[Federal Register Volume 65, Number 34 (Friday, February 18, 2000)]
[Proposed Rules]
[Pages 8597-8616]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-3275]



  Federal Register / Vol. 65, No. 34 / Friday, February 18, 2000 / 
Proposed Rules  

[[Page 8597]]


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NATIONAL CREDIT UNION ADMINISTRATION

12 CFR Part 702


Prompt Corrective Action; Risk-Based Net Worth Requirement

AGENCY: National Credit Union Administration (NCUA).

ACTION: Proposed rule.

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SUMMARY: NCUA proposes to supplement its system of prompt corrective 
action for federally-insured credit unions with a risk-based net worth 
requirement for credit unions defined as ``complex.'' In 1998, the 
Federal Credit Union Act was amended to require NCUA to adopt a system 
of prompt corrective action to commence when a federally-insured credit 
union becomes undercapitalized. In a separate component of that system, 
NCUA is required to define credit unions which are ``complex'' by 
reason of their portfolio of assets and liabilities and to develop a 
risk-based net worth requirement to apply to complex credit unions in 
the ``well capitalized'' or ``adequately capitalized'' statutory net 
worth categories. The statute classifies complex credit unions in those 
categories to the ``undercapitalized'' category if their net worth 
ratios do not meet their risk-based net worth requirement. NCUA seeks 
public comment on its proposed criteria for defining a ``complex'' 
credit union and on its proposed Call Report data-based formula for 
determining a complex credit union's risk-based net worth requirement.

DATES: Comments must be received on or before April 18, 2000.

ADDRESSES: Direct comments to Becky Baker, Secretary of the Board. Mail 
or hand-deliver comments to: National Credit Union Administration, 1775 
Duke Street, Alexandria, Virginia 22314-3428. Fax comments to (703) 
518-6319. Please send comments by one method only.

FOR FURTHER INFORMATION CONTACT: Technical: Herbert S. Yolles, Deputy 
Director, Office of Examination and Insurance, at the above address or 
telephone (703) 518-6360. Legal: Steven W. Widerman, Trial Attorney, 
Office of General Counsel, at the above address or telephone (703) 518-
6557.

SUPPLEMENTARY INFORMATION:

A. Background

1. The Credit Union Membership Access Act

    On August 7, 1998, Congress enacted the Credit Union Membership 
Access Act, Pub. L. No. 105-219, 112 State. 913 (1998). Section 301 of 
the statute added a new section 216 to the Federal Credit Union Act, 12 
U.S.C. 1790d (hereinafter referred to as ``CUMAA'' or ``the statute'' 
and cited as ``Sec. 1790d''). Section 1790d requires the NCUA Board to 
adopt by regulation a system of ``prompt corrective action'' (sometimes 
referred to as ``PCA'') to commence when a federally-insured ``natural 
person'' credit union becomes undercapitalized. The purpose of PCA is 
to ``resolve the problems of insured credit unions at the least 
possible long-term loss to the [National Credit Union Share Insurance 
Fund (NCUSIF)].'' Sec. 1790d(a)(1). The statute designates three 
principal components of PCA: (1) a framework of mandatory actions 
prescribed by statute, Sec. 1790d(c), (e), (f) and (g), and 
discretionary actions developed by NCUA, which are indexed to five 
statutory net worth categories and their corresponding net worth 
ratios, Sec. 1790d(c); (2) an alternative system of PCA to be developed 
by NCUA for credit unions which CUMAA defines as ``new,'' 
Sec. 1790d(a)(2); and (3) a risk-based net worth ratio to apply to 
credit unions which NCUA defines as ``complex.'' Sec. 1790d(d). The 
third component alone is the subject of this proposed rule.

2. Part 702 Final Rule

    Following the statutory mandate, the NCUA Board proposed a 
comprehensive system of PCA consisting of a framework of mandatory and 
discretionary supervisory actions and an alternative system of PCA to 
apply to ``new'' credit unions. 64 FR 27090 (May 18, 1999). Following a 
120-day comment period which generated 86 comment letters, the NCUA 
Board adopted a final rule, 12 CFR 702 et seq. (2000) (``part 702 final 
rule''), to take effect on August 7, 2000. (The final rule is found 
elsewhere in this issue of the Federal Register). The first quarter to 
which the part 702 final rule will apply is the fourth quarter of 2000, 
based on data reflected in the Call Report due to be filed January 22, 
2001. The part 702 final rule is the product of consultation with the 
Department of the Treasury, comments from the Federal banking agencies, 
and extensive collaboration with a committee of representative State 
credit union supervisors. See CUMAA Sec. 301(c).
    For credit unions which do not meet the statutory definition of a 
``new'' credit union, the part 702 final rule establishes a framework 
of mandatory and discretionary supervisory actions, indexed to the five 
net worth categories, and implements statutory conditions triggering 
conservatorship and liquidation. 12 CFR 702.210-702.206.
    For credit unions which CUMAA defines as ``new''--those having been 
in operation less than ten years and having $10 million or less in 
assets, Sec. 1790d(o)(4)--the part 702 final rule establishes a 
similarly-structured alternative system of PCA which recognizes that 
``new'' credit unions initially have no net worth and must have 
reasonable time to accumulate net worth and incentives to ultimately 
become ``adequately capitalized.'' Sec. 1790d(b)(2)(B). To that end, 
the system for ``new'' credit unions is modeled on the net worth 
category structure, but has six categories (including 
``uncapitalized'') which differ from the five statutory net worth 
categories. 12 CFR 702.301-702.307. The net worth ratio and category of 
a credit union, whether ``new'' or not, is determined quarterly. 12 CFR 
702.101(a)(1), 702.302(a).
    In addition to the substantive components of PCA, the part 702 
final rule implements an independent appeal process by which affected 
credit unions and officials can appeal decisions by NCUA staff imposing 
certain prompt corrective actions on a discretionary basis, and 
decisions by the NCUA Board reclassifying a credit union to a lower net 
worth category on safety and soundness grounds. 12 CFR 747.2001 et seq. 
Finally, the final rule retains certain of NCUA's current reserve and 
dividend payment requirements in modified form to reflect repeal of 
FCUA Sec. 116, 12 U.S.C. 1762, and to conform to CUMAA's earnings 
retention requirement. Sec. 1790d(e). 12 CFR 702.401 et seq.

3. Risk-Based Net Worth Requirement for ``Complex'' Credit Unions

    Independently of the general system of PCA in the part 702 final 
rule, CUMAA requires NCUA to develop the definition of a ``complex'' 
credit union based on the risk level of a credit union's portfolio of 
assets and liabilities, Sec. 1790d(d)(1), and to formulate a risk-based 
net worth (``RBNW'') requirement to apply to credit unions which meet 
that definition. The RBNW requirement must ``take account of any 
material risks against which the net worth ratio required for an 
insured credit union to be adequately capitalized [6%] may not provide 
adequate protection.'' Sec. 1790d(d)(2). NCUA must, ``for example, 
consider whether the 6 percent requirement provides adequate protection 
against interest-rate risk and other market risks, credit risk, and the 
risks posed by contingent liabilities, as

[[Page 8598]]

well as other relevant risks. The design of the [RBNW] requirement 
should reflect a reasoned judgment about the actual risks involved.'' 
S. Rep. No. 193, 105th Cong., 2d Sess. 13 (1998) (S. Rep.).
    CUMAA demands that a credit union which qualifies as ``complex,'' 
and whose net worth ratio initially places it in either of the 
``adequately capitalized'' or ``well capitalized'' net worth 
categories, must satisfy a separate RBNW requirement, which may exceed 
the minimum net worth ratio corresponding to its initial category (6% 
and 7%, respectively), in order to remain classified in that category. 
Sec. 1790d(c)(1)(A)(ii) and (c)(1)(B)(ii). A ``well capitalized'' or 
``adequately capitalized'' complex credit union which fails to meet its 
RBNW requirement is reclassified to the ``undercapitalized'' net worth 
category, and will be subject to certain mandatory and discretionary 
supervisory actions applicable to that category. 
Sec. 1790d(c)(1)(c)(ii).
    The RBNW requirement also has an indirect impact on the 
``undercapitalized'' and lower net worth categories. All credit unions 
which fall into those categories are required to operate under an 
approved net worth restoration plan. The plan must provide the means 
and a timetable for the credit union to reach the 6% net worth ratio 
``gate'' to the ``adequately capitalized'' category. Sec. 1790d(f)(5); 
12 CFR 702.206(c). However, for credit unions in the 
``undercapitalized'' or lower net worth categories which qualify as 
``complex,'' the net worth ratio ``gate'' to that category will be the 
credit union's RBNW requirement, which may be higher than 6%. Thus, to 
become ``adequately capitalized'' and to remain so, a complex credit 
union's net worth restoration plan will have to prescribe the steps a 
credit union will take to reach a higher net worth ratio ``gate'' to 
that category. See 12 CFR 702.206(c)(1)(i)(A).
    As directed by CUMAA, NCUA commenced rulemaking by issuing an 
Advance Notice of Proposed Rulemaking (ANPR) which, among other things, 
both suggested and invited concepts for an RBNW requirement and 
criteria for defining a ``complex'' credit union. CUMAA 
Sec. 301(d)(2)(A). 63 FR 57938 (October 29, 1998). Although there is no 
deadline for issuing NCUA's proposed rule implementing the RBNW 
requirement for ``complex'' credit unions, CUMAA set August 7, 2000, as 
the deadline for issuing the final rule, and January 1, 2001, as its 
effective date. CUMAA Sec. 301(d)(2)(B) and (e)(2). The first quarter 
to which the RBNW requirement for ``complex'' credit unions will apply 
is the first quarter of 2001, based on data reflected in the Call 
Report due to be filed in April 2001.

