[Federal Register Volume 62, Number 117 (Wednesday, June 18, 1997)]
[Rules and Regulations]
[Pages 32989-33006]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-15915]



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 Rules and Regulations
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  Federal Register / Vol. 62, No. 117 / Wednesday, June 18, 1997 / 
Rules and Regulations  

[[Page 32989]]


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NATIONAL CREDIT UNION ADMINISTRATION

12 CFR Part 703

RIN 3133-AB73


Investment and Deposit Activities

AGENCY: National Credit Union Administration (NCUA).

ACTION: Final rule.

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SUMMARY: The final regulation clarifies a number of areas, adds 
restrictions on some securities which have been determined to be 
inappropriate for credit unions, broadens authority in certain areas, 
and requires that a credit union's staff and board of directors meet 
certain safety and soundness standards with respect to the potential 
risks of the credit union's investment options.

DATES: This rule is effective January 1, 1998. However, early 
participation in the pilot program in Sec. 703.140 may begin on or 
after July 18, 1997.

ADDRESSES: National Credit Union Administration, 1775 Duke Street, 
Alexandria, Virginia 22314-3428.

FOR FURTHER INFORMATION CONTACT: David M. Marquis, Director, Office of 
Examination and Insurance, (703) 518-6360, or Daniel Gordon, Senior 
Investment Officer, Office of Investment Services, (703) 518-6620, or 
at the above address.

SUPPLEMENTARY INFORMATION:

A. Background

    In recent years there have been significant advances in modeling 
and measuring the risk factors of debt instruments. During this same 
period, financial market innovations severed any necessary link between 
the cash flows of an instrument and its underlying collateral. Based on 
these developments, which deal directly with safety and soundness 
issues, NCUA has shifted the focus of Part 703 from emphasis on 
specific instruments to the characteristics that affect risk management 
of investment activities.

Proposed Rule

    On November 16, 1995, the NCUA Board issued a proposed rule to 
significantly revise Part 703. 60 FR 61219 (November 29, 1995). The 
proposal (i) emphasized credit union board and staff understanding of 
the potential risks associated with a credit union's investment 
activities and (ii) established new procedures to value and monitor 
instruments in the investment portfolio. The comment period was to have 
expired on March 28, 1996, but was extended three times. 61 FR 8499 
(March 5, 1996); 61 FR 29697 (June 12, 1996); 61 FR 41750 (August 12, 
1996). The comment period expired on November 18, 1996.

Comments

    Federal credit unions, state-chartered credit unions, corporate 
credit unions, trade organizations, securities broker-dealers, 
investment advisors, state credit union regulators, law firms, banks, 
and individuals delivered a total of 596 comments to NCUA on the 
proposed rule. A majority of the commenters supported the general 
approach of the proposed rule but suggested specific changes. A sizable 
minority of the commenters disagreed with substantial portions of the 
proposed rule. NCUA thoroughly evaluated the comments and incorporated 
many of the suggested changes into this final rule.

CMO Study

    The preamble to the proposed rule noted an NCUA study of 
approximately 300 credit unions with investments in collateralized 
mortgage obligations (CMOs) and Real Estate Mortgage Investment 
Conduits (REMICs) in excess of capital (CMO Study). The CMO Study 
revealed that in 39 percent of the credit unions, credit union managers 
did not fully understand and appreciate the interest rate risk of CMOs/
REMICs, 24 percent of credit unions were taking unacceptable risks, and 
47 percent did not have acceptable asset-liability management policies. 
A number of commenters stated that the CMO Study, by itself, did not 
justify all of the proposed changes to Part 703.
    NCUA notes that while the CMO Study provided important information 
regarding the management and understanding of some individual 
investments, it was not the primary impetus for the proposed changes. 
The safety and soundness concerns raised by the prospect of continuous 
innovation in the financial marketplace and increasing interest rate 
risk to credit union balance sheets, together with technical 
innovations that aid the analysis of risk, motivated NCUA to amend the 
rule to place greater emphasis on risk management.

Final Rule

    This final rule establishes parameters for risk assessment and 
permits credit unions to operate flexibly within those parameters. At 
the same time, it minimizes the regulatory burden on those credit 
unions that choose to maintain a simple portfolio of investments.
    A credit union's balance sheet risk only partially arises from its 
investment activities. In fact, on average, investments constitute 
approximately one-third of all credit union assets. Comprehensive risk 
management should include an ongoing risk evaluation of the entire 
balance sheet and appropriate asset-liability management (ALM) policies 
and procedures. NCUA has decided not to develop an ALM rule at this 
time because of the diversity of approaches that could be appropriate 
for credit unions. Instead NCUA will evaluate a credit union's ALM 
through the examination process.
    An underlying premise of the regulation is that a credit union must 
establish its own risk limits and measure, monitor, and control the 
risks it decides to undertake. Credit unions that have the capacity for 
minimal risk management will necessarily set conservative risk 
parameters in order to meet the requirements of the rule. On the other 
hand, credit unions that have the capacity to measure, monitor, and 
control greater risks may set broader parameters.
    Many credit unions will, as part of their standard business 
practice, establish policies and procedures which properly go beyond 
the minimum requirements of this rule. In fact, one of the primary 
conclusions of the six focus groups conducted in the early stages of 
development of the rule was that the rule reflected sound business 
principles and would impose little additional burden on most credit 
unions.

[[Page 32990]]

Format

    Although the proposed rule was written in the traditional 
regulatory format, this final rule uses plain language drafting 
techniques that have been promoted by the Vice President's Regulatory 
Reinvention Initiative. The goal of plain language drafting is to 
decrease confusion, inadvertent errors, the need to seek clarification 
in correspondence and phone calls, and the amount of staff time credit 
unions must devote to understanding the regulations. Plain language 
drafting emphasizes the use of informative headings (often written as a 
question), lists and charts where appropriate, sections and paragraphs, 
non-technical language (including the use of ``you''), and sentences in 
the active voice. This final rule is written as a series of questions 
and answers, asked by a federal credit union and answered by NCUA. The 
words ``I'' in a question and ``you'' in an answer refer to a federal 
credit union. Occasionally, the regulation refers to ``you'' performing 
some action in relation to ``your'' board of directors. This should be 
read as a credit union's staff and/or management performing the action 
in relation to the credit union's board.
    One plain language drafting technique is to move definitions away 
from the beginning of a regulation, to avoid bombarding the reader with 
terms for which there is no context. In this final rule, a number of 
definitions have been moved to the end of the part, and others to where 
the term is used.
    Although commenters did not have the opportunity to express 
opinions on the plain language format prior to its use in this final 
rule, NCUA believes that the benefits of using the format justify this 
omission. NCUA welcomes comments on the format, however, and 
suggestions on how to improve it. NCUA is committed to converting more 
of its regulations to the plain language format in order to reduce 
regulatory burden and notes that the recently issued proposed rules 
governing credit union service organizations, 62 FR 11779 (March 13, 
1997), and production of nonpublic records and testimony of NCUA 
employees in legal proceedings, 62 FR 19941 (April 24, 1997), and an 
upcoming proposed rule governing member business loans use plain 
language drafting.

B. Section-by-Section Analysis

Section 703.10  What Does Part 703 Cover?

    The proposed rule deleted some sentences in the scope section as 
unnecessary, and added the provision that Part 703 does not apply to 
corporate credit unions. Investment activities of corporate credit 
unions are governed by Part 704. The proposed rule, however, did not 
change the format of the section. To improve readability, this final 
rule divides the section in two, with Section 703.10 addressing what 
Part 703 does cover and Section 703.20 addressing what it does not 
cover. The language in Section 703.10 is a slight rewording of the 
first two sentences in the scope section of the proposed rule to 
provide further clarification, with no change in meaning intended.

Section 703.20  What Does Part 703 Not Cover?

    In the scope section of the proposed rule, the clauses addressing 
the activities and entities not covered by Part 703 follow one another 
as part of one dense paragraph. To improve readability, Section 703.20 
of this final rule sets out each activity or entity separately.
    As noted above, the proposed rule added the provision that Part 703 
does not apply to corporate credit unions. The preamble explained that 
the investment activities of corporate credit unions are governed by 
Part 704 of NCUA's regulations. There was no objection to this 
proposal, and it has been retained in the final rule.
    One commenter suggested that the rule should expressly state that 
Part 703 does not apply to state-chartered credit unions. NCUA agrees 
and has added paragraph (f) to Section 703.20. That paragraph states 
that Part 703 does not apply to state-chartered credit unions, except 
as provided in Section 741.3(a)(3) of NCUA's regulations. Under Section 
741.3(a)(3), a state-chartered credit union must establish a separate 
reserve if it invests in instruments not permitted for federal credit 
unions by Part 703 or the Federal Credit Union (FCU) Act. In a limited 
sense, therefore, Section 703.110, which sets forth activities that are 
prohibited for federal credit unions, ``applies'' to state-chartered 
credit unions. Paragraph (f) clarifies, however, that the other 
requirements of Part 703 do not apply to state-chartered credit unions.

Section 703.30  What Are the Responsibilities of My (a Federal Credit 
Union's) Board of Directors?

    Section 703.3(a) of the proposed rule expanded on the current 
rule's requirements regarding investment policies. Section 703.3(b) of 
the proposed rule established a new list of required investment 
practices. This final rule divides policies and practices into two 
sections; Section 703.30 addresses policies and Section 703.40 
addresses practices. In addition, the final rule modifies many of the 
specific policies and practices that were proposed. Of the commenters 
who addressed this section generally, most agreed with the need to have 
investment policies.
Purposes and Objectives of Investment Activities
    Proposed Section 703.3(a)(1) required that the board of directors 
state in the credit union's policies the purposes and objectives of the 
credit union's investment activities. The intent was that the policy 
provide a clear statement of the credit union's investment goals. For 
example, a credit union's primary goals may be to minimize risk, 
provide liquidity, and generate a reasonable rate of return. The 
emphasis placed on each goal will vary based on individual credit union 
constraints or needs. NCUA received no comments on this provision and 
has retained it in Section 703.30(a) of the final rule.
Characteristics of Authorized Investments
    Proposed Section 703.3(a)(2) required that a credit union's 
investment policy set out the investments that the credit union may 
make, by issuer and characteristics. The definitions section of the 
proposed rule defined an investment characteristic as a feature of an 
investment such as its maturity, index, cap, floor, coupon rate, coupon 
formula, call provision, or average life. The preamble stated that a 
policy could, for example, authorize investments issued or guaranteed 
by the U.S. Treasury, the Federal Home Loan Mortgage Corporation, and 
the Federal National Mortgage Association, or could limit investments 
to instruments with a maximum maturity of 5 years, or those with a 
fixed coupon, or those tied to a particular index. A few commenters 
expressed concern that the requirement was too restrictive and would 
not allow management sufficient flexibility in making investment 
decisions.
    NCUA did not intend for boards to specify the parameters of each 
approved investment. The intent was for boards to establish guidelines 
for investment characteristics. NCUA believes that it is imperative for 
a board, which sets the overall ALM strategy for the credit union, to 
set investment guidelines and risk parameters that are consistent with 
that strategy. Further, for the guidelines to be meaningful, they must 
be fairly specific. Therefore, the requirement has been retained in the 
final rule, at Section 703.30(b). The language has been modified, 
however, to clarify that

