP; (4) No individual may be elected or (2) Will provide financial statements corporate CUSOs must not exceed 30 appointed to serve on the board if, after to the corporate credit union at least percent of a corporate credit union’s such election or appointment, the quarterly; capital. A corporate credit union may individual would be a director at more lend to member and nonmember (3) Will obtain an annual CPA opinion audit and provide a copy to the than one corporate credit union; corporate CUSOs an additional 15 (5) No individual may be elected or corporate credit union. A wholly owned percent of capital if the loan is appointed to serve on the board if, after or majority owned CUSO is not required collateralized by assets in which the such election or appointment, any to obtain a separate annual audit if it is corporate has a perfected security member of the corporate credit union interest under state law. included in the corporate credit union’s annual consolidated audit; would have more than one (3) If the limitations in paragraphs representative on the board of the (b)(1) and (b)(2) of this section are (4) Will not acquire control, directly or indirectly, of another depository corporate; reached or exceeded because of the (6) The chair of the board may not profitability of the CUSO and the related or to invest in shares, stocks, or obligations of an serve simultaneously as an officer, GAAP valuation of the investment insurance company, trade association, director, or employee of a credit union under the equity method without an liquidity facility, or similar trade association; additional cash outlay by the corporate, (7) A majority of directors may not organization; divestiture is not required. A corporate (5) Will allow the auditor, board of serve simultaneously as officers, credit union may continue to invest up directors, and NCUA complete access to directors, or employees of the same to the regulatory limit without regard to its personnel, facilities, equipment, credit union trade association or its the increase in the GAAP valuation books, records, and any other affiliates (not including chapters or resulting from the corporate CUSO’s documentation that the auditor, other subunits of a state trade profitability. directors, or NCUA deem pertinent; and association); (c) Due diligence. A corporate credit (6) Will comply with all the (8) For purposes of meeting the union must comply with the due requirements of this section. requirements of paragraphs (a)(6) and diligence requirements of §§ 723.5 and (h) Corporate credit union authority to (a)(7) of this section, an individual may 723.6(f) through (j) of this chapter for all invest in or loan to a CUSO is limited not serve as a director or chair of the loans to corporate CUSOs. This to that provided in this section. A board if that individual holds a requirement does not apply to loans corporate credit union is not authorized subordinate employment relationship to excluded under § 723.1(b). to invest in or loan to a CUSO under another employee who serves as an (d) Separate entity. (1) A corporate part 712 of this chapter. officer, director, or employee of a credit CUSO must be operated as an entity 16. Revise § 704.14 to read as follows: union trade association; separate from a corporate credit union. (9) In the case of a corporate credit (2) A corporate credit union investing § 704.14 Representation. union whose membership is composed in or lending to a corporate CUSO must (a) Board representation. The board of more than 25 percent non credit obtain a written legal opinion that will be determined as stipulated in its unions, the majority of directors serving concludes the corporate CUSO is bylaws governing election procedures, as representatives of member credit organized and operated in a manner that provided that: unions, including the chair, must be

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elected only by member credit unions, § 704.20 Limitations on golden parachute golden parachute payments described in and and indemnification payments. § 704.20(d); and (10) After [DATE 36 MONTHS AFTER (a) Definitions. The following (iii) In the case of any nonqualified DATE OF PUBLICATION OF THE definitions apply for this section: deferred compensation or supplemental (1) Board means the National Credit FINAL RULE IN THE FEDERAL retirement plans as described in Union Administration Board. paragraphs (a)(3)(i) and (ii) of this REGISTER], at least a majority of (2) Benefit plan means any plan, directors of every corporate credit section, the following requirements will contract, agreement or other apply: union, including the chair of the board, arrangement which is an ‘‘employee (A) The plan was in effect at least one must serve on the board as welfare benefit plan’’ as that term is year prior to any of the events described representatives of natural person credit defined in section 3(1) of the Employee in paragraph (a)(4)(ii) of this section; union members. Retirement Income Security Act of 1974, 17. Revise § 704.19 to read as follows: as amended (29 U.S.C. 1002(1)), or other (B) Any payment made pursuant to usual and customary plans such as such plan is made in accordance with § 704.19 Disclosure of executive and dependent care, tuition reimbursement, the terms of the plan as in effect no later director compensation. group legal services or cafeteria plans; than one year prior to any of the events described in paragraph (a)(4)(ii) of this (a) Annual disclosure. Corporate provided however, that such term does section and in accordance with any credit unions must annually prepare not include any plan intended to be amendments to such plan during such and maintain a disclosure of the subject to paragraphs (a)(4)(iv)(C) and one year period that do not increase the compensation, in dollar terms, of each (E) of this section. benefits payable thereunder; senior executive officer and director. (3) Bona fide deferred compensation plan or arrangement means any plan, (C) The IAP has a vested right, as (b) Availability of disclosure. Any contract, agreement or other defined under the applicable plan member may obtain a copy of the most arrangement whereby: document, at the time of termination of current disclosure, and all disclosures (i) An institution-affiliated party (IAP) employment to payments under such for the previous three years, on request voluntarily elects to defer all or a plan; made in person or in writing. The portion of the reasonable compensation, (D) Benefits under such plan are corporate credit union must provide the wages or fees paid for services rendered accrued each period only for current or disclosure(s), at no cost to the member, which otherwise would have been paid prior service rendered to the employer within five business days of receiving to the IAP at the time the services were (except that an allowance may be made the request. In addition, the corporate rendered (including a plan that provides for service with a predecessor must distribute the most current for the crediting of a reasonable employer); disclosure to all its members at least investment return on such elective (E) Any payment made pursuant to once a year, either in the annual report deferrals) and the corporate credit union such plan is not based on any or in some other manner of the either: discretionary acceleration of vesting or corporate’s choosing. (A) Recognizes compensation expense accrual of benefits which occurs at any (c) Supplemental information. In and accrues a liability for the benefit time later than one year prior to any of providing the disclosure required by payments according to Generally the events described in paragraph this section, a corporate credit union Accepted Accounting Principles (a)(4)(ii) of this section; may also provide supplementary (GAAP); or (F) The corporate credit union has information to put the disclosure in (B) Segregates or otherwise sets aside previously recognized compensation context, for example, salary surveys, a assets in a trust which may only be used expense and accrued a liability for the discussion of compensation in relation to pay plan and other benefits, except benefit payments according to GAAP or to other credit union expenses, or that the assets of such trust may be segregated or otherwise set aside assets compensation information from available to satisfy claims of the in a trust which may only be used to similarly sized credit unions or institution’s or holding company’s pay plan benefits, except that the assets financial institutions. creditors in the case of insolvency; or of such trust may be available to satisfy (ii) A corporate credit union (d) Special rule for mergers. With claims of the corporate credit union’s establishes a nonqualified deferred respect to any merger involving a creditors in the case of insolvency; and compensation or supplemental corporate credit union that would result (G) Payments pursuant to such plans retirement plan, other than an elective in a material increase in compensation, must not be in excess of the accrued deferral plan described in paragraph i.e., an increase of more than 15 percent liability computed in accordance with (a)(3)(i) of this section: or $10,000, whichever is greater, for any (A) Primarily for the purpose of GAAP. senior executive officer or director of providing benefits for certain IAPs in (4) Golden parachute payment means the merging corporate, the corporate excess of the limitations on any payment (or any agreement to make must: (i) describe the compensation contributions and benefits imposed by any payment) in the nature of arrangement in the merger plan sections 415, 401(a)(17), 402(g) or any compensation by any corporate credit documents submitted to NCUA for other applicable provision of the union for the benefit of any current or approval of the merger, pursuant to Internal Revenue Code of 1986 (26 USC former IAP pursuant to an obligation of § 708b of this part; and (ii) in the case 415, 401(a)(17), 402(g)); or such corporate credit union that: of any federally chartered corporate (B) Primarily for the purpose of (i) Is contingent on, or by its terms is credit union, describe the compensation providing supplemental retirement payable on or after, the termination of arrangement in the materials provided benefits or other deferred compensation such IAP’s primary employment or to the membership of the merging credit for a select group of directors, affiliation with the corporate credit union before the member vote on management or highly compensated union; and approving the merger. employees (excluding severance (ii) Is received on or after, or is made 18. Add a new § 704.20 to read as payments described in paragraph in contemplation of, any of the follows: (4)(ii)(E) of this section and permissible following events:

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(A) The insolvency (or similar event) condition specified in paragraph (4)(ii) trust is established or letter of credit or of the corporate that is making the of this section or in contemplation of other instrument is made available, payment; or such a condition without the prior without regard to whether the obligation (B) The appointment of any written consent of the Board; or to make such payment is contingent on: conservator or liquidating agent for such (F) Any severance or similar payment (A) The determination, after such corporate credit union; or which is required to be made pursuant date, of the liability for the payment of (C) A determination by the Board or to a state statute which is applicable to such amount; or the appropriate state supervisory all employers within the appropriate (B) The liquidation, after such date, of authority (in the case of a corporate jurisdiction (with the exception of the amount of such payment. credit union chartered by a state) employers that may be exempt due to (9) Prohibited indemnification respectively, that the corporate credit their small number of employees or payment means any payment (or any union is in a troubled condition; or other similar criteria); or agreement or arrangement to make any (D) The corporate credit union is (G) Any other payment which the payment) by any corporate credit union undercapitalized, as defined in § 704.4; Board determines to be permissible in for the benefit of any person who is or or accordance with § 704.20(d). was an IAP of such corporate credit (E) The corporate credit union is (5) Institution-affiliated party (IAP) union, to pay or reimburse such person subject to a proceeding to terminate or means any individual meeting the for any civil money penalty, judgment suspend its share account insurance; criteria specified in § 206(r) of the Act or other liability or legal expense and (12 U.S.C. § 1786(r)). resulting from any administrative or (iii) Is payable to an IAP whose (6) Liability or legal expense means: civil action instituted by the Board or employment by or affiliation with the (i) Any legal or other professional fees any appropriate state regulatory corporate is terminated at a time when and expenses incurred in connection authority that results in a final order or the corporate credit union by which the with any claim, proceeding, or action; settlement pursuant to which such IAP is employed or with which the IAP (ii) The amount of, and any cost person: is affiliated satisfies any of the incurred in connection with, any (i) Is assessed a civil money penalty; conditions enumerated in paragraphs settlement of any claim, proceeding, or (ii) Is removed from office or (a)(4)(ii)(A) through (E) of this section, action; and prohibited from participating in the or in contemplation of any of these (iii) The amount of, and any cost conduct of the affairs of the corporate conditions. incurred in connection with, any credit union; or (iv) Exceptions. The term golden judgment or penalty imposed with (iii) Is required to cease and desist parachute payment does not include: respect to any claim, proceeding, or from or take any affirmative action (A) Any payment made pursuant to a action. described in Section 206 of the Act with pension or retirement plan which is (7) Nondiscriminatory means that the respect to such corporate credit union. qualified (or is intended within a plan, contract or arrangement in (iv) Exceptions. The term prohibited reasonable period of time to be question applies to all employees of a indemnification payment does not qualified) under section 401 of the corporate credit union who meet include any reasonable payment by a Internal Revenue Code of 1986 (26 reasonable and customary eligibility corporate credit union that: U.S.C. § 401); or requirements applicable to all (A) is used to purchase any (B) Any payment made pursuant to a employees, such as minimum length of commercial or fidelity benefit plan as that term is defined in service requirements. A bond, provided that such insurance paragraph (a)(2) of this section; or nondiscriminatory plan, contract or policy or bond must not be used to pay (C) Any payment made pursuant to a arrangement may provide different or reimburse an IAP for the cost of any bona fide deferred compensation plan or benefits based only on objective criteria judgment or civil money penalty arrangement as defined in paragraph such as salary, total compensation, assessed against such person in an (a)(3) of this section; or length of service, job grade or administrative proceeding or civil (D) Any payment made by reason of classification, which are applied on a action commenced by NCUA or the death or by reason of termination proportionate basis (with a variance in appropriate state supervisory authority caused by the disability of an IAP; or severance benefits relating to any (in the case of a state chartered (E) Any payment made pursuant to a criterion of plus or minus ten percent) corporate), but may pay any legal or nondiscriminatory severance pay plan to groups of employees consisting of not professional expenses incurred in or arrangement which provides for less than the lesser of 33 percent of connection with such proceeding or payment of severance benefits to all employees or 1,000 employees. action or the amount of any restitution eligible employees upon involuntary (8) Payment means: to the corporate credit union or its termination other than for cause, (i) Any direct or indirect transfer of liquidating agent; or voluntary resignation, or early any funds or any asset; (B) represents partial indemnification retirement; provided, however, that no (ii) Any forgiveness of any debt or for legal or professional expenses employee will receive any such other obligation; specifically attributable to particular payment which exceeds the base (iii) The conferring of any benefit, charges for which there has been a compensation paid to such employee including but not limited to stock formal and final adjudication or finding during the twelve months (or such options and stock appreciation rights; or in connection with a settlement that the longer period or greater benefit as the (iv) Any segregation of any funds or IAP has not violated certain laws or Board will consent to) immediately assets, the establishment or funding of regulations or has not engaged in certain preceding termination of employment, any trust or the purchase of or unsafe or unsound practices or breaches resignation or early retirement, and such arrangement for any letter of credit or of fiduciary duty, unless the severance pay plan or arrangement must other instrument, for the purpose of administrative action or civil not have been adopted or modified to making, or pursuant to any agreement to proceeding has resulted in a final increase the amount or scope of make, any payment on or after the date prohibition order against the IAP. severance benefits at a time when the on which such funds or assets are (10) Troubled Condition means that corporate credit union was in a segregated, or at the time of or after such the corporate credit union:

