[Federal Register Volume 65, Number 140 (Thursday, July 20, 2000)]
[Rules and Regulations]
[Pages 44950-44974]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-18278]


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NATIONAL CREDIT UNION ADMINISTRATION

12 CFR Parts 700 and 702


Prompt Corrective Action; Risk-Based Net Worth Requirement

AGENCY: National Credit Union Administration (NCUA).

ACTION: Final rule.

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SUMMARY: In 1998, the Federal Credit Union Act was amended to require 
NCUA to adopt a system of prompt corrective action for federally-
insured credit unions. As a separate component of that system, NCUA is 
required to define credit unions that are ``complex'' by reason of 
their portfolio of assets and liabilities and to develop a risk-based 
net worth requirement to apply to such credit unions in the ``well 
capitalized'' or ``adequately capitalized'' statutory net worth 
categories. The NCUA Board issued a proposed rule consisting of a 
three-step process for defining a ``complex'' credit union and for 
determining its risk-based net worth requirement under either of two 
methods. As revised to reflect public comments and to incorporate other 
improvements, the final rule narrows the definition of ``complex'' by 
minimum asset size and minimum risk-based net worth requirement; 
modifies the composition of certain risk portfolios; adjusts certain 
corresponding thresholds and risk weightings; and adds a risk 
mitigation credit.

DATES: Effective January 1, 2001.

FOR FURTHER INFORMATION CONTACT: Technical: Herbert S. Yolles, Deputy 
Director, Office of Examination and Insurance, telephone 703/518-6360; 
Legal: Steven W. Widerman, Trial Attorney, Office of General Counsel, 
telephone 703/518-6557, at National Credit Union Administration, 1775 
Duke Street, Alexandria, VA 22314-3428.

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 Stat. 913 (1998). Section 301 of 
the statute added a new section 216 to the Federal Credit

[[Page 44951]]

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'' (``PCA'') to commence when a federally-insured ``natural 
person'' credit union becomes undercapitalized. The statute designated 
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 that CUMAA defines as ``new,'' 
Sec. 1790d(a)(2); and (3) a risk-based net worth ratio to apply to 
credit unions that NCUA defines as ``complex.'' Sec. 1790d(d). The 
third component alone is the subject of this final rule.

2. New Part 702--Prompt Corrective Action

    Following the statutory mandate, the NCUA Board adopted as a final 
rule (``part 702'') 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. 12 C.F.R. 
702 et seq. (2000); 65 FR 8560 (February 18, 2000).\1\ For credit 
unions that do not meet the statutory definition of a ``new'' credit 
union, part 702 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 C.F.R. 702.201--702.206. For credit unions that 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)--part 702 
establishes a similarly-structured alternative system of PCA that 
recognizes that ``new'' credit unions initially have no net worth, need 
reasonable time to accumulate net worth, and must have incentives to 
ultimately become ``adequately capitalized.'' Sec. 1790d(b)(2)(B). 
Under part 702, the net worth ratio and category of a credit union, 
whether ``new'' or not, are determined quarterly. 12 C.F.R. 
702.101(a)(1), 702.302(a).
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    \1\ Except for sections 702.103 through 702.108, which are the 
subject of this final rule, new part 702 takes effect August 7, 
2000, and will first apply on the basis of data in the Call Report 
due to be filed January 22, 2001, reflecting activity in the fourth 
quarter of 2000.
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    In addition to the substantive components of PCA, an independent 
appeal process is available to affected credit unions and officials to 
appeal decisions by NCUA staff imposing certain discretionary 
supervisory actions, and decisions by the NCUA Board reclassifying a 
credit union to a lower net worth category on safety and soundness 
grounds. 12 C.F.R. 747.2001 et seq. (2000). Part 702 also prescribes 
reserving and dividend payment requirements to conform to CUMAA's 
earnings retention requirement. Sec. 1790d(e); 12 C.F.R. 702.401 et 
seq.

3. Risk-Based Net Worth Requirement

    Independently of the general system of PCA in part 702, CUMAA 
requires NCUA to develop a 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 meeting 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 percent] may not provide adequate 
protection.'' Sec. 1790d(d)(2). NCUA was encouraged to, ``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 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.).
    These specifications reflect the Department of the Treasury's 
recommendation to Congress to require NCUA to develop a supplemental 
RBNW requirement ``for larger, more complex credit unions * * * to take 
account of risks * * * that may exist only for a small subset of credit 
unions.'' U.S. Dept. of Treasury, Credit Unions (1997) at 71.
    CUMAA demands that a credit union that meets the definition of 
``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 
percent and 7 percent, respectively), in order to remain classified in 
that category.\2\ Sec. 1790d(c)(1)(A)(ii) and (c)(1)(B)(ii). A ``well 
capitalized'' or ``adequately capitalized'' credit union that fails to 
meet its RBNW requirement is classified by statute in the 
``undercapitalized'' net worth category, and will be subject to the 
mandatory and discretionary supervisory actions applicable to that 
category. Sec. 1790d(c)(1)(c)(ii).
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    \2\ The RBNW requirement also indirectly impacts credit unions 
in the ``undercapitalized'' and lower net worth categories, which 
are required to operate under an approved net worth restoration 
plan. The plan must provide the means and a timetable to reach the 
``adequately capitalized'' category. Sec. 1790d(f)(5); 12 CFR 
702.206(c). However, for ``complex'' credit unions in the 
``undercapitalized'' or lower net worth categories, the minimum net 
worth ratio ``gate'' to that category will be 6 percent or the 
credit union's RBNW requirement, if higher than 6 percent. In that 
event, 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).
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    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). Accordingly, the RBNW requirement for 
credit unions meeting the definition of ``complex'' will first apply on 
the basis of data in the Call Report due to be filed by quarterly 
filers on April 23, 2001, reflecting activity in the first quarter of 
2001.

4. Rulemaking Process

    As directed by CUMAA, NCUA commenced rulemaking by issuing an 
Advance Notice of Proposed Rulemaking (``ANPR'') which, among other 
things, both suggested and invited proposed concepts for an RBNW 
requirement and criteria for defining ``complex.'' CUMAA 
Sec. 301(d)(2)(A). 63 FR 57938 (October 29, 1998). By the comment 
deadline of January 27, 1999, NCUA received 34 comment letters from 32 
commenters, the majority of which addressed the RBNW requirement.
    On February 3, 2000, NCUA issued a proposed rule establishing a 
three-step process. 65 FR 8597 (February 18, 2000). The first step 
determined whether a credit union meets the definition of ``complex.'' 
The second step relied on Call Report data to determine a credit 
union's RBNW requirement. The final step permitted a credit union to 
substitute certain alternative calculations that may reduce its RBNW 
requirement. The proposed rule discussed and reflected comments that 
NCUA had received in response to the ANPR. 65 FR at 8598-8599.
    By the close of the comment period for the proposed rule, April 18, 
2000, NCUA received 119 letters submitted by 113 public commenters (a 
few of whom submitted more than one comment). Comments were received 
from 42

[[Page 44952]]

federal credit unions, 26 state credit unions, 4 corporate credit 
unions, 21 state credit union leagues, 4 individuals serving as credit 
union directors, 4 credit union industry trade associations, an 
association of state credit union supervisors, 2 state financial 
institution regulators, and a bank which co-sponsors a collective 
investment fund for credit unions. In addition, comments were received 
from 2 consultants, 2 accounting firms, and 3 securities dealers and/or 
advisors, each of which serves credit union clients. A banking industry 
trade association also commented on the proposed rule.
    A preponderance of commenters advocated a minimum asset size as a 
criterion for defining ``complex,'' and criticized labeling a credit 
union ``complex'' when its RBNW requirement is 6 percent or less. For 
the various risk portfolios, commenters generally suggested upward 
adjustments to the threshold levels and downward adjustments to the 
corresponding risk weightings; however, most provided no justification 
or empirical evidence to support the suggested adjustment. The 
unsupported comments are noted but not discussed in the preamble.\3\ 
The handful of comments urging NCUA to abandon or ignore the purpose 
and criteria that Congress expressly prescribed for the RBNW 
requirement, and which NCUA lacks discretion to modify, are neither 
noted nor discussed in the preamble.\4\ All other comments are analyzed 
generally in section C. below, except for the single banking industry 
trade association comment, which is addressed separately in section 
D.2. below.
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    \3\ For this reason, references to the total number of comments 
received on a topic may not equal the number of comments 
specifically discussed in the preamble. In addition, nearly all 
comment letters contained multiple comments addressing various 
provisions of the proposed rule.
    \4\ For example, such comments advocated exempting from the RBNW 
requirement credit unions having a CAMEL ``1'' or ``2'' rating; 
urged NCUA to prescribe a 5 percent net worth ratio to be ``well 
capitalized,'' as bank regulators do, even though CUMAA mandates a 7 
percent minimum net worth for that category, Sec. 1790d(c)(1)(A); 
proposed limiting the RBNW requirement to off-balance sheet items; 
and urged approval of State rules allowing federally-insured, State 
chartered credit unions to grant member business loans to non-
members.
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B. Principal Differences Between Proposed Rule and Final Rule

    As revised to incorporate public comments and improvements 
initiated by NCUA staff, the final rule differs from the proposed rule 
in the following principal respects:
    1. Applicability of RBNW requirement. The proposed rule featured a 
``four-trigger'' test defining the term ``complex'' according to 
whether any one of four risk portfolios is exceeded by a corresponding 
threshold percentage of total assets. The final rule abandons that test 
in favor of a simple standard of applicability--an RBNW requirement is 
applicable, and must be met, only if a credit union's total assets 
exceed $10 million and its RBNW requirement exceeds 6 percent. 
Sec. 702.103.
    2. Classification and weighting of ``Investments'' by weighted-
average life. For purposes of defining ``complex'' and for calculating 
a credit union's RBNW requirement, the proposed rule generally 
identified an investment as long-term if its weighted-average life or 
next rate adjustment period was greater than three years. The final 
rule expands the proposed ``Long-term investments'' risk portfolio into 
a comprehensive ``Investments'' risk portfolio consisting of all 
investments permitted by law, regardless whether short- or long-term. 
Sec. 702.104(c). A weighted-average life is specified for each type of 
credit union investment. Sec. 702.105. When calculating the RBNW 
requirement, the contents of the ``Investments'' risk portfolio is 
classified among weighted-average life ``buckets.'' Each bucket then 
receives a corresponding risk weighting. Secs. 702.106(c), 702.107(c). 
Investments in CUSOs are defined as having a weighted-average life of 
greater than 1 year, but less than or equal to 3 years, 
Sec. 702.105(e), and are subsequently risk weighted at 6 percent. 
Sec. 702.106(c)(2).
    3. Redefinition and zero weighting of ``Low risk assets.'' The 
proposed ``Low-risk assets'' risk portfolio consisted of cash and cash 
equivalents and was risk weighted at 3 percent. The final rule moves 
cash on deposit in financial institutions and cash equivalents (e.g., 
investments with a maturity of 90 days or less)--which carry low risk--
to the ``Investments'' risk portfolio, where they continue to be 
weighted at 3 percent. Sec. 702.106(c)(1). The ``Low risk assets'' risk 
portfolio is left to consist exclusively of cash on hand (e.g., coin 
and currency) and the National Credit Union Share Insurance Fund 
(''NCUSIF'') deposit. Sec. 702.104(d). Because those assets carry 
virtually no risk, the final rule reduces the risk weighting of that 
portfolio to zero. Sec. 702.106(d).
    4. 5-year maturity and repricing threshold for ``Long-term real 
estate loans.'' The proposed ``Long-term real estate loans'' risk 
portfolio established a minimum maturity and repricing threshold of 3 
years. The final rule increases the maturity and repricing threshold to 
5 years in order to achieve general parity between consumer and real 
estate loans. Sec. 702.104(a). This will ensure a risk-weighting 
consistent with relative economic value exposure for all real estate 
loans (other than member business loans) that mature or reprice within 
5 years, regardless of underlying real estate-related collateral. The 
5-year threshold will omit a significant amount of home equity loans 
from this risk portfolio, yet still capture the majority of real estate 
loans with above average interest rate risk.
    5. Risk mitigation credit. For credit unions that do not meet their 
RBNW requirement under the ``standard calculation'' or by using 
``alternative components,'' the final rule introduces a ``risk 
mitigation credit.'' Under guidelines to be adopted by the NCUA Board, 
a credit union may apply for a credit to reduce the RBNW requirement to 
reflect mitigation of credit risk and/or interest rate risk. 
Sec. 702.108. The NCUA Board may, in its discretion, grant a risk 
mitigation credit based on quantitative evidence of mitigation.

C. Section-by-Section Analysis of Final Rule

1. Structural Overview

    (a) Three-step process. The final rule retains in restructured form 
a three-step process, applicable to all federally-insured credit 
unions.\5\ The first step, reflected in section 702.103, determines 
whether an RBNW requirement is applicable. The proposed rule defined a 
credit union as ``complex'' if any one of four ``risk portfolios'' 
exceed a corresponding ``trigger'' percentage of total assets. 65 FR at 
8609. The final rule replaces the four-trigger test with a simple 
standard of applicability based on minimum asset size ($10 million) and 
a minimum RBNW requirement (more than 6 percent).
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    \5\ Throughout the final rule, including the tables in the 
preamble and the rule text, and the appendices to subpart A which 
follow the rule text, the terms ``credit union'' and ``CU'' refer to 
federally-insured credit unions, whether federal- or State-
chartered. 12 CFR 702.2(c).
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    If an RBNW requirement is applicable, the second step, reflected in 
section 702.106, prescribes the ``standard calculation,'' which relies 
on the eight risk portfolios identified in Sec. 702.104. Under the 
standard calculation, each of the risk portfolios is multiplied by one 
or more corresponding risk weightings to produce eight ``standard 
components.'' (Risk weightings are applied to credit union investments 
by weighted-average life category, as specified in section 702.105.) 
The aggregate of the standard components equals the RBNW requirement a 
credit union must meet.

