[Federal Register Volume 66, Number 184 (Friday, September 21, 2001)]
[Proposed Rules]
[Pages 48742-48761]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 01-23290]



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Part II





National Credit Union Administration





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12 CFR Parts 703 and 704



Investment and Deposit Activities; Corporate Credit Unions; Proposed 
Rule

  Federal Register / Vol. 66, No. 184 / Friday, September 21, 2001 / 
Proposed Rules  

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NATIONAL CREDIT UNION ADMINISTRATION

12 CFR Parts 703 and 704


Investment and Deposit Activities; Corporate Credit Unions

AGENCY: National Credit Union Administration (NCUA).

ACTION: Proposed rule.

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SUMMARY: NCUA is issuing proposed revisions to the rule governing 
corporate credit unions (corporates). The rule was completely revised 
in 1997. The proposed amendments are based on NCUA's three-year 
experience with the rule and two advance notices of proposed 
rulemaking. The major revisions to the rule are in the areas of capital 
and credit concentration limits, with an emphasis on making these 
provisions more comparable to those of the other financial regulators 
while still taking into account the unique nature of corporates. The 
major changes to these two areas necessitate some substantive changes 
to other provisions of the rule. Several other minor revisions are 
generally either a clarification or a modernization of the existing 
rule.

DATES: Comments must be received on or before December 20, 2001.

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

FOR FURTHER INFORMATION CONTACT: Kent Buckham, Deputy Director, Office 
of Corporate Credit Unions, at the above address or telephone (703) 
518-6640; or Mary Rupp, Staff Attorney, Office of General Counsel, at 
the above address or telephone (703) 518-6540.

SUPPLEMENTARY INFORMATION:

A. Background

    On July 28, 1999, NCUA issued an advance notice of proposed 
rulemaking that requested comment on several issues the Board 
identified as areas of the corporate rule it was interested in 
clarifying or revising. 64 FR 40787, July 28, 1999. In addition, the 
Board welcomed comment on other sections of part 704 not addressed in 
the advanced notice. Id. As a result of those comments, the Board 
identified additional areas of part 704 it was interested in revising 
or clarifying and issued a second advance notice of proposed 
rulemaking. 65 FR 70319, November 22, 2000. The comments to both 
advance notices have greatly assisted the Board in drafting the 
proposed rule and will be discussed in the relevant section of the 
section-by-section analysis of the proposal.

B. Section-by-Section Analysis

Capital Section 704.3, Section 703.100

    The Board requested comment on amending the various capital 
definitions so that they are more analogous to those used by other 
financial regulators.
    Additionally, the Board sought specific comment on changes that 
would result in one measure of capital. Currently, the regulation 
provides two capital measures. One measure includes all the various 
components of capital. The second measure, which is utilized for credit 
concentration limits, is based on specific capital components. 12 CFR 
704.6(c).
    Sixteen of the 23 commenters that responded on this issue supported 
aligning capital requirements with other financial regulators but 
stressed the alignment must take into account the uniqueness of 
corporates. Only two commenters supported an alignment as proposed and 
five objected to any alignment.
    The sixteen qualified commenters, as well as the negative 
commenters, emphasized there are currently no safety and soundness 
problems in the corporate system, corporates have significantly lower 
risk than commercial banks, and corporates are unique in their mission, 
ownership, and structure. The majority of assets owned by commercial 
banks are loans made to businesses or individuals. Corporates' assets 
are generally investment-grade quality investments. In addition, the 
assets of a corporate generally mature much sooner than the assets of a 
bank. For these reasons, the commenters noted corporates have 
significantly lower risk than banks.
    The sixteen commenters, although not wanting identical capital 
requirements, note that some form of comparability would be helpful in 
promoting a clearer understanding of corporates by other regulators and 
Congress.
    Several of these commenters noted that other financial regulators 
are looking at different, simplified capital requirements for smaller, 
non-complex institutions. A determination that an institution is non-
complex would be based on structure, size, and complexity of 
operations. These commenters contended that corporates are most like 
the Federal Home Loan Bank System. The Federal Home Loan Bank System 
has new leverage and risk-based capital requirements. 12 CFR part 932.
    Those opposed to any revision noted that nothing has changed since 
the last rewrite of the corporate rule to warrant a change and, while 
it is a worthwhile goal to have comparable capital requirements, the 
issues of which regulator to align with and how to take into account a 
corporate's reduced risk outweigh the benefits of changing the capital 
requirements.
    The National Association of State Credit Union Supervisors (NASCUS) 
and the American Bankers Association (ABA) supported the proposed 
change. NASCUS stated that the proposed change would assist the 38 out 
of 48 state-chartered credit union supervisory authorities that also 
regulate banks. The ABA states the proposed changes would bring credit 
unions closer to banks, but did not go far enough.
    The majority of those that responded to the issue of membership 
capital (MC) and paid-in-capital (PIC) strenuously objected to adding 
additional requirements to these accounts in order for them to qualify 
as capital. The proposal counted as capital only PIC that qualified as 
capital under generally accepted accounting principles (GAAP), that 
being, non-cumulative dividend, perpetual maturity PIC. The proposal 
would have changed the minimum withdrawal period for MC from three 
years to five years. The proposal was intended to make MCs more 
analogous to Tier 2 capital utilized by other financial institution 
regulators. The practical effect of the change would be that corporates 
could only count 60 percent of every dollar of three year MC in the net 
economic value (NEV) calculation. Some of the reasons for opposing this 
change were that: it isn't warranted because MC is at 100 percent risk 
until maturity; it could send the wrong message to the industry, 
namely, that corporates are in trouble; based on a change to NCUA's 
regulations, corporates just four years ago asked their members to 
extend their MC accounts from one year to three years; and it would 
make corporates less competitive with other financial institutions that 
don't require a capital commitment.
    The commenters generally supported treating all MC, PIC, and 
reserves and undivided earnings (RUDE) as capital throughout the 
regulation.
    The Board recognizes the unique nature of the credit union system 
and the vital role that corporates play. The risks inherent in 
corporates are different than found in most other financial 
institutions. However, the Board is also cognizant that the regulation 
must provide a sound capital structure that

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helps maintain the confidence of members, the public, and Congress.
    The Board is not proposing to change the current definitions of MC 
and PIC to require those accounts to follow GAAP in order to qualify as 
capital. The Board recognizes the high credit quality and liquidity of 
most corporate assets provide reasonable assurance that MC and PIC will 
be available to absorb losses.
    The Board concurs that the various components of capital in the 
regulation should all be included in the definition of capital. The 
Board has eliminated the separate limitations based on ``the sum of 
reserves and undivided earnings and paid-in capital'' existing in the 
current regulation. 12 CFR 704.6, 704.7, 704.8 and 12 CFR part 704, 
Appendix B. In the proposed regulation, all references to capital 
include membership capital, paid-in capital, and RUDE.
    The Board believes a corporate should have the regulatory 
flexibility to use the alternatives best fitting its specific needs in 
building a strong capital position. The current regulation limits the 
amount of PIC a corporate may issue to no more than the total of RUDE. 
The existing limitation was adopted as a means of building RUDE and due 
to the lack of any historical experience on the part of corporates in 
issuing PIC. Since the revised part 704 became effective in 1998, 
corporates have been successful in building RUDE and their PIC 
offerings. 62 FR 12929, March 19, 1997. Therefore, the Board is no 
longer requiring PIC to be no greater than total RUDE.
    Additionally, the Board is changing the requirement that all 
nonmember PIC be approved by NCUA to provide regulatory relief. 
Nonmember PIC having terms and conditions identical to member PIC will 
not require prior NCUA approval. Nonmember PIC with different terms and 
conditions than member PIC will continue to require prior NCUA 
approval.
    NCUA asked for comment on whether the rule should require the 
measure for adjusted balance MC accounts be based on a 12-month 
average, rather than the current practice of basing the measure on a 
particular point in time. The current rule is silent on this issue.
    Seventeen of the 18 commenters responding to this issue objected to 
a 12-month average. Some of the reasons given in opposition to a 12-
month average were that: it would be difficult operationally because 
members only prepare these figures quarterly or semi-annually; a 
corporate shouldn't be requiring more information from its members than 
the regulator; it would be a huge burden on small credit unions; some 
credit unions may leave the system because of the added burden; and the 
method and frequency of the adjustment should be left to the discretion 
of the corporate not the regulator.
    The Board concurs with the commenters that tracking a 12-month 
average adjusted balance measure could place additional burden on 
corporates and on small natural person credit unions. However, the 
Board believes clarification of the requirements of adjusted balance 
accounts is necessary. Although not specifically stated in Sec. 704.2, 
it was intended that the adjustment period would be annual and the 
adjustment measure would be a natural person credit union's assets. The 
Board is wary of an adjustment measure that could fluctuate rapidly, 
resulting in an outflow of MC if the measure declines. In a scenario 
where investments in a corporate are the measure and the adjustment 
period is monthly, a member credit union could potentially withdraw its 
investments and be refunded its entire MC balance within a matter of 
days. The Board's overriding goal is that MC has a level of 
``permanence'' while allowing corporates the latitude to structure the 
accounts to best suit their needs, as well as the needs of their 
members. To that end, the Board is proposing the adjustment period may 
be no more frequent than once every six months. In addition, if a 
corporate uses a measure other than a member's assets, it must address 
the measure's permanence in its capital plan.
    NCUA requested comment on whether there should be a minimum RUDE 
ratio of two percent for all corporates. RUDE ratio is defined as RUDE 
divided by moving daily average net assets (DANA).
    Fifteen of the 21 commenters commenting on this issue objected to a 
minimum RUDE ratio of two percent. Those in opposition stated that 
there was no evidence it would have any impact on ensuring the 
stability of a corporate's capital. Those commenters stated it is not 
useful and the total capital ratio, coupled with minimum risk-based 
capital and NEV ratios, is a more appropriate way of determining 
capital adequacy. Several commenters questioned why it is necessary.
    Some of the comments in support of this requirement stated it 
provides a meaningful measure to compare corporates to other financial 
institutions because most other regulators have similar minimum core 
capital requirements.
    The Board remains convinced that a minimum RUDE ratio of two 
percent is useful in the overall determination of capital adequacy. 
Given the proposal to use one capital measure including all capital 
components, use the broader definition of capital for credit 
concentration limits, and lower the minimum credit rating requirements, 
the Board is convinced a minimum RUDE ratio of two percent will be 
beneficial. A minimum RUDE ratio requirement will provide a core 
capital level comparable to other financial institutions and ensure a 
level of protection to the holders of MC and PIC.
    The Board believes the introduction of a minimum RUDE ratio negates 
the need for a minimum reserve ratio or the need for mandated reserve 
transfer levels. Corporates will be required to maintain a minimum RUDE 
ratio on an ongoing basis and make operational adjustments as necessary 
to meet that goal. As such, the proposed regulation eliminates the 
reserve ratio and reserve transfer requirements.
    NCUA requested comment on whether there should be a credit-risk 
weighted capital requirement since corporates have capital in relation 
to risk that is comparable to the risked-based total capital of other 
financial institutions. This comparability may not be evident because 
of current definitions and the lack of a required measurement. The 
majority of commenters responding to this issue did not object to a 
requirement.
    Although the Board gave strong consideration to adopting a credit-
risk weighted capital requirement for corporates to enhance 
comparability with other financial institutions, the proposed rule does 
not have this requirement. The Board believes the adoption of a credit-
risk weighted capital requirement is not warranted because of the high 
credit quality of corporates' assets. In addition, it would 
significantly increase the size of the existing rule and add a 
regulatory burden. Comparability with other financial institutions can 
be attainted through some of the other proposed capital revisions. The 
Board notes corporates may voluntarily choose to calculate and monitor 
credit-risk weighted capital.
    A number of corporates responding to the issue of a credit-risk 
weighted capital requirement suggested reducing the qualifying portion 
of MC by 33\1/3\ percent each year after notice is given or before the 
term expires. Additionally, they recommended that PIC be reduced by 
33\1/3\ percent each year of its last three years to maturity. The 
commenters indicated that these adjustments would make the capital 
ratio more comparable to that used by other financial institutions. The 
Board is desirous of a

