[Federal Register Volume 62, Number 53 (Wednesday, March 19, 1997)]
[Rules and Regulations]
[Pages 12929-12949]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-6417]
[[Page 12929]]
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NATIONAL CREDIT UNION ADMINISTRATION
12 CFR Parts 704, 709, and 741
RIN 3133-AB67
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: Final rule.
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SUMMARY: NCUA is issuing a final rule governing corporate credit
unions. The rule strengthens capital requirements, establishes
parameters to ensure that the risk on corporate credit union balance
sheets is adequately managed, provides for corporate credit unions with
more developed systems and infrastructures to take more planned and
controlled risk, and sets forth special rules for wholesale corporate
credit unions.
EFFECTIVE DATE: January 1, 1998.
ADDRESSES: National Credit Union Administration, 1775 Duke Street,
Alexandria, Virginia 22314-3428.
FOR FURTHER INFORMATION CONTACT: Robert F. Schafer, 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
In April 1995, NCUA issued a proposed regulation to revise most of
Part 704. 60 FR 20438, Apr. 26, 1995. In response to the comments
received and results of risk-profile assessments of corporate credit
unions using simulated modeling techniques, NCUA determined to issue a
revised proposed rule for another round of public comment. 61 FR 28085,
June 4, 1996. The proposed rule provided for a 90-day comment period,
ending on September 3, 1996. On July 16, 1996, NCUA issued a proposed
rule addressing the special circumstances of wholesale corporate credit
unions. 61 FR 38117, July 23, 1996. The comment period to this proposal
also ended on September 3, 1996. The comment period for both proposals
subsequently was extended to October 18, 1996. 61 FR 41750, August 12,
1996. This final rule addresses both proposals.
A total of 289 comments were received on the proposals, 202 from
natural person credit unions, 36 from corporate credit unions, 24 from
state banking trade associations; 10 from state credit union leagues, 5
from state credit union regulatory authorities, 4 from national credit
union trade associations, 4 from credit union organizations and
consultants, 3 from other entities that do business with credit unions,
and 1 from another type of trade association. The commenters
complimented NCUA's efforts to strengthen the regulation and stated
that progress had been made from the previous proposal but that changes
were still necessary.
A general comment was a request to standardize the time frames for
corporate credit unions to take various actions described throughout
the regulation. The proposed regulation required corporate credit
unions to take action in some cases in business days and in others in
calendar days. There also were five different numbers of days for those
actions. To make compliance easier, all dates in the final regulation
have been changed to calendar days, and the number of days for
compliance has been reduced to either 10 days, when only notification
is required, or 30 days, when more substantive action is required.
A common thread in many of the comments was the comparison of
corporate credit unions with natural person credit unions, banks,
savings and loans, and other financial institutions. Another was the
suggestion that NCUA take the same approach with corporate credit
unions as its sister federal financial institution regulatory agencies
take with their respective institutions. While these comparisons are
understandable, NCUA cautions that in many cases, they are not
appropriate.
Corporate credit unions differ from natural person credit unions,
banks, savings institutions, and other financial institutions that
serve consumers. They serve exclusively one class of customer: credit
unions. Corporate credit union balance sheets, cash flows, and
liquidity demands differ significantly from those of other financial
institutions. In general, the volume of large dollar transactions
present unique risks not seen in consumer-oriented institutions. As a
result, while considering comparisons with other institutions and
sister agencies, NCUA has been careful to put those comparisons into
proper perspective and to regulate to the areas of risk.
A number of commenters strongly suggested that NCUA review the
corporate regulation on an annual basis. While NCUA believes that a
periodic review is necessary, it believes that circumstances and need
should determine the frequency. NCUA has identified a number of issues,
some of which are identified in this supplementary information section,
that warrant further study relatively soon after the regulation is
implemented. Accordingly, the Office of Corporate Credit Unions will
present a report of these and other issues within 18 months of
publication of the final rule.
B. Section-by-Section Analysis
Section 704.1--Scope
Part 704 applies directly to all federally insured corporate credit
unions. It applies to non federally insured corporate credit unions,
via Part 703 of the Rules and Regulations, if such credit unions accept
shares from federally chartered credit unions. To clarify the
application of Part 704, the proposed rule added language to the Scope
section stating 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. Although a few commenters questioned the need
for such a contract, the language has been retained in the final rule.
Since the majority of natural person credit unions are federally
insured, NCUA has a strong interest in ensuring that corporate credit
unions which accept their funds remain safe and sound institutions.
Proposed Section 704.1(b), which set forth NCUA's authority to
waive a requirement of Part 704, is retained in this final rule. NCUA
may use this authority to respond to innovation at corporate credit
unions and in the marketplace. NCUA envisions the approval of pilot
programs involving new investments or activities. Such programs would
be approved on a limited basis so that NCUA could assess their impact
on corporate credit unions.
Language has been added to clarify that a state chartered corporate
credit union's request for expanded authority must be approved by the
state supervisory authority before being submitted to NCUA.
Section 704.2--Definitions
The proposed rule added a number of new definitions, revised
others, and deleted some. A few commenters took exception to specific
proposed definitions. Their comments and NCUA's responses are discussed
below.
In response to a comment, the definitions of the following terms
have been changed from the language that was proposed. The definition
of ``adjusted trading'' has been amended to include transactions not
``used to defer
[[Page 12930]]
a loss.'' The definition of collateralized mortgage obligation has been
changed so that the collateral may consist simply of ``mortgages,''
rather than ``whole loan mortgages.'' The word ``may'' has been added
to the definition of ``commitment'' so that the list of items included
in the term is not absolute. Although the definition of ``expected
maturity'' was proposed to be deleted, it has been retained. A
commenter noted that the term is used in the definitions of ``long-term
investment'' and ``short-term investment.'' The definition of ``federal
funds'' has been broadened to include transactions with domestic
branches of foreign banks, various government-sponsored enterprises,
and other non depository entities. The definition of ``securities
lending'' has been expanded to more precisely describe the activity.
The definition of ``wholesale corporate credit union'' has been changed
in light of the addition of Section 701.19 to the regulation.
The proposed definition that elicited the most comments was that
for ``market value of portfolio equity (MVPE).'' The proposed
definition treated membership capital as a liability, rather than as
part of MVPE. A number of commenters urged that it be included in MVPE.
Before addressing that issue, it must be noted that NCUA has determined
to replace the term MVPE in the rule with that of net economic value
(NEV). The calculation itself has not been altered, merely renamed. The
adoption of the term ``net economic value'' in place of ``market value
of portfolio equity'' is preferred because of the potential confusion
that results from the integral terms ``market'' and ``portfolio.'' The
calculation of estimated fair value, for both assets and liabilities,
is not only obtained from market sources. The term ``portfolio'' is
more typically used to describe investment or loan assets in contrast
to an entire balance sheet. While MVPE is a commonly used term in the
profession of asset and liability management, many practitioners and
other financial regulators have recently opted for new terminology. NEV
better connotes the concept of intrinsic or fair value of the whole
balance sheet than does MVPE.
The suggestion that ``capital is capital,'' whatever its form, is
the basis for the argument that corporate credit unions should be
permitted to include secondary capital in the base for all risk-taking
activities. The calculation of NEV serves as the base for credit and
interest rate risk limits as well as other activity restrictions, and
many commenters suggested that corporate credit unions should have as
much risk-taking potential as possible. NCUA disagrees that membership
capital should be included in the definition of NEV.
The function of membership capital is to serve as a secondary
resource for the absorption of risk when reserves and undivided
earnings have been exhausted. The holder of membership capital has the
option to sell the shares back to the corporate credit union three
years after notification of intent to withdraw. This option makes the
membership capital considerably less permanent than ``core'' capital,
since it is not controlled by the corporate credit union and is
potentially short-lived. NCUA regards this form of capital to be
distinctly different and less reliable than internally generated
capital or paid-in capital with far longer or no maturity. Permitting
corporates to place this form of secondary capital directly at risk
substantially, and inappropriately, increases the risk of a crisis in
membership confidence when losses do occur.
NCUA views the balance between core capital and risk-taking as
essential if the corporate credit union network is to maintain and
enhance its ability to withstand financial crises, whether limited to
one institution or systemic in nature. This final rule is designed to
strengthen core capital so that the corporate credit union network can
better withstand financial stress without placing an inappropriate
reliance upon its membership resources. Corporate credit unions should
gradually reduce their reliance on secondary capital as core capital
accumulates over time.
To bolster the accumulation of core capital, the proposed rule
authorized the issuance of paid-in capital, defined as funds obtained
from credit union and non credit union sources, having no maturity, and
being 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. Paid-in capital is included in the
definition of NEV, thus giving corporate credit unions the option of
raising permanent capital from their membership. Only a few commenters
addressed paid-in capital. To make clear that paid-in capital is
subordinate to membership capital, the definition has been modified and
expanded in this final rule. The requirement that the funds have no
maturity has been deleted.
