[Federal Register Volume 61, Number 108 (Tuesday, June 4, 1996)]
[Proposed Rules]
[Pages 28085-28112]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-13518]
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NATIONAL CREDIT UNION ADMINISTRATION
12 CFR Parts 704, 709, and 741
Corporate Credit Unions; Involuntary Liquidation of Federal
Credit Unions and Adjudication of Creditor Claims Involving Federally
Insured Credit Unions in Liquidation; Requirements for Insurance
AGENCY: National Credit Union Administration (NCUA).
ACTION: Proposed rule.
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SUMMARY: NCUA is issuing proposed revisions to the rules governing
corporate credit unions. As the credit union industry has become more
complex and competitive, the demands on corporate credit unions have
become greater. Corporate credit unions are providing a greater variety
of more sophisticated services. The proposed rule is intended to
strengthen corporate credit union capital and ensure that the risk on
corporate credit union balance sheets is adequately managed and
controlled.
DATES: Comments must be received on or before September 3, 1996.
ADDRESSES: Comments should be directed to Becky Baker, Secretary of the
Board. Mail or hand-deliver comments to: National Credit Union
Administration, 1775 Duke Street, Alexandria, Virginia 22314-3428. Fax
comments to (703) 518-6319. Post comments on NCUA's electronic bulletin
board by dialing (703) 518-6480. Please send comments by one method
only.
FOR FURTHER INFORMATION CONTACT: Robert F. Schafer, Acting Director,
Office of Corporate Credit Unions, at the above address or telephone
(703) 518-6640; or Edward Dupcak, Director, Office of Investment
Services, at the above address or telephone (703) 518-6620.
SUPPLEMENTARY INFORMATION:
A. Background
Part 704 was amended in 1992 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. NCUA has had an opportunity to see how the
regulation has worked and to consider how it could be improved. Section
704.12, governing representation issues, was revised in 1994. See 59 FR
59357 (Nov. 17, 1994). In April 1995, NCUA issued a proposed regulation
to revise most of the sections of Part 704. See 60 FR 20438 (Apr. 26,
1995). Comments were due by June 26, 1995. On May 17, 1995, NCUA
extended the comment period an additional 60 days to August 25, 1995.
See 60 FR 27240 (May 23, 1995). The supplementary information section
noted that NCUA had been working with an outside firm to provide risk-
profile assessments of corporate credit unions, using simulated
modeling techniques, and that the process had proven to be more time-
consuming than envisioned.
In response to the comments received and results of the modeling,
NCUA determined to issue this revised proposed rule for another round
of public comment. In developing this revised proposal, NCUA considered
all of the written comments, the results of further modeling, and the
input provided by corporate credit union representatives in a number of
dialogue meetings conducted by NCUA.
It should be noted that the background section of the initial
proposed rule observed that NCUA supervises all corporate credit unions
but that only those that are federally chartered pay an operating fee
to the agency. Questions were raised as to whether this put federally
chartered corporate credit unions at a competitive disadvantage and
whether all corporate credit unions should pay for NCUA's corporate
credit union supervision program. NCUA asked for comment on whether it
would be appropriate to assess all corporate credit unions an
examination fee or to abolish corporate credit union fees altogether
and require natural person credit unions, since they benefit from the
existence of corporate credit unions, to make up the difference.
[[Page 28086]]
Most of those who commented on this issue favored assessing all
corporate credit unions a fee, rather than having natural person credit
unions pay for corporate credit union supervision. Many noted that not
all natural person credit unions use their corporate credit union. NCUA
has determined not to pursue the issue of funding corporate credit
union supervision expenses in this proposed regulation. However, given
the impact that the proposed rule could have on future supervision
efforts, this issue will be reviewed in the future.
B. Comments
NCUA received over 1300 comments on the proposed regulation, the
bulk of which were from natural person credit unions. Comments were
also received from the national credit union trade associations and
most of the corporate credit unions and state credit union leagues.
Finally, comments were received from other trade associations, state
credit union regulatory authorities, credit union organizations and
consultants, a Member of Congress, other entities that do business with
credit unions, and individuals.
The commenters generally opposed the proposed regulation,
particularly the asset-liability management and capital requirements.
The proposed regulation required that a corporate credit union
identically match all of its shares and deposits, except for 25 percent
of its overnight funds, to corresponding assets. The commenters stated
that the proposal represented an attempt to eliminate risk from the
system, whereas the appropriate role of a corporate credit union was to
manage risk. They stated that the proposal would make it impossible for
corporate credit unions to provide competitive products to their
members and to generate sufficient income to meet the proposed minimum
capital requirements. The proposed regulation required that corporate
credit unions achieve primary capital levels of 4 percent of average
daily assets by January 1, 1998.
The commenters also contended that the proposed rule would
disproportionately affect small natural person credit unions, which
rely more heavily on corporate credit unions for investments and other
services. They argued that because the corporate credit unions would
not be able to earn a spread on their investment activities, costs for
services would increase and yield on investments would decrease. -
C. Dialogue Meetings
After considering the comments and preliminary modeling results,
NCUA determined that some changes to the proposed regulation might be
appropriate. To obtain input on those changes, NCUA hosted a series of
meetings with representatives of corporate credit unions, natural
person credit unions, and national credit union trade associations.
There was a productive exchange of information and views. This proposed
rule incorporates a number of the suggestions received during the
meetings.
D. Modeling
NCUA contracted with a mortgage investment and interest rate risk
advisory firm (the firm) to estimate the market value of portfolio
equity and interest rate sensitivity of the balance sheets of seven
corporate credit unions. The modeling exercise was conducted to provide
NCUA with an independent assessment of the relative market risk in a
broad cross-section of corporate credit unions. The firm believes that
market value of portfolio equity (MVPE) is the best measure of interest
rate risk, as it can be computed quickly, captures interest and
principal cash flows, provides an analysis of embedded option risk, and
is more complete than income simulations. In addition, MVPE models are
not driven by assumptions regarding future behavior or reactions to
interest rate changes. The firm concluded that requiring corporate
credit unions to use MVPE techniques would introduce a necessary risk
analysis and reduction discipline. The firm stated that when properly
implemented, MVPE techniques would significantly reduce the likelihood
of another failure similar to that of Capital Corporate Federal Credit
Union, which failed in early 1995. Interestingly, many of the
commenters to the initial proposed rule recommended that NCUA use MVPE
to measure interest rate risk.
The firm noted that managing market value correctly can reduce the
volatility of earnings and net worth. The effects of good management
decisions stand out when earnings are not significantly affected by
unexpected changes in interest rates. Market value is the best measure
of the firm's value and is usually the best benchmark to judge
management's performance. Also, MVPE, and its volatility, is usually
the best indication of risk to the insurer and regulators.
The firm analyzed the corporate credit unions' base MVPE and the
sensitivity of MVPE for instantaneous and sustained parallel shifts in
interest rates up and down 400 basis points in 100 basis point
increments. It also provided a 12-month net interest income projection
for the same interest rate scenario.
Additional tests included stresses on several market-related
variables to determine their effect on MVPE. These included: (1)
flattening and steepening the reference yield curve with a pivot at the
three-year maturity; (2) increasing market volatilities by 50 percent
from the reference levels; (3) stressing prepayment speed projections
for mortgage-related securities 100 percent faster for the down 300
basis point scenario; (4) stressing prepayment speed projections for
mortgage-related securities 50 percent slower for the up 300 basis
point scenario; and (5) increasing market spreads by 50 basis points
above projected spreads.
Project results concluded that large changes in prepayment
expectations, widening spreads, and increases in volatility levels
would adversely affect corporate credit union MVPEs. Changes in the
shape of the yield curve did not have a significant adverse effect;
this was due, in large part, to the relatively short asset duration of
most corporate credit union balance sheets.
The balance sheets of the corporate credit unions studied were
``long the market,'' that is MVPE increased when interest rates
declined and decreased when interest rates rose. This is a result of
the effective duration of the corporate credit unions' assets being
longer than that of their liabilities. Some corporate credit union
assets were shown to be negatively convex, that is, projected gains to
MVPE were smaller for interest rate declines than losses for equivalent
interest rate increases. This negative convexity is caused by the
presence of embedded options, found most commonly in mortgage-related
securities and structured notes.
The firm determined that many corporate credit unions would need to
upgrade their interest rate risk models to account for the impact of
embedded options. It noted that the establishment of a minimum MVPE
ratio would be a key aspect of any regulation attempting to control
interest rate risk using MVPE techniques. According to the firm, the
minimum should provide a safe margin above the exposures created by a
positive or negative 300 basis point rate shift. This is necessary
because, as the tests indicated, MVPE can also be affected by changes
in the slope of the Treasury curve, prepayment activity that differs
from that expected, changes in market spread levels, and changes in
market volatilities. -
E. Three-Tiered Approach
In developing this revised proposed rule, NCUA acknowledged the
diversity within the corporate credit union network and the breadth of
functions
[[Page 28087]]
that are provided. Accordingly, this proposal provides the flexibility
for additional authorities for those corporate credit unions with a
more developed infrastructure and codifies the requirements to obtain
those authorities. Presently, such authorities are granted by waiver.
The basic regulatory requirements and authorities applicable to all
corporate credit unions are set forth in the main text of Part 704.
Thus, a corporate credit union that does not seek expanded authorities
need read only the main text and Appendix A, which contains model
disclosure forms that a corporate credit union may choose to use for
capital accounts. A ``basic'' corporate credit union need not read
Appendices B and C, which set forth additional authorities available to
corporate credit unions and the requirements to obtain such
authorities. The incorporation of expanded authorities allows for an
element of self-determination that was not a component of the initial
proposal. This approach is intended to remove the ``one-size-fits-all''
constraint and permit flexibility for a corporate credit union to
choose a path consistent with its members' needs. The board of a
corporate credit union may pursue, via a self- assessment, the level at
which it wishes its institution to operate.
F. Effective Date and Transition
Section 704.18 of the initial proposal stated that the rule would
take effect on January 1, 1996. Obviously, that date has passed. Due to
the complexity of this rule, it is difficult to determine when a final
rule will be issued, and thus to predict a reasonable effective date.
Accordingly, rather than stating an effective date in this proposal,
the final rule will announce an effective date that is approximately 1
year from the date the final rule is issued.
The preamble to the initial proposal stated that NCUA was
considering requiring compliance with the investment section 30 days
after issuance of the final rule, which would be prior to the effective
date of the rest of the regulation. This was to deter corporate credit
unions from ``loading up'' on investments that would no longer be
permissible under the new rule. The commenters generally objected to
this provision, and NCUA has determined not to proceed with it. As
noted in proposed Section 704.6(g), a corporate credit union's
authority to hold an investment is governed by the regulation in effect
at the time of purchase.-
As discussed above, if this proposal is made final, each corporate
credit union will have to determine the level at which it wishes to
operate. While a corporate credit union may change its level at a later
date, it will have to make an initial decision regarding what its
status will be when the final rule becomes effective. So that NCUA can
effectively supervise the transition to the new regulation, each
corporate credit union will be asked to inform NCUA, within 90 days of
the final rule's publication, of its decision.
A corporate credit union that plans to operate with expanded
authorities should submit its application for such authorities as soon
as possible to ensure approval and implementation prior to the
effective date. The application must demonstrate that the corporate
credit union either has sufficient staffing and infrastructure to
support the authorities or will make the necessary changes so that it
will have such staffing and infrastructure. The application also must
set forth the expected costs of such changes. Since there is no
guarantee of approval, a corporate credit union normally will not
implement these changes until it receives preliminary approval.
NCUA will work closely with a corporate credit union in evaluating
its application. Once all issues are resolved, NCUA will issue a
preliminary approval. If the issues cannot be resolved, NCUA will
notify the corporate credit union. Once preliminary approval has been
received, the corporate credit union must make the planned changes.
Once NCUA has been notified that the corporate credit union is ready to
begin using the expanded authorities, it will review the corporate
credit union's operations. If they are sufficient to support the
requested authorities, final approval will be granted.
Recognizing that an institution may not be at the required capital
level or within the required MVPE limitations by the effective date of
the regulation, NCUA plans to work with the corporate credit unions to
develop realistic time frames for compliance. NCUA also is aware of the
unique role of wholesale corporate credit unions and will make
accommodations to allow such institutions to comply with the
regulation. -
G. 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, NCUA proposed 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. Some commenters
objected to this latter requirement, arguing that it meant that NCUA
was holding non federally insured corporate credit unions to a higher
standard than other investment alternatives available to natural person
credit unions.
These credit unions may be held to a higher standard because they
are differently situated than other natural person credit union
investment alternatives. The failure of a corporate credit union, even
one not federally insured, would affect the credit union system more
dramatically than the failure of a bank or broker-dealer. First, the
public would not necessarily distinguish between a federally and non
federally insured corporate credit union: all would be tarnished.
Second, it is likely that a far greater number of federally insured
natural person credit unions would be affected by the failure of a
corporate credit union than would be affected by the failure of a bank
or broker-dealer. For these reasons, and because of NCUA's
responsibility to protect the National Credit Union Share Insurance
Fund (NCUSIF), NCUA has determined to retain in the revised proposed
rule the requirement 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.
As in the first proposed rule, Section 704.1(b), which sets forth
NCUA's authority to waive a requirement of Part 704, is retained in
this revised proposal. NCUA again emphasizes that corporate credit
unions are expected to comply with the rule and that waivers will not
be granted as a matter of course.
Section 704.2--Definitions
As noted in the initial proposed rule, Part 704 currently
incorporates by reference Part 703, which governs federal credit union
investments, except where inconsistent with Part 704. To eliminate the
confusion regarding the applicability of certain provisions of Part 703
to corporate credit unions, NCUA determined in the initial proposed
rule to make the investment section in Part 704 stand on its own.
[[Page 28088]]
Among other tasks, this necessitated importing a number of definitions
from Part 703 into Part 704. No commenters objected to this idea, and
it is continued in this revised proposal.
The definitions that have been repeated, either identically or with
minor changes, from current Part 703 are: ``adjusted trading,''
``collateralized mortgage obligation,'' ``federal funds transaction,''
``futures contract,'' ``immediate family member,'' ``market price,''
``maturity date,'' ``real estate mortgage investment conduit,''
``repurchase transaction,'' ``residual interest,'' ``reverse repurchase
transaction,'' ``Section 107(8) institution,'' ``senior management
employee,'' ``settlement date,'' ``short sale,'' ``stripped mortgage-
backed security,'' and ``trade date.''
Since the issuance of the initial proposed rule, NCUA has issued a
proposed revision to Part 703. 50 FR 61219 (Nov. 29, 1995). Proposed
Part 703 contains a number of new definitions, some of which have been
included in this revised proposed Part 704. These are: ``business
day,'' ``commercial mortgage related security,'' ``fair value,''
``industry-recognized information provider,'' ``mortgage related
security,'' ``mortgage servicing,'' ``pair-off transaction,''
``prepayment model,'' ``securities lending transaction,'' and ``small
business related security.''
The initial proposed rule also introduced a number of new
definitions, several of which have been included in this revised
proposal. These are: ``embedded option,'' ``forward rate agreement,''
``long-term investment,'' ``market value of portfolio equity,''
``matched'' (``identically matched'' in initial proposal),
``official,'' ``option contract,'' ``penalty for early withdrawal,''
``primary dealer,'' ``short-term investment,'' ``swap agreement,'' and
``wholesale corporate credit union.''
The initial proposal rule deleted a number of definitions because
the terms were not used in the proposed regulation, or because the
meaning was so self-evident as to not require definition. No commenters
objected to this idea and it is continued in this revised proposal. The
definitions that are proposed to be deleted are: ``average life,''
``capital of a broker/dealer,'' ``claims,'' ``corporate reserves,'' non
credit union member,'' ``original maturity,'' ``other reserves,''
``risk-based capital,'' ``secondary capital,'' ``speculative
activities,'' ``term subordinated debt,'' and ``United States
depository institutions.''
Finally, this revised proposal has introduced definitions for the
following terms: ``capital ratio,'' ``correspondent services,''
``credit enhancement,'' ``daily average net assets,'' ``dealer bid
indication,'' ``gains trading,'' ``membership capital,'' ``mortgage-
backed security,'' ``moving daily average net assets,'' ``NCUA,'' ``non
secured investment,'' ``paid-in capital,'' ``private placement,''
``reserves,'' ``reserve ratio,'' ``secured loan,'' ``tri-party
contract,'' and ``weighted average life.'' NCUA believes that the
definitions are self-explanatory, but will clarify any that are
confusing in the preamble to the final rule.
Section 704.3--Corporate Credit Union Capital
Section 704.11 of the current regulation establishes specific
levels of capital that corporate credit unions must maintain, based on
risk-weighted assets. Primary capital, which consists of reserves and
undivided earnings, must be at least 4 percent of risk- weighted
assets, and total capital, which consists of primary capital and
membership capital share deposits, must be at least 8 percent of risk-
weighted assets. In response to public expressions of concern regarding
the relatively low levels of primary capital in corporate credit
unions, Section 704.12 of the initial proposed rule established a new
capital requirement based on the ratio of primary capital to average
daily assets. The goal was for corporate credit unions to reach the
minimum ratio of 4 percent of primary capital to average daily assets
by January 1, 1998. The initial proposed rule also required that all
corporate credit unions maintain a minimum ratio of 10 percent of
capital to risk-weighted assets.
The proposed definition of primary capital included, in addition to
reserves and undivided earnings, certain other reserve accounts and a
new type of member-contributed capital, called a permanent capital
share account (PCSA). Up to 50 percent of primary capital could consist
of PCSAs, the most significant feature of which was that they could be
redeemed only with the written concurrence of NCUA. In general, the
commenters opposed this requirement. Corporate credit union commenters
stated that they would be unable to sell such shares, and natural
person credit unions stated that they would not purchase them.