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periodic, rather than annual reduction in qualifying MC and PIC, once 
notice is given or the last three years to maturity is reached. As 
such, the Board proposes MC placed on notice, term MC that is three 
years from expiring, or PIC with three years to maturity be amortized 
on a monthly basis with no portion of the balance counting as 
qualifying capital during the last 12 months. To achieve that result, 
the Board proposes an amortization of those accounts of \1/24\th per 
month so that the amount is fully amortized 12 months before the 
scheduled release of the funds.
    The Board is also adding wording to the definition of PIC that was 
inadvertently left out of the current regulation. Specifically, the 
revision states PIC cannot be pledged against borrowings. This 
provision currently exists for MC. The provision is equally important 
for PIC as it absorbs losses before MC.
    The proposal also clarifies that funds in MC and PIC accounts are 
not automatically releasable due to the merger, charter conversion, or 
liquidation of the natural person credit union member account holder. 
Further, in the event of the merger of the corporate, the MC and PIC 
accounts transfer to the continuing corporate.
    Finally, the Board proposes taking the requirements for MC and PIC 
out of the definitions in Sec. 704.2 and moving them to the capital 
requirements provision in Sec. 704.3(b) and (c). Section 704.2 still 
has definitions of MC and PIC. The definitions of ``member PIC'' and 
``nonmember PIC'' have been deleted from the definition section and the 
requirements for each are now included in proposed Sec. 704.3(c).
    The Board requested comment on amending Sec. 703.100(c) to increase 
the limit of the aggregate purchase of member PIC and MC in one 
corporate from one percent to two percent. Additionally, the Board 
sought comment on adding an aggregate limit of PIC and MC in all 
corporates of four percent. Fifteen commenters supported both 
proposals, one commenter only supported the increase to two percent 
aggregate in one corporate, and one commenter objected to both 
proposals.
    The NCUA Board believes the ability of natural person credit unions 
to purchase the capital instruments of corporates has been a positive 
force in bringing about capital redistribution within the credit union 
system. Many natural person credit unions rely heavily on corporates 
for liquidity, investment products, and other financial services. 
Historically, while capital in natural person credit unions has been 
very strong, corporate capital was not considered to be at desired 
levels. Since 1992, many natural person credit unions have committed 
their funds to build capital in the corporate credit union system.
    The Board is persuaded both the corporate and the natural person 
credit unions receive a benefit if a greater level of capital 
acquisition in one corporate is allowed. However, the Board is also 
cognizant that any excessive concentration of natural person credit 
union funds in corporate credit union capital offers the potential for 
additional risk in the system. Currently, the regulation does not place 
a limit on the number of corporates from which a natural person credit 
union may purchase MC or member PIC. As such, a natural person credit 
union could theoretically purchase up to one percent of its assets in 
the MC or member PIC of more than 30 corporates. The Board believes 
there is a need to balance the ability of natural person credit unions 
to purchase higher levels of capital in the one or two corporates in 
which they primarily obtain services with the need to place a 
reasonable limitation on the total corporate capital one natural person 
credit union can acquire.
    The existing regulation only limits ``member'' PIC. However, as a 
natural person credit union may acquire PIC of a corporate in which it 
is not a member, the regulation has been revised to set limitations on 
PIC as a whole.
    The Board proposes raising the limitation on the aggregate purchase 
of MC and PIC in one corporate from one percent to two percent of 
assets. Further, the Board proposes adding a limitation on the 
aggregate purchase of MC and PIC in all corporates to four percent of 
assets.
    The Board believes there is a need to clarify the existing wording 
on the limitations in Sec. 703.100. Purchases of MC and PIC are limited 
to a percentage of the assets of the natural person credit union. As 
assets are a fluid rather than a static measure, a natural person 
credit union could be deemed in compliance with the regulatory 
limitation on one day, and out of compliance the next as assets grow 
and contract. Therefore, the Board is proposing to clarify the 
limitation is a percentage of the natural person credit union's assets 
measured at the time of purchase.
Board Responsibilities Section 704.4
    This section of the regulation requires a corporate's board to 
approve and maintain comprehensive written strategic plans and 
operating policies and ensure senior management carries them out. One 
commenter expressed concern that use of the term ``operating policies'' 
may be construed to require a corporate board to develop operational 
policies or procedures. This is not the Board's intent. To clarify 
this, the Board proposes changing the term ``operating policies'' to 
``policies'' throughout this section of the rule.
    This commenter also expressed concern that using the word 
``procedures'' in subsection (c) could be interpreted to require a 
corporate's board to approve operational procedures. This section was 
not intended to turn directors into operating managers. To clarify 
this, the Board proposes changing the title of this section to ``Other 
requirements.''
Investments Section 704.5
    The Board proposes several changes to the investment related 
definitions in Sec. 704.2. The Board proposes deleting the definitions 
of: Commercial mortgage related security; Market price; Mortgage 
servicing; Non secured obligation; Prepayment model; and Real Estate 
Mortgage Investment Conduit (REMIC). These terms are no longer used in 
the regulation.
    The Board proposes amending the definitions of:
    Asset-backed security (ABS). The Board proposes eliminating the 
overlap between the definitions of mortgage related securities and ABS 
and conforming the definition to the current instructions for the 5310 
Call Report. The proposal excludes only mortgage related securities 
from the definition of ABS, rather than all mortgage backed securities.
    Collateralized mortgage obligation (CMO). Currently, the definition 
of a CMO includes all multi-class bonds collateralized by mortgages or 
mortgage-backed securities. The Board proposes to narrow this 
definition to a multi-class mortgage related security. This conforms to 
the amended definition of an ABS.
    Forward settlement. The Board proposes replacing ``settlement on a 
date other than the trade date'' with ``settlement on a date later than 
regular-way settlement.'' This change conforms the definition of 
forward settlement to the usage in Sec. 704.5(g).
    Quoted market price. The Board proposes defining a quoted market 
price as a recent sales price or a price based on current bid and asked 
quotations. This definition replaces the definition of market price, 
which is defined as the price at which a security can be bought or 
sold. Because market price is used to refer to the value of more than 
just securities, the Board proposes to omit the reference to a 
security. The

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proposed definition is consistent with the definition of a quoted 
market price in accounting standards. Statement of Financial Accounting 
Standards No. 133, as amended and interpreted (FASB Statement No. 133).
    Mortgage related security. The Board proposes replacing the phrase 
``i.e.'' with the phrase ``e.g.'' The Board did not intend to limit the 
definition to the one stated example, privately-issued securities. This 
change makes the definition consistent with the definition in the 
Securities Exchange Act of 1934.
    Regular-way settlement. The current definition refers to the 
specific number of days established for a type of security. The Board 
proposes to clarify this refers to the time frame the securities 
industry has established for immediate delivery. This change is 
consistent with the definition in Sec. 703.100(a) and FASB Statement 
No. 133. The Board proposes examples of regular-way delivery to further 
clarify its intent.
    Repurchase transaction. The current definition refers to resale of 
a security ``at a later date.'' The proposed definition refers to 
resale of a security ``at a specified future date and at a specified 
price.'' This is a non-substantive clarification that is consistent 
with the definition in Sec. 703.100(i).
    Residual interest. This proposed change deletes the reference to 
REMIC, which is redundant with CMO, and includes ABS residuals within 
the definition.
    In conjunction with the changes to the investment definitions in 
Sec. 704.2, the Board is proposing several changes to the investment 
provision of the rule. 12 CFR 704.5.
    Policies section 704.5(a). The Board proposes combining the policy 
requirements in this section and deleting ``if any'' from 
Sec. 704.5(a)(1) to clarify that a corporate must have ``appropriate 
tests and criteria'' to evaluate the investments it makes on an ongoing 
basis, as well as new types of investments.
    Section 704.5(a)(2). Since the marketing of liabilities to members 
is not an investment or investment transaction, the Board proposes 
deleting that provision from the investment policy requirements. The 
Board proposes requiring a corporate's investment policy to address 
reasonable concentration limits for limited liquidity investments. To 
ensure safety and soundness prior to purchase, a corporate must 
identify characteristics of an investment that may place restrictions 
on the sale of an investment (such as privately placed securities) or 
limit the appeal of an investment to other potential investors. A 
corporate's board must assess its liquidity position and establish 
appropriate aggregate limits on such limited liquidity investments.

Authorized Activities

    Section 704.5(c)(5). The Board proposes clarifying that ABS must be 
domestically issued. The Office of Corporate Credit Unions (OCCU) 
issued a guidance letter to all corporates dated May 19, 2000, noting 
many domestically issued ABS have some type of foreign exposure. As 
stated in that letter, the Board notes that any undue concentrations or 
safety and soundness issues arising from investments in domestically-
issued ABS with foreign exposure will be addressed as a supervision 
issue. Examiners will evaluate the ability of corporate staff to 
analyze ABS structures containing significant foreign exposure. The 
degree of foreign credit analysis expertise required at a corporate 
will depend on the extent of foreign exposure. For example, if a 
corporate relies on a domestic mono-line insurance wrap of foreign 
receivables, examiners will review a corporate's credit analysis of the 
insurance company and determine whether credit concentration limits to 
the insurance company are appropriate.
    Section 704.5(c)(6). This provision specifically authorizes 
investments in CMOs. Several corporates have noted CMOs are either 
within the meaning of mortgage related security or asset-backed 
security. Accordingly, the Board proposes to delete this provision. 
Investments in CMOs, as the Board proposes to amend that term, would 
continue to be authorized under Sec. 704.5(c)(1), the mortgage related 
security provisions of 12 U.S.C. 1757(15). Investments in other real-
estate related securities would continue to be authorized under 
Sec. 704.5(c)(5), domestically-issued asset-backed securities.
    Repurchase Agreements section 704.5(d). The Board proposes several 
changes to the requirements for repurchase agreements. The first 
amendment clarifies that a corporate must obtain a perfected first 
priority security interest in repurchase securities, either directly or 
through its agent. This change is consistent with the provisions in 
Sec. 704.5(e), for economically similar securities lending 
transactions. The second amendment deletes the requirement to sell a 
security in the event of a default. This change conforms to cash market 
practice and provisions of the Bond Market Association's Master 
Repurchase Agreement that permit a corporate to retain the securities. 
The third amendment clarifies a corporate may obtain daily assessment 
of the market value of the repurchase securities either directly or 
through its agent. This change conforms to the cash market practices of 
a third-party custodian acting as agent in a tri-party agreement 
between the corporate, the repurchase counterparty, and the safekeeping 
agent. Fourth, the Board proposes deleting the phrase ``including a 
market quote or dealer bid indication and any accrued interest'' 
because the cash market practice is to use ``market value'' as defined 
in the Bond Market Association's Master Repurchase Agreement. Fifth, 
the rule clarifies a corporate must ensure compliance with the contract 
terms. The Board notes a corporate using an agent must ensure its agent 
adequately ensures compliance. Finally, the rule deletes the 
requirement to have sufficient market relationships established in 
advance to timely execute the disposition of repurchase securities. 
This regulatory provision is unnecessary, as the prevailing cash market 
practice requires sale or deemed sale in a commercially reasonable 
manner.
    Securities Lending section 704.5(e). The Board proposes several 
changes to the requirements for securities lending transactions. The 
proposed rule clarifies that a corporate may act directly or through 
its agent. The requirement to assess collateral is currently based on a 
``market quote or dealer bid indication.'' The Board proposes deleting 
the phrase ``including a market quote or dealer bid indication and any 
accrued interest'' because the cash market practice is to use ``market 
value'' as defined in the Bond Market Association's Master Securities 
Loan Agreement. The proposal requires a written contract with all 
agents and requires the corporate or its agent to ensure compliance 
with the loan and security agreements. The Board proposes to delete as 
redundant the requirements to approve any form of agreement attached to 
the written loan and security agreement and the right to approve any 
material modification to such agreement. These proposed changes are 
consistent with the proposed changes for repurchase transactions.
    Investment companies Section 704.5(f). The Board proposes to 
clarify in Sec. 704.5(f) that the prospectus is the document 
restricting the portfolio of an investment company. This change is non-
substantive and is consistent with the provisions of Sec. 703.100(d).
    Prohibitions Section 704.5(h). This section prohibits pair-off 
transactions,

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when-issued trading, adjusted trading, and short sales. These 
prohibitions restrict a corporate from effectively engaging in trading 
securities. Accordingly, the Board proposes adding ``trading 
securities'' to the list of prohibited activities. Trading securities 
means buying and selling ``securities that are bought and held 
principally for the purpose of selling them in the near term (thus held 
for only a short period of time).'' FASB Statement No. 115.
    The Board proposes retaining the prohibition on investments in 
residual interests in CMOs, adding a prohibition on investment in 
residual interests in ABS, including real-estate related ABS, and 
eliminating the redundant prohibition on investments in REMICs. The 
purpose of these revisions is to continue the prohibition on residual 
interests in multi-class bond issues collateralized by mortgages or 
mortgage-backed securities that are not within the revised definition 
of CMO. The prohibition on investments in the residual interests in ABS 
is being added for safety and soundness reasons.
    The Board proposes deleting the prohibition against commercial 
mortgage related securities. The market for privately-issued commercial 
mortgage related securities is established. There does not appear to be 
undue risk relative to other debt obligations if a corporate can 
reasonably determine the value and price sensitivity of a commercial 
mortgage related security. The Board notes corporates currently may 
purchase certain commercial mortgage related securities, such as those 
issued by, or fully guaranteed as to principal and interest by, the 
Federal National Mortgage Association.
    The prohibition against the purchase of mortgage servicing rights 
is being moved from the investment section, to the retitled Permissible 
Services section, because their classification as a service is more 
appropriate.
Credit Risk Management Section 704.6
    The Board proposes adding a definition of ``obligor'' to the 
Sec. 704.2 definition section to clarify the meaning of the term. The 
Board proposes to define ``obligor'' as the primary party obligated to 
repay an investment. The definition clarifies obligor does not include 
the originator of receivables underlying an asset-backed security, the 
servicer of such receivables, or an insurer of an investment.
    Policies section 704.6(a). The Board proposes amending the policy 
requirements in this section to comply with the proposed new 
requirement in Sec. 704.6(c) that credit limits be based on capital.
    Section 704.6(a)(3). The Board proposes deleting the requirement 
that the credit risk management policy address loan credit limits, 
since these are addressed in the lending section.
    Section 704.6(a)(4). The Board proposes adding to the examples of 
concentrations of credit risk an ``originator of receivables'' and an 
``insurer.'' An ``originator of receivables'' includes a seller/
servicer of receivables and an ``insurer'' includes a monoline 
insurance company.
    Exemption Section 704.6(b). The Board proposes removing investments 
in subordinated debt of government sponsored enterprises from the 
exemption section. The issuance of subordinated debt is a recent market 
initiative. Subordinated debt ranks lower in payout priority than other 
debt issued or insured by a government sponsored enterprise. The Board 
believes minimum credit rating requirements and credit concentration 
limits should apply to lower ranking debt.
    Concentration limits section 704.6(c). The Board proposes setting 
concentration limits in relation to capital. Twenty of the 21 
commenters were in favor of setting credit concentration limits as a 
percentage of capital. Currently, credit concentration limits are based 
on percentages of RUDE and PIC, rather than the broader measure of 
capital. The only negative commenter in response to the Board's request 
for comment was the ABA. Most of the positive commenters qualified 
their support with the caveat that the definition of capital must give 
full credit to three-year MC and 20-year PIC. The Board's proposal 
adopts those comments.
    NCUA requested comment on whether credit concentration limits 
should vary depending upon the credit rating of an investment, in other 
words, the lower the credit rating, the more restrictive the credit 
concentration limit. Although the majority of commenters agree there 
should be limits in relation to risk, they believe a corporate should 
determine the limits, rather than being controlled by the limits 
specified in regulations according to ratings of a nationally 
recognized statistical rating organization (NRSRO or rating agency). 
They state that a corporate's concentration limits should be a 
supervisory issue and not a regulatory one. Some commenters noted that 
NCUA in the past has admonished corporates not to rely solely on 
ratings from a ratings agency. One commenter stated there is no need 
for a regulation because, through a combination of expanded 
authorities, a risk-based capital requirement, and a maximum individual 
credit exposure limit to any one issuer, there are sufficient 
safeguards.
    NCUA requested comment on establishing a limit for the aggregate 
credit exposure to a single obligor that has issued debt obligations 
across multiple rating categories. The majority of commenters 
responding to this issue believed there should be aggregate limits, but 
not as proposed. Most of these commenters suggested that the limit be a 
multiple of total capital, rather than tied to debt obligations across 
multiple rating categories. Many commenters gave examples of how, under 
the proposal, their ability to invest in AAA rated securities would be 
significantly curtailed, some as much as 80 percent. Those commenters 
noted that they would be forced to invest more heavily in U.S. Central 
Corporate Credit Union and United States government investments because 
they are exempt from the restrictions. This, they contend, could create 
additional risk problems for the whole corporate system. Several 
commenters noted that the proposal would severely limit their ability 
to invest in relatively safe, low risk repurchase agreements.
    The credit exposure limit suggested by several commenters is one 
times capital and, for repurchase agreements, two times capital.
    The Board is abandoning its proposal to set concentration limits 
depending upon an NRSRO's credit rating of an investment. The Board 
proposes to reorganize and streamline requirements for concentration 
limits, and to establish limits for the aggregate credit exposure to a 
single obligor.
    First, in Sec. 704.6(c)(1) the Board proposes a general 
concentration limit of 50 percent of capital or a de minimis limit of 
$5 million for the aggregate of all investments in any single obligor, 
whichever is greater. The 50 percent limit provides corporates with 
substantial flexibility in comparison to other depository institutions. 
The Board believes this limit is the most credit exposure a corporate 
should prudently take in investment-grade quality investments. NCUA 
requested comment on whether there should be a de minimis exemption 
from the general credit concentration limits, and if so, what amount. 
Fifteen of the 16 commenters that responded to this question supported 
a de minimis exemption, and most of those commenters suggested $5 
million as an appropriate amount. The one negative commenter was the 
ABA. Accordingly,