The final rule distinguishes between ``member paid-in capital'' and
``non member paid-in capital.'' The former is held by the corporate
credit union's members, has a minimum 20-year maturity, and may not be
a condition of membership, services, or prices. Member paid-in capital
may be retired prior to the stated maturity only when the corporate
credit union elects to ``call'' the shares. Non member paid-in capital
is sold to the outside marketplace and must be approved by NCUA. Most
of the features of non member paid-in capital remain unspecified in the
regulation so that issuance can be tailored to reflect prevailing
market demands. The marketplace is the most efficient distribution
mechanism for capital, as the market immediately determines the value
and liquidity of an issue based on an issuer's performance and the
perceived risk of the issue.
NCUA believes that paid-in capital should not be issued unless the
corporate credit union can convince the market or its members that it
will use the new capital to create new value. The members, like the
marketplace, need to risk-adjust the expected return on paid-in capital
and expect a fair return. A capital offering that serves to increase
risk without increasing value is in no one's interest.
The proposed separate definitions for ``reserves'' and ``undivided
earnings'' have been unified in the final rule as ``reserves and
undivided earnings.'' The following proposed definitions have been
deleted because the term is no longer used in the regulation or is so
self-evident as not to require a definition: ``business day,''
``commitment,'' ``forward rate agreement,'' ``futures contract,''
``gains trading,'' ``material,'' ``maturity date,'' ``mortgage-backed
security,'' ``option contract,'' ``primary dealer,'' ``private
placement,'' ``reverse repurchase transaction,'' ``secured loan,''
``swap agreement,'' tri-party contract,'' ``United States Government or
its agencies,'' and ``United States Government sponsored corporations
and enterprises.''
A few definitions that were not proposed have been added to the
final rule, generally to accommodate the granting of certain additional
investment authorities. Corporate credit unions may engage in the
forward settlement of transactions beyond regular way settlement, under
certain conditions, and definitions of ``forward settlement'' and
``regular way settlement'' have been provided. Corporate credit unions
with additional authorities have been authorized to engage in dollar
roll transactions and when-issued trading, and definitions of those
activities have been provided.
Section 704.3--Corporate Credit Union Capital
The proposal required that a corporate credit union without
expanded authorities have a capital, or leverage,
[[Page 12931]]
ratio of 4 percent. Most of the comments, with the notable exception of
those submitted by banking associations, were supportive of the minimum
leverage ratio of 4 percent. It is important to discuss the
dissimilarities between corporate credit unions and banks to understand
why the level of required capital should be different. Banks primarily
use capital to support exposures to credit risk in the form of
commercial and consumer loans. Corporate credit unions primarily use
capital to support exposures to liquidity and interest rate risk
associated with investment in money market instruments and fixed income
securities.
Corporate credit unions presently provide a contingent liquidity
resource for members at the same time they offer correspondent
financial services. An overwhelming portion of a corporate credit
union's business consists of providing banker's bank services and
issuing shares and share certificates as investment alternatives for
members' excess funds. Corporate credit unions are not, in practice,
primary-lending institutions.
Capital adequacy is the central tenet of the proposed regulation.
The type and amount of risk assumed were fully considered when capital
ratios and corresponding risk limitations were developed. Since
corporate credit union assets are predominantly high-grade investment
securities, not loans, the regulation did not adopt a base leverage
ratio target in excess of 4 percent.
Additionally, the rule has a number of triggers to measure the
adequacy of capital in a corporate credit union. These triggers are
related to market risk exposures as measured by NEV. Risk measures are
required on a regular basis, not only for the contemporary market
environment, but for stressed conditions as well. Similar to the other
federal financial institution regulators, NCUA is requiring the
development of risk management infrastructures which better measure and
control risk.
The scope of these new requirements will vary by institution but
will be commensurate with the amount of risk assumed and the degree of
depth and sophistication employed to control these risks. This approach
will facilitate a more appropriate control of risk and thereby
establish a better early warning detection system when capital adequacy
begins to deteriorate. Thus, the 4 percent minimum capital ratio is
appropriate based upon the type of assets held and the rigorous risk-
assessment requirements of the rule.
Using risk-weighted assets to produce a risk-based capital
calculation has been debated throughout the Part 704 revision process.
Proponents have argued that the calculation captures a meaningful
measure of credit risk exposure which helps members and the public
ascertain credit-risk trends in corporate credit union balance sheets.
Corporate credit unions have high risk-weighted capital-to-asset ratios
relative to other financial institutions, making the ratio a favorable
measure for comparative purposes.
Opponents have argued that the risk-based capital calculation is
too arbitrary in assigning credit risk weights and that the absence of
consideration for interest rate risk makes the numbers misleading. The
most recent proposal for changes to the interagency risk-based capital
standards adjusts some credit risk weights and adds a new calculation
for interest rate risk by adding weights for the duration of each
asset. The calculation appears to be complex and potentially unwieldy
while providing limited regulatory value where corporate credit unions
are concerned.
NCUA advocates meaningful measures for credit and interest rate
risk exposure expressed in relation to capital. Concentration limits,
for example, have been converted from a function of net assets to one
of core capital. While the risk-weighted asset approach is not
utilized, conservative credit risk limitations are explicitly defined
in the regulation and additional credit risk measurement and reporting
requirements have been developed in the new credit risk management
section, Section 704.6.
NCUA does not discourage corporate credit unions that desire to
calculate the risk-weighted capital-to-assets ratio from doing so but
would suggest that they adopt the same standard used by other financial
institutions and understand that the calculation is not a regulatory
requirement.
The proposed regulation provided authority for NCUA to impose a
higher or lower minimum capital requirement on a case-by-case basis,
with prior notice to the corporate credit union. Some commenters
supported this authority, while others expressed concern that the
regulation did not specify all of the circumstances in which it could
be exercised. They suggested that it could be abused by NCUA.
The proposed rule illustrated four situations which might cause
NCUA to require reserve levels other than those specified in the
regulation. The first two were examples of circumstances that could
require a higher level, while the last two were examples that could
warrant a lower one. While NCUA would like to be able to clearly define
every situation in which such actions could be taken, changes in market
conditions and the corporate credit union environment make that
impossible. Leaving the regulation open provides NCUA more flexibility
in addressing unusual or non recurring events, including those which
may result in a reduction in reserve levels.
It should be noted that NCUA already has the authority, under
Section 116(b) of the Federal Credit Union Act, to adjust reserve
requirements for federal corporate credit unions. This regulation will
ensure that such authority is available for state-chartered corporate
credit unions, in the rare event that it is needed.
To address concerns about NCUA abuse, the rule was amended so that
NCUA may take action when significant risk exposure exists only when it
is unsupported by adequate capital or risk management processes.
The proposed regulation also provided authority for NCUA to issue a
capital directive when a corporate credit union fell below its minimum
capital requirement and failed to submit or follow an adequate capital
restoration plan. The directive could 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. Some
commenters objected to this authority, arguing that it would give NCUA
management control over a corporate credit union. NCUA disputes that
directing a corporate credit union to take certain specific actions to
return to a safe and sound level of capital constitutes taking
``control'' of the institution. In addition, the authority in question
is one held by the other federal financial institution regulators and,
as with the authority to impose an individual minimum capital
requirement, would be exercised only rarely. Accordingly, it has been
retained in the final rule.
A number of commenters expressed concern that the NCUA Board would
delegate its capital directive authority to NCUA staff. Several
comments specifically objected to delegating this authority to
examiners. Some commenters requested that the NCUA Board specifically
state in the rule that this and other authorities could never be
delegated to staff.
These comments reflect a lack of understanding of Board practice
regarding administrative actions. While the Board has delegated some
administrative actions to regional and office directors, none of the
authorities
[[Page 12932]]
can be redelegated to other staff members, including examiners.
Additionally, none of the actions delegated are final.
Delegated actions have been limited to preliminary actions, such as
notices of charges and temporary cease and desist orders, which must go
to the Board for final action.
The Board does not intend to delegate its authority to take
administrative actions to examiners and never intended that any action
proposed in Part 704 be delegated to examiners. However, this Board is
unwilling to put into the regulation a restriction that would limit a
future Board from taking an action it believed to be necessary.
Proposed Section 704.3 provided that when taking action in the case
of a state-chartered corporate credit union, NCUA provide notice to the
state supervisory authority. NCUA agrees with comments that notice
should be provided when any action is contemplated, not just one
relating to capital. To simplify the regulation, a general provision
for consultation has been added to Section 704.17, governing state-
chartered corporate credit unions, and individual provisions to that
effect have been deleted. It should be noted that, contrary to the
suggestion of one commenter, consultation does not mean that the state
authority must give its approval before NCUA may act. In order to
protect the share insurance fund, NCUA must have the authority to take
action whenever safety and soundness demands it.
Section 704.4--Board Responsibilities
Proposed Section 704.4 required the board of directors of a
corporate credit union to approve comprehensive written plans and
policies and to oversee senior management to ensure these plans and
policies are carried out. To emphasize the board's ultimate
responsibility for the actions it delegates, the proposed rule stated,
``The board of directors must know and understand the activities,
policies, and procedures of the corporate credit union.'' While this
was not intended to turn directors into operating managers, a large
number of commenters expressed concern about this requirement. To
mitigate this concern, this sentence has been deleted from the final
rule. NCUA is confident that board members will provided appropriate
oversight if they recognize and meet their common law fiduciary
responsibilities.