With respect to the proposed capital requirements, the commenters
stated that if PCSAs were to be retained, all such shares should be
counted toward primary capital. In addition, the commenters objected to
the new membership capital shares, called secondary capital share
accounts, not being included in primary capital. They argued that such
shares were at risk and should be counted. The commenters also argued
that the asset and liability provisions were so stringent that it would
be impossible to meet the 4 percent requirement in the time frame
provided. Many commenters also objected to using two ratios to measure
the adequacy of corporate credit union capital.
NCUA is proposing to move away from the concept of risk-based
capital. Because corporate credit union assets tend to have relatively
low credit risk, most corporate credit unions have high risk-based
capital ratios, even if they have low levels of leverage capital to
protect against interest rate or market risks. This revised proposal
focuses on the capital that is available to protect against those
risks. Comments are specifically requested on whether NCUA should
require the calculation of the capital to risk-weighted assets ratio.
In responding to this issue, commenters should bear in mind that NCUA
would likely require that the ratio be calculated using the same risk
weights and risk categories required by the other federal financial
institution regulators.
Proposed Section 704.3(b) requires that a corporate credit union
without expanded authorities have a capital ratio of 4 percent. Capital
is defined as the sum of a corporate credit union's reserves and
undivided earnings, paid-in capital, and membership capital. Membership
capital accounts are similar to the current membership capital share
deposits, except that they must have at least a three-year notice
provision, rather than a one-year provision. Paid-in capital consists
of funds obtained from credit union and non credit union sources. Paid-
in capital has no maturity and is callable only at the option of the
corporate credit union and only if the corporate credit union meets its
minimum level of required capital after the funds are called.
The capital (or ``leverage'') ratio is calculated by dividing a
corporate credit union's capital by its moving daily average net
assets. Including membership capital in the definition of capital means
that most corporate credit unions are already at 4 percent. NCUA
believes that 4 percent is appropriate, because it is the amount
estimated to meet corporate credit union needs and is comparable to the
levels established by the other financial institution regulators.
The role of membership capital relative to a corporate credit
union's internally generated reserves and undivided earnings has been
cause for extensive debate. NCUA regards
[[Page 28089]]
membership capital as a vital component of the corporate network's
total capital structure. It is used in calculating the minimum leverage
ratio (also included in total capital requirement for expanded
authorities), the limit on loans to members, the limit on loans to
CUSOs, and the limit on fixed assets. However, for purposes of market
and credit risk exposure, this proposal sets the MVPE and concentration
limits as a percentage of the sum of reserves and undivided earnings
and paid-in capital. Indirectly, the member-contributed capital is in
line to absorb losses, but the revised proposal seeks to restrict the
incidence of losses to a corporate credit union's own equity.
The ability of a member to withdraw its capital contribution has
been preserved in this revised proposal. The fact that a member may
cancel its ownership stake, irrespective of any ability on the part of
the corporate credit union to replace it, adds an extraordinary
dimension to the capitalization of corporate credit unions. Some have
argued that a mechanism needs to exist which permits a member to
voluntarily provide a more permanent form of capital to its corporate
credit union. Thus, the revised proposal permits a member to purchase
paid-in capital. This establishes the alternative for a member to make
a perpetual capital investment which the corporate credit union can
use, along with its reserves and undivided earnings, for direct risk-
taking purposes. -
As members of a unique, private, and cooperative financial system,
corporate credit unions will benefit from building appropriate internal
capital reserves and, in turn, diminish the prospect of placing member
funds directly at risk. Over time, the buildup of internal reserves
will increase a corporate credit union's capacity to provide greater
products and services to members while it decreases the risk to members
that they will lose their capital stake due to market or credit risk
exposures or other business losses incurred by their corporate credit
union. -
Proposed Part 703, noted above, limits a natural person credit
union's purchase of capital shares in corporate credit unions to one
percent of the investing credit union's assets. Commenters with
opinions on this issue should direct them at proposed Part 703. -
Since NCUA believes that the stability of the corporate system will
be strengthened if each corporate credit union's reserves and undivided
earnings plus paid-in capital ultimately equals 4 percent of net
assets, proposed Section 704.3(c) establishes mandatory reserve
transfers when the amount is below 4 percent. Although NCUA expects
that a 4 percent capital ratio will be appropriate for most corporate
credit unions without expanded authorities, a higher level may be
necessary in the rare situation when, for example, a corporate credit
union refuses to recognize a loss, or a loss not anticipated by the
regulation occurs. A lower level may be appropriate in the event of a
natural disaster or when, for example, a merger results in the
continuing corporate credit union's reserves falling below 4 percent,
and a workout plan has been approved. To accommodate increasing or
decreasing the capital requirement, proposed Section 704.3(d) provides
that NCUA may require a different minimum capital ratio for an
individual corporate credit union based on its circumstances. Before
imposing a different capital requirement, NCUA will provide notice to
the corporate credit union and allow it to respond. -
In rare circumstances, conditions may exist in a corporate credit
union when additional reserves may be needed but are not available
immediately. In those cases, NCUA may require a corporate credit union
to increase the regularly scheduled reserve transfers with supplemental
transfers which will ultimately raise the reserves to the required
level. As an example, NCUA may require that a corporate credit union
transfer 12 basis points each period, rather than the 10 basis points
required by the regulations. This action may be taken in conjunction
with a reserve transfer, or in lieu of the reserve transfer. -
As noted earlier, NCUA and corporate credit union representatives
have discussed this revised proposal during its development. As the 4
percent capital ratio requirement has been debated, some corporate
credit union representatives have asked about the consequences of going
below 4 percent, because, for example, the corporate credit union has
accepted a large volume of shares. NCUA is committed to corporate
credit unions maintaining capital at the required minimum, but realizes
that there may be situations where a corporate credit union temporarily
drops below that level. To accommodate sudden spikes in share growth,
the capital ratio is calculated by dividing capital by the moving daily
average net assets for the previous 12 months. -
Proposed section 704.3(e) requires management of a corporate credit
union to notify the board of directors, the supervisory committee, and
NCUA within 10 business days when capital falls below the minimum
required. The 10 business days refers to the time period after the
books are closed at month end. It is important to notify the board and
supervisory committee so that they can act promptly, including the
calling of a special meeting, if necessary, to ensure compliance within
the month.
If a corporate credit union is not in compliance by month end,
proposed Section 704.3(f) requires that it submit a plan to restore and
maintain its capital ratio at the minimum required level. For example,
if a corporate credit union closes its books on March 31, and the
capital ratio is 3.9 percent, it must notify the board of directors,
the supervisory committee, and NCUA by April 10. If, on April 30, the
capital ratio is at or above 4 percent, no further action is necessary.
If, however, the ratio is at 3.95 percent, a plan must be submitted to
NCUA by May 15. -
Even if a corporate credit union comes into compliance by the end
of the month, a plan is required if the corporate credit union drops
below the required minimum two more times within 12 months from the
first violation. Violating the required minimum three times in one year
indicates a systemic problem that must be addressed. Failure to develop
an adequate plan, fully supported by projections and estimates,
increases the chances that NCUA will issue a capital directive, a
procedure that is provided for in proposed Section 704.3(g). -
A capital directive may order a corporate credit union to achieve
adequate capitalization by taking one or more of a number of actions,
such as reducing dividends and limiting deposits. Unless a corporate
credit union's capital level is severely under the required minimum, it
is intended that capital directive will be issued only after verbal and
written communication between NCUA and the corporate credit union has
failed to result in an acceptable capital restoration plan or a plan
has not been followed. -
Since a capital directive will be issued only as a last resort,
NCUA expects full and immediate compliance with any such directive.
NCUA will view failure to comply with a capital directive as a serious
issue. -
It should be noted that the proposed regulation provides for
consultation with the state regulator where a state-chartered corporate
credit union is involved. NCUA will support state requirements for
higher capital levels or shorter time frames for compliance. -
Section 704.3(a) requires that a corporate credit union develop
capital
[[Page 28090]]
goals, objectives, and strategies. A corporate credit union should
develop various scenarios to accommodate slow, medium, and rapid asset
growth. It also should consider setting goals higher than regulatory
minimums in order to avoid non compliance due to unexpected growth.
Preplanning for capital growth is needed if a corporate credit union
anticipates applying for expanded authorities.
Section 704.4--Board Responsibilities -
Currently, several different sections of Part 704 set out policy
and operational requirements for corporate credit union boards of
directors. For example, Section 704.3 requires boards to adopt and
review strategic plans and to prepare business plans for certain
material expenditures. Sections 704.4 through 704.7 require corporate
credit unions to develop certain policies and goals in the areas of
asset and liability management, capital, investments, and lending, but
the board is accountable for the ratification of and adherence to such
policies and goals. The initial proposed rule did not substantially
change this approach, maintaining the requirement for board development
of strategic and business plans in Section 704.3 and the requirement
for credit union development of capital goals, objectives, and
strategies in Section 704.6. Section 704.4, however, did combine the
requirements for credit union development of investment and asset and
liability management policies. -
No significant comments were received in this area, but to
emphasize the fact that the board sets the agenda and is ultimately
responsible for the corporate credit union, Section 704.4 of this
revised proposal requires a board to approve comprehensive written
plans and policies. The board should oversee senior management to
ensure that policy limits are consistent with the existing and forecast
levels of capital and that all activities are conducted in a safe and
sound manner and are consistent with the board's overall risk
management philosophy. The board should also understand the role
financial instruments play in the corporate credit union's business
strategies and the mechanisms used to manage risks. The board must
provide for adequate staffing and technological/financial resources to
support the corporate credit union's activities. When a corporate
credit union plans to enter a new market, the board evaluation should
reflect the cost of establishing appropriate controls, procedures, and
attracting professional staff with necessary expertise.
The emphasis upon board responsibilities is not intended to turn
directors into operating managers. A board needs to delegate the
development of goals, policies, and procedures to operating management.
However, the board retains the ultimate responsibility for ensuring
that such delegations are reasonably fulfilled. A board's active
commitment to this can significantly improve its awareness and control
of potential risks.
Section 704.5--Investments
Currently, Section 704.6 requires a corporate credit union to
develop written investment policies and sets out a list of authorized
investments and divestiture requirements. In the initial proposed rule,
the policies provision was moved to Section 704.4, and the remaining
provisions were revised and recodified at Section 704.5. Section 704.5
of the proposed rule also included the relevant provisions of Part 703,
governing natural person federal credit union investments, rather than
simply incorporating them by reference. No comments were received on
this matter, and the split between Parts 703 and 704 has been
maintained in this revised proposal.
Section 704.6 of the initial proposed rule restricted the aggregate
of a corporate credit union's investment in any one institution,
issuer, or trust to 25 percent of primary capital. It instituted
minimum asset size and rating requirements for investments in
depository institutions. It also tightened the standards for CMOs.
A number of commenters stated that the 25 percent of primary
capital limitation was too low, arguing that it would concentrate
corporate credit union investments in the hands of fewer issuers and
create more credit risk in the industry. They also suggested that U.S.
Government and Agency securities should be exempt from the restriction.
NCUA agrees that the 25 percent of primary capital concentration
limit was too low and has also determined that concentration concerns
should properly focus on credit risk. Therefore, new concentration
limits are set forth in proposed Section 704.6, which governs credit
risk management.
The weakness in the current CMO tests became evident during the
bear market of 1994. While the fixed-rate CMO test proved reasonably
adequate in preventing the purchase of many high risk fixed-rate CMOs,
the floating-rate test proved inadequate. Many floating-rate CMOs were
structured to enable them to pass the test even though they contained
significant market risk resulting from option and basis risk.
This revised proposal expands the fixed rate CMO test to include
limits on extension/contraction of weighted average life (WAL) and on
price volatility. These are similar to the second two tests of the
Federal Financial Institutions Examination Council (FFIEC) test for
CMOs. Unlike the current rule, the proposal allows for bonds to extend
from the initial expected WAL provision of five years to seven years.
The price volatility test sets the maximum market value decline at 15
percent of the base case value. This means that the volatility of a CMO
should not exceed the comparable price volatility of approximately a
five year zero coupon bond.
This proposal expands the floating rate CMO test to include three
new tests. There is an initial expected WAL limit, an extension/
contraction WAL limit, and a price volatility limit. These tests were
proposed in response to the volatile price history of floating rate
CMOs and the inability of the FFIEC test to adequately capture cap and
basis risk. The view that floating rate securities are immune from
general market risks has been rudely dispelled over the past several
years, and NCUA believes there is a need to subject such securities to
rigorous prepurchase selection tests.
During the dialogue sessions with corporate credit unions, several
participants argued have that a comprehensive MVPE analysis which
captures option and basis risk eliminates the need for a special CMO
test. The fact that total risk is addressed in MVPE, and subsequently
limited as a percentage of reserves and undivided earnings plus paid-in
capital, may make the CMO tests redundant and needlessly restrictive.
Commenters are specifically requested to address this issue.
To control possible ``cherry picking'' involving the testing of
CMOs (selecting a prepayment model that will allow a particular CMO to
pass the tests), this revised proposal requires a corporate credit
union board to approve at least three prepayment models, or a median
estimate, that will be used in the tests. The models must be used for
all subsequent tests.
Section 704.5(c) of this revised proposal establishes consistent,
minimum standards for repurchase and securities lending transactions.
These transactions create room for spread trade opportunities with
minimal MVPE and credit risk. Proposed Section 704.5(c)(4) requires
that collateral securities be legal for corporate credit unions, except
that CMO/REMIC securities that pass the FFIEC HRST are permissible
provided that the term of the transaction does not exceed 95 days. The
95-day limit will permit standard 3-month trades with such collateral.
[[Page 28091]]
Section 704.5(k) of the initial proposed rule carried over the
provision from Part 703 authorizing investment in a mutual fund if the
investments and investment transactions of the fund are legal for the
purchasing credit union. Proposed Section 704.5(d) broadens this
authority by permitting investment in an investment company that is
registered with the Securities and Exchange Commission under the
Investment Company Act of 1940, with the same restriction regarding the
permissibility of the underlying investments and investment
transactions. A mutual fund is the most common type of registered
investment company, but credit unions have been authorized by opinion
letter to invest in other types, such as money market mutual funds and
unit investment trusts. The regulatory language has been changed to
clarify that these other types of registered investment companies are
permissible investments for corporate credit unions. A corporate credit
union can determine if the investments and investment transactions of
an investment company are permissible by reviewing the fund's
prospectus and statement of additional information. Oral or other
written representations regarding the fund's activities are not
sufficient. The language also clarifies that investments such as asset-
backed securities (ABS), which are specifically authorized for
corporate credit unions but are not registered investment companies,
are permissible regardless of the underlying instruments that make up
the security.
Proposed Section 704.5(e) sets forth investment activities that are
prohibited for corporate credit unions that are not operating with
expanded authorities. Several prohibitions are carried over from Part
703. Proposed Section 704.5(e)(1) prohibits a corporate credit union
from purchasing and selling off-balance-sheet financial derivatives.
While derivatives can be important risk management tools, NCUA believes
that they are appropriate only for corporate credit unions that have
sophisticated risk management systems in place. Proposed Section
704.5(e)(3) prohibits a corporate credit union from purchasing
commercial mortgage related securities and small business related
securities because the market for these securities is undeveloped and
the potential timing of cash flows from the securities is not widely
disseminated. -
Section 704.6--Credit Risk Management
Except for the concept of risk-based assets, the current regulation
addresses credit risk only briefly. Section 704.6(a) requires that a
corporate credit union's investment policies address, among other
things, risk diversification and approved investment credit limits and
credit ratings. Section 704.6(b) authorizes the purchase of certain
investments only if they have specific minimum credit ratings.
The initial proposed rule did not significantly change this
approach. Section 704.4 required a corporate credit union to develop
policies regarding acceptable credit risk, to identify the credit risk
associated with an asset prior to purchase, and to monitor such risks
while an asset was held. Section 704.5 established minimum credit
ratings for certain investments and required corporate credit unions to
prepare quarterly evaluations of lines of exposure to foreign banks.
Some commenters took exception to some of the required ratings and to
the mandatory quarterly evaluations. In addition, there was a
suggestion that credit risk be discussed more comprehensively.
This revised proposed rule addresses credit risk in a separate
section and requires that the board of a corporate credit union adopt a
written credit policy that reflects objectives and limits consistent
with its risk management philosophy. Proposed Section 704.6 was
developed in response to concerns that some corporate credit unions
consider that credit risk management only requires the use of credit
ratings. This section requires a corporate credit union to establish a
credit risk management policy, sets concentration limits and minimum
credit ratings for certain investments, and establishes specific
reporting and documentation procedures.
In-depth credit risk management requires considerable human and
financial resources. Many corporate credit unions may not wish to
commit the resources necessary to assume significant credit risk
exposure. Therefore, the proposed rule establishes conservative credit
ratings and concentration requirements. It also permits an expansion of
these basic credit authorities provided that credit risk management
resources increase accordingly. For corporate credit unions that
restrict their credit activities, a minimum due diligence process is
required. However, if a corporate credit union increases its credit
exposure, the requirements will increase accordingly.
Proposed Section 704.6(a) requires that a corporate credit union's
credit risk management policy address how it will ensure that it has
exercised due diligence in analyzing credit risk. The due diligence
requirement will not be met solely by subscribing to a rating agency's
credit research. To the extent that a corporate credit union assumes
material credit risk exposures, the internal analysis must provide the
basis for acceptable credit lines. The analysis should contain a
rationale for the approved risk exposure. A corporate credit union
choosing to accept greater risk exposure must have resident credit
expertise commensurate with the level of risk assumed.
To ensure reduced risks to member credit unions, the proposal
requires a corporate credit union to establish maximum credit limits
based on its reserves, undivided earnings, and paid-in capital. NCUA
believes that establishing limits based upon net assets provides a poor
basis to support risk since the size of a corporate credit union's
balance sheet does not meaningfully correlate to its capacity to absorb
risk.