[[Page 44953]]

    The third step, reflected in section 702.107, permits a credit 
union to substitute any of three specific ``standard components'' in 
section 702.106 with a corresponding ``alternative component'' that may 
reduce the RBNW requirement against which the credit union's net worth 
ratio is measured. The alternative components recognize finer 
increments of risk.
    Finally, a ``risk mitigation credit'' is introduced in section 
702.108 to permit a credit union that fails its RBNW requirement under 
the ``standard calculation'' (step 2), and as computed using the 
``alternative components'' (optional step 3), to apply for a credit 
against its RBNW requirement, reflecting mitigation of credit risk or 
interest rate risk.
    When the three-step process is completed, an ``adequately 
capitalized'' (6 to 6.99 percent net worth ratio) or ``well 
capitalized'' (7 percent or greater net worth ratio) credit union 
retains its original net worth category classification if its net worth 
ratio meets or exceeds its RBNW requirement under the standard 
calculation, or as computed using one or more alternative components, 
or as reduced by a ``risk mitigation credit''. An otherwise 
``adequately capitalized'' or ``well capitalized'' credit union whose 
net worth ratio falls short of its RBNW requirement declines by one and 
two net worth categories, respectively, to the ``first tier'' of the 
``undercapitalized'' category, Sec. 1790d(c)(1)(A)(ii) and (B)(ii), 
where it is subject to four mandatory supervisory actions. 12 CFR 
702.202(c).
    (b) Reliance on Call Report data. For the following reasons, the 
NCUA Board has decided as a matter of policy to rely primarily on the 
objective data collected in the Call Report to administer PCA 
generally, and to implement the RBNW requirement in particular. First, 
use of the Call Report will minimize any additional recordkeeping 
burden and intrusion on credit unions because credit unions already 
file Call Reports either quarterly or semiannually. Second, Call 
Reporting is an efficient system of measurement that is an appropriate 
vehicle for implementing minimum risk-based capital requirements on an 
industry-wide scale. Third, the ``PCA Worksheet'' that will accompany 
the Call Report will permit credit unions to readily compare their net 
worth ratio and corresponding category classification with an 
applicable RBNW requirement at any time, rather than to depend on 
notice from NCUA. Fourth, reliance on objective numerical standards 
will ensure uniformity in measurement and enforcement of the RBNW 
requirement.
    Beginning with the 4th quarter of 2000, the Call Report will be 
accompanied by a ``PCA Worksheet'' which extracts data from the Call 
Report to populate two different schedules.\6\ The first will compute a 
credit union's net worth ratio. The second will perform the ``standard 
calculation'' to first determine whether an RBNW requirement is 
applicable, and if so, to determine whether it is met by the credit 
union's net worth ratio. Independent of the Call Report, a separate 
form will be available to calculate the ``alternative components'' to 
determine if any reduce the RBNW requirement under the standard 
calculation.
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    \6\ December 1999 data indicates that all but 60 credit unions 
with assets of $10 million or more file their Call Reports 
electronically and, therefore, will benefit from the electronic flow 
of data from the Call Report to the accompanying ``PCA Worksheet.''
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    Numerous commenters have encouraged NCUA to substantially expand 
and modify the Call Report on the theory that enhanced precision in the 
collection of PCA-related data would give them a greater opportunity to 
demonstrate mitigation of balance sheet risk. However, mandating such 
additional detail in the Call Report would increase the reporting 
burden for all credit unions while any resulting augmented level of 
precision would benefit a small minority. For this reason, NCUA plans 
only incremental expansion and modification of the Call Report as 
warranted by experience in implementing PCA. To that end, the NCUA 
Board adopts the practice of occasionally sacrificing precision for 
some in favor of simplicity for all.
    Other commenters have encouraged NCUA to conduct a subjective 
assessment of credit unions' success, through modeling and other risk 
management techniques, to mitigate credit and interest rate risk, in 
spite of what an RBNW requirement may indicate. In this regard, the 
NCUA Board prefers not to circumvent the final rule's reliance on Call 
Report data as reflected in the ``PCA Worksheet.'' However, NCUA will 
evaluate quantitative evidence of risk mitigation submitted by those 
credit unions that apply for a risk mitigation credit. Sec. 702.108.

2. Section 700.1(i)--Withdrawal of Definition of ``Risk Assets''

    The proposed rule failed to delete part 700's definition of ``risk 
assets'' to reflect the repeal of section 116 of the Federal Credit 
Union Act (``FCUA''), 12 U.S.C. 1762. Current section 700.1(i) defines 
the term ``risk assets'' exclusively ``[f]or the purpose of 
establishing the reserves required by section 116 of the [FCUA].'' 
Former section 116 required a credit union to transfer a percentage of 
gross income to its regular reserve until the reserve equaled a 
prescribed percentage of the credit union's outstanding loans and risk 
assets. Former part 702 prescribed rules for implementing the statutory 
requirement to establish and maintain a regular reserve. CUMAA repealed 
section 116 of the FCUA. CUMAA Sec. 301(f)(3). Former part 702 is in 
force under separate statutory authority until August 7, 2000--the 
effective date of new part 702, 65 FR 8560, which implements CUMAA's 
earnings retention requirement. See 12 U.S.C. 1790d(e). Under new part 
702, neither PCA generally, nor the RBNW requirement specifically, 
utilizes the concept or the term ``risk assets.'' Accordingly, the 
final rule abolishes that term as obsolete.

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

    Both the standard component and the alternative component for 
``Investments'' categorize investments according to weighted-average 
life for purposes of risk weighting. Secs. 702.106(c), 702.107(c). The 
proposed rule defined ``weighted-average life'' (``WAL'') as the ``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.'' 65 FR at 8068. See Fabozzi, Frank, and T. Dessa, eds., The 
Handbook of Fixed Income Securities (5th ed. 1997) (hereinafter 
``Fabozzi'') at 539.
    Twenty-two commenters addressed the proposed definition of WAL. All 
were content to use WAL to characterize relative interest rate risk, 
but ten preferred using ``effective duration'' or ``modified duration'' 
instead, \7\ reasoning that they are more refined measures of interest 
rate risk exposure. In contrast, one commenter supported using the 
remaining term to maturity of the investment.
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    \7\ ``Effective duration'' and ``modified duration'' are 
estimates of the percentage price change of an investment for a one 
percent change in interest rates. See Fabozzi at 104. ``Duration'' 
provides a time measure of when on average the cash flows of an 
investment are received based on the present value of the cash 
flows, rather than on the actual amounts to be received in the 
future. See Woelfel, Charles J., ed., Encyclopedia of Banking and 
Finance (10th ed. 1994) at 317.
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    NCUA concedes that ``effective duration,'' appropriately 
calculated, can be a more refined measure of interest

[[Page 44954]]

rate risk exposure. In contrast, using remaining term to maturity, 
although simple, can dramatically overstate the risk of certain 
investments. Examination experience indicates that WAL provides a fair 
indicator of interest rate risk exposure for typical credit union 
investments. Furthermore, the current Call Report requires investments 
to be reported according to WAL. To change the basis for reporting 
investments in Schedule C of the Call Report would be unduly disruptive 
to the process of acclimating to PCA.
    One commenter urged NCUA to go beyond a general WAL definition and 
establish approved methodologies and sources for determining WAL. NCUA 
believes this is unwarranted because the definition as proposed is 
sufficiently clear. Reliable models, and reasonable and supportable 
estimates of the time periods for cash flows, are readily available 
from investment industry sources. In addition, to establish a process 
for approving WAL sources and methodologies would be burdensome and 
unnecessarily intrusive.
    The final rule retains the general WAL definition as proposed, 
Sec. 702.2(k); however, to facilitate classification by WAL in the 
standard and the alternative components for ``investments,'' the final 
rule specifies the WAL for certain categories of credit union 
investments. Sec. 702.105.

4. Section 702.103--Applicability of Risk-Based Net Worth Requirement

    To decide which credit unions must comply with ``an applicable 
risk-based net worth requirement,'' Secs. 702.101(a)(2), 702.102(a), 
702.302(a), the proposed rule (in former Sec. 702.104) featured a 
``four-trigger'' test defining a credit union as ``complex'' if its 
holdings in any of four ``risk portfolios,'' representing above-average 
risk, exceeded a corresponding ``trigger'' percentage of its total 
assets. 65 FR at 8609. This provision drew 124 comments--more than all 
but one other provision of the proposed rule--generally falling into 
three categories: those seeking to elevate the proposed ``trigger'' 
percentages, those critical of the test's methodology; and those 
preferring entirely different criteria for determining whether an RBNW 
requirement is applicable.
    Addressing the trigger percentages of total assets, ten commenters 
urged raising the proposed 25 percent trigger for the ``Long-term real 
estate loans'' portfolio to between 30 and 50 percent, contending that 
a low percentage trigger would discourage lending. Two commenters 
disputed the validity of NCUA's reliance on comparable thrift 
institution data on long-term real estate loans to justify the 25 
percent trigger. Nineteen commenters advocated increasing the proposed 
12.25 percent trigger for the portfolio combining ``Member business 
loans outstanding'' and ``Unused member business loan commitments,'' 
generally surmising that the 12.25 percent trigger was arbitrarily 
borrowed from elsewhere in CUMAA. See 12 U.S.C. Sec. 1757a(a). Thirty-
three commenters supported increasing the proposed 15 percent trigger 
for the ``Long-term investments'' portfolio to between 20 and 33 
percent, citing the importance of investment income to profitability 
when loan volume is low. One commenter suggested setting the trigger 
percentages based on the decline in portfolio value based on gradual 
periodic rate increases, rather than based on a 300 basis point ``rate 
shock.'' Six commenters insisted upon raising the proposed 5 percent 
trigger for the ``Loans sold with recourse'' portfolio to at least 10 
percent of total assets, leaving a single commenter who was content 
with the 5 percent trigger.
    Addressing the methodology of the proposed four-trigger test, seven 
commenters insisted that a credit union should be deemed to meet the 
definition of ``complex'' only if it exceeds one or more of the trigger 
percentages for a period of consecutive quarters, not just a single 
quarter. Under this scenario, the RBNW requirement would be a lagging 
indicator of risk, inconsistent with the purpose of PCA. Ten commenters 
suggested merging the ``Long-term real estate loans'' and ``Long-term 
investments'' portfolios under a single threshold ranging between 30 
and 60 percent of total assets. Going further, another commenter 
proposed merging all four portfolios representing above-average risk 
under a single omnibus trigger percentage.
    Notably, a substantial number of commenters appealed to the NCUA 
Board to replace the four-trigger test altogether. Thirty-one 
commenters sought to establish in its place a minimum asset ``floor'' 
as a criterion for defining ``complex,'' reflecting the minimal level 
of risk to the NCUSIF posed by the aggregate assets of credit unions 
below a certain asset size. Commenters suggested setting that floor at 
amounts ranging from $5 million to $100 million in assets. In contrast, 
two commenters objected to the exclusion of credit unions based on 
asset size.
    Taking an alternative approach, nineteen commenters suggested 
defining as ``complex'' only those credit unions that have an RBNW 
requirement exceeding 6 percent. This would entail a reversal in 
sequence--instead of requiring only those credit unions that meet the 
definition of ``complex'' to calculate and meet an RBNW requirement, 
all credit unions would have to review an RBNW calculation to determine 
if they exceed 6 percent. Those with an RBNW requirement in excess of 6 
percent would be deemed ``complex'' and then must meet that 
requirement. Departing even further from the four-trigger test, another 
commenter apparently would have all credit unions calculate an RBNW 
requirement, but only those which ultimately fail to meet that 
requirement, whether more or less than 6 percent, would be designated 
``complex.'' Regardless which approach is adopted in the final rule, 
five commenters implored NCUA to minimize, if not to abandon, use of 
the statutory term ``complex'' due to what they perceive as its 
pejorative connotation.
    The difference of opinion among commenters over the appropriate 
criteria for defining a ``complex'' credit union has caused the NCUA 
Board to review the statutory criteria for designing the RBNW 
requirement, Sec. 1790d(d); to assess the impact of the four trigger-
test compared to commenters' suggested alternatives, based on the most 
recent Call Report data; and to consider which approach will, in the 
end, most efficiently capture the risks to the NCUSIF that are the 
intended target of the RBNW requirement. In addition, the NCUA Board 
shares commenters' concern that a significant number of credit unions 
that met the definition of ``complex'' under the four-trigger test had 
an RBNW requirement of 6 percent or less. This reevaluation has 
persuaded the NCUA Board to abandon the four-trigger test in favor of a 
simple standard of applicability that combines minimum asset size and a 
minimum RBNW requirement.
    Accordingly, the final rule provides that ``a credit union is 
defined as 'complex' and an RBNW requirement is applicable'' only if 
its total assets exceed $10 million and its RBNW requirement under the 
standard calculation exceeds 6 percent.\8\ Sec. 702.103. Both measures 
rely on quarter-end total assets as reflected in a credit union's most 
recent Call Report