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(i) Has been assigned: the case may be, will not be obligated (ii) The length of time the IAP was (A) A 4 or 5 Corporate Risk to pay the promised golden parachute affiliated with the corporate credit Information System (CRIS) rating by and the IAP will not be accorded union, and the degree to which the NCUA in either the Financial Risk or preferential treatment on the basis of proposed payment represents a Risk Management composites, in the such prior approval; or reasonable payment for services case of a federal corporate credit union, (ii) Such a payment is made pursuant rendered over the period of or to an agreement which provides for a employment; and (B) An equivalent 4 or 5 CRIS rating reasonable severance payment, not to (iii) Any other factors or in either the Financial Risk or Risk exceed twelve months salary, to an IAP circumstances which would indicate Management composites by the state in the event of a merger with another that the proposed payment would be supervisor in the case of a federally corporate credit union; provided, contrary to the intent of section 206(t) insured, state-chartered corporate credit however, that a corporate credit union of the Act or this part. union in a state that has adopted the must obtain the consent of the Board, (e) Permissible indemnification CRIS system, or an equivalent 4 or 5 before making such a payment and this payments. (1) A corporate credit union CAMEL composite rating by the state paragraph (d)(1)(iii) does not apply to may make or agree to make reasonable supervisor in the case of a federally any merger between corporates that indemnification payments to an IAP insured, state-chartered corporate credit results from an assisted transaction as with respect to an administrative union in a state that uses the CAMEL described in section 208 of the Act (12 proceeding or civil action initiated by system, or U.S.C. 1788) or the corporate credit NCUA or a state regulatory authority if: (C) A 4 or 5 CRIS rating in either the union being placed into conservatorship (i) The corporate credit union’s board Financial Risk or Risk Management or liquidation; or of directors, in good faith, determines in composites by NCUA based on core (iii) The Board, with the written writing after due investigation and work papers received from the state concurrence of the appropriate state consideration that the institution- supervisor in the case of a federally supervisory authority (in the case of a affiliated party acted in good faith and insured, state-chartered credit union in state-chartered corporate), determines in a manner he/she believed to be in the a state that does not use either the CRIS that such a payment or agreement is best interests of the institution; or CAMEL system. In this case, the state permissible. (ii) The corporate credit union’s board supervisor will be notified in writing by (2) A corporate credit union making a of directors, in good faith, determines in the Director of the Office of Corporate request pursuant to paragraphs (d)(1)(i) writing after due investigation and Credit Unions that the corporate credit through (iii) of this section must consideration that the payment of such union has been designated by NCUA as demonstrate that it does not possess and expenses will not materially adversely a troubled institution; or is not aware of any information, affect the institution’s or holding (ii) has been granted assistance as evidence, documents or other materials company’s safety and soundness; outlined under Sections 208 or 216 of which would indicate that there is a (iii) The indemnification payments do the Federal Credit Union Act. reasonable basis to believe, at the time not constitute prohibited (b) Golden parachute payments such payment is proposed to be made, indemnification payments as that term prohibited. that: is defined in § 704.20(c); and No corporate credit union will make (i) The IAP has committed any (iv) The IAP agrees in writing to or agree to make any golden parachute fraudulent act or omission, breach of reimburse the corporate credit union, to payment, except as otherwise provided trust or fiduciary duty, or insider abuse the extent not covered by payments in this section. with regard to the corporate credit from insurance or bonds purchased (c) Prohibited indemnification union that has had or is likely to have pursuant to § 704.20(a)(9)(iv)(A), for that payments. No corporate credit union a material adverse effect on the portion of the advanced indemnification will make or agree to make any corporate credit union; payments which subsequently become prohibited indemnification payment, (ii) The IAP is substantially prohibited indemnification payments, except as provided in this section. responsible for the insolvency of, the as defined in § 704.20(a)(9). (d) Permissible golden parachute appointment of a conservator or (2) An IAP seeking indemnification payments. (1) A corporate credit union liquidating agent for, or the troubled payments must not participate in any may agree to make or may make a condition, as defined by § 701.14(b)(4), way in the board’s discussion and golden parachute payment if and to the of the corporate credit union; approval of such payments; provided, extent that: (iii) The IAP has materially violated however, that such IAP may present his/ (i) Such an agreement is made in any applicable federal or state banking her request to the board and respond to order to hire a person to become an IAP law or regulation that has had or is any inquiries from the board concerning either at a time when the corporate likely to have a material effect on the his/her involvement in the credit union satisfies or in an effort to corporate credit union; and circumstances giving rise to the prevent it from imminently satisfying (iv) The IAP has violated or conspired administrative proceeding or civil any of the criteria set forth in § (a)(4)(ii), to violate section 215, 656, 657, 1005, action. and the Board, consents in writing to 1006, 1007, 1014, 1032, or 1344 of title (3) In the event that a majority of the the amount and terms of the golden 18 of the United States Code, or section members of the board of directors are parachute payment. Such consent by the 1341 or 1343 of such title affecting a named as respondents in an Board must not improve the IAP’s federally insured financial institution as administrative proceeding or civil position in the event of the insolvency defined in title 18 of the United States action and request indemnification, the of the corporate credit union since such Code. remaining members of the board may consent can neither bind a liquidating (3) In making a determination under authorize independent legal counsel to agent nor affect the provability of claims paragraphs (d)(1)(i) through (iii) of this review the indemnification request and in liquidation. In the event that the section, the Board may consider: provide the remaining members of the institution is placed into (i) Whether, and to what degree, the board with a written opinion of counsel conservatorship or liquidation, the IAP was in a position of managerial or as to whether the conditions delineated conservator or the liquidating agent, as fiduciary responsibility; in paragraph (e)(1) of this section have

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been met. If independent legal counsel [DATE 60 DAYS AFTER DATE OF (assets or other measure)—as of— opines that said conditions have been PUBLICATION OF FINAL RULE IN (date(s))—. If a term certificate—: The met, the remaining members of the FEDERAL REGISTER] will have priority, for membership capital account is a term board of directors may rely on such purposes of availability to absorb losses and certificate that will mature on—(date)—. payout in liquidation, over capital I have read the above terms and conditions opinion in authorizing the requested contributed to the corporate before that date. and I understand them. indemnification. The board of directors at a corporate credit I further agree to maintain in the credit (4) In the event that all of the union that desires to make this determination union’s files the annual notice of terms and members of the board of directors are must: conditions of the membership capital named as respondents in an (a) On or before [DATE 60 DAYS AFTER account. administrative proceeding or civil DATE OF PUBLICATION OF FINAL RULE The notice form must be signed by either action and request indemnification, the IN FEDERAL REGISTER], adopt a resolution all of the directors of the member credit board will authorize independent legal implementing its determination. union or, if authorized by board resolution, counsel to review the indemnification (b) Inform the credit union’s members and the chair and secretary of the board of the credit union. request and provide the board with a NCUA, in writing and as soon as practicable after adoption of the resolution, of the The annual disclosure notice form must be written opinion of counsel as to whether contents of the board resolution. signed by the chair of the corporate credit the conditions delineated in paragraph (c) Ensure the credit union uses the union. The chair must then sign a statement (e)(1) of this section have been met. If appropriate initial and periodic Model Form that certifies that the notice has been sent to independent legal counsel opines that disclosures in Part II below. member credit unions with membership said conditions have been met, the capital accounts. The certification must be Part II—Model Forms board of directors may rely on such maintained in the corporate credit union’s opinion in authorizing the requested Part II contains model forms intended for files and be available for examiner review. use by corporate credit unions to aid in Model Form B indemnification. compliance with the capital disclosure (f) Filing instructions. Requests to requirements of § 704.3 and Part I of this Terms and Conditions of Membership Capital make excess nondiscriminatory Appendix. Account severance plan payments pursuant to Model Form A § 704.20(a)(4)(iv)(E) and golden Note: This form is for use before [DATE 12 MONTHS AFTER PUBLICATION OF FINAL parachute payments permitted by Terms and Conditions of Membership Capital Account RULE IN THE FEDERAL REGISTER] in the § 704.20(d) must be submitted in writing circumstances where the credit union has to the Board. The request must be in Note: This form is for use before [DATE 12 determined THAT IT WILL give newly letter form and must contain all relevant MONTHS AFTER PUBLICATION OF FINAL issued capital priority over older capital as factual information as well as the RULE IN THE FEDERAL REGISTER] in the described in Part I of this Appendix. reasons why such approval should be circumstances where the credit union has (1) A membership capital account is not granted. determined NOT to give newly issued capital subject to share insurance coverage by the (g) Applicability in the event of priority over older capital as described in NCUSIF or other deposit insurer. liquidation or conservatorship. The Part I of this Appendix. (2) A membership capital account is not provisions of this part, or any consent (1) A membership capital account is not releasable due solely to the merger, charter or approval granted under the subject to share insurance coverage by the conversion or liquidation of the member NCUSIF or other deposit insurer. credit union. In the event of a merger, the provisions of this part by the Board, will (2) A membership capital account is not membership capital account transfers to the not in any way bind any liquidating releasable due solely to the merger, charter continuing credit union. In the event of a agent or conservator for a failed conversion or liquidation of the member charter conversion, the membership capital corporate credit union and will not in credit union. In the event of a merger, the account transfers to the new institution. In any way obligate the liquidating agent membership capital account transfers to the the event of liquidation, the membership or conservator to pay any claim or continuing credit union. In the event of a capital account may be released to facilitate obligation pursuant to any golden charter conversion, the membership capital the payout of shares with the prior written parachute, severance, indemnification account transfers to the new institution. In approval of NCUA. the event of liquidation, the membership (3) A member credit union may withdraw or other agreement. Claims for employee capital account may be released to facilitate membership capital with three years’ notice. welfare benefits or other benefits that the payout of shares with the prior written (4) Membership capital cannot be used to are contingent, even if otherwise vested, approval of NCUA. pledge borrowings. when a liquidating agent or conservator (3) A member credit union may withdraw (5)(a) Membership capital that is issued on is appointed for any corporate credit membership capital with three years’ notice. or after [DATE 60 DAYS AFTER DATE OF union, including any contingency for (4) Membership capital cannot be used to PUBLICATION OF FINAL RULE IN termination of employment, are not pledge borrowings. FEDERAL REGISTER], is available to cover provable claims or actual, direct (5) Membership capital is available to losses that exceed retained earnings, cover losses that exceed retained earnings contributed capital issued before [DATE 60 compensatory damage claims against and paid-in capital. DAYS AFTER DATE OF PUBLICATION OF such liquidating agent or conservator. (6) Where the corporate credit union is FINAL RULE IN FEDERAL REGISTER], and Nothing in this part may be construed liquidated, membership capital accounts are perpetual capital issued on or after [DATE 60 to permit the payment of salary or any payable only after satisfaction of all liabilities DAYS AFTER DATE OF PUBLICATION OF liability or legal expense of any IAP of the liquidation estate including uninsured FINAL RULE IN FEDERAL REGISTER]. Any contrary to 12 U.S.C. 1786(t)(3). obligations to shareholders and the NCUSIF. such losses will be distributed pro rata, at the 19. Revise Appendix A to part 704 to (7) Where the corporate credit union is time the loss is realized, among membership read as follows: merged into another corporate credit union, capital account holders with accounts issued the membership capital account will transfer on or after [DATE 60 DAYS AFTER DATE OF Appendix A to Part 704—Capital to the continuing corporate credit union. The PUBLICATION OF FINAL RULE IN Prioritization and Model Forms three-year notice period for withdrawal of the FEDERAL REGISTER]. To the extent that membership capital account will remain in NCA funds are used to cover losses, the Part I—Optional Capital Prioritization effect. corporate credit union is prohibited from Notwithstanding any other provision in (8) If an adjusted balance account—: The restoring or replenishing the affected this chapter, a corporate credit union, at its membership capital balance will be accounts under any circumstances. option, may determine that capital adjusted—(1 or 2)—time(s) annually in (b) Membership capital that is issued contributed to the corporate on or after relation to the member credit union’s— before [DATE 60 DAYS AFTER DATE OF

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PUBLICATION OF FINAL RULE IN The notice form must be signed by either accounts are payable only after satisfaction of FEDERAL REGISTER] is available to cover all of the directors of the member credit all liabilities of the liquidation estate losses that exceed retained earnings and union or, if authorized by board resolution, including uninsured obligations to perpetual capital issued before [DATE 60 the chair and secretary of the board of the shareholders and the NCUSIF. However, DAYS AFTER DATE OF PUBLICATION OF credit union. nonperpetual contributed capital that is used FINAL RULE IN FEDERAL REGISTER]. Any The annual disclosure notice form must be to cover losses in a fiscal year previous to the such losses will be distributed pro rata, at the signed by the chair of the corporate credit year of liquidation has no claim against the time the loss is realized, among membership union. The chair must then sign a statement liquidation estate. capital account holders with accounts issued that certifies that the notice has been sent to (7) Where the corporate credit union is before [DATE 60 DAYS AFTER DATE OF member credit unions with membership merged into another corporate credit union, PUBLICATION OF FINAL RULE IN capital accounts. The certification must be the nonperpetual contributed capital account FEDERAL REGISTER]. To the extent that maintained in the corporate credit union’s will transfer to the continuing corporate NCA funds are used to cover losses, the files and be available for examiner review. credit union. For notice accounts, the five- corporate credit union is prohibited from Model Form C year notice period for withdrawal of the restoring or replenishing the affected nonperpetual contributed capital account accounts under any circumstances. Terms and Conditions of Nonperpetual will remain in effect. For term accounts, the (c) Attached to this disclosure is a Contributed Capital original term will remain in effect. statement that describes the amount of NCA (8) If a term certificate—: The nonperpetual Note: This form is for use on and after the credit union has with the corporate credit contributed capital account is a term [DATE 12 MONTHS AFTER PUBLICATION union in each of the categories described in certificate that will mature on—(date)— OF FINAL RULE IN THE FEDERAL paragraphs (5)(a) and (5)(b) above. (insert date with a minimum five-year REGISTER] in the circumstances where the (6) If the corporate credit union is original maturity). credit union has determined NOT to give liquidated: I have read the above terms and conditions newly issued capital priority over older (a) Membership capital accounts issued on and I understand them. capital as described in Part I of this or after [DATE 60 DAYS AFTER DATE OF I further agree to maintain in the credit Appendix. Also, corporate credit unions PUBLICATION OF FINAL RULE IN union’s files the annual notice of terms and should ensure that existing membership FEDERAL REGISTER] are payable only after conditions of the nonperpetual contributed capital accounts that do not meet the satisfaction of all liabilities of the liquidation capital account. qualifying conditions for nonperpetual estate including uninsured obligations to The notice form must be signed by either contributed capital are modified so as to meet shareholders and the NCUSIF, but not all of the directors of the member credit those conditions. including contributed capital accounts issued union or, if authorized by board resolution, before [DATE 60 DAYS AFTER DATE OF the chair and secretary of the board of the PUBLICATION OF FINAL RULE IN Terms and Conditions of Nonperpetual Contributed Capital Account credit union. FEDERAL REGISTER] and perpetual capital The annual disclosure notice form must be accounts issued on or after [DATE 60 DAYS (1) A nonperpetual contributed capital signed by the chair of the corporate credit AFTER DATE OF PUBLICATION OF FINAL account is not subject to share insurance union. The chair must then sign a statement RULE IN FEDERAL REGISTER]. However, coverage by the NCUSIF or other deposit that certifies that the notice has been sent to membership capital that is used to cover insurer. member credit unions with nonperpetual losses in a fiscal year previous to the year of (2) A nonperpetual contributed capital contributed capital accounts. The liquidation has no claim against the account is not releasable due solely to the certification must be maintained in the liquidation estate. merger, charter conversion or liquidation of corporate credit union’s files and be available (b) Membership capital accounts issued the member credit union. In the event of a for examiner review. before [DATE 60 DAYS AFTER DATE OF merger, the nonperpetual contributed capital PUBLICATION OF FINAL RULE IN account transfers to the continuing credit Model Form D FEDERAL REGISTER], are payable only after union. In the event of a charter conversion, Terms and Conditions of Nonperpetual satisfaction of all liabilities of the liquidation the nonperpetual contributed capital account Contributed Capital estate including uninsured obligations to transfers to the new institution. In the event shareholders and the NCUSIF, but not of liquidation, the nonperpetual contributed Note: This form is for use before [DATE 12 including perpetual capital accounts issued capital account may be released to facilitate MONTHS AFTER PUBLICATION OF FINAL before [DATE 60 DAYS AFTER DATE OF the payout of shares with the prior written RULE IN THE FEDERAL REGISTER] in the PUBLICATION OF FINAL RULE IN approval of NCUA. circumstances where the credit union has FEDERAL REGISTER]. However, (3) If the nonperpetual contributed capital determined THAT IT WILL give newly membership capital that is used to cover account is a notice account, a member credit issued capital priority over older capital as losses in a fiscal year previous to the year of union may withdraw the nonperpetual described in Part I of this Appendix. Also, liquidation has no claim against the contributed capital with a minimum of five corporate credit unions should ensure that liquidation estate. years’ notice. If the nonperpetual contributed existing membership capital accounts that do (7) Where the corporate credit union is capital account is a term instrument it may not meet the qualifying conditions for merged into another corporate credit union, be redeemed only at maturity. The corporate nonperpetual contributed capital are the membership capital account will transfer credit union may not redeem any account modified so as to meet those conditions. to the continuing corporate credit union. The prior to the expiration of the notice period, three-year notice period for withdrawal of the or maturity, without the prior written Terms and Conditions of Nonperpetual membership capital account will remain in approval of the NCUA. Contributed Capital Account effect. (4) Nonperpetual contributed capital (1) A nonperpetual contributed capital (8) If an adjusted balance account—: The cannot be used to pledge borrowings. account is not subject to share insurance membership capital balance will be (5) Nonperpetual contributed capital is coverage by the NCUSIF or other deposit adjusted—(1 or 2)—time(s) annually in available to cover losses that exceed retained insurer. relation to the member credit union’s— earnings and perpetual contributed capital. (2) A nonperpetual contributed capital (assets or other measure)—as of— Any such losses will be distributed pro rata account is not releasable due solely to the (date(s))—. If a term certificate—: The among nonperpetual contributed capital merger, charter conversion or liquidation of membership capital account is a term account holders at the time the loss is the member credit union. In the event of a certificate that will mature on—(date)—. realized. To the extent that NCA funds are merger, the nonperpetual contributed capital I have read the above terms and conditions used to cover losses, the corporate credit account transfers to the continuing credit and I understand them. union is prohibited from restoring or union. In the event of a charter conversion, I further agree to maintain in the credit replenishing the affected accounts under any the nonperpetual contributed capital account union’s files the annual notice of terms and circumstances. transfers to the new institution. In the event conditions of the membership capital (6) Where the corporate credit union is of liquidation, the nonperpetual contributed account. liquidated, nonperpetual contributed capital capital account may be released to facilitate