The proposal also requires that a corporate credit union establish
limits on concentrations of credit risk that may occur, by, for
example, sector (e.g., automobile industry related receivables),
industry (e.g., banks), or region (e.g., geographical concentrations of
loans in private mortgage-backed securities). The policies must address
the fact that diversification by issuer does not mitigate all pertinent
credit risk factors. Absent the appropriate risk considerations, NCUA
is concerned that the corporate credit union system's assets could
become overly concentrated in one type of credit and be prone to a
systemic credit crisis. The remedy is not to avoid credit risk but
rather to analyze and manage it.
The credit risk management section establishes specific
concentration limits for certain types of securities and money market
transactions. These limits are higher than those set forth in the
initial proposal. NCUA was persuaded that the more conservative limits
could have the unintended consequence of forcing corporate credit
unions to purchase securities from issuers with greater credit risk. A
credit instrument which possesses structural components which reduce
the risk of default is preferred to a credit instrument that is based
upon the credit quality of the issuer. Therefore, the concentration
limits make a distinction between securities which have an element of
credit enhancement and non secured direct obligations. The latter have
no collateral or securitization enhancements to absorb losses resulting
from default.
Proposed Section 704.6(c)(1) provides that the aggregate
investments in any single mortgage-backed security (MBS) or asset-
backed security (ABS) or trust are limited to 200 percent of the sum of
[[Page 28092]]
the corporate credit union's reserves and undivided earnings and paid-
in capital. MBS and ABS are instruments with substantial credit
enhanced structures. The underlying instruments provide protection from
a credit risk perspective. The limit on MBS and ABS was set higher than
the limit on unsecured transactions because of the relative lower
credit risk associated with these secured investments. This limit
allows for an appropriate level of activity absent the substantial
credit review process that is requisite for proportionately greater
credit risk exposures.
Repurchase agreements provide opportunities for most corporate
credit unions to obtain spread income while limiting MVPE exposure.
Repurchase agreements and securities lending typically have a high
degree of protection against default. Since these transactions are
fully collateralized and valued on a daily basis, they have minimal
credit risk exposure. The concentration limits set forth in proposed
Section 704.6(c)(2) reflect the objective to maintain credit risk
management requirements commensurate with exposures. It provides that a
corporate credit union's aggregate investments in repurchase and
securities lending agreements with any one counterparty are limited to
400 percent of the sum of reserves and undivided earnings and paid-in
capital. This limit does not apply to investments in a wholesale
corporate credit union. The concentration limit restricts the volume of
repurchase transactions with one counterparty and will require a
corporate credit union to develop an adequate number of relationships
to support the level of current and projected repurchase activity.
Proposed Section 704.6(c)(3) limits non secured transactions to 100
percent of the sum of a corporate credit union's reserves and undivided
earnings and paid-in capital. To the extent that a corporate credit
union cannot conduct an in-depth analysis of credit counterparties,
this limit restrict exposures to an appropriate maximum. It is
understood that preferences for risk taking (i.e., credit versus market
risk) may change over time. The expanded authorities address the
capacity for a corporate credit union to assume greater levels of
credit exposure if and when it chooses. NCUA is concerned about
excessive exposures in non secured credit instruments that are not
supported by the requisite due diligence.
Proposed Section 704.6(d) addresses credit ratings. It cannot be
emphasized too strongly that a high rating is not a substitute for due
diligence. Debt structures and counterparty creditworthiness must still
be evaluated, and the approval of credit lines and limits must contain
rationale which reasonably justifies the willingness of the corporate
credit union to place its capital at risk. The proposed rule requires
that downgraded instruments be reviewed by the corporate credit union.
The corporate credit union must ensure that any decision to hold a
downgraded instrument can be justified. The provision does provide
flexibility to avoid automatic divestiture. The specific conditions for
instruments with rating which fall below the regulatory minimum is
addressed in proposed Section 704.10. Although the initial proposed
rule contained entity ratings, these have not been included in this
revised proposal due to the variability of standards on the part of the
rating agencies.
In establishing a minimum rating for asset-backed securities, NCUA
considered the additional legal and financial structure risks resident
in such securities. The complexity of these factors is typically
greater for lower rated bonds. Taking these other risk factors into
consideration, it was decided that that ABS would be limited to AAA,
despite the fact that the relative credit risk was not necessarily
different from other similarly rated securities.
Proposed Section 704.6(b) exempts from the credit requirements of
Section 704.6 securities issued by the United States government, its
agencies, and enterprises. Although government-sponsored enterprises,
such as Fannie Mae and Freddie Mac, have been exempted, they do possess
some credit risk. A corporate credit union should not fail to consider
that any material credit risk needs to be evaluated commensurate with
the exposure taken. These entities should not be considered exempt from
due diligence.
Section 704.7--Lending
Under Section 704.7 of the current rule, loans to one credit union
member are limited to the corporate credit union's capital or 10
percent of its shares and capital, whichever is greater. The aggregate
amount of loans to non credit union members is limited to 15 percent of
the corporate credit union's capital. The aggregate amount of loans to
credit union non members is limited to 25 percent of the corporate
credit union's shares and capital, with the loans to one credit union
non member being limited to capital or 10 percent of shares and
capital, whichever is greater.
Out of concern that the existing limitation was too permissive and
posed a potential threat to corporate credit unions and the NCUSIF,
Section 704.8 of the initial proposed regulation limited loans to one
member credit union to the corporate credit union's primary capital.
Corporate credit unions were prohibited from lending to members that
were not credit unions, except for loans to CUSOs and overdraft
protection for clearing accounts, and were also prohibited from lending
to non members.
A number of commenters argued that the limitation on loans to one
member credit union was too low. They argued that there should be a
separate limitation for secured and unsecured loans, due to the
differing magnitude of potential risk. NCUA agrees, noting that the
majority of corporate credit union lending to member credit unions is
done on a secured basis. NCUA also notes that a limit based solely on
capital, which includes membership capital, may be unfair to some
corporate credit unions, which may choose not to issue membership
capital. Therefore, Section 704.7(c) of this revised proposal limits
unsecured loans to 50 percent of capital or 75 percent of the sum of
the reserves and undivided earnings and paid-in capital, whichever is
greater, and limits secured loans to 100 percent of capital or 200
percent of the sum of reserves and undivided earnings and paid-in
capital, whichever is greater. NCUA believes that the unsecured limit
represents a balance between safety and soundness concerns and the
mission of corporate credit unions to make loans. The secured lending
limit allows for adequate diversification of the loan portfolio with
limited risk associated with any one borrower.
NCUA emphasizes that the term ``secured loan'' is defined to mean a
loan in which the lender has perfected a security interest in the
collateral. The rules for perfecting a security interest are governed
by state law. For example, if collateral consists of loans, and state
law requires possession of loan documents to perfect a security
interest in a loan, then the corporate credit union must take
possession of the documents. If this is not feasible, then the loan
must be included in the corporate credit union's unsecured loan limit.
To assess the impact of the unsecured vs. secured loan limits, NCUA
seeks comments on restrictions imposed by state law on individual
corporate credit unions' lending activities.
NCUA was convinced by comments that the corporate credit unions
should have the ability to make loans to non credit union members.
Section 704.7(d) of the revised proposal allows corporate
[[Page 28093]]
credit unions to make loans to members other than credit unions as long
as the loans are in compliance with Section 701.21(h) of the NCUA Rules
and Regulations, which governs member business loans. Additionally, the
aggregate of loans to members other than credit unions cannot exceed 15
percent of the corporate credit union's capital plus pledged shares.
NCUA also was convinced that corporate credit unions should have
the authority to make loans to non member credit unions in order to
accommodate credit unions with branches in other states. Proposed
Section 704.7(e) authorizes a corporate credit union to make an
overdraft loan related to correspondent services to a non member credit
union. Although such a loan generally will have a maturity of only one
business day, NCUA will not take exception if, in the regular course of
business, an overdraft loan occasionally has a maturity of two or three
days.
Section 704.8--Asset and Liability Management
Section 704.4 of the current regulation requires a corporate credit
union to develop and implement comprehensive written funds management
policies and to prepare monthly reports showing the degree of mismatch
between the sources and uses of funds. In addition, 704.6 requires a
corporate credit union to develop written investment policies which
address funds management strategies, among other things.
In response to the assumption of significant interest rate risk by
many corporate credit unions, Section 704.4 of the initial proposed
rule required that corporate credit unions identically match almost all
shares and deposits to corresponding assets. In addition, corporate
credit unions were required to calculate the fair value of all
investment securities monthly, limit aggregate losses on available-for-
sale assets to 15 percent of primary capital, limit investment in
instruments with embedded options to capital, and impose early
withdrawal penalties to guarantee protection from replacement risk.
Most respondents to the original proposal pointed out that this
combination was too restrictive to permit both a realistic management
of asset and liability positions and an adequate provision of basic
financial products and services.
To ensure that corporate credit unions were cognizant of potential
interest rate risk exposures before they arose, proposed Section 704.4
required the performance of monthly ``shock test'' calculations to show
the impact on net interest income and MVPE of interest rate changes.
The supplementary information section of the proposed regulation
indicated that NCUA would conduct analytical assessments of the
proposed rule through simulation modeling techniques.
The linchpin of the asset and liability management section of this
revised proposed rule is the use of MVPE. MVPE shocks provide a
critical insight into potential risks to earnings and capital. Most
financial institutions are comfortable viewing risk in terms of
variability of income. MVPE adds the dimension of capital-at-risk to
the assessment of risk exposure. Simulation models that produce
estimates for both net interest income and MVPE provide a more
comprehensive risk assessment.
NCUA is primarily focused upon the preservation of capital. MVPE
simulations provide a long-term, dynamic, and forward-looking
projection of the market risk impact upon capital. Coupled with net
interest income sensitivity analysis, MVPE provides a mechanism to view
earnings on a capital-at-risk basis. In most cases, the management of
MVPE will rely upon the management of asset price volatility.
NCUA realizes that the level of MVPE that a corporate credit union
targets is not static. As a corporate credit union assumes a greater
mismatch between liabilities and assets, MVPE variability will rise.
Corporate credit unions will need to make constant adjustments to the
level of MVPE exposure based upon their market biases and preferences.
It is assumed that a corporate credit union uncomfortable with
positioning its balance sheet based upon assumptions about future
market factors will minimize MVPE variability by matching a majority of
assets and liabilities. The management of higher MVPE variability
requires considerable human, financial, and system resources. The
proposed regulation recognizes that some corporate credit unions will
have sufficient infrastructure to permit them to incur more interest
rate risk.
This proposal requires that a corporate credit union maintain a
certain level of MVPE and that it not decline too drastically in
response to interest rate shocks. However, effective risk management
begins and ends with the board of directors. The board should consider
that the regulatory limitations in this rule are outer boundaries. It
is anticipated that boards will set policies within these boundaries,
recognizing that shock tests can only approximate real world events are
based upon a number of subjective inputs. Estimated results frequently
vary from actual results, and corporate credit unions will need to
develop procedures to ensure regulatory and board policy limits are not
exceeded.
The board also is required to establish policy limits on the
maximum decline in net income in both percentage and dollar terms.
While NCUA does not address specific limits for net interest income or
net income in the asset and liability management section, it recognizes
that corporate credit unions must evaluate risk both from a liquidation
and a going concern perspective. The board should receive reports which
reflect the impact on both the net interest margin and the non interest
components of income.
A corporate credit union also must model indexes so that it can
establish a relevant correlation between its cost of funds and the
reference indexes to which asset coupon formulas are linked. The risk
that an index will change independently of the factors which affect
liabilities creates basis risk. The MVPE calculation misses a
significant risk when indexes (market and non market) are not modeled
appropriately. This is particularly important for non market indexes,
such as COFI, where correlations to funding behavior may be weak or
changes may be difficult to project.
Proposed Section 704.8(e) requires a corporate credit union to
evaluate the risk in its balance sheet by measuring the impact of
interest rate changes on its MVPE and MVPE ratio. A corporate credit
union must limit its risk exposure to levels that do not result in an
MVPE ratio below 1 percent or a decline in MVPE of more than 18
percent. Frequency of testing is a function of the MVPE ratio. If MVPE
is 2 percent or above, testing must be done quarterly. If it falls
below 2 percent, monthly testing is required.
The MVPE floor provision of 1 percent is included in the regulation
to reflect, in part, the potential that a forecast of the effect of
interest rates on a corporate credit union's balance sheet will only
approximate actual market effects of interest rates. This floor
(remaining reserves and undivided earnings plus paid-in capital) must
also absorb other risks which could affect the corporate's balance
sheet such as operational, credit, legal, liquidity, settlement and
systemic risk.-
There has been considerable debate on the appropriate level of this
floor. A floor as low as 1 percent provides a reduced cushion to absorb
differences between forecast results and actual market conditions, the
impact of interest rate risk not fully reflected by a 300 basis point
parallel shock, and the other risks identified above. This increases
[[Page 28094]]
the potential that credit unions could lose membership capital during
significant market disruptions. Therefore, a low floor may require NCUA
to act more quickly and forcefully to protect both natural person
credit union membership capital and the NCUSIF.
NCUA seeks specific data from corporate credit unions to support
the claim that a floor other than 1 percent is appropriate. It seeks
similar analytical support for challenges to the 18, 35, and 50 percent
variation limits.
If all liabilities are matched with corresponding assets, investing
all reserves and undivided earnings and paid-in capital in a 6-year
zero coupon bond is about the same as an MVPE variance of 18 percent.
This is a moderate but acceptable risk limit for corporate credit
unions with limited risk management infrastructure. The firm's modeling
results showed that corporate credit unions with matched assets and
liabilities had MVPE variances of less than 5 percent when their
balance sheets were subjected to plus and minus 300 basis point
parallel shocks. Therefore, corporate credit unions that choose to
remain with the base case authorities will have room to manage a
mismatch of assets and liabilities while remaining within prudent
limits.
The assumption of higher MVPE variability is possible through
expanded authorities, but it is expected that a corporate credit union
with that authority will aggressively alter its balance sheet in
response to shifting market trends. Again, the MVPE variability limit
should not be viewed as a static operating level for market exposure.
Managing money via significantly mismatching assets and liabilities
carries a host of attendant risks which must be constantly evaluated. A
corporate credit union cannot run a mismatched portfolio with a ``buy
and hold'' strategy. Instead, it must actively manage its balance sheet
in response to changing market factors.
NCUA believes that the basic shock test set forth in this revised
proposal will reflect most interest rate risk, although it may fail to
capture some of the risk associated with other market conditions. One
of the primary concerns with the MVPE calculations is the estimate of
convexity risk resulting from embedded options. Most of the excessive
MVPE variability experienced within the corporate network in recent
years is the result of an excess of options written (e.g., prepayment
options on amortizing securities and periodic and lifetime caps on
variable rate bonds) versus options purchased (usually none). These
options typically represent the most dynamic component of the MVPE
variability.
Therefore, under the proposed rule, a corporate credit union with
instruments which possess unmatched embedded options in excess of 200
percent of the sum of its reserves and undivided earnings and paid-in
capital must conduct additional tests. NCUA recognizes that this is a
naive hurdle since the book amount of an instrument with an option does
not represent the actual amount of option risk. The development of a
specific measure of option risk was not pursued because of the unwieldy
nature of compliance. This level was chosen as an approximate threshold
when aggregate unmatched option exposure could have a material effect
upon MVPE. A number of tests, in addition to the standard rate shocks,
are required when this hurdle is exceeded. For example, a corporate
credit union must evaluate the effect on MVPE of non parallel shifts in
the yield curve. Simulation tests done in conjunction with this
proposal found that non linear shifts did not have a significant
incremental effect on the test results. However, the pivot point was
selected at the three year note. A corporate credit union would need to
conduct a test which pivots around a point on the curve that reflects
its balance sheet structure.
In addition, adjustments to prepayment speeds are necessary because
the historical evidence indicates that prepayment projections have
varied substantially from actual prepayment behavior. The adjustment to
prepayment speeds in the firm's simulated model exercise yielded
significantly different MVPE results.
The supply and demand factors which can dominate various investment
sectors are reflected in the spread at which such investments trade
relative to Treasuries. If a model maintains a static spread assumption
in all tests it may not reflect a crucial form of market risk. Credit
spreads can be driven by numerous factors, and a corporate credit union
should be prepared to address the impact of such spreads.
A major potential component of option value is the measure of
volatility. A corporate credit union must be able to measure the impact
of how changes in volatility affect MVPE if it has a material exposure
to option risk.
Proposed Section 704.8(f) sets forth procedures for violations of
the regulatory MVPE limits. This proposed rule does not require the use
of particular risk models, allowing corporate credit unions to use
their own. NCUA regards the timely disclosure of violations as
essential for this approach to remain valid. It is crucial that NCUA,
the corporate credit union board, and the supervisory committee, be
informed as soon as possible of any violation that is not corrected
within 5 days. NCUA will work with the corporate credit union to assist
it in returning to compliance.
Proposed Section 704.8(g) sets forth procedures for violations of
board asset and liability policy. Again, NCUA must be informed, but
after notification is provided to the board.
Section 704.9--Liquidity Management
The current rule does not address liquidity explicitly, although
the requirements in Sections 704.4 and 704.6 regarding the development
of funds management policies clearly include a concern for liquidity.
Further, Section 704.8 provides that a corporate credit union may
borrow up to 10 times capital or 50 percent of shares, whichever is
greater. The initial proposed rule also did not contain a separate
section regarding liquidity, but paragraph (j) of the asset and
liability section did require corporate credit unions to develop
contingency funding plans that ranked all sources of liquidity that
were available to service immediate outflows of member funds. Proposed
Section 704.9 authorized a corporate credit union to borrow up to 10
times capital or 50 percent of shares, whichever was less, and stated
that borrowing could only be done for liquidity needs.
