[Federal Register Volume 60, Number 80 (Wednesday, April 26, 1995)]
[Proposed Rules]
[Pages 20438-20458]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-10149]



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NATIONAL CREDIT UNION ADMINISTRATION

12 CFR Parts 704 and 741


Corporate Credit Unions; Requirements for Insurance

AGENCY: National Credit Union Administration (NCUA).

ACTION: Proposed rule.

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SUMMARY: The proposed rule would strengthen the capital of corporate 
credit unions, reduce the risk of their investments, and improve asset-
liability management. It would return corporate credit unions to their 
primary functions of serving as liquidity centers and service providers 
and would protect the safety and soundness of the corporate credit 
union system.

DATES: Comments must be postmarked or posted on NCUA's electronic 
bulletin board by June 26, 1995.

ADDRESSES: Mail comments to Becky Baker, Secretary of the Board, 
National Credit Union Administration, 1775 Duke Street, Alexandria, VA 
22314-3428. Send comments to Ms. Baker via the bulletin board by 
dialing 703-518-6480.

FOR FURTHER INFORMATION CONTACT: H. Allen Carver, Director, Office of 
Corporate Credit Unions (703) 518-6640, at the above address.

SUPPLEMENTARY INFORMATION:

A. Background

    The corporate credit union system consists of 44 corporate credit 
unions serving the nation's 13,000 natural person credit unions, and 
U.S. Central Credit Union serving the corporate credit unions. 
Corporate credit unions provide liquidity, investment, and payment 
services to credit unions. Over the years, natural person and corporate 
credit unions have gradually evolved into quite different types of 
institutions. In 1977, NCUA first issued Part 704, which dealt 
specifically with corporate credit unions. However, it was not until 
1992 that the agency broadened Part 704 to address a broad array of 
corporate credit union matters. See 57 FR 22626 (May 28, 1992). The 
regulation has been in effect for several years, during a time of great 
change in the credit union industry. The Agency has had an opportunity 
to see how the regulation has worked and to consider how it could be 
improved. Last year, the Board amended Section 704.12, governing 
representation issues. See 59 FR 59357 (Nov. 17, 1994). After 
consulting closely with the corporate credit union industry, credit 
union trade associations, and outside experts, the Board is now 
proposing to amend most of the remaining sections of Part 704 and to 
add several new sections.
    Before analyzing the specific proposed changes, the Board wishes to 
draw the attention of interested parties to a gross inequity in the 
corporate credit union system. NCUA oversight and supervision of 
corporate credit unions has grown in complexity in the past few years, 
resulting in additional costs for NCUA's corporate credit union 
program. Although NCUA examines all of the corporate credit unions, 
only federally chartered corporates currently pay an operating fee to 
NCUA. Federally insured corporate credit unions maintain a deposit of 
one percent of insured shares with the NCUSIF, but corporates have 
minimal insured shares, and the income generated is not significant. Of 
course, non federally insured corporate credit unions neither pay 
operating fees to NCUA nor maintain deposits with the NCUSIF.
    The Board is concerned that the additional monetary burden on 
federal credit unions puts them at a competitive disadvantage and is 
considering ways to level the playing field. One option is to assess 
all corporate credit unions an annual examination fee, to be based on 
the expenses associated with the NCUA corporate program. Alternatively, 
the Board could abolish the operating fee for federal corporate credit 
unions, [[Page 20439]] requiring natural person credit unions to make 
up the difference. Since corporate credit unions benefit natural person 
credit unions, it may be appropriate to ask the latter to pay for the 
whole system. The Board requests comment on these options.

B. Section-by-Section Analysis

Section 704.1--Scope

    Part 704 applies directly to all federally insured corporate credit 
unions. It applies to non federally insured corporate credit unions, 
via Part 703 of the Rules and Regulations, if such credit unions accept 
shares from federally chartered credit unions. To clarify the 
application of Part 704, the Board is proposing to amend the Scope 
section so that it states both that the regulation applies to all 
federally insured corporate credit unions, and that non federally 
insured corporate credit unions must agree, by written contract, to 
adhere to the regulation and submit to NCUA examination as a condition 
of receiving funds from federally insured credit unions.
    The Board considered deleting from the proposed rule Section 
704.1(b), which sets forth its authority to waive a requirement of Part 
704. In the few years that the provision has been in effect, NCUA has 
been deluged with requests for waivers. The Board is concerned that 
corporate credit unions may have received the impression that 
compliance with the rule is optional and that waivers are granted as a 
matter of course. The Board wishes to emphasize that corporate credit 
unions are expected to comply with the rule. The Board has determined 
to retain Section 704.1(b) in the proposed rule, however, to make clear 
its authority, in extraordinary circumstances, to waive provisions of 
the regulation.
    The Board proposes to add a sentence to Section 704.1(b) regarding 
state- chartered credit unions. Where a state law provision is also 
contained in Part 704, and a state-chartered corporate wishes to 
request a waiver of that provision, the corporate must obtain state 
approval of the waiver before requesting a waiver from NCUA.

Section 704.2--Definitions

Capital
    The Board is proposing to revise the definition of capital. The 
revised definition encompasses primary capital and secondary capital 
share accounts upon which notice has not been given. These terms are 
defined later in this Section. The current definition includes each of 
the balance sheet accounts that comprise primary capital. As these 
accounts are also listed in the definition of primary capital, it is 
not necessary to list them under capital.
Commitment -
    The Board is proposing to delete the phrase ``or lease financing 
receivables'' from the definition of ``commitments,'' as corporate 
credit unions generally do not enter into lease financing arrangements.
Corporate Service Organization (CSO)
    Currently, corporate credit unions can invest in and loan to credit 
union service organizations (CUSOs) as defined in Section 701.27 of the 
NCUA Rules and Regulations. Section 701.27 was written with natural 
person credit unions in mind and contains a broad list of permissible 
activities, many of which the Board believes are inappropriate for 
corporate CUSOs. Accordingly, the Board is proposing to create a new 
term and establish new rules for such organizations. They would be 
called ``corporate service organizations (CSOs)'' and would be limited 
to serving only the corporate credit unions that have invested in or 
loaned to the CSO and/or the members of such corporate credit unions. 
Thus, a CSO wholly owned by ABC Corporate Credit Union could serve only 
ABC and its member credit unions. If the CSO received a loan from DEF 
Corporate Credit Union, it could serve ABC and its member credit unions 
and DEF and its member credit unions. The Board believes that this 
restriction would preserve the integrity of field of membership 
requirements.
    The Board is also proposing that a CSO's services be limited to 
data and item processing, wire transfers, record retention and storage, 
securities brokerage services, investment advisory services, and trust 
services. The Board is concerned that some corporate CUSOs currently 
are performing services that have nothing to do with the daily 
activities of corporate credit unions, such as shared branching 
services and home banking.
    The Board is also proposing to require that a CSO be chartered as a 
corporation under state law.
Embedded Options
    Embedded options are a common feature in many investment 
securities. Mortgage backed securities, federal agency structured 
notes, and many other corporate obligations have features such as 
maturity calls, principal prepayments, periodic and lifetime interest 
rate caps, and conversion factors, over which the investor has no 
control. The fact that these options can be exercised by the issuer (or 
mortgage holder) and not the investor raises concerns for the Board.
    These features entail substantial risks for investors that do not 
properly understand and evaluate how these options impact the 
performance of the investment. The function of a matched book strategy 
is to immunize the effects that changing interest rates will have on 
the economic value of assets and liabilities. If the characteristics of 
an asset are not replicated in the corresponding source of funds, the 
integrity of the match is compromised. This is especially true for 
assets which have conditional cash flows that are linked to the level 
of interest rates and other market factors.
    One example of an investment with conditional cash flows is 
mortgage backed securities. Mortgage backed securities are impacted by 
the behavior of the underlying mortgage holders whose loans make up the 
securities. If they elect to pay off or refinance their mortgages, the 
securities will likewise pay down. The investor has no control over 
this action. Prepayment risk has a substantial impact on the market 
value and liquidity of an instrument and the uncertainty of the cash 
flow behavior makes these securities especially difficult to match.
    Many investors were caught by surprise during the rate upswing in 
1994 because the market values of their securities were adversely 
impacted far more than they had anticipated. The embedded options such 
as prepayment extension and caps on floating rate instruments caused a 
serious threat to the liquidity and solvency of many credit unions. The 
risk associated with such securities cannot be ignored and it must be 
factored into the matching strategies of corporate credit unions. This 
is imperative because corporate credit unions must ensure that the 
viability of the income, liquidity and net market value of the matched 
book balance sheet is not jeopardized.
Identically Matched
    The Board recognizes that it is not possible for corporate credit 
unions to perfectly match all shares and certificates to identical 
assets because there sometimes exists an immaterial difference in 
dollar amount, the accrual methods, or the precise maturity date. To be 
substantiated as immaterial, such minute differences cannot have the 
effect of causing any significant exposure to changing spread 
performance or the net market value of the match. The integrity of the 
matched book depends upon how substantially close the match is with 
regard to such factors as the dollar amounts, rate reset 
[[Page 20440]] features, final maturities, and embedded options.
Long-Term Investment; Short-Term Investment
    Section 704.6 of the current regulation frequently uses the phrases 
``long-term (initial maturity over 1 year) investments'' and ``short-
term (initial maturity of 1 year or less) investments.'' In the 
interests of simplifying the regulation, the proposed rule would simply 
define, for the purpose of investment ratings, a ``long-term 
investment'' as one having an initial or expected maturity greater than 
one year and a ``short-term investment'' as one having an initial or 
expected maturity of one year or less.'' These definitions apply only 
to investment ratings in Section 704.5, which sets forth corporate 
credit union investment authority in the proposed rule. ``Long-term'' 
and ``short-term'' have different meanings in the context of asset-
liability management.
Market Value of Portfolio Equity (MVPE)
    MVPE is designed to calculate the risk that changing interest rates 
will have on a corporate credit union's capital. The traditional 
practice of measuring interest rate risk sensitivity was the static Gap 
model. With the introduction in recent years of more dynamic income 
simulation models, a more sophisticated and precise calculation of 
income (and capital) at risk is possible. The evolution of asset/
liability management techniques has led to a greater understanding of 
how changing interest rates impact not only earnings but capital as 
well.
    The Board recognizes that, like any estimation, the validity of the 
MVPE is dependent upon the quality of assumptions and integrity of the 
data going into the calculation. If the MVPE is intended to capture 
true mark-to-market risk of capital, the discount rates in the net 
present value calculations must reflect any credit, liquidity, or 
option premiums that are inherent in a specific asset or liability.
    The development of simulation models that calculate changes in net 
worth for given changes in interest rates has changed the way many risk 
managers regard interest rate sensitivity. The MVPE calculation is 
significant because it is a measure that captures risk over a more long 
term horizon than net interest income (NII), and as such, it serves as 
a better early warning detection system. Where net interest income 
calculations typically focus on income over the next 12-24 months, MVPE 
captures the long-term economic risk that is inherent in the balance 
sheet. It is possible for an institution's current earnings to hold 
steady over the near term as the mark-to-market of the balance sheet is 
rapidly deteriorating. If a risk manager only focuses on earnings, the 
risk of capital depletion may go unnoticed.
    MVPE is intended to show how the economic values of both sides of 
the balance sheet will change in relation to one another as interest 
rates change. One need only look at the toll of the 1994 bear market to 
understand the ramifications of ignoring the risk of capital depletion. 
The Board is therefore compelled to ensure that all liquidity providers 
be cognizant of the risk exposures they take with regard to their 
capital and liquidity positions.
    Many institutions have borrowed short-term funds to buy long-term 
assets. The inducement is typically a steep yield curve that provides 
an instant spread opportunity and quick income. The contribution of 
retained earnings to capital is a favorable objective but the risk of 
mismatched assets and liabilities can easily produce a situation where 
the market takes all the benefits away faster than the income was 
produced. The ability to withstand a liquidity crisis rests on core 
solvency. Maintaining core solvency, on a mark-to-market basis, in all 
probable interest rate environments is imperative, and MVPE is a method 
by which oversight authorities can police the capital at risk.
    An institution that has negative capital on a mark-to-market basis 
cannot meet the demands or obligations of a liquidity crisis, and it is 
for this reason that the Board desires to expand the risk measurement 
techniques employed by corporate credit unions so as to detect 
unacceptable exposures of risk at the earliest opportunity and mandate 
an appropriate course of corrective action whenever necessary.
    The MVPE calculation serves to inform risk takers of what the 
stakes are before the adverse market changes occur. By employing a 
``what if'' scenario approach, risk managers can observe the changes in 
MVPE to determine the cost of entertaining certain risk exposures. It 
is a dynamic approach that allows the oversight authorities to know how 
much is at stake and to respond before problems arise.
Net Interest Income
    The standard measure of risk in income simulation calculations is 
the variability of net interest income, from ``most likely'' 
expectations, for given changes in interest rates. The relationship 
between interest bearing assets and liabilities is subject to adverse 
change when market rates rise and fall. The ability to capture the 
variability of returns that results from changing rates is widely 
regarded as a fundamental tool for managing interest rate risk.
    The policy makers at corporate credit unions need to place 
limitations upon the amount of income that is subject to interest rate 
risk. Net interest income simulation is useful for understanding what 
variables will impact earnings and it allows the user to subject the 
balance sheet to severe rate stress tests and balance sheet composition 
changes.
    ``What if'' analysis is essential for anticipating the damage that 
will result if rates move contrary to the corporate credit union's 
forecast. Since credit unions cannot predict interest rates, the risk 
of positioning the balance sheet for a specific purpose must be 
measured in a variety of interest rate scenarios. A net interest income 
simulation provides a better means for forecasting the potential risk 
to income posed by changing rates. Like MVPE, it helps senior 
management and the board of directors to determine if the levels of 
potential risk are acceptable.
Overnight
    The integrity of the corporate credit union system rests on its 
ability to repay member funds, other than PCSAs and SCSAs, upon demand 
and without delay. A large portion of the funds in the system is in 
overnight accounts, and the bulk of those funds should remain 
immediately available to meet all contingent member needs. Since 
overnight transactions might span several days when a weekend or 
holiday is involved, the term ``overnight'' is recognized to mean from 
one business day to the next.
Penalty for Early Withdrawal
    Market-based penalties on shares, deposits and liabilities are 
important because they protect corporate credit unions from the 
replacement risk that results when an early withdrawal by a member 
credit union can only be replaced by a higher cost alternative. This 
risk is tantamount to selling an investment security on the secondary 
market. Corporate credit unions are financial intermediaries that 
should not absorb the risk caused by members seeking an early 
redemption.
    Member credit unions will have an economic incentive to request 
early redemption when reinvestment prospects exceed early withdrawal 
penalties. Unless the penalties are assessed on a contemporaneous mark-
to-market basis, the corporate will have [[Page 20441]] to absorb the 
difference between the penalty and the replacement cost. While members 
may not behave in a perfect economic fashion (calculating the break-
even point), the risk exposure is still significant. The incorporation 
of mark-to-market penalties is consistent with the principle of running 
a matched book.
Permanent Capital Share Account (PCSA)
    The Board recognizes that it may be difficult for some corporate 
credit unions to reach the capital levels required under proposed 
Section 704.12 in the timeframes provided. The reports of the General 
Accounting Office and the Corporate Credit Union Study Committee both 
propose the use of a form of nonredeemable membership shares to assist, 
in the short-term, corporate credit unions to attain minimum capital 
goals. Accordingly, the Board is proposing to create a type of 
membership share that would be at risk, would not be redeemable without 
written concurrence of NCUA, and would pay non cumulative dividends. 
Because of these elements of permanency, up to 50 percent of primary 
capital could consist of PCSAs. The Board requests comment on the 
criteria NCUA should use to determine when PCSAs may be redeemed.
    PCSAs would be limited to credit unions within the corporate credit 
union's field of membership, would not be subject to insurance by the 
NCUSIF or other deposit insurer, and could not be used to collateralize 
borrowings. PCSAs would be available to absorb losses in the event of a 
deficit in the corporate credit union's other primary capital accounts. 
In the event of liquidation of a corporate credit union, PCSAs would be 
payable only after satisfaction of all liabilities.
    A corporate credit union would be required to adequately disclose 
the terms and conditions of PCSAs to each subscriber. A standard form 
for such disclosure is provided in the regulation.
Primary Capital
    Currently, primary capital is defined as all corporate statutory 
and regular reserves and undivided earnings. The Board is proposing to 
amend the definition to have primary capital consist of statutory 
reserves, undivided earnings, other reserves (excluding the allowance 
for loan losses and accumulated gains/losses on available-for-sale 
securities), net income/loss, and permanent capital share accounts 
(PCSAs). No more than 50 percent of primary capital would be permitted 
to be comprised of PCSAs. The proposed regulation would provide for 
several benchmarks that are tied to the level of the corporate credit 
union's primary capital.
Rated
    Section 704.6 of the current regulation frequently requires that a 
security be rated at a certain level ``by an SEC-recognized rating 
agency,'' which is defined in Sec. 704.2. In the interests of 
simplifying the regulation, the proposed rule would simply define 
``rated'' to mean ``rated by an SEC-recognized rating agency,'' which 
would then be defined.
Secondary Capital Share Account (SCSA)
    The current regulation introduced the concept of membership capital 
share deposits (MCSDs), which are subject to certain restrictions in 
order to qualify as secondary capital. The Board is proposing to retain 
this concept in a new form called secondary capital share accounts 
(SCSAs). As with PCSAs, SCSAs would be limited to credit unions within 
the corporate credit union's field of membership, would not be subject 
to insurance by the NCUSIF or other deposit insurer, could not be used 
to collateralize borrowings, and in the event of liquidation of a 
corporate credit union, would be payable only after satisfaction of all 
liabilities.
    In order for an SCSA to count as capital, it would have to have a 
minimum notice of withdrawal of two years. The Board weighed several 
options in establishing the notice period. The Board believes that the 
one year notice that currently exists for MCSDs is too short. If a 
corporate credit union experienced problems, all of its secondary 
capital could be depleted in 12 months. This is often not enough time 
to resolve problems, and a total depletion of secondary capital could 
threaten a corporate credit union's continued viability. The Board 
believes that a two year notice period would serve to preserve capital, 
yet allow maneuverability on the part of member credit unions. 
Individual corporates would be free to set longer notice periods if 
they wished.
    The Board also proposes that SCSAs be available to absorb losses in 
the event of a deficit in the corporate credit union's primary capital. 
SCSAs could be used not only if a corporate credit union were 
liquidated, but also to cover any losses in a continuing corporate 
credit union that has depleted its level of primary capital.
    The Board is concerned that all the requirements and conditions of 
SCSAs are adequately disclosed to each member credit union. Therefore, 
specific disclosure at the time of the opening of an SCSA, and annual 
disclosure thereafter, is provided in the regulation, along with 
standard forms that may be used by the corporate credit unions.
    The Board notes that SCSAs are the only permitted form of secondary 
capital in the proposed rule. Currently, secondary capital consists of 
MCSDs and term subordinated debt. A review of the corporate credit 
unions determined that none had in fact used term subordinated debt as 
a way to build secondary capital. In light of this, and the Board's 
belief that it is more appropriate to build capital through a corporate 
credit union's members, the proposed rule would not include term 
subordinated debt in secondary capital and would delete any reference 
to it in the regulation. Since SCSAs would be the only component of 
secondary capital, the proposed rule would simply refer to SCSAs 
instead of secondary capital.
Undivided Earnings
    The Board is proposing to revise the definition of ``undivided 
earnings'' to remove the term ``corporate reserves,'' as that term is 
not used in the proposed rule.
United States Government or its Agencies; United States Government-
Sponsored Corporations and Enterprises
    The Board is proposing to delete the reference to Appendix C from 
these definitions and to delete current Appendix C. Rather than having 
a fixed list of agencies and enterprises, which may become erroneous as 
entities are created, dissolved, or changed, the Board wishes to simply 
present the definition of government agencies and enterprises and place 
the responsibility of determining an entity's status on the corporate 
credit union. [[Page 20442]] 
Adjusted Trading; Bailment for Hire Contract; Cash Forward Agreement; 
Collateralized Mortgage Obligation; Facility; Federal Funds 
Transaction; Forward Rate Agreement; Futures Contract; Immediate Family 
Member; Market Price; Maturity Date; Official; Option Contract; Primary 
Dealer; Real Estate Mortgage Investment Conduit; Repurchase 
Transaction; Residual Interest; Reverse Repurchase Transaction; Section 
107(8) Institution; Senior Management Employee; Settlement Date; Short 
Sale; Standby Commitment; Stripped Mortgage Backed Security; Swap 
Agreement; Trade Date; Zero Coupon Bond
    Currently, Part 704 incorporates by reference Part 703, which 
governs federal credit union investments, except where inconsistent 
with Part 704. To eliminate the confusion that has arisen over the 
applicability of certain provisions of Part 703, and because Part 703 
may be amended in the future, the Board is proposing to move the 
relevant portions of Part 703 into Part 704. Most of these definitions 
are from Part 703; some have been altered slightly. A few other 
investment-related definitions have been added.
Capital of a Broker/Dealer; Claims; Corporate Reserves; Credit Union 
Service Organization; Membership Capital Share Deposit; Non Credit 
Union Member; Original Maturity; Other Reserves; Risk-Based Capital; 
Secondary Capital; Speculative Activities; Term Subordinated Debt
    The Board is proposing to eliminate all of these definitions, 
primarily because the terms are not used in the proposed regulation. 
The term ``claims'' is used in the appendices, but the definition, 
``loans or other debt obligations,'' is deemed to be self-evident.