Some commenters objected to the proposed rule's requirement that a
corporate credit union have in place, for all line support and audit
areas, back-up personnel with adequate cross-training. To lessen the
burden, the final rule allows for back-up resources rather than
personnel, which means that corporate credit unions could temporarily
support their operations with staff from other corporate credit unions
or consulting firms.
Two commenters noted that the proposed requirement that a corporate
credit union follow generally accepted accounting principles (GAAP)
conflicts with the classification of credit union shares as equity.
Since there may be other departures from GAAP in the future, the final
rule requires that corporate credit unions follow GAAP, except where
law or regulation has provided for a departure from GAAP.
Currently, the shares classification is the only departure.
Finally, a number of commenters questioned the proposed rule's
requirement that a corporate credit union retain external consultants
to review the adequacy of resources supporting major risk areas. To
address these concerns, the final rule requires the retention of such
consultants only as appropriate.
Section 704.5--Investments
The proposed rule inadvertently failed to require that a corporate
credit union establish an investment policy. This requirement has been
added to the final rule. The policy must be consistent with the
corporate credit union's other risk management policies and must
address, at a minimum, appropriate criteria for evaluating standard
investments and risk analysis requirements for any new investment type
or transaction considered for a corporate credit union's portfolio and/
or sale to a member.
Certain commenters asked for clarification of the ``risk analysis
requirements.''
This provision addresses the evolutionary nature of instruments in
the financial marketplace. It is expected that new money market and
fixed income securities will be created. Some of these securities may
be legally permissible but may be distinctly different from the
universe of instruments previously available. It is not possible to
anticipate what additional analytical parameters, if any, must be
employed before a product comes to market. Therefore, NCUA believes
that policies must clearly indicate that the potential risks of new
products, not unlike new services, must be carefully evaluated.
Many corporate credit unions engineer new certificate offerings
that are structured to mirror specific investment assets. Such
structured certificates effectively transfer the risk of the asset
through to the holder of the certificate (the member).
Corporate credit unions need to ensure that the risk
characteristics that are inherent, and perhaps unique, in a new
investment type be sufficiently identified and rigorously analyzed
before being purchased for its portfolio or marketed and sold to its
members.
A corporate credit union should not dictate what a member buys, but it
should understand a new product's implications and be able to explain
them to a member.
The proposed rule authorized investments in corporate credit unions
and corporate credit union service organizations (CUSOs). One commenter
asked that investments in wholesale corporate credit unions and CUSOs
be specifically authorized. This is not necessary, as wholesale
corporate credit unions are a subset of corporate credit unions and are
included when the latter term is used.
The proposed rule established an NCUA-modified High Risk Security
Test (HRST) for REMIC/CMO securities. The commenters on the test
generally expressed two views. The first was to urge adoption of the
standard Federal Financial Institutions Examination Council (FFIEC)
parameters for the HRST so that the test would be consistent with those
used by other depository institutions. The second was to drop the use
of the HRST altogether based upon the assertion that proper NEV
calculations would capture the risk of the underlying cash-flows and
their corresponding price sensitivities anyway. These comments were
about evenly divided. One commenter suggested that the proposed NCUA-
modified tests be retained while another expressed that HRST tests
should only be required if a corporate's NEV ratio fell below 1
percent.
NCUA is persuaded that the requirement to produce net interest
income and NEV measures, set forth in Section 704.8, should be
sufficient to evaluate the individual risk characteristics of all
financial instruments, including CMOs/REMICs. Because all instruments
will have to be individually modeled for plus and minus 300 basis point
shifts, the HRST is effectively part of the risk measurement process
already.
When appropriately modeling CMO/REMIC cash-flows in conjunction
with the calculation of net interest income and NEV sensitivity, the
HRST is redundant. The test is useful indication, however, of potential
price volatility and liquidity risk. Bonds which pass the
[[Page 12933]]
FFIEC test are regarded to have a substantially greater universe of
potential buyers. Given the liquidity priority of corporate credit
unions, it makes sense to subject bonds to a periodic analysis of
factors which will drive the market's bias towards such securities. By
utilizing the test employed by other depository institutions, corporate
credit unions gain useful insight into the contingent liquidity
potential of individual CMO/REMIC securities.
Several commenters urged that the requirement to run a monthly HRST
be changed to quarterly. NCUA agrees that if the net interest income
and NEV tests are appropriately prepared in accordance with the rule,
the HRST requirement is less significant and that quarterly testing
will be adequate.
Some commenters suggested that the rule allow for the use of fewer
prepayment models where the proposal called for at least three models.
The reason that the rule required three or more models was to avoid the
risk of ``cherry picking'' one favorable prepayment model to cause a
CMO/REMIC to pass whenever possible. With the advent of simulation
modeling requirements for net interest income and NEV, NCUA accepts
that a more sophisticated corporate credit union will have the capacity
to appropriately analyze the risk of a CMO/REMIC security with fewer
than three prepayment models. Thus, the requirement that the board
approve at least three prepayment models for CMOs/REMICs was removed
from the Part I and Part II authorities but retained at the base level.
The proposed rule established identical standards for repurchase
and securities lending transactions. One commenter noted that these are
distinguishable economic and legal transactions and urged that they be
separated in the regulation. NCUA agrees and effected that separation.
The proposed rule required that collateral securities be legal for
corporate credit unions, except that CMO/REMIC securities that passed
the FFIEC HRST were permissible provided that the term of the
transaction did not exceed 95 days. A number of commenters asked that
the 95-day limit be dropped. The whole exception is unnecessary, now,
with the substitution of the FFIEC HRST for the NCUA-modified test.
The proposed rule authorized investment in a registered investment
company, provided that the portfolio of such investment company was
restricted by its investment policy, changeable only if authorized by
shareholder vote, solely to investments that were permissible for the
corporate credit union making the investment. In response to comments,
the shareholder vote restriction has been deleted.
As proposed, the final rule provided a grandfather clause, allowing
corporate credit unions to continue to hold investments that were
permissible when purchased but have become impermissible because of
regulatory changes. One commenter stated that this was inconsistent
with proposed Section 704.10, governing divestiture. That section
requires divestiture of or a written plan to keep an investment that
fails a requirement of Part 704. It should be understood that the
grandfather provision supersedes the divestiture provision.
Section 704.6--Credit Risk Management
Most corporate and natural person credit unions recommended only
minor revisions to the credit risk management section. Some, however,
objected to the requirement of any credit due diligence, given that
minimum credit ratings were limited to the top of the investment-grade
range. Credit ratings obtained from nationally recognized statistical
rating organizations are a significant tool for investors to evaluate
credit risk associated with a specific security, issuer, guarantor, or
provider of credit. They are no substitute for due diligence, however,
and should be regarded as only one part of the credit risk management
process.
Significant exposures to credit risk require extensive and
continuous credit analysis by professionally trained staff. Managing a
large credit exposure requires considerable personnel and financial
resources, which many corporate credit unions do not possess. Expanded
authority provisions allow for a broader spectrum of credit risk, and
increased credit due diligence by corporate credit unions that obtain
such authorities is key. Conversely, the amount of credit analysis
conducted by institutions that operate at the base level and maintain
very limited exposure to credit risk is not expected to be significant.
Credit risk exposure can be limited by restriction of counterparty,
dollar amount, and/or maturity. Those corporate credit unions that
remain at the base level and do not assume significant exposures should
be able to achieve an adequate degree of credit risk management by
employing a combination of these techniques. If a corporate credit
union expands its tolerance for credit risk, it must increase its due
diligence accordingly. That may mean hiring adequately trained staff
and/or increasing the frequency and depth of review.
Several commenters suggested that specific concentration limits on
repurchase agreements be removed from the regulation and left up to a
corporate credit union's board of directors. The regulation allows
corporate credit unions with expanded authorities to develop their own
credit limits for these transactions based upon the additional depth
and scope of their credit risk management. The base level was designed
to accommodate institutions with restricted capacity to handle credit
risk. The concentration limits are commensurate with the very limited
due diligence expected to support low credit risk strategies.
One commenter requested that NCUA clearly state that it supported
corporate credit unions using outside providers for investment and
credit due diligence. The implication is that a CUSO or other third
party provider could become the primary arbiter of the appropriateness
and selection of investment assets. The desire of corporate credit
unions to create cost-effective approaches to risk management is
understandable, but outsourcing risk-management evaluations diminishes
the control, independence, and accountability of risk making decisions.
While discretionary judgments can be outsourced, the board and
management's accountability for investment decisions cannot be
delegated, and the issue of credit risk becomes particularly
complicated. For example, how would a CUSO, serving multiple
institutions, determine how to equitably alert all clients to a
declining credit which requires disposition? The sale of distressed
financial instruments often accelerates market value declines (not
inappropriately) leaving other investors with unsold positions at an
increasing disadvantage. In other words, which client gets out first?
In the event of material credit-related losses, who bears
responsibility for the justification of the exposure and what recourse
would affected clients have with a CUSO?