No significant comments were received on proposed Section 704.4(j),
but a number of commenters objected to the proposed limitation on
borrowed funds. In addition, many commenters questioned the restriction
on borrowing only for liquidity purposes. In Section 704.9 of this
revised proposal, NCUA has determined to leave the borrowing limit at
the current level, that is 10 times capital or 50 percent of shares,
whichever is greater. Further, the restriction on borrowing only for
liquidity needs has been removed. However, this revised proposal
requires that a corporate credit union take a number of actions to
ensure that it can fulfill one of its primary functions, that of being
a liquidity provider. A corporate credit union must evaluate the
potential liquidity needs of its members in a variety of economic
scenarios, continuously monitor sources of internal and external
liquidity, ensure that it has sufficient investment securities
classified as available-for-sale to meet liquidity needs, and develop a
contingency funding plan.
[[Page 28095]]
Section 704.10--Divestiture
Currently, Section 704.6(d) provides that a corporate credit union
in possession of an investment that does meet regulatory requirements
must either sell the investment within 10 days or request NCUA
permission to hold it. Section 704.5(a) of the initial proposed rule
required divestiture within 10 days of any downgraded asset, and
704.5(h)(4) required the same of any CMO that failed the average life
test or the price sensitivity test.
Many commenters objected to the general divestiture requirement,
stating that it could result in one corporate credit union being
required to sell a security at the same time that it was a legal
investment for another corporate credit union. The commenters also
objected to the absolute nature of both requirements and the fact that
corporate credit unions were given only 10 days to sell the downgraded
or failed securities. They stated that automatic divestiture within a
short time frame could magnify losses if a corporate credit union were
forced to sell in an adverse market.
With respect to instruments that have been downgraded but are still
permissible under the regulations, proposed Section 704.6 now requires
only that a corporate credit union review the investment and be able to
justify any decision to hold. With respect to instruments that have
failed a requirement of Part 704, proposed Section 704.10 requires that
the board and NCUA be informed within 20 business days. If the
investment continues to fail, the corporate credit union must provide
NCUA with a plan within 25 business days that provides the
characteristics and risks of the investment, how it fits into the
corporate credit union's asset and liability management strategy, the
impact of holding or selling, and the likelihood that the investment
will again meet the requirements of Part 704. Although the proposed
rule provides for NCUA to require submission of the plan in less than
25 days, it is anticipated that this would be necessary only if there
were a serious safety and soundness problem.
Section 704.11--Corporate Credit Union Service Organizations (Corporate
CUSOs)
Currently, the authority of corporate credit unions to invest in
credit union service organizations (CUSOs) is contained in Section
704.6 and the authority to lend to CUSOs is contained in Section 704.7.
In addition, rather than setting forth specific CUSO guidelines,
Section 704.6 incorporates by reference much of Section 701.27, which
governs natural person investments in and loans to CUSOs. NCUA
determined, in the initial proposed rule, to address corporate credit
union investments in and loans to CUSOs in one section and to
explicitly include the applicable portions of Section 701.27. This was
done in proposed Section 704.7.
NCUA also proposed to create a new term for corporate CUSOs:
corporate service organizations (CSOs). A CSO was limited to serving
only the corporate credit unions that had invested in or loaned to the
CSO and/or the members of such corporate credit unions. In addition,
CSOs were authorized to provide only a few of the services authorized
for natural person CUSOs. Finally, the proposed rule required that a
CSO be chartered as a corporation under state law.
In response to comments and because ``CUSO'' is a term used and
understood throughout the credit union industry, NCUA has determined to
retain use of the term in the context of corporate credit unions. To
avoid confusion with natural person CUSOs, however, this revised
proposal does adopt the term ``corporate CUSO.'' In addition, for ease
of reference, the definition of corporate CUSO has been included in
Section 704.11, rather than being placed in Section 704.2.
The limitation on the types of entities that could be served by a
CSO was designed to preserve the integrity of field of membership
requirements. The thought was that if a corporate credit union could
provide services to any natural person credit union through a CUSO,
field of membership limitations would be less meaningful. Further, NCUA
did not wish to address the issue of broadening corporate credit union
fields of membership in the proposed regulation. The commenters,
however, argued forcefully that CSOs should be able to provide services
to non members. They suggested that a CSO should be permitted to
develop expertise in a specific service which could benefit all natural
person credit unions. NCUA agrees and the proposed rule allows
corporate CUSOs to serve natural person credit unions that are not
members of affiliated corporate credit unions.
In proposing to limit the services that could be provided by CSOs,
NCUA was attempting to relate those services to the daily activities of
corporate credit unions, that is, serving credit unions rather than
natural persons. However, the commenters argued that CSOs should be
able to participate in ventures related to services for members of
natural person credit unions, such as shared branching and home
banking. NCUA is persuaded that corporate CUSOs can have a broader
purpose. Accordingly, this revised proposed rule requires simply that a
corporate CUSO restrict its services to those related to the daily
activities of credit unions. Section 701.27(d) of the NCUA Regulations
provides guidance in this area.
Section 704.7 of the initial proposed rule limited the aggregate of
all investments in and loans to member and non member CSOs to 15
percent of a corporate credit union's capital. Some commenters
expressed concern that CUSOs involved in secondary mortgage market
activities might need additional funds at certain times. This revised
proposal allows a corporate credit union to loan to CUSOs an additional
15 percent of capital, provided that the loan is secured.
Section 704.7 of the initial proposal also incorporated some of the
limitations and requirements of Section 701.27 (b) and (d). One of
these was the requirement that the credit union ``ensure'' that it will
not be held liable for the obligations of the CUSO. Some commenters
stated that it was impossible to provide absolute assurance on this
score. In response, Section 704.11(b) of this revised proposal requires
a corporate credit union to obtain a written legal opinion that the
corporate CUSO is organized and operated in such a manner that the
corporate credit union will not ``reasonably be held liable'' for the
obligations of the corporate CUSO. The point of this requirement is to
obtain reasonable assurance that a corporate CUSO is operated as a
sufficiently separate entity that a court would not ``pierce the
corporate veil,'' conclude that the CUSO and corporate credit union
were essentially the same organization, and hold the corporate credit
union liable for the obligations of the CUSO. Since there seems to be
some confusion on this issue, clarifying language has been added.
Since initial proposed Sections 704.7(b) and (c) received little
comment, they have been retained in revised proposed Sections 704.11(c)
and (d). Section 704.7(d) of the initial proposed rule required a
corporate credit union to take steps to bring its investments and loans
in line with the new regulation. Since CSOs were significantly more
restricted than were CUSOs, it was possible that many investments in
and loans to CUSOs would not have been authorized. This provision has
not been retained in the revised proposed rule, as
[[Page 28096]]
corporate CUSOs will have much the same authority as existing CUSOs,
and the majority of existing investments and loans will continue to be
authorized. Finally, Section 704.11(e) of the revised proposed rule
clarifies that the sole authority for a corporate credit union to
invest in or loan to a CUSOs is that contained in Part 704.
Section 704.12--Services
-Section 704.9 currently states that corporate credit unions may
provide services involving investments, liquidity management, payment
systems, and correspondent services. NCUA believed that this authority
had, on occasion, been interpreted too broadly and proposed revising
this section to eliminate the specific list of services. The initial
proposal simply stated that corporate credit unions could provide
services to their member credit unions, intending that to mean
traditional loan, deposit, and payment services. The initial proposal
also stated that a corporate credit union could provide services only
to its members and could not provide services to non members through
correspondent credit union arrangements or the service contract
authority of Section 701.26 of the NCUA Rules and Regulations.
Some commenters expressed confusion regarding the prohibition
against correspondent credit union arrangements. The intent was to
prohibit arrangements whereby two corporate credit unions would agree
for one to provide services to the members of another. NCUA has
determined, however, that a corporate credit union may provide services
to the members of another corporate credit union, provided that the
second corporate credit union consents and NCUA has given its prior
written approval. A corporate credit union also may provide
correspondent services to non member, natural person credit union
branch operating in the geographical area that the corporate credit
union serves. --
Section 704.13--Fixed Assets
Currently, Section 704.11 limits a corporate credit union's
investment in fixed assets to 15 percent of capital. The initial
proposed rule changed the limitation to 15 percent of primary capital,
in order to control future large fixed asset investments. Some
commenters argued that the proposed limitation was too restrictive,
while others stated that corporate credit unions should not put a
significant portion of their funds into fixed assets.
NCUA has determined that corporate credit unions may need to make
greater investments in fixed assets, in order to better serve their
member credit unions, and has set the limit in this revised proposed
rule at 15 percent of capital. In addition, the requirements relating
to the submission of waivers from the limitation have been condensed.
As in the initial proposed rule, this revised proposal eliminates 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 requests to invest more than 15 percent of capital in
fixed assets.
Section 704.14--Representation
As noted earlier, NCUA amended the representation section of Part
704 in 1994. Those changes were made because NCUA was concerned about
both real and apparent conflicts of interest. The initial proposed rule
recodified that section as 704.13, and amended it further by providing
that only representatives of member credit unions were permitted to
vote and stand for election. It also incorporated by reference the
provisions of Section 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.
Although few comments were received on this section, NCUA has
received assurances that this issue will be addressed by the corporate
credit unions themselves and, thus, has determined not to go forward
with the proposal to allow only representatives of member credit unions
to vote and run for office.
For the reasons stated in the preamble to the initial proposed
rule, this revised proposal again incorporates the provisions of
Section 701.14.
Section 704.15--Audit Requirements
Currently, Section 704.13 only addresses the requirements for
annual audits. The initial proposed rule recodified the provision at
Section 704.14 and added a requirement for an internal auditor function
for corporate credit unions with assets over $100 million. The proposed
rule did not require the hiring of a full-time internal auditor, and
the supplementary information section indicated that, based on the
asset size and complexity of the institution, it would be permissible
to hire a part-time auditor or contract with an outside firm to perform
the function. The proposed rule did list specific responsibilities of
the internal auditor.
Section 704.15 of the revised proposed rule segregates the audit
requirements by external and internal functions. The external audit
function relates to the annual opinion audit. Although the existing
regulation contains the phrase reportable conditions letter, some
commenters were confused about the meaning of the term. Accordingly, it
has been deleted. This revised proposal requires that all
correspondence provided to a corporate credit union by the external
auditor be made available to NCUA.
A number of commenters stated that $100 million was too low a
threshold for an internal auditor function requirement. NCUA agrees and
has set a threshold of $400 million in this proposal. In addition,
rather than listing specific responsibilities for the internal auditor,
the revised proposed rule simply states that the auditor must meet the
guidelines of the Standards and Professional Practices of Internal
Auditing, as established by the Institute of Internal Auditors. This
proposal also requires that the internal auditor report to the chair of
the supervisory committee, who may delegate supervision of the internal
auditor's daily activities to the chief executive officer of the
corporate credit union. The authority to delegate was provided in
response to comments that the supervisory committee normally is not
directly involved in the daily operation of the corporate credit union,
Notwithstanding the statement in the supplementary information
section that the proposed rule did not require the hiring of a full-
time internal auditor, some commenters stated that the corporate credit
union did not have the resources to hire such an auditor. Again, this
is not required. Some corporates have the operational complexity to
warrant a full-time internal auditor on staff. Other corporate credit
unions may choose to hire a part-time internal auditor or contract with
an outside firm to perform the internal auditor function. -
Section 704.16--Contracts/Written Agreements
Neither the initial proposed rule nor this revised proposal made
changes to this provision.
Section 704.17--State-Chartered Corporate Credit Unions
The initial proposed rule added new Section 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 were
considered ``institution-affiliated parties'' within Section 206(r) of
the Federal Credit Union Act and
[[Page 28097]]
subject to all of the enforcement provisions of the Act. There was no
significant objection to the proposal and it has been retained in this
revised proposed rule.
Section 704.18--Fidelity Bond Coverage
The currently regulation specifically lists the bond forms that
NCUA has approved for corporate credit unions. NCUA has recently
approved several new forms for credit unions, CUMIS Credit Union Bond
200, CUMIS Credit Union Bond 300, and CUMIS Credit Union Bond 400, all
of which corporate credit unions may use, although some may not be
appropriate for particular institutions. Rather than adding these to
the proposal and then having to amend the regulation as other forms are
approved in the future, this proposal deletes all references to
specific bond forms. Instead of listing them in the regulation, NCUA
will notify corporate credit unions of all approved forms as new forms
are approved.
In current Section 704.17, the deductibles are based on a corporate
credit unions primary capital to risk asset ratio. Since the initial
proposed rule eliminated this ratio, the primary capital ratio was used
in this section. The initial proposal also clarified that the minimum
bond coverage would be based on a corporate credit union's average
daily assets as of the preceding December 31. NCUA received few
comments on this section.
Since the primary capital ratio is being eliminated in this revised
proposed rule proposed Section 704.19 uses the corporate credit union's
reserve ratio. NCUA requests comments on the effect of this change on a
corporate credit union's deductible. In addition, the proposed rule
deletes current Section 704.17(e), which allows a corporate credit
union to request approval for reduced coverage. Under Section 704.1, a
corporate credit union may request a waiver of any provision of Part
704.
Appendix A--Model Forms
Appendix A of the current rule sets forth a summary of risk weights
and risk categories used to calculate a corporate credit union's
capital to risk-weighted assets ratio. Since this revised proposed rule
eliminates the required calculation of that ratio, the summary has been
deleted. Appendix A of this revised proposal contains variations of the
model disclosure forms that were set forth in Appendix C of the initial
proposal.
Appendix B--Expanded Authorities and Requirements; Appendix C--
Guidelines for Evaluating Requests for Expanded Authorities
Appendix B of the current rule sets out off-balance-sheet
conversion factors that are used in calculating the capital to risk-
weighted assets ratio. Since the ratio is not used in this proposal,
the factors have been deleted. Appendix C currently contains a list of
U.S. Government obligations and agencies. Rather than having a fixed
list, which may become outdated as entities are created, dissolved, or
changed, the proposed rule contains definitions of government agencies
and enterprises and places the responsibility for determining an
entity's status on the corporate credit union.
Appendix B of this revised proposal sets forth incrementally
greater authorities for corporate credit unions and the infrastructure
and capital requirements that must be in place to obtain such
authorities. NCUA recognizes that each corporate credit union has
partly evolved in response to unique competitive forces and member
needs. The mission of a corporate credit union and its capacity to
fulfill its respective goals can vary considerably from institution to
institution. Expanded authorities were established to permit the
corporate credit unions that qualify to obtain a reasonable expansion
of market and credit risk limits. This mechanism permits the
flexibility for self-determination and it avoids the consequence of
regulating down to the least developed institutions at the expense of
the most developed.
The expanded authorities are a natural extension of the existing
waiver process whereby a corporate can submit a request to NCUA to
obtain additional powers or an exemption from some provision of the
rules and regulations. None of the incremental powers provided for in
this proposal are beyond the scope of existing waiver authorities.
Codifying these powers in the regulation standardizes the process and
provides an established set of criteria for approval.
Authorities are segregated into four parts to allow for some
measure of selectivity by corporate credit unions that may seek only
limited expansions of their basic operating powers. These parts, and
their respective guidelines for approval, are based upon an increasing
scale of depth and complexity. Greater expansions of authority are
supported by greater capacities to measure and control the
corresponding risks.
Proposed Appendix C sets forth guidelines for evaluating requests
for expanded authorities. The guidelines are based, in part, on a
number of subjective factors. Factors include the areas of board,
management and staff; systems and operations; credit risk management;
liquidity risk management; audit and compliance; and legal.
The proposal requires that a corporate credit union seeking to use
the expanded authorities set forth in Part 1 of Appendix B have a
capital ratio of 5 percent and meet additional infrastructure criteria
set forth in Appendix C. Additional capital is required because of the
greater opportunity to take risk. Strengthened management, staff, and
systems are required in order to safely manage that risk. A corporate
credit union seeking to use the even more expanded authorities set
forth in Part 2 of Appendix B must have a capital ratio of 6 percent
and meet even stronger infrastructure criteria. Again greater risk
requires greater protection against loss and greater ability to manage
the risk.
The proposal requires that a corporate credit union seeking to
invest in foreign obligations, as set forth in Part 3 of Appendix B,
have a capital ratio of 5 percent, meet the infrastructure criteria
required for corporate credit unions seeking the expanded authorities
under Part 1 of Appendix B, and meet additional infrastructure criteria
relating to automation of systems and staff experience with foreign
credit. A corporate credit union seeking to use financial derivatives,
as set forth in Part 4 of Appendix B, also must have a capital ratio of
5 percent and meet the infrastructure required for corporate credit
unions seeking the expanded authorities under Part 1 of Appendix B. In
addition, the corporate credit union must apply to NCUA for the
specific derivatives authority sought and have additional staff and
systems in place to adequately control the risks of such instruments.
Part 709--Involuntary Liquidation and Creditor Claims
Section 709.5(b) of the NCUA Rules and Regulations establishes a
payout priority for claims against credit unions that are in
involuntary liquidation. Currently, the seventh item is membership
capital share deposits of corporate credit unions. Since the proposed
rule uses the term ``membership capital,'' the words ``share deposits''
have been deleted. The proposed rule also provides for an eighth item,
i.e., paid-in capital.
[[Page 28098]]
Part 741--Requirements for Insurance
The initial proposed rule amended Section 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 did not comply with Part 704 and were not
examined by NCUA. There was no significant objection to the proposal
and it has been retained in this revised proposed rule. In the interim,
Section 741.3 has been recodified, so this revised proposed rule
creates new Section 741.219, containing the same language as set forth
in the initial proposal.
H. Regulatory Procedures
Regulatory Flexibility Act
NCUA 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 collection of information contained in this notice of proposed
rulemaking has been submitted to the Office of Management and Budget
for review in accordance with the Paperwork Reduction Act of 1980 (44
U.S.C. 3504(h)). Comments on the collection of information should be
directed to Ms. Beauchesne, at the National Credit Union
Administration, 1775 Duke Street, Alexandria, Virginia 22314-3428; Fax
No. (703) 518-6433; E-Mail Address: [email protected] within 90 days from
the date of this publication in the Federal Register. Comments should
also be sent to the OMB Desk Officer at the following address: Mr. Milo
Sunderhauf, OMB Reports Management Branch, New Executive Office
Building, Room 10202, Washington DC 20530.