4. Advance Notice of Proposed Rulemaking

    By the comment deadline of January 27, 1999, NCUA received 34 
comment letters from 32 commenters in response to its ANPR soliciting 
concepts and criteria for a ``risk-based net worth requirement'' for 
``complex'' credit unions. The commenters consisted of 13 Federal 
credit unions, 3 State-chartered credit unions, 8 state credit union 
leagues, 2 credit union trade associations, 3 banking trade 
associations, a single State supervisory authority, a single State 
credit union supervisors association, and a single credit union 
consulting firm.
    The comments in response to the ANPR generally fall into three 
categories: (1) those which dwell on the four considerations NCUA had 
raised in the ANPR, two of which were abandoned as arbitrary even 
before the comment period expired; \1\ (2) those which suggest 
approaches that are contrary to CUMAA's express mandate and, thus, are 
outside NCUA's authority to adopt; \2\ and (3) those which suggest a 
genuinely new or different approach not at odds with the statutory 
mandate. Accordingly, this proposed rule addresses neither the 
considerations NCUA already has abandoned, nor the suggestions which 
are contrary to CUMAA. Other comments in response to the ANPR are 
addressed below.
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    \1\ The four considerations raised in the ANPAR were: (i) 
Whether the credit union's securities portfolio is subject to NCUA's 
300-basis-point ``shock test,'' 12 CFR 703.90(b)-(c); (ii) Whether 
the credit union's portfolio exceeds a certain threshold ratio of 
fixed-rate real estate mortgages; (iii) Whether the credit union has 
exceeded a certain threshold ratio of borrowed funds; and (iv) 
Whether the credit union's ``Capital'' and/or ``Asset'' CAMEL 
components are rated ``4'' or ``5.'' 63 FR at 57940. NCUA abandoned 
CAMEL components as a criterion because they are not readily 
accessible to credit unions to use in determining for themselves 
whether they are ``complex,'' and abandoned the 300-basis point 
``shock test'' because the purpose of the investment regulation 
fundamentally differs from that of a minimum capital requirement.
    \2\ For example, seven commenters advocated measuring risk by 
means other than a credit union's portfolio of assets and 
liabilities (e.g., asset size in relation to size of NCUSIF) and 
determining complexity according to the lack of diversification of 
products, geographic distribution of certain portfolios of assets, 
and lack of diversification of the field of membership (single 
employer).
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    Three commenters urged NCUA to base the RBNW requirement on a 
credit union's market value of portfolio equity (MVPE) or net economic 
value (NEV). One of these went further to recommend establishing 
assumptions for these measures, and to deem a credit union ``complex'' 
if the after-shock value of its capital is six percent or less. The 
NCUA Board declines to adopt these suggestions for two reasons. First, 
MVPE and NEV typically address only one type of risk--interest rate 
risk-not the range of relevant risks the statute contemplates. Second, 
relying on general assumptions to calculate MVPE or NEV may produce an 
inaccurate result; however, institution-specific assumptions may be 
costly and burdensome to formulate.
    Responding to the concept of establishing a threshold ratio of 
fixed-rate real estate mortgages as a criterion for defining a 
``complex'' credit union, one commenter suggested using fixed rate 
loans with maturities greater than 5 years in excess of 50 percent of 
assets. The proposed rule adopts this concept with a more inclusive 
asset threshold than the commenter urged and a 3-year remaining 
maturity criterion. Another commenter recommended excluding 
``conforming'' real estate loans which may be sold on the secondary 
market--a proposal that has been rejected because it addresses only 
liquidity risks, while ignoring interest rate, credit and other risks. 
Two commenters suggested using non-consumer, off-balance sheet 
commitments and contingencies exceeding 10 percent of assets. This 
recommendation has been adopted in part in the proposed rule through 
establishment of a risk portfolio consisting of unused commitments for 
member business loans.
    Four commenters urged using only ``unmatched'' fixed-rate mortgages 
(i.e., not matched against a like funding source such as Federal Home 
Loan Bank borrowings or long-term share deposits) in excess of 25 to 35 
percent of assets with terms greater than 12 to 15 years. NCUA 
concludes that the suggested matching criteria are unsuitable either 
because they cannot be applied on a consistent basis, or because they 
fail to sufficiently mitigate risk. As with MVPE or NEV calculations, 
the process of analyzing and monitoring a credit union's ``matched'' 
versus ``unmatched'' positions would be subject to inconsistent 
application because the process depends on individual, institution-
specific assumptions. The issue of how to treat ``non-maturity'' shares 
similarly invites inconsistency in maturity matching because it is open 
to various interpretations. Further, the maturity match proposed by the 
commenters, particularly in the absence of a market-based penalty for 
early withdrawal, would not fully mitigate interest rate risk. NCUA 
believes that longer term real estate loans inherently pose greater 
risks and therefore are an

[[Page 8599]]

appropriate indicator of the complexity of a credit union.
    Commenters advocated other criteria for defining a ``complex'' 
credit union--a defined segment of a credit union's investment 
portfolio and member business lending. NCUA agrees and has included in 
the proposed rule a risk portfolio combining three types of long-term 
investments, and a risk portfolio consisting of member business loans. 
Both risk portfolios are subject to a threshold percentage of the 
credit union's total assets.
    The commenters were divided as to whether credit union borrowing 
beyond a certain threshold of assets should be a criterion of 
``complexity.'' The opponents argued that using borrowed funds as a 
criterion could inhibit prudent cash management or risk reduction. The 
NCUA Board seriously considered, but ultimately rejected, borrowed 
funds as a criterion because management may use borrowed funds to 
accomplish different objectives. Properly structured, borrowed funds 
may be a risk-reducing measure taken by the credit union to improve its 
asset liability structure.
    Addressing the structure of the RBNW requirement, thirteen 
commenters advocated various basis point ceilings on the net worth 
ratio ``add on'' proposed in the ANPR. Three commenters favored a 100-
basis-point ceiling; another three favored that ceiling if it 
incorporates intermediate tiers or steps based on a credit union's 
complexity; one preferred a 50-basis-point maximum; another 
characterized a ceiling of 100 basis points as excessive; and the final 
commenter indicated that 100 basis points was not enough to capture all 
the risks. NCUA concurs with the final commenter because CUMAA sets no 
limit in directing NCUA to take into account ``any material risks 
against which [the 6% net worth ratio to be ``adequately capitalized''] 
may not provide adequate protection.'' Sec. 1790d(d)(2).
    Two commenters urged NCUA to model the RBNW requirement for complex 
credit unions on the risk-based system that has applied to banks since 
1992. To do so would not take account of the cooperative character and 
other unique features of credit unions, 12 U.S.C. 1790d((b)(1)(B), and 
would not ``reflect a reasoned judgment about the actual risks 
involved'' in credit unions. S. Rep. at 14. Embracing its mandate, NCUA 
is determined to develop an RBNW requirement that is tailored to each 
credit union's individual risk profile and thereby provides ``real 
protection against real risks.''
    Finally, commenters suggested three standards for the definition of 
a ``complex'' credit union: that size alone should not determine 
complexity; that a credit union should be able to determine for itself 
whether it is ``complex''; and that PCA rules should provide ``real 
protection against real risks.'' NCUA concurs and has incorporated the 
substance of these standards in its four goals described in section 5 
below.