[[Page 32991]]

the issuer is another type of characteristic.
    The following additional examples may prove helpful in illustrating 
the types of policy statements that NCUA might see boards establish: 3-
year bullets (securities that make one principal payment at maturity) 
with a fixed coupon; variable rate securities linked to the 3-month 
Treasury bill yield or U.S. dollar-denominated LIBOR that, at the time 
of purchase, are at least 300 basis points below their cap; and fixed 
rate federally insured deposits of one year or less. With respect to 
the last, NCUA would not view as necessary that the policy go on to 
list specific authorized depository institutions.
    As an alternative to the type of limits discussed above, or in 
addition to such limits, a board could specify acceptable interest rate 
risk for individual investments. For example, a policy could restrict 
the credit union to purchasing instruments that are predicted to 
experience a price change of less than a certain percentage for an 
immediate and sustained parallel shift in the yield curve of a certain 
amount. A credit union choosing this approach must be confident it has 
the methodology to assess this potential risk.
Interest Rate Risk
    Section 703.3(a)(3) of the proposed rule required credit unions to 
develop policies on interest rate risk management. One commenter noted 
that the rule did not define ``interest rate risk.'' Stated in the 
broad context of ALM, interest rate risk is the exposure of a credit 
union's current and future earnings and capital arising from adverse 
movements in interest rates. Changes in interest rates affect a credit 
union's earnings by changing its net interest income and the level of 
other interest-sensitive income and operating expenses. Changes in 
interest rates also affect the underlying economic value of the credit 
union's assets, liabilities, and off-balance sheet items. These changes 
occur because the present value of future cash flows, and in many cases 
the cash flows themselves, change when interest rates change. The 
combined effects of the changes in these present values reflect the 
change in the credit union's underlying economic value as well as 
provide an indicator of the expected change in the credit union's 
future earnings arising from the change in interest rates. While 
interest rate risk is inherent in the role of credit unions as 
financial intermediaries, a credit union that has a high level of risk 
can face diminished earnings, impaired liquidity and capital positions, 
and, ultimately, greater risk of insolvency.\1\
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    \1\ This discussion of interest rate risk comes from a joint 
agency policy statement on interest rate risk issued by the Office 
of the Comptroller of the Currency, the Board of Governors of the 
Federal Reserve System, and the Federal Deposit Insurance 
Corporation in May 1996. See 61 FR 33166, 33167 (June 26, 1996).
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    Since this rule is limited to investment activity, it only 
addresses interest rate risk in the investment portfolio. Several 
commenters observed that a credit union should manage interest rate 
risk through its ALM policies and procedures, which additionally take 
into account its loan portfolio and liabilities. NCUA recognizes that 
interest rate risk can be more fully evaluated this way but, for 
reasons discussed in the background section of this preamble, has 
decided to limit the rule to investments. A credit union with an ALM 
policy that addresses interest rate risk across the balance sheet, 
however, need not establish a separate policy addressing interest rate 
risk in the investment portfolio.
    No commenters objected to the requirement that a credit union 
develop a policy on how it will manage interest rate risk in its 
investment portfolio, and the requirement has been retained in Section 
703.30(c) of the final rule. Based on the comments and further NCUA 
discussion, a sentence has been added requiring that a credit union's 
interest rate risk management policy establish the amount of risk that 
the credit union can take with its investments in relation to its net 
capital and earnings.
    A credit union's interest rate risk policy must be commensurate 
with the scope, size, and complexity of the risks the credit union 
assumes. The policy of a credit union with a simple portfolio and 
conservative risk parameters might specify that net capital, earnings, 
or investment income, may not vary by more than a certain percentage 
for a parallel shift in interest rates. The policy of a credit union 
with a complex portfolio, however, might also set limits that reflect 
changes in the shape of the yield curve, credit spreads, prepayment 
patterns, and volatility.
Liquidity Risk
    Section 703.3(a)(6) of the proposed rule required credit unions to 
develop policies on liquidity risk management. Liquidity risk is the 
risk that a credit union will have insufficient liquid assets to meet 
immediate cash demands. A liquid asset is one that can be converted 
quickly into cash with minimal loss. The intent was that the board 
assess the potential for cash demands, document how it arrived at this 
assessment, and establish a liquidity policy that will enable it to 
meet the demands. Only one commenter opposed the requirement, and it 
has been retained in the final rule, in Section 703.30(d).
    In assessing the potential for immediate cash demands, credit 
unions may use a simple estimate, based upon the history of prior cash 
flows. Credit unions also may use a more elaborate approach. Two 
commenters suggested that the occasional, temporary use of alternative 
balance sheet funding sources (short-term borrowing) is a reasonable 
part of liquidity management. NCUA does not disagree but emphasizes 
that borrowing should be part of a well thought-out liquidity plan.
Credit Risk
    Section 703.3(a)(7) of the proposed rule required credit unions to 
develop policies on the management of credit risk, including approved 
issuers, or criteria for issuers, and limits on the amounts that may be 
invested with each issuer. As noted in the preamble to the proposed 
rule, a credit union may rely on credit ratings to manage credit risk. 
However, boards should be aware that ratings may fail to timely reflect 
a creditor's deteriorating ability to repay its obligations and is only 
one source of credit information. A credit union without the ability to 
evaluate credit risk may choose to limit its investments to those that 
are fully guaranteed or insured. The provision is located at Section 
703.30(e) of the final rule.
Concentration Risk
    Section 703.3(a)(4) of the proposed rule required credit unions to 
set concentration limits in their investment policies. The preamble 
stated that the board must develop concentration limits for, among 
other things, shares and deposits in corporate credit unions. The 
commenters generally supported the requirement to establish 
concentration limits, but a number asked whether NCUA would continue 
its policy of not taking exception to credit unions placing 100 percent 
of their investments in corporate credit unions. Examiners will not 
automatically object to 100 percent concentration in a corporate credit 
union, but will require all but the smallest credit unions investing 
more than the insured amount in a corporate to perform an appropriate 
credit analysis. The scope of credit analysis for investments in 
corporates and other institutions and issuers is addressed in the 
discussion of credit analysis under Section 703.40(e).

[[Page 32992]]

    Concentrations can increase a credit union's vulnerability to 
unforeseen market, credit, and liquidity risks. Each credit union must 
evaluate concentration risk in relation to its financial condition and 
its ability to analyze the risks of all investments. The provision is 
located at Section 703.30(f) of the final rule.
CMO/REMIC Prepayment Models
    Section 703.3(a)(5) of the proposed rule directed credit unions to 
identify in their investment policies the specific CMO/REMIC prepayment 
models they would use when performing the tests required to purchase or 
hold CMOs/REMICs. This was to control the practice of selecting the 
prepayment model that would allow a particular CMO/REMIC to pass the 
tests. The preamble noted that each credit union had the flexibility to 
choose the prepayment models it believed were the best measures of 
potential risk, as long as they were reasonable and supportable.
    One commenter stated that NCUA should specify which models are 
permissible and accept the fact that models are imperfect and will 
sometimes give different results.
    Since the forecasting of prepayments is an evolving science, NCUA 
prefers to leave to each credit union the decision as to which models 
it will use. For consistency, it is essential that a credit union use 
the same models for testing all CMOs/REMICs.
    This final rule moves some material that was in the CMO/REMIC 
testing section to the policy section. It clarifies that a credit union 
board's first policy decision will be whether the credit union will use 
a median prepayment estimate or individual, proprietary estimates. Once 
that determination is made, the credit union may use only that method. 
If the choice is to use a median estimate, the board then must 
determine the source of that estimate, whether it be Bloomberg or 
another similar source. If the choice is to use individual estimates, 
the board then must determine the sources of those estimates. In 
response to a comment, the final rule uses the less confusing term 
``prepayment estimate'' rather than ``prepayment model.'' Finally, in 
response to a comment, the final rule clarifies that a board must set 
policies for prepayment sources for CMO/REMIC testing only where it has 
authorized the purchase of CMOs/REMICs. The provision is located at 
Section 703.30(g) of the final rule.
Investment Authority
    Section 703.3(a)(8) of the proposed rule required a credit union to 
state in its investment policy the persons in the credit union to whom 
investment authority was delegated, the knowledge and experience 
required of such persons, and the extent of their authority. The 
provision also stated that this requirement could be met by the board's 
approval of position descriptions that address the same criteria. In 
addition to this policy requirement, Section 703.3(b)(2)(i) of the 
proposed rule required that a credit union follow certain practices 
regarding investment authority. It stated that any official or employee 
of a credit union who had discretionary investment authority had to 
``demonstrate'' an understanding of the risk characteristics of 
investments and investment transactions under that authority. It 
provided that only a credit union's officials, employees, and members 
could be voting members of its investment and/or asset-liability 
management committees. Finally, it explicitly affirmed that the 
ultimate responsibility for supervising a credit union's investment 
activities rested with the board of directors.
    There was some confusion regarding the burden that would be imposed 
on directors with respect to understanding the risk of authorized 
investments. It was never NCUA's intention to require volunteers to 
understand all of the factors that affect the risks of each instrument. 
This appropriately remains the responsibility of the individuals to 
whom investment authority has been delegated. It is the responsibility 
of the board, however, to set policy limits, approve procedures, 
understand the overall risks associated with the investments, and 
receive reports assessing whether the portfolio has remained within 
established limits.
    The final rule combines proposed Sections 703.3(a)(8) and 
703.3(b)(2)(i) into a policy requirement at Section 703.30(h). That 
provision requires the investment policy to specify who, of the credit 
union's officials and employees, has investment authority and the 
extent of that authority. The final rule does not explicitly provide 
that the requirement may be met by approving appropriate position 
descriptions. NCUA omitted the provision because it was unnecessarily 
detailed and might suggest that there was no other way to meet the 
requirement. It remains a permissible way to meet the requirement.
    Section 703.30(h) also states that individuals given investment 
authority must be professionally qualified, by education and/or 
experience, to exercise that authority in a prudent manner and to fully 
comprehend and assess the risk characteristics of investments and 
investment transactions under that authority. Rather than requiring 
that persons with investment authority ``demonstrate'' an understanding 
of the risk characteristics of the investments under that authority, 
the final rule simply requires that they be qualified to exercise that 
authority. It is the responsibility of the board to ensure such 
qualification.
    Section 703.30(h) states that only a credit union's officials and 
employees may be voting members of a credit union's ``investment-
related committee.'' Credit unions use a variety of terms for the 
committee that is primarily concerned with investments. The proposed 
rule used ``investment committee,'' ``asset-liability management 
committee,'' or a combination of the two. To avoid inadvertently 
excluding a committee with a different name, the final rule uses the 
term ``investment-related committee'' throughout.
    The final rule also does not include ``member'' in the list of 
individuals who can be voting members of that committee. The proposed 
rule intended to allow credit union members who serve on such 
committees to be able to vote. To lessen confusion, however, the final 
rule redefines ``official'' to include a member of a credit union's 
investment-related committee.
    Finally, Section 703.30(h) does not contain the statement that the 
ultimate responsibility for supervising a credit union's investment 
activities rests with the board. It is not necessary to make the 
statement in the regulation, as Section 113(6) of the FCU Act, 12 
U.S.C. 1761b(6), provides that a federal credit union's board of 
directors shall have charge of investments.

Broker-Dealers

    Section 703.3(a)(9) of the proposed rule required that a credit 
union's investment policy list approved broker-dealers and limits on 
the amounts and types of transactions for each. The preamble noted that 
although the proposal did not require approval of more than one broker-
dealer, reliance on a single individual or firm could be 
disadvantageous to the credit union. A credit union might choose to 
approve one broker-dealer for the full range of its investment 
activities and another for only certain of the investments authorized 
by policy. For example, the credit union may permit one broker, with 
more limited knowledge, to sell to

[[Page 32993]]

the credit union only Treasury securities with less than 1 year 
maturity, while permitting another, with more knowledge and ability, to 
sell longer term securities or securities with embedded options issued 
by U.S. government agencies, as well as Treasury securities. The 
preamble stated that details for these authorizations should be 
established by policy.
    In response to comments, NCUA has deleted the language regarding 
establishing limits on the amounts and types of transactions. In 
addition, Section 703.30(i) of the final rule clarifies that the 
requirement to list approved broker-dealers applies only if the credit 
union uses third parties to purchase or sell investments. A credit 
union could purchase an investment without using a third party by, for 
example, obtaining a certificate of deposit (CD) directly from a bank 
or a Treasury security through the Treasury Direct program. The final 
rule defines any such third party as a ``broker-dealer,'' even if that 
third party only buys and sells investments that do not meet the formal 
definition of ``security,'' such as CDs. Section 703.30(i) also 
requires that the credit union maintain the documentation the board 
used to approve a broker-dealer as long as the broker-dealer is 
approved and until the documentation has been both audited and 
examined. That requirement was located at Section 703.3(b)(10) of the 
proposed rule.
Safekeeping
    Section 703.3(a)(10) of the proposed rule required that a credit 
union's investment policy list approved safekeeping entities and limits 
on the amounts and types of investments that could be safekept with 
each entity. In response to comments, NCUA has deleted the language 
regarding amounts and types of investments and the requirement to 
maintain documentation used to approve a safekeeper. Section 703.30(j) 
of the final rule clarifies that the requirement to list approved 
safekeepers applies only if a credit union uses such entities. Also in 
response to comments, NCUA wishes to make clear that corporate credit 
unions may serve as safekeepers.
``Failed'' Investments
    Section 703.4(b)(3) of the proposed rule required that management 
notify the board by the next board meeting of any investment that, 
because of changing market conditions, falls outside of board policy 
after purchase. The proposed rule also created an entire section, 
Section 703.7, which established divestiture requirements for a credit 
union holding an investment that, because of a credit downgrade or 
failure to meet an interest rate shock test, no longer meets regulatory 
mandates. Many commenters stated that the proposed requirements, 
particularly those regarding ``failed'' investments, preempted the 
board's right to establish its own policies in those areas.
    NCUA has determined to retain only a few simple requirements for 
investments that fail board policy or part 703. They are contained in 
Section 703.40(f) of the final rule. Other than these, Section 
703.30(k) requires that the board establish its own policies for such 
investments.
Trading
    Section 703.3(a)(11) of the proposed rule required that a credit 
union establish trading policies, if it engages in trading. The 
provision listed a number of items that the policies should address. In 
1987 NCUA issued Letter to Credit Unions No. 89, which discussed 
trading activities. This Letter is still effective. No significant 
comments having been received on this provision, it is retained in the 
final rule, at Section 703.30(l).