The collection of information requirements in this proposed
regulation are found in 12 CFR [704.2; 704.3(a); 704.4(a); 704.6(a);
704.7(a); 704.8(a); 704.3(e)-(g); 704.5(b)(i)-(v); 704.6(e); 704.8(e)-
(g); 704.10; 704.15(b); and Appendices A and B]. This information is
required by corporate credit union management and staff in making
critical operational decisions on an ongoing basis. Additionally, the
information will be utilized by NCUA during the annual examination and
the ongoing supervision process. The respondents and recordkeepers are
corporate credit unions. Respondents and recordkeepers are not required
to respond to this collection of information unless it displays a
currently valid OMB control number.
Respondents: Corporate credit unions.
Estimated number of respondents and/or recordkeepers: 41.
Estimated average annual burden hours per respondent/recordkeeper:
3,909 hours.
Estimated total annual reporting and recordkeeping burden: 160,293
hours.
Estimated Total Annual Cost: $4,018,630.
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. NCUA 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.
NCUA, 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.
I. List of Subjects
12 CFR Part 704
Credit unions, Reporting and recordkeeping requirements.
12 CFR Part 709
Claims, Credit unions, Liquidation.
12 CFR Part 741
Bank deposit insurance, Credit unions, Reporting and recordkeeping
requirements.
By the National Credit Union Administration Board on May 22,
1996.
Becky Baker,
Secretary of the Board.
For the reasons set out in the preamble, NCUA proposes to amend 12
CFR parts 704, 709, and 741 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 Corporate credit union capital.
704.4 Board responsibilities.
704.5 Investments.
704.6 Credit risk management.
704.7 Lending.
704.8 Asset and liability management.
704.9 Liquidity management.
704.10 Divestiture.
704.11 Corporate Credit Union Service Organizations (Corporate
CUSOs).
704.12 Services.
704.13 Fixed assets.
704.14 Representation.
704.15 Audit requirements.
704.16 Contracts/written agreements.
704.17 State-chartered corporate credit unions.
704.18 Fidelity bond coverage.
Appendix A to Part 704--Model Forms
Appendix B to Part 704--Expanded Authorities and Requirements
Appendix C to Part 704--Guidelines for Evaluating Requests for Expanded
Authorities
Authority: 12 U.S.C. 1762, 1766(a), 1781, and 1789.
PART 704--CORPORATE CREDIT UNIONS
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 Chapter VII) 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.
[[Page 28099]]
(b) The 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 security means a security that is primarily serviced
by the cashflows of a discrete pool of receivables or other financial
assets, either fixed or revolving, that by their terms convert into
cash within a finite time period plus any rights or other assets
designed to assure the servicing or timely distribution of proceeds to
the securityholders. 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).
Business day means a day other than a Saturday, Sunday, or federal
holiday.
Capital means the sum of a corporate credit union's reserves and
undivided earnings, paid-in capital, and membership capital.
Capital ratio means the corporate credit union's capital divided by
its moving daily average net assets.
Collateralized Mortgage Obligation (CMO) means a multi-class bond
issue collateralized by whole loan mortgages or mortgage-backed
securities.
Commercial mortgage related security means a mortgage related
security where the mortgages are secured by real estate upon which is
located a commercial structure.
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.
Correspondent services means services provided by one financial
institution to another, and includes check clearing, credit and
investment services, and any other banking services.
Credit enhancement means collateral, third-party guarantees, and
other features that are designed to provide structural support and
protection against losses to investors in a particular security.
Daily average net assets means the average of net assets calculated
for each day during the period.
Dealer bid indication means a dealer's approximation of the bid
price of a security.
Embedded option means a characteristic of certain assets and
liabilities which gives the issuer of the instrument the ability to
change the features such as final maturity, rate, principal amount and
average life. Options include, but are not limited to, caps, floors,
and prepayment options.
Fair value of a financial instrument means the amount at which an
instrument could be exchanged in a current arms-length transaction
between willing parties, other than in a forced liquidation sale.
Market prices, if available, are the best evidence of the fair value of
financial instruments. If market prices are not available, the best
estimate of fair value may be based on the quoted market price of a
financial instrument with similar characteristics or on valuation
techniques (for example, the present value of estimated future cash
flows using a discount rate commensurate with the risks involved,
option pricing models, or matrix pricing models).
Federal funds transaction means a short-term or open-ended transfer
of funds between U.S. depository institutions.
Foreign bank means an institution which is organized under the laws
of a country other than the United States, is engaged in the business
of banking, and 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 contract between
counterparties where one party agrees to pay the other a specified
interest rate payment on a reference notional amount at a specified
date in the future (settlement date). The amount paid or received at
the settlement date of the contract is based on the market value of the
contract. The market value depends upon the notional amount, the
contract rate, and the prevailing market reference rate at the time of
settlement.
Futures contract means a contract for the future delivery of
commodities, including certain money market instruments and government
securities, sold on commodities exchanges.
Gains trading means the purchase of a security as an investment
portfolio asset and the subsequent sale of that same security at a
profit after a short-term holding period.
Immediate family member means a spouse or other family member
living in the same household.
Industry recognized information provider means an organization
which obtains compensation by providing information to investors and
receives no compensation for the purchase or sale of investments.
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 fair value of
assets minus the fair value of liabilities. All fair value calculations
must include the value of embedded options. Membership capital is
treated as a liability for purposes of this calculation. The MVPE ratio
is calculated by dividing MVPE by the fair value of assets.
Matched means, with respect to assets and liabilities, that the
factors which affect cash flows of an asset are replicated in a
corresponding liability.
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
[[Page 28100]]
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.
Membership capital means funds contributed by members which are
available to cover losses that exceed reserves and undivided earnings
and paid-in capital. In the event of liquidation of the corporate
credit union, membership capital is payable only after satisfaction of
all liabilities of the liquidation estate, including uninsured share
obligations to shareholders and the National Credit Union Share
Insurance Fund (NCUSIF). The funds have a minimum withdrawal notice of
three years, are not insured by the NCUSIF or other share or deposit
insurers, and cannot be used to pledge against borrowings. Membership
capital may be sold to a member, subject to the corporate credit
union's approval. The funds may be in the form of a term certificate,
or may be in the form of an adjusted balance account. An adjusted
balance account may be adjusted in relation to a measure established
and disclosed by the corporate credit union at the time the account is
opened (e.g., one percent of a member credit union's assets). Upon
written notice of intent to withdraw membership capital, the balance of
the account will be frozen (no annual adjustment) until the conclusion
of the notice period. The terms and conditions of a membership capital
account must be disclosed to the recorded owner of such account at the
time the account is opened and at least annually thereafter. Upon
notification of intent to withdraw, the amount of the account on notice
that can be considered membership capital is reduced by a constant
monthly amortization which ensures the recognition of membership
capital is fully amortized at the end of the notice period. The full
balance of a membership capital account that has been placed on notice,
not just the remaining non amortized portion, is available to absorb
losses in excess of the sum of reserves and undivided earnings and
paid-in capital until the funds are released by the corporate credit
union at the conclusion of the notice period.
Mortgage backed security means a security that represents either an
ownership claim in a pool of mortgages or an obligation that is secured
by such a pool, where the cash flows are passed through to the holders
of the security.
Mortgage related security means a security as defined in Section
3(a)(41) of the Securities Exchange Act of 1934, i.e., a privately-
issued security backed by mortgages secured by real estate upon which
is located a dwelling, mixed residential and commercial structure,
residential manufactured home, or commercial structure. -
Mortgage servicing means performing tasks to protect a mortgage
investment, including collecting the installment accounts, monitoring
and dealing with delinquencies, and overseeing foreclosures and
payoffs.
Moving daily average net assets means the average of daily average
net assets for the month being measured and the previous 11 months.
NCUA means NCUA Board (Board), unless the particular action has
been delegated by the Board.
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. For its
own account, a corporate credit union's payables under reverse
repurchase agreements and receivables under repurchase agreements may
be netted out if the Generally Accepted Accounting Principles (GAAP)
conditions for offsetting are met.
Net interest income means the difference between income earned on
interest bearing assets and interest paid on interest bearing
liabilities.
Nonsecured investment means an obligation backed solely by the
creditworthiness of the obligor.
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.
Paid-in capital means funds which are obtained from credit union
and non credit union sources and are available to cover losses that
exceed reserves and undivided earnings. Paid-in capital is nonvoting
and subordinate to membership capital and the NCUSIF. The funds have no
maturity and are callable only at the option of the corporate credit
union and only if the corporate credit union meets its minimum level of
required capital after the funds are called. The terms and conditions
of a paid-in capital account held by a member or non member credit
union must be disclosed to the recorded owner of such account at the
time the account is opened and at least annually thereafter.
Pair-off transaction means a security purchase transaction that is
closed out or sold at, or prior to, the settlement or expiration date.
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 losses since the
asset was purchased), or the replacement cost of funds, to meet the
demand for early withdrawal.
Prepayment model means an empirical method which produces a
reasonable and supportable forecast of mortgage prepayments in
alternative interest rate scenarios. Models are typically available
from securities broker-dealers and industry-recognized information
providers. These models are used in tests to forecast the weighted
average life, change in weighted average life, and price sensitivity of
CMOs/REMICs and mortgage-backed securities.
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.
Private placement means the sale of an entire issue to a small
group of investors. Except for investments with tax shelter provisions,
private placement to 35 or fewer investors are exempt from Securities
and Exchange Commission registration requirements.
Real Estate Mortgage Investment Conduit (REMIC) means a nontaxable
entity formed for the sole purpose of holding a fixed pool of mortgages
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.
Reserve ratio means the corporate credit union's reserves and
undivided earnings plus paid in capital divided by its moving daily
average net assets.
Reserves mean all regular or statutory reserves, including all
valuation allowances established to meet the full and fair disclosure
requirements of Sec. 702.3 of this chapter.
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
[[Page 28101]]
purchaser at a future date and at a specified price.
Section 107(8) institution means an institution described in
Section 107(8) of the Federal Credit Union Act (12 U.S.C. 1757(8)).
Secured loan means a loan collateralized by assets in which the
lender has perfected a security interest under state law.
Securities lending transaction means a transaction in which a
federal credit union agrees to lend a security to a counterparty.
Senior management employee means a 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.
Small business related security means a security as defined in
Section 3(a)(53) of the Securities and Exchange Act of 1934, i.e., a
security, rated in one of the four highest rating categories by a
nationally recognized statistical rating organization, that represents
ownership of one or more promissory notes or leases of personal
property which evidence the obligation of a small business concern. It
does not mean a security issued or guaranteed by the Small Business
Administration.
Stripped Mortgage-Backed Security 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 payments that are based
upon a specified dollar amount at specified dates in the future.
Trade association means an association of organizations or persons
formed to promote their common interests. For the purposes of
Sec. 704.14, 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.
Tri-party contract means a repurchase agreement between two parties
in which a third party acts as a custodian for the securities involved.
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 Government or its agencies means the United States
Government or instrumentalities of the United States, the debt
obligations of which 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, the debt obligations of which are not
explicitly guaranteed by the full faith and credit of the United States
Government.
Weighted average life means the weighted average time to principal
repayment of a security based upon the proportional balances of the
cash flows that make up the security.
Wholesale corporate credit union means a corporate credit union
which meets the requirements of Part II of Appendix B of this part and
which primarily serves other corporate credit unions.
Sec. 704.3 Corporate credit union capital.
(a) General. A corporate credit union must develop and ensure
implementation of written short- and long-term capital goals,
objectives, and strategies which provide for the building of capital
consistent with regulatory requirements, the maintenance of sufficient
capital to support the risk exposures that may arise from current and
projected activities, and the periodic review and reassessment of the
capital position of the corporate credit union.
(b) Capital ratio. A corporate credit union will maintain a minimum
capital ratio of 4 percent, except as otherwise provided in this part.
A corporate credit union must calculate its capital ratio at least
monthly.
(c) Reserve transfers. A corporate credit union's monthly reserve
transfers are based upon the level of its reserve ratio. Where the
reserve ratio is greater than or equal to 4 percent, the reserve
transfer is optional. Where the reserve ratio is greater than or equal
to 3 percent but less than 4 percent, the corporate credit union must
transfer .10 percent of its moving daily average net assets. Where the
reserve ratio is less than 3 percent, the corporate credit union must
transfer .15 percent of its moving daily average net assets. Reserve
transfers must be calculated on a monthly basis and funded on at least
a quarterly basis.
(d) Individual capital ratio, reserve transfer requirement. (1)
When significant circumstances or events warrant, NCUA may require a
different minimum capital ratio and/or reserve transfer level for an
individual corporate credit union based on its circumstances. Factors
that might warrant a different minimum capital ratio or reserve
transfer level include, but are not limited to, for example:
(i) An expectation that the corporate credit union has or
anticipates losses resulting in capital inadequacy;
(ii) Significant exposure exists due to credit, liquidity, market,
fiduciary, operational, and similar types of risks;
(iii) A merger has been approved; or
(iv) An emergency exists because of a natural disaster.
(2) When NCUA determines that a different minimum capital ratio or
reserve transfer level is necessary or appropriate for a particular
corporate credit union, NCUA will notify the corporate credit union in
writing of the proposed ratio or level and, if applicable, the date by
which the ratio should be reached. NCUA also will provide an
explanation of why the proposed ratio or level is considered necessary
or appropriate for the corporate credit union. In the case of a state-
chartered corporate credit union, NCUA also will provide notification
and explanation to the state supervisory authority.
(3)(i) The corporate credit union may respond to any or all of the
items in the notice. The response must be in writing and delivered to
NCUA within 10 business days after the date on which the corporate
credit union received the notice. NCUA may shorten the time period
when, in its opinion, the condition of the corporate credit union so
requires, provided that the corporate credit union is informed promptly
of the new time period, or with the consent of the corporate credit
union. In its discretion, NCUA may extend the time period for good
cause.
(ii) Failure to respond within 10 business days or such other time
period as may be specified by NCUA shall constitute a waiver of any
objections to any item in the notice. Failure to address any item in a
response shall constitute a waiver of any objection to that item.
(iii) After the close of the corporate credit union's response
period, NCUA will decide, based on a review of the corporate credit
union's response and other information concerning the corporate credit
union, and, in the case of a state-chartered corporate credit
[[Page 28102]]
union, in consultation with the state supervisory authority, whether a
different minimum capital ratio or reserve transfer level should be
established for the corporate credit union and, if so, the ratio or
level and the date the requirement will become effective. The corporate
credit union will be notified of the decision in writing. The notice
will include an explanation of the decision, except for a decision not
to establish a different minimum capital ratio or reserve transfer
level for the corporate credit union.
(e) Failure to maintain minimum capital ratio requirement. When a
corporate credit union's capital ratio falls below the minimum required
by paragraphs (b) or (d) of this section, or Appendix B, as applicable,
operating management of the corporate credit union must notify its
board of directors, supervisory committee, and NCUA within 10 business
days.
(f) Capital restoration plan. (1) A corporate credit union must
submit a plan to restore and maintain its capital ratio at the minimum
requirement when either of the following conditions exist:
(i) The capital ratio falls below the minimum requirement and is
not restored to the minimum requirement by the next month end; or
(ii) Regardless of whether the capital ratio is restored by the
next month end, the capital ratio falls below the minimum requirement
for three months in any 12-month period.
(2) The capital restoration plan must, at a minimum, include the
following:
(i) Reasons why the capital ratio fell below the minimum
requirement;
(ii) Descriptions of steps to be taken to restore the capital ratio
to the minimum requirement within specific time frames;
(iii) Actions to be taken to maintain the capital ratio at the
minimum required level and increase it thereafter;
(iv) Balance sheet and income projections, including assumptions,
for the current calendar year and one additional calendar year; and
(v) Certification from the board of directors that it will follow
the proposed plan if approved by NCUA.
(3) The capital restoration plan must be submitted to NCUA, and in
the case of a state-chartered corporate credit union, to the state
supervisory authority, within 30 business days of the occurrence.
(g) Capital directive. (1) If a corporate credit union fails to
submit a capital restoration plan; or the plan submitted is not deemed
adequate to either restore capital or restore capital within a
reasonable time; or the credit union fails to implement its approved
capital restoration plan, NCUA may issue a capital directive.
(2) A capital directive may order a corporate credit union to:
(i) Achieve adequate capitalization within a specified time frame
by taking any action deemed necessary, including but not limited to the
following:
(A) Increase the amount of capital to specific levels;
(B) Reduce dividends;
(C) Limit receipt of deposits to those made to existing accounts;
(D) Cease or limit issuance of new accounts or any or all classes
of accounts;
(E) Cease or limit lending or making a particular type or category
of loans;
(F) Cease or limit the purchase of specified investments;
(G) Limit operational expenditures to specified levels;
(H) Increase and maintain liquid assets at specified levels; and
(I) Restrict or suspend expanded authorities issued under Appendix
B of this part.
(ii) Adhere to a previously submitted plan to achieve adequate
capitalization.
(iii) Submit and adhere to a capital plan acceptable to NCUA
describing the means and a time schedule by which the corporate credit
union shall achieve adequate capitalization.
(iv) Meet with NCUA.
(v) Take a combination of these actions.
(3) Prior to issuing a capital directive, NCUA will notify a
corporate credit union in writing of its intention to issue a capital
directive. In the case of a state-chartered corporate credit union,
NCUA also will provide notice to the state supervisory authority.
(i) The notice will state:
(A) The reasons for the issuance of the directive; and
(B) The proposed content of the directive.
(ii) A corporate credit union must respond in writing within 10
business days of receipt of the notice stating that it either concurs
or disagrees with the notice. If it disagrees with the notice, it must
state the reasons why the directive should not be issued and/or propose
alternative contents for the directive. The response should include all
matters that the corporate credit union wishes to be considered. For
its comments to be considered, the state supervisory authority must
respond in writing within the same 10 business days. For good cause,
the response time may be shortened or lengthened, including the
following conditions:
(A) When the condition of the corporate requires, and the corporate
credit union is notified of the shortened response period in the
notice;
(B) With the consent of the corporate credit union; or
(C) When the corporate credit union already has advised NCUA that
it cannot or will not achieve adequate capitalization.