5. Proposed Rule

    The proposed rule reflects four goals in developing an RBNW for 
``complex'' credit unions. First, to allow a credit union to determine 
for itself at any point whether it qualifies as ``complex,'' and if so, 
to ascertain its RBNW requirement on its own. Second, to rely on 
objective numerical standards to ensure uniformity, rather than on 
subjective determinations that allow unequal treatment. Third, to rely 
primarily on already-existing data such as Call Report data, rather 
than to impose a new additional recordkeeping burden. Fourth, to tailor 
the RBNW requirement to a credit union's individual risk profile, 
rather than to impose a ``one size fits all'' requirement.
    Through this notice, NCUA invites public comment on all aspects of 
its proposed rule. As with the final rule implementing the general 
system of PCA, broad public input addressing the proposed rule will 
assist the NCUA Board in tailoring an RBNW requirement that is 
workable, fair and effective in light of the cooperative character of 
credit unions. See S. Rep. at 14. However, commenters are urged to 
recognize that NCUA lacks discretion to modify the statutory basis for 
defining a ``complex'' credit union (e.g., the risk level of its 
portfolio of assets and liabilities) and the impact of failing to meet 
an RBNW requirement (classification in the ``undercapitalized'' 
category). Within those limitations, public comments suggesting and 
justifying modifications to the proposed rule will be most beneficial.
    To facilitate consideration of public comments on the proposed 
rule, the NCUA Board urges commenters to organize their comment letters 
on a section-by-section basis to correspond to the sections of the 
proposed rule, and to include general comments, if any, in a separate 
section.

B. Section-by-Section Analysis of Proposed Rule

    While all credit unions determine their net worth ratio quarterly, 
12 CFR 702.101(a), the determination whether a credit union is 
``complex'' and, if so, the determination of its RBNW requirement, is 
made on a quarterly basis by credit unions which file Call Reports 
quarterly, and on a semiannual basis by credit unions which file Call 
Reports semiannually. Both determinations rely on month-end account 
balances, including the balance of total assets, as reflected in the 
Call Report. See n. 7 infra. Coupling both determinations with the Call 
Report filing will relieve semiannual filers of the burden of making 
and reporting those determinations separately for the first and third 
quarters. However, this may cause semiannual filers either to remain 
``complex,'' or to be subject to a higher RBNW requirement than would 
otherwise be the case.
    The proposed rule implements a three-step process involving eight 
``risk portfolios'' which are defined in section 702.103. The process 
applies to all federally-insured credit unions including those defined 
as ``new.'' \3\ 702.302(c)(1)-(2). The first step, reflected in 
proposed section 702.104, is to determine whether a credit union 
qualifies as ``complex'' based on whether any of four specific 
threshold percentages of total assets is exceeded by corresponding 
``risk portfolios.'' The second step, reflected in section 702.105, 
uses eight ``RBNW components'' (derived from the ``risk portfolios'') 
to calculate the individual RBNW requirement that applies to a credit 
union which meets section 702.104's definition of ``complex.'' The 
third and final step, reflected in section 702.106, gives a ``complex'' 
credit union the opportunity to substitute any of three specific ``RBNW 
components'' in section 702.105 with a corresponding ``alternative 
component'' that may reduce the RBNW requirement against which the 
credit union's net worth ratio is measured.
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    \3\ Throughout the proposed rule, including the tables in the 
preamble and the rule text, and the appendices which follow the rule 
text, the terms ``credit union'' and ``CU'' refer to federally-
insured credit unions, wherther federal- or State-chartered. 12 CFR 
702.2(c).
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    NCUA relied on several resources to construct the proposed process 
for identifying ``complex'' credit unions and formulating an RBNW 
requirement for each. First, NCUA assembled a ``complex'' credit union 
committee to analyze field staff experience in dealing with risk 
exposure and capital deficiencies of credit unions. Among the members 
of the committee is a combined 74 years of regulatory and private 
sector depository institution and related experience. The committee 
collaborated extensively with representative state credit union

[[Page 8600]]

supervisors. Second, the committee compared its findings against the 
results of interest rate risk measurement models incorporating 
Securities Industry Association standard calculation formulas. Finally, 
the committee consulted historical data from Call Reports identifying 
the relationship between specific asset and liability portfolios, which 
the committee identified as having higher than average risk, and 
capital deficiency. This process was used to construct the ``risk 
portfolios'' and derivative ``RBNW components'' and ``alternative 
components,'' as well as to establish the tiers, thresholds and RBNW 
factors incorporated in each.

1. Section 702.2(k)--Definition of Weighted-Average Life

    The proposed rule defines the term ``weighted-average life'' for 
use in identifying the contents of the ``Long-term investments'' risk 
portfolio, Sec. 702.103(c)(1), and the contents of the ``Long-term 
investments'' alternative component for calculating the RBNW 
requirement, Sec. 702.106(c). The definition is adopted in modified 
form from Fabozzi, Frank and T. Dessa, eds., The Handbook of Fixed 
Income Securities (4th ed. 1995) at 518, and reflects the method by 
which credit unions report investments in Schedule C of the Call 
Report.
    The definition treats investments in registered investment 
companies and collective investment funds differently because their 
weighted-average lives generally are not disclosed. In the current Call 
Report, these investments all are combined in a single weighted-average 
life category--less than or equal to one year. When the Call Report is 
revised to conform to this part, investments in registered investment 
companies and collective investment funds will be reported separately. 
Whereas money market funds will continue to be categorized as having a 
weighted-average life of less than or equal to one year, investments in 
a registered investment company or collective investment fund will be 
categorized as having a weighted-average life of greater than 5 years, 
but less than or equal to 7 years. That category reflects the interest 
rate risk of typical mutual funds. The final sentence of the 
``weighted-average life'' definition anticipates this revision to the 
Call Report.

2. Section 702.103--Risk Portfolios Defined

    Section 702.103 of the proposed rule identifies eight ``risk 
portfolios'' which are used in subsequent sections. Five portfolios are 
used to determine whether a credit union is ``complex.'' See Table 1 in 
Sec. 702.103. If so, all eight are used to calculate what that credit 
union's risk-based net worth requirement will be. The portfolios 
consist of assets, liabilities and contingent liabilities, and are 
based entirely upon Call Report data integrated in a ``PCA Worksheet'' 
planned for introduction on a trial basis in the Call Report for the 
last quarter of 2000 (the quarter preceding the first quarter in which 
the final rule will apply).
    (a) Long-term real estate loans. This risk portfolio contains loans 
with above average economic value exposure to interest rate changes.\4\ 
Examination experience indicates the vast majority of member loans with 
above average exposure to interest rate changes are real estate 
related. In contrast, short-term fixed-rate and frequently repricing 
adjustable-rate real estate loans typically do not have above average 
exposure to interest rate changes. Thus, this portfolio combines all 
fixed-rate real estate loans and lines of credit with a maturity 
greater than 3 years, with variable-rate real estate loans that will 
not reprice within 3 years. NCUA research indicates that a balloon real 
estate loan with a 5-year original maturity, 30-year amortization 
schedule, and 3-year remaining maturity, would have less than a 6 
percent decline in market value on a 200-basis-point increase in 
interest rates. This risk portfolio may be expanded when examination 
experience indicates significant new sources of long-term loans.
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    \4\ ``Economic value exposure to interest rate changes'' refers 
to price sensitivity of a credit union's assets (changes in the 
value of the assets over different interest rate/yield curve 
scenarios). Interpretive Ruling and Policy Statement No. 98-2, 
``Supervisory Policy Statement on Investment Securities and End-User 
Derivatives,'' 65 FR 20191 at 20195 (April 23, 1998).
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    (b) Member business loans outstanding. This risk portfolio is 
comprised of all member business loans (MBLs) outstanding, exclusive of 
unused MBL commitments.\5\ Examination experience indicates credit risk 
of MBLs generally is greater than credit risk of member non-business 
loans. This portfolio also includes real-estate-related MBLs that 
generally have above average exposure to interest rate risk.
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    \5\ In NCUA's rule on member business loans, 12 CFR 723.1(a), 
and elsewhere in part 702, the term ``Member Business Loan'' [MBL] 
combines MBLs outstanding and unused MBL commitments. E.g., 12 CFR 
702.202(a)(4), 702.304(a)(3). For purposes of sections 702.103 
through 702.106, however, MBLs outstanding and unused MBL 
commitments each constitute a separate risk portfolio, 12 CFR 
702.103 (b) and (g), as well as a separate RBNW component. 12 CFR 
702.105 (b) and (g). The two risk portfolios are combined into a 
single portfolio only for the purpose of applying a threshold to 
define a complex credit union. 12 CFR 702.104(b).
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    (c) Long-term investments. Long-term investments generally have 
greater economic value exposure to interest rate changes than 
investments with shorter terms. This portfolio contains all fixed-rate 
investments with a weighted-average life greater than 3 years. NCUA 
research indicates fixed-rate investments with a shorter weighted-
average life generally have less than a 6 percent decline in market 
value for a 200 basis-point increase in interest rates. This risk 
portfolio also contains infrequently reset variable-rate investments. 
While no distinction is made between investments of different credit 
quality, most credit union investments are of high credit quality. The 
examination process permits NCUA to monitor trends in credit quality of 
investments on a continuing basis.
    (d) Low-risk assets. This risk portfolio is comprised of cash and 
cash equivalents \6\ that typically have below average interest rate 
and credit risk. Such assets also contribute significantly to a credit 
union's liquidity position. Credit unions generally have well 
controlled processes for securing cash. Cash equivalents generally are 
maintained in low-risk investment instruments, which still have some 
level of credit risk.
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    \6\ ``Cash'' includes currency on hand, demand deposits with 
banks or other financial institutions, and other accounts which have 
the characteristics of demand deposits in that the customer may 
deposit additional funds at any time and also effectively may 
withdraw funds at any time without prior notice of penalty. All 
charges to those accounts are cash receipts or payments to both 
entity owning the account and the financial institution holding it. 
Statement of Financial Accounting Standards No. 95 at para.7, n.1. 
``Cash equivalents'' are short-term highly liquid investments that 
are both readily convertible to known amounts of cash, and so near 
to maturity that there is an insignificant risk of change in value 
because of changes in interest rates. Id. para.8. Generally Accepted 
Accounting Principles often interpret ``so near to maturity'' to 
mean within 3 months.
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    (e) Average-risk assets. Average-risk assets primarily consist of 
consumer loans, real estate loans that will contractually refinance, 
reprice or mature within 3 years, most investments with a weighted-
average life or repricing interval of less than 3 years, and land, 
building and fixed assets. This risk portfolio is calculated by 
subtracting the preceding four risk portfolios from Call Report month-
end total assets. Assets assigned to one of the preceding portfolios 
(``Long-term real estate loans,'' ``MBLs,'' ``Long-term investments'' 
and ``Low-risk assets'')