Section 704.3--Planning: Strategic and Business Plans

    The Board is proposing to revise Sec. 704.3 to specify that the 
board of directors of a corporate credit union must adopt written 
strategic and business plans. The Board is concerned that the directors 
of corporate credit unions might develop concepts for such plans 
through discussion and brainstorming sessions, but not place them in 
formal written format. The lack of written documentation would result 
in the inability of the directors to monitor their success in achieving 
their goals. Additionally, wording was added to require that the annual 
review of the plans be documented and provided to the corporate credit 
union's auditor and supervisory committee and to NCUA. -

Section 704.4--Asset/Liability Management

    Matched book requirement. The evolution of ``managed'' book 
strategies in the corporate credit union network has become a huge 
concern to the Board. The assumption of interest rate risk by some 
corporates has been demonstrably short-sighted as evidenced by the 
wide-spread exposure to rising interest rates taken by many corporates 
in recent years.
    In some dramatic instances, portfolios were merely matched by 
repricing characteristics, and not always effectively at that, which 
subjected some corporate credit unions to potentially extreme 
depletions of capital. The mismatches that result when short duration 
liabilities are matched against longer duration investment assets 
cannot be managed if the ability to sell troubled assets is forfeited 
by a ``hold-to-maturity'' philosophy. Thus, the managed book approach 
has, in many cases, resulted in an unmanaged wager against changing 
interest rates.
    The fact that most securities in corporate portfolios that can be 
adversely impacted by rising rates are classified as ``hold-to-
maturity'' largely contradicts the notion that the risks associated 
with these managed portfolios can be managed when and if the wrong 
combination of circumstances prevails.
    The Board is concerned about the potential problems that result 
when corporate credit unions that ``manage'' sources and uses of funds 
assume unreasonable levels of risk exposure with the overnight portion 
of member funds. The growth and complexity of the floating rate 
securities market has inspired many corporate credit unions to employ a 
``managed'' risk approach in which maturity and average life are 
disregarded in favor of matching sources and uses of funds by interest 
rate reset characteristics.
    This has led some corporate credit unions to assume substantial 
duration mismatches when they ``match'' their overnight funds against 
corresponding floating rate assets which have embedded options, long 
weighted average lives, or coupons linked to inappropriate indices. 
When such assets have interest rate dependent features that affect 
their market values, the liquidity and solvency of the credit union can 
be adversely affected. The Board believes that such risk exposures 
should be identified, measured, and limited to a reasonable level of 
primary capital. When such risks cannot be immunized in the matching 
process, they are unacceptable.
    The Board is aware that a floating rate security can have a very 
short duration if it is tied to a sensitive market index, reprices 
frequently, has little or no embedded option risk, and has a relatively 
short final maturity. The Board also recognizes that a portion of 
overnight shares at a corporate credit union represents a core amount 
of funds that is essentially permanent in nature. Such core funds are 
required to cover clearings and other daily activities. It is not 
inappropriate for a corporate credit union to mismatch a conservative 
portion of overnight funds into longer maturity assets provided that 
the assets are convertible to cash without suffering a material loss.
    The Board is proposing that a corporate credit union be permitted 
to mismatch 25 percent of funds in the overnight book. The parameters 
set forth on the assets permitted in this 25 percent portion are 
established to prevent any material adverse market value effect upon 
the liquidation potential of these assets if and when the need arises. 
The ability to mismatch a conservative portion of the overnight account 
allows corporate credit unions to augment their earnings potential in 
addition to the investment of capital.
    The Board does not believe that any interest rate risk should be 
taken with term certificates. Any source of funds, with the exception 
of capital, that has a maturity of greater than one business day must 
be identically matched to an asset that has the same maturity and 
repricing characteristics. The danger of entertaining duration 
mismatches with member certificates is regarded to be completely 
inconsistent with the charge of a liquidity facility. This activity is 
not regarded to be a legitimate means of generating retained earnings 
because of the risk and complexity associated with managing a 
mismatched portfolio.
    Portfolio pricing. It is essential for corporate credit unions to 
evaluate the risk inherent in their balance sheets on a regular basis. 
A frequent pricing of the investment portfolio is an important 
component of risk assessment since it provides critical information 
about changes in the liquidation value of the balance sheet.
    Whether assets are classified as available-for-sale or hold-to-
maturity, they need to be reviewed in the context of fair market value. 
The management of a corporate credit union should know at all times 
where the relative market value of its balance sheet stands in order to 
ensure that the core solvency of the institution is not remotely 
threatened by any adverse change in market rates. [[Page 20443]] 
    Maximum unrealized loss on available-for-sale assets. The Board is 
proposing that the aggregate loss in the accumulated unrealized gains/
losses on available-for-sale assets, net of any unrealized gains or 
losses on the corresponding source of funds, be limited to a 
conservative percentage of the corporate's primary capital. Consistent 
with the provision that all investment securities be priced to market 
on a monthly basis, the need to closely monitor the impact of changing 
market rates on the available-for-sale portfolio is imperative.
    The Board is also proposing that sufficient early withdrawal 
penalties be in place to guarantee protection from replacement risk. 
This would allow corporates to capture the economic benefit of the 
liabilities that are matched against available-for-sale assets; 
accordingly, it is appropriate to factor in the corresponding 
liabilities when setting a maximum limit upon the aggregate loss in the 
accumulated unrealized gain/loss on ``available-for-sale'' assets.
    Rate shock analysis. The use of scenario analysis to measure 
potential risk is not a new concept to many corporate credit unions. 
This discipline is already resident in a number of corporates. The 
purpose of using a rate shock calculation is to view interest rate risk 
from a severe but plausible perspective. The senior management and 
board of directors of a corporate should always be cognizant of 
potential interest rate risk exposures before they arise.
    It is clear that a perfectly matched book does not have the same 
volatility that a ``managed'' mismatched book has. Depending upon how 
the overnight and capital accounts are structured, they could 
potentially create some exposure to changing rates. Such exposures need 
to be identified, measured, related to primary capital, and reported to 
all oversight authorities on a regular basis.
    Rate shock analysis is a standard form of risk assessment that is 
used in many industry applications. The FFIEC High Risk Stress Test for 
CMOs, total return analysis, and income simulation models all feature 
this approach. It is a useful and conservative practice that enhances 
the risk management process.
    Risk analysis, supervision and compliance. The Board is 
particularly concerned that corporate credit unions have a 
comprehensive risk management process in place to identify all 
applicable risk exposures before and after an investment is made. The 
process should ensure that such risk exposures are measured on a 
regular basis and in relation to all limitations that are in place to 
govern such risks.
    The risk management process is a discipline that requires a large 
measure of vigilance on the part of management. The impact of changing 
market and credit conditions may be swift and severe. The risk 
management process must be a proactive and defensive mechanism for 
preserving the earnings and capital of the credit union. The more in-
depth the risk analysis and the greater the frequency of review, the 
more accountable the board of directors can be in policing the risks 
that are undertaken.
    The board of directors of a corporate credit union is responsible 
for the actions and risk exposures that the institution undertakes. In 
order to effectively understand and ultimately supervise risk, the 
board must receive a complete distillation of risk activities on a 
timely basis. That information must summarize the actions taken and the 
consequences, as stated in terms of capital at risk, that will result 
when applicable risk factors change.
    The board of directors cannot supervise and direct the actions of 
the credit union at the line level. However, the board is obligated to 
demand that management provide all of the information necessary for 
board members to make fully informed decisions. Thus the reporting 
element of the risk management process is no less important in the 
scheme of managing risk. The board must have clear, concise summaries 
of risk activities and exposures in order to carry out its oversight 
responsibilities.
    The Board regards risk analysis, supervision, and compliance as an 
essential process for all credit unions. Risk management procedures 
vary considerably among corporate credit unions and are a major 
concern. The need to standardize the discipline of the risk management 
process is obvious. The incorporation of a consistent framework will 
bolster the integrity and viability of the corporate credit union 
system.
    Contingency funding. The role of all corporate credit unions as 
liquidity custodians has drawn attention to a major deficiency in the 
system. The disregard for contingent funding plans has been a 
particularly troublesome issue. Contingency funding plans guarantee the 
role of a corporate as an inviolable provider of liquidity, regardless 
of the circumstances. The fact that liquidity is most scarce when it is 
most required underscores the danger of not planning for unexpected 
needs.
    The borrowing capacity of corporate credit unions is not an 
unlimited resource. Many corporate credit unions have suggested that 
liquidity will be easily obtainable through repurchase agreements and 
lines of credit. The reality is that many factors can impinge upon the 
ability of a corporate to borrow the amount of funds for the amount of 
time that is required.
    Corporate credit unions must evaluate all viable resources of 
liquidity on a regular basis and understand how changes in market 
factors will impact those resources over time. For example, it may be 
unreasonable to assume that borrowing capacity is not hindered by 
severe economic circumstances. The corporate must know that it can 
provide liquidity in normal or catastrophic situations. The board of 
directors needs to be assured that the plan to meet liquidity needs is 
realistic and up-to-date.
    Modeling. The Board wishes to quantify more precisely how the 
proposed changes to Part 704 will affect corporate credit union 
earnings and capital accumulation. To this end, NCUA will conduct 
analytical assessments of these changes through simulation modeling 
techniques using a sampling of corporate credit union balance sheets. 
Interested parties who believe the proposed changes, if implemented, 
would adversely affect corporate credit unions' ability to serve their 
members are requested to submit the results of similar assessments to 
support their positions.

