[Federal Register Volume 61, Number 189 (Friday, September 27, 1996)]
[Rules and Regulations]
[Pages 50696-50698]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-24457]


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NATIONAL CREDIT UNION ADMINISTRATION
12 CFR Parts 701, 709 and 741


Organization and Operations of Federal Credit Unions

AGENCY: National Credit Union Administration (NCUA).

ACTION: Final rule.

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SUMMARY: The final rule allows credit unions serving predominantly low-
income members (LICU) to raise secondary capital from foundations and 
other philanthropic-minded institutional investors. The rule will 
enable LICUs to make more loans and improve other financial services 
for the groups and communities they serve. The rule also allows 
federal- and state-chartered LICUs to offer secondary capital accounts 
and incorporates the existing regulatory provisions concerning the 
designation of low-income status. The rule also amends NCUA's 
regulations so that secondary capital accounts are last in payout 
priorities in the event of an involuntary liquidation.

EFFECTIVE DATE: September 27, 1996.

FOR FURTHER INFORMATION CONTACT: Joyce Jackson, Director, Office of 
Community Development Credit Unions, at 1775 Duke Street, Alexandria, 
Virginia 22314-3428 or telephone (703) 518-6610, or David Marquis, 
Director, or Stephen Austin, Acting Deputy Director, Office of 
Examination and Insurance, both at the above address or telephone (703) 
518-6360, or Robert M. Fenner, General Counsel, at the above address or 
telephone (703) 518-6540.

SUPPLEMENTARY INFORMATION:

Background

    On February 2, 1996, the NCUA Board issued an interim final rule 
(``Interim Rule''), 61 FR 3788, that authorized LICUs to accept funds 
as secondary capital from nonnatural persons and philanthropic 
institutional investors. The Board issued the Interim Rule to achieve 
the following goals: to assist LICUs in achieving their purpose of 
serving members and communities in financial need; to ensure that any 
authorized secondary capital will actually function as capital and be 
available to absorb losses; to ensure that investors in secondary 
capital understand the nature of their investment and the risk they are 
undertaking; and to eliminate any potential risk to the NCUSIF and 
insured credit unions generally as a result of this activity.

Summary of Comments and Discussion of Issues

    NCUA received six comment letters: three from state credit union 
leagues; two from national credit union trade associations; and one 
from an accounting trade group. The five credit union commenters 
expressed strong support for the Interim Rule with one commenter 
viewing the Interim Rule ``as the most important regulatory innovation 
of the last two decades in addressing the special needs of [LICUs].'' 
The accounting trade group neither supported nor opposed the Interim 
Rule.

Use of Secondary Capital To Replenish Operating Losses

    Two commenters expressed support for the Interim Rule's provisions 
that required LICUs to use the secondary capital to cover the LICU's 
operating losses. However, both commenters disagreed with NCUA's 
decision to prohibit LICUs from replenishing the secondary capital when 
the LICU regained financial health. One of the commenters questioned 
NCUA's rationale and the other commenter asked the NCUA to reexamine 
its position. The latter commenter believed NCUA could establish 
safeguards so the replenishment of secondary capital would be 
subordinate to the LICU's other goals, such as reinstituting dividends 
and building capital. The commenter also believed NCUA's position 
unfairly penalized investors and decreased the secondary capital's 
attractiveness.
    Permitting LICUs to replenish secondary capital accounts once 
financial health has been regained would defeat the purpose for 
establishing secondary capital. The goal of secondary capital is to 
enhance capital positions. The potential growth of primary capital 
could be slowed by allowing LICUs to replenish investor funds in the 
event those funds are depleted. Additionally, permitting replenishment 
could be interpreted as a ``guaranteed return of principal'' by the 
investor which was not the Board's original intent.