[[Page 44955]]

filed either quarterly or semiannually. \9\ Wherever possible, the 
final rule uses the statutory term ``applicable risk-based net worth 
requirement,'' e.g., Sec. 1790d(c)(1)(B)(ii) instead of the statutory 
label ``complex.'' An RBNW is not ``applicable'' to a credit union that 
does not meet both criteria; its net worth category classification is 
decided solely by its net worth ratio.
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    \8\ The final rule effectively exempts ``new'' credit unions 
under subpart C being defined as ``complex'' and subject to an RBNW 
requirement because, by definition, they have $10 million or less in 
assets. Compare Secs. 702.310(b) and 702.103(a)(2). Therefore, the 
final rule deletes references to an RBNW requirement for ``new'' 
credit unions from sections 702.302(a) and (c) in subpart C.
    \9\ When part 702 or the Call Report refers to total assets at 
quarter-end, it means the month-end balance as of the end of 
calendar quarter. E.g., Secs. 702.2(j)(1)(i) and (iv), 702.104, 
702.106, 702.107.
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    (a)(1) Minimum asset size. The prerequisite $10 million asset 
``floor'' imposed in the final rule reflects the conclusion that the 
aggregate assets of credit unions in that asset bracket do not expose 
the NCUSIF to material risk. CUMAA directed NCUA to develop an RBNW 
requirement that ``take[s] account of any material risks against which 
the net worth ratio required for an insured credit union to be 
adequately capitalized [6 percent] may not provide adequate 
protection.'' Sec. 1790d(d)(2) (emphasis added); S. Rep. at 13 (1998). 
Aggregate insured shares of credit unions with $10 million or less in 
assets equal $17,269,585,004, or 5.15 percent of all insured shares. Of 
the 6195 credit unions in this asset bracket, currently 105 would be 
subject to an RBNW requirement under Sec. 702.103(a)(2), representing 
$423,344,277 in insured shares. This would be the NCUSIF's maximum 
exposure in a worst case scenario that assumes all 105 credit unions 
with assets of $10 million or less fail and the NCUSIF is forced to 
absorb losses at the rate of 100 cents to the dollar. By comparison, 
today only 5 of the 105 credit unions meeting the definition of 
``complex'' in that asset group would fail their RBNW requirement under 
the standard calculation. Under typical circumstances, the NCUSIF's 
risk exposure from credit unions with $10 million or less in assets is 
insufficient to be considered material.
    With a sacrifice of minimal risk protection, the $10 million asset 
floor dramatically reduces the burden the RBNW requirement would 
impose. Credit unions with assets of $10 million or less number 6195, 
representing 58 percent of all credit unions. Thus, the $10 million 
asset floor relieves the majority of credit unions of any burden 
whatsoever associated with an RBNW requirement.
    The $10 million asset floor parallels use of a $10 million measure 
elsewhere in CUMMA to trigger other PCA provisions. A maximum of $10 
million in assets is one criterion of the statutory definition of a 
``new'' credit union, which is subject to an alternative system of PCA. 
Sec. 1790d(o)(4). CUMAA requires NCUA to provide assistance in 
preparing net worth restoration plans to credit unions having less than 
$10 million in assets. Sec. 1790d(f)(2). In addition, excluding credit 
unions beneath the $10 million asset floor is consistent with the 
Treasury Department recommendation that led Congress to enact an RBNW 
component of PCA--that it is needed ``for larger, more complex credit 
unions * * * to take account of risks * * * that may exist only for a 
small subset of credit unions.'' U.S. Dept. of Treasury, Credit Unions 
(1997) at 71.
    (a)(2) Minimum RBNW requirement. The minimum 6 percent RBNW 
``floor'' which the final rule imposes on credit unions with assets 
above $10 million reflects the conclusion that credit unions whose RBNW 
requirement is 6 percent or less fall outside the intended target of 
the RBNW requirement. CUMAA is explicit in concentrating the RBNW 
requirement on ``material risks against which the [6 percent] net worth 
ratio required * * * to be adequately capitalized may not provide 
adequate protection.'' Sec. 1790d(d). Further, NCUA was instructed to 
``consider whether the 6 percent requirement provides adequate 
protection against * * * relevant risks.'' S. Rep. at 13. The NCUA 
Board has determined that a 6 percent net worth ratio is sufficient to 
protect against an average level of risk, but that a measure of 
additional net worth is needed to compensate for risks which are above 
average. For this reason, the final rule limits the scope of its RBNW 
requirement to credit unions that have an above average level of risk 
exposure.
    Under the proposed rule, all credit unions, through the ``PCA 
Worksheet,'' were required to conduct the four trigger test, and once 
meeting the definition of ``complex,'' were required to calculate and 
meet an RBNW requirement. 65 FR at 8609. With the minimum 6 percent 
RBNW floor, that process is reordered as explained above; all credit 
unions with assets above $10 million will now have to review a standard 
RBNW calculation reflected in the ``PCA Worksheet'' to determine 
whether the result exceeds 6 percent. If so, the RBNW requirement is 
applicable and must be met; if not, an RBNW requirement is not 
applicable and the credit union retains its original net worth category 
classification. Although all credit unions with assets above $10 
million now will have to review an RBNW calculation, fewer will be 
required to meet an RBNW requirement.
    Primarily as a result of the final rule's $10 million asset floor, 
it is estimated that 452 credit unions will be required to meet an RBNW 
requirement under the final rule--less than one-third the number 
required to do so under the proposed rule. See section E below.
    (b) Optional Call Report filing. The proposed rule required the 
RBNW requirement to be determined according to a credit union's Call 
Report schedule--quarterly for quarterly filers, and semiannually for 
semiannual filers. 65 FR at 8599. Compare 12 CFR 702.101(a) (quarterly 
determination of net worth and corresponding category). One commenter 
protested that this would deprive semiannual filers of the means to 
demonstrate either that an RBNW requirement no longer is applicable, or 
that their RBNW requirement has declined (and perhaps has been met) in 
the 1st and 3rd quarters. Another commenter proposed a solution--
optional 1st and 3rd quarter Call Report filing for semiannual filers. 
Another would mandate quarterly Call Report filing by all credit unions 
that meet the definition of ``complex.''
    Mandatory quarterly Call Report filing for credit unions that meet 
the definition of ``complex'' currently is not warranted; however, NCUA 
concurs that optional 1st and 3rd quarter Call Report filing would give 
those credit unions maximum flexibility. The final rule is modified 
accordingly. Sec. 702.103(b).

5. Section 702.104--Risk Portfolios Defined.

    The proposed rule (in former Sec. 702.103) established eight ``risk 
portfolios,'' representing various levels of risk. 65 FR at 8608. The 
portfolios consist of assets, liabilities and contingent liabilities, 
as reflected in Call Report data to be collected in the ``PCA 
Worksheet'' accompanying the Call Report. In subsequent sections, the 
contents of each risk portfolio will be multiplied by one or more 
corresponding risk weightings. The final rule retains the eight 
proposed risk portfolios, modified as follows in section 702.104 (see 
Table 1 in Sec. 702.104):
    (a) Long-term real estate loans. The proposed risk portfolio for 
``Long-term real estate loans'' consisted of all fixed-rate real estate 
loans and lines of credit that mature or reprice in greater than 3 
years. 65 FR at 8608. NCUA examination experience and research 
confirmed that a vast majority of member loans with above average 
exposure to interest rate changes are real estate related. 65 FR at 
8600. The 124 overlapping comments addressing this provision generally 
seek either to

[[Page 44956]]

increase the 3-year maturity and repricing threshold or to narrow the 
composition of the portfolio by excluding certain types of loans.
    Forty-eight commenters urged an increase in the 3-year maturity and 
repricing threshold to either 5 or 7 years on various grounds. Although 
careful not to advocate an augmented risk portfolio for consumer loans, 
the majority of commenters protested that a threshold as low as 3 years 
discriminates against real estate loans compared with consumer loans, 
even though they have similar economic value exposure,\10\ indicating 
little difference in interest rate risk. The commenters predicted that 
this unequal treatment would cause credit unions to migrate to consumer 
lending at the expense of real estate lending in order to elude this 
risk portfolio. This would result in an increase in credit risk 
exposure due to the generally better performance and more stable 
collateral of real estate loans when compared with consumer loans. On 
similar grounds, nineteen commenters urged NCUA to exclude home equity 
loans with maturities of fewer than 6 or 7 years.
---------------------------------------------------------------------------

    \10\ ``Economic value exposure'' refers to price sensitivity of 
a credit union's assets (changes in the value of the assets over 
different interest rate/yield curve scenarios). NCUA Interpretive 
Ruling and Policy Statement No. 98-2, ``Supervisory Policy Statement 
on Investment Securities and End-User Derivatives Activities,'' 63 
FR 24097, 24101 (May 1, 1998).
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    Commenters supporting a 5-year maturity and repricing threshold for 
this portfolio observed that NCUA adopted a 5-year threshold in its 
pre-PCA definition of ``risk assets.'' 12 C.F.R. Sec. 700.1(i); but see 
section C.2. above. Others pointed elsewhere in the proposed rule, 
observing that the alternative component for ``Long-term real estate 
loans'' features a 3-to-5 year remaining maturity bucket that receives 
the risk weighting designated for average risk assets (6 percent). In 
contrast, a single commenter was content with the 3-year threshold, and 
another went even further to boldly suggest applying it to consumer 
loans as well.
    With regard to the composition of the ``Long-term real estate 
loans'' portfolio, a commenter suggested excluding loans having a 
government guarantee against default. While a guarantee against default 
mitigates credit risk, it does not affect interest rate risk. Because 
this portfolio measures primarily interest rate risk, it is appropriate 
that long-term, government guaranteed loans remain in this risk 
portfolio.
    Seeking a means to demonstrate risk mitigation, twenty-three 
commenters wished to exclude loans, or even the whole portfolio, upon 
proof that ``matching'' loans against liabilities or ``hedging'' 
through derivatives mitigates corresponding balance sheet risk. 
Fourteen commenters wanted to adopt WAL instead of contractual maturity 
to report real estate loans because WAL is more accurate and would 
reflect anticipated mortgage loan prepayments. If adopted, both 
suggestions would substantially narrow the scope of this risk 
portfolio.
    NCUA concedes that ``matching'' and ``hedging'' are prudent risk 
management tools, and that WAL is a potentially more accurate measure 
of risk exposure. As explained in section C.1(b) above, the NCUA Board 
has decided as a matter of policy to rely on objective data captured in 
the Call Report and reflected in the ``PCA Worksheet'' as the most 
efficient means to implement PCA. For this reason, the final rule 
neither incorporates WAL in the ``Long-term real estate loans'' risk 
portfolio, nor excludes ``matched'' or ``hedged'' loans.\11\
---------------------------------------------------------------------------

    \11\ Federally-charted ``natural person'' credit unions may 
apply to participate directly, or through a corporate credit union 
acting as a vendor, in an interest-rate-risk-hedging program 
involving derivative transactions. 12 CFR 703.140. Corporate credit 
unions may apply under Appendix B to 12 CFR 704 for expanded 
authorities to engage in derivative transactions.
---------------------------------------------------------------------------

    Two commenters recommended that this portfolio combine mortgage-
backed securities with long-term real estate loans. Due to the 
similarity in risk characteristics, NCUA concurs that this is the 
preferred business practice to manage balance sheet risk on an 
aggregate basis (See NCUA Letter to Credit Unions No. 99-CU-12, ``Real 
Estate Lending and Balance Sheet Risk Management,'' August 1999); 
however, since aggregate measurement is less accurate than measurement 
of the specific components, and would impose an undue burden on some 
credit unions to estimate reliable prepayment assumptions, NCUA 
declines to mandate the practice for all credit unions.
    Seeking a fundamental modification, three commenters recommended 
applying the three-year contractual maturity exclusion to the scheduled 
principal payments of all real estate loans. This is unnecessary 
because scheduled principal repayments are already taken into 
consideration in the risk weighting assigned as a result of NCUA's 
evaluation of the potential economic value exposure of long-term real 
estate loans.
    To achieve general parity among all types of loans, the final rule 
increases the maturity and repricing threshold for the ``Long-term real 
estate loans'' risk portfolio to 5 years. Sec. 702.104(a). This will 
ensure a risk-weighting consistent with relative economic value 
exposure for all types of loans (other than member business loans) that 
mature or reprice within 5 years, regardless of underlying collateral. 
The 5-year threshold will omit a significant amount of home equity 
loans from this risk portfolio, yet still capture the vast majority of 
real estate loans with above average interest rate risk.
    (b) Member business loans outstanding. The proposed risk portfolio 
for ``Member business loans outstanding'' consisted of loans 
outstanding that qualify as member business loans (``MBLs'') under 
NCUA's definition, 12 CFR 723.1, or under a State's NCUA-approved 
definition. 65 FR at 8608. Unused MBL commitments were expressly 
excluded because they are addressed in a separate risk portfolio, 
Sec. 702.104(g).
    NCUA received several comments generally seeking to exclude certain 
MBLs from this risk portfolio. Eleven commenters sought to exclude 
portions of MBLs that are government guaranteed, and six urged 
excluding portions with credit enhancements, such as those secured by 
shares or deposits in a federally-insured financial institution, or 
guaranteed by a non-governmental organization. NCUA's rule on MBLs 
(``Part 723'') already excludes from the loans-to-one-borrower limit, 
Sec. 723.8, portions of an MBL that are either: ``fully or partially'' 
government guaranteed; subject to a government's advanced commitment to 
purchase; or fully secured by shares or deposits in a federally-insured 
financial institution. Sec. 723.9(a)(3). See also Sec. 723.1(b)(4), 64 
FR 28721, 28722 (May 27, 1999). Consistent with part 723, NCUA declines 
to exclude MBLs guaranteed by a non-governmental organization from the 
``Member business loans outstanding'' risk portfolio.
    Purporting to seek further consistency with part 723, five 
commenters insisted upon excluding those MBLs having an aggregate 
remaining balance equal to or less than $50,000. Sec. 723.1(b)(3). 
However, the NCUA Board has determined that part 723's $50,000 
threshold is measured against the original balance of the loan at the 
time it is originated, not its subsequent remaining balance. If a loan 
qualifies as an MBL when it is originated, it remains so until it has 
been repaid in full, sold, or otherwise disposed of.
    Four commenters urged excluding loans secured by real estate from 
this risk portfolio, contending that long-term