Section 704.5--Investments

    The Board is proposing to modify and move the policies section of 
current Sec. 704.6 to proposed Sec. 704.4. The remaining sections of 
current Sec. 704.6 would be revised and recodified at proposed 
Sec. 704.5. The Board is also proposing to include the relevant 
provisions of Part 703, governing federal credit union investments, in 
proposed Part 704, rather than simply incorporating them by reference, 
as is done currently. Sections 703.4 and 703.5, with some 
modifications, would be included in Sec. 704.5, and Sec. 703.2, which 
provides definitions, would be included in proposed Sec. 704.2.
    Proposed Sec. 704.5(a) would replace current Sec. 704.6(b)(2)(i), 
except that the reference to investments authorized by Part 703 would 
be deleted. This paragraph would also explain the operation of the 
divestiture provisions set forth in the remainder of the section. 
Finally, this paragraph would address investments that must be 
classified as available-for-sale and the limit on investments in any 
one issuer. While the current rule bases all investment limitations on 
a percentage of assets, the [[Page 20444]] proposed rule would base 
those limitations on a percentage of primary capital. This would 
encourage the building of primary capital.
    The Board has determined that a corporate credit union should not 
be permitted to invest in any non federally insured state banks, trust 
companies, and mutual savings banks, so current Sec. 704.6(b)(2)(ii) is 
not included in proposed Sec. 704.5.
    Proposed Sec. 704.5(b) would replace current Sec. 704.6(b)(i), 
except that it would refer to CSOs rather than CUSOs. In addition, the 
limit on investments in CSOs would move to new Sec. 704.7, which would 
address a number of issues relating to CSOs.
    Proposed Sec. 704.5(c) would authorize corporate credit unions to 
invest in U.S. Central Corporate Credit Union.
    Proposed Sec. 704.5(d) would establish limits on investments in 
domestic banks for the first time. Proposed Sec. 704.5(e) would replace 
current Sec. 704.6(b)(2)(iii), except that it would add an entity 
rating requirement for foreign banks and establish limits on 
investments in foreign banks in any one country and in all foreign 
banks.
    Proposed Sec. 704.5 (f) and (g) would replace current 
Sec. 704.6(b)(2) (iv) and (v) respectively. Proposed Sec. 704.5(h) 
would replace current Sec. 704.6(b)(2)(vi), except that it would revise 
the stress test and would require corporate credit unions test their 
CMOs/REMICs on a monthly basis. Corporate credit unions would have to 
test floating as well as fixed rate CMOs.
    Proposed Sec. 704.5 (i)-(k) would set forth the relevant authorized 
activities listed in Sec. 703.4, and proposed Sec. 704.5(l) would set 
forth most of the prohibitions listed in Sec. 703.5. The Board is 
proposing additionally to prohibit corporate credit unions from buying 
or selling swap agreements, option contracts, and forward rate 
agreements, and making deposits in non federally insured state banks, 
trust companies, and mutual savings banks. While federal natural person 
credit unions may purchase stripped mortgage backed securities and CMO/
REMIC residuals to reduce interest rate risk, the Board is proposing to 
prohibit corporate credit unions from purchasing such securities for 
any purpose. The Board is also proposing to lower the maturity date on 
permissible zero coupon securities from 10 years Pto 5.
    Finally, the Board notes that Sec. 107(15)(B) of the Federal Credit 
Union Act authorizes federal credit unions to invest in mortgage 
related securities as defined in Sec. 3(a)(41) of the Securities 
Exchange Act of 1934, 15 U.S.C. 78c(a)(41). Until recently, that 
definition required that a security be backed by promissory notes 
secured by a first lien on real estate, upon which is located ``a 
dwelling or mixed residential and commercial structure.'' Because of 
this, a mortgage related security did not include a security backed by 
purely commercial mortgages. The Riegle Community Development and 
Regulatory Improvement Act of 1994, enacted on September 23, 1994, 
amended the Exchange Act to provide that the underlying notes of a 
mortgage related security may be directly secured by a first lien on 
real estate upon which is located one or more commercial structures. 
Thus, federal credit unions were granted the statutory authority to 
invest in commercial mortgage related securities.
    Under Sec. 107(15), however, this authority is ``subject to such 
regulations as the Board may prescribe.'' It is the Board's view that 
federal credit unions may not purchase commercial mortgage related 
securities until explicitly permitted to do so by regulation. The Board 
has not yet issued a regulation permitting federal natural person 
credit unions to purchase such securities but will consider the matter 
in its upcoming review of Part 703. The Board will also consider at 
that time whether commercial mortgage related securities are 
appropriate for corporate credit unions. In the meantime, to eliminate 
potential confusion, the proposed rule explicitly prohibits corporate 
credit unions from purchasing such securities.

Section 704.6--Capital Goals, Objectives, and Strategies

    The proposed rule would substitute ``CSO'' for ``CUSO'' and would 
require a cost/benefit analysis and impact study when an activity might 
have a material effect on a corporate credit union. When an impact 
study must be conducted, the proposed rule would require that it be on 
a corporate's earnings, in addition to its capital position.

Section 704.7--Corporate Service Organizations (CSOs)

    As noted in the definitions section, the Board is proposing to 
revise the CUSO concept for corporate credit unions. Currently, Part 
704 incorporates much of Sec. 701.27 by reference. Because of the 
proposed change in terminology, and the determination that some of the 
provisions of Sec. 701.27 are not applicable to corporate credit union 
service organizations, proposed Sec. 704.7 contains all of the 
necessary regulations governing CSOs. Therefore, the proposed rule does 
not reference Sec. 701.27.
    Proposed Sec. 704.7(a) would incorporate most of the definitions in 
current Sec. 701.27(c). Proposed Sec. 704.7(b) would limit a 
corporate's aggregate investments in and loans to member and non member 
CSOs to 15 percent of capital at the time the investment or loan is 
made. The current rule allows a corporate to invest 15 percent of 
capital in and loan 15 percent of capital to CUSOs. The Board has 
determined that it is inappropriate to allow corporate credit unions to 
risk 30 percent of capital in such organizations. The Board has added 
``member or non member'' to the limitation to clarify that loans to and 
investments in all CSOs are governed by the Sec. 704.7, regardless of 
whether the CSO is a member of the corporate credit union or not.
    Proposed Sec. 704.7(b) would incorporate some of the limitations of 
Sec. 701.27 (b) and (d). Proposed Sec. 704.7(c) would incorporate the 
conflicts provisions of Sec. 701.27(d)(6). Proposed Sec. 704.7(d) would 
replace the accounting and information access provisions of 
Sec. 701.27(d)(7).
    Finally, proposed Sec. 704.7(e) would require a corporate credit 
union to take steps to bring its investments and loans in line with the 
new regulation. Under the proposed rule, corporate credit unions would 
not be authorized to invest in or loan to CUSOs. If a CUSO already 
meets the CSO requirements, an investment in or loan to the CUSO 
becomes an investment in or loan to a CSO, and there is no problem. If 
a CUSO can meet the CSO requirements with some slight adjustments, as 
for example, eliminating a service that a CSO may not perform, it is 
expected that this be accomplished by the effective date of the 
regulation. If there is no way that a CUSO can meet the CSO 
requirements, a corporate credit union must divest itself of any 
investments in the CUSO by the effective date of the regulation. Any 
loan to such a CUSO must be terminated if permitted by contract. If not 
permitted, a corporate credit union may retain the loan on its books 
but may not renew or extend it.

Section 704.8--Lending

    The Board is proposing to revise Sec. 704.7(b)(1), which would be 
codified at Sec. 704.8(b)(1), to tighten the limitation on aggregate 
loans to one member credit union. In the existing regulation, loans to 
one borrower are limited to the corporate credit union's capital or 10 
percent of the corporate credit union's shares and capital, whichever 
is greater. Under the proposed regulation, the aggregate of loans to 
one member credit union would be limited to the corporate credit 
union's primary capital. The [[Page 20445]] Board believes that the 
existing limitation is far too permissive and poses a potential threat 
to the NCUSIF. In several of the larger corporate credit unions, the 
current limitation could allow one member to borrow in excess of $1 
billion. Limiting total loans to one borrower to the amount of a 
corporate credit union's primary capital would greatly reduce the 
exposure to the corporate credit union and the NCUSIF and, in addition, 
would provide an incentive to the corporate credit union to increase 
its level of primary capital.
    The Board is proposing to eliminate Sec. 704.7(b)(2) and (3), 
regarding loans to members that are not credit unions and to credit 
unions that are not members. Proposed Sec. 704.8(b)(5) would explicitly 
prohibit a corporate from making a loan to a non member or a natural 
person member. Except for providing overdraft protection for a clearing 
account, a corporate credit union would also be prohibited from making 
a loan to a trade association member. Loans to CSO members would be 
governed by proposed Sec. 704.7. The proposed rule would require any 
loan to a trade association member to be fully collateralized.

Section 704.9--Borrowing

    The Board is proposing to tighten the limitations on the amount a 
corporate credit union may borrow. In the existing regulation, a 
corporate credit union is permitted to borrow up to 10 times capital or 
50 percent of shares (excluding shares created by the use of member 
reverse repurchase agreements) and capital, whichever is greater. In 
the proposed regulation, the wording is changed to indicate whichever 
is less. The Board has determined that tying borrowing authority more 
closely to the level of capital would encourage capital growth. 
Additionally, unless extremely strong capital existed, the corporate 
would not be permitted to borrow up to 50 percent of shares and 
capital. The more well capitalized a corporate credit union, the higher 
borrowing capacity it would have. The Board views this as an 
enhancement to the safety and soundness of the corporate credit union 
system.
    This section is also revised in the proposed regulation to restrict 
a corporate credit union to borrowing only to meet liquidity needs, 
except for issuing a minimum amount of commercial paper to maintain a 
market presence. As a liquidity center, a corporate credit union must 
have the ability to borrow funds under certain circumstances to ensure 
that liquidity remains available to meet member credit unions' needs. 
However, the Board wishes to make it clear that corporate credit unions 
should not be borrowing in order to fund investment transactions to 
enhance net income. Therefore, the proposed regulation also requires 
that the need for borrowing be documented, in writing, and that the 
documentation be provided to the corporate credit union's auditor and 
supervisory committee and to NCUA.
    Finally, in acknowledging that there may exist extraordinary 
circumstances under which a corporate credit union may need to borrow 
in excess of the limitation set forth in this section, the regulation 
allows a corporate credit union to submit a request to NCUA for 
additional borrowing authority.

Section 704.10--Services

    The Board is proposing to revise this section to eliminate the list 
of services a corporate credit union may provide. Currently, corporate 
credit unions may provide services involving investments, liquidity 
management, payment systems, and correspondent services. The Board 
believes that this authority has, on occasion, been interpreted too 
broadly. Accordingly, the Board is proposing simply to say that 
corporate credit unions may provide services to their member credit 
unions, intending that to mean traditional loan, deposit and payment 
services. A corporate credit union wishing to provide other types of 
services should contact NCUA to determine whether such services are 
permissible.
    The Board is also proposing to clarify that a corporate credit 
union may provide services only to its members. Historically, two 
corporate credit unions might informally agree between themselves for 
one to provide services to the members of the other. These types of 
correspondent arrangements are permissible for natural person credit 
unions, but only when the agreements are formalized in writing and 
certain other requirements are met. The Board has determined that such 
arrangements, even if formalized, are inappropriate for corporate 
credit unions and is proposing to state that explicitly in the 
regulation.
    Corporate credit unions have also argued that they are authorized 
to provide services to non member credit unions pursuant to Sec. 701.26 
of the NCUA Rules and Regulations, which provides that a federal credit 
union may enter into a contract with one or more credit unions or other 
organizations ``for the purpose of sharing, utilizing, renting, 
leasing, purchasing, selling, and/or joint ownership of fixed assets or 
engaging in activities and/or services which relate to the daily 
operations of credit unions.'' NCUA never intended this provision to 
authorize corporate credit unions to provide services to non member 
credit unions. Such an interpretation would make field of membership 
limitations meaningless. The provision was intended to allow natural 
person credit unions to jointly contract to obtain services from a non 
credit union third party. In any event, the Board has the opportunity 
now to clarify that Sec. 701.26 does not authorize corporate credit 
unions to provide services to non member credit unions.
    Finally, corporate credit unions have argued that they can accept 
deposits from non member credit unions pursuant to Section 107(7)(G) of 
the Federal Credit Union Act, 12 USC 1757(7)(G), which authorizes 
federally chartered credit unions to invest in the shares or deposits 
of any central credit union. The Board has determined that corporate 
credit unions may only accept shares or deposits from members, pursuant 
to its authority, under Section 120(a) of the Federal Credit Union Act, 
12 USC 1766(a), to issue regulations governing corporate credit unions. 
--

Section 704.11--Fixed Assets

    The Board is proposing to revise Sec. 704.11(b)(1) to change the 
limitation on the amount a corporate credit union may invest in fixed 
assets without a waiver from NCUA. In the existing regulation, a 
corporate credit union may invest up to 15 percent of capital in fixed 
assets. In the proposed regulation, the limitation has been revised to 
15 percent of primary capital. While all of the corporates are 
presently in compliance with the proposed limitation, some may wish to 
make large fixed asset investments in the future. The Board views the 
proposed limit as a further incentive for corporate credit unions to 
build stronger levels of primary capital.
    Additionally, references to the Director, Office of Examination and 
Insurance have been changed to NCUA in the proposed rule. These 
references relate to the submission of waivers from the fixed asset 
limitation. For the time being, waivers should be submitted to the 
Director, Office of Corporate Credit Unions. Waivers may need to be 
submitted elsewhere in the future, however, if NCUA offices are 
restructured. Finally, the Board is proposing to eliminate the 
provision regarding a corporate credit union proceeding with its 
investment if it does not receive notification of the action taken on 
its request within 45 days. This will ensure that NCUA has adequate 
time to review any corporate credit union request to invest more than 
15 [[Page 20446]] percent of primary capital in fixed assets.