Secondary Capital as Equity

    Two commenters objected to the Interim Rule's provisions that 
required LICUs to treat secondary capital as equity. Instead, the 
commenters believed that LICUs should treat secondary capital as debt 
according to GAAP. One commenter stated that classifying secondary 
capital as equity was misleading and recommended that NCUA require 
LICUs to exclude non-GAAP financial information from the LICU's 
financial statements. The commenter also strongly encouraged NCUA to 
follow the other federal financial regulators and conform all of NCUA's 
regulatory accounting practices to GAAP. The other commenter requested 
additional guidance from NCUA since many LICUs and auditing firms will 
not be familiar with the accounting issues associated with secondary 
capital.
    The Board has considered the commenter's position, and acknowledges 
that while secondary capital accounts have characteristics of both debt 
and equity, in the final analysis, it believes secondary capital is 
more analogous to equity. Thus, for reporting purposes, LICUs should 
record secondary capital accounts consistent with Accounting Bulletin 
96-1 (the ``Bulletin''), which establishes the accounting entries for 
secondary capital. The Bulletin requires secondary capital to be 
treated as part equity and part subordinated debt based on a sliding 
scale. The Board anticipates that most LICUs will not be seeking audit 
opinions on their financial statements nor posting GAAP statements for 
members or other third-party reliance. Most LICUs financial statement 
reporting efforts will be directed to meeting NCUA regulatory 
requirements and thus, our approach is not at odds with the other 
federal banking agencies since they, too, have preserved their option 
to adopt regulatory reporting requirements for supervisory purposes.

[[Page 50697]]

Sliding Scale

    One commenter objected to the requirement that LICUs add a footnote 
to their financial statements reflecting the secondary capital's value 
as a percentage of its face value, on a five year sliding scale. The 
commenter suggested the footnote should state the secondary capital's 
total dollar amount and maturity date. According to the commenter, 
their proposed method would be consistent with GAAP and reflect the 
economic reality that all of the secondary capital would be available 
to absorb losses until maturity.
    The Bulletin specifically provides for two separate accounts for 
recognizing secondary capital. The first, uninsured secondary capital 
(account #925) shows the amount of secondary capital having a maturity 
greater than 5 years. Subordinated CDCU Debt (account #867) recognizes 
the secondary capital accounts with maturities of less than 5 years. 
The rule establishes a sliding scale for the capital value of accounts 
with less than 5 years remaining maturity. The Board believes a 
footnote disclosure recognizing the secondary capital's total dollar 
amount and maturity date would be appropriate. As a result, the final 
rule directs LICUs to reflect the secondary capital's full amount in a 
footnote to its balance sheet, and reflect the secondary capital's 
capital value based on the sliding scale in the LICU's balance sheet.

Requiring Secondary Capital as a Condition of Charter or Letter of 
Understanding and Agreement

    Finally, two commenters expressed concerns that the rule may result 
in tougher requirements for new or troubled LICUs. Both commenters 
believed that NCUA should not require a LICU to obtain secondary 
capital before the NCUA granted a charter or as a condition of a Letter 
of Understanding and Agreement. One commenter noted that the Interim 
Rule did not require LICUs to offer secondary capital and believed that 
NCUA should only direct a LICU to obtain secondary capital in rare 
instances.
    The Board strongly believes secondary capital will help support 
greater lending and financial services for members of LICUs; however, 
it was never the Board's intention to require secondary capital as a 
condition for new LICUs. The decision to use secondary capital accounts 
is within the discretion of the LICU.

Final Rule

    The final rule adopts with minor modifications the Interim Rule 
published on February 2, 1996. (61 FR 3788).

Regulatory Procedures

Regulatory Flexibility Act

    The NCUA Board certifies that this rule will not have a significant 
impact on a substantial number of small credit unions. The rule affects 
only low-income designated credit unions, and imposes no mandatory 
regulatory burden on those credit unions. Rather, it increases 
flexibility by providing a new method of raising capital through 
secondary capital accounts. Accordingly, a Regulatory Flexibility 
Analysis is not required.