Aside from accountability issues, NCUA fears that a CUSO serving
numerous corporate credit unions with credit risk research would
significantly increase the potential for a crisis in the credit union
system. The incidence of systemic crises is not uncommon for U.S.
depository institutions. Occurrences are infrequent but typically
severe, such as investments in Penn Square, where numerous corporate
credit unions were simultaneously affected to a significant degree.
[[Page 12934]]
Another commenter urged that NCUA remove the specific reporting and
documentation requirements. NCUA developed this language to convey the
minimum expectations for this important element of credit risk
management. While modifications were made to this section to make it
slightly more generalized, the need for some specificity was too
critical to dismiss altogether.
Several commenters sought clarification on the credit risk
management policy provision addressing concentrations of credit risk.
The examples of concentration characteristics included in the
regulation are ``industry type, sector type, and geographic.''
Commenters were concerned that NCUA would expect that all credit
instruments be evaluated on the basis of a set list of concentration
characteristics regardless of whether all of the characteristics
applied to an individual instrument.
Examples were provided to indicate that there are a number of
relevant concentration risks that can arise in the process of managing
credit risk. Not all concentration types apply to all credit
instruments. For example, a corporate credit union may need to consider
whether a particular industry is disproportionately represented in its
overall portfolio. To capture aggregate exposure, a corporate will need
to summarize such concentration by reviewing across all transaction
types.
Section 704.7--Lending
The proposed rule established limits on secured and unsecured loans
to one member. A secured loan was defined to mean one in which the
corporate credit union had perfected a security interest in the
collateral. In response to comments, the requirement that the security
interest be perfected has been deleted from the final rule. Further,
exclusions have been added for loans secured by shares and marketable
securities and for member reverse repurchase transactions.
The proposed rule required that a loan to a non credit union member
be made in conformance with the member business loan rule. In response
to comments, an exception has been provided for loans fully guaranteed
by a credit union or credit unions. A few commenters suggested that
corporate credit unions be permitted to participate with natural person
credit unions in making loans to natural person members. In the past,
NCUA was concerned that such activity could jeopardize a corporate
credit union's banker's bank exemption from the Federal Reserve Board's
Regulation D reserve requirements.
While NCUA believes that this area should be researched thoroughly,
for several reasons, it will take no action now. First, the research
necessary to analyze the potential impact of such loans would
unnecessarily delay this final rule. In light of the few credit unions
indicating interest, NCUA believes it more beneficial to finalize the
rule and take the issue up at a later date. Second, if corporate credit
unions were to participate in such loans, additional reserves would be
necessary to cover the risk of default by natural persons. The public
should have an opportunity to comment on such reserves before corporate
credit unions are required to comply with them.
The NCUA Board has asked the Office of Corporate Credit Unions to
study the issue and be prepared to make a recommendation when it
provides its interim report to the Board 18 months after publication of
this final rule.
Section 704.8--Asset and Liability Management
The proposed rule required a written asset and liability management
(ALM) policy which addressed, among other things, the modeling of
indexes that serve as references in financial instrument coupon
formulas. Several commenters raised questions about this requirement.
Many adjustable rate securities are available in the marketplace which
have interest rate formulas linked to a number of reference rates,
foreign currencies, and/or commodities. Corporate credit unions tend to
buy variable rate securities which are linked to U.S. money market
rates such as U.S. LIBOR or Fed Funds. Still others have purchased
securities linked to constant maturity Treasuries (CMT), the Prime
rate, or the 11th District Cost of Funds (COFI). It is important for an
institution to evaluate the basis risk in such instruments to ensure
that it has adequately measured the interest rate risk associated with
the respective repricing behavior (vis-a-vis its cost of funds). The
weaker the correlation between an index and the cost of funds, the
greater the need to estimate the future behavior of the index.
The proposed rule required a corporate credit union to evaluate the
risk in its balance sheet by measuring the impact of interest rate
changes on its NEV and NEV ratio. A corporate credit union was required
to limit its risk exposure to levels that did not result in an NEV
ratio below 1 percent or a decline in NEV of more than 18 percent. The
limit for corporate credit unions with Part I expanded authorities was
35 percent and for those with Part II authorities was 50 percent.
Frequency of testing was a function of the NEV ratio. If NEV was 2
percent or above, testing had to be done quarterly. If it fell below 2
percent, monthly testing was required.
The proposed rule also required corporate credit unions with
significant holdings of instruments with embedded options to perform
additional testing beyond the 300 basis point parallel shift of the
yield curve. The base test may not be sufficient to evaluate the
potential risk to the balance sheet, particularly for those portfolios
comprised of complex securities. Changes in the shape of the yield
curve, shifts in the credit and liquidity risk premium reflected in
spread changes, factors affecting prepayment speeds, and changes in
volatility, will all have an impact. While the rule did not establish
the testing frequency or the parameters to be used to evaluate the
impact of these factors, it did require that the tests reflect these
components of risk.
NCUA sought specific data from corporate credit unions to support
the claim that a floor other than 1 percent was appropriate. It sought
similar analytical support for challenges to the 18, 35, and 50 percent
variation limits.
Most corporate credit union commenters pointed out that the minimum
NEV ratio poses a major restriction on balance sheet growth even if
such growth adds no incremental risk to the balance sheet. Commenters
overwhelmingly supported keeping the minimum ratio at 1 percent of the
fair value of assets, and some suggested removal of a minimum NEV ratio
altogether. The vast majority of comments submitted were without
supporting data. It is intuitive, however, that substantial growth in
corporate credit union assets would exacerbate the risk of penetrating
a floor of 2 percent or higher, since average core capital levels are
presently between 2 percent and 3 percent of assets.
The use of a minimum NEV ratio is intended to establish a floor for
primary capital which prevents a corporate credit union's core leverage
ratio from falling dangerously low. It provides an estimate of the
internal capacity of an institution to handle its risk exposures in the
future and thus alerts the corporate credit union and NCUA to potential
capital shortfalls.
Corporate credit unions have not historically had a growth
inhibitor in the form of minimum capital ratios, and thus, the NEV
ratio introduces a new element for management to control. While the NEV
ratio does not indicate the nature or degree of risk that is
[[Page 12935]]
inherent in a balance sheet, it does indicate the degree of leverage.
Capital is the reserve of funds available to manage all the risks of
the institution, including those which are not part of the risks
associated with changes in interest rates.
Measuring risk is an imprecise business because of the multitude of
assumptions that are required to evaluate potential outcomes. NCUA
believes that an NEV ratio below 1 percent would be imprudent because
little room would remain for errors in measurement or for the potential
confluence of business risks. An NEV ratio of 1 percent will provide a
reasonable early-warning detection mechanism for capital inadequacy.
The present levels of capital would not permit a substantially higher
floor at this time without a risk of forced shrinkage in corporate
credit union balance sheets.
Consistent with the base level thresholds established in the credit
risk management section, an 18 percent NEV volatility limit is adopted
to set a conservative market risk limit for corporate credit unions
that do not possess the financial, system, or personnel resources to
support a significant market-risk earnings strategy. The 18 percent
limit allows corporate credit unions at the base authority level to
entertain a modest mismatch between liabilities and assets (overnight
and/or term) and capital investments inside of seven years.
NEV is an imperfect measure in the sense that it portrays the risk
inherent in the balance sheet as one number. It is a present value of
the asset cash-flows less a present value of the liability cash-flows
plus/minus the time value of any embedded options. NEV does not
indicate when the risk will occur but it does indicate the aggregate
amount of potential risk. Used in conjunction with income simulation (a
short-term view of risk), NEV provides a good method for simultaneously
managing the earnings and net worth of an institution.
It is expected that corporate credit unions will have some degree
of mismatch in the normal course of business because member demands for
amount and maturity on the liability side of the balance sheet do not
perfectly correlate to available market instruments on the asset side.
The NEV calculations will capture the aggregate market risk and permit
corporate credit unions, no matter how their respective mismatches are
structured, to convey risk in a relatively simple and consistent
manner.
An NEV volatility limit of 18 percent was criticized by many
commenters as being too low and ``essentially a matched book.'' Any NEV
variance can be achieved with a total matched book in place since the
duration of the asset purchased with capital (not matched) will
determine the net risk. If capital is invested in short duration
instruments, the NEV volatility will be correspondingly low. If capital
is invested in long duration instruments, the volatility will be
higher. There is no precise level of NEV that equates to a ``matched
book.'' The 18 percent NEV limit is the same as a net risk position
with a price sensitivity equal to that of seven year zero-coupon
Treasury bond. This is not an insignificant amount of market risk. It
is a corporate credit union's choice whether it takes that risk in an
overnight account or whether it spreads it out among various books of
business (overnight, term, capital, etc.). Some institutions may choose
to run matched books and take all the risk with their capital.
Regardless, the maximum decline will be limited to 18 percent of base
case NEV.
One aspect of using NEV which must be noted is the effect of
negative convexity. Two corporate credit unions may have an equivalent
net risk exposure at a given point in time, but the respective
exposures will change very differently with subsequent changes in
market factors, depending on the composition of assets. One may choose
to take the bulk of its mismatch in the overnight account using
optionless money market instruments and invest its capital in a medium-
maturity debenture. The other may incur a mismatch by buying low
duration floating rate securities which possess a considerable amount
of option and basis risk.