(iii) Failure to respond within 10 business days, or another time
period specified in the notice, shall constitute a waiver of any
objections to the proposed directive.-
(4) After the closing date of the corporate credit union's response
period, or the receipt of the response, if earlier, NCUA shall consider
the response and may seek additional information or clarification.
Based on the information provided during the response period, NCUA will
determine whether or not to issue a capital directive and, if issued,
the form it should take.
(5) Upon issuance, a capital directive and a statement of the
reasons for its issuance will be delivered to the corporate credit
union. A directive is effective immediately upon receipt by the
corporate credit union, or upon such later date as may be specified
therein, and shall remain effective and enforceable until it is stayed,
modified, or terminated by NCUA.
(6) A capital directive may be issued in addition to, or in lieu
of, any other action authorized by law in response to a corporate
credit union's failure to achieve or maintain the applicable minimum
capital ratios.
(7) Upon a change in circumstances, a corporate credit union may
request reconsideration of the terms of the directive. Requests that
are not based on a significant change in circumstances or are
repetitive or frivolous will not be considered. Pending a decision on
reconsideration, the directive shall continue in full force and effect.
Sec. 704.4 Board responsibilities.
(a) General. A corporate credit union's board of directors must
approve comprehensive written strategic plans and operating policies,
review them annually, and provide them upon request to the auditors,
supervisory committee, and NCUA. The board of directors must know and
understand the activities, policies, and procedures of the corporate
credit union.
(b) Operating policies. A corporate credit union's operating
policies must be commensurate with the scope and complexity of the
corporate credit union.
(c) Procedures. The board of directors of a corporate credit union
must ensure that:
[[Page 28103]]
(1) Senior managers have an in-depth, working knowledge of their
direct areas of responsibility and are capable of identifying, hiring,
and retaining qualified staff;
(2) Qualified personnel are employed or under contract for all line
support and audit areas, and designated back-up personnel with adequate
cross-training are in place;
(3) GAAP is followed;
(4) Accurate balance sheets, income statements, and internal risk
assessments (e.g., risk management measures of liquidity, market, and
credit risk associated with current activities) are produced timely in
accordance with Secs. 704.6, 704.8, and 704.9;
(5) Systems are audited periodically in accordance with industry-
established standards;
(6) Financial performance is evaluated to ensure that the
objectives of the corporate credit union and the responsibilities of
management are met; and
(7) Planning addresses the necessary retention of external
consultants to review the adequacy of technical, human, and financial
resources dedicated to support major risk areas.
Sec. 704.5 Investments.
(a) All investments must be U.S. dollar-denominated and subject to
the credit policy restrictions set forth in Sec. 704.6.
(b) A corporate credit union may invest in:
(1) Securities, deposits, and obligations set forth in Sections
107(7), 107(8), and 107(15) of the Federal Credit Union Act, 12 U.S.C.
1757(7), 1757(8), and 1757(15), except as provided in this section;
(2) Deposits in, the sale of federal funds to, and debt obligations
of corporate credit unions and Section 107(8) institutions and deposits
in state banks, trust companies, and mutual savings banks not domiciled
in the state in which the corporate credit union does business;
(3) Corporate CUSOs, as defined in and subject to the limitations
of Sec. 704.11;
(4) Marketable debt obligations of corporations chartered in the
United States. This authority does not apply to debt obligations that
are convertible into the stock of the corporation;
(5) Asset-backed securities; and
(6) CMOs/REMICs, subject to these additional limitations:
(i) Fixed rate CMOs/REMICs must meet the following NCUA-modified
Federal Financial Institutions Examination Council (FFIEC) High Risk
Security Test requirements:
(A) The weighted average life may not exceed 5 years at the time of
purchase;
(B) The weighted average life may not extend by more than 2 years,
nor contract by more than 3 years for an instantaneous, permanent, and
parallel shift in market rates of plus or minus 300 basis points;
(C) The extended weighted average life may not, in any case, exceed
7 years; and
(D) The investment's price may not decline by more than 15 percent
for an instantaneous, permanent, and parallel shift in market rates of
plus or minus 300 basis points;
(ii) Floating rate CMOs/REMICs must meet the following NCUA-
modified FFIEC High Risk Security Test requirements:
(A) The weighted average life of the security may not exceed 7
years at the time of purchase;
(B) The weighted average life may not extend by more than 2 years,
nor contract by more than 3 years for an instantaneous, permanent, and
parallel shift in market rates of plus or minus 300 basis points;
(C) The extended weighted average life may not, in any case, exceed
9 years; and
(D) The investment's price may not decline by more than 10 percent
for an instantaneous, permanent, and parallel shift in market rates of
plus or minus 300 basis points;
(iii) The NCUA-modified FFIEC High Risk Security Tests must be
prepared monthly on all CMO/REMICs, documented and reviewed by an
appropriate committee, and retained until after completion of the next
audit and examination;
(iv) A corporate credit union's board of directors must approve at
least three prepayment models for CMOs/REMICs unless a median estimate
from an industry-recognized information provider is used. These
approved models must be used consistently for all subsequent compliance
tests. Any changes in approved models should be infrequent and
documented with a reasonable and supportable justification; and
(v) A corporate credit union must obtain prepayment estimates,
based upon an instantaneous, permanent, parallel shift in market rates
of plus or minus 100, 200, and 300 basis points, to conduct the tests
set forth in paragraph (b)(6) of this section.
(A) If a median prepayment estimate is used, it must be obtained
from an industry-recognized information provider. At purchase, the
median estimate must be based on at least 5 prepayment models. At
retesting, the median estimate must be based on at least 2 prepayment
models.
(B) If individual prepayment models are used, estimates must be
obtained from all of the models identified in the corporate credit
union's investment policy. One of the individual prepayment models may
be the median prepayment estimate from an industry-recognized
information provider. All of the models identified in the investment
policy must be used when purchasing and retesting a CMO/REMIC. At
purchase, a CMO/REMIC must pass the tests for each prepayment model
used. At retesting, the CMO/REMIC must pass the tests for a majority of
the prepayment models used at the time of purchase.
(c) A corporate credit union may enter into a repurchase agreement
or securities lending transaction provided that:
(1) The corporate credit union takes physical possession of the
security, receives written confirmation of the purchase and a
safekeeping receipt from a third party under a written custodial
contract, or is recorded as owner of the security through the Federal
Reserve Book-Entry Securities Transfer System;
(2) Collateral securities are legal investments for corporate
credit unions, except that a corporate credit union may receive, as
permissible collateral, CMO/REMIC securities that pass the FFIEC High
Risk Security Test if the term of the repurchase transaction does not
exceed 95 days from the date of settlement;
(3) In the event of default, the corporate credit union sells the
collateral in a timely manner, subject to a bankruptcy stay, to satisfy
the commitment of any net principal and interest owed to it by the
counterpart;
(4) The corporate credit union receives daily assessment of the
market value of collateral securities, including a market quote or
dealer bid indication and any accrued interest, and maintains adequate
margin that reflects a risk assessment of the collateral securities and
the term of the transaction;
(5) The corporate credit union has entered into signed contracts
with all approved counterparts. Such contracts must address any
supplemental terms and conditions necessary to meet the specific
requirements of this part. Third party arrangements must be supported
by tri-party contracts in which collateral is priced and reported daily
and the tri-party agent ensures compliance; and
(6) The corporate credit union has sufficient market relationships
established in advance to timely execute the disposition of collateral
securities.
[[Page 28104]]
(d) A corporate credit union may invest in an investment company
registered with the Securities and Exchange Commission under the
Investment Company Act of 1940 (15 U.S.C. 80a), provided that the
portfolio of such management company is restricted by its investment
policy, changeable only if authorized by shareholder vote, solely to
investments and investment transactions that are permissible for that
corporate credit union.
(e) A corporate credit union is prohibited from:
(1) Purchasing or selling financial derivatives such as futures,
options, interest rate swap contracts, or forward rate agreement;
(2) Engaging in pair-off transactions, when issued trading,
adjusted trading, gains trading, or short sales; and
(3) Purchasing stripped mortgage-backed securities, residual
interests in CMO/REMICs, mortgage servicing rights, commercial mortgage
related securities or small business related securities.
(f) A corporate credit union's officials, 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. Employee compensation is exempt from
this prohibition. All transactions not specifically prohibited by this
paragraph must be conducted at arm's length and in the interest of the
corporate.
(g) A corporate credit union's authority to hold an investment is
governed by the regulation in effect at the time of purchase. However,
all grandfathered investments are subject to the requirements of
Sec. 704.8 and Sec. 704.9.
Sec. 704.6 Credit risk management.
(a) Policies. A corporate credit union must operate according to a
credit risk management policy, which addresses, at a minimum:
(1) The approval process associated with credit limits;
(2) Due diligence analysis requirements;
(3) Maximum credit limits with each obligor and transaction
counterpart, set as a percentage of the sum of reserves and undivided
earnings and paid-in capital. In addition to addressing loans,
deposits, and securities, limits with transaction counterparts must
address aggregate exposures of all transactions, including, but not
necessarily limited to, repurchase agreements, securities lending, and
forward settlement of purchases or sales of investments; and
(4) Concentrations of credit risk (e.g., sector, industry, and
regional concentrations);
(b) Exemption. The requirements of this section do not apply to
instruments that are issued or fully guaranteed as to principal and
interest by the U.S. government or its agencies or enterprises or are
fully insured (including accumulated interest) by the National Credit
Union Administration or Federal Deposit Insurance Corporation.
(c) Concentration limits. (1) Aggregate investments in mortgage-
backed and asset-backed securities are limited to 200 percent of the
sum of reserves and undivided earnings and paid-in capital for any
single security or trust.
(2) Except for investments in a wholesale corporate credit union,
aggregate investments in repurchase and securities lending agreements
with any one counterpart are limited to 400 percent of the sum of
reserves and undivided earnings and paid-in capital.
(3) Except for investments in a wholesale corporate credit union,
the aggregate of all investments in non secured obligations of any
single domestic issuer is limited to 100 percent of the sum of reserves
and undivided earnings and paid-in capital.
(4) For purposes of measurement, each new credit transaction must
be evaluated in terms of the corporate credit union's sum of reserves
and undivided earnings and paid-in capital at the time of the
transaction. A subsequent reduction in the sum of reserves and
undivided earnings and paid-in capital will require a suspension of
additional transactions until maturities, sales or terminations bring
existing exposures within the requirements of this part.-
(d) Credit ratings. (1) All debt instruments must have a credit
rating from at least one nationally recognized statistical rating
organization.
(2) The rating(s) must be monitored for as long as the corporate
owns an instrument.
(3) Any rated instrument that is downgraded by the nationally
recognized statistical rating organization(s) used to meet the
requirements of this part at the time of purchase must be reviewed by
an appropriate committee within 20 business days of the downgrade.
Instruments that fall below the minimum rating requirements of this
part are subject to the divestiture requirements of 704.10.
(4) Investments in asset-backed securities must be rated no lower
than AAA (or equivalent). All other investments must be rated no lower
than A-1 (or equivalent) for short-term investments and AA (or
equivalent) for long-term investments at the time of purchase and at
any subsequent time by the nationally recognized statistical rating
organization(s) used to meet the requirements of this part at the time
of purchase.
(e) Reporting and documentation.
(1) A written evaluation of each credit line must be prepared at
least annually and formally approved by an appropriate committee of the
board. A watch list of existing and/or potential credit problems must
be prepared at least monthly and provided to an appropriate committee
of the board. Summary credit exposure reports, which demonstrate
compliance with the corporate's risk management policies, must be
continuously maintained, reviewed by appropriate staff, and provided
monthly to the board.
(2) At a minimum, the corporate must maintain:
(i) A justification for each approved credit line;
(ii) Prospectuses for all publicly traded securities and offering
memoranda for private placements and securities that are exempt from
the registration requirements of the Securities Act of 1933 or the
margin requirements of the Securities Exchange Act of 1934; and
(iii) The latest available financial reports, industry analyses,
internal and external analyst evaluations, and rating agency
information for each approved credit line.
Sec. 704.7 Lending.
(a) Policies. A corporate credit union must operate according to a
lending policy which addresses, at a minimum:
(1) Loan types and limits;
(2) Required documentation and collateral; and
(3) Analysis and monitoring standards.
(b) General. Each loan or line of credit limit will be determined
after analyzing the financial and operational soundness of the borrower
and the ability of the borrower to repay the loan.
(c) Loans to member credit unions. The maximum aggregate amount in
loans and irrevocable lines of credit to any one member credit union,
excluding pass-through and guaranteed loans from the CLF and the
NCUSIF, shall not exceed 50 percent of capital or 75 percent of the sum
of reserves and undivided earnings and paid-in capital, whichever is
greater, for unsecured loans and irrevocable lines of credit, or 100
percent of capital or 200 percent of the sum of reserves and undivided
earnings and paid-in capital, whichever
[[Page 28105]]
is greater, for secured loans and irrevocable lines of credit.
(d) Loans to members that are not credit unions. Any loan or
irrevocable line of credit made to a member, other than a credit union
or a corporate CUSO, must be made in compliance with Sec. 701.21(h) of
this chapter, governing member business loans. The aggregate amount of
loans and irrevocable lines of credit to members other than credit
unions and corporate CUSOs shall not exceed 15 percent of the corporate
credit union's capital plus pledged shares.
(e) Loans to non member credit unions. A loan to a credit union
that is not a member of the corporate credit union is only permissible
if the loan is for an overdraft related to the providing of
correspondent services pursuant to Sec. 704.12. Generally, such a loan
will have a maturity of only one business day.
(f) Loans to corporate CUSOs. A corporate credit union may make
loans and issue lines of credit to corporate CUSOs, subject to the
limitations of Sec. 704.11.
(g) 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.
(h) Prepayment penalties. If provided for in the loan contract, a
corporate credit union is authorized to assess prepayment penalties on
loans.
Sec. 704.8 Asset and liability management.
(a) Policies. A corporate credit union must operate according to a
written asset and liability management policy which addresses, at a
minimum:
(1) The purpose and objectives of the corporate credit union's
asset and liability activities;
(2) The tests that will be used to evaluate instruments prior to
purchase;
(3) The maximum allowable percentage decline in market value of
portfolio equity (MVPE), over specified periods of time, compared to
current MVPE;
(4) The minimum allowable MVPE ratio under any condition;
(5) The maximum decline in net income (before reserve transfers),
in percentage and dollar terms, compared to current net income;
(6) Policy limits and specific test parameters for the interest
rate risk simulation tests set forth in paragraph (e) of this section;
(7) Concentration limits that reflect the default, liquidity, and
market risks of investments;
(8) Policy limits which address transaction types and amounts for
all off-balance sheet risk (e.g., lines of credit or other contracts);
and
(9) The modeling of indexes that serve as references in financial
instrument coupon formulas.
(b) Asset and liability management committee (ALCO). A corporate
credit union's ALCO must have at least one member who is also a member
of the board of directors. The ALCO must review the asset and liability
management reports on at least a monthly basis. These reports must
address compliance with Federal Credit Union Act, NCUA Rules and
Regulations, and all related risk management policies.
(c) Penalty for early withdrawals. A corporate credit union that
permits early certificate/share withdrawals must assess market-based
penalties sufficient to cover the estimated replacement cost of the
certificate/share redeemed.
(d) Risk analysis. A corporate credit union must adopt appropriate
tests and criteria for evaluating each investment prior to its
purchase. Risk analysis of the instrument type and industry sector must
be conducted for any new product that is considered for purchase by the
corporate credit union and/or for sale to members.
(e) Interest rate sensitivity analysis. (1) A corporate credit
union must:
(i) Evaluate the risk in its balance sheet by measuring, at least
quarterly, the impact of an instantaneous, permanent, and parallel
shock in the Treasury yield curve of plus or minus 100, 200, and 300
basis points on its MVPE and MVPE ratio. If the base case MVPE ratio
falls below 2 percent at the last testing date, these tests must be
calculated no less frequently than monthly until the base case MVPE
ratio again exceeds 2 percent; and
(ii) Limit its risk exposure to levels that do not result in a MVPE
ratio below 1 percent at any time either from a calculation of a base
case MVPE ratio or as a result of the tests indicated in paragraph
(e)(1)(i) of this section.
(2) A corporate credit union must limit its risk exposures to
levels that do not result in a decline in MVPE of more than 18 percent
at any time.
(3) A corporate credit union that owns an aggregate amount of
instruments which possess unmatched embedded options in a book value
amount which exceeds 200 percent of the sum of its reserves and
undivided earnings and paid-in capital must conduct additional tests
that address market factors which potentially can impact the value of
the instruments and that reflect the policy limits addressed in
paragraph (a) of this section. These factors should include, but not be
limited to, the following:
(i) Changes in the shape of the Treasury yield curve;
(ii) Adjustments to prepayment projections used for amortizing
securities to consider the impact of significantly faster/slower
prepayment speeds;
(iii) Adjustments to the market spread assumptions for non Treasury
instruments to consider the impact of widening spreads; and
(iv) Adjustments to volatility assumptions to consider the impact
that changing volatilities have on embedded option values.
(f) Regulatory violations. If a corporate credit union's base case
MVPE or MVPE ratio or the MVPE or MVPE ratio resulting from the tests
indicated in paragraph (e)(1)(i) of this section decline below the
limits established by this part and are not brought into compliance
within 5 business days, operating management of the corporate credit
union must report the information to the board of directors,
supervisory committee, and NCUA on the sixth business day. If any of
these measures remain below the limits established by this part by the
25th business day, the corporate credit union must submit a detailed,
written action plan to NCUA that sets forth the time needed and means
by which it intends to correct the violation. If NCUA determines that
the plan is unacceptable, the corporate credit union must immediately
restructure the balance sheet to bring the exposures back within
compliance or adhere to an alternative course of action determined by
NCUA.