Paperwork Reduction Act

    The collection of information requirements contained in the rule 
were approved by the Office of Management and Budget under OMB Control 
No. 3133-0140. Federally insured credit unions are not required, 
pursuant to the terms of the Paperwork Reduction Act, to comply with 
paperwork requirements until OMB approval and a OMB control number are 
received. However, NCUA expected LICUs that chose to offer secondary 
capital accounts, as a matter of safety and soundness, to adopt written 
plans, forward a copy of the LICU's plan to the Regional Director (and 
state supervisor in the case of state credit unions) and use account 
contract documents and disclosure forms that meet the requirements of 
this rule in every respect.
    Written comments on the collection of information should be sent to 
the Office of Management and Budget, OMB Reports Management Branch, New 
Executive Office Building, Room 10202, Washington, DC 20503. Attn: 
Alexander Hunt. The collection of information requirements relating to 
the final rule are found at 12 CFR 701.34(b) (1) and (11). NCUA 
believes these requirements are essential both to ensure the safe and 
sound operation of a secondary capital program and to ensure that 
account holders fully understand the nature of their investment in the 
credit union and the risks involved. The likely recordkeepers are 
Federally-insured credit unions with a low-income designation.
    Estimated number of respondents and/or recordkeepers: 50.
    Estimated average annual burden hours per respondent/recordkeeper: 
3 hours.
    Estimated total annual reporting and recordkeeping burden: 150 
hours.
    Start-up costs to respondents: None.

Executive Order 12612

    Executive Order 12612 requires NCUA to consider the effects of its 
actions on state interests. This rule has no adverse effects on state 
interests. The rule provides additional authority for federally insured 
state chartered credit unions, but only to the extent not inconsistent 
with state law and regulations. The NCUA Board, however, specifically 
requested the comments of State credit union regulators to obtain their 
guidance in how the rule may affect their credit unions. However, no 
State credit union regulator commented on the Interim Rule.

List of Subjects in 12 CFR Part 701

    Credit unions, Reporting and recordkeeping requirements.

    By the National Credit Union Administration Board on September 
18, 1996.
Becky Baker,
Secretary of the Board.

    Accordingly, the interim rule amending 12 CFR parts 701, 709, and 
741, which was published at 61 FR 3788 on February 2, 1996, is adopted 
as a final rule with the following change:

PART 701--ORGANIZATION AND OPERATIONS OF FEDERAL CREDIT UNIONS

    1. The authority citation for part 701 continues to read as 
follows:

    Authority: 12 U.S.C. 1752(5), 1755, 1756, 1757, 1759, 1761a, 
1761b, 1766, 1767, 1782, 1784, 1787, 1789 and Public Law 101-73. 
Section 701.6 is also authorized by 31 U.S.C. 3717. Section 701.31 
is also authorized by 12 U.S.C. 1601, et seq., 42 U.S.C. 1981 and 42 
U.S.C. 3601-3610. Section 701.35 is also authorized by 12 U.S.C. 
4311-4312.

    2. Section 701.34 is amended by revising paragraphs (b)(2) and (c) 
to read as follows:


Sec. 701.34  Designation of low-income status; receipt of secondary 
capital accounts by low-income designated credit unions.

* * * * *
    (b) * * *
    (2) The secondary capital account must be established as a 
uninsured secondary capital account or other form of non-share account.
* * * * *
    (c) Accounting treatment; weighted value for purposes of 
recognizing capital value of secondary capital accounts. (1) A low-
income designated credit union that issues secondary capital accounts 
pursuant to paragraph (b) of this section shall record the funds on its 
balance sheet in an equity account entitled ``uninsured secondary 
capital

[[Page 50698]]

account.'' For such accounts with remaining maturities of less than 
five years, the credit union shall reflect the capital value of the 
accounts in its financial statement in accordance with the following 
scale:
    (i) Four to less than five years remaining maturity--80 percent.
    (ii) Three to less than four years remaining maturity--60 percent.
    (iii) Two to less than three years remaining maturity--40 percent.
    (iv) One to less than two years remaining maturity--20 percent.
    (v) Less than one year remaining maturity--0 percent.
    (2) The credit union will reflect the full amount of the secondary 
capital on deposit in a footnote to its financial statement.
* * * * *
[FR Doc. 96-24457 Filed 9-26-96; 8:45 am]
BILLING CODE 7535-01-P