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the payout of shares with the prior written However, nonperpetual contributed capital the event of liquidation, the paid-in capital approval of NCUA. that is used to cover losses in a fiscal year account may be released to facilitate the (3) If the nonperpetual contributed capital previous to the year of liquidation has no payout of shares with the prior written account is a notice account, a member credit claim against the liquidation estate. approval of NCUA. union may withdraw the nonperpetual (b) Nonperpetual contributed capital (3) The funds are callable only at the contributed capital with a minimum of five accounts issued before [DATE 60 DAYS option of the corporate credit union and only years’ notice. If the nonperpetual contributed AFTER DATE OF PUBLICATION OF FINAL if the corporate credit union meets its capital account is a term instrument it may RULE IN FEDERAL REGISTER] are payable minimum required capital and NEV ratios be redeemed only at maturity. The corporate only after satisfaction of all liabilities of the after the funds are called. The corporate must credit union may not redeem any account liquidation estate including uninsured also obtain NCUA’s approval before the prior to the expiration of the notice period, obligations to shareholders and the NCUSIF, corporate calls any paid-in capital. or maturity, without the prior written but not including perpetual capital accounts (4) Paid-in capital cannot be used to pledge approval of the NCUA. issued before [DATE 60 DAYS AFTER DATE borrowings. (4) Nonperpetual contributed capital OF PUBLICATION OF FINAL RULE IN (5) Paid-in capital is available to cover cannot be used to pledge borrowings. FEDERAL REGISTER]. However, losses that exceed retained earnings. (5)(a) Nonperpetual contributed capital nonperpetual contributed capital that is used (6) Where the corporate credit union is that is issued on or after [DATE 60 DAYS to cover losses in a fiscal year previous to the liquidated, paid-in capital accounts are AFTER DATE OF PUBLICATION OF FINAL year of liquidation has no claim against the payable only after satisfaction of all liabilities RULE IN FEDERAL REGISTER] is available liquidation estate. of the liquidation estate including uninsured to cover losses that exceed retained earnings, (7) Where the corporate credit union is obligations to shareholders and the NCUSIF, all contributed capital issued before [DATE merged into another corporate credit union, and membership capital holders. 60 DAYS AFTER DATE OF PUBLICATION the nonperpetual contributed capital account (7) Where the corporate credit union is OF FINAL RULE IN FEDERAL REGISTER], will transfer to the continuing corporate merged into another corporate credit union, and perpetual capital issued on or after credit union. For notice accounts, the five- the paid-in capital account will transfer to [DATE 60 DAYS AFTER DATE OF year notice period for withdrawal of the the continuing corporate credit union. PUBLICATION OF FINAL RULE IN nonperpetual contributed capital account (8) Paid-in capital is perpetual maturity FEDERAL REGISTER]. Any such losses will will remain in effect. For term accounts, the and noncumulative dividend. be distributed pro rata, at the time the loss original term will remain in effect. I have read the above terms and conditions is realized, among nonperpetual contributed (8) If a term certificate—: The nonperpetual and I understand them. I further agree to capital account holders with accounts issued contributed capital account is a term maintain in the credit union’s files the on or after [DATE 60 DAYS AFTER DATE OF certificate that will mature on—(date)— annual notice of terms and conditions of the PUBLICATION OF FINAL RULE IN (insert date with a minimum five-year paid-in capital instrument. FEDERAL REGISTER]. To the extent that original maturity). The notice form must be signed by either NCA funds are used to cover losses, the I have read the above terms and conditions all of the directors of the credit union or, if corporate credit union is prohibited from and I understand them. authorized by board resolution, the chair and restoring or replenishing the affected I further agree to maintain in the credit secretary of the board of the credit union. accounts under any circumstances. union’s files the annual notice of terms and Model Form F (b) Nonperpetual contributed capital that is conditions of the nonperpetual contributed before [DATE 60 DAYS AFTER DATE OF capital account. Terms and Conditions of Paid-In Capital The notice form must be signed by either PUBLICATION OF FINAL RULE IN Note: This form is for use before [DATE 12 all of the directors of the member credit FEDERAL REGISTER], is available to cover MONTHS AFTER PUBLICATION OF FINAL union or, if authorized by board resolution, losses that exceed retained earnings and RULE IN THE FEDERAL REGISTER] in the the chair and secretary of the board of the perpetual capital issued before [DATE 60 circumstances where the credit union has credit union. DAYS AFTER DATE OF PUBLICATION OF determined THAT IT WILL give newly The annual disclosure notice form must be FINAL RULE IN FEDERAL REGISTER]. Any issued capital priority over older capital as signed by the chair of the corporate credit such losses will be distributed pro rata, at the described in Part I of this Appendix. time the loss is realized, among nonperpetual union. The chair must then sign a statement contributed capital account holders with that certifies that the notice has been sent to Terms and Conditions of Paid-In Capital member credit unions with nonperpetual accounts issued before [DATE 60 DAYS (1) A paid-in capital account is not subject AFTER DATE OF PUBLICATION OF FINAL contributed capital accounts. The certification must be maintained in the to share insurance coverage by the NCUSIF RULE IN FEDERAL REGISTER]. To the or other deposit insurer. extent that NCA funds are used to cover corporate credit union’s files and be available for examiner review. (2) A paid-in capital account is not losses, the corporate credit union is releasable due solely to the merger, charter prohibited from restoring or replenishing the Model Form E conversion or liquidation of the member affected accounts under any circumstances. Terms and Conditions of Paid-In Capital credit union. In the event of a merger, the (c) Attached to this disclosure is a paid-in capital account transfers to the statement that describes the amount of NCA Note: This form is for use before [DATE 12 continuing credit union. In the event of a the credit union has with the corporate credit MONTHS AFTER PUBLICATION OF FINAL charter conversion, the paid-in capital union in each of the categories described in RULE IN THE FEDERAL REGISTER] in the account transfers to the new institution. In paragraphs (5)(a) and (5)(b) above. circumstances where the credit union has the event of liquidation, the paid-in capital (6) If the corporate credit union is determined NOT to give newly issued capital account may be released to facilitate the liquidated: priority over older capital as described in payout of shares with the prior written (a) Nonperpetual contributed capital Part I of this Appendix. approval of NCUA. accounts issued on or after [DATE 60 DAYS (3) The funds are callable only at the AFTER DATE OF PUBLICATION OF FINAL Terms and Conditions of Paid-In Capital option of the corporate credit union and only RULE IN FEDERAL REGISTER] are payable (1) A paid-in capital account is not subject if the corporate credit union meets its only after satisfaction of all liabilities of the to share insurance coverage by the NCUSIF minimum required capital and NEV ratios liquidation estate including uninsured or other deposit insurer. after the funds are called. The corporate must obligations to shareholders and the NCUSIF, (2) A paid-in capital account is not also obtain NCUA’s approval before the but not including contributed capital releasable due solely to the merger, charter corporate calls any paid-in capital. accounts issued before [DATE 60 DAYS conversion or liquidation of the member (4) Paid-in capital cannot be used to pledge AFTER DATE OF PUBLICATION OF FINAL credit union. In the event of a merger, the borrowings. RULE IN FEDERAL REGISTER] or perpetual paid-in capital account transfers to the (5) Availability to cover losses. capital accounts issued on or after [DATE 60 continuing credit union. In the event of a (a) Paid-in capital issued before [DATE 60 DAYS AFTER DATE OF PUBLICATION OF charter conversion, the paid-in capital DAYS AFTER DATE OF PUBLICATION OF FINAL RULE IN FEDERAL REGISTER]. account transfers to the new institution. In FINAL RULE IN FEDERAL REGISTER] is

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available to cover losses that exceed retained annual notice of terms and conditions of the The notice form must be signed by either earnings. Any such losses must be paid-in capital instrument. all of the directors of the credit union or, if distributed pro rata, at the time the loss is The notice form must be signed by either authorized by board resolution, the chair and realized, among holders of paid-in capital all of the directors of the credit union or, if secretary of the board of the credit union. issued before [DATE 60 DAYS AFTER DATE authorized by board resolution, the chair and Model Form H OF PUBLICATION OF FINAL RULE IN secretary of the board of the credit union. FEDERAL REGISTER]. To the extent that Terms and Conditions of Perpetual Model Form G paid-in capital funds are used to cover losses, Contributed Capital the corporate credit union is prohibited from Terms and Conditions of Perpetual Note: This form is for use before [DATE 12 restoring or replenishing the affected Contributed Capital MONTHS AFTER PUBLICATION OF FINAL accounts under any circumstances. Note: This form is for use on and after RULE IN THE FEDERAL REGISTER] in the (b) Paid-in capital issued on or after [DATE circumstances where the credit union has 60 DAYS AFTER DATE OF PUBLICATION [DATE 12 MONTHS AFTER PUBLICATION OF FINAL RULE IN THE FEDERAL determined THAT IT WILL give newly OF FINAL RULE IN FEDERAL REGISTER] is issued capital priority over older capital as available to cover losses that exceed retained REGISTER] in the circumstances where the credit union has determined NOT to give described in Part I of this Appendix. Also, earnings and any contributed capital issued capital previously issued under the before [DATE 60 DAYS AFTER DATE OF newly issued capital priority over older capital as described in Part I of this nomenclature ‘‘paid-in capital’’ is considered PUBLICATION OF FINAL RULE IN perpetual contributed capital. FEDERAL REGISTER]. Any such losses must Appendix. Also, capital previously issued be distributed pro rata, at the time the loss under the nomenclature ‘‘paid-in capital’’ is (1) A perpetual contributed capital account is realized, among holders of paid-in capital considered perpetual contributed capital. is not subject to share insurance coverage by issued on or after [DATE 60 DAYS AFTER (1) A perpetual contributed capital account the NCUSIF or other deposit insurer. DATE OF PUBLICATION OF FINAL RULE is not subject to share insurance coverage by (2) A perpetual contributed capital account IN FEDERAL REGISTER]. To the extent that the NCUSIF or other deposit insurer. is not releasable due solely to the merger, paid-in capital funds are used to cover losses, (2) A perpetual contributed capital account charter conversion or liquidation of the the corporate credit union is prohibited from is not releasable due solely to the merger, member credit union. In the event of a merger, the perpetual contributed capital restoring or replenishing the affected charter conversion or liquidation of the account transfers to the continuing credit accounts under any circumstances. member credit union. In the event of a union. In the event of a charter conversion, (c) Attached to this disclosure is a merger, the perpetual contributed capital the perpetual contributed capital account statement that describes the amount of account transfers to the continuing credit transfers to the new institution. In the event perpetual capital the credit union has with union. In the event of a charter conversion, of liquidation, the perpetual contributed the corporate credit union in each of the the perpetual contributed capital account capital account may be released to facilitate categories described in paragraphs (5)(a) and transfers to the new institution. In the event the payout of shares with the prior written (5)(b) above. of liquidation, the perpetual contributed approval of NCUA. (6) Where the corporate credit union is capital account may be released to facilitate (3) The funds are callable only at the liquidated: the payout of shares with the prior written option of the corporate credit union and only (a) Paid-in capital accounts issued on or approval of NCUA. if the corporate credit union meets its after [DATE 60 DAYS AFTER DATE OF (3) The funds are callable only at the minimum required capital and NEV ratios PUBLICATION OF FINAL RULE IN option of the corporate credit union and only after the funds are called. The corporate must FEDERAL REGISTER] are payable only after if the corporate credit union meets its also obtain the prior, written approval of the satisfaction of all liabilities of the liquidation minimum required capital and NEV ratios NCUA before releasing any perpetual estate including uninsured obligations to after the funds are called. The corporate must contributed capital funds. shareholders and the NCUSIF, but not also obtain the prior, written approval of the (4) Perpetual contributed capital cannot be including contributed capital accounts issued NCUA before releasing any perpetual used to pledge borrowings. before [DATE 60 DAYS AFTER DATE OF contributed capital funds. (5) Perpetual contributed capital is PUBLICATION OF FINAL RULE IN (4) Perpetual contributed capital cannot be perpetual maturity and noncumulative FEDERAL REGISTER]. However, paid-in used to pledge borrowings. dividend. capital that is used to cover losses in a fiscal (5) Perpetual contributed capital is (6) Availability to cover losses. year previous to the year of liquidation has perpetual maturity and noncumulative (a) Perpetual contributed capital issued no claim against the liquidation estate. dividend. before [DATE 60 DAYS AFTER DATE OF (b) Paid-in capital accounts issued before (6) Perpetual contributed capital is PUBLICATION OF FINAL RULE IN [DATE 60 DAYS AFTER DATE OF available to cover losses that exceed retained FEDERAL REGISTER] is available to cover PUBLICATION OF FINAL RULE IN earnings. Any such losses must be losses that exceed retained earnings. Any FEDERAL REGISTER] are payable only after distributed pro rata among perpetual such losses must be distributed pro rata, at satisfaction of all liabilities of the liquidation contributed capital holders at the time the the time the loss is realized, among holders estate including uninsured obligations to loss is realized. To the extent that perpetual of perpetual contributed capital issued before shareholders and the NCUSIF, nonperpetual contributed capital funds are used to cover [DATE 60 DAYS AFTER DATE OF accounts issued before [DATE 60 DAYS losses, the corporate credit union is PUBLICATION OF FINAL RULE IN AFTER DATE OF PUBLICATION OF FINAL prohibited from restoring or replenishing the FEDERAL REGISTER]. To the extent that RULE IN FEDERAL REGISTER] and affected accounts under any circumstances. perpetual contributed capital funds are used contributed capital accounts issued on or (7) Where the corporate credit union is to cover losses, the corporate credit union is after [DATE 60 DAYS AFTER DATE OF liquidated, perpetual contributed capital prohibited from restoring or replenishing the PUBLICATION OF FINAL RULE IN accounts are payable only after satisfaction of affected accounts under any circumstances. FEDERAL REGISTER]. However, paid-in all liabilities of the liquidation estate (b) Perpetual contributed capital issued on capital that is used to cover losses in a fiscal including uninsured obligations to or after [DATE 60 DAYS AFTER DATE OF year previous to the year of liquidation has shareholders and the NCUSIF, and PUBLICATION OF FINAL RULE IN no claim against the liquidation estate. nonperpetual contributed capital holders. FEDERAL REGISTER] is available to cover (7) Where the corporate credit union is However, perpetual contributed capital that losses that exceed retained earnings and any merged into another corporate credit union, is used to cover losses in a fiscal year contributed capital issued before [DATE 60 the paid-in capital account will transfer to previous to the year of liquidation has no DAYS AFTER DATE OF PUBLICATION OF the continuing corporate credit union. claim against the liquidation estate. FINAL RULE IN FEDERAL REGISTER]. Any (8) Paid-in capital is perpetual maturity I have read the above terms and conditions such losses must be distributed pro rata, at and noncumulative dividend. and I understand them. I further agree to the time the loss is realized, among holders I have read the above terms and conditions maintain in the credit union’s files the of perpetual contributed capital issued on or and I understand them. I further agree to annual notice of terms and conditions of the after [DATE 60 DAYS AFTER DATE OF maintain in the credit union’s files the perpetual contributed capital instrument. PUBLICATION OF FINAL RULE IN