In the first example, the sensitivity of NEV is fairly constant and
the risk profile may be altered relatively quickly with the passage of
time (by letting short maturities roll into overnight). In the latter
example, the option and basis risk may not emerge until the interest
rate environment has changed. Because securities with call, prepayment,
and cap options can extend dramatically, it is possible for such a
portfolio to go from a sensitivity of 18 percent to an exposure many
times that amount in a short time as the institution calibrates its
rate shocks to a new plus and minus 3 percent range.
Several corporate commenters suggested that an interim operating
level be considered for moderate capacity corporates, consisting of an
NEV volatility limit of 25 percent, with no additional investment or
credit authorities. They argued that the cost of building a risk
management infrastructure was essentially a barrier to entry for
expanded authorities, and they viewed the higher NEV limit as a
mechanism for funding the incremental costs of getting there. To
compensate for the incrementally greater risk, the commenters suggested
that qualifying corporate credit unions conduct the rate shock tests
monthly, as opposed to quarterly, and that they also conduct the
additional tests, beyond the 300 basis point parallel shift of the
yield curve, regardless of their holdings of instruments with embedded
options.
NCUA agrees that select corporate credit unions are capable of
operating between the base and Part I limits, and has created a ``base-
plus'' level. With NCUA approval, an institution can operate with an
NEV volatility of 25 percent provided that it performs additional tests
and has additional management and infrastructure. NCUA will assess the
institution to verify that the incremental qualifications are resident.
For example, more than one senior manager will be expected to have
strong knowledge of investments and ALM. In addition to risk
measurement, the ability for the institution to withstand the departure
of a key staff member and the ability to achieve adequate separation
between risk takers and risk monitors will be important.
Corporate credit unions qualifying for a 25 percent NEV variance
will be expected to conduct risk modeling with greater vigilance than
those operating with an 18 percent variance, and such institutions must
establish commensurate policies, procedures, and internal controls.
NCUA will expect corporate credit unions that qualify for a 25 percent
NEV limit to demonstrate a greater ability and inclination to
aggressively respond to adverse market developments than base authority
institutions. Operating with an NEV volatility of 25 percent may
increase current earnings, but it also raises the probability of
experiencing future losses.
For corporate credit unions that want to run bigger mismatches, the
Part I expanded authorities doubles the amount of permitted market risk
from the base, allowing an NEV decline of 35 percent. This degree of
mismatch has the aggregate risk sensitivity of a 15 year zero-coupon
Treasury bond. Part II expanded authorities allows an NEV decline of 50
percent, equating to an aggregate risk sensitivity of a 24 year zero-
coupon bond. The following table shows the risk sensitivities of zero-
coupon bonds of various durations.
[[Page 12936]]
Price Sensitivity of Zero-Coupon Treasury Bonds
[Prices as of 01/08/97]
------------------------------------------------------------------------
Price Price
sensitivity sensitivity
Investment (years) +2% shock +3% shock
(percent) (percent)
------------------------------------------------------------------------
7...................................... -13 -18
10...................................... -18 -25
15...................................... -26 -36
24...................................... -38 -51
------------------------------------------------------------------------
Source: Bloomberg; S , TRA(O).
NCUA has allowed sophisticated and well-developed corporate credit
unions to take much greater market risk than that permitted for
institutions with base authorities. If a corporate credit union wishes
to make market timing a substantial portion of its earnings strategy,
the expanded authority levels provide ample room for managing sizable
mismatches between assets and liabilities. But, at the base level, the
rule must have prudent limitations on market risk that reflect the more
limited capacity of many smaller and/or more conservative institutions
which cannot afford or do not desire to commit the financial and
personnel resources to build the appropriate risk-taking infrastructure
that is required to support higher NEV volatility.
The base level is intended to establish a conservative territory
where even the smallest and most thinly developed corporate credit
union can continue to provide standard products and services without
being subject to imprudent risks or burdened with excessive
infrastructure costs. In order for the regulation to encompass the full
spectrum of corporate credit unions, it must provide both a minimum
safety and soundness barrier as well as a mechanism for expanding
opportunities (commensurate with an increasing capacity to manage
risk). The rule is structured to create distinctive operating
classifications in response to the widely diverse corporate credit
union network.
A number of commenters noted that NCUA was adopting specific limits
on interest rate risk where other federal financial institution
regulators have elected to handle it through supervision. NCUA
acknowledges this difference but disagrees with the notion that its
approach is inconsistent or inappropriate.
Corporate credit unions comprise a relatively small private
financial network which serves a finite universe of members. The credit
union system cannot afford the failure of a corporate credit union,
whereas the failure of an individual bank or thrift is less
consequential to the survival of all other banks and thrifts. Because
of these differences, NCUA believes that explicit measures of risk
tolerances are appropriate.
In addition, many corporate credit unions are making a transition
from a traditional strategy where little interest rate risk was taken
(achieved through maturity and rate-reset matching of assets and
liabilities) to a strategy which assumes a variety of intentional
market risk mismatches, including maturity, option, and basis risk.
Explicit risk measures are essential in such an environment.
One corporate credit union commenter, joined by a number of its
member credit unions, claimed that the rule encourages corporate credit
unions to take credit risk as opposed to interest rate risk. This
sentiment is troubling. The proposed rule is intended to promote and
reinforce the discipline of comprehensive risk management, regardless
of the risk type assumed.
If a corporate credit union intends to entertain significant
exposures to market, credit, and/or liquidity risk in order to generate
its spread income, the obligation to professionally control those risks
is substantial. The expanded authority concept is predicated on the
idea that professional risk taking must be supported by a state-of-the-
art risk management infrastructure.
Section 704.9--Liquidity Management
Relatively few comments were received on this section of the
proposed rule. However, in response to those comments, the rule has
been amended so that a corporate credit union need only monitor its
liquidity sources regularly, rather than continuously, and need not
necessarily test its external lines to ensure that contingent sources
of liquidity remain available. However, a corporate credit union must
be able to demonstrate, whether through testing, written confirmation,
or other means, that such sources remain available.
Section 704.10--Divestiture
Few comments were received on this section of the proposed rule,
and except for changes to time frames to standardize them with others
in the regulation and the addition of the supervisory committee to the
list of entities which must receive a failed investment report, no
changes have been made in the final rule.
Section 704.11--Corporate Credit Union Service Organizations (Corporate
CUSOs)
The proposed rule defined a corporate CUSO as 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. A number of
commenters pointed out that defining an entity that has received a loan
from a corporate credit union as a corporate CUSO would severely
restrict the ability of corporate credit unions to lend to natural
person CUSOs. This was not intended, and that portion of the definition
has been deleted.
Some commenters expressed concern that the restriction of services
to those related to the daily activities of credit unions might unduly
limit the activities of corporate CUSOs, since a legitimate activity
might not occur every day. It was not the intent of the proposed rule
to require that an activity occur every day; however, to allay
concerns, the final rule requires that services be related to the
normal course of business of credit unions.
In response to comments, the rule has been amended to permit
corporate CUSOs to be structured as limited liability companies or
limited partnerships, as well as corporations. NCUA agrees that these
forms are appropriate for corporate CUSOs. Also in response to
comments, the conflict of interest provision has been amended to permit
a corporate credit union to share employees with a corporate CUSO. NCUA
was persuaded that there is a legitimate business purpose for such an
arrangement. However, such arrangements will be scrutinized to ensure
there is no insider self-dealing. Further, the rule still prohibits
corporate credit union directors and committee members from receiving
compensation from a corporate CUSO.
Section 704.12--Services
Few comments were received on this section, and it is unchanged in
the final rule. This section was intended to protect the integrity of
federal corporate credit union fields of membership. However, should
NCUA authorize national fields of membership for federal corporate
credit unions, there may be a determination to eliminate this section
at a future date.
Section 704.13--Fixed Assets
As proposed, the final rule permits a corporate credit union to
invest in fixed assets where the aggregate of all such investments does
not exceed 15 percent of the corporate credit union's capital. In
response to one comment, NCUA wishes to clarify that the 15 percent
refers to book value. As proposed, the final rule provides for a
corporate credit
[[Page 12937]]
union to request a waiver of the limitation from NCUA. The proposed
rule eliminated the current provision that allows a corporate credit
union to proceed with its investment if it does not receive
notification of the action taken on its request within 45 days. Three
commenters objected to NCUA not having a deadline to respond, and the
45 day timeframe has been reinstated.
Section 704.14--Representation
The first proposal to revise Part 704, issued in 1995, amended the
representation section to provide that only representatives of member
credit unions were permitted to vote and stand for election. This
involved changes to a number of paragraphs. When the proposed revision
to Part 704 was reissued in 1996, NCUA determined not to go forward
with the member-only proposal and intended to reverse all of the
changes that had been made in that regard. Inadvertently, some of the
changes were left in place. The final rule corrects this error.
Section 704.15--Audit Requirements
In response to the few comments received on this section, the
language has been clarified and made more consistent with auditing
terminology.
Section 704.16--Contracts/Written Agreements
No changes were made to this provision.