(g) Policy violations. If a corporate credit union's MVPE or MVPE
ratio for any required test(s) exceed the limits established by the
board, it must determine how it will bring the exposures within policy
limits. The disclosure to the board of the limit violation must occur
no later than its next regularly scheduled board meeting. A specific
written disclosure detailing the limit violation(s) and the intended
course of action must be sent to NCUA within 25 business days after
disclosure to the board.
Sec. 704.9 Liquidity management.
(a) General. In the management of liquidity, a corporate credit
union must: -
(1) Evaluate the potential liquidity needs of its membership in a
variety of economic scenarios; -
[[Page 28106]]
(2) Continuously monitor sources of internal and external
liquidity; -
(3) Demonstrate that the accounting classification of investment
securities is consistent with its ability to meet potential liquidity
demands; and
(4) Develop a contingency funding plan that addresses alternative
funding strategies in successively deteriorating liquidity scenarios.
The plan must:
(i) List all sources of liquidity, by category and amount, that are
available to service an immediate outflow of funds in various liquidity
scenarios.
(ii) Analyze the impact that potential changes in fair value will
have on the disposition of assets in a variety of interest rate
scenarios; and
(iii) Be reviewed by an appropriate committee of the board no less
frequently than annually or as market or business conditions dictate.
(b) 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
greater. CLF borrowings and borrowed funds created by the use of member
reverse repurchase agreements are excluded from this limit. The
corporate credit union must demonstrate, through periodic usage of
external lines, that all contingent sources of liquidity remain
available.
Sec. 704.10 Divestiture.
(a) Any corporate credit union in possession of an investment that
fails to meet a requirement of this part must, within 20 business days
of the failure, report the failed investment to its board of directors
and NCUA. If the corporate credit union does not sell the failed
investment, and the investment continues to fail to meet a requirement
of this part, the corporate credit union must, by the 25th business day
after the failure, provide to NCUA a written action plan that
addresses:
(1) The investment's characteristics and risks;
(2) The process to obtain and adequately evaluate the investment's
market pricing, cash flows, and risk;
(3) How the investment fits into the credit union's asset and
liability management strategy;--
(4) The impact that either holding or selling the investment will
have on the corporate credit union's earnings, liquidity, and capital
in different interest rate environments; and
(5) The likelihood that the investment may again pass the
requirements of this part.
(b) NCUA may require, for safety and soundness reasons, a shorter
time period for plan development than that set forth in paragraph (a)
of this section.
(c) If the plan described in paragraph (a) of this section is not
approved by NCUA, the credit union must adhere to NCUA's directed
course of action.
Sec. 704.11 Corporate Credit Union Service Organizations (Corporate
CUSOs).
(a) A corporate CUSO is an entity that:
(1) Has received a loan from and/or is at least partly owned by a
corporate credit union;
(2) Primarily serves credit unions;
(3) Restricts its services to those related to the daily activities
of credit unions; and
(4) Is chartered as a corporation under state law.
(b) The aggregate of all investments in and loans to member and non
member corporate CUSOs shall not exceed 15 percent of a corporate
credit union's capital. However, a corporate credit union may loan to
member and non member corporate CUSOs an additional 15 percent of
capital if it is a secured loan. 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 obligations
of another financial institution, insurance company, trade association,
liquidity facility, or similar organization. A corporate CUSO must be
operated as an entity separate from any credit union. A corporate
credit union investing in or lending to a corporate CUSO must obtain a
written legal opinion that the corporate CUSO is organized and operated
in such a manner that the corporate credit union will not reasonably be
held liable for the obligations of the corporate CUSO. This opinion
must address factors that have led courts to ``pierce the corporate
veil,'' such as inadequate capitalization, lack of separate corporate
identity, common boards of directors and employees, control of one
entity over another, and lack of separate books and records.
(c) An official or senior management employee of a corporate credit
union which has invested in or loaned to a corporate CUSO, and
immediate family members of such an individual, may not receive, either
directly or indirectly, any salary, commission, investment income, or
other income, compensation, or consideration from the corporate CUSO.
This prohibition extends to any other corporate credit union employee
if such employee deals directly with the corporate CUSO.
(d) Prior to making an investment in or loan to a corporate CUSO, a
corporate credit union must obtain a written agreement that the
corporate CUSO 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, board of directors, and NCUA complete access
to its books, records, and any other pertinent documentation.
(e) Corporate credit union authority to invest in or loan to a CUSO
is limited to that provided in this section. A corporate credit union
is not authorized to invest in or loan to a CUSO under Sec. 701.27 of
this chapter.
Sec. 704.12 Services.
Except for correspondent services to a non member, natural person
credit union branch office operating in the geographic area defined in
the corporate credit union's charter, 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 agreements with other corporate credit unions or
pursuant to Sec. 701.26 of this chapter, except with the written
permission of NCUA.
Sec. 704.13 Fixed assets.
(a) 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) A corporate credit union may invest in fixed assets where the
aggregate of all such investments does not exceed 15 percent of the
corporate credit union's capital. A corporate credit union desiring to
exceed the limitation shall submit a written request to NCUA, which
will provide a written decision.
Sec. 704.14 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) At least a majority of directors, including the chair of the
board, must serve on the board as representatives of member credit
unions;
(2) The chair of the board may not serve simultaneously as an
officer, director, or employee of a credit union trade association;
(3) 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
[[Page 28107]]
(4) For purposes of meeting the requirements of paragraphs (a)(1)
and (a)(2) 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.
(5) In the case of a corporate credit union whose membership is
composed of more than 25 percent non credit unions, the majority of
directors serving as representatives of member credit unions, including
the chair, must be elected only by member credit unions.
(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. 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. 704.15 Audit requirements.
(a) External audit. The corporate credit union supervisory
committee shall cause an annual opinion audit to be made by an
independent, duly licensed certified public accountant (CPA) and shall
submit the audit report to the board of directors. A copy of the audit
report, and copies of all communications that are provided to the
corporate credit union by the external auditor, shall be submitted to
NCUA within 30 days after receipt by the board of directors. The CPA's
audit workpapers shall be provided upon request to NCUA. A summary of
the audit report shall be submitted to the membership at the next
annual meeting.
(b) Internal audit. A corporate credit union with average daily
assets in excess of $400 million for the preceding calendar year, or as
ordered by NCUA, must employ or contract, on a full- or part-time
basis, the services of an internal auditor. The internal auditor's
responsibilities will, at a minimum, comply with the Standards and
Professional Practices of Internal Auditing, as established by the
Institute of Internal Auditors. The internal auditor will report
directly to the chair of the corporate credit union's supervisory
committee, who may delegate supervision of the internal auditor's daily
activities to the chief executive officer of the corporate credit
union. The internal auditor's reports, findings, and recommendations
will be in writing and presented to the supervisory committee no less
than quarterly, and will be provided upon request to the external
auditor and NCUA.
Sec. 704.16 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.
Sec. 704.17 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 NCUSIF, 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. 704.18 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 NCUA. 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 NCUA, requiring written notification
by surety to NCUA:
(1) When the bond of a credit union is terminated in its entirety;
[[Page 28108]]
(2) When bond coverage is terminated, by issuance of a written
notice, on an employees, director, officer, supervisory or credit
committee member; or
(3) When a deductible is increased above permissible limits. Said
notification shall be sent to NCUA and shall include a brief statement
of cause for termination or increase.
(d) Minimum coverage amounts. (1) The minimum amount of bond
coverage will be computed based on the corporate credit union's daily
average net assets as of December 31 of the preceding year. The
following table lists the minimum requirements.
------------------------------------------------------------------------
Minimum
Daily average 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
$10.0-$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) Deductibles. (1) The maximum amount of deductibles allowed are
based on the corporate credit union's reserve ratio. The following
table sets out the maximum deductibles.
------------------------------------------------------------------------
Reserve ratio Maximum deductible
------------------------------------------------------------------------
Less than 1.0 percent..................... 7.5 percent of the sum of
reserves and undivided
earnings and paid-in
capital.
1.0-1.74 percent.......................... 10.0 percent of the sum of
reserves and undivided
earnings and paid-in
capital.
1.75-2.24 percent......................... 12.0 percent of the sum of
reserves and undivided
earnings and paid-in
capital.
Greater than 2.25 percent................. 15.0 percent of the sum of
reserves and undivided
earnings and paid-in
capital up to a maximum of
$1 million.
------------------------------------------------------------------------
(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 NCUA at least 20 days
prior to the effective date of the deductibles.
(f) Additional coverage. NCUA may require additional coverage for
any corporate credit union when, in the opinion of NCUA, 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 NCUA.
Appendix A--Model Forms
This appendix contains sample forms intended for use by corporate
credit unions to aid in compliance with the membership capital account
and paid-in capital account disclosure requirements of Sec. 704.2
Corporate credit unions that use this form will be in compliance with
those requirements.
Sample Form 1
Terms and Conditions of Membership Capital Account
(1) A membership capital account is not subject to share insurance
coverage by the NCUSIF or other deposit insurer.
(2) A member credit union may withdraw membership capital with
three years' notice.
(3) Membership capital cannot be used to pledge borrowings.
(4) Membership capital is available to cover losses that exceed
reserves and undivided earnings and paid-in capital.
(5) Where the corporate credit union is liquidated, membership
capital accounts are payable only after satisfaction of all liabilities
of the liquidation estate including uninsured obligations to
shareholders and the NCUSIF.
If the form is used when an account is opened, it must also contain
the following statement:
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 membership capital
account.
The form must be signed by either all of the directors of the
member credit union or, if authorized by board resolution, the chair
and secretary of the board of the credit union.
If the form is used for the annual notice requirement, it must be
signed by the chair of the corporate credit union. The chair must then
sign a statement which certifies that the form has been sent to member
credit unions with membership capital accounts. The certification must
be maintained in the corporate credit union's files and be available
for examiner review.
Sample Form 2
Terms and Conditions of Paid-In Capital Account
(1) A paid-in capital account is not subject to share insurance
coverage by the NCUSIF or other deposit insurer.
(2) The funds have no maturity and are callable only at the option
of the corporate credit union and only if the corporate credit union
meets its minimum level of required capital after the funds are called.
(3) Paid-in capital is available to cover losses that exceed
reserves and undivided earnings.
(4) Paid-in capital is nonvoting and subordinate to membership
capital and the NCUSIF.
If the form is used when an account is opened, it must also contain
the following statement:
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 paid-in capital
account.
The form must be signed by either all of the directors of the
credit union or, if authorized by board resolution, the chair and
secretary of the board of the credit union.
If the form is used for the annual notice requirement, it must be
signed by the chair of the corporate credit union. The chair must then
sign a statement which certifies that the form has been sent to credit
unions with paid-in capital accounts. The certification must be
maintained in the corporate credit union's files and be available for
examiner review.
Appendix B--Expanded Authorities and Requirements
A corporate credit union may obtain expanded authorities if it
meets all of the requirements of part 704, fulfills additional
capital, management, infrastructure, and asset and liability
requirements, and receives NCUA's written approval. The additional
requirements and authorities are set forth in this Appendix. A
corporate credit union which seeks expanded authorities must submit
to NCUA a self-assessment plan which analyzes and supports its
request. A corporate credit union may adopt these additional
authorities after NCUA has provided its written approval. If NCUA
denies a request for expanded authorities, it will advise the
corporate of the reasons for the denial and what it must do to
resubmit its request. NCUA may revoke these expanded authorities at
any time if an analysis indicates a significant deficiency. NCUA
will notify the corporate credit union in writing of the identified
deficiency. A corporate credit union may request, in writing,
reinstatement of the revoked authorities by providing a self-
assessment plan which details how it has corrected these
[[Page 28109]]
deficiencies. Further guidance on the characteristics necessary to
obtain additional authorities is available in Appendix C.
Part I
(a) In order to participate in the authorities set forth in
paragraphs (b)-(d) of this Part I, a corporate credit union must:
(1) Have a minimum capital ratio of 5 percent.
(2) Meet the management, staff, systems, compliance, legal, and
risk assessment requirements specified in Appendix C.
(3) Evaluate monthly the changes in MVPE and the MVPE ratio for
the tests set forth in Sec. 704.8(e)(1)(i).
(b) A corporate credit union which has met the requirements of
paragraph (a) of this Part I is not bound by the concentration
limits on investments set forth at Sec. 704.6(c) (1) and (2).
Instead, the corporate credit union must establish limits on such
investments as a percentage of the sum of reserves and undivided
earnings and paid-in capital that take into account the relative
amount of credit risk exposure based upon, but not limited to, the
legal and financial structure of the transaction, the collateral,
all other types of credit enhancement, and the term of the
transaction.
(c) A corporate credit union which has met the requirements of
paragraph (a) of this Part I may:
(1) Except for investments in a wholesale corporate credit
union, invest in non secured obligations of any single domestic
issuer up to 150 percent of the sum of reserves and undivided
earnings and paid-in capital;
(2) Purchase short-term investments rated no lower than A-1 (or
equivalent) and long-term investments rated no lower than AA- (or
equivalent); at the time of purchase and at any subsequent time by
same nationally recognized statistical rating organization(s) used
at the time of purchase.
(3) Purchase asset-backed securities rated no lower than AA (or
equivalent);
(4) Engage in short sales of permissible investments to reduce
interest rate risk; and
(5) Purchase principal only (PO) stripped mortgage-backed
securities to reduce interest rate risk.
(d) In performing the rate stress tests set forth in
Sec. 704.8(e)(1)(i), the MVPE of a corporate credit union which has
met the requirements of paragraph (a) of this Part I may decline as
much as 35 percent.
(e) The maximum aggregate amount in loans and irrevocable lines
of credit to any one member credit union, excluding pass-through and
guaranteed loans from the CLF and the NCUSIF, shall not exceed 100
percent of the corporate credit union's capital for unsecured loans
and irrevocable lines of credit. The board directors will establish
the limit, as a percent of the corporate credit union's capital plus
pledged shares for secured loans and irrevocable lines of credit.
Part II
(a) In order to participate in the authorities set forth in
paragraphs (b)-(d) of this Part II, a corporate credit union must:
(1) Have a minimum capital ratio of 6 percent;
(2) Meet the management, staff, systems, compliance, legal, and
risk assessment requirements specified in Appendix C.
(3) Evaluate monthly the changes in MVPE and the MVPE ratio for
the tests set forth in Sec. 704.8(e)(1)(i).
(b) A corporate credit union which has met the requirements of
paragraph (a) of this Part II is not bound by the concentration
limits on investments set forth at Sec. 704.6(c) (1) and (2).
Instead, the corporate credit union must establish limits on such
investments as a percentage of the sum of reserves and undivided
earnings and paid-in capital, that take into account the relative
amount of credit risk exposure based upon, but not limited to, the
legal and financial structure of the transaction, the collateral,
all other types of credit enhancement, and the term of the
transaction.
(c) A corporate credit union which has met the requirements of
paragraph (a) of this Part II may:
(1) Except for investments in a wholesale corporate credit
union, invest in non secured obligations of any single domestic
issuer up to 250 percent of the sum of reserves and undivided
earnings and paid-in capital;
(2) Purchase short-term investments rated no lower than A-1 (or
equivalent) and long-term investments rated no lower than A- (or
equivalent) at the time of purchase and at any subsequent time by
the nationally recognized statistical rating organizations used at
the time of purchase.
(3) Purchase asset-backed securities rated no lower than AA (or
equivalent);
(4) Engage in short sales of permissible investments to reduce
interest rate risk; and
(5) Purchase principal only (PO) stripped mortgage-backed
securities to reduce interest rate risk.
(d) In performing the rate stress tests set forth in
Sec. 704.8(e)(1)(i), the MVPE of a corporate credit union which has
met the requirements of paragraph (a) of this Part II may decline as
much as 50 percent.
(e) The maximum aggregate amount in secured and unsecured loans
and irrevocable lines of credit to any one member credit union,
excluding pass-through and guaranteed loans from the CLF and the
NCUSIF, shall be established by the board of directors as a
percentage of the corporate credit union's capital plus pledged
shares.
Part III
(a) A corporate credit union which has met the requirements of
paragraph (a) of Part I of this Appendix and the foreign investment
criteria set forth in Appendix C, may invest in:
(1) Debt obligations of a foreign country;
(2) Deposits in, the sale of federal funds to, and debt
obligations of foreign banks or obligations guaranteed by these
banks;
(3) Non secured obligations of any single foreign issuer, not
exceeding 150 percent of the sum of reserves and undivided earnings
and paid-in capital; and
(4) Non secured obligations in any single foreign country, not
exceeding 500 percent of the sum of reserves and undivided earnings
and paid-in capital.
(b) All investments with sovereign entities and foreign banks
are subject to the following requirements:
(1) Short-term investments must be rated no lower than A-1 (or
equivalent);
(2) Long-term investments must be rated no lower than AA (or
equivalent);
(3) A sovereign issuer, and/or the country in which a corporate
issuer is organized, must be rated no lower than AA (or equivalent)
for political and economic stability.
(4) For each approved foreign bank line, the corporate credit
union must identify the specific banking centers and branches to
which it will lend funds.
Part IV
A corporate credit union which has met the requirements of
paragraph (a) of Part I of this Appendix and the financial
derivatives criteria set forth in Appendix C, may engage in
derivatives transactions which are directly related to its financial
activities and which have been specifically approved by NCUA. A
corporate credit union may use such derivatives authority only for
the purposes of creating structured instruments and hedging its own
balance sheet and the balance sheets of its members.