Section 704.12--Corporate Credit Union Reserves

    A number of sources (including Congress, the General Accounting 
Office, and the Corporate Credit Union Study Committee) have expressed 
concern over the relativity low levels of capital in corporate credit 
unions. The proposed regulation provides for several very specific 
changes to the corporate credit union reserve structure. The existing 
regulation establishes specific levels of capital that corporate credit 
unions must maintain, based on risk-weighted assets. Currently, 
corporate credit unions must maintain a ratio of 4 percent of primary 
capital to risk-weighted assets and a ratio of 8 percent of total 
capital to risk-weighted assets.
    Under proposed Sec. 704.12(a), corporate credit unions would have 
to reach capital levels based on primary capital to average daily 
assets. The Board is proposing the changes to the reserve requirements 
in order to emphasize the need for stronger primary capital. The 
regulation provides for incremental increases in the minimum ratio of 
primary capital to average daily assets until the level of 4 percent is 
achieved by January 1, 1998. (The increments are 2.5 percent by January 
1, 1996 and 3 percent by January 1, 1997.) The regulation does allow 
for a possible waiver from the requirements at the first two intervals. 
However, the Board is committed to building primary capital in 
corporate credit unions. Any waiver request from this requirement must 
include very specific time frames, with supporting documentation, for 
reaching the regulatory capital level.
    Proposed Sec. 704.12(b) would require that all corporate credit 
unions maintain a minimum of 10 percent capital to risk-weighted 
assets. Under the existing regulation, corporate credit unions are 
required to maintain a capital to risk-weighted assets ratio of 8 
percent. Although the major focus will be on primary capital, the Board 
sees a continued need to provide a measure of capital compared to risk-
weighted assets. Risk-weighting of assets does provide some delineation 
of the risk in a corporate credit union's balance sheet. The amount of 
capital available to cover the risks associated with the balance sheet 
is valuable information to corporate credit union officials as well as 
NCUA. Currently, all corporate credit unions with the exception of U.S. 
Central have capital to risk-weighted assets in excess of 10 percent.
    Proposed Sec. 704.12(i) would require that each corporate credit 
union develop a written projection detailing its action plan to achieve 
the primary capital requirements established in Sec. 704.12(a). As part 
of the plan, a corporate credit union will need to make reserve 
transfers at levels that will ensure compliance with the minimum 
primary capital requirements. At a minimum, corporate credit unions 
that have already met the minimum 4 percent primary capital 
requirement, must make reserve transfers as set forth in 
Sec. 704.12(j).
    Section 704.12(j) establishes the required reserve transfers for 
corporate credit unions. The proposed rule makes certain changes to 
conform to the proposed definitions of primary capital and capital to 
risk-weighted asset ratios. There are five reserve transfer categories. 
All corporate credit unions would be required to maintain minimum 
primary capital to average daily assets of 4 percent and capital to 
risk-weighted assets of 10 percent. Therefore, Category 1 begins when 
these ratios are at 4 percent and 10 percent respectively. Once the 
primary capital ratio is greater than 6 percent, and the capital to 
risk-weighted assets ratios is greater than 20 percent, reserve 
transfers are no longer required. For the purposes of reserve 
transfers, it is proposed that PCSAs be excluded from primary capital.
    The Board is proposing to eliminate the term ``risk-based 
capital.'' In the current regulation, risk-based capital includes 
primary capital and secondary capital up to 100 percent of primary 
capital. Risk-based capital is used in comparison to risk-weighted 
assets to establish minimum risk-based capital ratios for reserving 
purposes. In the proposed regulation, reserve transfers are based on 
primary capital to average daily assets and capital to risk-weighted 
assets. There would no longer be any specific category of risk-based 
capital.

Section 704.13--Representation

    As noted earlier, the Board amended the representation section of 
Part 704 last year. In light of the proposed changes to the definition 
of ``member,'' the Board is proposing to delete certain provisions that 
were designed to ensure that corporate credit unions were controlled by 
their member credit unions. These provisions would no longer be 
necessary if only representatives of member credit unions are permitted 
to vote and stand for election. The Board is also proposing to 
specifically state that the provisions of Sec. 701.14 of the Rules and 
Regulations, governing changes in officials and senior executive 
officers in credit unions that are newly chartered or in troubled 
condition. This provision always was intended to apply to corporate 
credit unions, as it is not inconsistent with any provision in Part 
704. However, the provision refers to NCUA Regional Directors, and in 
light of the centralization of the corporate credit union program, its 
application to corporate credit unions may have been unclear. 
Accordingly, the Board is proposing to specifically include Sec. 701.14 
in Part 704, changing the reference from ``Regional Director'' to 
``NCUA.'' As with requests for waivers to the fixed asset limitation, 
notices required under Sec. 701.14 should be filed, for the time being, 
with the Director, Office of Corporate Credit Unions.

Section 704.14--Audit Requirements

    In the existing regulation, this section deals only with the need 
for an annual audit. The only change relating to the annual audit in 
the proposed regulation is the addition of wording to clearly specify 
that the annual opinion audit will include a letter of reportable 
conditions.
    The Board is proposing to add a new Sec. 704.14(b) to include a 
requirement for an internal auditor function in corporate credit unions 
with assets in excess of $100 million. The requirement would also apply 
to corporates with assets under $100 million, if so ordered by NCUA. 
The Board realizes that not all corporate credit unions can readily 
afford to hire a full-time internal auditor. Based on the asset size 
and complexity of the institution, the corporate could hire a part-time 
internal auditor or contract with an outside firm to perform the 
internal auditor function. The proposed regulation requires that the 
internal auditor report directly to the chair of the corporate credit 
union's supervisory committee. The regulation provides specific minimum 
responsibilities that the internal auditor must perform. Finally, the 
internal auditor's findings and reports must be documented and made 
available for review to the outside auditor and NCUA.

Section 704.15--Contracts/Written Agreements

    The Board is not proposing any changes to this provision.

Section 704.16--State-Chartered Corporate Credit Unions

    The Board is proposing to add new Sec. 704.16(b) to put non 
federally insured state-chartered corporate credit unions that receive 
funds from federally insured credit unions on notice that they are 
considered ``institution-affiliated parties'' within Section 206(r) 
[[Page 20447]] of the Federal Credit Union Act and subject to all of 
the enforcement provisions of the Act.

Section 704.17--Fidelity Bond Coverage

    The Board is proposing only minor changes to this Section. Section 
704.17(d) would be amended to clarify that the minimum bond coverage is 
based on a corporate credit union's average daily assets as of the 
preceding December 31. The Board notes that in current Sec. 704.17(f), 
the deductibles are based on a corporate credit union's primary capital 
to risk asset ratio. Since the proposed regulation eliminates this 
ratio, another one must be used. The Board is proposing that it be the 
primary capital ratio and specifically requests comments on this issue.

Section 704.18--Effective Date

    The Board is proposing to make any final regulation on these 
matters effective January 1, 1996. However, although not stated in the 
proposed regulation itself, the Board is also considering requiring 
compliance with Sec. 704.5, governing investments, 30 days after the 
final rule is published in the Federal Register. Investments purchased 
before that date would be governed by the regulation in effect at the 
time of purchase. The Board is proposing to make the investment 
provisions applicable before the remainder of the regulation to deter 
corporate credit unions from ``loading up'' on investments that would 
no longer be permissible after January 1, 1996. All investments, 
regardless of when acquired, would be subject to the asset-liability 
provisions of proposed Section 704.4. In order to accomplish this 
objective, it may be necessary for the Board to issue a final rule in 
two separate stages with different effective dates, or to issue one 
rule with a 30 day effective date, but with a delayed compliance date 
for all sections other than Secs. 704.2, Definitions, and 704.5, 
Investments.

Appendix A--Summary of Risk Weights and Risk Categories for 
Corporate Credit Unions

    The major focus of the Board's proposed amendments to the risk 
weight schedule is the risk weighting of certain mortgage-backed 
securities. The current regulation weights CMOs based on their 
response to the interest-rate sensitivity test, and the Board has 
determined that this is inappropriate in a scheme designed to 
address credit risk. In the proposed rule, mortgage-backed 
securities, including pass throughs and certain CMOs (but not 
stripped mortgage backed securities), that are issued or guaranteed 
by a U.S. Government agency or U.S. Government-sponsored enterprise 
are assigned to the risk weight category appropriate to the issuer 
or guarantor. Generally, a privately-issued mortgage backed security 
meeting certain criteria, as set forth in the proposed regulation, 
is treated as essentially an indirect holding of the underlying 
assets, and assigned to the same risk category as the underlying 
assets. Privately-issued mortgage backed securities whose structures 
do not qualify them to be regarded as indirect holdings of the 
underlying assets are assigned to the 100 percent risk category.
    While the risk category to which mortgage backed securities is 
assigned will generally be based upon the issuer or guarantor or, in 
the case of privately-issued mortgage backed securities, the assets 
underlying the security, any class of a mortgage backed security 
that can absorb more than its pro rata share of loss without the 
whole issue being in default, is assigned to the 100 percent risk 
category.
    The specific changes being proposed are as follows. In Category 
1, the Board is proposing to delete item (g), claims on or 
unconditionally guaranteed by sovereign central governments of 
``AAA'' rated countries. Its inclusion in the current rule was 
inadvertent, as such investments are not permissible for corporate 
credit unions.
    In Category 2, 20 percent risk weight, the Board is proposing to 
delete the material at the end of Category 2, addressing bank 
ratings. Proposed Section 704.5 sets forth the minimum ratings for 
deposits in banks. The Board is also proposing to delete items (j) 
and (k), which are certain types of repurchase transactions. Such 
transactions should be risk weighted according to the type of 
collateral involved. Item (m), CMOs/REMICs that pass the interest 
rate sensitivity test, would also be deleted from the regulation. As 
noted above, the proposed rule risk weights CMOs based on the 
issuer, guarantor, or assets underlying the security. Finally, the 
Board is proposing to change the risk weighting of claims on foreign 
banks from 20 percent to 50 percent.
    In Category 3, 50 percent risk weight, the Board is proposing to 
delete item (b), CMOs that pass the interest rate sensitivity test, 
and replace it with privately-issued mortgage backed securities that 
meet certain criteria relating to credit risk. Claims on foreign 
banks would be added to this category.
    In Category 4, 100 percent risk weight, the Board is proposing 
to delete investments in CUSOs from item (a), as corporate credit 
unions would not be permitted to hold such investments from the 
effective date of this regulation. The proposed rule would add item 
(b), loans to and investments in CSOs, and replace item (e), 
membership capital share deposits, with permanent and secondary 
capital share accounts. The Board is also proposing to delete item 
(d), hold-in-custody repurchase agreements, as the risk weighting of 
such agreements should be based on the underlying collateral. The 
Board is proposing to delete item (f), stripped mortgage backed 
securities and item (g), residual interests of CMOs/REMICs. Under 
the proposed rule, these investments would not be permissible for 
corporate credit unions. In this category, the Board is also 
proposing to add an item for other claims on private obligors, to 
make it clear that unless a claim on a private obligor is guaranteed 
or insured by a U.S. Government agency or enterprise, is 
collateralized by such a claim, or is secured or collateralized by 
highly liquid and reliable collateral, it is risk-weighted at 100 
percent.

Appendix C--Model Forms

    As noted earlier, the Board is proposing to delete the current 
Appendix C as unnecessary and potentially confusing. The proposed 
rule contains a new Appendix C, which features model disclosure 
forms for permanent and secondary capital share accounts. Corporate 
credit unions that use these forms will be deemed to be in 
compliance with the proposed disclosure requirements of Sec. 704.2.

Section 741.3--Other Requirements

    The Board is proposing to amend Sec. 741.3 of the NCUA Rules and 
Regulations, governing requirements for insured credit unions, to 
prohibit federally insured credit unions from transacting business with 
corporate credit unions that do not comply with Part 704 and are not 
examined by NCUA.

Regulatory Procedures

Regulatory Flexibility Act

    The NCUA Board certifies that the proposed rule, if made final, 
will not have a significant economic impact on small credit unions 
(those under $1 million in assets). The rule applies only to corporate 
credit unions, all of which have assets well in excess of $1 million. 
Accordingly, a Regulatory Flexibility Analysis is not required.

Paperwork Reduction Act

    The proposed rule contains a requirement for the collection of 
additional information and a maintenance of documentation by a 
corporate credit union. The proposed rule requires that each corporate 
credit union develop and implement certain policies and plans and 
document compliance with such policies and plans. The proposed rule 
also requires that certain information regarding asset-liability 
management and investments be sent to NCUA or maintained in the records 
of the corporate credit union.
    The paperwork requirements will be submitted to the Office of 
Management and Budget (OMB) for review under the Paperwork Reduction 
Act. Written comments on the paperwork requirements should be forwarded 
directly to the OMB Desk Officer indicated below at the following 
address: OMB Reports Management Branch, New Executive Office Building, 
Room 10202, Washington, DC 20530. Attn: Milo Sunderhauf. NCUA will 
publish a notice in the Federal Register [[Page 20448]] once OMB action 
is taken on the submitted request.

Executive Order 12612

    Executive Order 12612 requires NCUA to consider the effect of its 
actions on state interests. It states that: ``Federal action limiting 
the policy-making discretion of the states should be taken only where 
constitutional authority for the action is clear and certain, and the 
national activity is necessitated by the presence of a problem of 
national scope.'' The risk of loss to federally insured credit unions 
and the NCUSIF caused by actions of corporate credit unions are 
concerns of national scope. The proposed rule would help assure that 
proper safeguards are in place to ensure the safety and soundness of 
corporate credit unions.
    The rule applies to all corporate credit unions that accept funds 
from federally insured credit unions. The NCUA Board believes that the 
protection of such credit unions, and ultimately the NCUSIF, warrants 
application of the proposed rule to non federally insured corporate 
credit unions. The NCUA Board, pursuant to Executive Order 12612, has 
determined that this rule may have an occasional direct effect on the 
states, on the relationship between the national government and the 
states, or on the distribution of power and responsibilities among the 
various levels of government. However, the potential risk to the NCUSIF 
without these changes justifies them.

List of Subjects

12 CFR Part 704

    Credit unions, Reporting and recordkeeping requirements.

12 CFR Part 741

    Bank deposit insurance, Credit unions, Reporting and recordkeeping 
requirements.

    By the National Credit Union Administration Board on April 13, 
1995.
Becky Baker,
Secretary of the Board.
    For the reasons set forth in the preamble, NCUA proposes to amend 
12 CFR chapter VII as follows:
    1. Part 704 is revised to read as follows:

PART 704--CORPORATE CREDIT UNIONS

Sec.
704.1  Scope.
704.2  Definitions.
704.3  Planning; strategic and business plans.
704.4  Asset/liability management.
704.5  Investments.
704.6  Capital goals, objectives, and strategies.
704.7  Corporate Service Organizations (CSOs).
704.8  Lending.
704.9  Borrowing.
704.10 Services.
704.11 Fixed assets.
704.12 Corporate credit union reserves.
704.13 Representation.
704.14 Audit requirements.
704.15 Contracts/written agreements.
704.16 State-chartered corporate credit unions.
704.17 Fidelity bond coverage.
704.18 Effective date.