[[Page 44957]]

fixed-rate MBLs belong in the ``Long-term real estate loans'' risk 
portfolio because not all MBLs are long-term and fixed-rate. This would 
potentially lead to a higher than necessary risk weighting for shorter-
term MBLs. Similarly, four commenters suggested excluding loans secured 
by automobiles, as well as loans with maturities less than 3 years, 
asserting that they belong in the ``Average risk assets'' risk 
portfolio because such loans present minimal interest rate risk. Part 
723 defines an MBL as any loan, line of credit, or letter of credit 
where the proceeds are used for commercial, corporate or agricultural 
purposes, or for other business investment property or venture. 
Sec. 723.1(a). A loan that is fully secured by a lien on a 1 to 4 
family dwelling that is the member's primary residence is not an MBL. 
Sec. 723.1(b)(1). Such a loan would be included in either the ``Long-
term real estate loans'' risk portfolio or the ``Average risk assets'' 
risk portfolio depending on its remaining maturity. Part 723 also 
excludes other loans from its definition of an MBL, Sec. 723.1(b)(2)-
(5), which would be included in the ``Average risk assets'' portfolio.
    Finally, a single commenter sought to eliminate the ``MBLs 
outstanding'' risk portfolio altogether on ground that CUMAA did not 
explicitly mandate additional net worth for MBLs. In fact, CUMAA did 
not identify any particular assets warranting additional net worth; 
rather, the statute instructed NCUA to generally identify credit unions 
which meet a definition of ``complex'' based on their portfolios of 
assets and liabilities and to design an RBNW requirement that takes 
account of material risks not addressed by a 6 percent net worth ratio.
    The final rule retains the ``Member business loans outstanding'' 
risk portfolio without modification. Sec. 702.104(b).
    (c) Investments. The proposed risk portfolio for ``Long-term 
investments'' (here renamed simply ``Investments'') consisted of 
investments with a WAL greater than 3 years or which reprice more 
frequently than 3 years, and investments in a collective investment 
fund or a registered investment company. 65 FR 8608. NCUA research and 
experience indicated that such investments have greater economic value 
exposure to interest rate changes than do investments with shorter 
terms. 65 FR at 8600. Investments which fell below the threshold for 
this portfolio qualify for either of the proposed ``Low risk assets'' 
or ``Average risk assets'' risk portfolios.
    The 46 commenters who addressed this risk portfolio fall into two 
categories--those challenging the 3-year WAL and repricing threshold, 
and those who contend that certain investments belong in other risk 
portfolios. Forty-two insisted upon raising the threshold to between a 
low of 4 years and a high of 10 years, although few provided any 
rationale for the adjustment. In contrast, one commenter cited 
valuation modeling confirming that the 3-year threshold is reasonable. 
NCUA maintains that the 3-year WAL threshold is valid according to 
valuation modeling of fixed-rate investments. 65 FR 8600.
    In regard to composition of the portfolio, one commenter suggested 
reducing the dollar balances of investments above the 3-year threshold 
by the amount of projected amortizations within 3 years. Another would 
offset that balance by the amount of investments having a WAL of less 
than one year. Two commenters proposed to exclude investments 
classified as ``available-for-sale'' under Statement of Financial 
Accounting Standards No. 115 (``SFAS 115'') on the theory that marking-
to-market takes into account their current market values. NCUA 
disagrees, however, because these investments have potential interest 
rate risk and the current mark-to-market is not reflected in net worth, 
which is generally limited to retained earnings. Sec. 702.2(f); See 
also 65 FR at 8565. To put different assets in parity with each other, 
thirteen commenters insisted on putting investments with a WAL of less 
than one year in the ``Low risk assets'' portfolio.
    NCUA concurs with commenters that the RBNW requirement should treat 
similar investments similarly in terms of risk, and has determined that 
the most comprehensive and efficient means to that end is to define 
investments at the outset by WAL only, as specified in Sec. 702.105, 
and to subsequently apply the same risk weighting to all investments in 
the same WAL category. To implement this fundamental modification to 
the proposed rule, the final rule eliminates altogether the WAL and 
repricing threshold to distinguish long-term from short-term 
investments. Instead, the risk portfolio for investments is now 
expanded to consist of all investments permitted by law for federally-
insured credit unions, including investments in CUSOs. Sec. 702.104(c). 
To reflect this modification, this risk portfolio is renamed simply 
``Investments.''
    (d) Low-risk assets. The proposed risk portfolio for ``Low risk 
assets'' consisted of cash and cash equivalents as defined by Generally 
Accepted Accounting Principles (''GAAP''). 65 FR at 8608. GAAP 
generally interprets cash equivalents as investments with remaining 
maturities of 3 months or less. 65 FR at 8600 n.6.
    Thirty commenters insisted that cash be treated as a ``no risk 
asset'' so that it receives a risk weighting of zero, instead of the 3 
percent weighting that the proposed rule applied to this portfolio. 
Similarly, fourteen commenters inquired why a credit union's NCUSIF 
deposit was not also treated as a ``no risk asset.'' Three commenters 
asserted that mutual funds with portfolios maturing within 90 days 
constitute cash equivalents and should be classified as ``Low risk 
assets.''
    NCUA agrees that cash held by a credit union for normal 
operations--such as vault cash, ATM cash and teller cash--typically 
presents no risk because it is protected from loss by a credit union's 
fidelity bond. However, cash equivalents such as demand deposits and 
short-term investments at other financial institutions carry some 
degree of credit risk when they exceed applicable insuring limits. In 
contrast, the NCUSIF deposit clearly poses no credit risk to the NCUSIF 
or to the credit union. Further, although the NCUSIF deposit represents 
1 percent of insured shares and deposits on a credit union's balance 
sheet, it typically is augmented by a maximum of 30 basis points in 
NCUSIF retained earnings. This 30 basis point cushion is available to 
absorb losses before the NCUSIF deposit would be impaired.
    To distinguish no risk assets from low risk assets, the final rule 
deletes cash on deposit in financial institutions and cash equivalents 
(e.g., investments with a maturity of 90 days or less) from the ``Low 
risk assets'' portfolio, effectively shifting them to the 
``Investments'' risk portfolio, where they will subsequently be 
categorized in the one year or less WAL bucket and weighted at 3 
percent. See Secs. 702.106(c)(1), 702.107(c)(1). Cash on hand and the 
NCUSIF deposit remain in the ``Low risk assets'' risk portfolio, 
Sec. 702.104(d); however, because those assets carry no appreciable 
risk, the final rule reduces to zero the risk weighting subsequently 
given to that portfolio in the corresponding standard component. 
Sec. 702.106(d).
    (e) Average-risk assets. The proposed risk portfolio for ``Average 
risk assets'' consists of assets which do not fall within the scope of 
any other risk portfolio because such assets are neither below nor 
above average in risk. 65 FR at 8608. This portfolio typically includes 
consumer loans, short-term

[[Page 44958]]

real estate loans and fixed assets, 65 FR at 8600, and is subsequently 
weighted at 6 percent to reflect the 6 percent net worth ratio required 
to be classified ``adequately capitalized.''
    Two commenters argued that fixed assets should be put in the ``Low 
risk assets'' risk portfolio because land and buildings typically 
increase in value. However, NCUA research shows that credit unions with 
high levels of fixed assets on average have lower net income.
    Addressing investments which had been subject to the proposed 
rule's 3-year WAL and repricing threshold--since abandoned--sixteen 
commenters argued that investments having a WAL of less than 1 year 
appropriately belong in the ``Low risk assets'' portfolio, where they 
would be weighted at 3 percent instead of 6 percent. Twenty-three 
commenters believed that mutual funds with a WAL of less than one 
year--which had been included in the proposed ``Long-term investments'' 
portfolio regardless of WAL or repricing date--also belong in this 
portfolio. The final rule addresses these suggestions elsewhere by 
classifying all investments by WAL, as specified in Sec. 702.105, and 
applying a corresponding risk weighting, Secs. 702.106(c), 702.107(c). 
Because the ``Average risk assets'' risk portfolio contains only those 
assets that do not belong in the risk portfolios discussed in sections 
5.(a) through (d) above, the final rule retains the ``Average risk 
assets'' risk portfolio without modification. Sec. 702.104(e).
    (f) Loans sold with recourse. The proposed risk portfolio for 
``Loans sold with recourse'' consisted of a credit union's outstanding 
balance of loans sold or swapped with recourse. 65 FR at 8608. As 
contingent liabilities, they are an off-balance sheet item and, 
therefore, do not fall in any of the other risk portfolios.
    To avoid what was perceived as double-counting, seven commenters 
favored deducting recourse loans from this portfolio to the extent that 
they already have been reserved for through the provision for loan and 
lease losses expense in accordance with GAAP. NCUA disagrees because 
the ``Allowance'' standard component gives an offsetting credit for the 
Allowance for Loan and Lease Losses, Sec. 702.106(h); thus, there is no 
redundant reserving. Loans sold with recourse are treated no 
differently than on-balance sheet loans that also require GAAP 
reserving but still receive a minimum 6 percent risk weighting. See 
702.106(a)(1).
    Two commenters asserted that this risk portfolio should include 
only the portion of a loan that is subject to recourse against the 
credit union. The final rule does not recognize partial recourse 
because the Call Report does not collect data in sufficient detail to 
distinguish partial from full recourse. See ``Risk Based Capital 
Standards; Recourse and Direct Credit Substitutes,'' 65 FR 12320, 12344 
(March 8, 2000) (proposal to require banks to maintain capital against 
full amount of assets supported by a partial recourse obligation).
    One commenter requested corroboration on the risk exposure 
associated with recourse loans. NCUA maintains that examination 
experience with credit unions' limited activity in this area thus far 
suggests that the credit risk exposure associated with recourse loans 
is analogous to that associated with similar loans retained on the 
balance sheet. See 65 FR at 8601. In this regard six commenters urged 
NCUA to collect more detailed data to measure incremental levels and 
conditions of associated risk exposure. NCUA concurs that this 
information would be useful in developing risk gradations, identifying 
potential exclusions, and differentiating loans with only partial 
recourse. At present, however, only 55 credit unions report any 
recourse loan activity. Until this activity expands significantly, NCUA 
prefers to keep the burden and level of detail in recourse loan 
reporting to a minimum.
    The proposed rule's silence about loans sold in the secondary 
mortgage market prompted a commenter to request NCUA to clarify whether 
such loans are considered loans sold with recourse. In response, the 
final rule expressly excludes loans sold to the secondary mortgage 
market that feature representations and warranties customarily required 
by the U.S. Government (e.g., Ginnie Mae) and government-sponsored 
enterprises (e.g., Fannie Mae, Freddie Mac). Sec. 702.104(f). These 
include warranties that the credit union has underwritten the loan and 
appraised the collateral in conformity with identified standards. These 
warranties provide for the return of assets in instances of incomplete 
documentation or fraud. However, credit enhancing representations and 
warranties beyond the usual agency requirements are considered recourse 
and, therefore, are not excluded from this risk portfolio. The ``Loans 
sold with recourse'' risk portfolio is otherwise retained as proposed.
    (g) Unused member business loan commitments. The proposed risk 
portfolio for ``Unused member business loan commitments'' segregates 
unused MBL commitments from actual loans because commitments represent 
off-balance sheet, contingent liabilities. 65 FR at 8608. Large draws 
on unused MBL commitments may cause liquidity problems and heighten 
exposure to credit risk. 65 FR at 8601.
    Attempting to demonstrate a lower level of credit risk, two 
commenters wished to discount an unused commitment when it is 
revocable, e.g., on grounds of a ``material adverse condition.'' 
However, examiner experience indicates that MBL commitments typically 
do not feature a ``material adverse conditions'' clause as grounds for 
revocation.
    From a different approach, three commenters proposed discounting 
unused commitments by half due to the unlikelihood that all of a credit 
union's unused commitments would be drawn upon simultaneously. As 
explained above, part 723 does not discount or reduce a loan's original 
balance when aggregating MBLs or unused commitments to apply the 
$50,000 exclusion under section 723.1(b)(3). To remain consistent with 
part 723, the final rule retains this risk portfolio as proposed. 
Sec. 702.104(g). Commenters' observations already are reflected in the 
lower risk weighting (6 percent) the standard calculation applies to 
the entire contents of the ``Unused member business loan commitment'' 
portfolio, Sec. 702.106(g), compared to the 12 percent risk weighting 
it applies to the proportion of the ``Member business loans'' risk 
portfolio in excess of 12.25 percent of total assets. 
Sec. 702.106(b)(2).
    (h) Allowance. As proposed, the ``Allowance `` risk portfolio 
provides a credit of 100 percent of a credit union's Allowance for Loan 
and Lease Losses (``ALL'') not to exceed the equivalent of 1.5 percent 
of total loans. 65 FR at 8609. This credit is given to recognize that a 
credit union's ALL already mitigates risk.
    The commenters were at odds in addressing the composition of the 
``Allowance'' portfolio. One commenter suggested expanding the 
``Allowance'' portfolio to include the ``Allowance for investment 
losses,'' apparently unaware that SFAS 115 eliminated the need for that 
account. In bold contrast, another favored doing away with the 
portfolio altogether, objecting that it unnecessarily complicates the 
rule.
    A single commenter suggested that the ``Allowance'' portfolio 
consist of the equivalent of a fixed 1.5 percent of loans regardless 
whether a credit union's actual ALL is less than 1.5 percent of total 
assets. In that event, a credit union would receive a credit to reduce 
its RBNW requirement for reserves that it does not actually have.