[[Page 8601]]

have either above or below average risk. All other assets are grouped 
into this portfolio because they typically are average-risk assets.
    (f) Loans sold with recourse. Loans sold with recourse are an off-
balance sheet account and, therefore, are not included in any of the 
above portfolios of assets. Credit unions retain credit risk exposure 
on these contingent liabilities.
    (g) Unused member business loan commitments. Unused MBL commitments 
also are an off balance-sheet account. Large draws on unused MBL 
commitments may cause liquidity problems for credit unions with high 
levels of commitments. Unused commitments also represent contingent 
exposure to credit risk.
    (h) Allowance. This risk portfolio will reduce a credit union's 
RBNW requirement. The Allowance for Loan and Lease Losses (ALL) 
reflects provisions made for potential credit losses. Increases in the 
ALL account result in decreases in net worth, since provisions for ALL 
represent expense items. As of the June 1999 Call Report, about two-
thirds of all credit unions had an ALL of 1.50 percent or less of total 
loans outstanding. Thus, an ALL account of 1.50 percent or less is 
fairly typically observed. When the level of potential credit losses 
increases, the ALL account also should be increased. High levels of ALL 
accounts therefore reflect high levels of credit exposure. Because the 
Call Report does not make fine distinctions among loans by credit 
quality measures, its data cannot be used to finely distinguish 
different components of the RBNW requirement. Accordingly, the RBNW 
requirement is designed to reflect average credit risk exposures. Thus, 
the Allowance risk portfolio (expressed as a percentage of total 
assets) is limited to the ALL account up to the equivalent of 1.50 
percent of total loans. However, a credit union's ALL account will 
continue to be reviewed during the examination process to ensure its 
adequacy.

3. Section 702.104--Thresholds to Define Complex Credit Unions

    The first step of the proposed process, reflected in proposed 
section 702.104, is to determine whether a credit union is ``complex.'' 
A credit union is ``complex'' if any of four specific threshold 
percentages of total assets is exceeded by corresponding ``risk 
portfolios.'' \7\ See Table 2 in Sec. 702.104, and Appendix B. In that 
case, the credit union is ``complex'' and must proceed to calculate its 
RBNW requirement under section 702.105. Conversely, a credit union 
which does not exceed any of the four thresholds is not ``complex'' and 
may disregard the subsequent steps of the process.
---------------------------------------------------------------------------

    \7\ A credit union is required to use its calendar month-end 
account balances, including the balance of total assets, for 
purposes of sections 702.103 and 702.106. Since Call Report asset 
accounts are reported as of calendar month-end, the denominator for 
the eight ``risk portfolios'' also must be calendar month-end total 
assets. Otherwise, the sum of the balances in asset accounts 
(reported on a calendar month-end basis) would not necessarily equal 
assets (on other than a calendar month-end basis). For all other 
purposes under part 702, a credit union may elect among four methods 
for calculating its total assets--a daily average over the quarter, 
the month-end total, and the average of month-end totals for the 
most recent four quarters--to apply for that quarter. 12 CFR 
702.2(j)(2).
---------------------------------------------------------------------------

    NCUA proposes four thresholds only for the following five ``risk 
portfolios'' because they were designed to reflect above average risk, 
whereas each of the remaining three ``risk portfolios'' either reflects 
average or below average risk (``Average-risk assets'' and ``Low-risk 
assets'') or represents a cushion against loss (``Allowance'').
    (a) Long-term real estate loans. For long-term real estate loans, 
NCUA proposes a threshold of 25 percent of total assets. This proposal 
is based on NCUA's examination of interest rate risk data for a variety 
of typical loans. For example, a June 1998 analysis by the Office of 
Thrift Supervision estimates the industry aggregate present value of 
all thrifts' fixed-rate single-family first-mortgage loans and 
mortgage-backed securities would decline by about 8 percent for a 200-
basis-point increase in interest rates, and decline by about 12 percent 
for a 300-basis-point increase in interest rates. Office of Thrift 
Supervision, Division of Risk Management, ``Interest Rate Risk Exposure 
Report for All Reporting CMR'' as of June 1998. A credit union with a 
long-term real estate loan portfolio of 25 percent of total assets 
similar in composition to that of the average thrift institution would 
have an interest rate risk exposure of 2 percent of total assets for a 
rate increase of 200 basis points, and 3 percent of total assets for a 
rate increase of 300 basis points. Increased credit risk in such a 
higher interest rate environment would result in further declining 
present value of the long-term real estate loans. In this analysis, the 
risk of 25 percent of a credit union's assets would absorb half of the 
minimum net worth required to be ``adequately capitalized'' (i.e., a 6 
percent net worth ratio). Accordingly, NCUA concludes that a credit 
union having greater levels of long-term real estate loans needs 
additional net worth to adequately protect the NCUSIF.
    (b) Combined member business loans outstanding and unused 
commitments. NCUA proposes a threshold of 12.25 percent of total assets 
for the combined risk portfolios of ``MBLs outstanding'' and ``Unused 
commitments for MBLs.'' See note 5 supra. This threshold corresponds to 
the general MBL limit of 1.75 times 7 percent of total assets. 12 
U.S.C. 1757a(a). Credit unions permitted by exception to have greater 
levels of member business loans, id. Sec. 1757a(b), may need additional 
net worth to adequately protect the NCUSIF. Experience indicates that 
the value of typical business loan collateral is more volatile than 
typical non-business loan collateral. In addition, commercial real 
estate, as a whole, tends to decline far greater in value during 
recessions than does single family residential real estate. Therefore, 
MBLs present a higher level of credit risk than non-business loans, 
justifying a threshold of 12.25 percent instead of 25 percent.
    (c) Long-term investments. A threshold of 15 percent of total 
assets is proposed for long-term investments. Long-term investments 
expose a credit union to significant interest rate risk. For example, a 
newly issued 10-year, 6-percent-coupon Treasury note declines in value 
more than 13 percent for a 200-basis-point increase in rates, and more 
than 19 percent for a 300-basis-point increase in rates. A credit union 
with a long-term investments portfolio of 15 percent of total assets in 
such a security would have an economic value exposure of about 2 
percent of total assets with a 200-basis-point increase in rates and 
about 2.85 percent of total assets with a 300-basis-point increase in 
rates. Under this scenario, risk could absorb 47.5 percent of the 
minimum net worth required to be ``adequately capitalized'' (i.e., a 6 
percent net worth ratio). The investment portfolio typically is viewed 
as the guardian of a credit union's liquidity. A credit union needs 
financial assets that are readily convertible to cash to meet member 
withdrawal demands and to fund new member loans. Because of interest 
rate risk, long-term investments do not serve to adequately safeguard a 
credit union's liquidity.
    (d) Loans sold with recourse. NCUA proposes a threshold of 5 
percent of total assets for loans sold with recourse of any kind. A 
threshold level below 5 percent of total assets generally is not 
material. Loans sold with recourse are a contingent liability. When a 
loan is sold with recourse, net worth ratio generally increases; 
however, credit exposure typically does not decline.