[[Page 48747]]

and to permit smaller corporates to engage in block size transactions, 
investments in a single obligor may exceed 50 percent of capital up to 
a de minimis limit of $5 million.
    This general concentration limitation is applicable to all 
investments and investment transactions. The current rule is divided 
into categories of investments and has different limitations, depending 
on the category. Certain classes of marketable debt obligations of 
domestic corporations were inadvertently omitted from the categories. 
These are now covered under the general limitation that includes all 
investments. The current rule allows a higher limit for mortgage back 
securities and ABS than for nonsecured obligations of any single 
domestic issuer. The Board sees no basis for this distinction since 
there can be substantial credit risk in privately issued mortgage-
backed and asset-backed securities.
    Second, in Sec. 704.6(c)(2) the Board proposes exceptions to the 
general rule for repurchase and securities lending transactions, 
investments in corporate CUSOs, and investments in other corporates. 
The Board adopts the commenters suggestion to set the limit for 
repurchase and securities lending transactions at 200 percent of 
capital. This limit generally reflects the lower credit risk in these 
short-term, secured transactions. The inclusion of an exception for 
investments in corporate CUSOs is a clarification that those 
investments are subject to the limitations in Sec. 704.11. NCUA 
requested comment on whether corporates should be exempt from credit 
concentration limits when investing in other corporates. Ten of the 15 
commenters that responded to this question said they should not. These 
negative commenters believe that it would increase systemic risk and 
is, therefore, unjustifiable. Several commenters suggested that 
corporates should maintain a credit risk file for investments greater 
than $100,000 in any other corporate. To allow additional alternatives 
for moving liquidity within the corporate system and, therefore, the 
credit union movement, the Board proposes to remove the regulatory 
concentration limits on investments in any corporate. The Board 
believes the requirements for capital and RUDE for the receiving 
corporate will serve to limit the amount of investments any corporate 
may place in another corporate. The Board notes a corporate's credit 
risk management policy must address the risks of investments in 
corporates that are not fully insured by the National Credit Union 
Share Insurance Fund.
    As stated above, the Board proposes basing credit concentration 
limits on capital. Currently, they are based on RUDE and PIC and a 
reduction in the sum of RUDE and PIC after the purchase of an 
investment triggers a suspension of additional transactions. The Board 
proposes amending this provision to apply the divestiture requirements 
in Sec. 704.10 when a reduction in capital after the purchase of an 
investment results in a credit concentration that is higher than 
permitted by the regulation. The Board's intent is that a corporate 
consider the permanence of its MCs when evaluating its investment 
opportunities.
    Credit ratings section 704.6(d). The Board proposes to clarify each 
investment must have an applicable credit rating. For example, a 
corporate must ensure investments in commercial paper are from an 
issuer that has received an acceptable commercial paper program rating. 
Similarly, a financial strength rating for deposits may be appropriate 
for uninsured deposits or the sale of federal funds. Investments in a 
corporate or corporate CUSO are exempt from this requirement.
    The Board proposes lowering the minimum applicable rating for a 
long-term investment (including asset-backed securities) from AAA and 
AA to AA-(or equivalent). The market for asset-backed securities has 
matured since this rule was last amended. The Board is retaining the A-
1 requirement for short-term investments and intends that this category 
include short-term ABS. The current rule inadvertently excludes them.
    There has been some confusion regarding multiple credit ratings and 
the conditions for triggering the divesture requirements of 
Sec. 704.10. The Board does not want to discourage a corporate from 
using multiple credit ratings in meeting the requirements of the 
regulation. Accordingly, the Board proposes the divestiture 
requirements of Sec. 704.10 apply only if at least two ratings were 
downgraded when a corporate has relied on more than one rating to meet 
the minimum credit rating requirements at the time of purchase. This 
requirement is consistent with the guidance issued by OCCU in a letter 
dated October 5, 1999, to all corporates.
    Reporting and documentation Section 704.6(e). The requirements for 
annual approval are clarified to apply to each credit limit with each 
obligor or transaction counterparty, rather than the undefined ``each 
credit line.''
Lending Section 704.7
    Section 704.7(c)(1) and (2). These sections establish the maximum 
aggregates for secured and unsecured loans to one member. Currently, 
the aggregate limits are based on the higher of a percentage of capital 
or a percentage of RUDE and PIC. As with other provisions of the 
proposed rule, the Board proposes basing loan limits on capital. The 
proposed rule eliminates the option of basing secured and unsecured 
loan limits on a percentage of RUDE and PIC. In conjunction with this 
change, the Board proposes clarifying in these provisions and in 
Sec. 704.7(d) that the aggregate limits are based on both revocable and 
irrevocable lines of credit. Currently, the rule only states 
``irrevocable lines of credit.'' 12 CFR 704.7(c) and (d). The Board 
proposes deleting the modifier ``irrevocable'' from these sections to 
clarify this.
    Section 704.7(d). This section addresses loans to members, but 
excludes member credit unions and corporate CUSOs. This provision 
provides a partial exemption from part 723. A number of commenters 
suggested the criteria for exemption be expanded. The Board agrees that 
there are other situations where a loan is guaranteed that are 
appropriate to include as part of the exemption. The Board proposes 
expanding the language in this provision to include not only loans 
guaranteed by credit unions but also loans fully secured by US Treasury 
or agency securities. This expansion will reduce the burden for 
corporates providing loans to members that are not credit unions. The 
rule is also being clarified to address the fact that the aggregate 
limits of Sec. 723.16 are statutory and a corporate is not exempt from 
those unless it is a loan to a member credit union.
    Section 704.7(g). The Board proposes revising the provision 
governing loan participations, to include a requirement that a 
corporate execute a master participation loan agreement prior to the 
purchase or the sale of a participation loan. This requirement mirrors 
the requirement in the natural person loan participation rule and is 
appropriate to ensure the interests of a corporate engaging in this 
activity are adequately protected. 12 CFR 701.22(b)(2). Although the 
Board believes corporates presently engaging in this activity are 
voluntarily executing a master participation loan agreement, the Board 
believes use of this agreement must be mandatory due to safety and 
soundness concerns.
    The Board is deleting the language that a participation loan 
agreement may

[[Page 48748]]

be executed at any time prior to, during, or after the disbursement. 
The Board believes it is unnecessary to state this because this 
language could be confused with the requirements of a master 
participation loan agreement prior to the purchase or sale of a 
participation loan interest.
    Several commenters suggested corporates be permitted to participate 
with natural person credit unions in making loans to natural person 
members. They urged NCUA to permit participation lending with and 
without recourse. Some of these commenters specifically stated this 
activity should be permissible without expanded authority. Another 
commenter believed participation lending should be allowed only as an 
expanded authority because a corporate must be able to demonstrate an 
appropriate level of infrastructure and financial capacity to engage in 
this activity.
    The NCUA Board asked the OCCU to address the issue of permitting 
corporates to participate with natural person credit unions in making 
loans to natural person members. 62 FR 12929, 12934 (March 19, 1997). 
Based on OCCU's recommendation, the Board is proposing that corporates 
participate in loans with member natural person credit unions only as 
an expanded authority. This position is based on the need for 
corporates to demonstrate they have the ability to identify, measure, 
monitor, and control the risks associated with participation lending. 
Since a number of corporates do not exhibit a level of infrastructure 
commensurate with the risks associated with this activity, the Board 
will require corporates to apply for this authority through Appendix B, 
proposed Part V.
    Finally, the Board is reorganizing this section. Subsection (c) is 
retitled ``Loans to members.'' Within this subsection are subsections: 
(1) The aggregate limits for loans to credit unions; (2) the aggregate 
limits for loans to CUSOs by reference to Sec. 704.11; and (3) the 
aggregate limits for loans to other members. Subsection (d) is retitled 
``Loans to nonmembers'' and sets forth the requirements for loans to 
nonmember credit unions. Within this subsection are subsections: (1) 
The requirements for loans to nonmember credit unions; and (2) the 
requirements for loans to nonmember CUSOs by referencing Sec. 704.11.
    To avoid confusion about the applicability of the member business 
loan rule to corporates, the Board is clarifying in the proposal that 
the statutory aggregate limits on member business loans apply to all 
corporate loans, except the statutorily excluded loans to credit union 
members. 12 U.S.C. 1757a and 12 CFR 723.16. Subsection (e) is retitled 
``Member business loan rule'' and explains in subsection: (1) That part 
723 does not apply to loans to member credit unions; (2) that the 
aggregate loan limits and some of the due diligence requirements of 
part 723 apply to corporate CUSOs as stated in Sec. 704.11; and (3) 
that part 723 applies to loans to other members, unless it falls within 
the exception discussed above, and then it must comply with the 
aggregate loan limits but is exempt from the other requirements of part 
723.
    The Board proposes deleting subsection (f) ``Loans to corporate 
CUSOs'' because these loans are now addressed in proposed subsections 
(c), (d) and (e). Current subsections (g) and (h), with the changes to 
subsection (g) discussed above, are redesignated subsections (f) and 
(g).
Asset and Liability Management Section 704.8
    In conjunction with several proposed amendments to the asset and 
liability management section, the Board proposes deleting from the 
Sec. 704.2 definition section, the term ``Net interest income'' because 
it is no longer used in the regulation. The Board proposes amending the 
definition of ``Net economic value (NEV)'' and ``Fair Value.'' NEV 
means the fair value of assets minus the fair value of liabilities. 
Currently, the definition of NEV treats MC as a liability, and excludes 
PIC from liabilities, for purposes of the NEV calculation. The Board 
requested comment on amending the definition of NEV to exclude from 
liabilities both MC and PIC that are included in capital. All 22 
commenters that responded to this issue supported a change to the 
definition of NEV. Most of those commenters believed that three-year MC 
and 20-year PIC should be part of the exclusion.
    The Board proposes amending the definition of NEV to state that PIC 
and MC not qualifying as capital are included as liabilities for 
purposes of the NEV calculation. Therefore, PIC and MC qualifying as 
capital are excluded from liabilities for purposes of the NEV 
calculation.
    The proposed change to the definition of NEV will have the effect 
of increasing the base case NEV ratio. For the quarters ending June 
2000 through March 2001, corporates reported base case NEV ratios 
ranging from 1.98 percent to 7.89 percent, with a simple average ratio 
of 4.24 percent. For the same quarters the base NEV ratios under the 
proposed rule, which eliminates MCs from liabilities, would have ranged 
from 3.76 percent to 18.17 percent, with a simple average ratio of 8.87 
percent.
    The Board also proposes to delete from the definition of NEV the 
reference to off-balance sheet derivatives, since accounting standards 
now require material financial derivatives to be reported on the 
balance sheet.
    Fair value. The Board proposes a number of changes to the current 
definition of fair value. The reference to a financial instrument is 
deleted. The phrase ``forced liquidation sale'' is clarified by stating 
a ``forced or liquidation sale.'' ``Market price'' is replaced with 
``quoted market price.'' An estimate of fair value based on a valuation 
technique is required to be reasonable and supportable. An estimate of 
fair value may also be based on a quoted market price in an active 
market for a similar instrument or a current appraised value. The 
definition is amended to clarify examples of valuation techniques. 
Valuation techniques are required to incorporate assumptions that 
market participants would use in their estimates of values, future 
revenues, and futures expenses. These proposed changes more closely 
reflect the definition of fair value in accounting standards. FASB 
Statement No. 133, Appendix F.
    The Board proposes the following amendment to Sec. 704.8:
    Policies. Section 704.8(a)(2). Several corporates requested that 
NCUA eliminate redundancies between the policy requirements of this 
section and Sec. 704.5(a). Since appropriate tests and criteria for 
evaluating investment and investment transactions are required under 
investment policies, the Board is deleting that requirement but 
clarifying in proposed Sec. 704.8(a)(6) that the asset and liability 
management policy provisions must address the test used to evaluate the 
impact of investments on the percentage decline in NEV, compared to the 
base case NEV. The Board proposes changing the term ``current NEV'' to 
``base case NEV.'' This change provides uniform usage throughout the 
regulation.
    Section 704.8(a)(5). The Board proposes to delete the requirement 
for a policy limit on decline in net income. It may be beneficial for a 
corporate to measure and establish limits on earnings exposures, such 
as projections of potential decline in net income in alternative 
interest rate scenarios. However, because the balance sheet of a 
corporate frequently is highly liquid and short term, earnings 
forecasts may necessitate many assumptions. These assumptions may limit 
the utility of earnings exposure measures for regulatory purposes.

[[Page 48749]]

    Penalty for early withdrawals section 704.8(c). Currently, this 
section requires a corporate to impose a market-based penalty for early 
withdrawal, if early withdrawal is permitted. The Board proposes to 
limit such penalty to the estimated replacement cost of the 
certificate/share redeemed that is reasonably related to current 
offering rates of that corporate. This would permit a corporate to 
impose reasonable fees to cover the cost of the redemption, but would 
protect a withdrawing credit union from excessive penalties. In 
response to suggestions to provide flexibility to avoid market-based 
penalties, the Board notes a market-based penalty for early withdrawal 
is a critical factor in the confidence it places in the accuracy of the 
measurement of NEV. As an alternative to early withdrawal, corporates 
may consider providing share secured loans to members needing liquidity 
in advance of share maturity.
    Interest rate sensitivity analysis section 704.8(d). The Board 
proposes deleting the requirement to conduct periodic net interest 
income simulations. As noted above, while earnings exposure 
measurements may be beneficial, the balance sheet of a corporate 
frequently is highly liquid and short term, necessitating many 
assumptions for an earnings forecast. These assumptions may limit the 
utility of earnings exposure measures.
    NCUA requested comment on whether the minimum, base case NEV ratio 
that triggers monthly interest rate sensitivity analysis testing should 
be increased from two percent to three percent. Twelve of the 15 
commenters supported the increase. The majority of those commenters 
premised their support on the exclusion of three-year MC from 
liabilities. As noted above, the proposed change to the definition of 
NEV will have the effect of increasing the base case NEV ratio. In 
light of the estimated increases in the base case NEV ratios discussed 
above, the Board proposes to set the minimum, base case ratio that 
triggers monthly testing at a level of three percent.
    NCUA also requested comment on increasing the minimum NEV ratio 
from one to two percent. Eighteen of the 21 commenters that responded 
to this question approved of this change, but the majority of those 
commenters only support it if three-year MC is excluded from 
liabilities. One of the positive commenters believes the same 
limitations should apply to wholesale corporates. The negative 
commenters believe the change will drive deposits from the corporate 
system. Again, in light of the estimated increases in the base case NEV 
ratios, the Board proposes increasing the minimum NEV ratio to two 
percent.
    The Board proposes explicitly stating in the rule that a corporate 
must limit its risk exposure to minimum NEV ratio levels based on a 
base case NEV ratio or any NEV ratio resulting from the tests set forth 
in Sec. 704.8(d)(1)(i). This will eliminate confusion about the 
applicability of the minimum NEV ratio.
    The current NEV decline limit for a base corporate (a corporate 
with no expanded authorities) is 18 percent of the base case NEV ratio. 
In conjunction with the proposed change to the definition of NEV, the 
Board proposes decreasing that limit to 10 percent. Base corporates 
reported base case NEV ratios ranging from 2.32 percent to 7.89 
percent, with a simple average ratio of 4.34 percent, for the quarters 
ending June 2000 through March 2001. For the same quarters, the base 
case NEV ratios under the proposed rule would have ranged from 4.75 
percent to 18.17 percent, with a simple average ratio of 9.58 percent.
    The Board estimates the proposed NEV decline limits would have 
resulted in an average permissible NEV decline of 0.96 percent (9.58 
percent  x  10 percent, expressed as a percentage of the fair value of 
total assets) for the quarters ending June 2000 through March 2001. 
This is larger than the average permissible decline of 0.78 percent 
(4.34 percent  x  18 percent) for the same period under the current 
rule. All base corporates reflected NEV decline limits under adverse 
rate shocks within the proposed NEV decline limits. Summary information 
from the analysis is presented in Table 1.