[[Page 44959]]

    The other commenters challenged the portfolio's maximum of 1.5 
percent of total loans. Several predicted that it will be a 
disincentive to fund the ALL above the equivalent of that ceiling. This 
claim is not persuasive, however, because credit unions are bound by 
GAAP and Sec. 702.401(d) to compute the ALL accurately and in good 
faith, without regard to maximizing the credit derived from the 
``Allowance'' risk portfolio. In any event, NCUA research indicates 
that two-thirds of all credit unions' ALL does not reach 1.5 percent of 
total loans.
    The ``Allowance'' risk portfolio recognizes the credit risk 
mitigation resulting from reserving for losses in the ALL. Yet reserves 
in excess of 1.5 percent of total loans reflect higher than typical 
levels of credit exposure. 65 FR at 8601. To capture this higher risk, 
the ceiling on the ``Allowance'' risk portfolio remains intact in the 
final rule. Sec. 702.104(h).

6. Section 702.105--Weighted-Average Life of Investments

    Both the standard component and the alternative component for 
``Investments'' categorize the contents of the corresponding risk 
portfolio according to weighted-average life for purposes of risk 
weighting. Secs. 702.106(c), 702.107(c). For this purpose, section 
702.2(k), discussed above, provides a general definition of WAL. 
Section 702.105 prescribes rules for determining the WAL of certain 
investments (see Table 2 in Sec. 702.105).
    (a) Registered investment companies and collective investment 
funds. The proposed rule made an exception to the general WAL 
definition only for investments in registered investment companies or 
collective investment funds (other than money market mutual funds), 
assigning them a WAL of greater than 5 years, but less than or equal to 
7 years. 65 FR at 8608.
    Commenters who addressed the single proposed exception for 
registered investment companies and collective investment funds 
insisted that the target or maximum WAL disclosed in a prospectus or 
trust instrument is the most accurate measure of interest rate risk. 
NCUA concurs in this suggestion, but prefers to use maximum disclosed 
WAL because a mutual fund's actual WAL may exceed its stated target.
    The maximum WAL may be disclosed directly, or indirectly by 
reference to a maximum duration no greater than that of a bullet 
security (i.e., a security with all principal due at maturity). A 
bullet security is analogous because, by definition, its WAL is equal 
to the time period until its maturity, since all of its principal cash 
flow occurs on its maturity date. For example, a mutual fund that 
limits its duration to that of a two-year Treasury note would be 
defined as having a WAL of two years, since a Treasury note with a 
period remaining to maturity of two years has a WAL of two years.
    Five commenters insisted that short-term investment funds 
(``STIFs'') and money market funds be treated equally for purposes of 
defining WAL because of their similarly low interest rate risk. Indeed, 
collective investment funds that adhere to STIF rules for national 
banks must have an average portfolio maturity of 90 days or less. 12 
CFR 9.18(b)(4)(ii)(B)(1)-(3). NCUA concurs in this recommendation.
    For registered investment companies and collective investment 
funds, the final rule is revised to incorporate maximum WAL as 
disclosed in a prospectus or trust instrument. Sec. 702.105(a)(1). If 
not directly or indirectly disclosed there, however, the final rule 
retains the proposed WAL of greater than 5 years but less than or equal 
to 7 years. Sec. 702.105(a)(3). Treating STIFs and money market funds 
equally, the final rule classifies them as having a WAL of 1 year or 
less. Sec. 702.105(a)(2). To conform to these WAL classifications, the 
Call Report instructions will be revised to clearly classify mutual 
funds and collective investment funds by WAL.
    (b) Callable fixed-rate debt obligations and deposits. As 
determined under the general WAL definition, the WAL of a callable 
fixed-rate debt obligation or deposit would be its actual maturity 
date. Five commenters addressed this result--two contending that the 
rule should take into consideration an option to redeem an investment 
prior to maturity; another urging use of ``effective WAL'' since the 
WAL of callable investments may change; and yet another preferring, 
without explanation, to rely on the WAL for callable ``Agency'' 
investments. One commenter criticized the use of WAL for callable 
investments as not appropriately recognizing the extent of risk.
    Typical credit union investments in callable securities (such as 
``Agency'' callable securities) are callable at the option of the 
issuer, not of the credit union. Investments in which credit unions 
hold an option to redeem prior to maturity typically would be 
characterized as ``putable'' investments,\12\ rather than callable 
investments. Examination experience indicates credit unions rarely hold 
``putable'' investment securities. In such rare instances, however, the 
general WAL definition would permit the WAL of ``putable'' securities 
to be computed on the basis of reasonable and supportable estimates of 
the times for principal cash flow.
---------------------------------------------------------------------------

    \12\ An investment is ``putable'' if the owner of the investment 
(i.e., the holder) has the right, but not the obligation, to sell to 
the issuer at a given price (i.e., the strike price) on or during a 
specified time period (i.e., the exercise period). The issuer of a 
``putable'' investment has the obligation to purchase the investment 
from the holder in the event the holder elects during the exercise 
period to sell to the issuer at the strike price. See Fabozzi at 11.
---------------------------------------------------------------------------

    To clarify reporting of debt obligations and deposit investments 
that are callable in whole at the option of the issuer, the final rule 
explicitly adopts the current Call Report practice of reporting such 
callable instruments with a WAL equal to the period remaining until the 
final maturity date, Sec. 702.105(b), instead of the period remaining 
until a call date. The final rule does not rely on WAL for the entire 
portfolio of callable instruments because such a dollar-weighted 
average measure would reduce the accuracy of the risk measure.
    (c) Variable-rate debt obligations and deposits. Under the proposed 
rule, a variable-rate debt obligation or deposit would be categorized 
by its next rate adjustment period, rather than by its WAL. 65 FR at 
8608. NCUA received no comments on this outcome. To clarify reporting 
of variable-rate investments, the final rule explicitly adopts the 
current Call Report practice of reporting variable-rate debt 
obligations and deposits in the WAL category corresponding to the 
period remaining to the next rate adjustment. Sec. 702.105(c).
    (d) Capital in mixed-ownership Government corporations and 
corporate credit unions. The proposed WAL definition did not explicitly 
address the determination of WAL of stock in mixed-ownership Government 
corporations (e.g., Federal Home Loan banks and NCUA's Central 
Liquidity Facility) or capital in corporate credit unions. However, a 
commenter's inquiry about the WAL of Federal Home Loan bank stock that 
may be redeemed after a notice period led the NCUA Board to examine the 
WAL of stock in mixed-ownership Government corporations, and member 
paid-in capital and membership capital in corporate credit unions. 
While such investments may have credit risk exposure, membership in 
such entities can provide credit unions with access to substantial 
sources of liquidity or funding. To better protect the NCUSIF from the 
risk of losses arising from liquidity events, NCUA encourages

[[Page 44960]]

credit unions to join such entities that provide contingent liquidity.
    To ensure that the WAL of investments in liquidity-enhancing 
entities does not excessively increase an RBNW requirement, thereby 
deterring such investments, the final rule explicitly specifies capital 
stock in mixed-ownership Government corporations, and member paid-in 
capital and membership capital in corporate credit unions, as having a 
WAL of greater than 1 year, but less than or equal to 3 years. 
Sec. 702.105(d).
    (e) Investments in CUSOs. The proposed rule did not explicitly 
address investments in CUSOs. By properly structuring a CUSO, a credit 
union may limit its losses resulting from such operations to the amount 
of its investment in, and loans to, the CUSO. NCUA believes that the 
NCUSIF will be better protected from the risk of losses arising from 
service operations, and credit union members will be better served, if 
credit unions are not discouraged from forming and participating in 
CUSOs. In the absence of a CUSO, balance sheet assets used to support 
CUSO service operations would be treated as average risk assets and 
would be risk weighted as such. To ensure that CUSO investments are 
treated similarly, the final rule defines investments in CUSOs as 
having a WAL of greater than 1 year, but less than or equal to 3 years, 
Sec. 702.105(e), and subsequently weights them the same as average risk 
assets.
    (f) Other equity securities. The final rule adds this provision to 
address equity securities (in which some federally-insured, State-
chartered credit unions (``FISCUs'') may be permitted to invest) for 
which a WAL is not explicitly defined elsewhere in Sec. 702.105, or 
cannot be determined because they do not have maturity dates (although 
certain preferred instruments may have conversion dates). Because there 
is no scheduled time for the return of principal, such securities have 
an infinite WAL. Accordingly, the final rule defines WAL for ``other 
equity securities'' as greater than 10 ten years, Sec. 702.105(f), 
corresponding to the final rule's maximum WAL category for investments. 
Sec. 702.106(c)(4).

7. Section 702.106--Standard Calculation of Risk-Based Net Worth 
Requirement

    To implement the second step of the three-step process, called the 
``standard calculation,'' section 702.106 multiplies either the whole 
or different percentage tiers of each risk portfolio in section 702.104 
by a corresponding risk weighting to yield a standard component. The 
sum of the eight standard components equals the RBNW requirement. See 
Table 3 in Sec. 702.106, and Appendix A. If a credit union's RBNW 
requirement under the standard calculation exceeds 6 percent, the 
credit union ``is defined as `complex' and [an RBNW] requirement is 
applicable.'' Sec. 702.103(a)(2). The RBNW requirement is met when it 
is exceeded by a credit union's net worth ratio (generally, retained 
earnings as a percentage of total assets). The final rule retains the 
proposed components (formerly called ``RBNW components''), modified as 
follows in section 702.106:
    (a) Long-term real estate loans. The proposed standard component 
for ``Long-term real estate loans'' divided the contents of the 
corresponding risk portfolio into three percentage tiers of total 
assets--zero to 25 percent, weighted at 6 percent to represent average 
risk; 25 to 40 percent, weighted at 14 percent to protect against the 
higher marginal risk; and in excess of 40 percent, weighted at 16 
percent to reflect corresponding increases in credit concentration risk 
and in the ratio of new loans to seasoned loans. 65 FR at 8609.
    Twenty-five commenters sought to restructure the tiers and to 
reduce the corresponding weightings for each, but generally provided no 
justification for the adjustments. Five were content to apply the 14 
percent weighting to the 25 to 40 percent tier, but objected that the 
16 percent weighting applied to the tier in excess of 40 percent of 
total assets was excessive. Their rationale is that a credit union with 
a 40 percent concentration in long-term real estate loans does not 
necessarily have a greater percentage of new 30-year mortgages than a 
credit union with a 25 percent concentration. To acknowledge that 
credit union liabilities typically do not all reset overnight, NCUA 
agrees to reduce to 14 percent the proposed 16 percent weighting.
    One commenter challenged as too conservative NCUA's reliance on a 
300 basis point interest rate ``shock test'' to corroborate the 
assigned risk weightings. The 300 basis point shock test is a widely 
accepted measure of interest rate risk adopted for financial 
institution investment pre-purchase analysis by the Federal Financial 
Institutions Examination Council. FFIEC, ``Supervisory Policy Statement 
on Investment Securities and End-User Derivatives Activities,'' 63 FR 
20191, 20195 (April 23, 1998). For balance sheet-wide application, see 
Office of Thrift Supervision, ``Thrift Bulletin 13a: Management of 
Interest Rate Risk, Investment Securities, and Derivative Activities,'' 
63 FR 66351, 66361 (December 1, 1998). Therefore, the 300 basis point 
``shock test'' is a legitimate basis for determining appropriate risk 
weightings.
    In response to criticism of the 16 percent weighting, the final 
rule modifies the standard component for ``Long-term real estate 
loans'' by reducing it from three to two percentage tiers--up to and 
including 25 percent of total assets, weighted at 6 percent; and in 
excess of 25 percent of total assets, weighted at 14 percent. 
Sec. 702.106(a).
    (b) Member business loans outstanding. The proposed standard 
component for ``Member business loans outstanding'' divided the 
contents of the corresponding risk portfolio by a single threshold of 
12.25 percent of total assets. The tier below was weighted at 6 
percent, and the tier in excess was weighted at 14 percent. 65 FR at 
8609.
    Asserting various justifications, fourteen commenters advocated 
reducing the proposed weightings to as low as 4 percent and reserving 
the 14 percent weighting only for MBLs in excess of 20 percent of total 
assets. Some compared losses for consumer loans against the losses for 
MBLs over an 8-year period and noted that actual losses for MBLs for 
that period were only 57 basis points, or 75 percent of the amount for 
consumer loans. Others pointed to the risk mitigating characteristics 
of MBLs with low loan-to-value (``LTV'') ratios (e.g., 60 percent) 
which typically reprice within 3 to 5 years; and to short-term, 
seasonal loans secured by land, which are subject to greater regulation 
and higher reserving.
    The commenters focused on credit risk exposure only, overlooking 
the interest rate risk and other relevant risks associated with MBLs. 
As the amount of MBLs outstanding increases, interest rate risk also 
typically increases, as does credit concentration risk. Accordingly, 
the final rule retains the proposed standard component without 
modification. Sec. 702.106(b).
    (c) Investments. The proposed standard component for ``Long-term 
investments'' (since renamed simply ``Investments'') divided the 
contents of the corresponding risk portfolio by a single threshold of 
15 percent of total assets. The tier below was weighted at 6 percent, 
and the tier in excess was weighted at 14 percent. 65 FR at 8609.
    Although content with the 6 percent weighting, thirty-four 
commenters, generally without explanation, advocated increasing the 
threshold to a higher percentage of total assets. Two commenters 
suggested introducing an intermediate tier of 15 to 25 percent of total 
assets, weighted at 8 percent, with