Appendix A to Part 704--Summary of Risk Weights and Risk Categories for 
Corporate Credit Unions

Appendix B to Part 704--Off-Balance Sheet Credit Conversion Factors

Appendix C to Part 704--Model Forms

    Authority: 12 U.S.C. 1762, 1766(a), 1781, and 1789.


Sec. 704.1  Scope.

    (a) This part establishes special rules for all federally insured 
corporate credit unions. Non-federally insured corporate credit unions 
must agree, by written contract, to both adhere to the requirements of 
this part and submit to examinations, as determined by NCUA, as a 
condition of receiving shares or deposits from federally insured credit 
unions. This part grants certain additional authorities to federal 
corporate credit unions. Except to the extent that they are 
inconsistent with this part, other provisions of NCUA's Rules and 
Regulations (12 CFR Parts 700-795) and the Federal Credit Union Act 
apply to federally chartered corporate credit unions and federally 
insured state-chartered corporate credit unions to the same extent that 
they apply to other federally chartered and federally insured state-
chartered credit unions, respectively.
    (b) The NCUA Board has the authority to issue orders which vary 
from this Part. This authority is provided under Section 120(a) of the 
Federal Credit Union Act, 12 U.S.C. 1766(a). Requests by state-
chartered corporate credit unions for waivers to this part must be 
approved by the state regulator before being submitted to NCUA.


Sec. 704.2  Definitions.

    Adjusted trading means any method or transaction used to defer a 
loss whereby a corporate credit union sells a security to a vendor at a 
price above its current market price and simultaneously purchases or 
commits to purchase from the vendor another security at a price above 
its current market price.
    Asset-backed securities (ABS) means all securities supported by 
installment loans or leases or by revolving lines of credit. This 
definition excludes those securities referred to in the financial 
markets as mortgage-backed securities (MBS) which includes 
collateralized mortgage obligations (CMOs) and real estate mortgage 
investment conduits (REMICs).
    Average daily assets means the daily average of net assets 
calculated on the basis of assets at the close of each day in the 
period.
    Average life means the weighted average time to principal repayment 
with the amount of the principal paydowns (both scheduled and 
unscheduled) as the weights.
    Bailment for hire contract means a contract whereby a third party, 
bank, or other financial institution, for a fee, agrees to exercise 
ordinary care in protecting the securities held in safekeeping for its 
customers.
    Capital means the total of all primary capital and secondary 
capital share accounts upon which notice of withdrawal has not been 
given.
    Cash forward agreement means an agreement to purchase or sell a 
security with delivery and acceptance being mandatory and at a future 
date in excess of thirty (30) days from the trade date.
    Collateralized mortgage obligation (CMO) means a multi-class bond 
issue collateralized by whole loan mortgages or mortgage-backed 
securities (MBS).
    Commitment means any unconditional arrangement that obligates a 
corporate credit union to extend credit in the form of loans; to 
purchase loans, securities or other assets; or to participate in loans 
and leases. Commitments also include overdraft facilities, revolving 
credit, home equity, and mortgage lines of credit, and similar 
transactions. An obligation is conditional if the corporate credit 
union is not automatically obligated to extend funds.
    Corporate credit union means an organization that:
    (1) Is chartered under Federal or state law as a credit union;
    (2) Receives shares from and provides loan services to credit 
unions;
    (3) Is operated primarily for the purpose of serving other credit 
unions;
    (4) Is designated by NCUA as a corporate credit union;
    (5) Limits natural person members to the minimum required by state 
or federal law to charter and operate the credit union; and
    (6) Does not condition the eligibility of any credit union to 
become a member on that credit union's membership in any other 
organization. [[Page 20449]] 
    Corporate service organization (CSO) means an entity that:
    (1) Serves only corporate credit unions that have made investments 
in or loans to the entity and/or the member credit unions of such 
corporate credit unions;
    (2) Limits the services it provides to data and item processing, 
wire transfers, record retention and storage, securities brokerage 
services, investment advisory services, and trust services; and
    (3) Is chartered as a corporation under state law.
    Credit equivalent amount means the face amount of each off-balance 
sheet item multiplied by a credit conversion factor outlined in 
Appendix B of this part.
    Embedded options mean characteristics of certain assets and 
liabilities which give the issuer of the instrument the ability to 
change the features such as final maturity, rate, principal amount and 
average life. These options include, but are not limited to, caps, 
floors, and prepayment options. These options are found in most 
mortgage-backed securities, structured notes, and some Network 
instruments.
    Expected maturity means the date on which all remaining principal 
amounts of an instrument or bond are anticipated to be paid off on the 
basis of projected payment assumptions.
    Facility means the home office of a corporate credit union or any 
suboffice thereof including, but not necessarily limited to, wire 
service, telephonic station, or mechanical teller station.
    Federal funds transaction means a short-term or open-ended transfer 
of funds between U.S. depository institutions.
    -Federally issued CMO/REMIC means a CMO or REMIC which is issued by 
a U.S. Government agency or a U.S. Government-sponsored corporation or 
enterprise.
    -Foreign bank means an institution which is organized under the 
laws of a country other than the United States, which is engaged in the 
business of banking, and which is recognized as a bank by the banking 
supervisory authority of the country in which it is organized.
    --Forward rate agreement means an over-the-counter market 
instrument that allows two parties to trade interest rates on a 
notional principal amount for a specified time period in the future.-
    --Futures contract means a contract for the future delivery of 
commodities, including certain government securities, sold on 
commodities exchanges.
    -Identically matched means matched, to the extent possible, by 
amount, repricing, behavior, and final maturity. Any embedded options, 
such as calls, caps, and prepayments, must be replicated in the 
corresponding source or use of funds.
    -Immediate family member means a person related by blood, marriage, 
or adoption.
    -Long-term investment means, for the purpose of issue ratings, an 
investment that has an initial maturity, or expected maturity, greater 
than one year.
    --Market price means the price at which a security can be bought or 
sold.
    -Market value of portfolio equity (MVPE) means the net market value 
of all assets and liabilities, including their embedded options. This 
reflects the liquidation value of the balance sheet.
    -Material means an amount that exceeds 5 percent of the corporate 
credit union's capital.
    --Maturity date means the date on which a security matures, and 
shall not mean the call date or the average life of the security.
    -Member reverse repurchase transaction means an integrated 
transaction in which a corporate credit union purchases a security from 
one of its member credit unions under agreement by that member credit 
union to repurchase the same security at a specified time in the 
future. The corporate credit union then sells that same security, on 
the same day, to a third party, under agreement to repurchase it on the 
same date on which the corporate credit union is obligated to return 
the security to its member credit union.
    -Net assets means total assets less Central Liquidity Facility 
(CLF) stock subscriptions, CLF loans guaranteed by the NCUSIF, U.S. 
Central CLF certificates, and member reverse repurchase transactions.
    -Net interest income means the difference between income earned on 
interest bearing assets and interest paid on interest bearing 
liabilities.
    -Official means any director or committee member.
    -Option contract means a right, but not an obligation, to buy or 
sell a security at a specified price and settlement date in the future.
    -Overnight means having a maturity or call date of one business 
day.
    -Penalty for early withdrawal of a share, deposit, or liability 
means a fee which will, at a minimum, fully compensate a corporate 
credit union for the difference between fair value and book value of 
the asset that is divested (including any accumulated unrealized losses 
since the asset was purchased), or the replacement cost of funds, to 
meet the demand for early withdrawal.
    -Permanent capital share account (PCSA). (1) PCSA means a share 
account that:
    -(i) Is restricted to credit unions within a corporate credit 
union's field of membership;
    -(ii) Is not subject to share insurance coverage by the NCUSIF or 
other deposit insurer;
    -(iii) Cannot be used by member credit unions to collateralize 
borrowings;
    -(iv) Is available to absorb losses in the event of a deficit in 
other primary capital accounts in the corporate credit union;
    -(v) In the event of liquidation of the corporate credit union, is 
payable only after satisfaction of all liabilities of the liquidation 
estate including uninsured obligations to shareholders and the NCUSIF;
    -(vi) Is redeemable only with the written concurrence of NCUA; and
    -(vii) Pays noncumulative dividends.
    -(2) The terms and conditions of permanent capital share accounts 
must be disclosed at the time an account is opened. The board of 
directors of the member credit union must acknowledge those terms and 
conditions by signing a disclosure form. A copy of the disclosure form 
must be given to the member credit union, with the original retained by 
the corporate credit union.
    -Primary capital means statutory reserves, undivided earnings, 
other reserves (excluding the allowance for loan losses and accumulated 
unrealized gains/losses on available-for-sale securities), net income 
(loss), and permanent capital share accounts (PCSAs). No more than 50 
percent of primary capital may be comprised of PCSAs.
    -Primary dealer means a bank or investment dealer authorized to buy 
and sell government securities in direct dealings with the Federal 
Reserve Bank of New York in its execution of Fed open market 
operations.
    -Privately issued CMO/REMIC means a CMO or REMIC that qualifies as 
a permissible investment for a federal credit union pursuant to the 
provisions of Section 107(15)(B) of the Federal Credit Union Act.
    -Rated, in the context of investments under Sec. 704.5, means rated 
by an SEC-recognized rating agency. An SEC-recognized rating agency is 
any firm recognized by the Securities and Exchange Commission (SEC) as 
qualified to assign risk ratings to various investment instruments 
required to be registered with the SEC.
    Real Estate Mortgage Investment Conduit (REMIC) means a nontaxable 
entity formed for the sole purpose of holding a fixed pool of mortgages 
[[Page 20450]] secured by an interest in real property and issuing 
multiple classes of interests in the underlying mortgages.
    --Repurchase transaction means a transaction in which a corporate 
credit union agrees to purchase a security from a counterpart and to 
resell the same or any identical security to that counterpart at a 
later date.
    --Residual interest means the remainder cash flows from a CMO or 
REMIC transaction after payments due bondholders and trust 
administrative expenses have been satisfied.
    --Reverse repurchase transaction means a transaction whereby a 
corporate credit union agrees to sell a security to a purchaser and to 
repurchase the same or any identical security from that purchaser at a 
future date and at a specified price.
    -Risk-weighted assets means the sum of total balance sheet assets 
and off-balance sheet credit equivalent amounts multiplied by their 
appropriate risk weights.
    -Secondary capital share account. (1) Secondary capital share 
account means a share account that:
    -(i) Is restricted to credit unions within a corporate credit 
union's field of membership;
    -(ii) Is not subject to share insurance coverage by the NCUSIF or 
other deposit insurer;
    -(iii) Is established, at a minimum, as a two year notice account;
    -(iv) Cannot be used by member credit unions to collateralize 
borrowings;
    -(v) Is available to absorb losses in the event of a deficit in 
primary capital in the corporate credit union; and
    -(vi) In the event of liquidation of the corporate credit union, is 
payable only after satisfaction of all liabilities of the liquidation 
estate including uninsured obligations to shareholders and the NCUSIF.
    -(2) Notwithstanding the notice requirement, in the case of a 
member credit union's merger or liquidation, a corporate credit union 
shall return the member's secondary capital shares, less any penalty 
for early withdrawal, within 30 days of written notification from NCUA.
    -(3) The terms and conditions of secondary capital share accounts 
must be disclosed at the time an account is opened. The board of 
directors of the member credit union must acknowledge those terms and 
conditions by signing a disclosure form. A copy of the disclosure form 
must be given to the member credit union, with the original retained by 
the corporate credit union. A statement of the terms and conditions of 
a secondary capital share account must be provided to member credit 
unions annually. The annual disclosure statement must be signed by the 
chairman of the board of the corporate credit union.
    Section 107(8) institution means an institution described in 
Section 107(8) of the Federal Credit Union Act (12 U.S.C. 1757(8)).
    -Senior management employee means the corporate credit union's 
chief executive officer, any assistant chief executive officer (e.g., 
any assistant president, any vice president or any assistant treasurer/
manager) and the chief financial officer (controller).
    Settlement date means the date originally agreed to by a corporate 
credit union and a counterpart for settlement of the purchase or sale 
of a security.
    --Short sale means the sale of a security not owned by the seller.
    Short-term investment means, for the purpose of issue ratings, an 
investment that has an initial maturity, or expected maturity, of one 
year or less.
    Standby commitment means a commitment to either buy or sell a 
security, on or before a future date, at a predetermined price. The 
seller of the commitment is the party receiving payment for assuming 
the risk associated with committing either to purchase a security in 
the future at a predetermined price, or to sell a security in the 
future at a predetermined price. The seller of the commitment is 
required to either accept delivery of a security (in the case of a 
commitment to buy) or make delivery of a security (in the case of a 
commitment to sell), in either case at the option of the buyer of the 
commitment.
    Stripped mortgage-backed security (SMBS) means a security that 
represents either the principal or interest only portion of the cash 
flows of an underlying pool of mortgages.
    Swap agreement means a contract to exchange interest payments that 
are based upon a specified dollar amount (the ``notional'') at 
specified dates in the future.
    Trade association means an association of organizations or persons 
formed to promote their common interests. The term includes entities 
owned or controlled directly or indirectly by such an association but 
does not include credit unions.
    Trade date means the date a corporate credit union originally 
agrees, whether orally or in writing, to enter into the purchase or 
sale of a security.
    Undivided earnings means all forms of retained earnings, except:
    (1) Regular or statutory reserves; and
    (2) Valuation allowances established to meet the full and fair 
disclosure requirements of Sec. 702.3 of this chapter.
    United States depository institutions means offices or branches 
(foreign and domestic) of federally insured banks and depository 
institutions chartered and headquartered in the United States, Puerto 
Rico, and U.S. territories and possessions. This includes banks, mutual 
or stock savings banks, savings or building and loan associations, 
cooperative banks, credit unions, international banking facilities of 
domestic depository institutions, and U.S. chartered depository 
institutions owned by entities outside of the United States.
    United States Government or its agencies means the United States 
Government or instrumentalities of the United States whose debt 
obligations are fully and explicitly guaranteed as to the timely 
payment of principal and interest by the full faith and credit of the 
United States Government.
    United States Government-sponsored corporations and enterprises 
means agencies originally established or chartered to serve public 
purposes specified by Congress, but whose obligations are not 
explicitly guaranteed by the full faith and credit of the United States 
Government.
    Wholesale corporate credit union means a corporate credit union 
that serves other corporate credit unions.
    Zero coupon bond means a debt obligation that makes no periodic 
interest payments but instead is sold at a discount from its face 
value. The holder of a zero coupon bond realizes the rate of return 
through the gradual appreciation of the security, which is redeemed at 
face value on a specified maturity date.