Section 703.40  What General Practices and Procedures Must I Follow in 
Conducting Investment Transactions?

    As noted earlier, Section 703.3(b) of the proposed rule established 
a list of required investment practices. Those practices, many of which 
have been modified, are found in Section 703.40 of this final rule.
Classification of Securities
    Section 703.3(b)(1) of the proposed rule required that a credit 
union classify securities in accordance with generally accepted 
accounting principles (GAAP). The applicable principle is Statement of 
Financial Accounting Standard (SFAS) 115. The preamble stated that 
deposits and shares in depository institutions are not securities and 
are not subject to SFAS 115. In response to comments, NCUA notes that 
the Financial Accounting Standards Board has stated that jumbo CDs may 
meet the definition of security and may be subject to SFAS 115. A 
credit union should review the relevant disclosure documents to 
determine whether a CD meets the definition of security. The 
classification provision has been retained in the final rule, at 
Section 703.40(a).
Delegation of Discretionary Investment Authority
    Section 703.3(b)(2)(ii) of the proposed rule established a general 
prohibition against delegating discretionary control of investment 
authority to a person other than an official or employee of the credit 
union. However, proposed Section 703.3(b)(2)(iii) permitted a credit 
union to delegate such control to an investment adviser who is 
registered with the Securities and Exchange Commission (SEC) under the 
Investment Advisers Act of 1940. Proposed Section 703.3(b)(2)(iii) 
limited the total of a credit union's delegation of discretionary 
investment control and investment in mutual funds to 100 percent of 
capital.
    The commenters strongly opposed the limitation on delegation of 
discretionary investment control, particularly the inclusion of 
investments in mutual funds in that limitation. Some of the concern 
stemmed from confusion over the concept of ``delegation of control.'' 
Although Section 703.3(b)(2)(ii) stated that control was not considered 
delegated if the credit union authorized each purchase and sale, 
several commenters thought that a traditional relationship with a 
broker-dealer was included in the concept. A credit union has not 
delegated discretionary investment control where its broker-dealer 
recommends purchases and sales but does not act until it has received 
the credit union's approval for the specific transaction. Likewise, if 
a credit union is receiving investment advice from an investment 
adviser but is still approving each purchase and sale, it has not 
delegated discretionary investment control.
    For example, if a broker proposed that a credit union purchase a 
specific security, and the credit union authorized the purchase, the 
credit union has not delegated discretionary control. On the other 
hand, if a broker informed a credit union that CMOs/REMICs with 2-year 
weighted average lives looked like good investments, and the credit 
union responded that the broker should purchase one that ``looks 
good,'' the credit union has delegated discretionary control.
    NCUA has determined to retain the general prohibition against 
delegation of discretionary investment control, except under certain 
conditions. Section 703.40(b) establishes the prohibition, and Section 
703.40(c) establishes the conditions under which delegation is 
permitted. No commenters objected to the proposed requirement that 
delegations of discretionary control be limited to investment advisers 
registered with the SEC, and it has been retained in paragraph (c)(1). 
Paragraph (c)(2) makes explicit what is a part of normal business 
practices; that is, analyzing a potential investment adviser's 
background.

[[Page 32994]]

    Section 703.3(b)(2)(iii) of the proposed rule restricted how an 
investment adviser could be compensated, to keep his or her interest 
allied with that of the credit union. Several commenters suggested that 
the provision be modified to make it clear that there are no 
restrictions on compensating a registered investment adviser who does 
not have discretionary investment control. NCUA agrees and has made the 
change. The provision is located at paragraph (c)(3) of Section 703.40.
    Proposed Section 703.3(b)(2)(v) required that investments under the 
discretionary control of an investment adviser be classified as either 
available-for-sale or trading. One commenter was opposed to this 
provision, but NCUA continues to believe it is necessary and has 
retained it, at paragraph (c)(4) of Section 703.40. Paragraph (c)(5) 
codifies what should be a part of normal business practices, that is 
receiving a monthly statement from an adviser.
    Finally, as noted above, proposed Section 703.3(b)(2)(iii) limited 
the total of a credit union's delegation of discretionary investment 
control and investment in mutual funds to 100 percent of capital. In 
response to the commenters' concerns, NCUA has determined not to 
include investments in mutual funds in the limitation. Also in response 
to the comments, NCUA has clarified that the limitation is the 
aggregate of a credit union's delegation of discretionary control, that 
is, regardless of the number of investment advisers a credit union 
uses, it may delegate discretionary control over the portion of its 
investment portfolio that represents 100 percent of its capital. This 
provision is located at paragraph (c)(6) of Section 703.40. NCUA notes 
that whenever a credit union uses any third party, such as investment 
adviser, broker-dealer, or safekeeper, to carry out investment 
transactions on its behalf, it must ensure that the third party 
complies with the restrictions of Part 703 and the FCU Act. This could 
be accomplished through written agreement with the third party.
Credit Analysis
    Section 703.3(b)(6) of the proposed rule required credit unions to 
perform credit analyses of issuing entities unless the investment is 
issued or guaranteed by the U.S. government or is covered by share or 
deposit insurance. Recognizing that it often is difficult for credit 
unions to perform detailed credit analyses, the proposed rule 
established a minimum rating of B/C for financial institutions that are 
rated. The preamble noted that credit unions should perform credit 
analyses for uninsured investments in nonrated financial institutions, 
including corporate credit unions.
    A number of commenters expressed concern regarding the proposed 
requirements, particularly credit analyses of corporate credit unions. 
They argued that credit analyses were too burdensome and that credit 
unions should be permitted to rely entirely on ratings. Many wondered 
how credit analyses of corporate credit unions could be conducted, 
while others believed it was not necessary, since corporate credit 
unions are examined by NCUA.
    NCUA recognizes that a small credit union may be unable to perform 
a detailed credit analysis. For a small credit union, investing funds 
in corporate credit unions is an appropriate risk management 
alternative to investing in securities. NCUA will not take exception to 
a small credit union investing all of its surplus funds in a corporate 
credit union.
    NCUA expects a larger credit union, however, to perform a credit 
analysis whenever there is credit risk. The uninsured portion of an 
investment in a corporate credit union presents such risk. NCUA 
supervises corporate credit unions and is primarily concerned with 
their safe and sound operations and adherence to applicable laws, 
rules, and regulations. This supervision does not serve as a guarantee 
of the investment products a corporate credit union may offer, nor as 
assurance against potential loss.
    A credit union's membership relationship with its corporate should 
assist it in evaluating the corporate's operations and financial 
condition. A credit union should review the corporate credit union's 
earnings performance, capital level, and investment portfolio. A credit 
union also should be aware of the corporate's operating level under 
Part 704 and its exposure to a 300 basis point shift in interest rates.
    In addition to uninsured investments in corporate credit unions, 
investments with credit risk include uninsured CDs, federal funds, bank 
notes, municipal securities, and repurchase transactions. As with 
investments in corporate credit unions, a credit union must conduct a 
credit analysis of these other investments that is commensurate with 
the risk of the exposure. The analysis should include a review of 
capital, ratings, financial trends, earnings, and loan losses. While 
the proposed rule required that this analysis be updated semiannually, 
the final rule requires only an annual update. The final rule, located 
at Section 703.40(d), also does not establish a minimum financial 
institution rating. The commenters noted that the ratings from the 
various rating agencies are not consistent and that too many 
institutions are unrated.
``Failed'' Investments
    As noted above in the discussion of Section 703.30(k), the proposed 
rule required board notification of investments that fall outside of 
board policy after purchase and also established divestiture 
requirements for investments that fail the regulation. In response to 
comments, NCUA determined to retain the board notification requirement 
for investments failing board policy and to eliminate all of the 
requirements for investments failing the regulation except board and 
NCUA notification. These requirements are located at Section 703.40(e) 
of the final rule. To the extent that Section 703.40(e) conflicts with 
Letter to Credit Unions No. 169, governing CMOs/REMICs that fail the 
stress test, the Letter is superseded. Credit unions should not 
interpret the removal of specific divestiture requirements from the 
final rule as NCUA's tacit approval to hold a failed investment 
indefinitely. On the contrary, NCUA will continue to review the safety 
and soundness of failed investments to determine whether divestiture is 
necessary. As always, instruments that were impermissible when 
purchased may be subject to immediate divestiture.
Documentation
    Proposed Section 703.3(b)(10) required that documentation be 
maintained through the examination and audit cycles. The preamble noted 
that there had been instances where credit unions failed to maintain 
enough documentation for the examiner and auditor to properly analyze 
the security or determine the relationship of the investment decisions 
to the credit union's policies. There were few comments on this 
section, and it has been retained in the final rule, at Section 
703.30(f). A credit union must maintain sufficient information to 
demonstrate that it has exercised prudent judgment in making investment 
decisions.

Section 703.50  What Rules Govern My Dealings With Entities I Use To 
Purchase and Sell Investments (``Broker-Dealers'')?

    Section 703.3(b)(7) of the proposed rule required that any broker-
dealer used by a credit union be either a federally regulated 
depository institution or registered with the Securities and Exchange 
Commission

[[Page 32995]]

(SEC). The proposed rule also required that credit unions conduct an 
analysis of the financial condition and reputation of the broker-dealer 
and sales representative. The comments on this section were mixed, with 
some in favor of the proposed requirements and others objecting that 
they were too burdensome. NCUA continues to believe that credit unions 
should do business only with broker-dealers that meet a certain minimum 
standard of conduct and has retained the requirement. This means that 
even when purchasing a CD through a broker who only sells CDs, the 
broker must be either registered with the SEC or a federally regulated 
depository institution.
    NCUA also believes that credit unions should exercise due diligence 
in determining whether to transact business with a broker-dealer and/or 
sales representative. As an additional control, a credit union should 
consider prohibiting any official or employee with discretionary 
investment authority from maintaining a personal account with the same 
sales representative that the credit union uses. If the broker-dealer 
acts as a credit union's counterparty in transactions, introducing 
credit risk, the credit union must increase its level of due diligence.

Section 703.60  What Rules Govern My Safekeeping of Investments?

    Section 703.3(b)(8) of the proposed rule established new 
safekeeping requirements for credit unions. It required that a credit 
union maintain its securities independently of its broker-dealer and 
that it receive a safekeeping receipt for each investment held in 
safekeeping. It permitted an investment to be held in street name as 
long as the credit union and/or safekeeper maintain documentation 
establishing that the credit union is the beneficial owner of the 
investment. It required a credit union to review the financial 
condition of approved safekeepers at least annually and that purchases 
and sales be ``delivery versus payment,'' where payment for an 
investment occurs simultaneously with its delivery.
    In response to comments, NCUA has eliminated the requirement to 
obtain safekeeping receipts, the requirement to review the financial 
condition of approved safekeepers, and the language regarding street 
name. A credit union may permit investments to be held in the name of a 
broker or nominee and should maintain documentation showing that it is 
the true owner of the investments. The credit union should be listed as 
owner on the individual confirmation statements and monthly safekeeping 
statements required by the final rule.
    The proposed requirement for investments to be held by a safekeeper 
under a written custodial agreement has been retained in the final 
rule. In response to comments, however, NCUA wishes to clarify that the 
provision does not require that the agreement be between the credit 
union and the custodian. The agreement may be between the broker and 
the custodian, although in that case, the credit union should obtain a 
copy.

Section 703.70  What Must I Do to Monitor My Non-Security Investments 
in Banks, Credit Unions, and Other Depository Institutions?

    One of the challenges of this rule was establishing criteria to 
ensure that credit unions with portfolios of securities know the risks 
of those instruments, while permitting credit unions that restrict 
their investments to CDs and corporate credit union deposits to do so 
without undue burden, even though those instruments can present some 
credit and interest rate risk. Sections 703.3 (b)(4) and (b)(5) of the 
proposed rule required credit unions to perform certain actions to 
value and monitor their securities. The GAAP definition of ``security'' 
includes marketable instruments such as Treasuries, agencies, mortgage 
backed instruments, and as previously discussed, certain jumbo CDs. The 
only monitoring provision that addressed investments that were not 
securities, such as ordinary CDs and corporate deposits, was at 
proposed Section 703.3(b)(4)(ii)(A), which required credit unions to 
prepare monthly reports listing the characteristics of each investment 
held.
    Some commenters expressed concern that the requirements for 
securities also applied to ordinary CDs and corporate deposits. This 
final rule maintains the proposed rule's distinction between 
``securities'' and ``investments,'' but to make it clearer that a 
credit union that chooses to invest only in ordinary shares and 
deposits need not worry about the requirements for securities, this 
final rule establishes a separate section for investments in depository 
institutions that do not constitute securities. Further, the regulatory 
burden itself has been reduced. Section 703.70 requires a credit union 
to list, quarterly rather than monthly, the dollar value of only those 
non-security shares or deposits that have embedded options, remaining 
maturities greater than 3 years, or coupon formulas related to more 
than one index or inversely related to, or multiples of, an index. A 
credit union's board should be aware of the potential risk of shares or 
deposits with these characteristics.