[[Page 44961]]

the excess over 25 percent weighted at no more than 10 percent.
    Other commenters questioned NCUA's reliance on the 300 basis point 
interest rate ``shock test'' to develop risk weightings for 
investments. One commenter preferred using a gradual 1 or 2 percent 
rate ``ramp,'' while another supported using a 200 basis point ``shock 
test.'' Because the Call Report data does not provide mark-to-market 
valuation of all investments, the 300 basis point rate shock is 
appropriate to capture both current and potential mark-to-market loss. 
As explained above, it is widely accepted as a basis for financial 
institution investment pre-purchase analysis.
    Finally, a commenter observed that the proposed 6 percent and 14 
percent weightings for credit union investments exceed the weightings 
applied to investments under the credit-risk-weighted capital 
requirements applicable to banks under their system of PCA. See, e.g., 
12 CFR 325.103. Indeed, the risk weightings proposed for credit unions 
are higher because the banks' credit-risk-weighted capital standards 
consider only credit risk, whereas CUMAA mandates that the RBNW 
requirement for credit unions take account of material risks, such as 
market risk, interest rate risk and other relevant risks. See 
Sec. 1790d(d)(2); S. Rep. at 13.
    Consistent with the NCUA Board's determination to treat similar 
investments similarly in terms of risk, the final rule abandons the 
proposed 15 percent threshold in favor of uniform classification by 
WAL--a more refined measure of risk. To implement this fundamental 
modification, the final rule establishes the following four WAL 
buckets: 1 year or less; greater than 1 year, but less than or equal to 
3 years; greater than 3 years, but less than or equal to 10 years; and 
greater than 10 years. The four WAL buckets are risk-weighted at 3, 6, 
12 and 20 percent, respectively. Sec. 702.106(c). In the Call Report 
investment schedule, credit unions will now report their investments 
solely by WAL as specified in section 702.105.
    In ascending order, the 3 percent weighting applied to the first 
WAL bucket, Sec. 702.106(c)(1), is the same weighting originally 
proposed for the ``Low risk assets'' risk portfolio, as explained in 
section C.5(d) above. The 6 percent weighting applied to the second 
bucket, Sec. 702.106(c)(2), is the same as that applied to the 
``Average risk assets'' risk portfolio, Sec. 702.106(e), and reflects 
the inclusion of average risk investments in the ``Investments'' risk 
portfolio. The 12 percent weighting applied to the third bucket, 
Sec. 702.106(c)(3), mirrors the weighting that the ``Investments'' 
alternative component applies to the WAL bucket for greater than 5 
years, but less than 7 years, Sec. 702.107(c)(4), and reflects an 
average level of risk across the three more refined buckets of that 
component having a WAL greater than 3 years, but less than 10 years. 
Finally, the 20 percent weighting for the fourth bucket, 
Sec. 702.106(c)(4), is based on the weighting that the ``Investments'' 
alternative component applies to investments with a WAL greater than 10 
years. Sec. 702.107(c)(6).
    (d) Low-risk assets. The proposed standard component for ``Low risk 
assets'' applied a risk weighting of 3 percent to the entire contents 
of the corresponding risk portfolio. 65 FR at 8609. As explained in 
section C.5(d) above, the ``Low risk assets'' risk portfolio has been 
modified to consist only of cash on hand and the NCUSIF deposit. 
Sec. 702.104(d). Because these assets carry virtually no risk, the 
final rule reduces to zero the risk weighting applied to the standard 
component for ``Low risk assets.'' Sec. 702.106(d).
    (e) Average-risk assets. The proposed standard component for 
``Average risk assets'' applied a risk weighting of 6 percent to the 
entire contents of the corresponding risk portfolio. 65 FR at 8609. 
This weighting corresponds to the 6 percent net worth ratio required by 
CUMAA to be classified ``adequately capitalized.'' Sec. 702.102(a)(2). 
No commenters addressed the risk weighting applied to this component; 
therefore, it is retained as proposed. Sec. 702.106(e).
    (f) Loans sold with recourse. The proposed standard component for 
``Loans sold with recourse'' applies a risk weighting of 6 percent to 
the entire contents of the corresponding risk portfolio, 65 FR at 8609, 
to account for retained credit risk and the operational risk of 
servicing such loans. The 6 percent weighting also parallels the 
minimum weighting required for on-balance sheet loans that have similar 
credit risk exposure. See, e.g., Sec. 702.106(a)(1) and (e). Two 
commenters advocated replacing the fixed 6 percent weighting for this 
component with a sliding scale of weights based on the loss experience 
of like assets as measured by, for example, the five-year loan loss 
ratio. At present, the limited number of credit unions that sell or 
swap loans with recourse does not justify the increased burden of 
reporting the data needed to analyze loss experience for this purpose. 
Accordingly, the final rule retains the fixed 6 percent risk weighting 
proposed for this component. Sec. 702.106(f).
    (g) Unused member business loan commitments. The proposed standard 
component for ``Unused member business loans'' applied a risk weighting 
of 6 percent to the entire contents of the corresponding risk 
portfolio. 65 FR 8609. Eleven commenters invited NCUA to reduce the 
weighting for this component to between 3 and 4.5 percent, but 
generally gave no rationale. Others proposed inserting a threshold to 
divide the contents of the portfolio according to a minimum percentage 
of either assets, equity, or an historical rate at which MBL 
commitments convert to actual loans. The commenters would give the tier 
below that threshold a zero percent weighting. No empirical evidence 
was provided to support weighting different portions of the portfolio 
differently, much less to support weighting any portion of it at zero. 
Accordingly, the final rule retains the risk weighting for this 
standard component without modification. Sec. 702.106(g).
    (h) Allowance. The proposed standard component for the 
``Allowance'' risk portfolio applies a risk weighting of negative 100 
percent to the entire contents of the corresponding risk portfolio 
(which itself is limited to the equivalent of 1.5 percent of total 
loans). Sec. 702.106(h). This effectively offsets the RBNW requirement 
otherwise resulting from the standard calculation, to reflect 
mitigation of risk through reserving for loan losses in the ALL. No 
commenters addressed the negative 100 percent risk weighting applied to 
this component to produce a credit against the RBNW requirement; 
therefore, it is retained as proposed. Sec. 702.106(h).

8. Section 702.107--Alternative Components for Standard Calculation.

    The third step of the three-step process gives a credit union the 
option to reduce the amount of its RBNW requirement under the standard 
calculation. To implement that step, section 702.107 (formerly section 
702.106) multiplies the different remaining maturity or WAL buckets in 
each of three risk portfolios representing above average risk by a 
corresponding risk weighting to yield an ``alternative component.'' See 
Table 4 in Sec. 702.107, and Appendix F. Compared to the standard 
components, the alternative components classify real estate loans, 
member business loans and investments in finer remaining maturity and 
WAL increments based on additional data provided by the credit union. 
Each alternative component that produces a smaller percentage than its

[[Page 44962]]

corresponding standard component may then be substituted for its 
counterpart in section 702.106 to reduce the RBNW requirement 
originally determined under the standard calculation.
    The sole commenter addressing the structure of section 702.107 
insisted upon allowing all or none of the alternative components to be 
substituted for their counterpart standard components. NCUA disagrees, 
preferring to give credit unions maximum flexibility in meeting an RBNW 
requirement. Therefore, the final rule retains the proposed alternative 
components, modified as follows in section 702.107:
    (a) Long-term real estate loans. The proposed alternative component 
for ``Long-term real estate loans `` divided the contents of the 
corresponding risk portfolio by remaining 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. The four remaining maturity 
buckets were weighted at 6, 8, 12 and 16 percent, respectively. 65 FR 
at 8610-8611. The sum of the weighted buckets equals the ``alternative 
component.''
    Seeking wholesale modification, one commenter condemned this 
alternative component as completely unnecessary, while another praised 
it as important in aiding credit unions to comply with PCA. Two 
commenters urged NCUA to require reporting of real estate loan balances 
by WAL instead of remaining maturity. Due to the inherent difficulty of 
relying on objective data in the Call Report to validate prepayment 
assumptions that affect the WAL of long-term real estate loans, NCUA 
considers remaining maturity to be the most reliable and least 
burdensome means of reporting real estate loans.
    Ten other commenters generally sought to modify the maturity 
buckets and corresponding risk weightings. Two protested that the 
weightings were too harsh and should be adjusted downward to account 
for low LTV ratios. In contrast, a single commenter felt the weightings 
were too low. Two others indicated that the maturity ranges of the 
buckets were too broad, while another insisted there were too many 
buckets. Upon reconsideration, NCUA considers the maturity ranges of 
the buckets and all but one of the risk weightings to be reasonable 
based on examiner judgment of credit risk and interest rate risk in 
typical fixed-rate real estate loans.
    The final rule modifies this alternative component in two respects. 
First, to parallel the 5-year maturity threshold adopted in the 
corresponding risk portfolio, Sec. 702.104(a), the 3-to-5 year 
remaining maturity bucket is deleted altogether from the ``Long-term 
real estate loans'' alternative component. Second, to parallel the 14 
percent weighting adopted for loans above the 25 percent threshold in 
the corresponding standard component, Sec. 702.106(a)(2), the weighting 
applied in the alternative component to the remaining maturity bucket 
for loans in excess of 20 years is reduced from 16 to 14 percent. 
Sec. 702.107(a)(3); see Appendix C. The final rule otherwise retains 
the proposed alternative component without modification.
    (b) Member business loans outstanding. The proposed alternative 
component for ``Member business loans outstanding'' categorized the 
contents of the corresponding risk portfolio first by fixed-versus 
variable-rate MBLs, and then by remaining maturity in five buckets for 
each category--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.\13\ 65 FR at 8610-8611. The five maturity buckets for fixed-rate 
MBLs were weighted at 6, 9, 12, 14 and 16 percent, respectively. The 
five maturity buckets for variable-rate MBLs were weighted at 6, 8, 10, 
12 and 14 percent, respectively. The sum of the weighted buckets equals 
the ``alternative component.''
---------------------------------------------------------------------------

    \13\ For federally-chartered credit unions, maturity of MBLs is 
limited to 12 years, except ``lines of credit are not subject to a 
statutory or regulatory maturity limit.'' 12 C.F.R. 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. 702.107(b)(1)(v) and (b)(2)(v).
---------------------------------------------------------------------------

    Two commenters addressed this alternative component, suggesting 
structural modifications. The first argued that fixed-rate MBLs should 
be classified by WAL to take account of the interest rate premium, but 
that variable-rate MBLs should be weighted at a static 6 percent, 
regardless of WAL or remaining maturity, since it is unrealistic to 
require reserves equivalent to the decline in market value. The second 
commenter proposed weighting MBLs on a sliding scale to take account of 
the LTV ratios, e.g., 6 percent for an LTV ratio of less than 60 
percent, and a 7 percent weighting for an LTV ratio between 60 and 70 
percent.
    NCUA declines to depart from the proposed rule for the following 
reasons. First, as explained in the preceding section, due to the 
inherent difficulty of relying on objective Call Report data to 
validate prepayment assumptions, NCUA considers remaining maturity to 
be the most reliable and least burdensome means of reporting MBLs. 
Second, while the value of a variable-rate MBL may decline less in 
value than a similar fixed-rate MBL as a result of a given interest 
rate change, credit risk of a variable-rate MBL typically increases in 
a higher rate environment, as the borrower is forced to meet increased 
interest expense burden. Third, the proposed rule already recognized 
the inherent variation in risk between fixed-rate and variable-rate 
MBLs; in the 3-to-5 year remaining maturity bucket, the weighting 
applied to fixed-rate MBLs is 100 basis points higher than that applied 
to variable-rate MBLs; in the three buckets for remaining maturities 
greater than 5 years, the weighting applied to fixed-rate MBLs is 200 
basis points higher than that applied to variable-rate MBLs. 65 FR at 
8611 (Table 4.b.).
    For these reasons, the final rule retains this alternative 
component without modification. Sec. 702.107(b) and Appendix D.
    (c) Investments. The proposed alternative component for ``Long-term 
investments'' (here renamed simply ``Investments'') classified the 
contents of the corresponding risk portfolio into four WAL buckets: 
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. The four WAL buckets are 
weighted at 8, 12, 16 and 20 percent, respectively. 65 FR 8604. The sum 
of the weighted buckets yields the alternative component.
    According to one commenter, NCUA did not select representative 
securities with sufficient interest rate risk, resulting in inadequate 
weightings. Although the representative securities reflect the shorter 
end of each WAL bucket, NCUA's research indicates that the proposed 
weighting applied to each WAL bucket approximates the economic value 
exposure. 65 FR at 8605. In addition, these securities implicitly 
acknowledge that credit union liabilities typically do not all reset 
overnight. As a result, the proposed weightings are adequate to protect 
the NCUSIF from material risk, and do not need to be increased.
    Protesting that the proposed WAL buckets do not adequately 
recognize WAL differences within buckets, another commenter compared 
the U.S. Securities and Exchange Commission's (``SEC'') use of smaller 
``haircuts'' (i.e., percentage deductions) in computing net capital 
requirements for broker-dealers. 17 C.F.R. 240.15c3-1(c)(2)(vi).