Section 704.17--State-Chartered Corporate Credit Unions
As noted earlier, a paragraph has been added which provides that
NCUA will consult with the state supervisory authority before taking
administrative action against a state-chartered corporate credit union.
Section 704.18--Fidelity Bond Coverage
In response to comments, the calculation of minimum bond has been
clarified and a $5 million cap has been added to each category in the
maximum deductible table.
Section 704.19--Wholesale Corporate Credit Unions
The commenters generally supported this section, and it has been
retained as proposed.
Appendix A--Model Forms
Some changes have been made to Sample Form 2 in the final rule to
accommodate the changes to the definition of paid-in capital.
Appendix B--Expanded Authorities and Requirements
The proposed rule introduced a multi-tier approach to the
regulation of corporate credit unions. Proposed Appendix B set forth
incrementally greater authorities for corporate credit unions and the
infrastructure and capital requirements that were required to be in
place to obtain such authorities. The commenters supported the multi-
tier approach, and it has been retained in the final rule. Based on the
comments received, several additional authorities have been added to
Parts I and II. So that NCUA can effectively supervise the transition
to this final rule, each corporate credit union is asked to inform
NCUA, by April 15, 1997, of its initial decision regarding the level at
which it wishes to operate.
One commenter thought that all investments should be grandfathered
in a case where a corporate has its expanded authorities revoked. This
observation raises an important issue. The final rule will shift the
major focus of risk evaluation from individual financial instruments
towards an aggregate or ``balance sheet'' risk assessment. While
individual securities and transactions might be grandfathered from
automatic divestiture, the revocation of expanded authorities would
likely be precipitated by concerns about the overall risk profile of
that institution. While individual transactions will not necessarily be
singled out, a corporate credit union must be prepared to employ asset
disposition to reduce excessive risk when exposures warrant.
For example, a substantial weakness in internal controls and/or
major capital inadequacy would necessitate a reduction in risk. If
expanded authorities are regarded to be adding risk to an already
unacceptable exposure, then NCUA would have to consider a revocation of
the authorities. This could prompt NCUA to mandate a risk reduction
strategy that requires the institution to adopt asset disposition in
order to achieve an appropriate and timely risk reduction. Once
revocation occurs, any additional expanded-authority activities will
cease and NCUA will evaluate, based on the unique circumstances, what
corrective actions are necessary. Thus, while the rule does not
predetermine the sale of specific expanded-authority transactions,
forbearance from divestiture will not be assured.
Proposed Appendix C set forth guidelines for evaluating requests
for expanded authorities. In response to the comments received, these
guidelines have been removed from the regulation and put into a
handbook format. Consequently, Appendix C has been deleted. The
guidelines will be provided to all corporate credit unions.
Part 709--Involuntary Liquidation and Creditor Claims
No comments were received on this section, and it has been retained
in the final rule.
Part 741--Requirements for Insurance
No comments were received on this section, and it has been retained
in the final rule.
C. 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 reporting requirements in Part 704 have been submitted to and
approved by the Office of Management and Budget under OMB control
number 3133-0129. Under the Paperwork Reduction Act of 1995, no persons
are required to respond to a collection of information unless it
displays a valid OMB control number. The control number will be
displayed in the table at 12 CFR Part 795.
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 final rule will 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
[[Page 12938]]
that this rule may have an occasional direct effect on the states, on
the relationship between the national government and the states, or on
the distribution of power and responsibilities among the various levels
of government. However, the potential risk to the NCUSIF without these
changes justifies them.
List of Subjects
12 CFR Part 704
Credit unions, Reporting and recordkeeping requirements, Surety
bonds.
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 March 7,
1997.
Becky Baker,
Secretary of the Board.
For the reasons set out in the preamble, NCUA amends 12 CFR chapter
VII as follows:
1. Part 704 is revised to read as follows:
PART 704--CORPORATE CREDIT UNIONS
Sec.
704.1 Scope.
704.2 Definitions.
704.3 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.
704.19 Wholesale corporate credit unions.
Appendix A to Part 704--Model Forms
Appendix B to Part 704--Expanded Authorities and Requirements
Authority: 12 U.S.C. 1762, 1766(a), 1781, and 1789.
Sec. 704.1 Scope.
(a) This part establishes special rules for all federally insured
corporate credit unions. Non federally insured corporate credit unions
must agree, by written contract, to both adhere to the requirements of
this part and submit to examinations, as determined by NCUA, as a
condition of receiving shares or deposits from federally insured credit
unions. This part grants certain additional authorities to federal
corporate credit unions. Except to the extent that they are
inconsistent with this part, other provisions of NCUA's Rules and
Regulations (12 CFR 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.
(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 and for
expansions of authority under Appendix B of 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 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).
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 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.
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.
Dollar roll means the purchase or sale of a mortgage backed
security to a counterparty with an agreement to resell or repurchase a
substantially identical security at a future date and at a specified
price.
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, calls, caps, and
prepayment options.
Expected maturity means the date on which all remaining principal
amounts of an instrument or bond are anticipated to be paid off on the
basis of projected payment assumptions.
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
[[Page 12939]]
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
unsecured transfer of immediately available funds by one depository
institution to another depository institution or entity.
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 settlement of a transaction means settlement on a date
other than the trade date.
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.
Matched means, with respect to assets and liabilities, that the
factors which affect cash flows of an asset are replicated in a
corresponding liability.
Member paid-in capital means paid-in capital that: Is held by the
corporate credit union's members; and has an initial maturity of at
least 20 years. A corporate credit union may not condition membership,
services, or prices for services on a credit union's ownership of paid-
in capital. When a paid-in capital instrument has a remaining maturity
of 5 years, the amount of the instrument that may be considered paid-in
capital for the purposes of this part is reduced by a constant monthly
amortization which ensures the recognition of paid-in capital is fully
amortized when the instrument has a remaining maturity of 3 years. The
terms and conditions of any member paid-in capital instrument must be
disclosed to the recorded owner of such instrument at the time the
instrument is created and at least annually thereafter.
Member reverse repurchase transaction means an integrated
transaction in which a corporate credit union purchases a security from
one of its member credit unions under agreement by that member credit
union to repurchase the same security at a specified time in the
future. The corporate credit union then sells that same security, on
the same day, to a third party, under agreement to repurchase it on the
same date on which the corporate credit union is obligated to return
the security to its member credit union.
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), but excluding paid-in capital. 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. A member may sell its membership capital to a
credit union in the corporate credit union's field of membership,
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 (e.g., one percent of a member credit union's
assets) established and disclosed by the corporate credit union at the
time the account is opened without regard to any minimum withdrawal
notice period. 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 related security means a security as defined in Section
3(a)(41) of the Securities Exchange Act of 1934 (15 U.S.C. 78c(a)(41)),
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 economic value (NEV) means the fair value of assets minus the
fair value of liabilities. All fair value calculations must include the
value of forward settlements and embedded options and of off balance
sheet financial derivatives, such as futures, options, interest rate
swaps, and forward rate agreements. Membership capital is treated as a
liability for purposes of this calculation. The NEV ratio is calculated
by dividing NEV by the fair value of assets.
Net interest income means the difference between income earned on
interest bearing assets and interest paid on interest bearing
liabilities.
Non member paid-in capital means paid-in capital that is approved
by NCUA, upon application by the corporate credit union. In determining
whether or not to approve any paid-in capital instrument, NCUA will
consider such features as maturity, capital amortization schedule,
participation, voting, acceleration, redemption, or other rights of the
holder, if any. NCUA will also consider the strategic purpose and
financial impact of the proposed paid-in capital issuance and the
corporate credit union's financial condition and management
capabilities.
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Non secured obligation means an obligation backed solely by the
creditworthiness of the obligor.
Official means any director or committee member.
Paid-in capital means accounts or other interests of a corporate
credit union that: Are available to cover losses that exceed reserves
and undivided earnings; are not insured by the NCUSIF or other share or
deposit insurers; 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. Paid-in capital
includes both member paid-in capital and non member paid-in capital. In
the event of liquidation of the corporate credit union, paid-in capital
is payable only after satisfaction of all liabilities of the
liquidation estate, including uninsured share obligations to
shareholders, the NCUSIF, and membership capital holders. Paid-in
capital shall not exceed reserves and undivided earnings.
Pair-off transaction means a security purchase transaction that is
closed out or sold at, or prior to, the settlement or expiration date.
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.
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.
Regular way settlement means delivery of a security from a seller
to a buyer within the specified number of days established for that
type of security.
Repurchase transaction means a transaction in which a corporate
credit union agrees to purchase a security from a counterparty and to
resell the same or any identical security to that counterparty 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 and undivided earnings means all forms of retained
earnings, including regular or statutory reserves and 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.
Section 107(8) institution means an institution described in
Section 107(8) of the Federal Credit Union Act (12 U.S.C. 1757(8)).
Securities lending means lending a security to a counterparty,
either directly or through an agent, and accepting collateral in
return.
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 counterparty 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 Exchange Act of 1934 (15 U.S.C.
78c(a)(53)), 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.
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.
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.
When-issued trading means the buying and selling of securities in
the period between the announcement of an offering and the issuance and
payment date of the securities.