Section 703.80  What Must I Do to Value My Securities?

    Proposed Section 703.3(b)(5)(i) required that before purchasing or 
selling a security, a credit union obtain a price quotation from a 
second broker or from an industry-recognized information provider. The 
preamble noted that credit unions have been known to pay or receive 
prices that were significantly different from market prices because 
their brokers knew they were not verifying prices with other sources.
    A number of commenters objected to the requirement to obtain a 
second price, arguing that it was burdensome and unrealistic. NCUA 
continues to believe that it is imperative for credit unions to ensure 
that they know the market prices of the securities they buy and sell, 
and has retained the requirement, at Section 703.80(a). Again, to 
minimize burden, the rule allows a credit union to obtain a second 
price from an industry-recognized information provider. This may be an 
electronic service that provides market information (Bloomberg, 
Reuters, etc.) or a newspaper of general and regular circulation (Wall 
Street Journal, New York Times, etc.). NCUA recognizes that prices from 
information providers are indicative only, but they should show whether 
a broker's price is reasonable. To further reduce burden, and in 
response to comments, an exception has been added for new issues 
purchased at par.
    The rule does not require that the credit union use the broker with 
the best price. NCUA understands that a credit union can receive 
ancillary services from a broker that are not reflected in fees, and a 
credit union may choose to compensate the broker by occasionally 
accepting a poorer price than that available from another broker. 
However, credit unions should be aware of the implicit cost of these 
services. Therefore, as discussed earlier, Section 703.40(g) requires 
that a credit union document the prices it pays or receives for 
securities. NCUA understands that prices received from broker-dealers 
generally will not be in writing; however, the credit union should 
document who was called, the date and time of the call, and the quoted 
price or spread to the relevant security. A phone note with the 
identified information would meet this requirement.
    Proposed Section 703.3(b)(5)(ii) required a monthly review of the 
fair value of each security in a credit union's

[[Page 32996]]

portfolio. The preamble noted that this information generally is 
provided by broker-dealers or safekeepers. There was virtually no 
opposition to this requirement, and it has been retained in the final 
rule, at Section 703.90(b).
    To ensure some independent verification of a broker's or 
safekeeper's prices, proposed Section 703.3(b)(5)(iii) required credit 
unions to obtain semi-annual prices on their securities from another 
broker or an industry-recognized information provider. In response to 
comments, Section 703.80(c) of the final rule simply requires a credit 
union's supervisory committee to comply with existing auditing 
standards and annually assess the reliability of prices received from a 
broker or safekeeper. Credit unions or their auditors should refer to 
the practices and procedures discussed in the investments chapter of 
the American Institute of Certified Public Accountants guide Audits of 
Credit Unions.
    Proposed Section 703.3(b)(5) provided, throughout, that where a 
credit union could not obtain the price of a particular security, it 
could obtain the price of one with substantially similar 
characteristics. Rather than repeating this each time a price is 
required, Section 703.80(d) of the final rule states it generally.

Section 703.90  What Must I Do to Monitor the Risk of My Securities?

Monthly Report
    Proposed Section 703.3(b)(4)(ii) (A) and (B) required a federal 
credit union to prepare a monthly report showing the characteristics of 
each investment in the portfolio and the change in the fair value or 
total return of each security since the date of purchase and for the 
last month. In response to comments, NCUA has eliminated the 
requirement to list the characteristics of each investment each month. 
In addition, since several commenters were confused about the total 
return concept, NCUA has deleted all references to total return from 
the rule, although credit unions may choose to calculate it in addition 
to fair value.
    A number of commenters questioned the need to calculate the fair 
value of securities classified as hold-to-maturity. NCUA has determined 
to retain the requirement for a credit union to report the fair value 
and dollar change since the prior month-end of all its securities, 
since those changes can affect future earnings. For example, in a 
rising interest rate environment, with rate-sensitive members, a credit 
union may be compelled to increase its share rates. A credit union with 
fixed coupon investments experiences no equivalent increase in interest 
income. The resulting decline in earnings occurs regardless of whether 
the securities are classified as hold-to-maturity or available-for-
sale. Therefore, it is important for the investment-related committee 
and board to know what has happened to the value of all those 
securities. The requirement is located at Section 703.90(a) of the 
final rule. A credit union that chooses to keep all of its investments 
in CDs and corporate credit union shares and deposits is not required 
to price its investments and therefore is not subject to the 
requirement.
Quarterly Report
    Proposed Section 703.3(b)(4)(ii)(C) required a credit union to 
calculate, quarterly, the value of securities that NCUA determined 
represented greater potential interest rate risk. They were: (1) 
Securities that amortize; (2) securities with embedded options; (3) 
securities with maturities greater than 3 years; and (4) securities 
where contract rates are related to more than one index or are 
inversely related to, or multiples of, an index.
    In response to comments, NCUA has removed amortizing securities 
from the list, located at Section 703.90(b) of the final rule. Most 
amortizing securities that represent greater potential interest rate 
risk will be included because they contain embedded options. NCUA 
includes all securities with embedded options because even put 
provisions and interest rate floors can affect the price of a security 
independent of actual changes in interest rates. To be consistent with 
market terminology, NCUA also has changed the term ``contract rate'' to 
``coupon formula.''
    A number of commenters urged that the maturity threshold be 
extended to 5 years, to be consistent with the definition of risk asset 
in Section 700.1(i) of the NCUA Rules and Regulations. NCUA notes that 
the proposed requirement and the risk asset regulation have different 
purposes and effects. The classification of a security as a risk asset 
under Section 700.1(i), results in a credit union having to transfer 
additional income to reserves under Section 116 of the FCU Act. In 
contrast, the only result of classifying a security as representing 
greater potential risk under Part 703 is that a credit union might have 
to test its securities to gain important information about the interest 
rate risk on its balance sheet. NCUA believes that significant risk 
would be missed by failing to include securities with maturities from 3 
to 5 years in the category that could trigger testing requirements and 
has determined to leave the threshold at 3 years. NCUA has clarified, 
however, that maturity means remaining maturity.
    Several commenters suggested excluding U.S. Treasury and agency 
securities from the group that represents greater potential risk. This 
comment reflects a misunderstanding of the risk being evaluated. The 
securities at issue are those that represent greater potential interest 
rate risk, not credit risk. Although Treasury and agency securities do 
not present credit risk, they can have considerable interest rate risk 
depending on their characteristics. To some extent, this risk can be 
estimated by subjecting these securities to interest rate shock tests.
Shock Test
    Under Section 703.3(b)(4)(iii) of the proposed rule, if the total 
value of securities determined to represent greater potential risk was 
greater than a credit union's capital, the credit union was required to 
calculate the potential impact, on the fair value and/or total return 
of each security in the portfolio and the portfolio as a whole, of 
parallel shifts of plus and minus 300 basis points. The purpose of the 
analysis was to determine the impact of potential shifts in interest 
rates on the credit union's future capital position.
    NCUA recognized this was a naive test and that substantial risks 
could be missed by credit unions holding potentially more risky 
securities in a total amount less than capital. NCUA believed, however, 
that the requirement represented a reasonable compromise between 
imperfect risk assessment and the burden that would result if every 
credit union had to test every security.
    As limited as the testing was, a number of commenters argued that 
it would be too burdensome, suggesting that the threshold of 100% of 
capital be raised to 150% or 200%. To determine the impact of the 
requirement on federal credit unions, NCUA analyzed data from December 
1995 call reports. NCUA used assumptions about the characteristics of 
Treasury and agency securities that probably caused more of such 
securities to be included than would actually be the case. The results 
of the analysis are described in the following table:

------------------------------------------------------------------------
         Asset size (in millions)               A         B         C   
------------------------------------------------------------------------
<$2.......................................        18     2,173      0.8%
$2-$10....................................        90     2,507      3.6%
$10-$50...................................       351     1,769     19.8%
>$50......................................       462       795     58.1%
                                           -----------------------------

[[Page 32997]]

                                                                        
      Total...............................       921     7,244    12.7% 
------------------------------------------------------------------------
 A--Number of federal credit unions that would be required to complete  
  the 300 basis point stress test.                                      
 B--Total number of federal credit unions in the respective asset       
  ranges.                                                               
 C--Percentage of A to B (AB=C).                                

    The analysis shows that, at most, only 921, or 12.7 percent, of all 
federal credit unions would be required to subject their portfolios to 
the test. The vast majority of these have assets greater than $10 
million. NCUA believes that the test would not be a significant burden 
to these credit unions and that it is imperative for these credit 
unions to monitor their potential interest rate risk. Therefore, it has 
retained the test, at Section 703.90(c). Credit unions that are either 
unwilling or unable to monitor their risk through the test should 
rethink their investment strategy. In response to comments, however, 
NCUA has reduced their frequency of the test from monthly to quarterly. 
Further, as discussed earlier, to avoid confusion, there is no longer 
any reference to total return.
    NCUA understands that credit unions with deteriorating securities 
in the hold-to-maturity portfolio may have less and less likelihood of 
meeting the shock test ``hurdle'' due to the use of fair value versus 
amortized cost in the calculation. Since securities classified as hold-
to-maturity are not adjusted to fair value, when their value goes down, 
there is no corresponding decrease in net capital. As a result, the 
ratio of potentially more risky securities to net capital declines. 
This may lead to the anomalous situation of a decreasing requirement to 
test, because the threshold is less likely to be triggered when hold-
to-maturity values are declining substantially. However, the purpose of 
the test is to show potential problems with the portfolio, and 
securities rapidly losing value will already be reported under Section 
703.90(a).
    Some commenters suggested that a test that applies to securities 
but not deposits could induce some credit unions to purchase deposit 
instruments that have the same risk characteristics as the securities 
that trigger the test. If the test is not triggered, the credit unions 
will be ignorant of the interest rate risk of their investments. NCUA 
was aware of this trade-off, and chose not to impose the test on credit 
unions with minimal investments in securities. However, Section 703.70 
requires credit unions to list shares and deposits with the relevant 
risk characteristics. This information should make credit union boards 
aware of the possibility of interest rate risk. In addition, NCUA 
intends to collect the information through the call report.

Section 703.100  What Investments and Investment Activities Are 
Permissible for Me?

Contracting for Securities
    Current Section 703.4(a) permits a credit union to contract for the 
purchase or sale of a security provided that the delivery of the 
security is to be made within 30 days from the trade date. This 
accommodates the settlement of U.S. government and agency securities. 
Section 703.4(b) permits a credit union to enter into a cash forward 
agreement to purchase or sell a security provided that the period from 
the trade date to the settlement date does not exceed 120 days. This 
was designed to accommodate the settlement of mortgage-backed 
securities. Section 703.4(a) of the proposed rule deleted these 
specific time frames, and the authority to enter into cash forward 
agreements, and simply provided for a credit union to contract for the 
purchase or sale of a security provided that delivery of the security 
was by ``regular-way'' settlement.
    The current regulation had created some problems distinguishing 
between regular delivery and forward commitments. The proposed 
regulation was intended to permit a credit union to contract for the 
purchase of a security no matter when it settles, as long as the 
settlement date is within the normal time frame that the securities 
industry has established for that type of security. Regular-way 
settlement varies, depending on the type of security and whether it is 
being purchased or sold on the secondary market or is a new issuance.
    Securities industry practices for regular-way settlement have 
become well-defined for most types of investments that are permissible 
for credit unions. The time frames arise from customary practice in the 
securities industry among brokers and dealers, guidelines established 
by the Public Securities Association, and requirements of the 
Securities and Exchange Commission and the Municipal Securities 
Rulemaking Board.
    Regular-way settlement for the most common types of secondary 
market securities purchased or sold by credit unions is either one or 
three business days after the trade date. For securities that are just 
being issued, the time frame from trade date to settlement date can be 
considerably longer, depending on the period between the announcement 
of the offering and the issuance of the security. Although several 
commenters expressed concern about being bound by regular-way time 
frames, NCUA is not convinced that it is necessary to go beyond regular 
way. Therefore, it has retained the requirement, at Section 703.100(a).
Indexes
    The current rule is silent as to the types of indexes to which 
variable rate instruments can be tied. Section 703.4(h) of the proposed 
rule limited permissible indexes to those tied to domestic interest 
rates only. These include, for example, constant maturity Treasury and 
U.S. dollar-denominated LIBOR rates, Prime, and the 11th District Cost 
of Funds. The preamble noted that this would prohibit a credit union 
from purchasing an investment linked to an equity index, either as a 
speculative investment or to match against a product offered to a 
member. NCUA continues to believe that it is not appropriate for a 
credit union to invest in an instrument that does not correlate to its 
cost of funds, and has retained the prohibition, at Section 703.100(b). 
The provision also prohibits a credit union from purchasing the new 
inflation-indexed Treasury bonds.
Corporate Credit Unions
    Proposed Section 703.4(f) addressed credit union investments in 
corporate credit union capital shares and deposits. The proposed rule 
limited credit union investment in the capital shares of a corporate 
credit union to a total of one percent of the investing credit union's 
assets, due to the potential risk associated with such investments.
    A number of commenters seemed confused by the provision, believing 
that NCUA was proposing a limit on all investments in corporate credit 
unions. That is not the case. The proposed limit does not apply to 
regular shares or deposits in corporate credit unions; it applies only 
to capital shares, which can come in two forms:
    Membership capital and member paid-in capital. To clarify the scope 
of the limitation, the final rule expressly uses those terms. NCUA 
intends that a credit union be limited to investing a total of 1 
percent of its assets, all in membership capital, all in member paid-in 
capital, or divided between them, in each corporate credit union in 
which it invests. A few commenters expressed concern that some credit 
unions might now have more than 1 percent of assets in capital shares 
in one corporate credit union. Any such investment will be 
grandfathered.