[[Page 8602]]

4. Section 702.105--RBNW Components to Calculate Risk-Based Net Worth 
Requirement

    The second step of the proposed process, reflected in section 
702.105, is to calculate the RBNW requirement that applies to those 
credit unions which meet section 702.104's definition of ``complex.'' 
This is accomplished by tallying eight ``RBNW components,'' each of 
which is derived by multiplying its corresponding ``risk portfolio'' by 
an RBNW factor corresponding to its level of risk. See Table 3 in 
Sec. 702.105, and Appendix B. One such component, ``Allowance,'' is 
credited as an offset against the total of the other seven. The sum 
total percentage for the ``RBNW components'' yields the ``complex'' 
credit union's actual RBNW requirement, against which its net worth 
ratio (generally, retained earnings as a percentage of total assets) is 
compared.
    (a) Long-term real estate loans. The ``Long-term real estate 
loans'' risk portfolio, up to its 25 percent threshold, is weighted by 
a 6 percent RBNW factor, based on the net worth level at which a non-
complex credit union is ``adequately capitalized.'' The interest rate 
risk of this first 25 percent of total assets potentially is large in 
comparison to a 6 percent net worth ratio based on 100 percent of total 
assets. Thus, the next 15 percent of total assets in this risk 
portfolio is weighted by a 14 percent RBNW factor, a higher marginal 
rate to protect against additional risk. NCUA research indicates that a 
typical seasoned portfolio of 30-year mortgage loans declines in value 
by about 14 percent for a 300-basis-point increase in interest rates. 
As long-term real estate loans exceed 40 percent of a credit union's 
total assets, examination experience indicates typical increases in 
credit concentration risk and in the ratio of new loans to seasoned 
loans, with new loans having greater risk than seasoned loans. Thus, 
the portion of this risk portfolio in excess of 40 percent of total 
assets is weighted by 16 percent. By way of comparison, NCUA research 
indicates a newly-issued 30-year mortgage backed security declines in 
value by about 17 percent for a 300-basis-point increase in interest 
rates.
    (b) Member business loans outstanding. The ``MBLs outstanding'' 
risk portfolio also is weighted by a 6 percent RBNW factor up to its 
threshold of 12.25 percent of total assets. Unused commitments for MBLs 
are weighted separately, below. MBLs outstanding above 12.25 percent of 
total assets are weighted by a 14 percent RBNW factor. As the level of 
MBLs increases, the average factor for all MBLs rises. The average 
factor is 8 percent when this risk portfolio equals 16.33 percent of 
total assets, comparable to a bank's 8 percent credit-risk-weighted 
capital requirement.\8\ Unlike a bank's credit-risk-weighted capital 
requirement, this factor also must account for material interest rate 
risk and other relevant risks. As the amount of MBLs outstanding 
increases, interest rate risk also typically increases, as may credit 
concentration risk. The resulting risk-based net worth requirements 
typically should adequately protect the NCUSIF.
---------------------------------------------------------------------------

    \8\ Calculated as ((MBLs to the threshold of 12.25 times 6 
percent) plus (MBLs over the threshold of 4.08 times 14 percent)) 
divided by total MBLs of 16.33.
---------------------------------------------------------------------------

    By way of example, assume a credit union has 25.40 percent of total 
assets in MBLs, no unused commitments or other contingent liabilities, 
74.60 percent of total assets in average risk categories (such as the 
``Average-risk assets'' risk portfolio), a total of 70 percent of total 
assets in loans, and an ALL of 1.50 percent of total loans. Such a 
credit union would have an RBNW requirement of 6.00 percent, equal to 
the net worth ratio required for a credit union to be ``adequately 
capitalized.'' \9\ If this credit union increased MBLs to 37.90 percent 
of total assets, its RBNW requirement would be 7.00 percent, equal to 
the net worth ratio for a credit union to be ``well capitalized.'' \10\ 
In an extreme example, a credit union with 100 percent of total assets 
in MBLs, with no unused commitments or contingent liabilities, and an 
allowance of 1.50 percent of total loans, would have an RBNW 
requirement of 11.52 percent.\11\
---------------------------------------------------------------------------

    \9\ Calculated as (MBLs to the threshold of 12.25 times 6 
percent) plus (MBLs above the threshold of 13.15 times 14 percent) 
plus (average risk assets of 74.60 times 6 percent) minus (ALL of 
1.50 as a percent of total loans times 70 percent total loans/total 
assets.)
    \10\ Calculated as (MBLs to the threshold of 12.25 times 6 
percent) plus (MBLs above the threshold of 25.65 times 14 percent) 
plus (average risk assets of 62.10 times 6 percent) minus (ALL of 
1.50 as a percent of total loans times 70 percent total loans/total 
assets.)
    \11\ Calculated as (MBLs to the threshold of 12.25 times 6 
percent) plus (MBLs over the threshold of 87.75 times 14 percent) 
minus (ALL of 1.50 as a percent of total loans times 100 percent 
total loans/total assets.)
---------------------------------------------------------------------------

    (c) Long-term investments. The portion of the ``Long-term 
investments'' risk portfolio up to and including its threshold of 15 
percent of total assets is weighted by an RBNW factor of 6 percent. 
Long-term investments in excess of 15 percent of total assets are 
weighted by an RBNW factor of 12 percent. NCUA research indicates a 6-
percent-coupon Treasury note with a maturity slightly longer than 5 
years declines in value by about 12 percent for a 300-basis-point 
increase in interest rates. By way of comparison, a new issue 30-year 
mortgage-backed security declines in value by about 17 percent for a 
300-basis-point increase in interest rates, as is the case for a 6-
percent-coupon Treasury note with a maturity slightly longer than 8 
years.
    (d) Low-risk assets. All of the ``Low-risk assets'' portfolio is 
weighted by an RBNW factor of 3 percent. This reflects the credit risk 
of typical uninsured overnight or short-term accounts in corporate 
credit unions, other financial institutions, and Fed Funds sold.
    (e) Average-risk assets. The ``Average-risk assets'' risk portfolio 
is weighted by an RBNW factor of 6 percent, equivalent to the net worth 
level required for a credit union to be ``adequately capitalized.'' The 
average level of risk for all assets in this portfolio typically is 
expected to be adequately protected by a 6 percent net worth ratio.
    (f) Loans sold with recourse. This contingent liability is weighted 
by an RBNW factor of 6 percent. Examination experience indicates 6 
percent is an adequate level to protect against credit risk retained 
and operation risk of servicing such loans.
    (g) Unused member business loan commitments. This contingent 
liability is weighted by an RBNW factor of 6 percent. Examination 
experience indicates that not all commitments ultimately are drawn as 
loans. Thus, less net worth is necessary to protect against the total 
of unused commitments than would be necessary to protect against a 
similar level of outstanding loans.
    (h) Allowance. This portfolio is weighted by negative 100 percent, 
thereby reducing the RBNW requirement otherwise resulting from the 
aggregate of the seven risk portfolios discussed above. 
Sec. 702.105(a)-(g) .

5. Section 702.106--Alternative Components to Calculate Risk-Based Net 
Worth Requirement

    The third and final step of the proposed process, reflected in 
section 702.106, gives ``complex'' credit unions the option to reduce 
the amount of the RBNW requirement calculated under section 702.105. 
This entails comparing any of three specific ``RBNW components'' in 
section 702.105 with its corresponding ``alternative component'' in 
section 702.106. Each ``alternative component,'' derived from 
additional financial data (to be included in optional, supplemental 
schedules of the Call Report), may yield a smaller percentage than its 
counterpart. See Appendix G. When this is the case, any of three 
``alternative components'' can