Table 1.--Analysis of Proposed Permissible Declines in NEV For Base Corporates For the Quarters Ending June 2000
                                               through March 2001
----------------------------------------------------------------------------------------------------------------
                                                                                                     Proposed
                                                   Current base      Permitted                       permitted
                                                  case NEV ratio    decline (as    Base case NEV    decline (as
                                                      for all       percent of      ratio under     percent of
                                                    corporates     fair value of   the  proposal   fair value of
                                                   (in percent)       assets)                         assets)
----------------------------------------------------------------------------------------------------------------
Simple average over 4 quarters..................            4.34            0.78            9.58            0.96
Minimum of all quarters.........................            2.32            0.42            4.75            0.47
Maximum of all quarters.........................            7.89            1.42           18.17            1.82
----------------------------------------------------------------------------------------------------------------

    The Board proposes moving the base-plus expanded authorities 
requirements to Appendix B, so that all expanded authorities are in one 
place. In conjunction with that change, all references to base-plus in 
Sec. 704.8 are deleted.
    The Board proposes requiring all corporates to assess annually 
whether it is appropriate to conduct periodic, additional, interest 
rate risk tests. The amendment deletes the requirement to conduct tests 
based on unmatched embedded options. The tracking of unmatched embedded 
options may not be cost effective for credit unions that adhere 
strictly to a matched book of business approach.
    The Board believes all corporates should assess whether there are 
indications of material risks, including interest rate risk and credit 
risk that may not be related to unmatched embedded options. For 
example, a corporate may not adhere to a matched book of business 
approach requiring a significant match between the maturity of assets 
and liabilities. In that case, measures of the NEV may have a 
significant exposure to changes in the shape of the Treasury yield 
curve. In contrast, another corporate may not hold material amounts of 
mortgage-backed securities and, therefore, may reasonably assert its 
NEV measures would be relatively insensitive to changes in prepayment 
projections. In both cases, there may be a significant exposure to 
widening spreads due to the credit risk inherent in the investment 
portfolios.
    Regulatory Violations and Policy Violations section 704.8(e) and 
(f). The Board proposes non-substantive grammatical amendments to the 
provisions for regulatory and policy violations.

[[Page 48750]]

Corporate Credit Union Service Organizations (Corporate CUSOs) Section 
704.11
    The Board requested comment on amending the definition of a 
corporate CUSO to require that a CUSO be considered a corporate CUSO 
only if any corporate owns a minimum of 25 percent interest or the 
aggregate interest by all corporates exceeds 50 percent. 65 FR at 
70322. Currently, the rule requires partial ownership by a corporate 
but does not specify a minimum ownership requirement. 12 CFR 
704.11(a)(1).
    Fifteen of the 17 commenters that responded objected to the 
proposed change. Some of the reasons given in opposition were that: the 
proposal will have the unintended effect of limiting a corporate's role 
as a liquidity provider in the credit union system; it will jeopardize 
the exemption in Sec. 704.7(d) from portions of the business loan rule 
for loans made to corporate CUSOs; and, if the reason for the proposed 
change is that corporates are not doing due diligence in loans to 
corporate CUSOs, this should be handled as a supervisory issue, not as 
a regulation.
    The Board agrees with the commenters' concern that a minimum 
investment requirement could have a negative impact on a corporate's 
role as a liquidity provider in the credit union system and, therefore, 
the Board will not impose a minimum investment requirement. But, 
because of safety and soundness concerns associated with a high 
concentration of loans with one borrower, the Board is adding some due 
diligence requirements to the corporate CUSO lending provision.
    These due diligence requirements, taken from the member business 
loan rule, require that the corporate establish a specific loan policy 
that addresses loans to corporate CUSOs and review it annually. 12 CFR 
723.5. The proposed rule will also require that the policy address, at 
a minimum, the applicable factors listed in the member business loan 
rule. 12 CFR 723.6(f)-(l). Loans that are fully secured by shares in 
the corporate making the loan or in other financial institutions are 
exempt from these requirements.
    The Board has added a provision to clarify that the statutory 
limits on member business loans, as stated in Sec. 723.16 of the member 
business loan rule, apply to corporate CUSOs. 12 U.S.C. 1757a.
    The Board has also added a provision to clarify that GAAP is to be 
used in accounting for a corporate's investments in and loans to a CUSO 
for the regulatory limitations under Sec. 704.11(b). By using the 
equity GAAP method, a situation could develop in which a corporate's 
initial investment is within the regulatory limitation but, as the CUSO 
operates with continued profitability and the corporate absorbs its 
proportionate share of the profits through no additional cash outlay, 
the corporate could exceed its regulatory limitation. Because 
divestiture at this point could be contrary to prudent business 
practice, the Board will require the corporate to account for the 
investment according to GAAP, but it will not require divestiture or 
prohibit future investments if the regulatory limit is exceeded under 
the equity GAAP method without any additional cash outlay. This change 
mirrors a change made to the natural person CUSO rule. 64 FR 33184, 
June 22, 1999.
    The Board proposes some cosmetic changes to this section, so that 
it is easier to read. Proposed subsection (b) will only address the 
investment and loan limitations. The rest of current subsection (b), as 
well as the new due diligence requirements, are now in proposed 
subsections (c) through (e). Subsection (c) addresses due diligence; 
subsection (d) addresses separate structures; and subsection (e) 
addresses prohibited activities. Prior subsections (c) through (e) are 
redesignated (f) through (h).
Permissible Services Section 704.12
    The Board requested comment on eliminating this provision currently 
titled ``Services.'' 64 FR 40788. This section states that a corporate: 
may provide services to its members; may provide services through a 
correspondent services agreement to nonmember natural person credit 
union branch offices operating in the corporate's geographic field of 
membership; and may not perform services for nonmember natural person 
credit unions through agreements with other corporates or pursuant to 
Sec. 701.26 of NCUA's rules except with the permission of NCUA. 
Fourteen of the 16 commenters that responded to this issue suggested 
eliminating this provision because, in practice, the geographic area 
defined in a corporate's charter is likely to be a national one. One of 
the commenters that opposed eliminating the section identified itself 
as a small corporate and stated that the current process of requiring 
corporates to apply for expanded fields of membership should be 
preserved in order to ascertain that the applicant has the ability and 
structure to serve a larger geographic area.
    The Board agrees that, based on current national fields of 
membership for most corporates, the rationale for limiting a 
corporate's authority to provide correspondent services no longer 
exists. The Board proposes eliminating this limitation on correspondent 
services.
    Before 1998, services were defined to include investments, 
liquidity management, payment systems and correspondent services. 53 FR 
20122, June 2, 1986. The current rule and its preamble do not define 
services, but the preamble to the proposed rule indicated that the 
Board intended to limit services. The proposal stated that the prior 
list of services had been interpreted too broadly and that the intent 
was that services be limited to ``traditional loan, deposit and payment 
services.'' 61 FR 28085, 28096 (June 4, 1996).
    Upon further reflection, the Board believes that limiting services 
to ``traditional loan, deposit and payment services'' is too 
restrictive. As stated in the preamble to a prior corporate rule, 
``[t]he purpose of this section is to grant [c]orporate [f]ederal 
credit unions the power to offer innovative programs and services to 
their members in the areas of investments, liquidity management, 
payment systems and correspondent services subject to applicable 
provisions of law, regulation, bylaws and any orders of the NCUA 
Board.'' 53 FR 20122, 20123.
    The Board proposes retitling this section ``Permissible Services'' 
and permitting eight broad categories of financial services. The four 
broad categories of financial services included in the prior rule's 
definition will be reinstated as permissible financial services. The 
Board is adding to the 1986 definition four additional categories of 
financial services. They are: asset and liability management; 
electronic financial services; sale or lease of excess physical or 
information system capacity; and operational services associated with 
administering or providing financial products or services. Again, as in 
1986, the Board will not issue a specifically authorized list of 
activities, but rather a list of broad categories, because 
``technology, regulation and various financial groupings and networks 
are all changing rapidly.'' Id. With this approach, ``the staff 
believes corporates can be most responsive in a dynamic environment.'' 
Id.
    The list of permissible financial services is intended to establish 
broad categories of permissible financial services. If a corporate 
believes a financial service falls within a broad category it is not 
required to seek an opinion from NCUA. The test a corporate should use 
to determine if a

[[Page 48751]]

financial service falls within one of the specifically authorized broad 
categories is whether it is the functional equivalent or logical 
outgrowth of a broad category and whether the financial service 
involves risks similar in nature to those already assumed as part of 
the business of corporates. An opinion from NCUA is recommended if 
there is doubt as to whether a specific financial service falls within 
one of the broad categories.
    The Board also asked for comment on clarifying the definition of 
correspondent services. 12 CFR 704.2. Currently, correspondent services 
are defined as ``services provided by one financial institution to 
another and includes check clearing, credit and investment services, 
and any other banking services.'' Id. Thirteen of the fourteen 
commenters that commented opposed changing the definition. The reasons 
given were that, if the services are listed, they may become outdated 
and limiting and that the existing definition provides the appropriate 
balance of flexibility and guidance. The Board proposes defining 
correspondent services in the provision governing permissible financial 
services to members and allowing the same types of services to 
nonmembers through a correspondent services agreement as are permitted 
to members.
    In addition to the issue of permissible financial services offered 
under a correspondent services agreement, the definition needs to 
clarify that a correspondent agreement is an agreement between two 
corporates for one of the corporates to provide services to the members 
of the other. Usually, the reason for the agreement is because the 
recipient corporate does not provide the services or the member's 
geographic location makes it impractical to do so.
    Finally, the proposal moves the current prohibition on the purchase 
of mortgage servicing rights from the investment section of the rule to 
this section because servicing rights are more closely aligned with 
services than investments. In addition, the term ``mortgage servicing 
rights'' is replaced with ``loan servicing rights'' to reflect the 
intent behind the prohibition that the purchase of all loan servicing 
rights is prohibited.
Fixed Assets Section 704.13
    The Board recognizes the ongoing need to evaluate the significance 
and relevance of existing rules. The current fixed asset requirement 
for corporates does not appear to offer any added value to the safety 
and soundness of corporates. None of the corporates have fixed assets 
at levels that approach the existing regulatory limit of 15 percent of 
capital.
    Corporates operate on a very small net margin. An excessive 
investment in fixed assets will have a noticeable impact on earnings. 
The Board believes monitoring of fixed assets in corporates is best 
accomplished through ongoing supervision rather than through 
regulation. As such, the Board proposes eliminating this section.
Representation Section 704.14
    The Board intended the definition of a credit union trade 
association to include its affiliates. The preamble to the final rule 
explains that ```[c]redit union trade association' includes but is not 
necessarily limited to, state credit union leagues and league service 
corporations, national credit union trade associations and their 
affiliates and service organizations, and local, state, and national 
special interest credit union associations and organizations.'' 59 FR 
59357, 59358, November 17, 1994 (emphasis added). There is some 
confusion because Sec. 704.14(a)(3) includes the term ``affiliates'' in 
limiting directors' ties to the same credit union trade association but 
Sec. 704.14(a)(2) does not include the term ``affiliates'' in its 
prohibition of the chair of the board serving as an officer, director 
or employee of a credit union trade association. Although the 
definition of credit union trade association includes affiliates, it is 
necessary to include the term in Sec. 704.14(a)(3) because for purposes 
of that provision, the trade association and its affiliate are 
considered one and the same.
    To eliminate the confusion, the Board proposes deleting the 
definition of ``trade association'' from the definition's section of 
the rule and replacing it with the definition of a ``credit union trade 
association'' since this is the only way the term is used. The Board 
proposes using the definition in the 1994 preamble to the final rule 
quoted above. 59 FR 59358.
    In addition, the Board is amending the requirement in 
Sec. 704.14(a) that both federal and state-chartered corporates comply 
with the federal corporate bylaws governing election procedures. The 
intent behind this requirement is that all corporates' election 
procedures comply with Sec. 704.14(a), not that state-chartered 
corporates must adopt the Federal Corporate Bylaws. The rule is being 
amended to reflect this.
Wholesale Corporate Credit Unions Section 704.19
    The Board requested comment on whether the need for separate 
wholesale corporate regulatory requirements still exists and, if so, 
the appropriateness of the existing wholesale corporate regulatory 
requirements. Currently, separate wholesale corporate rules apply for 
minimum capital ratio, calculation of reserve transfers, minimum NEV 
ratio, maximum NEV volatility, and validation of the asset and 
liability management modeling system. 12 CFR 704.19(b) and (c).
    Nine of the 13 commenters supported separate regulatory 
requirements for wholesale corporates. Some of the reasons in support 
were: their size; their unique role in the corporate credit union 
system; risks inherent in their portfolios; and scope of services 
offered. Most of the supporting commenters believed the existing rules 
are adequate. Some of the commenters suggested revising the rules to 
provide wholesale corporates more flexibility.
    Commenters opposing separate wholesale corporate regulatory 
requirements noted the risks are similar regardless of whether or not 
the corporate is designated as a wholesale corporate. They questioned 
both the appropriateness and the need to differentiate between the two.
    Although the Board agrees with the commenters that risks inherent 
in corporate balance sheets are similar regardless of whether or not 
the corporate is a wholesale corporate, there is one area, RUDE ratio, 
where the Board believes a separate rule is necessary. Providing a 
lower minimum RUDE ratio for wholesale corporates recognizes their 
unique position in the two tier corporate system. Wholesale corporate 
credit union members provide one level of RUDE. The Board does not 
believe a second level of RUDE, at the same level as corporate members, 
is warranted for wholesale corporates. The lower RUDE ratio is also 
justified because wholesale corporates have a greater ability to raise 
other forms of capital, including from non-credit union sources, if 
needed. Accordingly, the Board is establishing a 1 percent minimum RUDE 
ratio requirement for wholesale corporates, as opposed to the 2 percent 
minimum RUDE ratio requirement for other corporates.
    As explained below, in all other areas, the Board sees no basis for 
maintaining different regulatory requirements for wholesale corporates. 
Capital should be commensurate with the risks taken. The Board proposes 
eliminating the requirement that wholesale corporates must maintain a 
minimum capital ratio of 5 percent. 12 CFR 704.19(b)(1). The Board 
proposes requiring wholesale corporates to maintain the same 4 percent 
minimum capital ratio as other corporates.