[[Page 32998]]

    A credit union must fully understand the risks associated with 
paid-in and membership capital before making such investments. An 
investing credit union must be aware that its funds are at risk and 
that it may not have access to them for 20 years, in the case of paid-
in capital, and 3 years, in the case of membership capital. Corporate 
credit unions are required to fully disclose the conditions of their 
capital instruments, and a credit union should review the disclosures 
carefully before deciding to invest.
Common Trust Funds, Mutual Funds, and Other Investment Companies
    Section 703.4(j) of the current regulation provides that a federal 
credit union may invest in a mutual fund, provided that the investments 
and investment transactions of the fund are legally permissible for 
federal credit unions under the FCU Act and NCUA regulations. Proposed 
Section 703.4(d) broadened this authority by permitting investment in 
an investment company that was registered with the Securities and 
Exchange Commission under the Investment Company Act of 1940.
    The proposal retained the requirement that the investments and 
investment transactions of the investment company be permissible for 
federal credit unions and clarified that this limitation be established 
by the company's prospectus and/or statement of additional information, 
changeable only by shareholder vote. One method of establishing that a 
fund was a permissible investment was for the prospectus to state that 
it was ``a legal investment for federal credit unions'' or ``legal 
under the FCU Act and NCUA Rules and Regulations.'' The proposed rule 
also limited the aggregate of a credit union's investment in investment 
companies and delegation of discretionary investment control to an 
investment adviser to 100 percent of capital.
    In response to comments, NCUA has eliminated the shareholder 
approval requirement in Section 703.100(d) of the final rule. NCUA also 
has determined that Section 703.100(d) need not explicitly mention the 
statement of additional information, since it is generally incorporated 
by reference into the prospectus. In addition, NCUA has removed the 
limitation on how much a credit union may invest in an investment 
company.
    NCUA also has deleted the sentence that described how a mutual fund 
can establish that it is a permissible investment for federal credit 
unions. Some commenters mistakenly concluded that it meant that for a 
mutual fund to be legal for federal credit unions, the prospectus was 
required to say that the fund complies with the FCU Act and NCUA Rules 
and Regulations. The sentence was intended to make it clear that NCUA 
was departing from the position taken in Letter to Credit Unions No. 
155, which required that a prospectus detail every investment and 
transaction authorized for a fund, so that a credit union could 
determine whether the fund was a permissible investment. As noted in 
the preamble to the proposed rule, NCUA found it difficult to establish 
how much detail was necessary to determine that a fund engaged only in 
activities that were permissible for credit unions. The proposed 
sentence intended to convey that one way of meeting that requirement 
was for a prospectus to state that the fund was permissible. Federal 
securities laws require that a prospectus accurately represent the 
activities of the fund.
    To avoid confusion, NCUA has deleted the sentence. The position 
remains the same, however. A credit union should review the prospectus 
of any mutual fund in which it is considering investing. If the 
prospectus lists the authorized investments and investment activities 
of the fund in sufficient detail for the credit union to determine that 
all of them are permissible, it may invest in the fund. If the 
prospectus lists the activities of the fund generally, and none of them 
are impermissible for federal credit unions, but also states that the 
fund is ``legal under the FCU Act and NCUA Rules and Regulations,'' or 
something to that effect, a credit union may invest in the fund. 
Regardless of whether a prospectus states that a fund is legal for 
federal credit unions, if it is clear that some of the activities are 
impermissible, a credit union may not invest in the fund.
    A final change to this section was the addition of bank-managed 
collective investment funds, also known as common trust funds, as 
permissible investments. Such funds are subject to the same rules as 
are mutual funds regarding the underlying investments and content of 
the prospectus.
CMOs/REMICs
    Section 704.4(e) of the proposed rule addressed the high risk 
securities test (HRST) for CMOs/REMICs. The most significant change was 
the application of the entire test to variable as well as fixed rate 
CMOs/REMICs. NCUA had determined that the price sensitivity portion of 
the HRST failed to reflect adequately the impact of basis and cap risk. 
Although a number of commenters objected to applying the average life 
and average life sensitivity tests to variable rate CMOs/REMICs, NCUA 
has concluded that the requirement should substantially reduce the risk 
exposure for these securities and has retained it at Section 
703.100(e).
Municipal Securities
    Section 703.4(g) of the proposed rule established minimum credit 
ratings for municipal bonds. Credit unions were limited to purchasing 
bonds rated in one of the two highest rating categories by at least one 
nationally recognized statistical rating organization (NRSRO). In 
response to comments, NCUA has expanded the category of permissible 
municipal bonds to those rated in one of the four highest rating 
categories, that is, those that are investment grade. NCUA also has 
added language to explain NRSROs. The provision is located at Section 
703.100(f).
Depository Institutions
    Section 703.4(c) of the proposed rule permitted a credit union to 
sell federal funds to a Section 107(8) institution, and Section 
703.4(h) provided that a credit union could purchase yankee dollar 
deposits, eurodollar deposits, and banker's acceptances. NCUA received 
no comments on these sections and has retained them in Sections 703.100 
(g) and (h), respectively, of the final rule. To clarify and 
standardize positions it has taken in opinion letters, NCUA also has 
added the authority to purchase deposit notes and certain bank notes.
Repurchase Transactions
    Section 703.4(b) of the proposed rule simplified the language 
authorizing credit union investment in repurchase transactions. NCUA 
received no negative comments on the provision and has retained it at 
Section 703.100(i) of the final rule. The provision has been clarified 
to require daily assessment of the market value of the repurchase 
securities and explicitly includes the standard practice of entering 
into signed contracts with approved counterparties. Credit unions 
should review NCUA Interpretive Ruling and Policy Statement (IRPS) No. 
85-2 for a detailed discussion of appropriate controls for repurchase 
transactions.
Reverse Repurchase Transactions and Securities Lending
    Proposed Section 703.6 established a new section addressing the 
pledging of securities through reverse repurchase transactions, 
securities lending, and collateralized borrowing. In response to a 
comment, the final rule establishes separate sections for reverse 
repurchase

[[Page 32999]]

transactions and securities lending, Sections 703.100 (j) and (k), 
respectively. The final rule does not explicitly address collateralized 
borrowing. The new sections have been clarified to require daily 
pricing of any securities received in the transaction. The sections 
also include the standard practice of entering into signed contracts 
with approved counterparties and borrowers. IRPS 85-2, discussed above, 
provides guidance for reverse repurchase transactions and may also be 
consulted when lending securities.
Trading
    The current regulation does not specifically address trading 
practices. Section 703.3(b)(9) of the proposed rule incorporated 
trading practices from Letter to Credit Unions No. 89. NCUA received no 
comments regarding the proposed trading practices but did receive 
several comments urging that when-issued trading and pair-off 
transactions be permitted in the trading account. NCUA agrees, and in 
addition to describing required trading practices, Section 703.100(l) 
of the final rule authorizes when-issued trading and pair-offs. NCUA 
notes that IRPS 92-1 states that federal credit unions engaging in 
when-issued trading must follow NCUA's regulation on cash forward 
agreements. When this rule becomes effective, that statement will no 
longer be accurate. Cash forward agreements will be impermissible, and 
when-issued trading will be permissible without restriction, except for 
being accounted for in accordance with GAAP. In general, when IRPS 92-1 
conflicts with this rule, the IRPS is superseded.

Section 703.110  What Investments and Investment Activities Are 
Prohibited for Me?

    Section 703.5 of the proposed rule added prohibitions against 
engaging in when-issued trading and pair-off transactions and 
purchasing or selling options, interest rate swaps, stripped mortgage-
backed securities, CMO/REMIC residuals, commercial mortgage related 
securities, and small business related securities. It also prohibited 
credit unions from purchasing mortgage servicing rights directly. As 
noted above, NCUA has determined to permit credit unions to engage in 
when-issued trading and pair-offs, when conducted in the trading 
account. These activities have been deleted from the prohibitions 
section, located at Section 703.110 of the final rule.
    Several commenters urged that credit unions be permitted to engage 
in financial derivatives. NCUA recognizes that in a dynamic financial 
environment it will be desirable for credit unions to consider a 
broader range of financial alternatives. The most likely extension will 
be into swaps, futures and options, which can be used to reduce 
interest rate exposure. NCUA has decided to consider allowing a limited 
number of individual credit unions to expand into these areas through 
the investment pilot program, described in Section 703.140.
    Other than comments regarding financial derivatives, only a few 
commenters opposed the proposed prohibitions. NCUA continues to believe 
that the listed investments are inappropriate for federal credit 
unions, and has prohibited them in the final rule. NCUA notes, however, 
that a CMO/REMIC with the characteristics of a stripped mortgage-backed 
security is permissible if it meets the CMO/REMIC stress tests in this 
regulation. NCUA also notes that the prohibition against small business 
related securities does not prohibit credit unions from purchasing 
investments in securities issued or guaranteed by the Small Business 
Administration. Finally, NCUA notes that the prohibition against 
purchasing mortgage servicing rights directly does not affect a credit 
union's authority to retain servicing rights of loans that it sells, 
whether the loans have been made by the credit union or purchased to 
complete a pool for sale or pledge on the secondary market.

Section 703.120  May My Officials or Employees Accept Anything of Value 
in Connection With an Investment Transaction?

    No commenters objected to Section 703.8 of the proposed rule, which 
addressed prohibited fees, and it has been retained at Section 703.120 
of the final rule.

Section 703.130  May I Continue To Hold Investments Purchased Before 
January 1, 1998, That Will Be Impermissible After That Date?

    To assist credit unions in determining what regulations govern 
investments purchased prior to January 1, 1998, the effective date of 
this final rule, Section 703.9 of the proposed rule set out various 
provisions that have governed certain investments since 1991. Minor 
corrections have been made to these provisions, and they have been 
retained at Section 703.130 of the final rule.

Section 703.140  What Is the Investment Pilot Program and How Can I 
Participate in It?

    A number of commenters asked for authority to engage in certain 
investment activities that NCUA does not believe are appropriate for 
all federal credit unions at this time. However, certain activities 
that are permissible under the FCU Act but prohibited under this rule, 
such as financial derivatives, may be appropriate for some credit 
unions. As credit unions and NCUA gain experience with the activities, 
NCUA may determine that they are appropriate for all credit unions, are 
suitable only for some, or remain inappropriate for all credit unions. 
To assist credit unions and NCUA in gaining experience with these 
activities, NCUA has developed the investment pilot program.
    Under the program, a credit union that wishes to engage in an 
otherwise prohibited activity must apply to NCUA for permission to 
engage in the activity. Section 703.140 sets out the requirements and 
procedures for the application. NCUA will assess the credit union to 
determine its ability to safely and soundly engage in the activity. 
NCUA will determine the scope of the activity to assess its impact on 
the credit union industry as a whole. If NCUA determines that a 
particular activity is appropriate for all credit unions, it will 
consider amending Part 703.
    The pilot program also provides for NCUA to approve a third party's 
investment program. In such a case, a credit union would not be 
required to obtain individual approval to participate in the program, 
although NCUA might limit the number of credit unions to which the 
third party may market the program.
    NCUA notes that the pilot program is not equivalent to a waiver 
process. That is, once there are enough credit unions engaging in an 
activity for NCUA to assess it, no more credit unions will be approved 
to engage in the activity. An important factor in the number of credit 
unions and activities that will be approved for the program is the 
availability of NCUA staff resources.
    Although commenters did not have the opportunity to express 
opinions on the investment pilot program, NCUA notes that without 
adding it to the final rule, credit unions would have no ability to 
engage in these activities, which may benefit the credit union industry 
and NCUA. NCUA believes that the benefits of the program justify adding 
it at this late date. NCUA welcomes comments on the program, however, 
and suggestions on how to improve it.