[[Page 8603]]

be substituted for its counterpart ``RBNW component,'' thereby reducing 
the credit union's RBNW requirement originally calculated under section 
702.105.
    (a) Long-term real estate loans. This ``alternative component'' 
requires long-term real estate loans to be allocated by remaining 
maturity into four maturity buckets--greater than 3, but less than or 
equal to 5 years; greater than 5, but less than or equal to 12 years; 
greater than 12, but less than or equal to 20 years; and greater than 
20 years. These four maturity buckets are weighted by factors of 6, 8, 
12, and 16 percent, respectively. The sum of the weighted buckets 
yields the ``alternative component.'' All long-term real estate loans 
are included in these four buckets without regard to the 25 percent 
threshold level in section 702.105(b). See Table 4(a) in Sec. 702.106, 
and Appendix D.
    The factors applied to the long-term real estate loan maturity 
buckets reflect examiner judgment of credit risk and interest rate risk 
in typical fixed-rate real estate loans. Since such loans are secured 
by residential real estate, after consideration of an adequate factor 
for interest rate risk, no additional percentage was judged necessary 
to adequately cover typical levels of other risks. By way of example, a 
4\1/2\-year remaining maturity amortizing home equity loan would 
decline in value by 6-percent for a 300-basis-point increase in 
interest rates. Similarly, a 6-year remaining maturity amortizing home 
equity loan would decline in value by about 8 percent for a 300-basis-
point increase in interest rates. A pool of 15-year original maturity 
mortgages, with an average 13-year remaining maturity and assuming a 6 
percent constant prepayment rate, would decline in value by about 12 
percent for a 300-basis-point increase in interest rates. A pool of 30-
year original maturity mortgages, with an average 27-year remaining 
maturity and assuming a 6 percent constant prepayment rate, would 
decline in value by about 16 percent for a 300-basis-point increase in 
interest rates.
    (b) Member business loans outstanding. This alternative component 
requires MBLs first to be categorized as fixed-rate or variable-rate. 
Next, MBLs in each category are allocated by remaining maturity into 
five maturity buckets--3 years or less; greater than 3, but less than 
or equal to 5 years; greater than 5, but less than or equal to 7 years; 
greater than 7, but less than or equal to 12 years; and greater than 12 
years.\12\ The five maturity buckets of fixed-rate MBLs are weighted by 
factors of 6, 9, 12, 14, and 16 percent, respectively. The five 
maturity buckets of variable-rate MBLs are weighted by factors of 6, 8, 
10, 12, and 14 percent, respectively. The sum of the weighted buckets 
yields the ``alternative component.'' All MBLs are included in these 
ten buckets without regard to the 12.25 percent threshold level in 
section 702.105(b). See Table 4(b) in Sec. 702.106, and Appendix E.
---------------------------------------------------------------------------

    \12\ For federally-chartered credit unions, the maturity of MBLs 
is limited to 12 years, except ``lines of credit are not subject to 
a statutory or regulatory maturity limit.'' 12 CFR 701.21(c)(4). 
This limit does not apply to MBLs and lines of credit issued by 
federally-insured, State-chartered credit unions. Thus, the 
alternative component for MBLs includes a bucket to accommodate MBLs 
and lines of credit ``with a remaining maturity greater than 12 
years.'' Sec. 702.106(b)(1)(v) and (b)(2)(v).
---------------------------------------------------------------------------

    The factors applied to the maturity buckets for fixed- and 
variable-rate MBLs outstanding reflect examiner judgment of the credit 
risk and interest rate risk in representative MBLs outstanding. Typical 
MBLs include operating loans, equipment loans, and commercial real 
estate loans. Credit union portfolios of shorter (5 years or less) 
remaining maturity MBLs typically include a mix of types of seasoned 
MBLs, with reduced levels of credit risk in comparison to longer term 
loans. For example, a representative fixed-rate MBL is an amortizing 
loan with a remaining maturity of 1 year and 9 months. Such a loan 
would decline in value about 2\1/2\ percent for a 300-basis-point 
increase in interest rates. Considering credit risk is not expected to 
be fully correlated with interest rate risk, 3\1/2\ additional 
percentage points was judged adequate for coverage of credit risk.
    For the remaining maturity buckets longer than 5 years, each factor 
equals the interest rate risk of a representative fixed-rate amortizing 
MBL for a 300-basis-point increase in interest rates, plus 4 percentage 
points for adequate coverage of credit risk. Representative fixed rate 
MBLs are summarized in Table 1 below.
[GRAPHIC] [TIFF OMITTED] TP18FE00.008

    For the variable-rate MBLs, each of the factors for the three 
categories with a remaining maturity of greater than 5 years was 
reduced by 2 percent in comparison to the factors for fixed-rate MBLs. 
The factor for the category with a remaining maturity greater than 3 
but less than or equal to 5 years, was reduced by 1 percent in 
comparison to the factor for the corresponding fixed-rate MBLs. The 
value of a variable-rate MBL may decline less than the value of

[[Page 8604]]

a similar fixed-rate MBL for a given interest rate change, not 
considering credit risk. However, credit risk of a variable-rate loan 
typically increases in a higher rate environment, as the borrower comes 
under stress from meeting the increased interest expense burden.
    (c) Long-term investments. This ``alternative component'' requires 
long-term investments to be allocated in categories by weighted-average 
life in finer increments than reported in the Call Report investment 
schedule. The four categories are: greater than 3, but less than or 
equal to 5 years; greater than 5, but less than or equal to 7 years; 
greater than 7, but less than or equal to 10 years; and greater than 10 
years. These four categories are weighted by factors of 8, 12, 16, and 
20 percent, respectively. See Table 4(c) in Sec. 702.106, and Appendix 
F.
    The factors applied to the weighted-average life categories 
approximate the economic value exposure to interest rate risk of 
representative investment securities. For example, a 300-basis-point 
increase in interest rates from 6 percent would result in: about an 8 
percent decline in value of a 6-percent-coupon Treasury note of just 
over 3 years remaining maturity; about a 12 percent decline in value of 
a 6-percent-coupon Treasury note of just over 5 years remaining 
maturity; about a 16 percent decline in value of a 6-percent-coupon 
Treasury note of about 7\1/2\ years remaining maturity; and about a 20 
percent decline in value of a 6-percent coupon Treasury bond of about 
10\1/2\ years remaining maturity.

C. Impact of Risk-Based Net Worth Requirement

    Once calculated, a ``complex'' credit union's RBNW requirement 
affects its classification among the statutory net worth categories. An 
``adequately capitalized'' or a ``well capitalized'' credit union (6 to 
6.99% and 7% or greater net worth ratio, respectively) whose net worth 
ratio meets its RBNW requirement remains classified in its original 
category. An otherwise ``adequately capitalized'' or ``well 
capitalized'' credit union whose net worth ratio falls short of its 
RBNW requirement declines by one or two net worth categories, 
respectively, to the top tier of the ``undercapitalized'' category, 
Sec. 1790d(c)(1)(A)(ii) and (B)(ii), and thereby is subject to the four 
mandatory supervisory actions. 12 CFR 702.202(c).
    Using Call Report data as of June 1999, NCUA estimates that 1490 
federally-insured credit unions would qualify as ``complex.'' \13\ The 
average estimated RBNW requirement was 6.63 percent for all 1490 of 
these credit unions. By way of comparison, the individual average net 
worth ratio for these credit unions is 12.70 percent. The estimated 
RBNW requirement was less than or equal to 7.01 percent for 75 percent 
of complex credit unions, and less than or equal to 7.66 percent for 90 
percent of complex credit unions. Of the complex credit unions with a 
net worth ratio of 6 percent or greater, only 35 were estimated to fail 
their RBNW requirement using RBNW components in section 702.105 and, 
thus, would decline to the ``undercapitalized'' net worth category. 
These 35 credit unions still would have the option to substitute one or 
more ``alternative components'' under section 702.106 in an attempt to 
reduce their RBNW requirement.
---------------------------------------------------------------------------

    \13\ The Call Report as of June 1999 does not provide data in 
sufficient detail to distinguish money market funds from mutual 
funds. When revised to conform to part 702, the Call Report will do 
so.
---------------------------------------------------------------------------

    As indicated in Table 2 below, there is a strong relationship 
between increasing asset size of a federally-insured credit union and 
the likelihood that it will be deemed ``complex.'' In general, the 
larger a credit union's asset size, the more likely it is to have the 
resources to manage the above average risks associated with risk 
portfolios that would qualify a credit union as ``complex.''

[[Page 8605]]

[GRAPHIC] [TIFF OMITTED] TP18FE00.009

    The estimates in Table 2 above are based on June 1999 Call Report 
data as indicated in Tables 3 and 4 below: \14\
---------------------------------------------------------------------------

    \14\ Call Report line item references are subject to change when 
the Call Report is revised to conform with CUMAA and to incorporate 
the ``PCA Worksheet.''