Wholesale corporate credit union means a corporate credit union
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, unsupported by adequate capital
or risk management processes, 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
[[Page 12941]]
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.
(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 30 calendar 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 30 calendar 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, 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 of this part,
as applicable, operating management of the corporate credit union must
notify its board of directors, supervisory committee, and NCUA within
10 calendar 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 within
30 calendar days of the occurrence. NCUA will respond to the corporate
credit union regarding the adequacy of the plan within 45 calendar days
of its receipt.
(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.
(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 30
calendar 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
good cause, including the following conditions, the response time may
be shortened or lengthened:
(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 30 calendar 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
[[Page 12942]]
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.
(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:
(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 or resources
with adequate cross-training are in place;
(3) GAAP is followed, except where law or regulation has provided
for a departure from GAAP;
(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 retention of external consultants, as
appropriate, to review the adequacy of technical, human, and financial
resources dedicated to support major risk areas.
Sec. 704.5 Investments.
(a) Policies. A corporate credit union must operate according to an
investment policy that is consistent with its other risk management
policies, including, but not limited to, those related to credit risk
management, asset and liability management, and liquidity management.
The policy must address, at a minimum:
(1) Appropriate tests and criteria, if any, for evaluating standard
investments and investment transactions prior to purchase; and
(2) Risk analysis requirements for any new investment type or
transaction, not previously owned or marketed by the corporate credit
union, considered for purchase by the corporate credit union and/or for
sale to members.
(b) General. All investments must be U.S. dollar-denominated and
subject to the credit policy restrictions set forth in Sec. 704.6.
(c) Authorized activities. 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, Section 107(8) institutions, and 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 that meet the Federal Financial Institutions
Examination Council High Risk Security Test (HRST) requirements.
(i) The HRST must be prepared quarterly on all CMOs/REMICs,
documented and reviewed by an appropriate committee, and retained while
the instrument is held in portfolio and until completion of the next
audit and NCUA examination.
(ii) 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.
(iii) 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 HRST.
(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.
(d) Repurchase agreements. A corporate credit union may enter into
a repurchase agreement provided that:
(1) The corporate credit union, or its agent, nominee, or designee,
receives written confirmation of the transaction and either takes
physical possession or control of the repurchase securities or is
recorded as owner of the repurchase securities through the Federal
Reserve Book-Entry Securities Transfer System;
(2) The repurchase securities are legal investments for that
corporate credit union;
(3) In the event of default, the corporate credit union sells the
repurchase securities in a timely manner, subject to a bankruptcy stay,
to satisfy the commitment of any net principal and interest owed to it
by the counterparty;
(4) The corporate credit union receives daily assessment of the
market value of the repurchase securities, including a market quote or
dealer bid indication and any accrued interest, and maintains adequate
margin that reflects a risk assessment of the repurchase securities and
the term of the transaction;
(5) The corporate credit union has entered into signed contracts
with all approved counterparties. 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 the repurchase securities are 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
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the disposition of the repurchase securities.
(e) Securities Lending. A corporate credit union may enter into a
securities lending transaction provided that:
(1) The corporate credit union, or its agent, nominee, or designee,
receives written confirmation of the loan, obtains a perfected first
priority security interest in the collateral, and either takes physical
possession or control of the collateral or is recorded as owner of the
collateral through the Federal Reserve Book-Entry Securities Transfer
System;
(2) The collateral is a legal investment for that corporate credit
union;
(3) The corporate credit union, directly or through its agent,
receives daily assessment of the market value of collateral, including
a market quote or dealer bid indication and any accrued interest, and
maintains adequate margin that reflects a risk assessment of the
collateral and terms of the loan; and
(4) The corporate credit union, directly or through its agent, has
executed a written loan and security agreement with the borrower,
approved any form of agreement attached thereto, and obtained the right
to approve any material modification to such agreement.
(f) Investment companies. 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 investment company is restricted by
its investment policy solely to investments and investment transactions
that are permissible for that corporate credit union.
(g) Forward settlement of transactions later than regular way. A
corporate credit union may enter into an agreement to purchase or sell
an instrument, with settlement later than regular way, provided that:
(1) Delivery and acceptance are mandatory;
(2) The transaction is clearly disclosed in the appropriate risk
reporting required under Sec. 704.8(b);
(3) If the corporate credit union is the purchaser, it has adequate
cash flow projections evidencing its ability to purchase the
instrument;
(4) If the corporate credit union is the seller, it owns the
instrument on the trade date; and
(5) The transaction is settled on a cash basis at the settlement
date.
(h) Prohibitions. A corporate credit union is prohibited from:
(1) Purchasing or selling off balance sheet financial derivatives,
such as futures, options, interest rate swaps, or forward rate
agreements;
(2) Engaging in pair-off transactions, when-issued trading,
adjusted 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.
(i) Conflicts of interest. 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 credit union.
(j) Grandfathering. 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 Secs. 704.8 and 704.9.
Sec. 704.6 Credit risk management.
(a) Policies. A corporate credit union must operate according to a
credit risk management policy that is commensurate with the investment
and lending risks and activities it undertakes. The policy must
address, 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
counterparty, 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 counterparties 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., industry type, sector
type, and geographic).
(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 counterparty 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 (NRSRO).
(2) The rating(s) must be monitored for as long as the corporate
owns an instrument.
(3) At the time of purchase, asset-backed securities must be rated
no lower than AAA (or equivalent), other long-term investments must be
rated no lower than AA (or equivalent), and short-term investments must
be rated no lower than A-1 (or equivalent).
(4) Any rated instrument that is downgraded by the NRSRO used to
meet the requirements of this part at the time of purchase must be
reviewed by the board or an appropriate committee within 30 calendar
days of the downgrade. Instruments that fall below the minimum rating
requirements of this part are subject to the requirements of
Sec. 704.10.
(e) Reporting and documentation. (1) A written evaluation of each
credit line must be prepared at least annually and formally approved by
the board or an appropriate committee. At least monthly, the board or
an appropriate committee must receive a watch list of existing and/or
potential credit problems and summary credit exposure reports, which
demonstrate compliance with the corporate credit union's risk
management policies.
(2) At a minimum, the corporate credit union must maintain:
[[Page 12944]]
(i) A justification for each approved credit line;
(ii) Disclosure documents, if any, for all instruments held in
portfolio. Documents for an instrument that has been sold must be
retained until completion of the next NCUA examination; and
(iii) The latest available financial reports, industry analyses,
internal and external analyst evaluations, and rating agency
information sufficient to support 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. (1) The maximum aggregate amount
in 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 not exceed 50 percent of capital or 75 percent of
the sum of reserves and undivided earnings and paid-in capital,
whichever is greater.
(2) The maximum aggregate amount in secured loans and irrevocable
lines of credit to any one member credit union, excluding those secured
by shares or marketable securities and member reverse repurchase
transactions, shall not exceed 100 percent of capital or 200 percent of
the sum of reserves and undivided earnings and paid-in capital,
whichever is greater.
(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, unless such loan or line
of credit is fully guaranteed by a credit union. 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, other than through
a loan participation with another 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 net economic value
(NEV), compared to current NEV;
(4) The minimum allowable NEV ratio;
(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 (d) of this section;
and
(7) 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 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 (12 CFR chapter VII), 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) 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 and minus 100, 200, and 300
basis points on its NEV, NEV ratio, and net interest income. If the
base case NEV ratio falls below 2 percent at the last testing date,
these tests must be calculated at least monthly until the base case NEV
ratio again exceeds 2 percent;
(ii) Limit its risk exposure to levels that do not result in an NEV
ratio below 1 percent; and
(iii) Limit its risk exposures to levels that do not result in a
decline in NEV of more than 18 percent, except as provided in paragraph
(e) of this section.
(2) 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 periodically, as
appropriate, 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.
(e) Base-plus. (1) In performing the rate stress tests set forth in
paragraph (d)(1)(i) of this section, the NEV of a corporate credit
union which has met the requirements of this paragraph (e) may decline
as much as 25 percent.
(2) The corporate credit union must meet additional management and
infrastructure requirements and receive NCUA's written approval. The
additional requirements are set forth in the NCUA publication
Guidelines for Submission of Requests for Expanded Authority. The
procedures for processing base-plus authority are the same as those set
forth in Appendix B
[[Page 12945]]
of this part for requesting expanded authorities.
(3) The corporate credit union must evaluate monthly the changes in
NEV, NEV ratio, and net interest income for the tests set forth in
paragraph (d)(1)(i) of this section.
(4) Regardless of the amount of instruments which possess unmatched
embedded options, the corporate credit union must conduct periodically,
as appropriate, the tests set forth in paragraph (d)(2) of this
section.
(f) Regulatory violations. If a corporate credit union's base case
NEV or NEV ratio or the NEV or NEV ratio resulting from the tests
indicated in paragraph (d)(1)(i) of this section decline below the
limits established by this part and are not brought into compliance
within 10 calendar days, operating management of the corporate credit
union must immediately report the information to the board of
directors, supervisory committee, and NCUA. If any of these measures
remain below the limits established by this part within 30 calendar
days of the violation, 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 NEV or NEV
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.