Section 703.150  What Additional Definitions Apply to This Part?

    NCUA proposed to add a number of new definitions, to clarify 
certain already-defined terms by re-definition,

[[Page 33000]]

and to delete several unnecessary definitions. In the final rule, some 
of the proposed terms are not used, some new terms have been added, 
and, based on comments, some definitions have been modified. In 
addition, NCUA has deleted definitions for some terms, believing them 
to be of such common usage as to no longer require definitions.

C. Derivation Table

------------------------------------------------------------------------
       Original provision            New provision          Comment     
------------------------------------------------------------------------
703.1...........................  703.10 & 703.20...  Modified.         
703.2...........................  703.150...........  Significantly     
                                                       Changed.         
703.3(a)........................  703.30(a).........  Modified.         
703.3(b)........................  703.30(h).........  Modified.         
703.3(c)........................  703.30(f).........  Modified.         
703.3(d)........................  703.30(b).........  Significantly     
                                                       Changed.         
703.3(e)........................  703.30(c).........  Modified.         
703.3(f)........................  703.30(e).........  Modified.         
703.3(g)........................  703.30(i).........  Modified.         
703.3(h)........................  703.30(j).........  Modified.         
N/A.............................  703.30 (d), (g),    Added.            
                                   (k), & (l).                          
N/A.............................  703.40 (a), (b),    Added.            
                                   (c), (e), & (f).                     
N/A.............................  703.70, 703.80, &   Added.            
                                   703.90.                              
703.4 (a) & (b).................  703.100(a)........  Significantly     
                                                       Changed.         
703.4(c)........................  703.40(d) &         Significantly     
                                   703.100(c).         Changed.         
703.4(d)........................  703.100(i)........  Significantly     
                                                       Changed.         
703.4(e)........................  703.100(j)........  Modified.         
703.4(f)........................  703.100(g)........  Modified.         
703.4 (g), (h), & (i)...........  703.100(h) (1),     No Change.        
                                   (2), & (3).                          
703.4(j)........................  703.100(d)........  Modified.         
N/A.............................  703.100 (b), (f),   Added.            
                                   (h) (4) & (5),                       
                                   (k), & (l).                          
703.5(a)........................  N/A...............  Removed.          
703.5(b)........................  703.110(a)........  No Change.        
703.5 (c) & (d).................  703.110(b)........  No Change.        
703.5(e)........................  703.100(c)........  Modified.         
703.5 (f) & (h).................  703.110(c)........  Modified.         
703.5 (g) & (j).................  703.100(e)........  Modified.         
703.5(i)........................  N/A...............  Removed.          
703.5(k)........................  703.110(d)........  No Change.        
703.5 (l) & (m).................  703.120...........  Modified.         
N/A.............................  703.130 & 703.140.  Added.            
------------------------------------------------------------------------

D. Regulatory Procedures

Regulatory Flexibility Act

    The Regulatory Flexibility Act requires NCUA to prepare an analysis 
to describe any significant economic impact any final regulation may 
have on a substantial number of small credit unions, defined as those 
having less than $1 million in assets. The NCUA Board has determined 
and certifies that the final rule will not have a significant economic 
impact on a substantial number of small credit unions. Approximately 
1,300 federal credit unions, out of 7,200, have assets of $1 million or 
less. Of these 1,300, only 95 have investments in treasury or agency 
securities, which are the investments that are subject to the majority 
of the policy, reporting, and monitoring requirements of the final 
rule. Accordingly, the NCUA Board has determined that a regulatory 
flexibility analysis is not required.

Paperwork Reduction Act

    The information collection requirements of the proposed rule were 
submitted to the Office of Management and Budget. Fifteen commenters 
addressed NCUA's estimates of the burden of those requirements, with 
all but one stating that the estimates were too low. Credit unions 
range in asset size from less than $100,000 to over $9 billion, 
however, and the estimates were based on averaging the time it would 
take both small and large credit unions to comply with the 
requirements. Although the estimates may be understated for larger 
credit unions, the reverse is true for smaller institutions.
    The final rule has been modified from the proposed rule in ways 
that reduce the burden estimates. The requirement to prepare a monthly 
written report of investments was reduced by eliminating the obligation 
to list all characteristics. The frequency of the interest rate shock 
test was changed from monthly to quarterly. The requirement to 
semiannually verify the pricing of all securities held was changed to 
annually and only the amount necessary to satisfy generally accepted 
auditing standards. The credit analysis requirement was changed from 
semiannually to annually. Finally, the requirement to prepare and 
provide to the Regional Director a written divestiture plan was 
eliminated.
    A revised Paperwork Reduction Act estimate will be sent to the 
Office of Management and Budget (OMB). The NCUA Board invites comment 
on: (1) Whether the collection of the information is necessary for the 
proper performance of the functions of NCUA, including whether the 
information will have practical utility; (2) the accuracy of NCUA's 
estimate of the burden of collecting the information; (3) ways to 
enhance the quality, utility, and clarity of the information to be 
collected; and (4) ways to minimize the burden of collecting the 
information. Send comments to Attn: Alexander Hunt, OMB Reports 
Management Branch, New Executive Office Building, Rm. 10202, 
Washington, DC 20530, with copies to Betty May, Acting Paperwork 
Reduction Act Coordinator, NCUA, 1775 Duke St., Alexandria, VA 22314-
3428.
    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. The final rule applies directly only to 
federal credit unions, with Sec. 704.110 of the final rule applying 
indirectly to state-chartered credit unions, through the insurance 
provisions at 12 CFR Part 741. NCUA has determined that the final rule 
does not constitute a ``significant regulatory action'' for purposes of 
the Executive Order.

Small Business Regulatory Enforcement Fairness Act

    The Small Business Regulatory Enforcement Fairness Act of 1996 
(Public Law 104-121) provides generally for Congressional review of 
agency rules. The reporting requirement is triggered in instances where 
NCUA issues a final rule as defined by Section 551 of the 
Administrative Procedure Act, 5 U.S.C. 551.
    OMB has determined that this final revision to Part 703 does not 
constitute a ``major'' rule as defined by the statute. A ``major'' rule 
is defined as being any final rule that the Administrator of the Office 
of Information and Regulatory Affairs of OMB finds has resulted in or 
is likely to result in: (1) An annual effect on the economy of $100 
million or more; (2) A major increase in costs or prices for consumers, 
individual industries, Federal, State, or local government agencies, or 
geographic regions; or (3) Significant adverse effects on competition, 
employment, investment, productivity, innovation, or on the ability of 
United States based

[[Page 33001]]

enterprises to compete with foreign-based enterprises in domestic and 
export markets.

List of Subjects in 12 CFR Part 703

    Credit unions, Investments, Reporting and recordkeeping 
requirements.

    By the National Credit Union Administration Board on June 12, 
1997.
Becky Baker,
Secretary of the Board.

    For the reasons set forth in the preamble, NCUA revises 12 CFR part 
703 to read as follows:

PART 703--INVESTMENT AND DEPOSIT ACTIVITIES

Sec.
703.10  What does this part 703 cover?
703.20  What does this part 703 not cover?
703.30  What are the responsibilities of my (a federal credit 
union's) board of directors?
703.40  What general practices and procedures must I follow in 
conducting investment transactions?
703.50  What rules govern my dealings with entities I use to 
purchase and sell investments (``broker-dealers'')?
703.60  What rules govern my safekeeping of investments?
703.70  What must I do to monitor my non-security investments in 
banks, credit unions, and other depository institutions?
703.80  What must I do to value my securities?
703.90  What must I do to monitor the risk of my securities?
703.100  What investments and investment activities are permissible 
for me?
703.110  What investments and investment activities are prohibited 
for me?
703.120  May my officials or employees accept anything of value in 
connection with an investment transaction?
703.130  May I continue to hold investments purchased before January 
1, 1998, that will be impermissible after that date?
703.140  What is the investment pilot program and how can I 
participate in it?
703.150  What additional definitions apply to this part?

    Authority: 12 U.S.C. 1757(7), 1757(8), 1757(15).


Sec. 703.10  What does this part 703 cover?

    This part 703 interprets several of the provisions of Sections 
107(7), 107(8), and 107(15) (B) and (C) of the Federal Credit Union Act 
(``Act''), 12 U.S.C. 1757(7), 1757(8), 1757(15) (B) and (C), which list 
those securities, deposits, and other obligations in which a federal 
credit union (``you'') may invest.


Sec. 703.20  What does this part 703 not cover?

    This part 703 does not apply to:
    (a) Investment in loans to members and related activities, which is 
governed by Secs. 701.21, 701.22, and 701.23 of this chapter;
    (b) The purchase of real estate-secured loans pursuant to Section 
107(15)(A) of the Act, which is governed by Sec. 701.23 of this 
chapter;
    (c) Investment in credit union service organizations, which is 
governed by Sec. 701.27 of this chapter;
    (d) Investment in fixed assets, which is governed by Sec. 701.36 of 
this chapter;
    (e) Investment by corporate credit unions, which is governed by 
part 704 of this chapter; or
    (f) Investment activity by state-chartered credit unions, except as 
provided in Sec. 741.3(a)(3) of this chapter.


Sec. 703.30  What are the responsibilities of my (a federal credit 
union's) board of directors?

    Your (a federal credit union's) board of directors must establish a 
written investment policy that is consistent with the Act, this part, 
and other applicable laws and regulations. The investment policy may be 
part of a broader, asset-liability management policy. Your board must 
review the policy at least annually. The policy must address the 
following items:
    (a) The purposes and objectives of your investment activities.
    (b) The characteristics of the investments you may make. The 
characteristics of an investment are such things as its issuer, 
maturity, index, cap, floor, coupon rate, coupon formula, call 
provision, average life, and interest rate risk.
    (c) How you will manage your interest rate risk, including the 
amount of risk you can take with your investments in relation to your 
net capital and earnings.
    (d) How you will manage your liquidity risk.
    (e) How you will manage your credit risk. The policy must list 
specific institutions, issuers, and counterparties you may use, or 
criteria for their selection, and limits on the amounts you may invest 
with each. Counterparty means the party on the other side of a 
transaction.
    (f) How you will manage your concentration risk, which can result 
from single or related issuers, lack of geographic distribution, 
holdings of obligations with similar characteristics, such as 
maturities and indexes, holdings of bonds having the same trustee, and 
holdings of securitized loans having the same originator, packager, or 
guarantor.
    (g) If you purchase CMOs/REMICs, whether you will use a median 
prepayment estimate or individual prepayment estimates for the CMO/
REMIC testing required in Sec. 703.100(e). Once the board makes that 
determination, you may use only that method.
    (1) If the policy states that you will use a median estimate, it 
must identify the industry-recognized information provider that will 
supply the estimate.
    (2) If the policy states that you will use individual estimates, it 
must identify at least two specific sources for those estimates. One 
source may be the median estimate from an industry-recognized 
information provider.
    (h) Who of your officials or employees has investment authority and 
the extent of that authority. The individuals given investment 
authority must be professionally qualified by education and/or 
experience to exercise that authority in a prudent manner and to fully 
comprehend and assess the risk characteristics of investments and 
investment transactions under that authority. Only your officials and 
employees may be voting members of any investment-related committee.
    (i) If you use third-party entities to purchase or sell investments 
(``broker-dealers''), the specific broker-dealers you may use. You must 
maintain the documentation the board used to approve a broker-dealer as 
long as the broker-dealer is approved and until the documentation has 
been audited in accordance with Sec. 701.12 of this chapter and 
examined by NCUA.
    (j) If you use a third-party entity to safekeep your investments, 
the specific entities you may use.
    (k) How you will handle an investment that either is outside board 
policy after purchase or fails a requirement of this part.
    (l) If you engage in trading activities, how you will conduct those 
activities. The policy should address the following:
    (1) The persons who have purchase and sale authority;
    (2) Trading account size limitations;
    (3) Allocation of cash flow to trading accounts;
    (4) Stop loss or sale provisions;
    (5) Dollar size limitations of specific types, quantity and 
maturity to be purchased;
    (6) Limits on the length of time an investment may be inventoried 
in the trading account; and
    (7) Internal controls, including appropriate segregation of duties.


Sec. 703.40  What general practices and procedures must I follow in 
conducting investment transactions?