[[Page 48752]]

    As with other corporates, the Board is eliminating the reserve 
ratio and reserve transfer requirements for wholesale corporates. 12 
CFR 704.19(b)(2).
    The Board believes exposures associated with interest rate risk are 
the same regardless of the type of corporate. Therefore, the Board 
proposes eliminating separate regulatory requirements for the minimum 
base case NEV ratio and the maximum decline in NEV for wholesale 
corporates. The existing rule for wholesale corporates establishes .75 
percent as the minimum base case NEV ratio and limits the decline in 
NEV to no more than 35 percent when conducting the interest rate 
sensitivity analysis in Sec. 704.8(d)(1)(i). 12 CFR 704.19(c). For the 
reasons cited for other corporates, the Board proposes requiring the 
same minimum base case NEV ratio of 2 percent for wholesale corporates. 
The Board also proposes establishing the same rules limiting the 
maximum decline in NEV to no more than 10 percent or as approved under 
Appendix B of this part.
    The Board proposes eliminating the requirement that wholesale 
corporates must obtain an annual third-party review of their asset and 
liability management modeling system. 12 CFR 704.19(c)(2). The issue of 
whether a third-party review is required should not be based upon 
whether the corporate is a wholesale corporate, but rather, review 
should be undertaken by all corporates periodically, in accordance with 
industry standards, or when changes are made to their modeling system. 
The Board believes Sec. 704.4(c)(5) and (7) adequately address audits 
and reviews of systems and that asset and liability management system 
review is best left as a supervision issue.
Appendix A to Part 704--Model Forms
    The Board proposes additional wording to the model disclosure forms 
for MC and PIC accounts. The purpose of the disclosure forms is to 
establish the minimum terms and conditions. The Board desires that 
corporates have flexibility in designing capital accounts that best 
suit their needs and the needs of their members. Additional disclosure 
may be required based on the specific characteristics of a corporate's 
capital accounts. As such, the form no longer states corporates that 
utilize the minimum standard wording will be in compliance with the 
regulation. Any additional material terms and conditions must be 
disclosed.
    The additional wording in the proposal clarifies that funds in MC 
and PIC accounts are not automatically releasable due to the merger, 
charter conversion or liquidation of the natural person credit union 
member account holder. Further, in the event of the merger of the 
corporate, the MC and PIC accounts transfer to the continuing 
corporate. The sample disclosure forms have also been revised to 
require disclosure on whether MC is a term certificate or an adjusted 
balance account. In the case of an adjusted balance account, the 
adjustment period and adjustment measure must be disclosed. In the case 
of PIC, the disclosure must note if the account is either term or 
perpetual.
Appendix B to Part 704--Expanded Authorities and Requirements
    Currently, Appendix B provides corporates with incrementally 
greater authorities if additional infrastructure and capital 
requirements are met. The Board proposes introducing a more flexible 
approach to expanded authorities. The proposed changes to this section: 
move all expanded authorities to Appendix B; expand permissible credit 
ratings on investments; provide more options for the use of expanded 
powers; and allow more corporates the opportunity to participate in 
risk reducing derivative activities.
    In addition, the proposed rule establishes minimum standards for 
any corporate participating in expanded authorities. The minimum 
standards require monthly NEV modeling and an annual updating of the 
self-assessment plan. NEV modeling is currently required for all 
expanded authority parts and so, including this as a minimum 
requirement is not a substantive change. The addition of the 
requirement to update the self-assessment plan annually is being 
proposed to ensure corporates operating with expanded authorities 
maintain the systems, controls and policies in place on an ongoing 
basis. This requirement is being incorporated into Appendix B, since 
the annual review requirements currently in Sec. 704.4(a) have been 
interpreted as not applying to the expanded authorities self-assessment 
plan.
    As part of its overall change to expanded authorities, the Board 
proposes tying mandatory capital levels to NEV volatility. The more 
volatile the NEV measure during instantaneous, permanent, and parallel 
shocks of the Treasury yield curve, the greater the risk. Recognizing 
that all corporates do not operate at the same levels of risk, the 
Board is proposing to reduce mandatory capital levels if NEV volatility 
is maintained at lower levels. As volatility increases, additional 
capital levels will be required.
    Several commenters suggested changing the expanded authorities 
provision of the rule to a menu-driven approach, rather than bundling 
several activities under one category. Often, the corporate only wants 
to engage in one activity but it must get approval for all the 
activities in a given category. The commenters advocated the menu 
approach would reduce burden on corporates and the NCUA. The Board 
agrees with the commenters and proposes a modified, menu-driven 
approach, as explained below.
    The current NEV decline limit for a base-plus corporate is 25 
percent of the base case NEV ratio. The current NEV decline limits for 
Part I and II corporates are 35 percent and 50 percent, respectively.
    The Board proposes decreasing the NEV decline limit for a base-plus 
corporate to 15 percent, as illustrated in Table 2. The Board also 
proposes a menu-driven approach for NEV decline limits for corporates 
requesting Part I or Part II Expanded Authorities. A corporate seeking 
Part I approval could request one of two NEV decline limits: 15 
percent; or 20 percent, provided the corporate maintains a minimum 
capital ratio of 5 percent. A corporate seeking Part II approval could 
request one of three NEV decline limits: 15 percent; 20 percent, 
provided the corporate maintains a minimum capital ratio of 5 percent; 
or 30 percent, provided the corporate maintains a minimum capital ratio 
of 6 percent.

                                      Table 2.--Proposed NEV Decline Limits
----------------------------------------------------------------------------------------------------------------
                                                                                     Proposed
                                                    Current NEV   Proposed level      minimum      Proposed NEV
      Current level of expanded authorities        decline limit    of expanded       capital      decline limit
                                                                    authorities     requirement
----------------------------------------------------------------------------------------------------------------
Base plus.......................................              25       Base plus               4              15
Part I..........................................              35   Part I NEV 15               4              15
  ..............................................                   Part I NEV 20               5              20

[[Page 48753]]

 
Part II.........................................              50  Part II NEV 15               4              15
  ..............................................                  Part II NEV 20               5              20
  ..............................................                  Part II NEV 30               6              30
----------------------------------------------------------------------------------------------------------------

    The Board's analysis of the effect of the proposed NEV decline 
limits on corporates with expanded authorities is summarized in Table 
3. Although the proposed permissible NEV declines are smaller for some 
corporates with expanded authorities, no corporate's reported NEV 
declines under adverse rate shocks would violate the proposed NEV 
decline limits.

   Table 3.--Analysis of Proposed Permissible NEV Declines For Base-plus, Part I, and Part II Corporate Credit
                   Unions Simple Averages For the Quarters Ending June 2000 Through March 2001
                                                    [Percent]
----------------------------------------------------------------------------------------------------------------
                                                                                                     Permitted
                                                                                    NEV decline    decline as %
                                                                     NEV ratio         limit         of FV of
                                                                                                      assets
----------------------------------------------------------------------------------------------------------------
Base plus:
Current rule....................................................            4.23              25            1.06
Proposed rule...................................................            9.24              15            1.39
Part I:
Current rule....................................................            3.62              35            1.27
Proposed rule...................................................            8.44              20            1.69
Part II:
Current rule....................................................            3.53              50            1.76
Proposed rule...................................................            6.51              30            1.95
----------------------------------------------------------------------------------------------------------------

    The Board proposes permitting any corporate currently approved for 
Part I or Part II Expanded Authorities to request to lower its NEV 
decline limit in conjunction with a request to lower its minimum 
capital requirement from 5 percent or 6 percent, respectively.
    The Board proposes moving Base-Plus Expanded Authorities from 
Sec. 704.8(e) to Appendix B to include all expanded authorities in 
Appendix B. As previously discussed, the NEV testing requirements are 
being moved to the Minimum Requirements section of the proposed rule. 
The remaining authority relating to maximum NEV decline remains under 
the applicable expanded authority. The current NEV decline limit for a 
Base-Plus corporate is 25 percent of the base case NEV ratio. In light 
of the proposed change to the definition of NEV, the Board proposes to 
decrease that limit to 15 percent.
    As discussed above in Sec. 704.6 Credit Risk Management analysis, 
the Board proposes to establish limits for the aggregate credit 
exposure to a single obligor at 50 percent of capital. This limit 
provides corporates with substantial flexibility in comparison to other 
depository institutions. The Board believes that this limit is the most 
credit exposure a corporate should prudently take in investment-grade 
quality investments. This 50 percent limit would apply to all 
corporates.
    Proposed Sec. 704.6(c)(2)(i) increases the 50 percent limit to 200 
percent for base and base-plus corporates for repurchase and securities 
lending transactions. The Board proposes expanding this increase for 
Part I and II corporates. Due to the increased infrastructure 
requirements for Parts I and II corporates, the Board proposes 
establishing a 300 percent limit for Part I corporates, and a 400 
percent limit for Part II corporates.
    Currently, corporates with Part I authority may purchase long-term 
investments rated no lower than AA-. The Board proposes lowering the 
minimum rating requirement for a long-term investment (including asset-
backed securities) to A-. Currently, corporates may purchase a short-
term investment rated no lower than A-1. For Part I corporates, the 
Board proposes lowering the minimum rating requirement for a short-term 
investment (including asset-backed securities) to A-2, provided that 
the issuer has a long-term rating no lower than A-. The Board believes 
these changes in permissible ratings represent reasonable increases in 
risk given the additional infrastructure requirements of a Part I 
corporate.
    The Board proposes deleting the authority for Part I corporates to 
enter into repurchase transactions where the collateral securities are 
rated no lower than A (or equivalent). This authority is no longer 
necessary because the Board proposes permitting Part I corporates to 
purchase long-term investments rated no lower than A- (or equivalent).
    The current rule permits Part I and II corporates to engage in when 
issued trading, when accounted for on a trade date basis. The Board 
proposes amending this provision to also permit pair-off transactions, 
when accounted for on a trade date basis. Although not specifically 
stated, the current rule by its absence of a prohibition, impliedly 
permits trading securities. The Board proposes prohibiting trading 
securities for base and base-plus corporates. Due to the increased 
infrastructure requirements for Part I and II corporates, the Board 
proposes permitting them to engage in this activity but will require 
trade date accounting to ensure all transactions are reflected in the 
accounting records of the corporate. This requirement parallels the 
requirement in Sec. 703.100(l).
    In both Part I and II, the Board proposes clarifying that the 
aggregate loan limits apply to both revocable and irrevocable lines of 
credit. Currently, the rule only states ``irrevocable lines of 
credit.'' The Board proposes deleting the modifier ``irrevocable'' to 
clarify this.

[[Page 48754]]

    Currently, corporates with Part II authority may purchase long-term 
investments rated no lower than A- (or equivalent). The Board proposes 
lowering the minimum rating requirement for a long-term investment 
(including asset-backed securities) to BBB (flat). Currently, 
corporates may purchase a short-term investment rated no lower than A-1 
(or equivalent). For Part II corporates, the Board proposes lowering 
the minimum rating requirement for a short-term investment (including 
asset-backed securities) to A-2 (or equivalent), provided that the 
issuer has a long-term rating no lower than BBB (flat). The Board 
believes these changes in permissible ratings represent reasonable 
increases in risk given the additional infrastructure requirements of a 
Part II corporate.
    Currently, corporates with Part II authority must establish limits 
for secured and unsecured loans as a percentage of their capital plus 
pledged shares. The Board proposes limiting unsecured loans to 100 
percent of capital. This proposed unsecured loan limit is the same as 
the current and proposed limit for a Part I corporate. The Board does 
not believe it is appropriate for any corporate to risk more than 100 
percent of its capital to any one member credit union on an unsecured 
basis.
    The Board proposes a number of changes to Part III expanded 
authorities. The Board proposes relaxing the long-term investment 
rating from AA- (or equivalent) to AA- (or equivalent). This change 
represents only a minor increase in risk, and provides Part III 
corporates with additional investment alternatives.
    Currently, Part III requires for foreign investments, that the 
foreign country be rated no lower than AA (or equivalent) for political 
and economic stability. The Board proposes replacing this requirement 
with a requirement for a long-term foreign currency (non-local 
currency) debt rating no lower than AA- (or equivalent). The long-term 
foreign currency rating is based on a broader analysis than that of the 
political and economic stability rating. The Board believes this is a 
more appropriate rating for US dollar denominated investments.
    The Board proposes relaxing the bank issuer/guarantor rating from 
AA (or equivalent) to AA- (or equivalent). This change represents only 
a minor increase in risk, and provides Part III corporates with 
additional investment alternatives.
    The current rule limits non-secured obligations of any single 
foreign issuer to 150 percent of RUDE and PIC. The Board proposes to 
limit all obligations of any single foreign issuer/guarantor to 50 
percent of capital. The Board believes that the limits for foreign 
issuers/guarantors should be parallel to those of domestic obligors and 
based on capital rather than RUDE and PIC.
    The current rule limits non-secured obligations of any single 
foreign country to 500 percent of RUDE and PIC. The Board proposes to 
limit all obligations of any single foreign country to 250 percent of 
capital. This change equates the existing limit based on RUDE and PIC 
to a limit using the new definition of capital. The Board notes that 
sovereign risk is present in foreign debt obligations, whether secured 
or unsecured.
    The Board proposes restructuring Part IV expanded authorities to 
provide more flexibility for corporates to use the authorities to 
reduce risk. The current rule requires corporates to have either Part I 
or II expanded authorities to qualify for Part IV. The proposal removes 
this requirement. The Board believes that all corporates demonstrating 
and possessing the resources, knowledge, systems, and procedures 
necessary to measure, monitor, and control the risks associated with 
derivative transactions should be permitted to use these powers. As 
with all expanded authorities, a corporate in its application must 
detail the specific types of activities it may utilize. The Board 
believes that, used properly, derivative activities can reduce risk to 
the institution and its members. For this reason, the Board is 
proposing this change.
    The current rule states that a corporate may use derivatives only 
for ``creating structured instruments and hedging its own balance sheet 
and the balance sheets of its members.'' 12 CFR part 704, Appendix B, 
Part IV. The proposed rule restates those requirements, but in slightly 
different terms, to clarify the Board's intent. The Board believes 
corporates should be allowed to use derivatives to manage their own 
balance sheets, which may at times add risk, but that the use of 
derivatives for their members is still limited to hedging their 
members' balance sheets, which should only reduce risk.
    The current rule is silent as to counterparty rating for derivative 
transactions with foreign and domestic counterparties. The Board 
proposes adding language to Part IV to clarify its intent that the 
rating requirements for counterparties be comparable to the ratings for 
the corporate's other parallel permissible activities.
    As discussed in the lending section, new Part V gives corporates 
the authority to enter into loan participations with their member 
natural person credit unions. The Board proposes limiting the maximum 
aggregate amount of participation loans with one member credit union to 
25 percent of capital and the maximum aggregate amount of participation 
loans with all member credit unions to 100 percent of capital. A 
corporate is not required to have any other expanded authority to 
qualify for Part V.
    The proposed requirements for Part V that will be included in the 
Guidelines for Submission of Requests for Expanded Authority will 
require a corporate to submit: (1) An economic viability assessment of 
the participation lending program; (2) Proposed staffing, revised 
organizational charts and positions descriptions, and the 
qualifications and experience of participating staff; (3) Discussion of 
the inherent risks associated with the proposed program and how the 
corporate will identify, measure, monitor, and control these risks; (4) 
Proposed participation lending policies and procedures addressing 
limits on the aggregate amount of credit limits for participation loans 
purchased from any one credit union, an aggregate limit of 
participation lending based on capital (with a maximum up to 100 
percent of capital), due diligence (off- and on-site) reviews to be 
performed by the corporate or its authorized agent, and practices 
relating to loan underwriting, loan documentation, collateral 
performance, loan servicing, and loan loss reserving; (5) Plans for a 
periodic independent review of the corporate's participation loan 
program; and (6) Due diligence requirements the corporate will follow 
prior to engaging in the sale or transfer of participation loan pools 
to third parties including: accounting issues, risk management, and 
legal issues.