[[Page 44963]]

However, the SEC uses haircuts in what is generally a marked-to-market 
environment, and broker-dealers subject to its requirements are able to 
issue equity to increase net worth. In contrast, investments by credit 
unions generally are not marked-to-market. Even a credit union's gain 
or loss on ``available-for-sale'' securities is not reflected in net 
worth. See Sec. 702.2(f); 65 FR at 8565. Further, credit unions 
typically cannot issue equity instruments to increase net worth.
    Principally to capture cash on deposit and cash equivalents 
(formerly within the ``Low risk assets'' risk portfolio) and other 
investments (formerly in the ``Average risk assets'' risk portfolio), 
the final rule modifies the alternative component for ``Investments'' 
by adding two buckets at the bottom of the WAL scale: one for 
investments having a WAL of one year or less, and another for 
investments with a WAL of greater than one year but less than or equal 
to 3 years. These buckets are weighted at 3 percent and 6 percent, 
respectively. Sec. 702.107(c)(1) and (2), and Appendix E. This 
alternative component is otherwise unchanged from the proposed rule.

9. Section 702.108--Risk Mitigation Credit To Reduce Risk-Based Net 
Worth Requirement.

    Sixty-four commenters appealed to the NCUA Board to adopt a 
subjective or quantitative means for credit unions to demonstrate that 
the actual level of risk exposure to the NCUSIF is less than that 
indicated by the RBNW requirement resulting from the standard 
calculation, Sec. 702.106, or alternative components, Sec. 702.107.
    To recognize mitigation of interest rate risk, forty-four 
commenters suggested considering the structure of funding liabilities 
and the results of ``hedging'' strategies. Commenters generally 
advocated flexibility toward sophisticated credit unions that implement 
internal modeling of an economic value exposure measure such as net 
economic value (``NEV''). A few commenters urged NCUA to consider a 
maturity gap, a ``matched book,'' or an earnings exposure measure such 
as income simulation. For example, one commenter argued for an 
adjustment to the RBNW requirement in response to internal modeling 
that demonstrates limited interest rate risk through an NEV fluctuation 
calculation, with the calculation to be certified by NCUA. More 
subjectively, another commenter proposed an RBNW adjustment in 
consideration of a credit union's history, policies, practices, and 
risk management techniques.
    To recognize mitigation of credit risk, fourteen commenters 
recommended considering the impact of such quantitative factors as low 
LTV ratio and private mortgage insurance. Ten advocated evaluating the 
quality of loan underwriting and standards.
    Upon consideration of the comments, the NCUA Board is persuaded to 
permit credit unions to demonstrate interest rate risk mitigation 
through internal modeling of an economic value exposure measure such as 
NEV, and to demonstrate credit risk mitigation through quantitative 
indicators of below average credit risk in loan portfolios. To this 
end, the final rule introduces a ``risk mitigation credit'' (``RMC'') 
to offset a credit union's applicable RBNW requirement.
    Under section 702.108, a credit union which fails to meet its 
applicable RBNW requirement under both the standard calculation, 
Sec. 702.106, and the alternative components, Sec. 702.107, may apply 
to the NCUA Board for an RMC to reduce that requirement. The NCUA Board 
may, in its discretion, grant an RMC upon proof of mitigation of credit 
risk, or interest rate risk as demonstrated by economic value exposure 
measures. To ensure uniformity, an RMC request will be evaluated 
according to guidelines to be duly adopted by the NCUA Board. 
Sec. 702.108(a).
    In the case of a FISCU seeking an RMC, the request must first be 
submitted to the appropriate State official (as defined in 12 C.F.R. 
702.2(b) and appropriate Regional Director having jurisdiction over the 
FISCU. Sec. 702.108(b)(1). When evaluating a FISCU's request, the NCUA 
Board is required to ``consult and seek to work cooperatively'' with 
the appropriate State official and to provide prompt notice to him or 
her of its decision on the request. Sec. 702.108(b)(2).
    The RMC is available only to credit unions which otherwise fail an 
RBNW requirement, because of the substantial commitment of NCUA 
resources required to administer the process of evaluating and deciding 
RMC applications. NCUA will be responsible for ensuring the validity 
and reliability of the quantitative measures used to demonstrate 
mitigation of risk through individual qualitative assessment of each 
applicant credit union. Under guidelines to be adopted before the 
effective date of the final rule, NCUA envisions a process for 
evaluating RMC applications which resembles the process used to 
consider requests for expanded authority by corporate credit unions 
under Appendix B to part 704, 12 C.F.R. 704.

D. General Comments on Proposed Rule

    1. Regulatory capital. Numerous commenters reiterated the call for 
new forms of ``regulatory capital'' to play a role in PCA. NCUA may 
have the statutory authority to permit new sources of capital for 
federally-chartered credit unions. 12 U.S.C. 1757(7), 1757(9) 
(permitting NCUA to authorize regulatory capital in the form of shares 
and subordinated debt). However, CUMAA's express, limited definition of 
net worth--retained earnings under GAAP--clearly precludes all but low 
income-designated credit unions from classifying such regulatory 
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. See Sec. 702.206(e) (criterion in evaluating net worth 
restoration plans). Depending on how it is structured, regulatory 
capital on the balance sheet of a credit union that meets the 
definition of ``complex'' could conceivably reduce the risk for which 
the RBNW requirement is designed to compensate. In the future, 
therefore, NCUA may consider proposals to amend part 702 to allow 
regulatory capital to offset an RBNW requirement. See, e.g., 
Sec. 702.106(h) (``Allowance'' component).
    2. Banking industry trade association comments. In its comment 
letter, a trade association of the banking industry made four principal 
comments on the proposed rule. First, that the final rule should exempt 
credit unions having assets of $10 million or less. This proposal to 
establish a minimum asset floor, made by many commenters, is adopted. 
Second, that a credit union should be deemed ``complex'' if it has 
either $50 million or more in assets, any MBLs in its asset portfolio, 
or any investments for which it is required to submit a quarterly 
monitoring report to NCUA. See 12 C.F.R. 703.70(a), 703.90(b). These 
three sweeping criteria, while simple, are overwhelmingly 
overinclusive; NCUA's objective is to develop an RBNW requirement that 
is tailored to a credit union's individual risk profile. Third, that 
CUMAA and the Treasury Department intended that NCUA model the RBNW 
requirement on the banks' risk-based capital framework. On the 
contrary, neither CUMAA nor the Treasury Department envisioned a clone 
of the banks' risk-based capital standards; rather, Congress instructed 
NCUA to develop a credit union-specific RBNW requirement, 
Sec. 1790d(i), which takes account of a full range of relevant risks. 
S. Rep. at 13. As explained in section C.7(d) above, the

[[Page 44964]]

banks' approach addresses credit risk only. Third, that the proposed 
rule fails to take account of differences in credit quality among 
assets. The banks' risk-based capital standards create many broad 
categories of assets and do not further distinguish credit quality 
within a category. The final rule establishes fewer categories (i.e., 
risk portfolios, Sec. 702.104) and designates risk weightings to 
account for a broader range of risks (e.g., credit and interest rate 
risk). As explained in section C.4. above, NCUA's approach efficiently 
captures the risks to the NCUSIF that are the intended target of the 
RBNW requirement.
    3. Recognition of unrealized gains and losses. Five commenters 
inquired about treatment of unrealized gains and losses on ``available-
for-sale'' securities under SFAS 115. NCUA research indicated that 
failure to adjust net worth to reflect such gains and losses would 
rarely result in artificially misstating a credit union's net worth 
category classification. 65 FR at 8565. Thus, neither part 702 nor this 
final rule recognizes such gains and losses. NCUA reiterates that 
unrealized gains and losses are not reflected in net worth, the 
numerator of the net worth ratio, but do affect the denominator, total 
assets. Sec. 702.2(f).
    4. ``PCA Oversight Task Force.'' Ten commenters requested NCUA to 
periodically review implementation of the final rule and to revise it 
as needed. Another commenter was concerned that NCUA would modify the 
final rule in response to changing economic conditions, without giving 
credit unions sufficient notice and opportunity to comply. In response 
to these concerns, the NCUA Board in February 2000 established a ``PCA 
Oversight Task Force'' and directed its members to review at least a 
full year of implementation of PCA and to recommend modifications in 
the Fall of 2001. Any such modifications (apart from RMC guidelines) 
will be made by formal rulemaking, including public notice and an 
opportunity to comment.
    5. Method of calculating total assets. Several commenters inquired 
why a credit union is required to use its calendar quarter-end account 
balances to calculate an RBNW requirement, but may elect among four 
methods to calculate total assets in determining its net worth ratio. 
See Sec. 702.2(j). Similarly, another proposed calculating the RBNW 
requirement using average assets. The RBNW requirement must rely on 
quarter-end balances, rather than average balances, for consistency; 
because Call Report asset accounts are reported as of calendar quarter-
end, the denominator for the eight ``risk portfolios'' also must be 
calendar quarter-end total assets. Otherwise, the sum of the balances 
in asset accounts (reported on a calendar quarter-end basis) would not 
necessarily equal the total assets (on other than a calendar quarter-
end basis). To reconstruct the Call Report so that asset accounts are 
reported on an average basis does not appear to be cost justified for 
NCUA or for credit unions at this time.

E. Impact of Final Rule

    Under the proposed rule's four-trigger test, December 1999 Call 
Report data indicates that an estimated 1408 credit unions, or 13.2 
percent of all credit unions, met the definition of ``complex'' and 
would be required to meet an RBNW requirement. Compare 65 FR at 8605 
(6/99 data). As a result, an estimated twelve credit unions--
representing 2.3 percent of credit unions defined as ``complex'' and 
.08 percent of all credit unions--would have failed their RBNW 
requirement under the proposed standard calculation.
    By contrast, December 1999 Call Report data indicates the final 
rule's minimum asset ``floor'' would exempt 6195 credit unions having 
assets of $10 million or less. Of the remaining 4434 credit unions, 
3982 would fall below the minimum 6 percent RBNW ``floor.'' Thus, a 
total of 96 percent of all credit unions would be exempt from meeting 
an RBNW requirement at the outset.
    The remaining 452 credit unions, by virtue of having an RBNW 
requirement in excess of 6 percent, would meet the definition of 
``complex'' and be required to meet an ``applicable risk-based net 
worth requirement.'' Sec. 702.103(a). Among these, the average RBNW 
requirement is estimated at 6.8 percent. Seventy-five percent of these 
credit unions have an RBNW requirement of 7.02 percent or less. For 90 
percent of them, the RBNW requirement is 7.83 percent or less.
    In contrast, the average net worth ratio is an estimated 12.16 
percent--more than 500 basis points higher than the average RBNW 
requirement. As a result, only an estimated 17 credit unions--
representing 3.7 percent of the 452 credit unions meeting the 
definition of ``complex,'' and .0015 percent of all credit unions--
would have failed their RBNW requirement under the standard 
calculation. Sec. 702.106. Some of these undoubtedly would meet that 
requirement by substituting alternative components, Sec. 702.107, or by 
obtaining an offsetting RMC. Sec. 702.108.
    As Table 1 below indicates, as asset size increases toward $500 
million, it becomes more likely that an RBNW requirement will be 
applicable.

                       Table 1.--Estimated Applicability and Impact OF RBNW Requirement 14
----------------------------------------------------------------------------------------------------------------
                                                                                C            D
                                                                            Percentage   Percentage       E
 Source: 12/99 data:  Range of total assets for   A  Number    B  Number    of CUs to    of All CUs   Estimated
     credit unions (CUs) > $10 million  (in      of CUs >$10   of CUs to    which RBNW    to which      number
                   $millions)                      million     which RBNW   applies /       RBNW       failing
                                                                applies    All  CUs  B/ applies  B/      RBNW
                                                                              A = C     B total = D
----------------------------------------------------------------------------------------------------------------
Greater than $500..............................          122           19        15.6%         4.2%            0
Greater than $100 to $500......................          698          137        19.6%        30.3%            5
Greater than $50 to $100.......................          688           88        12.8%        19.5%            5
Greater than $20 to $50........................        1,473          133         9.0%        29.4%            5
Greater than $15 to $20........................          572           34         5.9%         7.5%            0
Greater than $10 to $15........................          881           41         4.7%         9.1%            2

[[Page 44965]]

 
      Total....................................        4,434          452        10.2%                       17
----------------------------------------------------------------------------------------------------------------
14 NCUA has relied on estimates to assess the impact of certain modifications to the final rule because the
  present Call Report does not collect the necessary data in sufficient detail. As a result, the use of Call
  Report data has the following impact: (1) the ``Long-term real estate loans'' risk portfolio includes loans
  with a remaining maturity between 3 to 5 years, resulting in an overestimate of the RBNW requirement under the
  standard calculation, Sec.  702.104(a); (2) the ``Investments'' risk portfolio includes mutual funds in the
  WAL bucket of one year or less, resulting in an underestimate of the RBNW requirement under the standard
  calculation, Secs.  702.104(c), 702.105(a)(1); (3) the ``Low risk assets'' risk portfolio includes cash on
  deposit and cash equivalents, resulting in an underestimate of the RBNW requirement under the standard
  calculation, Sec.  702.104(d); and (4) the ``Unused member business loan commitments'' risk portfolio includes
  only unused commitments for commercial real estate construction and land development, resulting in an
  underestimate of the RBNW requirement under the standard calculation. Sec.  702.104(g).

    The estimates in Table 1 above are based on December 1999 Call 
Report data as indicated in Table 2 below. The line item references are 
subject to change when the Call Report is revised to conform with part 
702 and to incorporate the ``PCA Worksheet.''

