[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,

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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

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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.

[[Page 12940]]

    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

[[Page 12943]]

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