    (a) You (a federal credit union) must classify a security as hold-
to-maturity, available-for-sale, or trading, in accordance with 
generally accepted

[[Page 33002]]

accounting principles and consistent with your documented intent and 
ability regarding the security.
    (b) Except as provided in paragraph (c) of this section, you must 
retain discretionary control over the purchase and sale of investments. 
NCUA does not consider you to have delegated discretionary control when 
you are required to authorize a recommended purchase or sale 
transaction prior to its execution and you, in practice, review such 
recommendations and authorize such transactions.
    (c)(1) You may delegate discretionary control over the purchase and 
sale of investments, within established parameters, to a person other 
than your official or employee, provided that the person is an 
investment adviser registered with the Securities and Exchange 
Commission under the Investment Advisers Act of 1940 (15 U.S.C. 80b).
    (2) In determining whether to transact business with an investment 
adviser, you must analyze his or her background and information 
available from state or federal securities regulators, including any 
enforcement actions against the adviser or associated personnel.
    (3) You may not compensate an investment adviser with discretionary 
control over the purchase and sale of investments on a per transaction 
basis or based on capital gains, capital appreciation, net income, 
performance relative to an index, or any other incentive basis.
    (4) When you have delegated discretionary control over the purchase 
and sale of investments to a person other than your official or 
employee, you do not direct the holdings under that person's control. 
Therefore, you must classify those holdings as either available-for-
sale or trading.
    (5) You must obtain a report from your investment adviser, at least 
monthly, that details your investments under his or her control and how 
they are performing.
    (6) Your aggregate delegation of discretionary control over the 
purchase and sale of investments under this paragraph (c) is limited to 
100 percent of net capital at the time of delegation.
    (d) Except for investments that are issued or fully guaranteed as 
to principal and interest by the U.S. government or its agencies, 
enterprises, or corporations or fully insured (including accumulated 
interest) by the National Credit Union Administration or the Federal 
Deposit Insurance Corporation, you must conduct and document a credit 
analysis of the issuing entity and/or investment before you purchase 
the investment. You must update the analysis at least annually as long 
as you hold the investment.
    (e) You must notify your board of directors as soon as possible, 
but no later than the next regularly scheduled board meeting, of any 
investment that either is outside board policy after purchase or has 
failed a requirement of this part. You must document the board's action 
regarding the investment in the minutes of the board meeting, including 
a detailed explanation of any decision not to sell an investment that 
has failed a requirement of this part. Within 5 days after the board 
meeting, you must notify the appropriate regional director in writing 
of an investment that has failed a requirement of this part.
    (f) You must maintain documentation regarding an investment 
transaction as long as you hold the investment and until the 
documentation has been both audited and examined. The documentation 
should include, where applicable, bids and prices at purchase and sale 
and for periodic updates, relevant disclosure documents or a 
description of the security from an industry-recognized information 
provider, financial data, and tests and reports required by your 
investment policy and this part.


Sec. 703.50  What rules govern my dealings with entities I use to 
purchase and sell investments (``broker-dealers'')?

    (a) You (a federal credit union) may use a third-party entity to 
purchase and sell investments (a ``broker-dealer'') as long as the 
broker-dealer either is registered with the Securities and Exchange 
Commission under the Securities Exchange Act of 1934 (15 U.S.C. 78a et 
seq.) or is a depository institution whose broker-dealer activities are 
regulated by a federal regulatory agency.
    (b) In determining whether to buy or sell investments through a 
broker-dealer, you must analyze and annually update the following 
factors:
    (1) The background of any sales representative with whom you are 
doing business.
    (2) Information available from state or federal securities 
regulators and securities industry self-regulatory organizations, such 
as the National Association of Securities Dealers and the North 
American State Administrators Association, about any enforcement 
actions against the broker-dealer, its affiliates, or associated 
personnel.
    (3) If the broker-dealer is acting as your counterparty, the 
ability of the broker-dealer and its subsidiaries or affiliates to 
fulfill commitments, as evidenced by capital strength, liquidity, and 
operating results. You should consider current financial data, annual 
reports, reports of nationally recognized statistical rating agencies, 
relevant disclosure documents, and other sources of financial 
information.


Sec. 703.60  What rules govern my safekeeping of investments?

    (a) Your (a federal credit union's) purchased investments and 
repurchase collateral must be in your possession, recorded as owned by 
you through the Federal Reserve Book-Entry System, or held by a board-
approved safekeeper under a written custodial agreement. A custodial 
agreement is a contract in which a third party agrees to exercise 
ordinary care in protecting the securities held in safekeeping for its 
customers.
    (b) You must obtain an individual confirmation statement for each 
investment purchased or sold.
    (c) You may not allow the selling broker-dealer to safekeep 
purchased investments or repurchase collateral, except that where the 
broker-dealer is a bank or corporate credit union, you may allow a 
separately identifiable department or division of the bank or corporate 
credit union to safekeep investments or collateral.
    (d) You must obtain and reconcile monthly a statement of purchased 
investments and repurchase collateral held in safekeeping.
    (e) All purchases and sales of investments must be delivery versus 
payment (i.e., payment for an investment must occur simultaneously with 
its delivery).


Sec. 703.70  What must I do to monitor my non-security investments in 
banks, credit unions, and other depository institutions?

    (a) At least quarterly you (a federal credit union) must prepare a 
written report listing all of your shares and deposits in banks, credit 
unions, and other depository institutions, that have one or more of the 
following features:
    (1) Embedded options;
    (2) Remaining maturities greater than 3 years; or
    (3) Coupon formulas that are related to more than one index or are 
inversely related to, or multiples of, an index.
    (b) The requirement described in paragraph (a) of this section does 
not apply to your shares and deposits that are securities.
    (c) Where you do not have an investment-related committee, each 
member of your board of directors must receive a copy of the report 
described in paragraph (a) of this section. Where you have an 
investment-related committee, each member of the committee must

[[Page 33003]]

receive a copy of the report, and each member of the board must receive 
a summary of the information in the report.


Sec. 703.80  What must I do to value my securities?

    (a) Prior to purchasing or selling a security, except for new 
issues purchased at par, you (a federal credit union) must obtain, 
either:
    (1) Price quotations on the security from at least two broker-
dealers; or
    (2) A price quotation on the security from an industry-recognized 
information provider.
    (b) At least monthly, you must determine the fair value of each 
security you hold. You may determine fair value by obtaining a price 
quotation on the security from an industry-recognized information 
provider, a broker-dealer, or a safekeeper.
    (c) At least annually, your supervisory committee (itself or 
through its external auditor) must independently assess the reliability 
of monthly price quotations you receive from a broker-dealer or 
safekeeper. Your supervisory committee (or external auditor) must 
follow Generally Accepted Auditing Standards, which require either 
recomputation or reference to market quotations.
    (d) Where you are unable to obtain a price quotation required by 
this section for the precise security in question, you may obtain a 
quotation for a security with substantially similar characteristics.


Sec. 703.90  What must I do to monitor the risk of my securities?

    (a) At least monthly, you (a federal credit union) must prepare a 
written report setting forth, for each security you hold, the fair 
value and dollar change since the prior month-end, with summary 
information for the entire portfolio.
    (b) At least quarterly, you must prepare a written report setting 
forth the sum of the fair values of all fixed and variable rate 
securities you hold that have one or more of the following features:
    (1) Embedded options;
    (2) Remaining maturities greater than 3 years; or
    (3) Coupon formulas that are related to more than one index or are 
inversely related to, or multiples of, an index.
    (c) Where the amount calculated in paragraph (b) of this section is 
greater than your net capital, the report described in that paragraph 
must provide a reasonable and supportable estimate of the potential 
impact, in percentage and dollar terms, of an immediate and sustained 
parallel shift in market interest rates of plus and minus 300 basis 
points on:
    (1) The fair value of each security in your portfolio;
    (2) The fair value of your portfolio as a whole; and
    (3) Your net capital.
    (d) Where you do not have an investment-related committee, each 
member of your board of directors must receive a copy of the reports 
described in paragraphs (a) through (c) of this section. Where you have 
an investment-related committee, each member of the committee must 
receive copies of the reports, and each member of the board must 
receive a summary of the information in the reports.


Sec. 703.100  What investments and investment activities are 
permissible for me?

    (a) You (a federal credit union) may contract for the purchase or 
sale of a security as long as the delivery of the security is by 
regular-way settlement. Regular-way settlement means delivery of a 
security from a seller to a buyer within the time frame that the 
securities industry has established for that type of security.
    (b) You may invest in a variable rate investment, as long as the 
index is tied to domestic interest rates and not, for example, to 
foreign currencies, foreign interest rates, or domestic or foreign 
commodity prices, equity prices, or inflation rates. For purposes of 
this part, the U.S. dollar-denominated London Interbank Offered Rate 
(LIBOR) is a domestic interest rate.
    (c) You may purchase shares or deposits in a corporate credit 
union, except where the NCUA Board has notified you that the corporate 
credit union is not operating in compliance with part 704 of this 
chapter. Your aggregate purchase of member paid-in capital and 
membership capital in one corporate credit union is limited to one 
percent of your assets. Member paid-in capital and membership capital 
are defined in part 704 of this chapter.
    (d) You may invest in a registered investment company or collective 
investment fund, as long as the prospectus of the company or fund 
restricts the investment portfolio to investments and investment 
transactions that are permissible for federal credit unions. For the 
purposes of this part, the following definitions apply:
    (1) A registered investment company is an investment company that 
is registered with the Securities and Exchange Commission under the 
Investment Company Act of 1940 (15 U.S.C. 80a). Examples of registered 
investment companies are mutual funds and unit investment trusts.
    (2) A collective investment fund is a fund maintained by a national 
bank under 12 CFR part 9.
    (e)(1) You may invest in a fixed or variable rate CMO/REMIC only if 
it meets all of the following tests:
    (i) Average Life Test. The CMO/REMIC's estimated average life is 10 
years or less.
    (ii) Average Life Sensitivity Test. The CMO/REMIC's estimated 
average life extends by 4 years or less, assuming an immediate and 
sustained parallel shift in interest rates of up to and including plus 
300 basis points, and shortens by 6 years or less, assuming an 
immediate and sustained parallel shift in interest rates of up to and 
including minus 300 basis points.
    (iii) Price Sensitivity Test. The CMO/REMIC's estimated price 
change is 17 percent or less, as a result of an immediate and sustained 
parallel shift in interest rates of up to and including plus and minus 
300 basis points.
    (2) You must retest CMOs/REMICs at least quarterly, more frequently 
if market or business conditions dictate.
    (3) If you use individual prepayment estimates for testing, you 
must obtain estimates from all of the prepayment sources listed in your 
investment policy. When you purchase a CMO/REMIC, it must pass the 
tests for each estimate. When you retest the CMO/REMIC, it must pass 
the tests for a majority of the estimates.
    (4) If you use a median prepayment estimate, the median estimate 
when you purchase a CMO/REMIC must be based on at least five prepayment 
sources. When you retest the CMO/REMIC, the median estimate must be 
based on at least two prepayment sources.
    (f) You may purchase and hold a municipal security only if a 
nationally recognized statistical rating organization (NRSRO) has rated 
it in one of the four highest rating categories. A municipal security 
is a security as defined in Section 107(7)(K) of the Act. An NRSRO is a 
rating organization that the Securities and Exchange Commission has 
recognized as an NRSRO.
    (g) You may sell federal funds to Section 107(8) institutions and 
credit unions, as long as the interest or other consideration received 
from the financial institution is at the market rate for federal funds 
transactions.
    (h) You may invest in the following instruments issued by a Section 
107(8) institution or branch:
    (1) Yankee dollar deposits;
    (2) Eurodollar deposits;
    (3) Banker's acceptances;
    (4) Deposit notes; and

[[Page 33004]]

    (5) Bank notes with original weighted average maturities of less 
than five years.
    (i) A repurchase transaction is a transaction in which you agree to 
purchase a security from a counterparty and to resell the same or an 
identical security to that counterparty at a specified future date and 
at a specified price. You may enter into a repurchase transaction as 
long as:
    (1) The repurchase securities are legal investments for federal 
credit unions;
    (2) You receive a daily assessment of the market value of the 
repurchase securities, including accrued interest, and maintain 
adequate margin that reflects a risk assessment of the repurchase 
securities and the term of the transaction; and
    (3) You have entered into signed contracts with all approved 
counterparties.
    (j) A reverse repurchase transaction is a transaction in which you 
agree to sell a security to a counterparty and to repurchase the same 
or an identical security from that counterparty at a specified future 
date and at a specified price. You may enter into reverse repurchase 
and collateralized borrowing transactions as long as:
    (1) Any securities you receive are permissible investments for 
federal credit unions, you receive a daily assessment of their market 
value, including accrued interest, and you maintain adequate margin 
that reflects a risk assessment of the securities and the term of the 
transaction;
    (2) Any cash you receive is subject to the borrowing limit 
specified in Section 107(9) of the Act, and any investments you 
purchase with that cash are permissible for federal credit unions and 
mature no later than the maturity of the transaction; and
    (3) You have entered into signed contracts with all approved 
counterparties.
    (k) You may enter into a securities lending transaction as long as:
    (1) You receive written confirmation of the loan;
    (2) Any collateral you receive is a legal investment for federal 
credit unions, you obtain a perfected first priority interest in the 
collateral, you either take physical possession or control of the 
collateral or are recorded as owner of the collateral through the 
Federal Reserve Book-Entry Securities Transfer System; and you receive 
a daily assessment of the market value of the collateral, including 
accrued interest, and maintain adequate margin that reflects a risk 
assessment of the collateral and the term of the loan;
    (3) Any cash you receive is subject to the borrowing limit 
specified in Section 107(9) of the Act, and any investments you 
purchase with that cash are permissible for federal credit unions and 
mature no later than the maturity of the transaction; and
    (4) You have executed a written loan and security agreement with 
the borrower.
    (l)(1) You may trade securities, including engaging in when-issued 
trading and pair-off transactions, as long as you can show that you 
have sufficient resources, knowledge, systems, and procedures to handle 
the risks.
    (2) You must record any security you purchase or sell for trading 
purposes at fair value on the trade date. The trade date is the date 
you commit, orally or in writing, to purchase or sell a security.
    (3) At least monthly, you must give your board of directors or 
investment-related committee a written report listing all purchase and 
sale transactions of trading securities and the resulting gain or loss 
on an individual basis.