Sec. 704.3  Planning; strategic and business plans. -

    (a) The board of directors of a corporate credit union shall adopt 
a written strategic plan with appropriate objectives and goals. This 
plan will be reviewed periodically during the year to determine that 
the goals are being accomplished. At least annually, the strategic plan 
will be reviewed and updated. These reviews will be documented in 
writing and provided upon request to the auditor, supervisory 
committee, and NCUA. -
    (b) A written business plan will be prepared for any material 
expenditure in fixed assets, new products and services, or investments 
in a CSO and/or for any planned field of membership expansion. Such 
plans shall be provided upon request to the auditor, supervisory 
committee, and NCUA. [[Page 20451]] 


Sec. 704.4-  Asset/liability management. -

    (a) Matching. All shares and deposits, exclusive of permanent 
capital share accounts and secondary capital share accounts, whether 
fixed or variable rate, must be identically matched to a corresponding 
asset. An identical match means that any factor which impacts the cash 
flows of an asset must be identically replicated in the corresponding 
liability. The corporate's capital is exempt from the matching 
requirement. The overnight shares of a corporate credit union are 
subject to the matching requirement with the following exception: Up 
to, but no more than, 25 percent of a corporate credit union's 
overnight shares and deposits (based on the average daily overnight 
balance for the preceding calendar year) can be matched against 
variable rate securities with a final maturity of three years or less 
provided that the following provisions are met: the security coupon 
reprices at least monthly, the coupon formula is tied to an appropriate 
market index (such as LIBOR, PRIME, Fed funds and Treasury Bills) not a 
lagging indicator (such as COFI); the change in coupon formula is not 
inverse to or a multiple of the change in the market index, and, if the 
asset is a marketable security, is classified as ``available for 
sale''.-
    (b) Unmatched embedded option limitation. A corporate credit union 
is limited to an aggregate amount of instruments that possess unmatched 
embedded options of no more than capital. -
    (c) Penalty for early withdrawal. All shares and deposits must 
either be non redeemable or include a fair value penalty for early 
withdrawal as defined in Sec. 704.2. -
    (d) Portfolio pricing. The fair value of all investment securities, 
regardless of classification, must be calculated and documented on a 
monthly basis using reliable market price indicators. Such 
documentation shall be provided upon request to the auditor, 
supervisory committee, and NCUA. -
    (e) Maximum unrealized loss on ``available-for-sale'' assets. The 
aggregate loss in the accumulated unrealized gains/losses on 
``available-for-sale'' assets, net of any unrealized gains/losses on 
the corresponding source of funds, may not exceed 15 percent of primary 
capital excluding accumulated unrealized gains/losses on available for 
sale securities. Any violation of this limit must be addressed with a 
corrective action that reduces the loss below the maximum allowed 
within 10 days.
    -(f) Rate shock analysis. A corporate credit union must perform a 
monthly ``shock test'' calculation to show the impact upon its net 
interest income and market value of portfolio equity (MVPE) for an 
immediate and sustained tandem shift in interest rates of plus and 
minus 300 basis points. The MVPE cannot change by more than plus or 
minus 25 percent for a plus or minus 300 basis point rate shock. The 
documentation for these calculations must include the balance sheet 
categories, interest rates, and other assumptions used. This 
information must be presented to a senior committee that includes board 
membership and provided upon request to the auditor, supervisory 
committee and NCUA.
    -(g) Risk analysis. A corporate credit union must identify and list 
all risks associated with an asset or source of funds prior to purchase 
or issuance. Where applicable, the risk analysis must include, at a 
minimum, liquidity, market, credit, legal, systems/operations, 
sovereign, exchange, and management risks. The risk analysis shall be 
maintained with other supporting documentation in a permanent record, 
which shall be provided upon request to the auditor, supervisory 
committee, and NCUA.
    -(h) Risk supervision. A corporate credit union must identify, 
measure, and document the risks associated with all assets. The measure 
of risk exposure and a comparison of such exposure to board policy 
limits must be reported in writing on a quarterly basis. Such reports 
shall be provided upon request to the auditor, supervisory committee, 
and NCUA.
    -(i) Risk compliance. A corporate credit union must review all 
investment assets on a monthly basis for compliance with NCUA Rules and 
Regulations and board of director policies to determine whether any 
such assets require divestiture. The results and analysis shall be 
provided upon request to the auditor, supervisory committee, and NCUA.
    -(j) Contingency funding. A corporate credit union must develop a 
contingency funding plan that ranks, in order of priority, all sources 
of liquidity, by category and amount, that are available to service an 
immediate outflow of member funds. The plan must analyze the impact 
that potential changes in fair value will have on the disposition of 
assets in a variety of interest rate scenarios and be reviewed by a 
committee of the board no less frequently than annually or as market 
and business conditions dictate. The plan and annual review shall be 
provided upon request to the auditor, supervisory committee, and NCUA.
    -(k) Policies. Corporate credit unions must develop and implement 
comprehensive written policies, which shall be reviewed annually and 
provided upon request to the auditor, supervisory committee, and NCUA. 
The policies must address, at a minimum, the following:
    -(1) Diversification of assets by issuer, type and risk;
    -(2) Approved issuers, instruments, and broker-dealers;
    -(3) Liabilities, including pricing strategies, diversification and 
penalties for early withdrawal;-
    (4) Limits on the maximum permitted change in net interest income 
as calculated for a plus and minus 300 basis point rate shock; -
    (5) Acceptable credit risk; -
    (6) Authorization of and limitations on persons/committees involved 
with asset/liability management.


Sec. 704.5  Investments.

     -(a) A corporate credit union may invest in those securities, 
deposits, and obligations set forth in Sections 107(7), 107(8), and 
107(15)(B) of the Federal Credit Union Act (12 U.S.C. 1757(7), 1757(8), 
and 1757(15)(B)), except as provided in this section. Any asset that 
has the potential to be divested must be classified as available-for-
sale. An asset downgraded by the same rating agency used when the 
investment was purchased must be divested within 10 business days of 
the downgrade. Other than investments in wholesale corporate credit 
unions, CSOs, and repurchase transactions, the aggregate of a corporate 
credit union's investments in any one institution, issuer, or trust is 
limited to 25 percent of the corporate credit union's primary capital 
at the time of purchase.
    -(b) A corporate credit union may invest in CSOs, as defined in 
Sec. 704.2 and subject to the limitations of Sec. 704.7.
    -(c) A corporate credit union may invest in deposits in, the sale 
of Federal Funds to, and debt obligations of wholesale corporate credit 
unions.
    -(d)(1) A corporate credit union may invest in deposits in, the 
sale of Federal Funds to, and debt obligations of Section 107(8) 
institutions subject to the following requirements:
    -(i) The institution must have assets of at least US $5 billion and 
an entity rating no lower than B (or equivalent);
    -(ii) The investment must be rated no lower than A-1 (or 
equivalent) for short-term investments and no lower than AA (or 
equivalent) for long-term investments; and
    -(iii) The investment must be denominated in United States dollars. 
-
    (2) A written evaluation of lines of exposure to all Section 107(8) 
[[Page 20452]] institutions must be prepared quarterly by qualified 
staff and approved by an appropriate committee of the board so that 
changes in credit quality can be detected at the earliest opportunity. 
This approval must be documented in the minutes of the committee and be 
provided upon request to the auditor, supervisory committee, and NCUA.
    -(e)(1) A corporate credit union may invest in deposits in, the 
sale of Federal Funds to, and debt obligations of foreign banks, 
subject to the following requirements: -
    (i) The bank must have assets of at least US $20 billion and an 
entity rating no lower than A/B (or equivalent); -
    (ii) The investment must be rated no lower than A-1 (or equivalent) 
for short-term investments and no lower than AA (or equivalent) for 
long-term investments; -
    (iii) The investment must be denominated in United States dollars; 
-
    (iv) The country in which the issuing bank is organized must be 
rated AAA (or equivalent) for political and economic stability; -
    (v) Aggregate investments in banks in any single foreign country 
are limited to 50 percent of the corporate credit union's primary 
capital at the time of purchase; and -
    (vi) Aggregate investments in all foreign banks are limited to 300 
percent of the corporate credit union's primary capital at the time of 
purchase. -
    (2) A written evaluation of lines of exposure to all foreign banks 
must be prepared quarterly by qualified staff and approved by an 
appropriate committee of the board so that changes in credit quality 
can be detected at the earliest opportunity. This approval must be 
documented in the minutes of the committee and be provided upon request 
to the auditor, supervisory committee, and NCUA. -
    (f) A corporate credit union may invest in marketable debt 
obligations of corporations chartered in the United States, provided 
that the obligations are rated not lower than A-1 (or equivalent) for 
short-term investments and not lower than AA- (or equivalent) for long-
term investments. A marketable obligation is one that may be sold with 
reasonable promptness at a price which corresponds reasonably to its 
fair value. This authority does not apply to debt obligations that are 
convertible into the stock of the corporation.
    -(g) A corporate credit union may invest in asset-backed securities 
subject to the following requirements:
    -(1) Rated not lower than AAA (or equivalent); and
    -(2) Having an average life at the time of purchase not to exceed 5 
years.
    -(h) A corporate credit union may invest in federally and privately 
issued CMOs/REMICs, subject to the following limitations:
    (1) All investments in fixed rate CMOs/REMICs must meet the 
following NCUA-modified FFIEC High Risk Security Test requirements:
    (i) The weighted average life of the security may not exceed 5 
years at the time of purchase;
    (ii) The weighted average life may not extend by more than 2 years 
nor contract by more than 3 years for an instantaneous shift in market 
rates of plus or minus 300 basis points;
    (iii) The investment's price may not decline by more than 10 
percent for an instantaneous shift in market rates of plus or minus 300 
basis points.
    (2) All investments in floating rate CMOs/REMICs must meet the 
following NCUA-modified FFIEC High Risk Security Test requirements:
    (i) The weighted average life of the security may not exceed 5 
years at the time of purchase;
    (ii) The weighted average life may not extend by more than 2 years 
nor contract by more than 3 years for an instantaneous shift in market 
rates of plus or minus 300 basis points;
    (iii) The investment's price may not decline by more than 5 percent 
for an instantaneous shift in market rates of plus or minus 300 basis 
points.
    (3) The prepayment assumption for the underlying mortgages shall be 
based on an industry standard median prepayment estimate or the median 
estimate of no fewer than five independent brokerage firms, at least 
one of which must be a primary dealer. When estimates from specific 
dealers are used, those dealers must be approved by an appropriate 
committee and listed along with monthly test results. The same industry 
standard or selection of dealers must be used for all CMO/REMIC 
securities each time the tests are performed. In computing the average 
life of a CMO/REMIC investment, it must be assumed that the anticipated 
rate of prepayment remains constant over the remaining life of the 
mortgage collateral.
    (4) Any CMO/REMIC security that fails the average life standard or 
the price sensitivity test shall be divested within 10 business days.
    (5) Results of monthly CMO/REMIC tests must be documented and 
reviewed by an appropriate committee and maintained in a permanent 
record. Such results shall be provided upon request to the auditor, 
supervisory committee, and NCUA.
    (i) A corporate credit union may enter into a cash forward 
agreement to purchase or sell a security, provided that:
    (1) The period from the trade date to the settlement date does not 
exceed one hundred and twenty (120) days;
    (2) If the credit union is the purchaser, it has written cash flow 
projections evidencing its ability to purchase the security;
    (3) If the credit union is the seller, it owns the security on the 
trade date; and
    (4) The cash forward agreement is settled on a cash basis at the 
settlement date.
    (j)- A corporate credit union may enter into a repurchase or 
reverse repurchase transaction provided that the collateral securities 
are permissible investments for corporate credit unions and the 
transaction is priced to reflect accrued interest, the risk of the 
securities, and the term of the trade. A corporate credit union 
purchasing a security in a repurchase transaction must take physical 
possession of the security, receive written confirmation of the 
purchase and a safekeeping receipt from a third party under a written 
bailment for hire contract, or be recorded as the owner of the security 
through the Federal Reserve Book-Entry System. A corporate credit union 
obtaining funds from a reverse repurchase transaction may not invest 
those funds for a term greater than the maturity date of the reverse 
repurchase transaction. A repurchase transaction shall be considered to 
have a credit exposure of 5 percent of the principal and accrued 
interest outstanding on the transaction for the purpose of the 
limitation on investments in a single institution, issuer, or trust set 
forth in paragraph (a) of this section.
    (k) A corporate credit union may invest in a mutual fund if the 
investments and investment transactions of the fund are legally 
permissible for corporate credit unions.
    (l) A corporate credit union is prohibited from:
    (1) Purchasing or selling a standby commitment, except as provided 
in Sec. 701.21(i) of this Chapter;
    (2) Buying or selling a futures contract, forward rate agreement, 
swap agreement, or option contract;
    (3) Engaging in adjusted trading;
    (4) Engaging in a short sale;
    (5) Purchasing a stripped mortgage-backed security or residual 
interest in a CMO/REMIC;
    (6) Purchasing a zero coupon security with a maturity date that is 
more than 5 years from the settlement date for purchase of the 
security, except for funds matched against primary capital; 
[[Page 20453]] 
    (7) Making deposits in nonfederally insured state banks, trust 
companies, and mutual savings banks; and
    (8) Purchasing commercial mortgage-related securities.
    (m) A corporate credit union's officials, senior management 
employees, and immediate family members of such individuals, may not 
receive pecuniary consideration in connection with the making of an 
investment or deposit by the corporate credit union. The prohibition 
contained in this subsection also applies to any employee not otherwise 
covered if the employee is directly involved in investments or 
deposits. All transactions not specifically prohibited by this 
paragraph must be conducted at arm's length and in the interest of the 
credit union.


Sec. 704.6  Capital goals, objectives and strategies.

    (a) General. Corporate credit unions shall adopt formal, written 
goals (both long-term and short-term), objectives and strategies, 
including a budgetary process, for the building of capital.
    (b) Impact study. Where a proposed new service or program, purchase 
or lease of a fixed asset, or investment in or loan to a CSO may have a 
material effect on a corporate credit union, the corporate credit union 
shall perform a cost/benefit analysis of the activity and a study of 
its impact on the earnings and capital position of the corporate credit 
union.
    (c) Monitoring. Management will establish monitoring standards and 
procedures to periodically review and reassess the capital position of 
the corporate credit union and will document these reviews.


Sec. 704.7  Corporate service organizations (CSOs).

    (a) The aggregate of all investments in and loans to member and non 
member CSOs shall not exceed 15 percent of a corporate credit union's 
capital at the time the investment or loan is made. A corporate credit 
union may not use this authority to acquire control, directly or 
indirectly, of another financial institution, or to invest in shares, 
stocks or obligation of another financial institution, insurance 
company, trade association, liquidity facility, or similar 
organization. A CSO must be operated as an entity separate from any 
credit union. A corporate credit union investing in or lending to a CSO 
must take those steps necessary to ensure that it will not be held 
liable for the obligations of the CSO.
    (b) An official or senior management employee of a corporate credit 
union which has invested in or loaned to a CSO, and immediate family 
members of such an individual, may not receive, either directly or 
indirectly, any salary, commission, investment income, or other income 
or compensation, from the CSO. This prohibition extends to any other 
corporate credit union employee if such employee deals directly with 
the CSO.
    (c) Prior to making an investment in or loan to a CSO, a corporate 
credit union must obtain a written agreement that the CSO will:
    (1) Follow GAAP;
    (2) Provide financial statements to the corporate credit union at 
least quarterly;
    (3) Obtain an annual CPA audit and provide a copy to the corporate 
credit union; and
    (4) Allow the auditor, supervisory committee, and NCUA complete 
access to its books, records, and any other pertinent documentation.
    (d) A corporate credit union with an investment in, or a loan to, a 
credit union service organization (CUSO) as defined in Sec. 701.27 of 
this chapter must, by January 1, 1996, divest of the investment, 
terminate the loan if contractually possible, or ensure that the 
organization meets the requirements of this section and Sec. 704.2. If 
the loan cannot legally be terminated by January 1, 1996 it cannot be 
renewed or extended upon its next renewal or extension date.-


Sec. 704.8  Lending.