Appendix C--Guidelines for Evaluating Requests for Expanded
Authorities
This Appendix provides guidance for corporate credit unions
which seek expanded authorities under Appendix B of part 704. These
guidelines represent the prudent practices and acceptable
qualifications which must be evident in a corporate credit union for
NCUA to approve its request. There are four distinct expanded
authority alternatives which are set forth Appendix B. Corporate
credit unions which are granted expanded authorities must adhere at
all times to the requirements set forth in Appendix B and Appendix
C. NCUA will ensure that corporate credit unions continue to meet
the necessary qualifications and remain in sound financial condition
through its regular, on-going safety and soundness review. Provided
that the corporate credit union is in sound financial condition, the
primary areas which are used to evaluate each request for expanded
authority are: board, senior management, and staff; systems and
operations; credit risk management; liquidity risk management; audit
and compliance; and legal matters.
Part I
(a) General. Requests for the expanded authorities as outlined
in Appendix B, Part I, will be evaluated based on the criteria
outlined in paragraphs (b) through (g) of this Appendix C, Part I.
(b) Board, senior management, and staff.
(1) The board has received adequate training and is sufficiently
knowledgeable to make informed decisions regarding the risk
activities of the corporate credit union and to properly evaluate
the use of the expanded authorities.
(2) Senior management has in-depth experience in their direct
areas of responsibility and a working knowledge of most key areas.
(3) The asset and liability committee (ALCO) members are
conversant in investment activities and strategies and are
[[Page 28110]]
capable of individually explaining, justifying, and supporting the
risk exposures of the corporate credit union.
(4) Senior investment managers and asset and liability managers
have knowledge and experience commensurate with the potential
expanded authorities of the corporate credit union.
(5) Staff supporting the asset and liability management
functions have expert knowledge in developing and applying the
assumptions, methodologies, and interrelationships between the
financial factors driving the risk measurement results. The staff
has the ability to adjust the model and customize applications
consistent with the additional test requirements of
Sec. 704.8(e)(3).
(6) Qualified designated back-ups are in place and capable of
assuming primary responsibilities. Back-ups are adequately trained
to ensure that minimum disruption would occur in the event of the
loss (temporary or permanent) of primary personnel.
(7) Qualified, cross-trained personnel are in place for all
essential support positions.
(c) Systems/Operations. (1) Systems support and operational
capacity are adequate to process, measure, monitor, and report all
financial transactions. This includes the capacity to handle volume
and complexity with timely and accurate results. Systems can provide
sophisticated measures of valuation for a variety of simulated
market scenarios. Systems can interface, and automation ensures a
strong measure of control and standardization.
(2) The major financial-related areas, which require a
particular emphasis upon support and control, are the accounting and
risk measurement systems. Specific areas of infrastructure strength
include, but are not limited to, the following areas:
(i) Valuation of instruments and risk measurement.
(A) Methodologies permit alternative scenario analysis in
addition to those required in Sec. 704.8(e)(3).
(B) Qualified staff are capable of challenging and validating
the analytical applications and assumptions of the risk measurement
methodologies.
(C) Simulations can be produced in a timely, accurate manner on
at least a monthly basis.
(D) Variance analysis is conducted each month to evaluate and
explain the reasons for differences between projected and actual
results.
(E) The model(s) and supporting processes are capable of meeting
the needs of management reporting for both compliance and decision-
making.
(F) The model(s) and supporting statistical analyses used to
measure risk are validated prior to use and periodically thereafter.
(ii) Accounting for transactions.
(A) Accounting processes are independent of the risk taking unit
(investments).
(B) Accounting systems and processes are commensurate with
instruments that have complex structures and/or embedded options,
including off-balance sheet activities.
(C) Systems have a demonstrated ability to produce timely,
accurate financial statements for internal and external purposes, in
conformance with GAAP.
(D) There is an on-line, dedicated, and automated system capable
of providing timely, accurate reports independent of the corporate
credit union's risk taking unit. Reports are standardized and may be
customized for both financial and risk reporting purposes. For
example, systems would include:
(1) Automated data transfer;
(2) On-demand report generation based on current data;
(3) Ability to account for investments with complex structures
and/or embedded options including off-balance sheet activities;
(4) Accounts for all investment characteristics and cash flows;
(5) General ledger treatment--amortization/accretion of
discounts/premiums can be produced for dynamic cash-flow instruments
and transactions;
(6) Security safeguards that ensure protection and integrity of
input and output through a dedicated and controlled system
environment;
(7) Ability to handle expanded authorities and changes in
strategies and external market factors; and
(8) Establishment and maintenance of adequate back-up
arrangements to minimize the disruption of major services and to
address system problems timely.
(d) Credit risk management. The credit risk management function
is independent and able to assess the inherent risk associated with
all concentrations, limits and proposed transactions, including any
additional authorities provided in Appendix B. The measuring and
monitoring methodologies are sufficient to meet the scope and
complexity of all credit related activities. (1) Management/Staff.
(i) Credit risk management is independent from the risk taking unit
and is directed by a level of senior management sufficient to ensure
that credit risk activities remain consistent with board policies
and objectives.
(ii) Analysts are qualified to identify and assess the inherent
credit risk in all transactions that possess material credit
exposures. Analysts have knowledge and experience in evaluating
credit risk in the money and capital markets.
(2) Policies and procedures. (i) Procedures address the
methodology for measuring and monitoring credit risk and the means
of responding to a deterioration in credit.
(ii) There is a daily process of measuring and reporting the
credit exposures in comparison to policy limits.
(iii) Procedures provide the risk taking unit with daily credit
exposures and remaining limit capacity.
(iv) Credit limits and transaction types are approved by a
credit risk committee to ensure consistency with corporate credit
union objectives.
(v) Senior credit personnel have the direct authority to reduce,
suspend, or revoke a credit limit.
(e) Liquidity risk management. (1) Effective controls exist for
liquidity exposures arising from both market or product liquidity
and instrument cash flows.
(2) Daily liquidity management procedures for investment
activities are an integral part of the day-to-day operations.
(3) Management reporting includes an on-going daily liquidity
assessment which is updated to reflect current changes to investment
and funding positions.
(f) Audit and compliance. (1) The internal audit and compliance
area has staff, or has engaged outside personnel, with expert
knowledge and experience adequate to support the scope and
complexity of all activities associated with expanded authorities.
(2) The scope of review addresses appropriateness of risk as
well as general compliance issues.
(g) Legal issues. The corporate credit union has inside legal
counsel or has access to outside counsel which can provide a
specialized review of all associated legal matters.
Part II
(a) General. Requests for the expanded authorities as outlined
in Appendix B, Part II, will be evaluated based on the criteria
outlined in paragraphs (b) through (f) of this Appendix C, Part II.
(b) Senior management and staff. (1) Senior management is
demonstrably familiar with key areas of the corporate credit union
and conversant in technical factors affecting the institution's
risk.
(2) Senior management is substantially represented by
individuals who have extensive related experience with a depository
institution, investment banker, or broker/dealer.
(3) Investment and risk management staff have substantial
experience and have received extensive training to support expanded
authorities.
(c) Systems and operations. (1) Qualified staff are capable of
modeling securities and financial transactions to determine that
components are valued consistent with the market. This means that
the value of all transactions, securities, and options can be
independently determined by corporate credit union staff.
(2) Senior management receives a daily position report detailing
current activities, mark-to-market valuations, balance sheet
positions, and other critical financial information.
(d) Credit risk management. (1) Management and staff. (i) Senior
credit analyst(s) has extensive experience (e.g., years of
experience, held positions of responsibility, and/or completed
specialized credit training in capital markets) with particular
emphasis on evaluating financial institutions and debt securities.
(ii) Sufficient number of analysts are on staff to ensure that
all credits receive appropriate, timely, and in-depth analysis.
(2) Policies and procedures. (i) The credit risk management is a
stand-alone unit.
(ii) There is a formal credit risk committee which approves all
credit limits.
(e) Audit and compliance. (1) There is an independent, stand-
alone risk compliance unit managed by senior staff who are capable
of comprehending, evaluating, and challenging all potential risk
areas of the corporate credit union.
[[Page 28111]]
(2) A highly qualified senior management executive is
responsible for the unit.
(3) The unit is responsible for assuring the board of directors
that staff in all potential risk areas are conducting their
activities in conformance with all board policies and procedures.
(4) The unit is also responsible for assisting management in
developing and enhancing the existing risk management processes to
improve the areas where potential weaknesses or deficiencies are
identified.
(5) The unit has specialized staff with extensive knowledge of
systems, policies, and procedures used to govern all approved
activities and which understands the inherent risk issues affecting
those activities.
(f) Legal issues. The corporate credit union maintains inside
counsel or has established relationships with outside legal firms
which specialize in evaluating relevant contracts and transactions
to ensure that the corporate credit union's legal and business
interests are represented for all expanded authorities.
Part III
(a) General. Requests for the expanded authorities as outlined
in Appendix B, Part III, will be evaluated based on the criteria for
management, staff, systems, compliance, legal, and risk assessment
specified in Part I of this Appendix C and the additional criteria
outlined in paragraphs (b) and (c) of this Part III.
(b) Senior management and staff. (1) Senior management has
addressed the unique potential risk impact of foreign investments
and has contingency policies and procedures to address these
factors.
(2) Staff includes qualified analysts with knowledge and
experience evaluating cross-border risk.
(3) Analysts are experienced in evaluating sovereign and foreign
institution credits and conduct a timely, in-depth analysis for all
approved foreign limits.
(4) Analysts have training and/or experience in evaluating the
political, economic and regulatory environment and the unique
financial and accounting standards which affect the interpretation
of financial data used to evaluate foreign counterparties.
(c) Systems and operations. (1) An automated system is in place
which monitors all foreign investment exposures by entity and
country and is updated daily or as exposures change; and
(2) Credit risk management procedures address the unique
political, legal, and economic factors which potentially affect all
approved foreign counterparties.
Part IV
(a) General. Requests for the expanded authorities as outlined
in Appendix B, Part IV, will be evaluated based on the criteria for
management, staff, systems, compliance, legal, and risk assessment
specified in Part I of this Appendix C and the additional criteria
outlined in paragraphs (b) through (h) of this Part IV.
(b) Request to NCUA for authority. The request for derivative
authority must include, at a minimum, the following:
(1) A detailed description of the relevant products, markets and
business strategies including examples of how each type of proposed
transaction will work;
(2) The methodology for measuring exposures and the proposed
limits on each type of transaction, as well as an aggregate limit
based upon a percentage of capital at risk;
(3) The costs associated with establishing effective risk
management systems and hiring and retaining professionals with
derivative transaction experience;
(4) An analysis which justifies the reasonableness of the
proposed activities relative to the corporate credit union's overall
financial condition and capital level;
(5) An analysis of the risks that may arise from the use of
derivatives which includes, at a minimum, market, credit, liquidity,
operations, and legal risks;
(6) The detailed procedures the corporate credit union will use
to effectively identify, measure, monitor, report, and control
risks;
(7) The relevant accounting guidelines to be used;
(8) Internal control procedures detailing the segregating of
duties between the staff that executes transactions and operational
personnel that monitor and report activity; and
(9) The scope of the audit and internal risk monitoring
functions.
(c) Board, senior management, and staff. (1) Board and senior
management have sufficient knowledge and experience to understand,
approve, and provide oversight for all proposed derivative
activities.
(2) Board members and responsible management and staff have
received adequate training to familiarize them with all relevant
aspects of effective derivative use and related control issues
before assuming risk exposures.
(3) Board and senior management understand and agree that the
risk management process that will be used is appropriate and that
actual and potential risk exposures will be clearly identified and
fully disclosed to the board on a regular basis.
(4) Senior management has retained knowledgeable and experienced
personnel in derivative transactions for both the management and
operations functions.
(5) The manager directly responsible for these activities has
extensive related experience with a depository institution,
investment banker, or broker/dealer.
(d) Systems and operations. (1) The board has dedicated
sufficient financial and personnel resources to support operations
and systems development and maintenance. The sophistication of the
systems support and operational capacity is commensurate with the
size and complexity of the derivatives activity.
(2) Derivatives support systems provide accurate and timely
transactions processing and allow for proper risk exposure
monitoring and interfacing with other systems of the corporate
credit union.
(3) The risk measurement system is capable of quantifying the
risk exposures resulting from derivatives activities arising from
changes in relevant market factors.
(4) The market risk measurement system is capable of producing
prompt and accurate assessments at least monthly.
(5) The risk management system addresses, at a minimum, the
following:
(i) Procedures that accurately identify and quantify risk levels
on a timely basis;
(ii) Limits and other controls on levels of risk associated with
counterparty credit, concentrations and other relevant market
factors;
(iii) Limits on aggregate risk positions which capture the
inter-connected effect of all positions;
(iv) Reports to senior management and the board that accurately
present the types and amounts of risks assumed and demonstrate
compliance with approved policies and limits; and
(v) Auditing procedures to ensure the integrity of risk
management systems and confirm compliance with approved policies and
procedures.
(6) Appropriate resources are devoted to operations sufficient
to support the scope and complexity of the activities.
(7) Effective senior management supervision and Board oversight
is in place to ensure that all derivative activities are conducted
in a safe and sound manner.
(8) Comprehensive written policies and procedures are approved
by the board and periodically reviewed thereafter as activity levels
or market and business conditions warrant.
(9) Procedures support the proper control over the recordation,
settlement, and monitoring of derivative transactions. Internal
controls assure that proper processing procedures for all
transactions and reconciliation of front and back office databases
is done on a regular basis.
(10) Policies and procedures address risk management (market,
credit, liquidity, and operations), legal issues, capital
requirements, and accounting standards. In conjunction with the
credit risk function, the methods of valuation (e.g. bid side or
mid-market) are appropriate and the sources and methods of pricing
are reasonable and supportable.
(e) Credit risk management. (1) Policies and procedures are in
place to address, at a minimum, significant counterparty exposures,
concentrations, credit exceptions, risk ratings, and non performing
contracts. Management has established internal limits which are
prudent and consistent with the corporate credit union's financial
condition and management's expertise.
(2) Timely, detailed reports, which are consistent with the
policy and procedure requirements, are available for board and
senior management review. Reports consolidate activities by
counterparty and are incorporated into aggregate credit exposure
reports for other non derivative exposures.
(3) Approved counterparts have credit ratings no lower than
operating parameters authorized for the corporate credit union under
Part I of this Appendix B.
(4) Credit personnel are qualified to identify and assess the
inherent credit risk in all proposed derivative transactions.
(5) Procedures ensure credit analysis of counterparties is
performed before transactions are executed and there is periodic
assessment of credit throughout the life of outstanding derivative
transactions.
[[Page 28112]]
(6) Credit procedures address the availability and impact of
credit exposure reduction techniques (e.g., bilateral collateral
agreements and/or mutual margining agreements).
(7) The corporate credit union can calculate the current mark-
to-market (current exposure) as well as projected changes in value
(potential exposure) when assessing credit exposure per transaction
and counterparty.
(8) Reports track the aggregate and net exposures for each
counterparty.
(9) Mark-to-market calculations are obtained independently from
qualified sources as frequently as necessary.
(10) Policies and procedures address the issue of settlement
risk and establish prudent settlement limits where applicable.
(f) Liquidity risk management. (1) Effective controls exist for
liquidity exposures arising from both market or product liquidity
and instrument cash flows.
(2) Policies address the exposures to cash flow gaps arising
from derivative transactions and establish appropriate limits on the
size and duration of such gaps (e.g., concentration of swap
payments, margin calls, or early terminations).
(3) Liquidity management procedures for derivatives are an
integral part of the day-to-day operations and are also incorporated
into the overall liquidity stress test and contingency funding plan
requirements of Sec. 704.8.
(4) Monitoring procedures are integrated with the overall
liquidity management process for all corporate credit union
activities.
(g) Audit and compliance. (1) An independent risk management
unit is responsible for measuring and reporting risk exposures taken
in derivatives.
(2) Audit coverage is adequate to ensure timely identification
of internal control weaknesses or system deficiencies. Audit
coverage is provided by competent professionals who are
knowledgeable about the risks inherent in derivative transactions
and have commensurate experience auditing financial institutions
which utilize the same or similar types of derivatives. The scope of
the audit includes coverage of the accounting, legal, operating, and
risk controls.
(3) All risk measurement applications and models are reviewed
and validated annually.
(4) Controls are in place to ensure documentation is confirmed,
maintained and safeguarded. Any documentation exceptions are
monitored and reviewed by appropriate senior management and legal
counsel.
(h) Legal issues. (1) The corporate credit union has in-house
legal counsel or has access to outside counsel which can reasonably
ensure that any derivatives related contracts adequately represent
the legal and business interests of the corporate credit union.
(2) The corporate credit union has access to outside counsel
which is expert in all financial derivatives contracts and related
matters. -
PART 709--INVOLUNTARY LIQUIDATION AND CREDITOR CLAIMS
2. The authority citation for part 709 continues to read as
follows:
Authority: 12 USC 1766; Pub. L. 101-73, 103 Stat. 183, 530
(1989) (12 USC 1787 et seq.).
3. Section 709.5 is amended by revising paragraphs (b)(6) and
(b)(7); removing the period and adding a semicolon and the word ``and''
at the end of paragraph (b)(8); and adding paragraph (b)(9) to read as
follows:
Sec. 709.5 Payout Priorities in Involuntary Liquidation.
* * * * *
(b) * * *
(6) Shareholders to the extent of their respective uninsured shares
and the National Credit Union Share Insurance Fund, to the extent of
its payment of share insurance;
(7) In a case involving liquidation of a corporate credit union,
membership capital; and
* * * * *
(9) In a case involving liquidation of a corporate credit union,
paid-in capital.
* * * * *
PART 741--REQUIREMENTS FOR INSURANCE
4. The authority citation for part 741 continues to read as
follows:
Authority: 12 USC 1757, 1766, and 1781-1790. Section 741.11 is
also authorized by 31 USC 3717.
5. Section 741.219 is added to read as follows:
Sec. 741.219 Investment requirements.
Any credit union which is insured pursuant to Title II of the Act
must adhere to the requirements stated in part 703 of this chapter
concerning transacting business with corporate credit unions.
[FR Doc. 96-13518 Filed 6-3-96; 8:45 am]
BILLING CODE 7535-01-U