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FEDERAL REGISTER]. To the extent that authorities when NCUA has provided final (d) The maximum aggregate amount in perpetual contributed capital funds are used approval. If NCUA denies a request for unsecured loans and lines of credit to any to cover losses, the corporate credit union is expanded authorities, it will advise the one member credit union, excluding pass- prohibited from restoring or replenishing the corporate credit union of the reason(s) for the through and guaranteed loans from the CLF affected accounts under any circumstances. denial and what it must do to resubmit its and the NCUSIF, must not exceed 100 (c) Attached to this disclosure is a request. NCUA may revoke these expanded percent of the corporate credit union’s statement that describes the amount of authorities at any time if an analysis capital. The board of directors must establish perpetual capital the credit union has with indicates a significant deficiency. NCUA will the limit, as a percent of the corporate credit the corporate credit union in each of the notify the corporate credit union in writing union’s capital plus pledged shares, for categories described in paragraphs (6)(a) and of the identified deficiency. A corporate secured loans and lines of credit. (6)(b) above. credit union may request, in writing, (e) The aggregate total of investments (7) Where the corporate credit union is reinstatement of the revoked authorities by purchased under the authority of Part I (a)(1) liquidated: providing a self-assessment plan detailing and Part I (a)(2) may not exceed the lower of (a) Perpetual contributed capital accounts how it has corrected the deficiency. 500 percent of the corporate credit union’s issued on or after [DATE 60 DAYS AFTER capital or 25 percent of assets. DATE OF PUBLICATION OF FINAL RULE Minimum Requirement (f) On or after [DATE 12 MONTHS AFTER IN FEDERAL REGISTER] are payable only In order to participate in any of the DATE OF PUBLICATION OF FINAL RULE after satisfaction of all liabilities of the authorities set forth in Base-Plus, Part I, Part IN FEDERAL REGISTER], corporate credit liquidation estate including uninsured II, Part III, or Part IV of this Appendix, a unions will substitute ‘‘leverage ratio’’ for obligations to shareholders and the NCUSIF, corporate credit union must evaluate ‘‘capital ratio’’ wherever it appears in Part I. but not including contributed capital monthly the changes in NEV, NEV ratio, and Part II accounts issued before [DATE 60 DAYS WAL for the tests set forth in paragraphs AFTER DATE OF PUBLICATION OF FINAL (d)(1)(i), (e)(1((i), (f)(1)(i), and (h) of § 704.8. (a) A corporate credit union that has met RULE IN FEDERAL REGISTER]. However, the requirements of Part I of this Appendix perpetual contributed capital that is used to Base-Plus and the additional requirements established cover losses in a fiscal year previous to the A corporate that has met the requirements by NCUA for Part II may invest in: year of liquidation has no claim against the for this Base-plus authority may, in (1) Debt obligations of a foreign country; (2) Deposits and debt obligations of foreign liquidation estate. performing the rate stress tests set forth in banks or obligations guaranteed by these (b) Perpetual contributed capital accounts 704.8(d)(1)(i) and (e)(1)(i), allow its NEV to banks; issued before [DATE 60 DAYS AFTER DATE decline as much as 20 percent, and in (3) Marketable debt obligations of foreign OF PUBLICATION OF FINAL RULE IN performing the rate stress tests set forth in corporations. This authority does not apply FEDERAL REGISTER] are payable only after 704.8(f)(1)(i), allow its NEV to decline as to debt obligations that are convertible into satisfaction of all liabilities of the liquidation much as 30 percent. the stock of the corporation; and estate including uninsured obligations to (4) Foreign issued asset-backed securities. shareholders and the NCUSIF, nonperpetual Part I (b) All foreign investments are subject to capital accounts issued before [DATE 60 (a) A corporate credit union that has met the following requirements: all the requirements established by NCUA for DAYS AFTER DATE OF PUBLICATION OF (1) Investments must be rated no lower this Part I, including a minimum capital ratio FINAL RULE IN FEDERAL REGISTER], and than the minimum permissible domestic of at least six percent, may: all contributed capital accounts issued on or rating under the corporate credit union’s Part (1) Purchase investments with long-term after [DATE 60 DAYS AFTER DATE OF I or Part II authority; ratings no lower than A¥(or equivalent); PUBLICATION OF FINAL RULE IN (2) A sovereign issuer, and/or the country (2) Purchase investments with short-term FEDERAL REGISTER]. However, perpetual in which an obligor is organized, must have ratings no lower than A–2 (or equivalent), contributed capital that is used to cover a long-term foreign currency (non-local losses in a fiscal year previous to the year of provided that the issuer has a long-term ¥ ¥ currency) debt rating no lower than AA (or liquidation has no claim against the rating no lower than A (or equivalent) or equivalent); liquidation estate. the investment is a domestically-issued asset- (3) For each approved foreign bank line, I have read the above terms and conditions backed security; the corporate credit union must identify the and I understand them. I further agree to (3) Engage in short sales of permissible specific banking centers and branches to maintain in the credit union’s files the investments to reduce interest rate risk; which it will lend funds; annual notice of terms and conditions of the (4) Purchase principal only (PO) stripped (4) Obligations of any single foreign obligor perpetual contributed capital instrument. mortgage-backed securities to reduce interest may not exceed 50 percent of capital; and The notice form must be signed by either rate risk; and (5) Obligations in any single foreign all of the directors of the credit union or, if (5) Enter into a dollar roll transaction. country may not exceed 250 percent of authorized by board resolution, the chair and (b) In performing the rate stress tests set capital. secretary of the board of the credit union. forth in § 704.8(d) and (e), the NEV of a corporate credit union that has met the Part III 21. Revise Appendix B to Part 704 to requirements of this Part I may decline as read as follows: (a) A corporate credit union that has met much as: the requirements established by NCUA for Appendix B to Part 704—Expanded (1) 20 percent; this Part III may enter into derivative Authorities and Requirements (2) 28 percent if the corporate credit union transactions specifically approved by NCUA has a seven percent minimum capital ratio to: A corporate credit union may obtain all or and is specifically approved by NCUA; or (1) Create structured products; part of the expanded authorities contained in (3) 35 percent if the corporate credit union (2) Mitigate interest rate risk and credit risk this Appendix if it meets the applicable has an eight percent minimum capital ratio on its own balance sheet; and requirements of Part 704 and Appendix B, and is specifically approved by NCUA. (3) Hedge the balance sheets of its fulfills additional management, (c) In performing the rate stress tests set members. infrastructure, and asset and liability forth in § 704.8(f), the NEV of a corporate (b) Credit Ratings: requirements, and receives NCUA’s written credit union that has met the requirements of (1) All derivative transactions are subject to approval. Additional guidance is set forth in this Part I may decline as much as: the following requirements: the NCUA publication Guidelines for (1) 30 percent; (i) If the counterparty is domestic, the Submission of Requests for Expanded (2) 38 percent if the corporate credit union counterparty rating must be no lower than Authority. has a seven percent minimum capital ratio the minimum permissible rating for A corporate credit union seeking expanded and is specifically approved by NCUA; or comparable term permissible investments; authorities must submit to NCUA a self- (3) 45 percent if the corporate credit union and assessment plan supporting its request. A has an eight percent minimum capital ratio (ii) If the counterparty is foreign, the corporate credit union may adopt expanded and is specifically approved by NCUA. corporate must have Part II expanded

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authority and the counterparty rating must be (3) Assets not included (i.e., deducted from corporate credit union’s interest in the third- no lower than the minimum permissible capital) for purposes of calculating capital party asset. If a corporate credit union has no rating for a comparable term investment under part 704 are not included in claim on the third-party asset, then the under Part II Authority. calculating risk-weighted assets. corporate credit union’s assumption of any (iii) Any rating(s) relied upon to meet the (4) Although this Appendix describes risk- credit risk is a direct credit substitute. Direct requirements of this part must be identified weightings for various assets and activities, credit substitutes include: at the time the transaction is entered into and this Appendix does not provide authority for (1) Financial standby letters of credit that must be monitored for as long as the contract corporate credit unions to invest in or support financial claims on a third party that remains open. purchase any particular type of asset or to exceed a corporate credit union’s pro rata (iv) Section 704.10 of this part if: engage in any particular type of activity. A share in the financial claim; (A) One rating was relied upon to meet the corporate credit union must have other (2) Guarantees, surety arrangements, credit requirements of this part and that rating is identifiable authority for any investment it derivatives, and similar instruments backing downgraded below the minimum rating makes or activity it engages in. financial claims that exceed a corporate requirements of this part; or (b) Definitions. credit union’s pro rata share in the financial (B) Two or more ratings were relied upon The following definitions apply to this claim; to meet the requirements of this part and at Appendix. Additional definitions, applicable (3) Purchased subordinated interests that least two of those ratings are downgraded to this entire Part, are located in § 704.2 of absorb more than their pro rata share of below the minimum rating requirements of this Part. losses from the underlying assets, including this part. Cash items in the process of collection any tranche of asset-backed securities that is (2) Exceptions. Credit ratings are not means checks or drafts in the process of not the most senior tranche; required for derivative transactions with: collection that are drawn on another (4) Credit derivative contracts under which (i) Domestically chartered credit unions; depository institution, including a central the corporate credit union assumes more (ii) U.S. government sponsored enterprises; bank, and that are payable immediately upon than its pro rata share of credit risk on a or presentation; U.S. Government checks that third-party asset or exposure; (iii) Counterparties if the transaction is are drawn on the United States Treasury or (5) Loans or lines of credit that provide fully guaranteed by an entity with a any other U.S. Government or Government- credit enhancement for the financial minimum permissible rating for comparable sponsored agency and that are payable obligations of a third party; term investments. immediately upon presentation; broker’s (6) Purchased loan servicing assets if the security drafts and commodity or bill-of- servicer is responsible for credit losses or if Part IV lading drafts payable immediately upon the servicer makes or assumes credit- A corporate credit union that has met all presentation; and unposted debits. enhancing representations and warranties the requirements established by NCUA for Commitment means any arrangement that with respect to the loans serviced. Servicer this Part IV may participate in loans with obligates a corporate credit union to: cash advances as defined in this section are member natural person credit unions as (1) Purchase loans or securities; not direct credit substitutes; approved by the NCUA and subject to the (2) Extend credit in the form of loans or (7) Clean-up calls on third party assets. following: leases, participations in loans or leases, However, clean-up calls that are 10 percent (a) The maximum aggregate amount of overdraft facilities, revolving credit facilities, or less of the original pool balance and that participation loans with any one member home equity lines of credit, eligible ABCP are exercisable at the option of the corporate credit union must not exceed 25 percent of liquidity facilities, or similar transactions. credit union are not direct credit substitutes; capital; and Depository institution means a financial and (b) The maximum aggregate amount of institution that engages in the business of (8) Liquidity facilities that provide support participation loans with all member credit providing ; that is to asset-backed commercial paper (other than unions will be determined on a case-by-case recognized as a bank or a credit union by the eligible ABCP liquidity facilities). basis by the NCUA. supervisory or monetary authorities of the Exchange rate contracts means cross- 22. Add a new Appendix C to Part country of its incorporation and the country currency interest rate swaps; forward foreign 704 to read as follows: of its principal banking operations; that exchange rate contracts; currency options receives deposits to a substantial extent in purchased; and any similar instrument that, Appendix C to Part 704—Risk-Based the regular course of business; and that has in the opinion of the NCUA, may give rise Capital Credit Risk-Weight Categories the power to accept demand deposits. In the to similar risks. United States, this definition encompasses all Face amount means the notational Table of Contents federally insured offices of commercial principal, or face value, amount of an off- I. Introduction banks, mutual and stock savings banks, balance sheet item or the amortized cost of (a) Scope savings or building and loan associations an on-balance sheet asset. (b) Definitions (stock and mutual), cooperative banks, credit Financial asset means cash or other II. Risk-Weightings unions, and international banking facilities of monetary instrument, evidence of debt, (a) On-balance sheet assets domestic depository institutions. Bank evidence of an ownership interest in an (b) Off-balance sheet activities holding companies and savings and loan entity, or a contract that conveys a right to (c) Recourse obligations, direct credit holding companies are excluded from this receive or exchange cash or another financial substitutes, and certain other positions definition. For the purposes of assigning risk- instrument from another party. weights, the differentiation between OECD Financial standby letter of credit means a Part I: Introduction depository institutions and non-OECD letter of credit or similar arrangement that Section I. depository institutions is based on the represents an irrevocable obligation to a (a) Scope. country of incorporation. Claims on branches third-party beneficiary: (1) This Appendix explains how a and agencies of foreign banks located in the (1) To repay money borrowed by, or corporate credit union must compute its risk- United States are to be categorized on the advanced to, or for the account of, a second weighted assets for purposes of determining basis of the parent bank’s country of party (the account party); or its capital ratios. incorporation. (2) To make payment on behalf of the (2) Risk-weighted assets equal risk- Direct credit substitute means an account party, in the event that the account weighted on-balance sheet assets (computed arrangement in which a corporate credit party fails to fulfill its obligation to the under Section II(a) of this Appendix), plus union assumes, in form or in substance, beneficiary. risk-weighted off-balance sheet activities credit risk associated with an on-balance OECD-based country means a member of (computed under Section II(b) of this sheet or off-balance sheet asset or exposure that grouping of countries that are full Appendix), plus risk-weighted recourse that was not previously owned by the members of the Organization for Economic obligations, direct credit substitutes, and corporate credit union (third-party asset) and Cooperation and Development (OECD) plus certain other positions (computed under the risk assumed by the corporate credit countries that have concluded special Section II(c) of this Appendix). union exceeds the pro rata share of the lending arrangements with the International