    (a) Policies. A corporate credit union shall develop, implement, 
and adhere to written loan policies which address, at a minimum:
    (1) Loan types and limits;
    (2) Documentation for each loan and line of credit;
    (3) Security;
    (4) Analysis of financial and operational data;
    (5) Monitoring standards; and
    (6) Review and reassessment of the credit quality of the member 
credit union.
    (b) General. Each loan or line of credit limit will be determined 
after analyzing the financial and operational soundness of the member 
credit union and the ability of the member credit union to repay the 
loan. Loans are limited as follows:
    (1) Loans to member credit unions. The maximum aggregated amount in 
loans and approved lines of credit to any one member credit union, 
excluding pass-through and guaranteed loans from the CLF and the NCUSIF 
and repurchase transactions, shall not exceed the corporate credit 
union's primary capital.
    (2) Loans to CSOs. A corporate credit union may make loans and 
issue lines of credit to CSOs, as defined in Sec. 704.2 and subject to 
the limitations of Sec. 704.7
    (3) Participation loans with other corporate credit unions. A 
corporate credit union is permitted to participate in a loan with 
another corporate credit union and must retain an interest of at least 
5 percent of the face amount of the loan. The participation agreement 
may be executed at any time prior to, during, or after disbursement. A 
participating corporate credit union must exercise the same due 
diligence as if it were the originating corporate credit union.
    (4) Prepayment penalties. If provided for in the loan contract, a 
corporate credit union is authorized to assess prepayment penalties on 
loans made to member credit unions.
    (5) Prohibitions. A corporate credit union may not make loans, 
issue lines of credit, or otherwise provide loan services to non 
members or natural person members. Except for providing overdraft 
protection for clearing accounts, a corporate credit union may not 
provide loan services to member trade associations. A loan or line of 
credit provided to a member trade association for the purpose of 
overdraft protection must be fully collateralized by any security which 
is permissible under Sec. 704.5.


Sec. 704.9  Borrowing.

    A corporate credit union may borrow up to 10 times capital or 50 
percent of shares (excluding shares created by the use of member 
reverse repurchase agreements) and capital, whichever is less. Other 
that the issuance of the minimum amount of commercial paper to maintain 
a market presence, a corporate credit union may borrow only to meet 
liquidity needs. The need must be documented in writing and provided 
upon request to the auditor, supervisory committee, and NCUA. CLF 
borrowings, as agent member for natural person credit unions, and 
borrowed funds created by the use of repurchase agreements are excluded 
from this limit. In the event of extreme liquidity demands from its 
member credit unions, a corporate credit union may submit a request to 
NCUA for additional borrowing authority.


Sec. 704.10  Services.

    A corporate credit union may provide services only to its members, 
subject to the limitations of this Part. A corporate credit union may 
not provide services to non members through the correspondent credit 
union authority or pursuant to Sec. 701.26 of this 
chapter. [[Page 20454]] 


Sec. 704.11  Fixed assets.

    (a) General. A corporate credit union's ownership in fixed assets 
shall be limited as described in Sec. 701.36 of this chapter, except 
that in lieu of Sec. 701.36 (c)(1) through (4), paragraph (b) of this 
section applies.
    (b) Investment in fixed assets. (1) A corporate credit union may, 
invest in fixed assets where the aggregate of all such investments does 
not exceed 15 percent of primary capital.
    (2) A corporate credit union shall submit requests to exceed the 
limitation of paragraph (b)(1) of this section to NCUA. Requests shall 
be supplemented by such statements and reports as NCUA may require. If 
NCUA determines that the proposal will not adversely affect the 
corporate credit union, it will respond in writing and an aggregate 
dollar amount or percentage of primary capital will be approved for 
investment in fixed assets.


Sec. 704.12  Corporate Credit Union Reserves.

    (a) Minimum Primary Capital Ratio. The primary capital ratio is 
computed by dividing primary capital by average daily assets for the 
month. Each corporate credit union shall maintain a minimum primary 
capital ratio as follows:
    (1) By January 1, 1996, primary capital shall be at least 2.5 
percent of average daily assets. If this level of primary capital is 
not achieved, the corporate must submit a request for a waiver of this 
requirement to NCUA. The waiver request must provide an acceptable plan 
for meeting the requirement. This waiver request must be submitted to 
NCUA no later than 90 days prior to the effective date of this 
requirement.
    (2) By January 1, 1997, primary capital shall be at least 3.0 
percent of average daily assets. If this level of primary capital is 
not achieved, the corporate must submit a request for a waiver of this 
requirement to NCUA. The waiver request must provide an acceptable plan 
for meeting the requirement. This waiver request must be submitted to 
NCUA no later than 90 days prior to the effective date of this 
requirement.
    (3) By January 1, 1998, primary capital must be at least 4.0 
percent of average daily assets. Thereafter, each corporate credit 
union will be required to maintain a minimum primary capital to average 
daily assets ratio of 4.0 percent. Any corporate credit union that does 
not meet this provision will be considered to be inadequately 
capitalized and must submit to NCUA a plan of action to achieve this 
capital level within an acceptable period of time. This plan must be 
submitted to NCUA within 30 calendar days of the month-end in which 
minimum primary capital fell below 4.0 percent.
    (b) Capital to risk-weighted assets ratio. The capital to risk-
weighted assets ratio is computed by dividing capital by total risk-
weighted assets at month end. Each corporate credit unions shall 
maintain capital of at least 10.0 percent of risk-weighted assets. Any 
corporate credit union that does not meet this provision will be 
considered to be inadequately capitalized and must submit to NCUA a 
plan of action to achieve this capital level within an acceptable 
period of time. This plan must be submitted to NCUA within 30 calendar 
days of the month-end in which capital fell below 10.0 percent of risk-
weighted assets.
    (c) Failure to comply with minimum capital requirements. NCUA will 
review each plan of action to achieve stated levels of capital as put 
forth in paragraphs (a) and (b) of this section. NCUA will make a 
determination as to the viability of the plan of action, and analyze 
the impact of the capital level on the corporate credit union and its 
member credit unions. If it is determined that a plan of action is not 
viable, the corporate credit union's board of directors will be 
required to merge or accept other corrective action as set forth by 
NCUA.
    (d) Procedures. Balance sheet assets and credit equivalent amounts 
for off- balance sheet items are assigned to a risk-weight category. 
The total dollar amount in each category shall be multiplied by the 
risk-weight assigned to that category. The sum of the categories 
comprises risk-weighted assets.
    (e) Frequency. Each corporate credit union shall calculate and 
document the ratio of primary capital to average daily assets and 
capital to risk-weighted assets each month. Documentation of such 
calculations shall be maintained and provided upon request to the 
auditor, supervisory committee, and NCUA.
    (f) Risk weights for balance sheet assets. Each balance sheet asset 
shall be assigned a risk weight of 0 percent, 20 percent, 50 percent, 
and 100 percent as indicated in Appendix A of this part.
    (g) Other considerations. (1) An investment in the shares of a 
mutual fund is assigned to the risk category appropriate to the highest 
risk-weighted asset that the fund is permitted to hold.
    (2) Accruals will be assigned the risk-weighting of the underlying 
asset that they represent.
    (h) Credit conversion factors for off-balance sheet Items. Off-
balance sheet items will be risk-weighted each month using credit 
conversion factors as indicated in Appendix B of this part.
    (i) Interim reserve accumulation. Corporate credit unions will be 
required to accumulate sufficient amounts of primary capital to meet 
the requirements of paragraph (a) of this section. Each corporate 
credit union must prepare a written projection, including assumptions 
utilized, which shows compliance with the minimum primary capital 
requirements each year through the accumulation of net income and 
reserve transfers, the issuance of PCSAs, and/or the shrinkage of the 
corporate credit union's assets. The written projection must be 
provided upon request to the auditor, supervisory committee, and NCUA. 
In addition, each corporate credit union must meet the reserve transfer 
requirements outlined in paragraph (j) of this section.
    (j) Required reserve transfers. The amount that a corporate credit 
union is required to transfer or set aside in reserves is based on both 
the corporate credit union's primary capital and capital to risk-
weighted assets ratios. For the purposes of calculating required 
reserve transfers, PCSAs shall be excluded from primary capital. Ranges 
of capital ratios have been established. These capital ratio ranges are 
then associated with 1 of 5 corresponding categories in determining the 
required reserve transfer. To qualify for a lower reserve transfer 
category, the capital ratio must fall in both the primary capital and 
capital to risk-weighted assets ratio ranges of the applicable 
category. The corporate credit union shall set aside an amount equal to 
the appropriate required reserve transfer percentage multiplied by the 
corporate credit union's average daily assets for the transfer period 
multiplied by the number of days in the transfer period divided by 365.
    (1) Category 1 requires a corporate reserve transfer percentage of 
20 basis points of average daily assets when either the primary capital 
ratio is greater than 4.0 percent and less than 4.75 percent or the 
capital to risk-weighted assets ratio is greater than 10.0 percent and 
less than 11.0 percent.
    (2) Category 2 requires a corporate reserve transfer percentage of 
15 basis points of average daily assets when either the primary capital 
ratio is greater than 4.75 percent and less than 5.25 percent or the 
capital to risk-weighted assets ratio is greater than 11.0 percent and 
less than 14.0 percent.
    (3) Category 3 requires a corporate reserve transfer percentage of 
10 basis points of average daily assets when either the primary capital 
ratio is greater [[Page 20455]] than 5.25 percent and less than 5.75 
percent or the capital to risk-weighted assets ratio is greater than 
14.0 percent and less than 17.0 percent.
    (4) Category 4 requires a corporate reserve transfer percentage of 
5 basis points of average daily assets when either the primary capital 
ratio is greater than 5.75 percent and less than 6.0 percent or the 
capital to risk-weighted assets ratio percentage is greater than 17.0 
percent and less than 20.0 percent.
    (5) Category 5 requires a corporate reserve transfer percentage of 
0 basis points when the primary capital ratio is greater than 6.0 
percent and the capital to risk-weighted assets ratio percentage is 
greater than 20.0 percent.
    (k) Full and fair disclosure. Corporate credit unions must provide 
reserves necessary for full and fair disclosure as specified in 
Sec. 702.3 of this chapter.


Sec. 704.13  Representation.

    (a) Board representation. The board shall be determined as 
stipulated in the standard corporate federal credit union bylaws 
governing election procedures, provided that:
    (1) The chair of the board may not serve simultaneously as an 
officer, director, or employee of a credit union trade association;
    (2) A majority of directors may not serve simultaneously as 
officers, directors, or employees of the same credit union trade 
association or its affiliates (not including chapters or other subunits 
of a state trade association); and -
    (3) For purposes of meeting the requirements of paragraphs (a)(2) 
and (a)(3) of this section, an individual may not serve as a director 
or chair of the board if that individual holds a subordinate employment 
relationship to another employee who serves as an officer, director, or 
employee of a credit union trade association.
    (b) Representatives of member credit unions. (1) A member credit 
union may appoint one of its members or officials as a representative 
to the corporate credit union. The representative shall be empowered to 
attend membership meetings, to vote, and to stand for election on 
behalf of the member. Only a member credit union representative is 
eligible to vote and to stand for election. No individual may serve as 
the representative of more than one member credit union in the same 
corporate credit union.
    (2) Any vacancy on the board of a corporate credit union caused by 
a representative being unable to complete his or her term shall be 
filled by the board of the corporate credit union according to its 
bylaws governing the filling of board vacancies.
    (c) Recusal provision. (1) No director, committee member, officer, 
or employee of a corporate credit union shall in any manner, directly 
or indirectly, participate in the deliberation upon or the 
determination of any question affecting his or her pecuniary interest 
or the pecuniary interest of any entity (other than the corporate 
credit union) in which he or she is interested, except if the matter 
involves general policy applicable to all members, such as setting 
dividend or loan rates or fees for services.
    (2) An individual is ``interested'' in an entity if he or she:
    (i) Serves as a director, officer, or employee of the entity;
    (ii) Has a business, ownership, or deposit relationship with the 
entity; or
    (iii) Has a business, financial, or familial relationship with an 
individual whom he or she knows has a pecuniary interest in the entity.
    (3) In the event of the disqualification of any directors, by 
operation of paragraph (c)(1) of this section, the remaining qualified 
directors present at the meeting, if constituting a quorum with the 
disqualified directors, may exercise, by majority vote, all the powers 
of the board with respect to the matter under consideration. Where all 
of the directors are disqualified, the matter must be decided by the 
members of the corporate credit union.
    (4) In the event of the disqualification of any committee member by 
operation of paragraph (c)(1) of this section, the remaining qualified 
committee members, if constituting a quorum with the disqualified 
committee members, may exercise, by majority vote, all the powers of 
the committee with respect to the matter under consideration. Where all 
of the committee members are disqualified, the matter shall be decided 
by the board of directors.
    (d) Administration. (1) A corporate credit union shall be under the 
direction and control of its board of directors. While the board may 
delegate the performance of administrative duties, the board is not 
relieved of its responsibility for their performance. The board may 
employ a chief executive officer who shall have such authority and such 
powers as delegated by the board to conduct business from day to day. 
Such chief executive officer must answer solely to the board of the 
corporate credit union, and may not be an employee of a credit union 
trade association.
    (2) The provisions of Sec. 701.14 of this chapter apply to 
corporate credit unions, except that where reference is made to 
``Regional Director,'' substitute ``NCUA.''


Sec. 704.14  Audit requirements.

    (a) Annual audit. (1) The corporate credit union supervisory 
committee shall cause an annual opinion audit, which shall include a 
reportable conditions letter (i.e. management letter) to be made by an 
independent, duly licensed certified public account (CPA) and shall 
submit the audit report to the board of directors. A summary of the 
audit report shall be submitted to the membership at the next annual 
meeting.
    (2) The CPA's audit workpapers shall be provided upon request to 
NCUA.
    (3) A copy of the audit report and reportable conditions letter 
(i.e. management letter) shall be submitted to NCUA, within 30 days 
after receipt by the board of directors.
    (b) Internal auditor function. (1) A corporate credit union with 
net assets in excess of $100 million as of the preceding December 31, 
or as ordered by NCUA, will be required to employ or contract the 
services of an internal auditor.
    (2) The internal auditor will report directly to the chairperson of 
the corporate credit union's supervisory committee.
    (3) The internal auditor's responsibilities will include, but are 
not limited to, the review of ongoing compliance with statutory and 
regulatory requirements, adherence to the corporate credit union's own 
policies and procedures, testing of the accuracy and completeness of 
recordkeeping and operation functions, ensuring adequate control 
measures are in place, apprising the supervisory committee of all 
findings, and providing appropriate recommendations to address concerns 
and deficiencies relating to the condition or operations of the 
corporate credit union.
    (4) The internal auditor's reports, findings, and recommendations 
will be in writing. Oral presentations by the internal auditor to the 
supervisory committee will be documented in the supervisory committee 
minutes. All documentation relating to the work of the internal auditor 
will be provided upon request to the external auditor and NCUA.