---------------------------------------------------------------------------

[[Page 8606]]

[GRAPHIC] [TIFF OMITTED] TP18FE00.010

D. Potential Impact of New Forms of Regulatory Capital

    Many of those who commented on the proposed version of the part 702 
final rule advocated a role for new forms of ``regulatory capital'' in 
PCA. While NCUA may have the statutory authority to permit new sources 
of capital,\15\ CUMAA's express, limited definition of net worth--
retained earnings under

[[Page 8607]]

GAAP--clearly precludes all but low income-designated credit unions 
from classifying such capital as net worth for PCA purposes. 
Sec. 1790d(o)(2). Nevertheless, NCUA recognizes that, if established, 
regulatory capital would be available to absorb losses, thereby 
insulating the NCUSIF from such losses. For this reason, the part 702 
final rule makes regulatory capital, should it be established by NCUA, 
or authorized by State law and recognized by NCUA, a criterion in 
evaluating net worth restoration plans. 12 CFR 702.206(e).
---------------------------------------------------------------------------

    \15\ FCUA Sec. 107 permits NCUA to authorize regulatory capital 
in the form of shares and subordinated debt. NCUA may authorize a 
federal credit union to (1) ``receive from its members, from other 
credit unions, from an officer, employee or agent of those nonmember 
units of Federal, Indian Tribal, or local governments and political 
subdivisions thereof, * * * [shares, share certificates, and share 
draft accounts]; subject to such terms, rates and conditions as may 
be established by the board of directors, within limitations 
prescribed by the [NCUA] Board''; and (2) ``borrow in accordance 
with such rules as may be prescribed by the [NCUA] Board, from any 
source, in an aggregate amount not exceeding * * * 50 per centum of 
its paid-in and unimpaired capital and surplus.'' 12 U.S.C. 1757(7), 
1757(9) (emphasis added).
---------------------------------------------------------------------------

    Depending on how it is structured, regulatory capital on the 
balance sheet of a ``complex'' credit union could conceivably reduce 
the risk for which the RBNW requirement is designed to compensate. 
Therefore, NCUA may consider proposals to incorporate regulatory 
capital as a risk portfolio in section 702.103. This portfolio could be 
applied as an RBNW factor to reduce a credit union's RBNW requirement, 
as the ``Allowance'' RBNW component does in the proposed rule. 
Sec. 702.105(h).

Regulatory Procedures

Regulatory Flexibility Act

    The Regulatory Flexibility Act requires NCUA to prepare an analysis 
describing any significant economic impact a proposed regulation may 
have on a substantial number of small credit unions (primarily those 
under $1 million in assets). The proposed rule establishes an RBNW 
requirement to apply to federally-insured credit unions which meet the 
definition of ``complex.'' The RBNW requirement is expressly mandated 
by CUMAA as a component of NCUA's system of prompt corrective action. 
Sec. 1790d(d).
    For the purpose of this analysis, credit unions under $1 million in 
assets will be considered small entities. As of June 30, 1999, there 
were 1,690 such entities, with a total of $807.3 million in assets, 
with an average asset size of $0.5 million. These small entities make 
up 15.6 percent of all credit unions, but only 0.2 percent of all 
credit union assets.
    The proposed rule implements a three-step process involving eight 
``risk portfolios.'' The first step is to determine whether a credit 
union qualifies as ``complex'' based on whether any of four threshold 
percentages of total assets is exceeded by corresponding ``risk 
portfolios.'' The second step uses eight ``RBNW components'' (derived 
from the ``risk portfolios'') to calculate the individual RBNW 
requirement that applies to a credit union that qualifies as 
``complex.'' The third step provides a ``complex'' credit union the 
opportunity to substitute any of three specific ``RBNW components'' 
with a corresponding ``alternative component'' that may reduce the RBNW 
requirement against which the credit union's quarterly net worth ratio 
is measured.
    The NCUA Board does not believe that the proposed regulation would 
impose reporting or recordkeeping burdens that require specialized 
professional skills not available to them. Further, NCUA estimates that 
fewer than 50 of these small entities will meet the definition of 
``complex'' and therefore be subject to the additional requirements of 
the proposed regulation. There are no other relevant federal rules 
which duplicate, overlap, or conflict with the proposed regulation.
    The NCUA Board welcomes comments about ways to ease the burden on 
small entities.

Paperwork Reduction Act

    NCUA has determined that three requirements of the proposed rule 
constitute collections of information under the Paperwork Reduction 
Act. The requirements are: (1) To determine whether the credit union 
qualifies as ``complex'' based on specific threshold percentages of 
total assets; (2) If a credit union qualifies as ``complex,'' to 
calculate the individual RBNW requirement; and (3) If a ``complex'' 
credit union prefers, to calculate any of three ``alternative 
components'' which may reduce its RBNW requirement. NCUA is submitting 
a copy of the proposed regulation to the Office of Management and 
Budget (OMB) for its review.
    NCUA estimates that 10,800 federally insured credit unions would 
have to determine whether the credit union qualifies as ``complex'' 
under the proposed rule, based on data already collected in the Call 
Report. NCUA estimates that 1,500 federally-insured credit unions would 
qualify as ``complex,'' and would therefore be required to calculate 
the individual RBNW requirement using data already collected in the 
Call Report. NCUA further estimates that 35 federally-insured credit 
unions would opt to calculate the ``alternative components.'' For the 
23 credit unions which file Call Reports semiannually, the burden of 
performing the calculation is 8 hours each (4 hours per quarter for the 
second and fourth quarters) for a total of 184 burden hours. For the 12 
credit unions which file Call Reports quarterly, the burden of 
performing the calculation is 16 hours each (4 hours per quarter) for a 
total of 192 burden hours. In total, the burden created by the proposed 
rule is 376 hours. It is NCUA's view that the additional requirements 
are necessary for affected federally-insured credit unions to comply 
with the RBNW requirement implemented in the proposed rule as required 
by statute.
    The Paperwork Reduction Act of 1995 and OMB regulations require 
that the public be provided an opportunity to comment on information 
collection requirements, including an agency's estimate of the burden 
of the collection of information. The NCUA Board invites comment on: 
(1) whether the collection of information is necessary; (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 
collection of information. Comments should be sent to: OMB Reports 
Management Branch, New Executive Office Building, Room 10202, 
Washington, D.C. 20503; Attention: Alex T. Hunt, Desk Officer for NCUA. 
Please send NCUA a copy of any comments you submit to OMB.

Executive Order 13132

    Executive Order 13132 encourages independent regulatory agencies to 
consider the impact of their regulatory actions on state and local 
interests. NCUA, an independent regulatory agency as defined in 44 
U.S.C. 3502(5), voluntarily adheres to the fundamental federalism 
principles addressed by the executive order. This proposed rule will 
apply to all federally-insured credit unions, including federally-
insured, State-chartered credit unions. Accordingly, it may have a 
direct effect on the States, on the relationship between the national 
government and the States, or on the distribution of power and 
responsibilities among the various levels of government. This impact is 
an unavoidable consequence of carrying out the statutory mandate to 
adopt a system of prompt corrective action to apply to all federally-
insured credit unions.

Agency Regulatory Goal

    NCUA's goal is clear, understandable regulations that impose a 
minimal regulatory burden. Although much of the language of this rule 
is mandated by Congress, we request your comments on whether the 
proposed rule is understandable and minimally intrusive if implemented 
as proposed.

List of Subjects in 12 CFR Part 702

    Credit unions, Reporting and recordkeeping requirements.


[[Page 8608]]


    By the National Credit Union Administration Board on February 3, 
2000.
Becky Baker,
Secretary of the Board.
    Accordingly, it is proposed that 12 CFR part 702 be amended as set 
forth below:

PART 702--PROMPT CORRECTIVE ACTION

    1. The authority citation for part 702 continues to read as 
follows:

    Authority: 12 U.S.C. 1766(a), 1790d.

    2. Paragraph (k) is added to Sec. 702.2 to read as follows:


Sec. 702.2  Definitions.

* * * * *
    (k) Weighted-average life means, for purposes of 
Secs. 702.103(c)(1) and 702.106(c), the weighted-average time to the 
return of a dollar of principal, calculated by multiplying each portion 
of principal received by the time at which it is expected to be 
received, and then summing and dividing by the total amount of 
principal. The time at which the principal is expected to be received 
must be a reasonable and supportable estimate. The weighted-average 
life for portfolio investments in registered investment companies or 
collective investment funds (other than a money market fund) is defined 
as greater than five (5) years, but less than or equal to seven (7) 
years.
    3. Sections 702.103, 702.104, 702.105 and 702.106 are added to 
Subpart A of part 702 to read as follows:


Sec. 702.103  Risk portfolios defined.