Request for Comment

    The Board is interested in receiving comment on all of the issues 
raised in this proposal, as well as any other issues the commenters 
believe will assist the Board in issuing its final rule.

Regulatory Procedures

Regulatory Flexibility Act

    The Regulatory Flexibility Act requires NCUA to prepare an analysis 
to describe any significant economic impact any proposed regulation may 
have on a substantial number of small entities (those under $1 million 
in assets). The rule only applies to

[[Page 48755]]

corporates, all of which have assets well in excess of $1 million. The 
proposed amendments will not have a significant economic impact on a 
substantial number of small credit unions and, therefore, a regulatory 
flexibility analysis is not required.

Paperwork Reduction Act

    NCUA has determined that the proposed regulation does not increase 
paperwork requirements under the Paperwork Reduction Act of 1995 and 
regulations of the Office of Management and Budget.

Executive Order 13132

    Executive Order 13132 encourages independent regulatory agencies to 
consider the impact of their actions on state and local interests. In 
adherence to fundamental federalism principles, NCUA, an independent 
regulatory agency as defined in 44 U.S.C. 3502(5), voluntarily complies 
with the executive order. The executive order states that: ``National 
action limiting the policymaking discretion of the states shall be 
taken only where there is constitutional and statutory authority for 
the action and the national activity is appropriate in light of the 
presence of a problem of national significance.'' The risk of loss to 
federally insured credit unions and the NCUSIF caused by actions of 
corporates are concerns of national scope. The proposed rule, if 
adopted, will help assure that proper safeguards are in place to ensure 
the safety and soundness of corporates.
    The proposed rule, if adopted, applies to all corporates that 
accept funds from federally insured credit unions. NCUA believes that 
the protection of such credit unions, and ultimately the NCUSIF, 
warrants application of the proposed rule to all corporates, including 
nonfederally insured. The proposed rule does not impose additional 
costs or burdens on the states or affect the states' ability to 
discharge traditional state government functions. NCUA has determined 
that this proposal may have an occasional direct effect on the states, 
on the relationship between the national government and the states, or 
on the distribution of power and responsibilities among the various 
levels of government. However, the potential risk to the NCUSIF without 
the proposed changes justifies them.

The Treasury and General Government Appropriations Act, 1999---
Assessment of Federal Regulations and Policies on Families

    The NCUA has determined that this proposed rule will not affect 
family well-being within the meaning of section 654 of the Treasury and 
General Government Appropriations Act, 1999, Pub. L. 105-277, 112 Stat. 
2681 (1998).

Agency Regulatory Goal

    NCUA's goal is to promulgate clear and understandable regulations 
that impose minimal regulatory burden. We request your comments on 
whether the proposed rule is understandable and minimally intrusive if 
implemented as proposed.

List of Subjects

12 CFR Part 703

    Credit unions, Investments.

12 CFR Part 704

    Credit unions, Reporting and record keeping requirements, Surety 
bonds.

    By the National Credit Union Administration Board on September 
13, 2001.
Becky Baker,
Secretary of the Board.
    Accordingly, NCUA proposes to amend 12 CFR parts 703 and 704 as 
follows:

PART 703--INVESTMENT AND DEPOSIT ACTIVITIES

    1. The authority citation for part 703 will continue to read as 
follows:

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

    2. Amend Sec. 703.100 paragraph (c) by revising the second and 
third sentences and adding a fourth sentence to read as follows:


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

* * * * *
    (c) * * * Your aggregate purchase of paid-in capital and membership 
capital in one corporate credit union is limited to two percent of your 
assets measured at the time of purchase. Your aggregate purchase of 
paid-in capital and membership capital in all corporate credit unions 
is limited to four percent of your assets measured at the time of 
purchase. Paid-in capital and membership capital are defined in part 
704 of this chapter.
* * * * *

PART 704--CORPORATE CREDIT UNIONS

    3. The authority citation for part 704 will continue to read as 
follows:

    Authority: 12 U.S.C. 1762, 1766(a), 1781, and 1789.

    4. Amend Sec. 704.2 as follows:
    a. Remove the definition of ``commercial mortgage related 
security'', ``correspondent services'', ``market price'', ``member 
paid-in capital'', ``mortgage servicing'', ``net interest income'', 
``non member paid-in capital'', ``non secured obligation'', 
``prepayment model'', ``real estate mortgage investment conduit 
(REMIC)'', ``reserve ratio'', and ``trade association'';
    b. Revise the definitions of ``collateralized mortgage obligation 
(CMO)'', ``fair value'', ``forward settlement'', ``membership 
capital'', ``mortgage related security'', ``paid-in capital'', 
``regular-way settlement'', ``repurchase transaction'', and ``residual 
interest'';
    c. Amend the definitions of ``asset-backed security'' by revising 
the last sentence, and ``net economic value (NEV)'' by revising the 
second and third sentences; and
    d. Add new definitions for ``obligor'', ``quoted market price'' and 
``RUDE ratio''.


Sec. 704.2  Definitions.

* * * * *
    Asset-backed security * * * This definition excludes mortgage 
related securities.
* * * * *
    Collateralized mortgage obligation (CMO) means a multi-class 
mortgage related security.
* * * * *
    Fair value means the amount at which an instrument could be 
exchanged in a current, arms-length transaction between willing 
parties, other than in a forced or liquidation sale. Quoted market 
prices in active markets are the best evidence of fair value. If a 
quoted market price in an active market is not available, fair value 
may be estimated using a valuation technique that is reasonable and 
supportable, a quoted market price in an active market for a similar 
instrument, or a current appraised value. Examples of valuation 
techniques include the present value of estimated future cash flows, 
option-pricing models, and option-adjusted spread models. Valuation 
techniques should incorporate assumptions that market participants 
would use in their estimates of values, future revenues, and future 
expenses, including assumptions about interest rates, default, 
prepayment, and volatility.
* * * * *
    Forward settlement of a transaction means settlement on a date 
later than regular-way settlement.
* * * * *
    Membership capital means funds contributed by members that: are 
adjustable balance with a minimum withdrawal notice of 3 years or are 
term

[[Page 48756]]

certificates with a minimum term of 3 years; are available to cover 
losses that exceed reserves and undivided earnings and paid-in capital; 
are not insured by the NCUSIF or other deposit insurers; and cannot be 
used to pledge against borrowings.
    Mortgage related security means a security as defined in Section 
3(a)(41) of the Securities Exchange Act of 1934 (15 U.S.C. 78c(a)(41)), 
e.g., a privately-issued security backed by mortgages secured by real 
estate upon which is located a dwelling, mixed residential and 
commercial structure, residential manufactured home, or commercial 
structure.
* * * * *
    Net economic value (NEV) * * * All fair value calculations must 
include the value of forward settlements and embedded options. 
Membership capital not qualifying as capital and paid-in capital not 
qualifying as capital are treated as liabilities for purposes of this 
calculation. * * *
    Obligor means the primary party obligated to repay an investment, 
e.g., the issuer of a security, the taker of a deposit, or the borrower 
of funds in a Federal funds transaction. Obligor does not include an 
originator of receivables underlying an asset-backed security, the 
servicer of such receivables, or an insurer of an investment.
* * * * *
    Paid-in capital means accounts or other interests of a corporate 
credit union that: have an initial maturity of at least 20 years; are 
available to cover losses that exceed reserves and undivided earnings; 
are not insured by the NCUSIF or other share or deposit insurers; and 
cannot be used to pledge against borrowings.
* * * * *
    Quoted market price means a recent sales price or a price based on 
current bid and asked quotations.
    Regular-way settlement means delivery of a security from a seller 
to a buyer within the time frame that the securities industry has 
established for immediate delivery of that type of security. For 
example, regular-way settlement of a Treasury security includes 
settlement on the trade date (``cash''), the business day following the 
trade date (``regular way''), and the second business day following the 
trade date (``skip day'').
    Repurchase transaction means a transaction in which a corporate 
credit union agrees to purchase a security from a counterparty and to 
resell the same or any identical security to that counterparty at a 
specified future date and at a specified price.
* * * * *
    Residual interest means the remainder cash flows from a CMO or ABS 
transaction after payments due bondholders and trust administrative 
expenses have been satisfied.
    RUDE ratio means the corporate credit union's reserves and 
undivided earnings divided by its moving daily average net assets.
* * * * *
    5. Amend Sec. 704.3 as follows:
    a. Redesignate paragraphs (d) through (g) as paragraphs (f) through 
(i) and paragraph (b) as paragraph (d);
    b. Remove paragraph (c);
    c. Add paragraphs (b), (c), and (e); and
    d. Revise redesignated paragraphs (f) heading, (f)(1) introductory 
text, (f)(2) and (f)(3)(iii), (g), (h)(1), (h)(2) introductory text, 
(h)(2)(i) through (h)(2)(iii), (i)(1) and (i)(2)(i)(A).


Sec. 704.3  Corporate credit union capital.

* * * * *
    (b) Requirements for membership capital--(1) Form. Membership 
capital funds may be in the form of a term certificate or an adjusted 
balance account.
    (2) Disclosure. The terms and conditions of a membership capital 
account must be disclosed to the recorded owner of the account at the 
time the account is opened and at least annually thereafter.
    (3) Three-year remaining maturity. When a membership capital 
account has been placed on notice or has a remaining maturity of three 
years, the amount of the account that can be considered membership 
capital is reduced by a constant monthly amortization that ensures 
membership capital is fully amortized one year before the date of 
maturity or the end of the notice period. The full balance of a 
membership capital account that is being amortized, not just the 
remaining non-amortized portion, is available to absorb losses in 
excess of the sum of reserves and undivided earnings and paid-in 
capital until the funds are released by the corporate credit union at 
the time of maturity or the conclusion of the notice period.
    (4) Release. Membership capital may not be released due solely to 
the merger, charter conversion or liquidation of a member credit union. 
In the event of a merger, the membership capital transfers to the 
continuing credit union. In the event of a charter conversion, the 
membership capital transfers to the new institution. In the event of a 
liquidation, the membership capital may be released to facilitate the 
payout of shares with the prior written approval of NCUA.
    (5) Sale. A member may sell its membership capital to a credit 
union in the corporate credit union's field of membership, subject to 
the corporate credit union's approval.
    (6) Liquidation. In the event of liquidation of a corporate credit 
union, membership capital is payable only after satisfaction of all 
liabilities of the liquidation estate, including uninsured share 
obligations to shareholders and the National Credit Union Share 
Insurance Fund (NCUSIF), but excluding paid-in capital.
    (7) Merger. In the event of a merger of a corporate credit union, 
membership capital shall transfer to the continuing corporate credit 
union. The three-year notice period for withdrawal of membership 
capital shall remain in effect.
    (8) Adjusted balance accounts:
    (i) May be adjusted no more frequently than once every six months; 
and
    (ii) Must be adjusted in relation to a measure (e.g., one percent 
of a member credit union's assets) established and disclosed at the 
time the account is opened without regard to any minimum withdrawal 
period. If the measure is other than assets, the corporate credit union 
must address the measure's permanency characteristics in the capital 
plan.
    (iii) Notice of Withdrawal. Upon three years written notice of 
intent to withdraw membership capital, the balance of the account will 
be frozen (no further adjustments) until the conclusion of the notice 
period.
    (c) Requirements for Paid-in capital--(1) Disclosure. The terms and 
conditions of any paid-in capital instrument must be disclosed to the 
recorded owner of the instrument at the time the instrument is created.
    (2) Three-year remaining maturity. When a paid-in capital 
instrument has a remaining maturity of 3 years, the amount of the 
instrument that may be considered paid-in capital for this part is 
reduced by a constant monthly amortization that ensures the paid-in 
capital is fully amortized 1 year before the date of maturity. The full 
balance of a paid-in capital instrument that is being amortized, not 
just the remaining non-amortized portion, is available to absorb losses 
in excess of the sum of reserves and undivided earnings until the funds 
are released by the corporate credit union at maturity.
    (3) Release. Paid-in capital may not be released due solely to the 
merger, charter conversion or liquidation of a member credit union. In 
the event of a merger, the paid-in capital transfers to the continuing 
credit union. In the event of a charter conversion, the paid-in capital 
transfers to the new institution.