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Monetary Fund (IMF) associated with the If a corporate credit union holds the first principal and interest payments on the new IMF’s General Arrangements to Borrow. This and junior lien(s) on a residential property loan in accordance with the applicable debt term excludes any country that has and no other party holds an intervening lien, service requirement. rescheduled its external sovereign debt the transaction is treated as a single loan Qualifying residential construction loan, within the previous five years. A secured by a first lien for the purposes of also referred to as a residential bridge loan, rescheduling of external sovereign debt determining the LTV ratio and the means a loan made in accordance with sound generally would include any renegotiation of appropriate risk-weight under Appendix C. lending principles satisfying the following terms arising from a country’s inability or Also, a loan to an individual borrower for the criteria: unwillingness to meet its external debt construction of the borrower’s home may be (1) The builder must have substantial service obligations, but generally would not included as a qualifying mortgage loan. project equity in the home construction include renegotiations of debt in the normal Qualifying multifamily mortgage loan project; course of business, such as a renegotiation to means a loan secured by a first lien on (2) The residence being constructed must allow the borrower to take advantage of a multifamily residential properties consisting be a 1–4 family residence sold to a home decline in interest rates or other change in of 5 or more dwelling units, provided that: purchaser; market conditions. (1) The amortization of principal and (3) The lending entity must obtain Original maturity means, with respect to a interest occurs over a period of not more than sufficient documentation from a permanent commitment, the earliest date after a 30 years; lender (which may be the construction commitment is made on which the (2) The original minimum maturity for lender) demonstrating that the home buyer commitment is scheduled to expire (i.e., it repayment of principal on the loan is not less intends to purchase the residence and has the will reach its stated maturity and cease to be than seven years; ability to obtain a permanent qualifying binding on either party), provided that either: (3) When considering the loan for mortgage loan sufficient to purchase the (1) The commitment is not subject to placement in a lower risk-weight category, all residence; extension or renewal and will actually expire principal and interest payments have been (4) The home purchaser must have made on its stated expiration date; or made on a timely basis in accordance with a substantial earnest money deposit; (2) If the commitment is subject to its terms for the preceding year; (5) The construction loan must not exceed extension or renewal beyond its stated (4) The loan is performing and not 90 days 80 percent of the sales price of the residence; expiration date, the stated expiration date or more past due; (6) The construction loan must be secured will be deemed the original maturity only if (5) The loan is made in accordance with by a first lien on the lot, residence under the extension or renewal must be based upon prudent underwriting standards; and construction, and other improvements; terms and conditions independently (6) If the interest rate on the loan does not (7) The lending credit union must retain negotiated in good faith with the member at change over the term of the loan, the current sufficient undisbursed loan funds throughout the time of the extension or renewal and loan balance amount does not exceed 80 the construction period to ensure project upon a new, bona fide credit analysis percent of the value of the property securing completion; utilizing current information on financial the loan, and for the property’s most recent (8) The builder must incur a significant condition and trends. fiscal year, the ratio of annual net operating percentage of direct costs (i.e., the actual Performance-based standby letter of credit income generated by the property (before costs of land, labor, and material) before any means any letter of credit, or similar payment of any debt service on the loan) to drawdown on the loan; arrangement, however named or described, annual debt service on the loan is not less (9) If at any time during the life of the which represents an irrevocable obligation to than 120 percent, or in the case of construction loan any of the criteria of this the beneficiary on the part of the issuer to cooperative or other not-for-profit housing rule are no longer satisfied, the corporate make payment on account of any default by projects, the property generates sufficient must immediately recategorize the loan at a a third party in the performance of a cash flows to provide comparable protection 100 percent risk-weight and must accurately nonfinancial or commercial obligation. Such to the institution; or report the loan in the corporate’s next letters of credit include arrangements backing (7) If the interest rate on the loan changes quarterly call report; subcontractors’ and suppliers’ performance, over the term of the loan, the current loan (10) The home purchaser must intend that labor and materials contracts, and balance amount does not exceed 75 percent the home will be owner-occupied; construction bids. of the value of the property securing the loan, (11) The home purchaser(s) must be an Prorated assets means the total assets (as and for the property’s most recent fiscal year, individual(s), not a partnership, joint determined in the most recently available the ratio of annual net operating income venture, trust corporation, or any other entity GAAP report but in no event more than one generated by the property (before payment of (including an entity acting as a sole year old) of a consolidated CUSO multiplied any debt service on the loan) to annual debt proprietorship) that is purchasing the by the corporate credit union’s percentage of service on the loan is not less than 115 home(s) for speculative purposes; and ownership of that consolidated CUSO. percent, or in the case of cooperative or other (12) The loan must be performing and not Qualifying mortgage loan means a loan not-for-profit housing projects, the property more than 90 days past due. that: generates sufficient cash flows to provide The NCUA retains the discretion to (1) Is fully secured by a first lien on a one- comparable protection to the institution. determine that any loans not meeting sound to four-family residential property; For purposes of paragraphs (6) and (7) of lending principles must be placed in a higher (2) Is underwritten in accordance with this definition, the term value of the property risk-weight category. The NCUA also reserves prudent underwriting standards, including means, at origination of a loan to purchase the discretion to modify these criteria on a standards relating the ratio of the loan a multifamily property, the lower of the case-by-case basis provided that any such amount to the value of the property (LTV purchase price or the amount of the initial modifications are not inconsistent with the ratio), as presented in the Interagency appraisal, or if appropriate, the initial safety and soundness objectives of this Guidelines for Real Estate Lending Policies, evaluation. In cases not involving purchase definition. 57 FR 62890 (December 31, 1992). A of a multifamily loan, the value of the Qualifying securities firm means: nonqualifying mortgage loan that is paid property is determined by the most current (1) A securities firm incorporated in the down to an appropriate LTV ratio (calculated appraisal, or if appropriate, the most current United States that is a broker-dealer that is using value at origination, appraisal obtained evaluation. registered with the Securities and Exchange within the prior six months, or updated value In cases where a borrower refinances a loan Commission (SEC) and that complies with using an automated valuation model) may on an existing property, as an alternative to the SEC’s net capital regulations (17 CFR become a qualifying loan if it meets all other paragraphs (3), (6), and (7) of this definition: 240.15c3(1)); and requirements of this definition; (1) All principal and interest payments on (2) A securities firm incorporated in any (3) Maintains an appropriate LTV ratio the loan being refinanced have been made on other OECD-based country, if the corporate based on the amortized principal balance of a timely basis in accordance with the terms credit union is able to demonstrate that the the loan; and of that loan for the preceding year; and securities firm is subject to consolidated (4) Is performing and is not more than 90 (2) The net income on the property for the supervision and regulation (covering its days past due. preceding year would support timely subsidiaries, but not necessarily its parent

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organizations) comparable to that imposed on Residual interest means any on-balance exposures into securities that can be sold to depository institutions in OECD countries. sheet asset that: investors. Structured financing programs Such regulation must include risk-based (1) Represents an interest (including a allocate credit risk, generally, between the capital requirements comparable to those beneficial interest) created by a transfer that participants and credit enhancement imposed on depository institutions under the qualifies as a sale (in accordance with provided to the program. Accord on International Convergence of Generally Accepted Accounting Principles) Traded position means a position retained, Capital Measurement and Capital Standards of financial assets, whether through a assumed, or issued in connection with a (1988, as amended in 1998). securitization or otherwise; and securitization that is rated by a NRSRO, Recourse means a corporate credit union’s (2) Exposes a corporate credit union to where there is a reasonable expectation that, retention, in form or in substance, of any credit risk directly or indirectly associated in the near future, the rating will be relied credit risk directly or indirectly associated with the transferred asset that exceeds a pro upon by: with an asset it has sold (in accordance with rata share of that corporate credit union’s (1) Unaffiliated investors to purchase the Generally Accepted Accounting Principles) claim on the asset, whether through security; or that exceeds a pro rata share of that corporate subordination provisions or other credit (2) An unaffiliated third party to enter into credit union’s claim on the asset. If a enhancement techniques. a transaction involving the position, such as corporate credit union has no claim on a Residual interests generally include credit- a purchase, loan, or repurchase agreement. asset it has sold, then the retention of any enhancing interest-only strips, spread Unconditionally cancelable means, with credit risk is recourse. A recourse obligation accounts, cash collateral accounts, retained respect to a commitment-type lending typically arises when a corporate credit subordinated interests (and other forms of arrangement, that the corporate credit union union transfers assets in a sale and retains an overcollateralization), and similar assets that may, at any time, with or without cause, explicit obligation to repurchase assets or to function as a credit enhancement. Residual refuse to advance funds or extend credit absorb losses due to a default on the payment interests further include those exposures under the facility. of principal or interest or any other that, in substance, cause the corporate credit United States Government or its agencies deficiency in the performance of the union to retain the credit risk of an asset or means an instrumentality of the U.S. underlying obligor or some other party. exposure that had qualified as a residual Government whose debt obligations are fully Recourse may also exist implicitly if a interest before it was sold. Residual interests and explicitly guaranteed as to the timely corporate credit union provides credit generally do not include assets purchased payment of principal and interest by the full enhancement beyond any contractual from a third party, but a credit-enhancing faith and credit of the United States obligation to support assets it has sold. interest-only strip that is acquired in any Government. Recourse obligations include: asset transfer is a residual interest. United States Government-sponsored (1) Credit-enhancing representations and Corporate credit unions will use this agency or corporation means an agency or warranties made on transferred assets; definition of the term ‘‘residual interests,’’ corporation originally established or (2) Loan servicing assets retained pursuant and not the definition in § 704.2, for chartered to serve public purposes specified to an agreement under which the corporate purposes of applying this Appendix. by the United States Congress but whose credit union will be responsible for losses Risk participation means a participation in obligations are not explicitly guaranteed by associated with the loans serviced. Servicer which the originating party remains liable to the full faith and credit of the United States cash advances as defined in this section are Government. not recourse obligations; the beneficiary for the full amount of an (3) Retained subordinated interests that obligation (e.g., a direct credit substitute), Part II: Risk-Weightings absorb more than their pro rata share of notwithstanding that another party has Section II. losses from the underlying assets; acquired a participation in that obligation. (a) On-balance sheet assets. (4) Assets sold under an agreement to Risk-weighted assets means the sum total Except as provided in Section II(b) of this repurchase, if the assets are not already of risk-weighted on-balance sheet assets, as Appendix, risk-weighted on-balance sheet included on the balance sheet; calculated under Section II(a) of this assets are computed by multiplying the on- (5) Loan strips sold without contractual Appendix, and the total of risk-weighted off- balance sheet asset amounts times the recourse where the maturity of the balance sheet credit equivalent amounts. The appropriate risk-weight categories. The risk- transferred portion of the loan is shorter than total of risk-weighted off-balance sheet credit weight categories are: the maturity of the commitment under which equivalent amounts equals the risk-weighted (1) Zero percent Risk-Weight (Category 1). the loan is drawn; off-balance sheet activities as calculated (i) Cash, including domestic and foreign (6) Credit derivatives that absorb more than under Section II(b) of this Appendix plus the currency owned and held in all offices of a the corporate credit union’s pro rata share of risk-weighted recourse obligations, risk- corporate credit union or in transit. Any losses from the transferred assets; weighted direct credit substitutes, and foreign currency held by a corporate credit (7) Clean-up calls on assets the corporate certain other risk-weighted positions as union must be converted into U.S. dollar credit union has sold. However, clean-up calculated under Section II(c) of this equivalents; calls that are 10 percent or less of the original Appendix. (ii) Securities issued by and other direct pool balance and that are exercisable at the Servicer cash advance means funds that a claims on the U.S. Government or its option of the corporate credit union are not residential mortgage servicer advances to agencies (to the extent such securities or recourse arrangements; and ensure an uninterrupted flow of payments, claims are unconditionally backed by the full (8) Liquidity facilities that provide support including advances made to cover faith and credit of the United States to asset-backed commercial paper (other than foreclosure costs or other expenses to Government) or the central government of an eligible ABCP liquidity facilities). facilitate the timely collection of the loan. A OECD country; Replacement cost means, with respect to servicer cash advance is not a recourse (iii) Notes and obligations issued or interest rate and exchange-rate contracts, the obligation or a direct credit substitute if: guaranteed by the Federal Deposit Insurance loss that would be incurred in the event of (1) The servicer is entitled to full Corporation or the National Credit Union a counterparty default, as measured by the reimbursement and this right is not Share Insurance Fund and backed by the full net cost of replacing the contract at the subordinated to other claims on the cash faith and credit of the United States current market value. If default would result flows from the underlying asset pool; or Government; in a theoretical profit, the replacement value (2) For any one loan, the servicer’s (iv) Deposit reserves at, claims on, and is considered to be zero. This mark-to-market obligation to make nonreimbursable balances due from Federal Reserve Banks; process must incorporate changes in both advances is contractually limited to an (v) The book value of paid-in Federal interest rates and counterparty credit quality. insignificant amount of the outstanding Reserve Bank stock; Residential properties means houses, principal amount on that loan. (vi) That portion of assets directly and condominiums, cooperative units, and Structured financing program means a unconditionally guaranteed by the United manufactured homes. This definition does program where receivable interests and asset- States Government or its agencies, or the not include boats or motor homes, even if or mortgage-backed securities issued by central government of an OECD country. used as a primary residence, or timeshare multiple participants are purchased by a (viii) Claims on, and claims guaranteed by, properties. special purpose entity that repackages those a qualifying securities firm that are