    A risk portfolio is a portfolio of assets, liabilities, or 
contingent liabilities as specified below, each expressed as a 
percentage of the credit union's month-end total assets corresponding 
to its Call Report period, rounded to two decimal places (Table 1):
    (a) Long-term real estate loans. Total real estate loans and real 
estate lines of credit outstanding, exclusive of those outstanding that 
will contractually refinance, reprice or mature within 3 years, and 
exclusive of all member business loans (as defined in 12 CFR 723.1 or 
as approved under 12 CFR 723.20);
    (b) Member business loans outstanding. All member business loans 
(as defined in 12 CFR 723.1 or as approved under 12 CFR 723.20) that 
are outstanding, exclusive of unused commitments;
    (c) Long-term investments. Investments (as defined by 12 CFR 
703.150 or applicable State law) that are either:
    (1) Fixed-rate investments with a weighted-average life (as defined 
in Sec. 702.2(k)) greater than 3 years;
    (2) Variable-rate investments with the next rate adjustment period 
greater than 3 years; or
    (3) Investments in a collective investment fund (e.g., a common 
trust as defined in 12 CFR 703.100) or a registered investment company 
(e.g., a mutual fund) other than a money market fund as defined in 17 
CFR 270.2a-7;
    (d) Low-risk assets. Cash and cash equivalents as defined under 
Generally Accepted Accounting Principles;
    (e) Average-risk assets. One hundred percent (100%) of total assets 
minus the sum of the risk portfolios in paragraphs (a) through (d) of 
this section;
    (f) Loans sold with recourse. Outstanding balance of loans sold or 
swapped with recourse;
    (g) Unused member business loan commitments. Unused commitments for 
member business loans (as defined in 12 CFR 723.1 or as approved under 
12 CFR 723.20); and
    (h) Allowance. The Allowance for Loan and Lease Losses not to 
exceed the equivalent of one and one-half percent (1.5%) of total loans 
outstanding.
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Sec. 702.104  Thresholds to define complex credit unions.

    A credit union is deemed complex if it exceeds the threshold 
percentage of month-end total assets corresponding to its Call Report 
period, in any of the following risk portfolios (Table 2):
    (a) Long-term real estate loans. The threshold of long-term real 
estate loans, as defined in Sec. 702.103(a), is twenty-five percent 
(25%) of total assets;
    (b) Combined member business loans outstanding and unused 
commitments. The threshold of member business loans outstanding, as 
defined in Sec. 702.103(b), and unused member business loan 
commitments, as defined in Sec. 702.103(g), in the aggregate, is twelve 
and one-quarter percent (12.25%) of total assets.
    (c) Long-term investments. The threshold of long-term investments, 
as defined in Sec. 702.103(c), is fifteen percent (15%) of total 
assets; or
    (d) Loans sold with recourse. The threshold of loans sold with 
recourse, as defined in Sec. 702.103(f), is five percent (5%) of total 
assets.
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Sec. 702.105  RBNW components to calculate risk-based net worth 
requirement.

    For purposes of Secs. 702.102 and 702.302, a complex credit union's 
risk-based net worth requirement is the aggregate of the following RBNW 
component amounts, each expressed as a percentage of the credit union's 
month-end total assets corresponding to its Call Report period, rounded 
to two decimal places (Table 3):
    (a) Long-term real estate loans. The sum of:
    (1) Six percent (6%) of the amount of long-term real estate loans 
up to twenty-five percent (25%) of total assets; and
    (2) Fourteen percent (14%) of the amount in excess of twenty-five 
percent (25%) up to forty percent (40%) of total assets; and
    (3) Sixteen percent (16%) of the amount in excess of forty percent 
(40%) of total assets;
    (b) Member business loans outstanding. The sum of:
    (1) Six percent (6%) of the amount of member business loans 
outstanding up to twelve and one-quarter percent (12.25%) of total 
assets; and
    (2) Fourteen percent (14%) of the amount in excess of twelve and 
one-quarter percent (12.25%) of total assets;
    (c) Long-term investments. The sum of:
    (1) Six percent (6%) of the amount of long-term investments up to 
fifteen percent (15%) of total assets; and
    (2) Twelve percent (12%) of the amount in excess of fifteen percent 
(15%) of total assets;
    (d) Low-risk assets. Three percent (3%) of the entire portfolio of 
low-risk assets;
    (e) Average-risk assets. Six percent (6%) of the entire portfolio 
of average-risk assets;
    (f) Loans sold with recourse. Six percent (6%) of the entire 
portfolio of loans sold with recourse;
    (g) Unused member business loan commitments. Six percent (6%) of 
the entire portfolio of unused member business loan commitments; and
    (h) Allowance. Negative one hundred percent (-100%) of the balance 
of the Allowance for Loan and Lease Losses account, not to exceed the 
equivalent of one and one-half percent (1.5%) of total loans 
outstanding.

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Sec. 702.106  Alternative components to calculate risk-based net worth 
requirement.

    A complex credit union may substitute an alternative component 
below, in place of a corresponding RBNW component in Sec. 702.105 
above, when any alternative component amount, expressed as a percentage 
of the credit union's month-end total assets corresponding to its Call 
Report period, rounded to two decimal places, is smaller (Table 4):
    (a) Long-term real estate loans. The sum of:
    (1) Six percent (6%) of the amount of long-term real estate loans 
with a remaining maturity of greater than 3 years, but less than or 
equal to 5 years;
    (2) Eight percent (8%) of the amount of such loans with a remaining 
maturity of greater than 5 years, but less than or equal to 12 years;
    (3) Twelve percent (12%) of the amount of such loans with a 
remaining maturity of greater than 12 years, but less than or equal to 
20 years; and
    (4) Sixteen percent (16%) of the amount of such loans with a 
remaining maturity greater than 20 years;
    (b) Member business loans outstanding. The sum of:
    (1) Fixed-rate member business loans outstanding as follows:
    (i) Six percent (6%) of the amount of such loans with a remaining 
maturity of 3 or fewer years;
    (ii) Nine percent (9%) of the amount of such loans with a remaining 
maturity greater than 3 years, but less than or equal to 5 years;
    (iii) Twelve percent (12%) of the amount of such loans with a 
remaining maturity greater than 5 years, but less than or equal to 7 
years;
    (iv) Fourteen percent (14%) of the amount of such loans with a 
remaining maturity greater than 7 years, but less than or equal to 12 
years; and
    (v) Sixteen percent (16%) of the amount of such loans with a 
remaining maturity greater than 12 years; and
    (2) Variable-rate member business loans outstanding as follows:
    (i) Six percent (6%) of the amount of such loans with a remaining 
maturity of 3 or fewer years;
    (ii) Eight percent (8%) of the amount of such loans with a 
remaining maturity greater than 3 years, but less than or equal to 5 
years;
    (iii) Ten percent (10%) of the amount of such loans with a 
remaining maturity greater than 5 years, but less than or equal to 7 
years;
    (iv) Twelve percent (12%) of the amount of such loans with a 
remaining maturity greater than 7 years, but less than or equal to 12 
years; and
    (v) Fourteen percent (14%) of the amount of such loans with a 
remaining maturity greater than 12 years.
    (c) Long-term investments. The sum of:
    (1) Eight percent (8%) of the amount of long-term investments with 
a weighted-average life (as defined in Sec. 702.2(k) above) greater 
than 3 years, but less than or equal to 5 years;
    (2) Twelve percent (12%) of the amount of such investments with a 
weighted-average life greater than 5 years, but less than or equal to 7 
years;
    (3) Sixteen percent (16%) of the amount of such investments with a 
weighted-average life greater than 7 years, but less than or equal to 
10 years; and
    (4) Twenty percent (20%) of the amount of such investments with a 
weighted-average life greater than 10 years.

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    4. Appendices A through H are added to subpart A to read as 
follows:

Appendices to Subpart A
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Appendix H--Structural Overview of Secs. 702.103 through 702.106

    Sections 702.103 through 702.106 implement a three-step process 
involving eight ``risk portfolios'' which are defined in 
Sec. 702.103. The first step, reflected in Sec. 702.104, is to 
determine whether a credit union qualifies as ``complex'' based on 
whether any of four specific threshold percentages of total assets 
is exceeded by corresponding ``risk portfolios.'' The second step, 
reflected in Sec. 702.105, uses eight ``RBNW components'' (derived 
from the ``risk portfolios'' in Sec. 702.103) to calculate the 
individual RBNW requirement that applies to a credit union which 
meets Sec. 702.104's definition of ``complex.'' The third and final 
step, reflected in Sec. 702.106, gives a ``complex'' credit union 
the opportunity to substitute any of three specific ``RBNW 
components'' with a corresponding ``alternative component'' that may 
reduce the RBNW requirement against which the credit union's net 
worth ratio is measured. While all credit unions determine their net 
worth ratio quarterly, 12 CFR 702.101(a), the determination whether 
a credit union is ``complex'' and, if so, the determination of its 
RBNW requirement, is made on a quarterly basis by credit unions 
which file Call Reports quarterly, and on a semiannual basis by 
credit unions which file Call Reports semiannually.

[FR Doc. 00-3275 Filed 2-17-00; 8:45 am]
BILLING CODE 7535-01-P