Sec. 703.110  What investments and investment activities are prohibited 
for me?

    (a) You (a federal credit union) may not purchase or sell financial 
derivatives, such as futures, options, interest rate swaps, or forward 
rate agreements, except as permitted under Sec. 701.21(i) of this 
chapter.
    (b) You may not engage in adjusted trading or short sales.
    (c) You may not purchase stripped mortgage backed securities, 
residual interests in CMOs/REMICs, mortgage servicing rights, 
commercial mortgage related securities, or small business related 
securities.
    (d) You may not purchase a zero coupon investment with a maturity 
date that is more than 10 years from the settlement date.


Sec. 703.120  May my officials or employees accept anything of value in 
connection with an investment transaction?

    (a) Your (a federal credit union's) officials and senior management 
employees, and their immediate family members, may not receive anything 
of value in connection with your investment transactions. This 
prohibition also applies to any other employee, such as an investment 
officer, if the employee is directly involved in investments, unless 
your board of directors determines that the employee's involvement does 
not present a conflict of interest. This prohibition does not include 
compensation for employees.
    (b) Your officials and employees must conduct all transactions with 
business associates or family members that are not specifically 
prohibited by paragraph (a) of this section at arm's length and in your 
best interest.
    (c) Senior management employee means your chief executive officer 
(typically this individual holds the title of President or Treasurer/
Manager), any assistant chief executive officers (e.g., Assistant 
President, Vice President, or Assistant Treasurer/Manager) and the 
chief financial officer (Comptroller).
    (d) Immediate family member means a spouse or other family member 
living in the same household.


Sec. 703.130  May I continue to hold investments purchased before 
January 1, 1998, that will be impermissible after that date?

    (a) Subject to safety and soundness considerations, your (a federal 
credit union's) authority to hold an investment is governed by the 
regulations in effect when you purchased the investment. Paragraphs (b) 
through (d) of this section describe past regulations governing certain 
investments.
    (b) Subject to safety and soundness considerations, you may hold a 
CMO/REMIC purchased:
    (1) Before December 2, 1991;
    (2) On or after December 2, 1991, but before July 30, 1993, if its 
average life does not extend or shorten by more than 6 years if 
interest rates rise or fall 300 basis points;
    (3) On or after December 2, 1991, but before January 1, 1998, if 
for the sole purpose of reducing interest rate risk and:
    (i) You have a monitoring and reporting system in place that 
provides the documentation necessary to evaluate the expected and 
actual performance of the investment under different interest rate 
scenarios;
    (ii) You use the monitoring and reporting system to conduct and 
document an analysis that shows, before purchase, that the proposed 
investment will reduce your interest rate risk;
    (iii) After purchase, you evaluate the investment at least 
quarterly to determine whether or not it actually has reduced your 
interest rate risk; and
    (iv) You classify the investment as either trading or available-
for-sale.
    (c) Subject to safety and soundness considerations, and 
notwithstanding paragraph (b) of this section, you may hold a variable-
rate CMO/REMIC purchased:
    (1) On or after December 2, 1991, but before July 30, 1993, if:
    (i) The interest rate is reset at least annually;
    (ii) The maximum allowable interest rate on the instrument is at 
least 300

[[Page 33005]]

basis points above the interest rate of the instrument at the time of 
purchase; and
    (iii) The interest rate of the instrument varies directly (not 
inversely) with the index upon which it is based and is not reset as a 
multiple of the change in the related index; or
    (2) On or after July 30, 1993, but before January 1, 1998, if:
    (i) The interest rate of the instrument is reset at least annually;
    (ii) The interest rate of the instrument, at the time of purchase 
or at a subsequent testing date, is below the contractual cap of the 
instrument;
    (iii) The index upon which the interest rate is based is a 
conventional widely-used market interest rate such as the London 
Interbank Offered Rate (LIBOR);
    (iv) The interest rate of the instrument varies directly (not 
inversely) with the index upon which it is based and is not reset as a 
multiple of the change in the related index; and
    (v) The estimated change in the instrument's price is 17 percent or 
less, due to an immediate and sustained parallel shift in the yield 
curve of plus or minus 300 basis points.
    (d) Subject to safety and soundness considerations, you may hold a 
CMO/REMIC residual, SMBS, or zero coupon security with a maturity 
greater than 10 years, if you purchased the investment:
    (1) Before December 2, 1991; or
    (2) On or after December 2, 1991, but before January 1, 1998, if 
for the purpose of reducing interest rate risk and you meet the 
requirements of paragraph (b)(3) of this section.
    (e) All grandfathered investments are subject to the valuation and 
monitoring requirements of Secs. 703.70, 703.80, and 703.90.


Sec. 703.140  What is the investment pilot program and how can I 
participate in it?

    (a) Under the investment pilot program, NCUA will permit a limited 
number of federal credit unions to engage in investment activities 
prohibited by this part but permitted by statute.
    (b) Except as provided in paragraph (c) of this section, before you 
(a federal credit union) may engage in additional activities, you must 
obtain written approval from
    NCUA. To begin the approval process, you must submit a request to 
your regional director that addresses the following items:
    (1) Board policies approving the activities and establishing limits 
on them.
    (2) A complete description of the activities, with specific 
examples of how you will conduct them and how they will benefit you.
    (3) A demonstration of how the activities will affect your 
financial performance, risk profile, and asset-liability management 
strategies.
    (4) Examples of reports you will generate to monitor the 
activities.
    (5) A projection of the associated costs of the activities, 
including personnel, computer, audit, etc.
    (6) A description of the internal systems to measure, monitor, and 
report the activities, and the qualifications of the staff and/or 
official(s) responsible for implementing and overseeing the activities.
    (7) The internal control procedures you will implement, including 
audit requirements.
    (c) You need not obtain individual written approval to engage in 
investment activities prohibited by this part but permitted by statute 
where the activities are part of a third-party investment program that 
NCUA has approved under this paragraph (c). A third party seeking 
approval of such a program must submit a request to the Director of the 
Office of Examination and Insurance that addresses the following items:
    (1) A complete description of the activities, with specific 
examples of how a credit union will conduct them and how they will 
benefit a credit union.
    (2) A description of any risks to a credit union from participating 
in the program.


Sec. 703.150  What additional definitions apply to this part?

    The following definitions apply to this part:
    Adjusted trading means selling a security to a counterparty at a 
price above its current fair value and simultaneously purchasing or 
committing to purchase from the counterparty another security at a 
price above its current fair value.
    Average life means the weighted average time to principal repayment 
with the amount of the principal paydowns (both scheduled and 
unscheduled) as the weights.
    Bank note means a direct, unconditional, and unsecured general 
obligation of a bank that ranks equally with all other senior unsecured 
indebtedness of the bank, except deposit liabilities and other 
obligations that are subject to any priorities or preferences.
    Banker's acceptance means a time draft that is drawn on and 
accepted by a bank and that represents an irrevocable obligation of the 
bank.
    Commercial mortgage related security means a mortgage related 
security where the mortgages are secured by real estate upon which is 
located a commercial structure.
    Deposit note means an obligation of a bank that is similar to a 
certificate of deposit but is rated.
    Embedded option means a characteristic of an investment that gives 
the issuer or holder the right to alter the level and timing of the 
cash flows of the investment. Embedded options include call and put 
provisions and interest rate caps and floors. Since a prepayment option 
in a mortgage is a type of call provision, a mortgage-backed security 
composed of mortgages that may be prepaid is an example of an 
investment with an embedded option.
    Eurodollar deposit means a U.S. dollar-denominated deposit in a 
foreign branch of a United States depository institution.
    Fair value means the price at which a security can be bought or 
sold in a current, arms length transaction between willing parties, 
other than in a forced or liquidation sale.
    Industry-recognized information provider means an organization that 
obtains compensation by providing information to investors and receives 
no compensation for the purchase or sale of investments.
    Investment means any security, obligation, account, deposit, or 
other item authorized for purchase by a federal credit union under 
Sections 107(7), 107(8), or 107(15) (B) or (C) of the Federal Credit 
Union Act, or this part, other than loans to members.
    Maturity means the date the last principal amount of a security is 
scheduled to come due and does not mean the call date or the average 
life of the security.
    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 payments, managing the 
escrow accounts, monitoring and dealing with delinquencies, and 
overseeing foreclosures and payoffs.
    Net capital means the total of all undivided earnings, regular 
reserves, other reserves (excluding the allowance for loan losses), net 
income, accumulated unrealized gains (losses)

[[Page 33006]]

on available-for-sale securities, and secondary capital as defined in 
Sec. 701.34 of this chapter.
    Official means any member of a federal credit union's board of 
directors, credit committee, supervisory committee, or investment-
related committee.
    Pair-off transaction means a security purchase transaction that is 
closed or sold at, or prior to, the settlement date. In a pair-off, an 
investor commits to purchase a security, but then pairs-off the 
purchase with a sale of the same security prior to or on the settlement 
date.
    Prepayment estimate means a reasonable and supportable forecast of 
mortgage prepayments in alternative interest rate scenarios. Broker-
dealers and industry-recognized information providers are sources for 
these estimates. Estimates 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.
    Residual interest means the remainder cash flows from a CMO/REMIC, 
or other mortgage-backed security transaction, after payments due 
bondholders and trust administrative expenses have been satisfied.
    Section 107(8) institution means an institution in which Section 
107(8) of the Act authorizes you to make deposits, i.e., an institution 
that is insured by the Federal Deposit Insurance Corporation or is a 
state bank, trust company or mutual savings bank operating in 
accordance with the laws of a state in which you maintain a facility. A 
facility is your home office or any suboffice, including, but not 
necessarily limited to, a credit union service center, wire service, 
telephonic station, or mechanical teller station.
    Security means a share, participation, or other interest in 
property or in an enterprise of the issuer or an obligation of the 
issuer that: (1) Either is represented by an instrument issued in 
bearer or registered form or, if not represented by an instrument, is 
registered in books maintained to record transfers by or on behalf of 
the issuer;
    (2) Is of a type commonly dealt in on securities exchanges or 
markets or, when represented by an instrument, is commonly recognized 
in any area in which it is issued or dealt in as a medium for 
investment; and
    (3) Either is one of a class or series or by its terms is divisible 
into a class or series of shares, participations, interests, or 
obligations.
    Settlement date means the date to which a purchaser and seller 
originally agree for settlement of the purchase or sale of a security.
    Short sale means the sale of a security not owned by the seller.
    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 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 (SMBS) means a security that 
represents either the principal-only or the interest-only portion of 
the cash flows of an underlying pool of mortgages or mortgage-backed 
securities. Some mortgage-backed securities represent essentially 
principal-only cash flows with nominal interest cash flows or 
essentially interest-only cash flows with nominal principal cash flows. 
These securities are considered SMBSs for the purposes of this part.
    When-issued trading of securities 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.
    Yankee dollar deposit means a deposit in a United States branch of 
a foreign bank licensed to do business in the state in which it is 
located, or a deposit in a state-chartered, foreign controlled bank.
    You means a federal credit union.
    Zero coupon investment means an investment that makes no periodic 
interest payments but instead is sold at a discount from its face 
value. The holder of a zero coupon investment realizes the rate of 
return through the gradual appreciation of the investment, which is 
redeemed at face value on a specified maturity date.

[FR Doc. 97-15915 Filed 6-17-97; 8:45 am]
BILLNG CODE 7535-01-P