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;
(2) Regularly 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 the board or an appropriate committee 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 that sufficient 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 30 calendar days
of the failure, report the failed investment to its board of directors,
supervisory committee, 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,
within 30 calendar days of 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) Is at least partly owned by a corporate credit union;
(2) Primarily serves credit unions;
(3) Restricts its services to those related to the normal course of
business of credit unions; and
(4) Is structured as a corporation, limited liability company, or
limited partnership 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 collateralized by assets in which the corporate credit union
has perfected a security interest under state law. 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 of a corporate credit union which has invested in
or loaned to a corporate CUSO may not receive, either directly or
indirectly, any salary, commission, investment income, or other income,
compensation, or consideration from the corporate CUSO. This
prohibition also extends to immediate family members of officials.
(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 opinion 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.
[[Page 12946]]
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) of this chapter, 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. Requests
shall be supplemented by such statements and reports as NCUA may
require. If the corporate credit union does not receive notification of
the action taken on its request within 45 calendar days of the date all
required information has been received, it may proceed with its
proposed investment in fixed assets.
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);
(4) For purposes of meeting the requirements of paragraphs (a)(2)
and (a)(3) of this section, an individual may not serve as a director
or chair of the board if that individual holds a subordinate employment
relationship to another employee who serves as an officer, director, or
employee of a credit union trade association; and
(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 organizational members. (1) An
organizational member of a corporate credit union is a member that is
not a natural person. An organizational member 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 organizational member
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 ``Regional Director'' is
used, read ``NCUA Board.''
Sec. 704.15 Audit requirements.
(a) External audit. The corporate credit union supervisory
committee shall cause an annual opinion audit of the financial
statements to be made. The audit must be performed in accordance with
generally accepted auditing standards and the audited financial
statements must be prepared consistent with GAAP, except where law or
regulation has provided for a departure from GAAP. The supervisory
committee 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 calendar days after receipt by the board
of directors. If requested by NCUA, the external auditor's workpapers
shall be made available, at the auditor's office or elsewhere, for
NCUA's review. The corporate credit union shall submit a summary of the
audit report 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
[[Page 12947]]
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).
(c) NCUA will notify, consult with, and provide explanation to the
appropriate state supervisory authority before taking administrative
action against a state-chartered corporate credit union.
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;
(2) When bond coverage is terminated, by issuance of a written
notice, on an employee, 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 for the preceding calendar 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 minimums in the table in paragraph (d)(1) of this section.
(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, except that in each category
the maximum deductible shall be $5 million:
------------------------------------------------------------------------
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.
------------------------------------------------------------------------
(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 30
calendar 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 calendar days
after the date of written notice from NCUA.
Sec. 704.19 Wholesale corporate credit unions.
(a) General. Wholesale corporate credit unions are subject to the
preceding requirements of this part, except as set forth in this
section.
(b) Capital. (1) A wholesale corporate credit union will maintain a
minimum capital ratio of 5 percent.
(2) A wholesale corporate credit union shall make reserve transfers
at the lower of .10 percent of its moving daily average net assets or
the amount that would be required under Sec. 704.3(c).
(i) Required transfers are to be made from earnings in either the
prior calendar month or prior twelve-month period. Transfers made
during the prior twelve-month period must be greater than or equal to
the aggregate amount of required reserve transfers for each of the
months in that twelve-month period.
(ii) NCUA and, in the case of state-chartered wholesale corporate
credit unions, the state supervisory authority, must be notified within
30 calendar days of the close of any calendar month in which a
wholesale corporate credit union's required reserve transfer exceeds
earnings for that month. The notice must include the dollar amounts of
the required reserve transfer and earnings for that month and for the
prior twelve-month period. The notice must also provide an explanation
of why the current month's required reserve
[[Page 12948]]
transfer exceeded earnings for that month.
(c) Asset and liability management. (1) In conducting the interest
rate sensitivity analysis set forth in Sec. 704.8(d)(1)(i), a wholesale
corporate credit union must limit its risk exposure to levels that do
not result, at any time, in an NEV ratio below .75 percent or a decline
in NEV of more than 35 percent.
(2) A wholesale corporate credit union must obtain, at its expense,
an annual third-party review of its asset and liability management
modeling system.
Appendix A to Part 704--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 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
(1) Paid-in capital is not subject to share insurance coverage
by the NCUSIF or other deposit insurer.
(2) The funds 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 subordinate to membership capital and the
NCUSIF.
If the form is used when a paid-in capital instrument is
created, 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
instrument.
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 to Part 704-- Expanded Authorities and Requirements
A corporate credit union may obtain expanded authorities if it
meets all of the requirements of this 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 and in
the NCUA publication Guidelines for Submission of Requests for
Expanded Authority. 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 expanded authorities when NCUA has provided final 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
deficiencies.
(a) In order to participate in the authorities set forth in
paragraphs (b) through (d) of this Part I, a corporate credit union
must:
(1) Have a minimum capital ratio of 5 percent;
(2) Evaluate monthly the changes in NEV, NEV ratio, and net
interest income for the tests set forth in Sec. 704.8(d)(1)(i); and
(3) Regardless of the amount of instruments which possess
unmatched embedded options, conduct periodically, as appropriate,
the tests set forth in Sec. 704.8(d)(2).
(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 long-term investments rated no lower than AA-(or
equivalent);
(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;
(5) Purchase principal only (PO) stripped mortgage-backed
securities to reduce interest rate risk;
(6) Purchase CMOs/REMICs using fewer prepayment models than
required in Sec. 704.5(c)(6);
(7) Enter into a repurchase transaction where the collateral
securities are rated no lower than A (or equivalent);
(8) Enter into a dollar roll transaction; and
(9) Engage in when-issued trading, when accounted for on a trade
date basis.
(d) In performing the rate stress tests set forth in
Sec. 704.8(d)(1)(i), the NEV 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 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 not exceed 100 percent of the corporate credit union's
capital. The board of 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; and
(2) Evaluate monthly the changes in NEV, NEV ratio, and net
interest income for the tests set forth in Sec. 704.8(d)(1)(i); and
(3) Regardless of the amount of instruments which possess
unmatched embedded options, conduct periodically, as appropriate,
the tests set forth in Sec. 704.8(d)(2).
(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
[[Page 12949]]
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 nonsecured obligations of any single domestic
issuer up to 250 percent of the sum of reserves and undivided
earnings and paid-in capital;
(2) Purchase long-term investments rated no lower than A- (or
equivalent);
(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;
(5) Purchase principal only (PO) stripped mortgage-backed
securities to reduce interest rate risk;
(6) Purchase CMOs/REMICs using fewer prepayment models than
required in Sec. 704.5(c)(6);
(7) Enter into a dollar roll transaction; and
(8) Engage in when-issued trading, when accounted for on a trade
date basis.
(d) In performing the rate stress tests set forth in
Sec. 704.8(d)(1)(i), the NEV 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 either Part I or Part II of this Appendix may
invest in:
(1) Debt obligations of a foreign country; and
(2) Deposits in, the sale of federal funds to, and debt
obligations of foreign banks or obligations guaranteed by these
banks.
(b) All foreign investments are subject to the following
requirements:
(i) Short-term investments must be rated no lower than A-1 (or
equivalent);
(ii) Long-term investments must be rated no lower than AA (or
equivalent);
(iii) A sovereign issuer, and/or the country in which a bank
issuer/guarantor is organized, must be rated no lower than AA (or
equivalent) for political and economic stability;
(iv) A bank issuer/guarantor must be rated no lower than AA;
(v) For each approved foreign bank line, the corporate credit
union must identify the specific banking centers and branches to
which it will lend funds;
(vi) Non secured obligations of any single foreign issuer may
not exceed 150 percent of the sum of reserves and undivided earnings
and paid-in capital; and
(vii) Non secured obligations in any single foreign country may
not exceed 500 percent of the sum of reserves and undivided earnings
and paid-in capital.
Part IV
A corporate credit union which has met the requirements of
paragraph (a) of either Part I or Part II of this Appendix 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.
PART 709--INVOLUNTARY LIQUIDATION OF FEDERAL CREDIT UNIONS AND
ADJUDICATION OF CREDITOR CLAIMS INVOLVING FEDERALLY INSURED CREDIT
UNIONS IN LIQUIDATION
2. The authority citation for part 709 continues to read as
follows:
Authority: 12 U.S.C. 1766; Pub. L. 101-73, 103 Stat. 183, 530
(1989) (12 U.S.C. 1787 et seq.).
3. Section 709.5 is amended by revising paragraphs (b)(7) and
(b)(8) and adding paragraph (b)(9) to read as follows:
Sec. 709.5 Payout priorities in involuntary liquidation.
* * * * *
(b) * * *
(7) In a case involving liquidation of a corporate credit union,
membership capital;
(8) In a case involving liquidation of a low-income designated
credit union, any outstanding secondary capital accounts issued
pursuant to the authority of Secs. 701.34 or 741.204(c) of this
chapter; 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 U.S.C. 1757, 1766, and 1781-1790. Section 741.4 is
also authorized by 31 U.S.C. 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. 97-6417 Filed 3-18-97; 8:45 am]
BILLING CODE 7535-01-P