[[Page 48757]]

In the event of a liquidation, the paid-in capital may be released to 
facilitate the payout of shares with the prior written approval of 
NCUA.
    (4) Callability. Paid-in capital accounts are callable on a pro-
rata basis across an issuance class only at the option of the corporate 
credit union and only if the corporate credit union meets its minimum 
level of required capital and NEV ratios after the funds are called.
    (5) Liquidation. In the event of liquidation of the corporate 
credit union, paid-in capital is payable only after satisfaction of all 
liabilities of the liquidation estate, including uninsured share 
obligations to shareholders, the NCUSIF, and membership capital 
holders.
    (6) Merger. In the event of a merger of a corporate credit union, 
paid-in capital shall transfer to the continuing corporate credit 
union.
    (7) Paid-in capital includes both member and nonmember paid-in 
capital.
    (i) Member paid-in capital means paid-in capital that is held by 
the corporate credit union's members. A corporate credit union may not 
condition membership, services, or prices for services on a credit 
union's ownership of paid-in capital.
    (ii) Nonmember paid-in capital means paid-in capital that is not 
held by the corporate credit union's members. Nonmember paid-in capital 
does not require NCUA approval if all terms and conditions are 
identical to member paid-in capital. Nonmember paid-in capital with 
unlike terms and conditions requires NCUA approval. In determining 
whether or not to approve a nonmember paid-in capital instrument, NCUA 
will consider features such as maturity, capital amortization schedule, 
participation, voting, acceleration, redemption, or other rights of the 
holder. NCUA will also consider the purpose and financial impact of the 
proposed paid-in capital issuance and the corporate credit union's 
financial condition and management capabilities.
* * * * *
    (e) RUDE ratio. A corporate credit union will maintain a minimum 
RUDE ratio of 2 percent. A corporate credit union must calculate its 
RUDE ratio monthly.
    (f) Individual capital ratio requirement. (1) When significant 
circumstances or events warrant, NCUA may require a different minimum 
capital ratio for an individual corporate credit union based on its 
circumstances. Factors that may warrant a different minimum capital 
ratio include, but are not limited to, for example:
* * * * *
    (2) When NCUA determines that a different minimum capital ratio is 
necessary or appropriate for a particular corporate credit union, NCUA 
will notify the corporate credit union in writing of the proposed 
capital ratio and, if applicable, the date by which the capital ratio 
should be reached. NCUA also will provide an explanation of why the 
proposed capital ratio is considered necessary or appropriate for the 
corporate credit union.
    (3) * * *
    (iii) After the close of the corporate credit union's response 
period, NCUA will decide, based on a review of the corporate credit 
union's response and other information concerning the corporate credit 
union, whether a different minimum capital ratio should be established 
for the corporate credit union and, if so, the capital ratio and the 
date the requirement will become effective. The corporate credit union 
will be notified of the decision in writing. The notice will include an 
explanation of the decision, except for a decision not to establish a 
different minimum capital ratio for the corporate credit union.
    (g) Failure to maintain minimum capital ratio, RUDE ratio 
requirement. When either a corporate credit union's capital ratio or 
RUDE ratio falls below the minimum required by paragraphs (d), (e), or 
(f) of this section, or appendix B to this part, as applicable, 
operating management of the corporate credit union must notify its 
board of directors, supervisory committee, and NCUA within 10 calendar 
days.
    (h) Capital restoration plan. (1) A corporate credit union must 
submit a plan to restore and maintain its capital ratio or its RUDE 
ratio at the minimum requirement if either of the following conditions 
exists:
    (i) The capital ratio or RUDE ratio falls below the minimum 
requirement and is not restored to the minimum requirement by the next 
month end; or
    (ii) Regardless of whether the capital ratio or RUDE ratio is 
restored by the next month end, the capital ratio or RUDE ratio falls 
below the minimum requirement for three months in any 12-month period.
    (2) The capital restoration plan must include the following, at a 
minimum:
    (i) Reasons why the capital ratio or RUDE ratio fell below the 
minimum requirement;
    (ii) Descriptions of steps to be taken to restore the capital ratio 
or RUDE ratio to the minimum requirement within specific time frames;
    (iii) Actions to be taken to maintain the capital ratio or RUDE 
ratio at the minimum required level and increase it thereafter;
* * * * *
    (i) * * *
    (1) If a corporate credit union fails to submit a capital 
restoration plan; or the plan submitted is not deemed adequate to 
either restore capital and/or RUDE or restore capital and/or RUDE 
within a reasonable time; or the credit union fails to implement its 
approved capital restoration plan, NCUA may issue a capital directive.
    (2) * * *
    (i) * * *
    (A) Increase the amount of capital and/or RUDE to specific levels;
* * * * *
    6. Amend Sec. 704.4 by removing the word ``operating'' wherever it 
appears in paragraphs (a) and (b) and revising paragraph (c) 
introductory text to read as follows:


Sec. 704.4  Board responsibilities.

* * * * *
    (c) Other requirements. The board of directors of a corporate 
credit union must ensure:
* * * * *
    7. Amend Sec. 704.5 as follows:
    a. Revise paragraphs (a)(1) and (2), (c)(5), (d)(1), (e)(1), (3) 
and (4), (f), and (h)(2) and (3);
    b. Remove paragraphs (c)(6), (d)(3) and (d)(6);
    c. Redesignate paragraphs (d)(4) and (d)(5) as paragraphs (d)(3) 
and (d)(4); and
    d. Revise redesignated paragraphs (d)(3) and (4).


Sec. 704.5  Investments.

    (a) * * *
    (1) Appropriate tests and criteria for evaluating investments and 
investment transactions prior to purchase; and
    (2) Reasonable concentration limits for limited liquidity 
investments (e.g., private placements and funding agreements).
* * * * *
    (c) * * *
    (5) Domestically-issued asset-backed securities.
    (d) * * *
    (1) The corporate credit union, directly or through its agent, 
receives written confirmation of the transaction, obtains a perfected 
first priority security interest in the repurchase securities and 
either takes physical possession or control of the repurchase 
securities or is recorded as owner of the repurchase securities through 
the Federal Reserve Book-Entry Securities Transfer System;
* * * * *

[[Page 48758]]

    (3) The corporate credit union, directly or through its agent, 
receives daily assessment of the market value of the repurchase 
securities and maintains adequate margin that reflects a risk 
assessment of the repurchase securities and the term of the 
transaction; and
    (4) The corporate credit union has entered into signed contracts 
with all approved counterparties and agents, and ensures compliance 
with the contracts.
* * * * *
    (e) * * *
    (1) The corporate credit union, directly or through its agent, 
receives written confirmation of the loan, obtains a perfected first 
priority security interest in the collateral and either takes physical 
possession or control of the collateral or is recorded as owner of the 
collateral through the Federal Reserve Book-Entry Securities Transfer 
System;
    (2) * * *
    (3) The corporate credit union, directly or through its agent, 
receives daily assessment of the market value of collateral and 
maintains adequate margin that reflects a risk assessment of the 
collateral and terms of the loan; and
    (4) The corporate credit union has entered into signed contracts 
with all agents and, directly or through its agent, has executed a 
written loan and security agreement with the borrower. The corporate or 
its agent ensures compliance with the agreements.
    (f) Investment companies. A corporate credit union may invest in an 
investment company registered with the Securities and Exchange 
Commission under the Investment Company Act of 1940 (15 U.S.C. 80a), 
provided that the prospectus of the company restricts the investment 
portfolio to investments and investment transactions that are 
permissible for that corporate credit union.
* * * * *
    (h) * * *
    (2) Engaging in pair-off transactions or trading securities, 
including when-issued trading, adjusted trading, or short sales; and
    (3) Purchasing stripped mortgage-backed securities, small business 
related securities, or residual interests in CMOs or asset-backed 
securities.
* * * * *
    8. Amend Sec. 704.6 by revising paragraphs (a) introductory text 
and paragraphs (a)(3), (a)(4), and (6) through (e) to read as follows:


Sec. 704.6  Credit risk management.

    (a) Policies. A corporate credit union must operate according to a 
credit risk management policy that is commensurate with the investment 
risks and activities it undertakes. The policy must address at a 
minimum:
* * * * *
    (3) Maximum credit limits with each obligor and transaction 
counterparty, set as a percentage of capital. In addition to addressing 
deposits and securities, limits with transaction counterparties must 
address aggregate exposures of all transactions, including, but not 
necessarily limited to, repurchase agreements, securities lending, and 
forward settlement of purchases or sales of investments; and
    (4) Concentrations of credit risk (e.g., originator of receivables, 
insurer, industry type, sector type, and geographic).
    (b) Exemption. The requirements of this section do not apply to 
investments that are issued or fully guaranteed as to principal and 
interest by the U.S. government or its agencies or enterprises 
(excluding subordinated debt) or are fully insured (including 
accumulated interest) by the National Credit Union Share Insurance Fund 
or Federal Deposit Insurance Corporation.
    (c) Concentration limits--(1) General rule. The aggregate of all 
investments in any single obligor is limited to 50 percent of capital 
or $5 million, whichever is greater.
    (2) Exceptions. Exceptions to the general rule are:
    (i) Aggregate investments in repurchase and securities lending 
agreements with any one counterparty are limited to 200 percent of 
capital;
    (ii) Investments in corporate CUSOs are subject to the limitations 
of Sec. 704.11; and
    (iii) Aggregate investments in corporate credit unions are not 
subject to the limitations of paragraph (c)(1) of this section.
    (3) For purposes of measurement, each new credit transaction must 
be evaluated in terms of the corporate credit union's capital at the 
time of the transaction. A subsequent reduction in capital that results 
in noncompliance with this section will require compliance with 
Sec. 704.10.
    (d) Credit ratings. (1) All investments, other than in a corporate 
credit union or CUSO, must have an applicable credit rating from at 
least one nationally recognized statistical rating organization 
(NRSRO).
    (2) At the time of purchase, long-term investments must be rated no 
lower than AA- (or equivalent) and short-term investments must be rated 
no lower than A-1 (or equivalent).
    (3) Any rating(s) relied upon to meet the requirements of this part 
must be identified at the time of purchase and must be monitored for as 
long as the corporate owns the investment.
    (4) Any rating relied upon to meet the requirements of this part at 
the time of purchase that is downgraded below the minimum rating 
requirements of this part must be reviewed by the board or an 
appropriate committee within 30 calendar days of the downgrade.
    (5) Investments are subject to the requirements of Sec. 704.10 if:
    (i) One rating was relied upon to meet the requirements of this 
part and that rating is downgraded below the minimum rating 
requirements of this part; or
    (ii) Two or more ratings were relied upon to meet the requirements 
of this part and at least two of those ratings are downgraded below the 
minimum rating requirements of this part.
    (e) Reporting and documentation. (1) A written evaluation of each 
credit limit with each obligor or transaction counterparty must be 
prepared at least annually and formally approved by the board or an 
appropriate committee. At least monthly, the board or an appropriate 
committee must receive a watch list of existing and/or potential credit 
problems and summary credit exposure reports, which demonstrate 
compliance with the corporate credit union's risk management policies.
    (2) At a minimum, the corporate credit union must maintain:
    (i) A justification for each approved credit limit;
    (ii) Disclosure documents, if any, for all instruments held in 
portfolio.
    Documents for an instrument that has been sold must be retained 
until completion of the next NCUA examination; and
    (iii) The latest available financial reports, industry analyses, 
internal and external analyst evaluations, and rating agency 
information sufficient to support each approved credit limit.
    9. Amend Sec. 704.7 by removing paragraphs (c) through (g), adding 
paragraphs (c) through (f) and redesignating paragraph (h) as paragraph 
(g) to read as follows:


Sec. 704.7  Lending.

* * * * *
    (c) Loans to members--(1) Credit unions. (i) The maximum aggregate 
amount in unsecured loans and lines of credit to any one member credit 
union, excluding pass-through and guaranteed loans from the CLF and the 
NCUSIF, must not exceed 50 percent of capital. (ii) The maximum 
aggregate amount in secured loans and lines of credit to any one member 
credit union, excluding those secured by shares or marketable 
securities and member reverse

[[Page 48759]]

repurchase transactions, must not exceed 100 percent of capital.
    (2) Corporate CUSOs. Any loan or line of credit must comply with 
Sec. 704.11.
    (3) Other members. The maximum aggregate amount of loans and lines 
of credit to any other members must not exceed 15 percent of the 
corporate credit union's capital plus pledged shares.
    (d) Loans to nonmembers--(1) Credit unions. A loan to a nonmember 
credit union, other than through a loan participation with another 
corporate credit union, is only permissible if the loan is for an 
overdraft related to the providing of correspondent services pursuant 
to Sec. 704.12. Generally, such a loan will have a maturity of one 
business day.
    (2) Corporate CUSOs. Any loan or line of credit must comply with 
Sec. 704.11.
    (e) Member business loan rule. Loans or lines of credit to:
    (1) Member credit unions are exempt from part 723 of this chapter;
    (2) Corporate CUSOs must comply with Sec. 704.11; and
    (3) Other members must comply with part 723 of this chapter unless 
the loan or line of credit is fully guaranteed by a credit union or 
fully secured by US Treasury or agency securities. Those guaranteed and 
secured loans must comply with the aggregate limits of Sec. 723.16 but 
are exempt from the other requirements of part 723.
    (f) Participation loans with other corporate credit unions. A 
corporate credit union is permitted to participate in a loan with 
another corporate credit union provided the corporate retains an 
interest of at least 5 percent of the face amount of the loan and a 
master participation loan agreement is in place before the purchase or 
the sale of a participation. A participating corporate credit union 
must exercise the same due diligence as if it were the originating 
corporate credit union.
* * * * *
    10. Amend Sec. 704.8 as follows:
    a. Remove paragraphs (a)(2), (a)(5) and (e);
    b. Redesignate (a)(3) and (a)(4) as (a)(2) and (a)(3), (a)(6) and 
(a)(7) as (a)(4) and (a)(5), and (f) and (g) as (e) and (f);
    c. Add paragraph (a)(6);
    d. Revise redesignated paragraphs (a)(2), (e) and (f); and
    e. Revise paragraphs (c), (d)(1)(i) through (iii) and (d)(2) 
introductory text.


Sec. 704.8  Asset and liability management.

    (a) * * *
    (2) The maximum allowable percentage decline in net economic value 
(NEV), compared to base case NEV;
* * * * *
    (6) The tests that will be used, prior to purchase, to evaluate the 
impact of investments on the percentage decline in NEV, compared to 
base case NEV.
* * * * *
    (c) Penalty for early withdrawals. A corporate credit union that 
permits early certificate/share withdrawals must assess a market-based 
penalty equal to the estimated replacement cost of the certificate/
share redeemed. The market-based penalty must be reasonably related to 
current offering rates of that corporate credit union.
    (d) * * *
    (1) * * *
    (i) Evaluate the risk in its balance sheet by measuring, at least 
quarterly, the impact of an instantaneous, permanent, and parallel 
shock in the Treasury yield curve of plus and minus 100, 200, and 300 
basis points on its NEV, and NEV ratio. If the base case NEV ratio 
falls below 3 percent at the last testing date, these tests must be 
calculated at least monthly until the base case NEV ratio again exceeds 
3 percent;
    (ii) Limit its risk exposure to levels that do not result in a base 
case NEV ratio or any NEV ratio resulting from the tests set forth in 
paragraph (d)(1)(i) of this section below 2 percent; and
    (iii) Limit its risk exposures to levels that do not result in a 
decline in NEV of more than 10 percent.
    (2) A corporate credit union must assess annually if it should 
conduct periodic additional tests to address market factors that 
potentially can materially impact that corporate credit union's NEV. 
These factors should include, but are not limited to, the following:
* * * * *
    (e) Regulatory violations. If a corporate credit union's decline in 
NEV, base case NEV ratio or any NEV ratio resulting from the tests set 
forth in paragraph (d)(1)(i) of this section violates the limits 
established by this rule and is not brought into compliance within 10 
calendar days, operating management of the corporate credit union must 
immediately report the information to the board of directors, 
supervisory committee, and NCUA. If any violation persists for 30 
calendar days, the corporate credit union must submit a detailed, 
written action plan to NCUA that sets forth the time needed and means 
by which it intends to correct the violation. If NCUA determines that 
the plan is unacceptable, the corporate credit union must immediately 
restructure the balance sheet to bring the exposures back within 
compliance or adhere to an alternative course of action determined by 
NCUA.
    (f) Policy violations. If a corporate credit union's decline in 
NEV, base case NEV ratio, or any NEV ratio resulting from the tests set 
forth in paragraph (d)(1)(i) of this section violates the limits 
established by its board, it must determine how it will bring the 
exposure within policy limits. The disclosure to the board of the 
violation must occur no later than its next regularly scheduled board 
meeting.
    11. Amend Sec. 704.11 by revising paragraph (b), redesignating 
paragraphs (c) through (e) as paragraphs (f) through (h) and adding 
paragraphs (c), (d) and (e) to read as follows:


Sec. 704.11  Corporate Credit Union Service Organizations (Corporate 
CUSOs).