Table 2.--Present Call Report Line Items for Estimating RBNW Requirement
------------------------------------------------------------------------
                                Call report items
       Risk Portfolio           used to estimate    Call report estimate
                                 risk portfolios
------------------------------------------------------------------------
(a) Long-term real estate     Total real estate     Schedule A, line 3
 loans.                        loans less:.          (Acct. codes 710)
                                                     less:
                              i. The amount of      i. Schedule A, line
                               real estate loans     9 (Acct. code 718).
                               that meet the
                               definition of a
                               member business
                               loan.
                              ii. Real estate       ii. Schedule A, line
                               loans that will       11 (Acct. code
                               contractually         712).
                               refinance, reprice
                               or mature within 3
                               years.
(b) Member business loans...  Outstanding member    Schedule B, line 3
                               business loans.       (Acct. code 400).
(c) Investments.............  All credit union      Schedule C:
                               investments
                               categorized by
                               weighted-average
                               life or repricing
                               interval:.
                              i. Less than 1 Year.  i. Line 12 (Acct.
                                                     code 799A).
                              ii. 1-3 Years.......  ii. Line 12 (Acct.
                                                     code 799B).
                              iii. 3-10 Years.....  iii. Line 12 (Acct
                                                     code 799C).
                              iv. Greater than 10   iv. Line 12 (Acct
                               Years.                code 799D).
(d) Low-risk Assets.........  i. Cash and cash      i. Assets, line 1
                               equivalents.          (Acct. code 730).
                              ii. NCUSIF Deposit..  ii. Assets line 25
                                                     (Acct code 794).
(e) Average-risk Assets.....  Total Assets less:    Assets, line 27
                               Risk Portfolios (a)   (Acct. code 010)
                               through (d).          less: Risk
                                                     Portfolio line
                                                     items (a) through
                                                     (d) above.
(f) Loans sold with recourse  Outstanding balance   Schedule G, line
                               of loans sold or      2.B. (Acct. code
                               swapped with          819).
                               recourse.
(g) Unused MBL Commitments..  Commercial real       Schedule G, line
                               estate construction   1.D. (Acct. code
                               and land              814).
                               development.
(h) Allowance...............  Allowance for Loan    Assets, line 21
                               and Lease Losses.     (Acct. code 719)
                                                     (Limited to
                                                     equivalent of 1.5
                                                     percent of total
                                                     loans.).
------------------------------------------------------------------------

Regulatory Procedures

Regulatory Flexibility Act

    The Regulatory Flexibility Act requires NCUA to prepare an analysis 
describing any significant economic impact a final regulation may have 
on a substantial number of small credit unions (primarily those under 
$1 million in assets). The final 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 meets the definition of ``complex'' and an RBNW requirement is 
applicable, based on a minimum asset size of $10 million and minimum 
RBNW requirement of 6 percent. The second step uses eight standard 
components (which multiply the ``risk portfolios'' by corresponding 
risk weightings) to determine the applicable RBNW requirement. The 
third step provides a credit union the opportunity to substitute any of 
three specific standard components with a corresponding alternative 
component that may reduce the RBNW requirement against which the credit 
union's quarterly net worth ratio is measured. Credit unions that do 
not meet an applicable RBNW requirement under both the standard 
calculation and the alternative components may apply for a risk 
mitigation credit to reduce that

[[Page 44966]]

requirement to reflect mitigation of credit risk or interest rate risk.
    The NCUA Board does not believe that the final rule would impose 
reporting or recordkeeping burdens that require specialized 
professional skills not available to small entities. Further, NCUA 
estimates that, due to the $10 million asset minimum, none of these 
small entities will be subject to an applicable RBNW requirement under 
the additional requirements of the final rule. There are no other 
relevant federal rules that duplicate, overlap, or conflict with the 
final rule.

Paperwork Reduction Act

    The reporting requirements in this rule have been submitted to the 
Office of Management and Budget. Under the Paperwork Reduction Act of 
1995, no person is required to respond to a collection of information 
unless it displays a valid OMB number. Control number 3133-0161 has 
been issued and will be displayed in the table at 12 CFR part 795.

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 final 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. Throughout the rulemaking process, NCUA staff has consulted 
with a committee of representative state regulators regarding the 
impact of the RBNW requirement on state-chartered credit unions. The 
committee's comments and suggestions are reflected in the final rule.

Small Business Regulatory Enforcement Fairness Act

    The Small Business Regulatory Enforcement Fairness Act of 1996 
(Pub. L. 104-121) provides generally for congressional review of agency 
rules. A 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. The Office of Management and Budget has 
determined that this rule is not a major rule.

List of Subjects

12 CFR Part 700

    Credit unions.

12 CFR Part 702

    Credit unions, Reporting and recordkeeping requirements.

    By the National Credit Union Administration Board on July 13, 
2000.
Becky Baker,
Secretary of the Board.

    Accordingly, 12 CFR parts 700 and 702 are amended as set forth 
below:

PART 700--DEFINITIONS

    1. The authority citation for part 700 continues to read as 
follows:

    Authority: 12 U.S.C. 1752(5), 1757(6) and 1766.


Sec. 700.1  [Amended]

    2. Section 700.1 is amended by removing paragraph (i) and 
redesignating paragraphs (j) and (k) as paragraphs (i) and (j), 
respectively.

PART 702--PROMPT CORRECTIVE ACTION

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

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


    4. Section 702.2 is amended in paragraph (j)(2) by removing 
``702.106'' and adding ``702.108'' in its place; and by adding 
paragraph (k) to read as follows:


Sec. 702.2  Definitions

* * * * *
    (k) Weighted-average life means 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 (based on a reasonable and supportable estimate of that time), 
and then summing and dividing by the total amount of principal.


Sec. 702.102  [Amended]

    5. Section 702.102 is amended in paragraphs (a)(1), (a)(2) and 
(a)(3) by removing the phrase ``702.105 and 702.106'' and by adding 
``702.103 through 702.108'' in its place.

    6. Sections 702.103, 702.104, 702.105, 702.106, 702.107 and 702.108 
are added to subpart A of part 702 to read as follows:


Sec. 702.103  Applicability of risk-based net worth requirement.

    (a) Criteria. For purposes of Sec. 702.102, a credit union is 
defined as ``complex'' and a risk-based net worth requirement is 
applicable only if the credit union meets both of the following 
criteria as reflected its most recent Call Report:
    (1) Minimum asset size. Its quarter-end total assets exceed ten 
million dollars ($10,000,000); and
    (2) Minimum RBNW calculation. Its risk-based net worth requirement 
as calculated under Sec. 702.106 exceeds six percent (6%).
    (b) Optional Call Report filing. For purposes of this part, a 
credit union which is required to file a Call Report only semiannually 
may elect to file a Call Report for the first and/or third quarter of a 
calendar year.


Sec. 702.104  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 quarter-end total assets reflected in 
its most recent Call Report, 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 the next five 
(5) 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;
    (c) Investments. Investments as defined by 12 CFR 703.150 or 
applicable State law, including investments in CUSOs (as defined by 
Sec. 702.2(d));
    (d) Low-risk assets. Cash on hand (e.g., coin and currency, 
including vault, ATM and teller cash) and the NCUSIF deposit;
    (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, excluding loans sold to the secondary mortgage 
market that have representations and warranties consistent with those 
customarily required by the U.S. Government and government sponsored 
enterprises;
    (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

[[Page 44967]]

equivalent of one and one-half percent (1.5%) of total loans 
outstanding.
[GRAPHIC] [TIFF OMITTED] TR20JY00.000

Sec. 702.105  Weighted-average life of investments.

    Except as provided below (Table 2), the weighted-average life of an 
investment for purposes of Secs. 702.106(c) and 702.107(c) is defined 
pursuant to Sec. 702.2(k):
    (a) Registered investment companies and collective investment 
funds.
    (1) For investments in registered investment companies (e.g., 
mutual funds) and collective investment funds, the weighted-average 
life is defined as the maximum weighted-average life disclosed, 
directly or indirectly, in the prospectus or trust instrument;
    (2) For investments in money market funds, as defined in 17 CFR 
270.2a-7, and collective investment funds operated in accordance with 
short-term investment fund rules set forth in 12 CFR 
9.18(b)(4)(ii)(B)(1)-(3), the weighted-average life is defined as one 
(1) year or less; and
    (3) For other investments in registered investment companies or 
collective investment funds, the weighted-average life is defined as 
greater than five (5) years, but less than or equal to seven (7) years;
    (b) Callable fixed-rate debt obligations and deposits. For fixed-
rate debt obligations and deposits that are callable in whole, the 
weighted-average life is defined as the period remaining to the 
maturity date;
    (c) Variable-rate debt obligations and deposits. For variable-rate 
debt obligations and deposits, the weighted-average life is defined as 
the period remaining to the next rate adjustment date;
    (d) Capital in mixed-ownership Government corporations and 
corporate credit unions. For capital stock in mixed-ownership 
Government corporations, as defined in 31 U.S.C. 9101(2), and member 
paid-in capital and membership capital in corporate credit unions, as 
defined in 12 CFR 704.2, the weighted-average life is defined as 
greater than one (1) year, but less than or equal to three (3) years;
    (e) Investments in CUSOs. For investments in CUSOs (as defined in 
Sec. 702.2(d)), the weighted-average life is defined as greater than 
one (1) year, but less than or equal to three (3) years; and
    (f) Other equity securities. For other equity securities, the 
weighted average life is defined as greater than ten (10) years.

[[Page 44968]]

[GRAPHIC] [TIFF OMITTED] TR20JY00.001

Sec. 702.106  Standard calculation of risk-based net worth requirement.

    A credit union's risk-based net worth requirement is the aggregate 
of the following standard component amounts, each expressed as a 
percentage of the credit union's quarter-end total assets as reflected 
in its most recent Call Report, 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 
less than or equal to twenty-five percent (25%) of total assets; and
    (2) Fourteen percent (14%) of the amount in excess of twenty-five 
percent
    (25%) of total assets;
    (b) Member business loans outstanding. The sum of:
    (1) Six percent (6%) of the amount of member business loans 
outstanding less than or equal 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) Investments. The sum of:
    (1) Three percent (3%) of the amount of investments with a 
weighted-average life (as specified in Sec. 702.105 above) of one (1) 
year or less;
    (2) Six percent (6%) of the amount of investments with a weighted-
average life greater than one (1) year, but less than or equal to three 
(3) years;
    (3) Twelve percent (12%) of the amount of investments with a 
weighted-average life greater than three (3) years, but less than or 
equal to ten (10) years; and
    (4) Twenty percent (20%) of the amount of investments with a 
weighted-average life greater than ten (10) years;
    (d) Low-risk assets. Zero percent (0%) 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.

[[Page 44969]]

[GRAPHIC] [TIFF OMITTED] TR20JY00.002

Sec. 702.107  Alternative components for standard calculation.

    A credit union may substitute one or more alternative components 
below, in place of the corresponding standard components in 
Sec. 702.106 above, when any alternative component amount, expressed as 
a percentage of the credit union's quarter-end total assets as 
reflected in its most recent Call Report, rounded to two decimal 
places, is smaller (Table 4):
    (a) Long-term real estate loans. The sum of:
    (1) 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;
    (2) 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
    (3) Fourteen percent (14%) 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. 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. 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) Investments. The sum of:
    (1) Three percent (3%) of the amount of investments with a 
weighted-average life (as specified in Sec. 702.105 above) of one (1) 
year or less;
    (2) Six percent (6%) of the amount of investments with a weighted-
average life greater than one (1) year, but less than or equal to three 
(3) years;
    (3) Eight percent (8%) of the amount of investments with a 
weighted-average life greater than three (3) years, but less than or 
equal to five (5) years;
    (4) Twelve percent (12%) of the amount of investments with a 
weighted-average life greater than five (5) years, but less than or 
equal to seven (7) years;
    (5) Sixteen percent (16%) of the amount of investments with a 
weighted-average life greater than seven (7) years, but less than or 
equal to ten (10) years; and
    (6) Twenty percent (20%) of the amount of investments with a 
weighted-average life greater than ten (10) years.

BILLING CODE 7535-01-P

[[Page 44970]]

[GRAPHIC] [TIFF OMITTED] TR20JY00.003


[[Page 44971]]




Sec. 702.108  Risk mitigation credit to reduce risk-based net worth 
requirement.

    (a) Application for credit. Upon application by a credit union 
which fails to meet its applicable risk-based net worth requirement, 
and pursuant to guidelines duly adopted by the NCUA Board, the NCUA 
Board may in its discretion grant a credit to reduce a risk-based net 
worth requirement under sections 702.106 and 702.107 upon proof of 
mitigation of:
    (1) Credit risk; or
    (2) Interest rate risk as demonstrated by economic value exposure 
measures.
    (b) Application by FISCU. In the case of a FISCU seeking a risk 
mitigation credit--
    (1) Before an application under paragraph (a) above may be 
submitted to the NCUA Board, it must be submitted in duplicate to the 
appropriate State official and the appropriate Regional Director; and
    (2) The NCUA Board, when evaluating the application of a FISCU, 
shall consult and seek to work cooperatively with the appropriate State 
official, and shall provide prompt notice of its decision to the 
appropriate State official.

    7. Appendices A through F are added to subpart A to read as 
follows:

BILLING CODE 7535-01-P

[[Page 44972]]

APPENDICES TO SUBPART A
[GRAPHIC] [TIFF OMITTED] TR20JY00.004


[[Page 44973]]


[GRAPHIC] [TIFF OMITTED] TR20JY00.005


[[Page 44974]]


[GRAPHIC] [TIFF OMITTED] TR20JY00.006


    8. Section 702.302 is amended by removing the phrase ``and any risk 
based net worth requirement applicable to a new credit union defined as 
`complex` under Secs. 702.103 through 702.106'' from paragraph (a); and 
by removing the phrase ``and also meets any applicable risk-based net 
worth requirement under Secs. 702.105 and 702.106'' from paragraphs 
(c)(1), (c)(2) and (c)(3).

[FR Doc. 00-18278 Filed 7-19-00; 8:45 am]
BILLING CODE 7535-01-C