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collateralized by cash on deposit in the avoided under applicable law of the relevant Also included in this category are the credit corporate credit union or by securities issued jurisdiction. For example, a claim is exempt equivalent amounts of risk participations in or guaranteed by the United States from the automatic stay in bankruptcy in the bankers’ acceptances conveyed to other Government or its agencies, or the central United States if it arises under a securities depository institutions incorporated in an government of an OECD country. To be contract or a repurchase agreement subject to OECD country. However, bank-issued eligible for this risk-weight, the corporate section 555 or 559 of the Bankruptcy Code securities that qualify as capital of the issuing credit union must maintain a positive margin (11 U.S.C. 555 or 559), a qualified financial bank are not included in this risk category; of collateral on the claim on a daily basis, contract under section 207(c)(8) of the (xvii) Claims on, or guaranteed by taking into account any change in a corporate Federal Credit Union Act (12 U.S.C. depository institutions other than the central credit union’s exposure to the obligor or 1787(c)(8)) or section 11(e)(8) of the Federal bank, incorporated in a non-OECD country, counterparty under the claim in relation to Deposit Insurance Act (12 U.S.C. 1821(e)(8)), with a remaining maturity of one year or less; the market value of the collateral held in or a netting contract between or among (xviii) That portion of local currency support of the claim. financial institutions under sections 401–407 claims conditionally guaranteed by central (2) 20 percent Risk-Weight (Category 2). of the Federal Deposit Insurance Corporation governments of non-OECD countries, to the (i) Cash items in the process of collection; Improvement Act of 1991 (12 U.S.C. 4401– extent the corporate credit union has local (ii) That portion of assets conditionally 4407), or Regulation EE (12 CFR part 231). currency liabilities in that country. guaranteed by the United States Government (C) If the securities firm uses the claim to (3) 50 percent Risk-Weight (Category 3). or its agencies, or the central government of satisfy its applicable capital requirements, (i) Revenue bonds issued by any public- an OECD country, the claim is not eligible for a risk-weight sector entity in an OECD country for which (iii) That portion of assets collateralized by under this paragraph II(a)(2)(viii); the underlying obligor is a public-sector the current market value of securities issued (ix) Claims representing general obligations entity, but which are repayable solely from or guaranteed by the United States of any public-sector entity in an OECD the revenues generated from the project government or its agencies, or the central country, and that portion of any claims financed through the issuance of the government of an OECD country; guaranteed by any such public-sector entity; obligations; (iv) Securities (not including equity (x) Balances due from and all claims on (ii) Qualifying mortgage loans and securities) issued by and other claims on the domestic depository institutions. This qualifying multifamily mortgage loans; U.S. Government or its agencies which are includes demand deposits and other (iii) Privately-issued mortgage-backed not backed by the full faith and credit of the transaction accounts, savings deposits and securities (i.e., those that do not carry the United States Government; time certificates of deposit, federal funds guarantee of the U.S. government, U.S. (v) Securities (not including equity sold, loans to other depository institutions, government agency, or U.S. government securities) issued by, or other direct claims including overdrafts and term federal funds, sponsored enterprise) representing an on, United States Government-sponsored holdings of the corporate credit union’s own interest in qualifying mortgage loans or agencies; discounted acceptances for which the qualifying multifamily mortgage loans. If the (vi) That portion of assets guaranteed by account party is a depository institution, security is backed by qualifying multifamily United States Government-sponsored holdings of bankers acceptances of other mortgage loans, the corporate credit union agencies; institutions and securities issued by must receive timely payments of principal (vii) That portion of assets collateralized by depository institutions, except those that and interest in accordance with the terms of the current market value of securities issued qualify as capital; the security. Payments will generally be or guaranteed by United States Government- (xi) The book value of paid-in Federal considered timely if they are not 30 days past sponsored agencies; Home Loan Bank stock; due; and (viii) Claims on, and claims guaranteed by, (xii) Deposit reserves at, claims on and (iv) Qualifying residential construction a qualifying securities firm, subject to the balances due from the Federal Home Loan loans. following conditions: Banks; (4) 100 percent Risk-Weight (Category 4). (A) A qualifying securities firm must have (xiii) Assets collateralized by cash held in All assets not specified above or deducted a long-term issuer credit rating, or a rating on a segregated deposit account by the reporting from calculations of capital pursuant to at least one issue of long-term unsecured corporate credit union; § 704.2 and § 704.3 of this part, including, debt, from a NRSRO. The rating must be in (xiv) Claims on, or guaranteed by, official but not limited to: one of the three highest investment grade multilateral lending institutions or regional (i) Consumer loans; categories used by the NRSRO. If two or more development institutions in which the (ii) Commercial loans; NRSROs assign ratings to the qualifying United States Government is a shareholder or (iii) Home equity loans; 69 securities firm, the corporate credit union contributing member; (iv) Non-qualifying mortgage loans; must use the lowest rating to determine (xv) That portion of assets collateralized by (v) Non-qualifying multifamily mortgage whether the rating requirement of this the current market value of securities issued loans; paragraph is met. A qualifying securities firm by official multilateral lending institutions or (vi) Residential construction loans; may rely on the rating of its parent regional development institutions in which (vii) Land loans; consolidated company, if the parent the United States Government is a (viii) Nonresidential construction loans; consolidated company guarantees the claim. shareholder or contributing member. (ix) Obligations issued by any state or any (B) A collateralized claim on a qualifying (xvi) All claims on depository institutions political subdivision thereof for the benefit of securities firm does not have to comply with incorporated in an OECD country, and all a private party or enterprise where that party the rating requirements under paragraph (a) assets backed by the full faith and credit of or enterprise, rather than the issuing state or depository institutions incorporated in an if the claim arises under a contract that: political subdivision, is responsible for the OECD country. This includes the credit (1) Is a reverse repurchase/repurchase timely payment of principal and interest on equivalent amount of participations in agreement or securities lending/borrowing the obligations, e.g., industrial development commitments and standby letters of credit transaction executed using standard industry bonds; sold to other depository institutions documentation; (x) Debt securities not specifically risk- incorporated in an OECD country, but only (2) Is collateralized by debt or equity weighted in another category; if the originating bank remains liable to the securities that are liquid and readily (xi) Investments in fixed assets and member or beneficiary for the full amount of marketable; premises; the commitment or standby letter of credit. (3) Is marked-to-market daily; (xii) Servicing assets; (4) Is subject to a daily margin maintenance (xiii) Interest-only strips receivable, other 69 requirement under the standard industry These institutions include, but are not limited than credit-enhancing interest-only strips; documentation; and to, the International Bank for Reconstruction and (xiv) Equity investments; Development (World Bank), the Inter-American (5) Can be liquidated, terminated or Development Bank, the Asian Development Bank, (xv) The prorated assets of subsidiaries accelerated immediately in bankruptcy or the African Development Bank, the European (except for the assets of consolidated CUSOs) similar proceeding, and the security or Investments Bank, the International Monetary Fund to the extent such assets are included in collateral agreement will not be stayed or and the Bank for International Settlements. adjusted total assets;

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(xvi) All repossessed assets or assets that equivalent amount must be assigned to the (A) Purchase the obligations the member is are more than 90 days past due; and appropriate risk-weight category using the unable to sell by a stated date; or (xix) Intangible assets not specifically criteria regarding obligors, guarantors, and (B) Advance funds to its member, if the weighted in some other category. collateral listed in Section II(a) of this obligations cannot be sold. (5) Indirect ownership interests in pools of Appendix. The following are the credit (3) 20 percent credit conversion factor assets. Assets representing an indirect conversion factors and the off-balance sheet (Group C). Trade-related contingencies, i.e., holding of a pool of assets, e.g., mutual items to which they apply. short-term, self-liquidating instruments used funds, are assigned to risk-weight categories (1) 100 percent credit conversion factor to finance the movement of goods and under this section based upon the risk-weight (Group A). collateralized by the underlying shipment. A that would be assigned to the assets in the (i) Risk participations purchased in commercial letter of credit is an example of portfolio of the pool. An investment in shares bankers’ acceptances; such an instrument. of a mutual fund whose portfolio consists (ii) Forward agreements and other (4) 10 percent credit conversion factor primarily of various securities or money contingent obligations with a certain draw (Group D). Unused portions of eligible ABCP market instruments that, if held separately, down, e.g., legally binding agreements to liquidity facilities with an original maturity would be assigned to different risk-weight purchase assets at a specified future date. On of one year or less. The resulting credit categories, generally is assigned to the risk- the date a corporate credit union enters into equivalent amount is assigned to the risk weight category appropriate to the highest a forward agreement or similar obligation, it category appropriate to the assets to be risk-weighted asset that the fund is permitted should convert the principal amount of the funded by the liquidity facility based on the to hold in accordance with the investment assets to be purchased at 100 percent as of assets or the obligor, after considering any objectives set forth in its prospectus. The that date and then assign this amount to the collateral or guarantees, or external credit corporate credit union may, at its option, risk-weight category appropriate to the ratings under paragraph II(c)(3) of this assign the investment on a pro rata basis to obligor or guarantor of the item, or the nature Appendix, if applicable; different risk-weight categories according to of the collateral; (5) Zero percent credit conversion factor the investment limits in its prospectus. In no (iii) Indemnification of members whose (Group E). (i) Unused portions of case will an investment in shares in any such securities the corporate credit union has lent commitments with an original maturity of fund be assigned to a total risk-weight less as agent. If the member is not indemnified one year or less, except for eligible ABCP than 20 percent. If the corporate credit union against loss by the corporate credit union, the liquidity facilities; chooses to assign investments on a pro rata transaction is excluded from the risk-based (ii) Unused commitments with an original basis, and the sum of the investment limits capital calculation. When a corporate credit maturity greater than one year, if they are of assets in the fund’s prospectus exceeds union lends its own securities, the unconditionally cancelable at any time at the 100 percent, the corporate credit union must transaction is treated as a loan. When a option of the corporate credit union and the assign the highest pro rata amounts of its corporate credit union lends its own corporate credit union has the contractual total investment to the higher risk categories. securities or is acting as agent, agrees to right to make, and in fact does make, either: If, in order to maintain a necessary degree of indemnify a member, the transaction is (A) A separate credit decision based upon short-term liquidity, a fund is permitted to assigned to the risk-weight appropriate to the the borrower’s current financial condition hold an insignificant amount of its assets in obligor or collateral that is delivered to the before each drawing under the lending short-term, highly liquid securities of lending or indemnifying institution or to an facility; or superior credit quality that do not qualify for independent custodian acting on their behalf; (B) An annual (or more frequent) credit a preferential risk-weight, such securities and review based upon the borrower’s current will generally be disregarded in determining (iv) Unused portions of ABCP liquidity financial condition to determine whether or the risk-weight category into which the facilities that do not meet the definition of an not the lending facility should be continued; corporate credit union’s holding in the eligible ABCP liquidity facility. The resulting and overall fund should be assigned. The prudent credit equivalent amount is assigned to the (iii) The unused portion of retail credit use of hedging instruments by a mutual fund risk category appropriate to the assets to be card lines or other related plans that are to reduce the risk of its assets will not funded by the liquidity facility based on the unconditionally cancelable by the corporate increase the risk-weighting of the mutual assets or the obligor, after considering any credit union in accordance with applicable fund investment. For example, the use of collateral or guarantees, or external credit law. hedging instruments by a mutual fund to ratings under paragraph II(c)(3) of this (6) Off-balance sheet contracts; interest rate reduce the interest rate risk of its government Appendix, if applicable. and foreign exchange rate contracts (Group bond portfolio will not increase the risk- (2) 50 percent credit conversion factor F).— weight of that fund above the 20 percent (Group B). (i) Calculation of credit equivalent category. Nonetheless, if the fund engages in (i) Transaction-related contingencies, amounts. The credit equivalent amount of an any activities that appear speculative in including, among other things, performance off-balance sheet interest rate or foreign nature or has any other characteristics that bonds and performance-based standby letters exchange rate contract that is not subject to are inconsistent with the preferential risk- of credit related to a particular transaction; a qualifying bilateral netting contract in weighting assigned to the fund’s assets, (ii) Unused portions of commitments accordance with paragraph II(b)(6)(ii) of this holdings in the fund will be assigned to the (including home equity lines of credit and Appendix is equal to the sum of the current 100 percent risk-weight category. eligible ABCP liquidity facilities) with an credit exposure, i.e., the replacement cost of (6) Derivatives. Certain transactions or original maturity exceeding one year except the contract, and the potential future credit activities, such as derivatives transactions, those listed in paragraph II(b)(5) of this exposure of the off-balance sheet rate may appear on corporate’s balance sheet but Appendix. For eligible ABCP liquidity contract. The calculation of credit equivalent are not specifically described in the Section facilities, the resulting credit equivalent amounts is measured in U.S. dollars, II(a) on-balance sheet risk-weight categories. amount is assigned to the risk category regardless of the currency or currencies These items will be assigned risk-weights as appropriate to the assets to be funded by the specified in the off-balance sheet rate described in Section II(b) or II(c) below. liquidity facility based on the assets or the contract. (b) Off-balance sheet items. obligor, after considering any collateral or (A) Current credit exposure. The current Except as provided in Section II(c) of this guarantees, or external credit ratings under credit exposure of an off-balance sheet rate Appendix, risk-weighted off-balance sheet paragraph II(c)(3) of this Appendix, if contract is determined by the mark-to-market items are determined by the following two- applicable; and value of the contract. If the mark-to-market step process. First, the face amount of the off- (iii) Revolving underwriting facilities, note value is positive, then the current credit balance sheet item must be multiplied by the issuance facilities, and similar arrangements exposure equals that mark-to-market value. If appropriate credit conversion factor listed in pursuant to which the corporate credit the mark-to-market value is zero or negative, this Section II(b). This calculation translates union’s CUSO or member can issue short- then the current exposure is zero. In the face amount of an off-balance sheet term debt obligations in its own name, but for determining its current credit exposure for exposure into an on- balance sheet credit- which the corporate credit union has a multiple off-balance sheet rate contracts equivalent amount. Second, the credit- legally binding commitment to either: executed with a single counterparty, a

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corporate credit union may net positive and (B) Potential future credit exposure. The factor.70 Corporate credit unions, subject to negative mark-to-market values of off-balance potential future credit exposure of an off- examiner review, should use the effective sheet rate contracts if subject to a bilateral balance sheet rate contract, including a rather than the apparent or stated notional netting contract as provided in paragraph contract with a negative mark-to-market amount in this calculation. The conversion II(b)(6)(ii) of this Appendix. value, is estimated by multiplying the factors are: 71 notional principal by a credit conversion

Foreign Interest rate exchange rate Remaining maturity contracts contracts (percents) (percents)