* * * * *
    (b) Investment and loan limitations. (1) The aggregate of all 
investments in and loans to member and nonmember corporate CUSOs must 
not exceed 15 percent of a corporate credit union's capital. A 
corporate credit union may loan to member and nonmember corporate CUSOs 
an additional 15 percent of capital if the loan is collateralized by 
assets in which the corporate has a perfected security interest under 
state law.
    (2) If the limitations in paragraph (b)(1) of this section are 
reached or exceeded because of the profitability of the CUSO and the 
related GAAP valuation of the investment under the equity method 
without an additional cash outlay by the corporate, divestiture is not 
required. A corporate credit union may continue to invest up to the 
regulatory limit without regard to the increase in the GAAP valuation 
resulting from the corporate CUSO's profitability.
    (3) The aggregate of all loans to corporate CUSOs must comply with 
the aggregate limits of Sec. 723.16 of this chapter.
    (c) Due diligence. A corporate credit union must comply with the 
due diligence requirements of Secs. 723.5 and 723.6(f) through (l) of 
this chapter for all loans to corporate CUSOs. This requirement does 
not apply to loans fully secured by shares in the corporate credit 
union making the extension of credit or in other financial 
institutions.
    (d) Separate entity. (1) A corporate CUSO must be operated as an 
entity separate from a corporate credit union.
    (2) The corporate credit union investing in or lending to a 
corporate CUSO must obtain a written legal

[[Page 48760]]

opinion that the corporate CUSO is organized and operated in a manner 
that the corporate credit union will not reasonably be held liable for 
the obligations of the corporate CUSO. This opinion must address 
factors that have led courts to ``pierce the corporate veil'' such as 
inadequate capitalization, lack of corporate identity, common boards of 
directors and employees, control of one entity over another, and lack 
of separate books and records.
    (e) Prohibited activities. A corporate credit union may not use 
this authority to acquire control, directly or indirectly, of another 
financial institution, or to invest in shares, stocks, or obligations 
of another financial institution, insurance company, trade association, 
liquidity facility, or similar organization.
* * * * *
    12. Revise Sec. 704.12 to read as follows:


Sec. 704.12  Permissible services.

    (a) A corporate credit union may provide the following financial 
services to its members: credit and investment services; liquidity and 
asset and liability management; payment systems; electronic financial 
services; sale or lease of excess physical or information system 
capacity; and operational services associated with administering or 
providing financial products or services.
    (b) A corporate credit union may only provide financial services to 
nonmembers through a correspondent services agreement. A correspondent 
services agreement is an agreement between two corporate credit unions, 
whereby one of the corporate credit unions agrees to provide services 
to a member of the other corporate credit union.
    (c) A corporate credit union is prohibited from purchasing loan 
servicing rights.


Sec. 704.13  [Removed and Reserved]

    13. Remove and reserve Sec. 703.13.
    14. Amend Sec. 704.14 by revising paragraph (a) introductory text, 
redesignating paragraphs (b) through (d) as (c) through (e), and adding 
a new paragraph (b) to read as follows:


Sec. 704.14  Representation.

    (a) Board representation. The board will be determined as 
stipulated in its bylaws governing election procedures, provided that:
* * * * *
    (b) Credit union trade association. As used in this section, it 
includes but is not limited to, state credit union leagues and league 
service corporations, national credit union trade associations and 
their affiliates and service organizations, and local, state, and 
national special interest credit union associations and organizations.
* * * * *
    15. Amend Sec. 704.19 by revising paragraph (b) and removing 
paragraph (c) as follows:


Sec. 704.19  Wholesale corporate credit unions.

* * * * *
    (b) Capital. A wholesale corporate credit union will maintain a 
minimum RUDE ratio of 1 percent.
    16. Revise appendix A to part 704 as follows:

Appendix A to Part 704--Model Forms

    This appendix contains sample forms intended for use by 
corporate credit unions to aid in compliance with the membership 
capital account and paid-in capital disclosure requirements of 
Sec. 704.2.

SAMPLE FORM 1

Terms and Conditions of Membership Capital Account

    (1) A membership capital account is not subject to share 
insurance coverage by the NCUSIF or other deposit insurer.
    (2) A membership capital account is not releasable due solely to 
the merger, charter conversion or liquidation of the member credit 
union. In the event of a merger, the membership capital account 
transfers to the continuing credit union. In the event of a charter 
conversion, the membership capital account transfers to the new 
institution. In the event of liquidation, the membership capital 
account may be released to facilitate the payout of shares with the 
prior written approval of NCUA.
    (3) A member credit union may withdraw membership capital with 
three years' notice.
    (4) Membership capital cannot be used to pledge borrowings.
    (5) Membership capital is available to cover losses that exceed 
reserves and undivided earnings and paid-in capital.
    (6) Where the corporate credit union is liquidated, membership 
capital accounts are payable only after satisfaction of all 
liabilities of the liquidation estate including uninsured 
obligations to shareholders and the NCUSIF.
    (7) Where the corporate credit union is merged into another 
corporate credit union the membership capital account shall transfer 
to the continuing corporate credit union. The three-year notice 
period for withdrawal of the membership capital account will remain 
in effect.
    (8) {If an adjusted balance account}: The membership capital 
balance will be adjusted __(1 or 2)__ time(s) annually in relation 
to the member credit union's ____(assets or other measure)____ as of 
__(date(s))____. {If a term certificate}: The membership capital 
account is a term certificate that will mature on __(date)__.
    When an account is opened, the notice must also contain the 
following statement:

    I have read the above terms and conditions and I understand 
them.
    I further agree to maintain in the credit union's files the 
annual notice of terms and conditions of the membership capital 
account.

    The notice form must be signed by either all of the directors of 
the member credit union or, if authorized by board resolution, the 
chair and secretary of the board of the credit union.
    The annual disclosure notice form must be signed by the chair of 
the corporate credit union. The chair must then sign a statement 
that certifies that the notice has been sent to member credit unions 
with membership capital accounts. The certification must be 
maintained in the corporate credit union's files and be available 
for examiner review.

SAMPLE FORM 2

Terms and Conditions of Paid-In Capital

    (1) A paid-in capital account is not subject to share insurance 
coverage by the NCUSIF or other deposit insurer.
    (2) A paid-in capital account is not releasable due solely to 
the merger, charter conversion or liquidation of the member credit 
union. In the event of a merger, the paid-in capital account 
transfers to the continuing credit union. In the event of a charter 
conversion, the paid-in capital account transfers to the new 
institution. In the event of liquidation, the paid-in capital 
account may be released to facilitate the payout of shares with the 
prior written approval of NCUA.
    (3) The funds are callable only at the option of the corporate 
credit union and only if the corporate credit union meets its 
minimum required capital and NEV ratios after the funds are called.
    (4) Paid-in capital cannot be used to pledge borrowings.
    (5) Paid-in capital is available to cover losses that exceed 
reserves and undivided earnings.
    (6) Where the corporate credit union is liquidated, paid-in 
capital accounts are payable only after satisfaction of all 
liabilities of the liquidation estate including uninsured 
obligations to shareholders and the NCUSIF, and membership capital 
holders.
    (7) Where the corporate credit union is merged into another 
corporate credit union the paid-in capital account shall transfer to 
the continuing corporate credit union.
    (8) Paid-in capital is perpetual maturity {or} Paid-in capital 
is a term account with a maturity of ____(at least 20)____ years.
    When a paid-in capital instrument is created, the notice must 
also contain the following statement:

    I have read the above terms and conditions and I understand 
them.
    I further agree to maintain in the credit union's files the 
annual notice of terms and conditions of the paid-in capital 
instrument.

    The notice form must be signed by either all of the directors of 
the credit union or, if authorized by board resolution, the chair 
and secretary of the board of the credit union.
    The annual disclosure notice form must be signed by the chair of 
the corporate credit union. The chair must then sign a statement 
that certifies that the form has been sent to credit unions with 
paid-in capital accounts. The certification must be maintained in 
the corporate credit union's files and be available for examiner 
review.

[[Page 48761]]

    17. Revise appendix B to part 704 as follows:

Appendix B to Part 704--Expanded Authorities and Requirements

    A corporate credit union may obtain all or part of the expanded 
authorities contained in this section if it meets all of the 
requirements of this part 704, fulfills additional management, 
infrastructure, and asset and liability requirements, and receives 
NCUA's written approval. The additional requirements and authorities 
are set forth in this Appendix and in the NCUA publication 
Guidelines for Submission of Requests for Expanded Authority.
    A corporate credit union seeking expanded authorities must 
submit to NCUA a self-assessment plan supporting its request. A 
corporate credit union may adopt expanded authorities when NCUA has 
provided final approval. If NCUA denies a request for expanded 
authorities, it will advise the corporate of the reasons for the 
denial and what it must do to resubmit its request. NCUA may revoke 
these expanded authorities at any time if an analysis indicates a 
significant deficiency. NCUA will notify the corporate credit union 
in writing of the identified deficiency. A corporate credit union 
may request, in writing, reinstatement of the revoked authorities by 
providing a self-assessment plan detailing how it has corrected the 
deficiencies.

Minimum Requirements

    In order to participate in any of the authorities set forth in 
Base-Plus, Part I, Part II, Part III, Part IV, and Part V of this 
Appendix, a corporate credit union must:
    (a) Evaluate monthly the changes in NEV and the NEV ratio for 
the tests set forth in Sec. 704.8(d)(1)(i); and
    (b) Update its self-assessment plan for approved expanded 
authorities annually.

Base-plus

    A corporate which has met the minimum requirements for this 
Base-plus may in performing the rate stress tests set forth in 
Sec. 704.8(d)(1)(i), allow its NEV to decline as much as 15 percent.

Part I

    (a) A corporate credit union which has met the minimum 
requirements for this Part I may:
    (1) Purchase long-term investments rated no lower than A- (or 
equivalent);
    (2) Purchase short-term investments rated no lower than A-2 (or 
equivalent), provided that the issuer has a long-term rating no 
lower than A- (or equivalent);
    (3) Engage in short sales of permissible investments to reduce 
interest rate risk;
    (4) Purchase principal only (PO) stripped mortgage-backed 
securities to reduce interest rate risk;
    (5) Enter into a dollar roll transaction; and
    (6) Engage in trading securities including pair-off transactions 
and when-issued trading, when accounted for on a trade date basis.
    (b) Aggregate investments in repurchase and securities lending 
agreements with any one counterparty are limited to 300 percent of 
capital.
    (c) In performing the rate stress tests set forth in 
Sec. 704.8(d)(1)(i), the NEV of a corporate credit union which has 
met the requirements of this Part I may decline as much as:
    (1) 15 percent; or
    (2) 20 percent if the corporate credit union has a 5 percent 
minimum capital ratio and is specifically approved by NCUA.
    (d) The maximum aggregate amount in unsecured loans and lines of 
credit to any one member credit union, excluding pass-through and 
guaranteed loans from the CLF and the NCUSIF, must not exceed 100 
percent of the corporate credit union's capital. The board of 
directors will establish the limit, as a percent of the corporate 
credit union's capital plus pledged shares, for secured loans and 
lines of credit.

Part II

    (a) A corporate credit union, which has met the minimum 
requirements for this Part II, may:
    (1) Purchase long-term investments rated no lower than BBB 
(flat) (or equivalent);
    (2) Purchase short-term investments rated no lower than A-2 (or 
equivalent), provided that the issuer has a long-term rating no 
lower than BBB (flat) (or equivalent);
    (3) Engage in short sales of permissible investments to reduce 
interest rate risk;
    (4) Purchase principal only (PO) stripped mortgage-backed 
securities to reduce interest rate risk;
    (5) Enter into a dollar roll transaction; and
    (6) Engage in trading securities including pair-off transactions 
and when-issued trading, when accounted for on a trade date basis.
    (b) Aggregate investments in repurchase and securities lending 
agreements with any one counterparty are limited to 400 percent of 
capital.
    (c) In performing the rate stress tests set forth in 
Sec. 704.8(d)(1)(i), the NEV of a corporate credit union, which has 
met the requirements of this Part II, may decline as much as:
    (1) 15 percent;
    (2) 20 percent if the corporate credit union has a 5 percent 
minimum capital ratio and is specifically approved by NCUA; and
    (3) 30 percent if the corporate credit union has a 6 percent 
minimum capital ratio and is specifically approved by NCUA.
    (d) The maximum aggregate amount in unsecured loans and lines of 
credit to any one member credit union, excluding pass-through and 
guaranteed loans from the CLF and the NCUSIF, must not exceed 100 
percent of the corporate credit union's capital. The board of 
directors must establish the limit, as a percent of the corporate 
credit union's capital plus pledged shares, for secured loans and 
lines of credit.

Part III

    (a) A corporate credit union, which has met the minimum 
requirements of either Part I or Part II of this Appendix and the 
additional requirements for Part III, may invest in:
    (1) Debt obligations of a foreign country; and
    (2) Deposits in, the sale of federal funds to, and debt 
obligations of foreign banks or obligations guaranteed by these 
banks.
    (b) All foreign investments are subject to the following 
requirements:
    (1) Short-term investments must be rated no lower than A-1 (or 
equivalent);
    (2) Long-term investments must be rated no lower than AA- (or 
equivalent);
    (3) A sovereign issuer, and/or the country in which a bank 
issuer/guarantor is organized, must have a long-term foreign 
currency (non-local currency) debt rating no lower than AA- (or 
equivalent);
    (4) A bank issuer/guarantor must be rated no lower than AA-;
    (5) For each approved foreign bank line, the corporate credit 
union must identify the specific banking centers and branches to 
which it will lend funds;
    (6) Obligations of any single foreign issuer/guarantor may not 
exceed 50 percent of capital; and
    (7) Obligations in any single foreign country may not exceed 250 
percent of capital.

Part IV

    (a) A corporate credit union, which has met the requirements for 
this Part IV, may enter into derivative transactions specifically 
approved by NCUA to:
    (1) Create structured products;
    (2) Manage its own balance sheet; and
    (3) Hedge the balance sheet of its credit union members.
    (b) All derivative transactions are subject to the following 
requirements:
    (1) If the counterparty is domestic, the counterparty rating can 
be no lower than the minimum rating for comparable term permissible 
investments.
    (2) If the counterparty is foreign, the counterparty rating can 
be no lower than the minimum rating for comparable term permissible 
investments under Part III Authority.

Part V

    A corporate credit union, which has met the requirements for 
this Part V, may participate in loans with member natural person 
credit unions as approved by NCUA and subject to the following 
limitations:
    (a) The maximum aggregate amount of participation loans with any 
one member credit union shall not exceed 25 percent of capital; and
    (b) The maximum aggregate amount of participation loans with all 
member credit unions shall not exceed 100 percent of capital.
[FR Doc. 01-23290 Filed 9-20-01; 8:45 am]
BILLING CODE 7535-01-P