Sec. 704.15  Contracts/written agreements.

    Services, facilities, personnel, or equipment shared with any party 
shall be supported by a written contract, with the duties and 
responsibilities of each party specified and the allocation of service 
fee/expenses fully supported and documented. [[Page 20456]] 


Sec. 704.16  State-chartered corporate credit unions.

    (a) This part does not expand the powers and authorities of any 
state-chartered corporate credit union, beyond those powers and 
authorities provided under the laws of the state in which it was 
chartered. -
    (b) A state-chartered corporate credit union that is not insured by 
the National Credit Union Share Insurance Fund, but that receives funds 
from federally insured credit unions, is considered an ``institution-
affiliated party'' within the meaning of Section 206(r) of the Federal 
Credit Union Act, 12 U.S.C. 1786(r).


Sec. 704.17  Fidelity bond coverage.

    (a) Scope. This section provides the fidelity bond requirements for 
employees and officials in corporate credit unions.
    (b) Review of coverage. The board of directors of each corporate 
credit union shall, at least annually, carefully review the bond 
coverage in force to determine its adequacy in relation to risk 
exposure and to the minimum requirements in this section.
    (c) Minimum coverage; Approved forms. Every corporate credit union 
will maintain bond coverage with a company holding a certificate of 
authority from the Secretary of the Treasury. All bond forms, and any 
riders and endorsements which limit the coverage provided by approved 
bond forms, must receive the prior written approval of the NCUA Board. 
The Corporate Credit Union Discovery Bond (NCUA 100) and Standard Form 
24 with Credit Union Bond Conversion Endorsement are approved for use 
by corporate credit unions. Credit Union Blanket Bond Form 581 and Form 
23--Extended Form, may also be utilized by corporate credit unions. 
Fidelity bonds must provide coverage for the fraud and dishonesty of 
all employees, directors, officers, and supervisory and credit 
committee members. Notwithstanding the foregoing, all bonds must 
include a provision, in a form approved by the NCUA Board, requiring 
written notification by surety to the Board: When the bond of a credit 
union is terminated in its entirety; or when bond coverage is 
terminated, by issuance of a written notice, on an employees, director, 
officer, supervisory or credit committee member. Said notification 
shall be sent to the Secretary of the NCUA Board or designee and shall 
include a brief statement of cause for termination.
    (d) Minimum; coverage amounts. (1) The minimum amount of bond 
coverage will be computed based on the corporate credit union's average 
daily assets as of December 31 of the preceding year. The following 
table lists the minimum requirements:

------------------------------------------------------------------------
                                                               Minimum  
                         Net assets                              bond   
                                                              (million) 
------------------------------------------------------------------------
Less than $50 million--....................................         $1.0
$50--$99 million...........................................          2.0
$100--$499 million.........................................          4.0
$500--$999 million.........................................          6.0
$1.0--$1.999 billion.......................................          8.0
$2.0--$4.999 billion.......................................         10.0
$5.0--$9.999 billion.......................................         15.0
$10--$24.999 billion.......................................         20.0
$25.0 billion plus.........................................         25.0
------------------------------------------------------------------------

    (2) It is the duty of the board of directors of each corporate 
credit union to provide adequate protection to meet its unique 
circumstances by obtaining, when necessary, bond coverage in excess of 
the above minimums. -
    (e) Reduced coverage; NCUA approval. Any proposal for reduced 
coverage must be approved in writing by the NCUA Board at least 20 days 
in advance of the proposed effective date of the reduction. -
    (f) Deductibles. (1) The maximum amount of deductibles allowed are 
based on the corporate credit union's primary capital ratio as defined 
in Sec. 704.12(a). The following table sets out the maximum 
deductibles:

------------------------------------------------------------------------
       Primary capital ratio                  Maximum deductible        
------------------------------------------------------------------------
Less than 4.0 percent..............  7.5 percent of primary capital.    
4.0--7.99 percent..................  10.0 percent of primary capital.   
8.0--11.99 percent.................  12.0 percent of primary capital.   
Greater than 12.0 percent..........  15.0 percent of primary capital. - 
------------------------------------------------------------------------

    (2) A deductible may be applied separately to one or more insuring 
clauses in a blanket bond. Deductibles in excess of those showing in 
this section must have the written approval of the NCUA Board at least 
20 days prior to the effective date of the deductibles. -
    (g) Additional coverage. The NCUA Board may require additional 
coverage for any corporate credit union when, in the opinion of the 
Board, current coverage is insufficient. The board of directors of the 
corporate credit union must obtain additional coverage within 30 days 
after the date of written notice from the NCUA Board.


Sec. 704.18  Effective date.

    The regulations in this part are effective beginning January 1, 
1996.

Appendix A to Part 704--Summary of Risk Weights and Risk Categories 
for Corporate Credit Unions

    Category 1: Zero Percent Risk Weight.
    a. Coin and currency on hand or physically in transit.
    b. Balances due from and claims on Federal Reserve Banks.
    c. Claims on and portions of claims that are unconditionally 
guaranteed by the U.S. Government or its agencies.
    d. Claims collateralized by cash or eligible deposits.
    e. CLF subscriptions, including U.S. Central CLF Participation 
Certificates, and CLF Pass-Through Loans from the CLF through U.S. 
Central to the corporate credit unions.
    f. Asset Accounts related to Member Reverse Repurchase 
Agreements without indemnity obligation.
    g. Accrued Interest Receivable on the above.
    Category 2: 20 Percent Risk Weight.
    a. Items, other than coin and currency, in process of 
collection.
    b. Claims on or portions of claims guaranteed by U.S. 
Government-sponsored corporations and enterprises.
    c. Claims conditionally guaranteed by the U.S. Government or its 
agencies or U.S. Government-sponsored corporations and enterprises.
    d. Claims or portions of claims (including Repurchase 
Agreements) collateralized by securities issued by the U.S. 
Government or its agencies or U.S. Government-sponsored corporations 
and enterprises.
    e. General obligation claims on state and local governments 
located in the United States.
    -f. Claims on U.S. depository institutions (including Federal 
Funds sold)
    -g. Claims on a corporate credit union.
    -h. Asset accounts related to Member Reverse Repurchase 
Agreements with indemnity obligation.
    -i. Asset-backed securities with remaining weighted average 
lives of 3 years or less.
    -j. Secured loans to credit unions.
    -k. Accrued Interest Receivable on the above.
    Category 3: 50 Percent Risk Weight.
    -a. Asset-backed securities with remaining weighted average 
lives greater than 3 years.
    -b. Privately-issued mortgage-backed securities provided that: 
(1) The security is structured so that it is treated as an indirect 
holding of the underlying assets;\1\ (2) If the 
[[Page 20457]] security is backed by a pool of conventional 
mortgages, 1- to 4-family residential, or multifamily residential 
properties, each underlying mortgage must have been made in 
accordance with prudent underwriting standards, be performing in 
accordance with its original terms, and not be 90 days or more past 
due or carried in nonaccrual status; (3) If the security is backed 
by privately-issued mortgage-backed securities, each underlying 
security qualifies for the 50 percent risk category at the time the 
pool is originated; and (4) if the security is backed by a pool of 
multifamily residential mortgages, principal and interest payments 
on the security are not 30 days or more past due.

    \1\A private-issued mortgage-backed security may be treated as 
an indirect holding of the underlying assets provided that: (1) The 
underlying assets are held by an independent trustee and the trustee 
has a first priority, perfected security interest in the underlying 
assets on behalf of the holders of the security; (2) either the 
holder of the security has an undivided pro rata ownership interest 
in the underlying mortgage assets or the trust or single purpose 
entity (or conduit) that issues the security has no liabilities 
unrelated to the issued securities; (3) the security is structured 
such that the cash flow from the underlying assets in all cases 
fully meets the cash flow requirements of the security without undue 
reliance on any reinvestment income; and (4) there is no material 
reinvestment risk associated with any funds awaiting distribution to 
the holders of the security. In addition, if the underlying assets 
of a mortgage-backed security are composed of more than one type of 
asset, for example, U.S. Government-sponsored agency securities and 
privately-issued pass-through securities that qualify for the 50 
percent risk category, the entire mortgage-backed security is 
generally assigned to the category appropriate to the highest risk-
weighted asset underlying the issue. Thus, in this example, the 
security would receive the 50 percent risk weight appropriate to the 
privately-issued pass-through securities.
---------------------------------------------------------------------------

    -c. Accrued Interest Receivable on the above.
    -d. Claims on foreign banks (including Fed Funds sold).
    Category 4: 100 Percent Risk Weight for All Other Assets 
Including, but NOT LIMITED to:
    -a. Loans to CUSOs outstanding as of January 1, 1996.
    -b. Loans to and Investments in CSOs.
    -c. Unsecured loans to credit unions.
    -d. All fixed assets, including land, buildings, furniture, 
fixtures, equipment, automobiles, and leasehold improvements.
    -e. Permanent capital share account and secondary capital share 
account investments in a corporate credit union.
    -f. Any mortgage-backed securities that do not meet the criteria 
for assignment to a lower risk weight (including any classes of 
mortgage-backed securities that can absorb more than their pro rata 
share of loss without the whole issue being in default).-
    -g. Zero Coupon Securities.
    -h. Claims on U.S. chartered corporations and bank holding 
companies, including commercial paper and corporate bonds.
    -i. Mutual Funds that do not qualify for a lower risk weighting.
    -j. Prepaid Assets.
    -k. Accounts Receivable and other receivables.
    -l. NCUSIF Deposit
    -m. Mortgage servicing rights.
    -n. Intangible assets.
    -o. All other claims on private obligors.
    -p. Accrued Interest Receivable on the above.

Appendix B to Part 704--Off-Balance Sheet Credit Conversion Factors

    Zero Percent Credit Conversion Factor:
    -Unused portions of credit lines with original maturities of 6 
months or less, or which are unconditionally cancelable.
    50 Percent Credit Conversion Factor:
    -a. Unused portions of credit lines with original maturities 
exceeding 6 months.
    -b. Commitments to participate in a loan or loan package.
    100 Percent Credit Conversion Factor:
    -a. Irrevocable standby letters of credit guaranteeing financial 
performance (including VISA letters of credit issued by corporate 
credit unions on behalf of their members, or standby letters of 
credit backing Industrial Revenue Bonds).
    -b. Forward Commitments to purchase an asset or perform under a 
lease contract.
    -c. Securities held in safekeeping loaned with indemnification. 
Other off-balance sheet items will be addressed on a case-by-case 
basis by NCUA.

Appendix C to Part 704--Model Forms

    This appendix contains three sample forms intended for use by 
corporate credit unions to aid in compliance with the permanent 
capital share account and secondary capital share account disclosure 
requirements of Sec. 704.2. Corporate credit unions that use these 
forms will be in compliance with those requirements.
    C-1 Sample disclosure for opening of secondary capital share 
account.
    Terms and Conditions of Secondary Capital Share Account
    -(1) A secondary capital share account is not subject to share 
insurance coverage by the NCUSIF or other deposit insurer.
    -(2) A member credit union may withdraw shares from its 
secondary capital share account only with two years' notice, except 
where the member credit union is merging or liquidating. If a member 
credit union merges, the corporate credit union will return the 
member's secondary capital shares, less any penalty for early 
withdrawal, within 30 days of written notification from NCUA.
    -(3) Secondary capital share accounts cannot be used by member 
credit unions to collateralize borrowings.
    -(4) Secondary capital share accounts are available to absorb 
losses in the event of a deficit in primary capital in the corporate 
credit union.
    -(5) Where the corporate credit union is liquidated, secondary 
capital share accounts are payable only after satisfaction of all 
liabilities of the liquidation estate including uninsured 
obligations to shareholders and the NCUSIF.
    I have read the above terms and conditions and I understand 
them. I further agree to maintain in the credit union's files the 
annual notice of terms and conditions of the secondary capital share 
account.

Signatures of Directors and Date

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----------------------------------------------------------------------
----------------------------------------------------------------------
----------------------------------------------------------------------
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Name of member credit union:

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Address of member credit union:

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    C-2 Sample annual notice of terms and conditions of secondary 
capital share account.

Terms and Conditions of Secondary Capital Share Account

    (1) A secondary capital share account is not subject to share 
insurance coverage by the NCUSIF or other deposit insurer.
    (2) A member credit union may withdraw shares from its secondary 
capital share account only with two years' notice, except where the 
member credit union is merging or liquidating. If a member credit 
union merges, the corporate credit union will return the member's 
secondary capital shares, less any penalty for early withdrawal, 
within 30 days of written notification from NCUA.
    -(3) Secondary capital shares cannot be used by member credit 
unions to collateralize borrowings.
    -(4) Secondary capital share accounts are available to absorb 
losses in the event of a deficit in primary capital in the corporate 
credit union.
    -(5) Where the corporate credit union is liquidated, secondary 
capital share accounts are payable only after satisfaction of all 
liabilities of the liquidation estate including uninsured 
obligations to shareholders and the NCUSIF. -----
Mailed to member - ----------------------------------------------------
                           Month/Year.  
----------------------------------------------------------------------

Signature of the Chairman of the Board

    C-3 Sample disclosure for opening of permanent capital share 
account.

Terms and Conditions of Permanent Capital Share Account

    -(1) A permanent capital share account is not subject to share 
insurance coverage by the NCUSIF or other deposit insurer.
    -(2) Permanent capital shares are not redeemable without the 
written concurrence of NCUA.
    -(3) Permanent capital share accounts cannot be used by member 
credit unions to collateralize borrowings.
    -(4) Permanent capital share accounts are available to absorb 
losses in the event of a deficit in other primary capital accounts 
in the corporate credit union.
    -(5) Where the corporate credit union is liquidated, permanent 
capital share accounts are payable only after satisfaction of all 
liabilities of the liquidation estate including uninsured 
obligations to shareholders and the NCUSIF.
    -(6) Permanent capital share account dividends are 
noncumulative.
    I have read the above terms and conditions and I understand 
them.

Signatures of Directors and Date

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----------------------------------------------------------------------
----------------------------------------------------------------------

Name of member credit union: --

----------------------------------------------------------------------

Address of member credit union: --

 - ---- --------------------------------------------------------------
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PART 741--REQUIREMENTS FOR INSURANCE

    -2. The authority citation for part 741 continues to read as 
follows:

     [[Page 20458]] Authority: 12 U.S.C. 1757, 1766, and 1781-1790. 
Section 741.11 is also authorized by 31 U.S.C. 3717.

    -3. Section 741.3 is amended by revising the heading and adding new 
paragraph (c) to read as follows:


Sec. 741.3  Other requirements.

* * * * *
    (c) Adhere to the requirements stated in Part 703 of this chapter 
concerning transacting business with corporate credit unions.

[FR Doc. 95-10149 Filed 4-25-95; 8:45 am]
BILLING CODE 7535-01-P