One year or less ...... 0.0 1.0 Over one year ...... 0.5 5.0

(ii) Off-balance sheet rate contracts subject (D) The corporate credit union establishes (1) A corporate credit union that qualifies to bilateral netting contracts. In determining and maintains procedures to monitor as a primary beneficiary and must its current credit exposure for multiple off- possible changes in relevant law and to consolidate an ABCP program that is a balance sheet rate contracts executed with a ensure that the bilateral netting contract variable interest entity under Generally single counterparty, a corporate credit union continues to satisfy the requirements of this Accepted Accounting Principles may exclude may net off-balance sheet rate contracts section; and the consolidated ABCP program assets from subject to a bilateral netting contract by (E) The corporate credit union maintains in risk-weighted assets if the corporate credit offsetting positive and negative mark-to- its files documentation adequate to support union is the sponsor of the ABCP program. market values, provided that: the netting of an off-balance sheet rate (2) If a corporate credit union excludes (A) The bilateral netting contract is in contract.72 such consolidated ABCP program assets from writing; (iii) Walkaway clause. A bilateral netting risk-weighted assets, the corporate credit (B) The bilateral netting contract creates a contract that contains a walkaway clause is union must assess the appropriate risk-based single legal obligation for all individual off- not eligible for netting for purposes of capital requirement against any exposures of balance sheet rate contracts covered by the calculating the current credit exposure the corporate credit union arising in bilateral netting contract. In effect, the amount. The term ‘‘walkaway clause’’ means connection with such ABCP programs, bilateral netting contract provides that the a provision in a bilateral netting contract that including direct credit substitutes, recourse corporate credit union has a single claim or permits a nondefaulting counterparty to obligations, residual interests, liquidity obligation either to receive or pay only the make a lower payment than it would make facilities, and loans, in accordance with net amount of the sum of the positive and otherwise under the bilateral netting sections II(a), II(b), and II(c) of this Appendix. negative mark-to-market values on the contract, or no payment at all, to a defaulter (3) If a corporate credit union bank has individual off-balance sheet rate contracts or the estate of a defaulter, even if the multiple overlapping exposures (such as a covered by the bilateral netting contract. The defaulter or the estate of the defaulter is a net program-wide credit enhancement and a single legal obligation for the net amount is creditor under the bilateral netting contract. liquidity facility) to an ABCP program that is operative in the event that a counterparty, or (iv) Risk-weighting. Once the corporate not consolidated for risk-based capital a counterparty to whom the bilateral netting credit union determines the credit equivalent purposes, the corporate credit union is not contract has been validly assigned, fails to amount for an off-balance sheet rate contract, required to hold duplicative risk-based perform due to any of the following events: that amount is assigned to the risk-weight capital under this part against the default, insolvency, bankruptcy, or other category appropriate to the counterparty, or, overlapping position. Instead, the corporate similar circumstances; if relevant, to the nature of any collateral or credit union should apply to the overlapping (C) The corporate credit union obtains a guarantee. Collateral held against a netting position the applicable risk-based capital written and reasoned legal opinion(s) contract is not recognized for capital treatment that results in the highest capital representing, with a high degree of certainty, purposes unless it is legally available for all charge. that in the event of a legal challenge, contracts included in the netting contract. (c) Recourse obligations, direct credit including one resulting from default, However, the maximum risk-weight for the substitutes, and certain other positions. insolvency, bankruptcy or similar credit equivalent amount of such off-balance (1) In general. Except as otherwise circumstances, the relevant court and sheet rate contracts is 50 percent. permitted in this Section II(c), to determine administrative authorities would find the (v) Exceptions. The following off-balance the risk-weighted asset amount for a recourse corporate credit union’s exposure to be the sheet rate contracts are not subject to the obligation or a direct credit substitute (but net amount under: above calculation, and therefore, are not part not a residual interest): (1) The law of the jurisdiction in which the of the denominator of a corporate credit (i) Multiply the full amount of the credit- counterparty is chartered or the equivalent union’s risk-based capital ratio: enhanced assets for which the corporate location in the case of noncorporate entities, (A) A foreign exchange rate contract with credit union directly or indirectly retains or and if a branch of the counterparty is an original maturity of 14 calendar days or assumes credit risk by a 100 percent involved, then also under the law of the less; and conversion factor. (For a direct credit jurisdiction in which the branch is located; (B) Any interest rate or foreign exchange substitute that is an on-balance sheet asset (2) The law that governs the individual off- rate contract that is traded on an exchange (e.g., a purchased subordinated security), a balance sheet rate contracts covered by the requiring the daily payment of any variations corporate credit union must use the amount bilateral netting contract; and in the market value of the contract. of the direct credit substitute and the full (3) The law that governs the bilateral (C) Asset-backed commercial paper amount of the asset it supports, i.e., all the netting contract; programs. more senior positions in the structure); and

70 For purposes of calculating potential future rate indices, so-called floating/floating or basis for inspection by the NCUA. Upon determination credit exposure for foreign exchange contracts and swaps; the credit equivalent amount is measured by the NCUA that a corporate credit union’s files other similar contracts, in which notional principal solely on the basis of the current credit exposure. are inadequate or that a bilateral netting contract is equivalent to cash flows, total notional principal 72 By netting individual off-balance sheet rate may not be legally enforceable under any one of the is defined as the net receipts to each party falling contracts for the purpose of calculating its credit bodies of law described in paragraphs II(b)(5)(ii) of due on each value date in each currency. equivalent amount, a corporate credit union this Appendix, the underlying indivudual off- 71 No potential future credit exposure is represents that documentation adequate to support calculated for single currency interest rate swaps in the netting of an off-balance sheet rate contract is balance sheet rate contracts may not be netted for which payments are made based upon two floating in the corporate credit union’s files and available the purposes of this section.

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(ii) Assign this credit equivalent amount to (A) Traded positions. A position is eligible (ii) Eligibility. A position extended in the risk-weight category appropriate to the for the treatment described in paragraph connection with a securitization is eligible obligor in the underlying transaction, after II(c)(3)(i) of this Appendix if: for the treatment described in paragraph considering any associated guarantees or (1) The position is a recourse obligation, II(c)(4)(i) of this section if it is not rated by collateral. Section II(a) lists the risk-weight direct credit substitute, residual interest, or an NRSRO, is not a residual interest, and categories. asset- or mortgage-backed security and is not meets the one of the three alternative (2) Residual interests. Except as otherwise a credit-enhancing interest-only strip; standards described in paragraphs (A), (B), or permitted under this Section II(c), a corporate (2) The position is a traded position; and (C) below: credit union must maintain risk-based capital (3) The NRSRO has rated a long term (A) Position rated internally. A direct for residual interests as follows: position as one grade below investment grade credit substitute, but not a purchased credit- (i) Credit-enhancing interest-only strips. A or better or a short term position as enhancing interest-only strip, is eligible for corporate credit union must maintain risk- investment grade. If two or more NRSROs the treatment described under paragraph based capital for a credit-enhancing interest- assign ratings to a traded position, the II(c)(4)(i) of this Appendix, if the position is only strip equal to the remaining amount of corporate credit union must use the lowest assumed in connection with an asset-backed the strip even if the amount of risk-based rating to determine the appropriate risk- commercial paper program sponsored by the capital that must be maintained exceeds the weight category under paragraph (3)(i). corporate credit union. Before it may rely on full risk-based capital requirement for the (B) Non-traded positions. A position that is an internal credit risk rating system, the assets transferred. not traded is eligible for the treatment corporate must demonstrate to NCUA’s (ii) Other residual interests. A corporate described in paragraph(3)(i) if: satisfaction that the system is adequate. credit union must maintain risk-based capital (1) The position is a recourse obligation, Acceptable internal credit risk rating systems for a residual interest (excluding a credit- direct credit substitute, residual interest, or typically: enhancing interest-only strip) equal to the asset- or mortgage-backed security extended (1) Are an integral part of the corporate credit union’s risk management system that face amount of the residual interest, even if in connection with a securitization and is not explicitly incorporates the full range of risks the amount of risk-based capital that must be a credit-enhancing interest-only strip; arising from the corporate credit union’s maintained exceeds the full risk-based (2) More than one NRSRO rate the position; participation in securitization activities; capital requirement for the assets transferred. (3) All of the NRSROs that rate the position (iii) Residual interests and other recourse (2) Link internal credit ratings to rate it as no lower than one grade below measurable outcomes, such as the probability obligations. Where a corporate credit union investment grade (for long term position) or holds a residual interest (including a credit- that the position will experience any loss, the no lower than investment grade (for short expected loss on the position in the event of enhancing interest-only strip) and another term investments). If the NRSROs assign recourse obligation in connection with the default, and the degree of variance in losses different ratings to the position, the corporate in the event of default on that position; same transfer of assets, the corporate credit credit union must use the lowest rating to union must maintain risk-based capital equal (3) Separately consider the risk associated determine the appropriate risk-weight with the underlying loans or borrowers, and to the greater of: category under paragraph (3)(i); the risk associated with the structure of the (A) The risk-based capital requirement for (4) The NRSROs base their ratings on the particular securitization transaction; the residual interest as calculated under same criteria that they use to rate securities (4) Identify gradations of risk among Section II(c)(2)(i) through (ii) of this that are traded positions; and ‘‘pass’’ assets and other risk positions; Appendix; or (5) The ratings are publicly available. (5) Use clear, explicit criteria to classify (B) The full risk-based capital requirement (C) Unrated senior positions. If a recourse assets into each internal rating grade, for the assets transferred, subject to the low- obligation, direct credit substitute, residual including subjective factors; level recourse rules under Section II(c)(5) of interest, or asset- or mortgage-backed security (6) Employ independent credit risk this Appendix. is not rated by an NRSRO, but is senior or management or loan review personnel to (3) Ratings-based approach—(i) preferred in all features to a traded position assign or review the credit risk ratings; Calculation. A corporate credit union may (including collateralization and maturity), (7) Include an internal audit procedure to calculate the risk-weighted asset amount for the corporate credit union may risk-weight periodically verify that internal risk ratings an eligible position described in Section the face amount of the senior position under are assigned in accordance with the corporate II(c)(3)(ii) of this section by multiplying the paragraph (3)(i) of this section, based on the credit union’s established criteria; face amount of the position by the rating of the traded position, subject to (8) Monitor the performance of the appropriate risk-weight determined in supervisory guidance. The corporate credit assigned internal credit risk ratings over time accordance with Table A or B of this section. union must satisfy NCUA that this treatment to determine the appropriateness of the is appropriate. This paragraph (3)(i)(c) initial credit risk rating assignment, and TABLE A applies only if the traded position provides adjust individual credit risk ratings or the substantive credit support to the unrated overall internal credit risk rating system, as position until the unrated position matures. Long term rating category Risk-weight needed; and (In percent) (4) Certain positions that are not rated by (9) Make credit risk rating assumptions that NRSROs. (i) Calculation. A corporate credit are consistent with, or more conservative Highest or second highest union may calculate the risk-weighted asset than, the credit risk rating assumptions and investment grade ...... 20 amount for eligible position described in methodologies of NRSROs. Third highest investment paragraph II(c)(4)(ii) of this section based on (B) Program ratings. grade ...... 50 the corporate credit union’s determination of (1) A recourse obligation or direct credit Lowest investment grade ... 100 the credit rating of the position. To risk- substitute, but not a residual interest, is One category below invest- weight the asset, the corporate credit union eligible for the treatment described in ment grade ...... 200 must multiply the face amount of the paragraph II(c)(4)(i) of this Appendix, if the position by the appropriate risk-weight position is retained or assumed in connection determined in accordance with Table C of with a structured finance program and an TABLE B this section. NRSRO has reviewed the terms of the program and stated a rating for positions Short term rating category Risk-weight TABLE C associated with the program. If the program (In percent) has options for different combinations of assets, standards, internal or external credit Highest investment grade ... 20 Risk-weight Rating category (In percent) enhancements and other relevant factors, and Second highest investment the NRSRO specifies ranges of rating grade ...... 50 Investment grade ...... 100 categories to them, the corporate credit union Lowest investment grade ... 100 One category below invest- may apply the rating category applicable to ment grade ...... 200 the option that corresponds to the corporate (ii) Eligibility. credit union’s position.

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(2) To rely on a program rating, the recourse obligations or direct credit 747.3003 Review of order reclassifying a corporate credit union must demonstrate to substitutes. In that case, the corporate credit corporate credit union on safety and NCUA’s satisfaction that the credit risk rating union must separately risk-weight the on- soundness criteria. assigned to the program meets the same balance sheet servicing asset and the related 747.3004 Review of order to dismiss a standards generally used by NRSROs for recourse obligations and direct credit director or senior executive officer. rating traded positions. The corporate credit substitutes under this section, and 747.3005 Enforcement of directives. union must also demonstrate to NCUA’s incorporate these amounts into the risk-based 747.3006 Conservatorship or liquidation of satisfaction that the criteria underlying the capital calculation. critically undercapitalized corporate assignments for the program are satisfied by (6) Obligations of CUSOs. All recourse credit union. the particular position. obligations and direct credit substitutes (3) If a corporate credit union participates retained or assumed by a corporate credit Subpart M—Issuance, Review and in a securitization sponsored by another union on the obligations of CUSOs in which Enforcement of Orders Imposing party, NCUA may authorize the corporate the corporate credit union has an equity Prompt Corrective Action on Corporate investment are risk-weighted in accordance credit union to use this approach based on Credit Unions a program rating obtained by the sponsor of with this Section II(c), unless the corporate the program. credit union’s equity investment is deducted § 747.3001 Scope. (C) Computer program. A recourse from credit union’s capital and assets under obligation or direct credit substitute, but not § 704.2 and § 704.3. (a) Independent review process. The a residual interest, is eligible for the rules and procedures set forth in this treatment described in paragraph II(c)(4)(i) of PART 709—INVOLUNTARY subpart apply to corporate credit this Appendix, if the position is extended in LIQUIDATION OF FEDERAL CREDIT unions, which are subject to connection with a structured financing UNIONS AND ADJUDICATION OF discretionary supervisory actions under program and the corporate credit union uses CREDITOR CLAIMS INVOLVING section 704.4 of this chapter and to an acceptable credit assessment computer FEDERALLY INSURED CREDIT reclassification under § 704.4(d)(3) of program to determine the rating of the UNIONS IN LIQUIDATION this chapter, to facilitate prompt position. An NRSRO must have developed corrective action, and to senior the computer program and the corporate 23. The authority citation for part 709 executive officers and directors of such credit union must demonstrate to NCUA’s continues to read as follows: satisfaction that the ratings under the corporate credit unions who are program correspond credibly and reliably Authority: 12 U.S.C. 1757, 1766, 1767, dismissed pursuant to a discretionary with the rating of traded positions. 1786(h), 1787, 1788, 1789, 1789a. supervisory action imposed under (5) Limitations on risk-based capital 24. Revise paragraphs (b)(7) and (b)(9) section 704.4 of this chapter. Section requirements— of § 709.5 to read as follows: 747.3002 of this subpart provides an (i) Low-level exposure rule. If the § 709.5 Payout priorities in involuntary independent appellate process to maximum contractual exposure to loss liquidation. challenge such decisions. retained or assumed by a corporate credit (b) Notice to State officials. With union is less than the effective risk-based * * * * * capital requirement, as determined in (b) * * * respect to a State-chartered corporate accordance with this Section II(c), for the (7) in a case involving liquidation of credit union under §§ 747.3002, assets supported by the corporate credit a corporate credit union, holders of 747.3003 and 747.3004 of this subpart, union’s position, the risk-based capital nonperpetual contributed capital any notices, directives and decisions on requirement is limited to the corporate credit accounts or instruments, subject to the appeal served upon a corporate credit union’s contractual exposure less any capital priority option described in union, or a dismissed director or officer recourse liability account established in Appendix A of Part 704 of this chapter; thereof, by the NCUA will also be accordance with Generally Accepted * * * * * served upon the appropriate State Accounting Principles. This limitation does official. Responses, requests for a not apply when a corporate credit union (9) in a case involving liquidation of provides credit enhancement beyond any a corporate credit union, holders of hearing and to present witnesses, contractual obligation to support assets it has perpetual contributed capital requests to modify or rescind a sold. instruments, subject to the capital discretionary supervisory action and (ii) Mortgage-related securities or priority option described in Appendix A requests for reinstatement served upon participation certificates retained in a of this chapter; the NCUA by a corporate credit union, mortgage loan swap. If a corporate credit * * * * * or any dismissed director or officer of a union holds a mortgage-related security or a corporate credit union, will also be participation certificate as a result of a PART 747—ADMINISTRATIVE served upon the appropriate State mortgage loan swap with recourse, it must official. hold risk-based capital to support the ACTIONS, ADJUDICATIVE HEARINGS, recourse obligation and that percentage of the RULES OF PRACTICE AND § 747.3002 Review of orders imposing mortgage-related security or participation PROCEDURE, AND INVESTIGATIONS discretionary supervisory action. certificate that is not covered by the recourse obligation. The total amount of risk-based 25. The authority citation for part 747 (a) Notice of intent to issue capital required for the security (or continues to read as follows: directive.— certificate) and the recourse obligation is Authority: 12 U.S.C. 1766, 1782, 1784, (1) Generally. Whenever the NCUA limited to the risk-based capital requirement 1786, 1787; 42 U.S.C. 4012a; Pub. L. 101– intends to issue a directive imposing a for the underlying loans, calculated as if the 410; Pub. L. 104–134. discretionary supervisory action under corporate credit union continued to hold 26. Add a new subpart M to part 747 §§ 704.4(k)(2)(v) and 704.4(k)(3) of this these loans as an on-balance sheet asset. to read as follows: chapter on a corporate credit union (iii) Related on-balance sheet assets. If an classified ‘‘undercapitalized’’ or lower, asset is included in the calculation of the Subpart M—Issuance, Review and Enforcement of Orders Imposing Prompt the NCUA will give the corporate credit risk-based capital requirement under this union prior notice of the proposed Section II(c) and also appears as an asset on Corrective Action on Corporate Credit the corporate credit union’s balance sheet, Unions action and an opportunity to respond. the corporate credit union must risk-weight Sec. (2) Immediate issuance of directive the asset only under this Section II(c), except 747.3001 Scope. without notice. The NCUA may issue a in the case of loan servicing assets and 747.3002 Review of orders imposing directive to take effect immediately similar arrangements with embedded discretionary supervisory action. under paragraph (a)(1) of this section

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without notice to the corporate credit (3) Seek additional information or (i) File a written response to the union if the NCUA finds it necessary in clarification from the corporate credit notice of reclassification, within the order to carry out the purposes of union or any other relevant source. specified time period, will be deemed to § 704.4 of this chapter. A corporate (e) Failure to file response. A have waived the opportunity to credit union that is subject to a directive corporate credit union which fails to file respond, and to have consented to which takes effect immediately may a written response to a notice of the reclassification; appeal the directive in writing to the Board’s intention to issue a directive (ii) Request a hearing will be deemed NCUA Board (Board). Such an appeal imposing a discretionary supervisory to have waived any right to a hearing; must be received by the Board within 14 action, within the specified time period, and calendar days after the directive was will be deemed to have waived the (iii) Request the opportunity to issued, unless the Board permits a opportunity to respond, and to have present witness testimony will be longer period. Unless ordered by the consented to the issuance of the deemed have waived any right to NCUA, the directive will remain in directive. present such testimony. effect pending a decision on the appeal. (f) Request to modify or rescind (c) Contents of response to notice. A The Board will consider any such directive. A corporate credit union that corporate credit union’s response to a appeal, if timely filed, within 60 is subject to an existing directive notice under paragraph (b) of this calendar days of receiving it. imposing a discretionary supervisory section must: (b) Contents of notice. The NCUA’s action may request in writing that the (1) Explain why it contends that the notice to a corporate credit union of its Board reconsider the terms of the corporate credit union should not be intention to issue a directive imposing directive, or rescind or modify it, due to reclassified; a discretionary supervisory action will changed circumstances. Unless (2) Include any relevant information, state: otherwise ordered by the Board, the mitigating circumstances, (1) The corporate credit union’s directive will remain in effect while documentation, or other evidence in capital measures and capital category such request is pending. A request support of the corporate credit union’s classification; under this paragraph which remains position; (3) If desired, request an informal (2) The specific restrictions or pending 60 days following receipt by hearing before the Board under this requirements that the Board intends to the Board is deemed granted. section; and impose, and the reasons therefore; § 747.3003 Review of order reclassifying a (4) If a hearing is requested, identify (3) The proposed date when the corporate credit union on safety and any witness whose testimony the discretionary supervisory action would soundness criteria. corporate credit union wishes to present take effect and the proposed date for (a) Notice of proposed reclassification and the general nature of each witness’s completing the required action or based on unsafe or unsound condition expected testimony. terminating the action; and or practice. When the Board proposes to (d) Order to hold informal hearing. (4) That a corporate credit union must reclassify a corporate credit union or Upon timely receipt of a written file a written response to a notice within subject it to the supervisory actions response that includes a request for a 14 calendar days from the date of the applicable to the next lower hearing, the Board will issue an order notice, or within such shorter period as capitalization category pursuant to commencing an informal hearing no the Board determines is appropriate in § 704.4(d)(3) of this chapter (such action later than 30 days after receipt of the light of the financial condition of the hereinafter referred to as request, unless the corporate credit corporate credit union or other relevant ‘‘reclassification’’), the Board will issue union requests a later date. The hearing circumstances. and serve on the corporate credit union will be held in Alexandria, Virginia, or (c) Contents of response to notice. A reasonable prior notice of the proposed at such other place as may be designated corporate credit union’s response to a reclassification. by the Board, before a presiding officer notice under paragraph (b) of this (b) Contents of notice. A notice of designated by the Board to conduct the section must: intention to reclassify a corporate credit hearing and to recommend a decision. (1) Explain why it contends that the union based on unsafe or unsound (e) Procedures for informal hearing.— proposed discretionary supervisory condition or practice will state: (1) The corporate credit union may action is not an appropriate exercise of (1) The corporate credit union’s appear at the hearing through a discretion under this section; current capital ratios and the capital representative or through counsel. The (2) Request the Board to modify or to category to which the corporate credit corporate credit union will have the not issue the proposed directive; and union would be reclassified; right to introduce relevant documents (3) Include other relevant information, (2) The unsafe or unsound practice(s) and to present oral argument at the mitigating circumstances, and/or condition(s) justifying reasons hearing. The corporate credit union may documentation, or other evidence in for reclassification of the corporate introduce witness testimony only if support of the corporate credit union’s credit union; expressly authorized by the Board or the position regarding the proposed (3) The date by which the corporate presiding officer. Neither the provisions directive. credit union must file a written of the Administrative Procedure Act (5 (d) NCUA Board consideration of response to the notice (including a U.S.C. 554–557) governing response. The Board, or an independent request for a hearing), which date will adjudications required by statute to be person designated by the Board to act on be no less than 14 calendar days from determined on the record nor the the Board’s behalf, after considering a the date of service of the notice unless Uniform Rules of Practice and response under paragraph (c) of this the Board determines that a shorter Procedure (12 CFR part 747) will apply section, may: period is appropriate in light of the to an informal hearing under this (1) Issue the directive as originally financial condition of the corporate section unless the Board orders proposed or as modified; credit union or other relevant otherwise. (2) Determine not to issue the circumstances; and (2) The informal hearing will be directive and to so notify the corporate (4) That a corporate credit union recorded, and a transcript will be credit union; or which fails to— furnished to the corporate credit union

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upon request and payment of the cost (3) That the Respondent’s failure to— presiding officer. The presiding officer thereof. Witnesses need not be sworn, (i) Request reinstatement will be may ask questions of any witness. unless specifically requested by a party deemed a waiver of any right to seek (3) The presiding officer may order or by the presiding officer. The reinstatement; that the hearing be continued for a presiding officer may ask questions of (ii) Request a hearing will be deemed reasonable period following completion any witness. a waiver of any right to a hearing; and of witness testimony or oral argument to (3) The presiding officer may order (iii) Request the opportunity to allow additional written submissions to that the hearing be continued for a present witness testimony will be the hearing record. reasonable period following completion deemed a waiver of the right to present (4) A Respondent will bear the burden of witness testimony or oral argument to such testimony. of demonstrating that his or her allow additional written submissions to (c) Contents of request for continued employment by or service the hearing record. reinstatement. A request for with the corporate credit union would (4) Within 20 calendar days following reinstatement in response to a notice materially strengthen the corporate the closing of the hearing and the under paragraph (b) of this section must: credit union’s ability to— record, the presiding officer will make (1) Explain why the Respondent (i) Become ‘‘adequately capitalized,’’ a recommendation to the Board on the should be reinstated; to the extent that the directive was proposed reclassification. (2) Include any relevant information, issued as a result of the corporate credit (f) Time for final decision. Not later mitigating circumstances, union’s capital classification category or than 60 calendar days after the date the documentation, or other evidence in its failure to submit or implement a record is closed, or the date of receipt support of the Respondent’s position; capital restoration plan; and of the corporate credit union’s response (3) If desired, request an informal (ii) Correct the unsafe or unsound in a case where no hearing was hearing before the Board under this condition or unsafe or unsound requested, the Board will decide section; and practice, to the extent that the directive whether to reclassify the corporate (4) If a hearing is requested, identify was issued as a result of reclassification credit union, and will notify the any witness whose testimony the of the corporate credit union pursuant corporate credit union of its decision. Respondent wishes to present and the to § 704.4(d)(3) of this chapter. The decision of the Board will be final. general nature of each witness’s (5) Within 20 calendar days following (g) Request to rescind reclassification. expected testimony. the date of closing of the hearing and Any corporate credit union that has (d) Order to hold informal hearing. the record, the presiding officer will been reclassified under this section may Upon receipt of a timely written request make a recommendation to the Board file a written request to the Board to from a Respondent for an informal concerning the Respondent’s request for reconsider or rescind the hearing on the portion of a directive reinstatement with the corporate credit reclassification, or to modify, rescind or requiring a corporate credit union to union. remove any directives issued as a result dismiss from office any director or (f) Time for final decision. Not later of the reclassification. Unless otherwise senior executive officer, the Board will than 60 calendar days after the date the ordered by the Board, the corporate issue an order directing an informal record is closed, or the date of the credit union will remain reclassified, hearing to commence no later than 30 response in a case where no hearing was and subject to any directives issued as days after receipt of the request, unless requested, the Board will grant or deny a result, while such request is pending. the Respondent requests a later date. the request for reinstatement and will The hearing will be held in Alexandria, notify the Respondent of its decision. If § 747.3004 Review of order to dismiss a Virginia, or at such other place as may the Board denies the request for director or senior executive officer. be designated by the Board, before a reinstatement, it will set forth in the (a) Service of directive to dismiss and presiding officer designated by the notification the reasons for its decision. notice. When the Board issues and Board to conduct the hearing and The decision of the Board will be final. serves a directive on a corporate credit recommend a decision. (g) Effective date. Unless otherwise union requiring it to dismiss from office (e) Procedures for informal hearing.— ordered by the Board, the Respondent’s any director or senior executive officer (1) A Respondent may appear at the dismissal will take and remain in effect under §§ 704.4(g) and 704.4(k)(3) of this hearing personally or through counsel. pending a final decision on the request chapter, the Board will also serve upon A Respondent will have the right to for reinstatement. the person the corporate credit union is introduce relevant documents and to directed to dismiss (Respondent) a copy present oral argument at the hearing. A § 747.3005 Enforcement of directives. of the directive (or the relevant portions, Respondent may introduce witness (a) Judicial remedies. Whenever a where appropriate) and notice of the testimony only if expressly authorized corporate credit union fails to comply Respondent’s right to seek by the Board or by the presiding officer. with a directive imposing a reinstatement. Neither the provisions of the discretionary supervisory action, or (b) Contents of notice of right to seek Administrative Procedure Act (5 U.S.C. enforcing a mandatory supervisory reinstatement. A notice of a 554–557) governing adjudications action under section 704.4 of this Respondent’s right to seek reinstatement required by statute to be determined on chapter, the Board may seek will state: the record nor the Uniform Rules of enforcement of the directive in the (1) That a request for reinstatement Practice and Procedure (12 CFR part appropriate United States District Court (including a request for a hearing) must 747) apply to an informal hearing under pursuant to 12 U.S.C. 1786(k)(1). be filed with the Board within 14 this section unless the Board orders (b) Administrative remedies—(1) calendar days after the Respondent otherwise. Failure to comply with directive. receives the directive and notice under (2) The informal hearing will be Pursuant to 12 U.S.C. 1786(k)(2)(A), the paragraph (a) of this section, unless the recorded, and a transcript will be Board may assess a civil money penalty Board grants the Respondent’s request furnished to the Respondent upon against any corporate credit union that for further time; request and payment of the cost thereof. violates or otherwise fails to comply (2) The reasons for dismissal of the Witnesses need not be sworn, unless with any final directive issued under Respondent; and specifically requested by a party or the section 704.4 of this chapter, or against

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any institution-affiliated party of a (c) Other enforcement action. In § 747.3006 Conservatorship or liquidation corporate credit union (per 12 U.S.C. addition to the actions described in of critically undercapitalized corporate 1786(r)) who participates in such paragraphs (a) and (b) of this section, credit union. violation or noncompliance. the Board may seek enforcement of the Notwithstanding any other provision (2) Failure to implement plan. directives issued under section 704.4 of of this title, the NCUA may, without any administrative due process, Pursuant to 12 U.S.C. 1786(k)(2)(A), the this chapter through any other judicial immediately place into conservatorship Board may assess a civil money penalty or administrative proceeding authorized or liquidation any corporate credit against a corporate credit union which by law. union that has been categorized as fails to implement a capital restoration critically undercapitalized. plan under § 704.4(e) of this chapter, regardless whether the plan was [FR Doc. E9–28219 Filed 12–8–09; 8:45 am] published. BILLING CODE 7535–01–P

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