[Federal Register Volume 67, Number 207 (Friday, October 25, 2002)]
[Rules and Regulations]
[Pages 65640-65659]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-26902]



[[Page 65639]]

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

Part II





National Credit Union Administration





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



12 CFR Parts 703 and 704



Investment and Deposit Activities; Corporate Credit Unions; Final Rule

  Federal Register / Vol. 67, No. 207 / Friday, October 25, 2002 / 
Rules and Regulations  

[[Page 65640]]


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

NATIONAL CREDIT UNION ADMINISTRATION

12 CFR Parts 703 and 704


Investment and Deposit Activities; Corporate Credit Unions

AGENCY: National Credit Union Administration (NCUA).

ACTION: Final rule.

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

SUMMARY: NCUA is issuing final revisions to the rule governing 
corporate credit unions (corporates). The major revisions to the rule 
are in the areas of capital, credit concentration limits and services. 
The amendments enable corporates to remain competitive in the 
marketplace while retaining NCUA's historic focus on the safety and 
soundness of the corporate credit union system. The major changes to 
these 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: This rule is effective November 25, 2002, except that the 
revision of the definition ``paid-in capital'' in Sec. 704.2 is 
effective July 1, 2003. Compliance with this rule is not required until 
January 1, 2003.

FOR FURTHER INFORMATION CONTACT: Kent Buckham, Director, Office of 
Corporate Credit Unions, 1775 Duke Street, Alexandria, Virginia 22314-
3428 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, and November 22, 2000, NCUA issued advance 
notices of proposed rulemaking (ANPRs). 64 FR 40787, July 28, 1999; 65 
FR 70319, November 22, 2000. Based on the comments received in response 
to the ANPRs, the Board issued a proposed rule. 66 FR 48742, September 
21, 2001. In response to the comments received, particularly in the 
area of capital, the Board issued a revised proposed rule for another 
round of public comment. 67 FR 44270, July 1, 2002. The Board received 
37 comments on the revised proposal: 22 from corporate credit unions, 
six from natural person credit unions, four from credit union trade 
associations, two from bank trade associations, two from state credit 
union leagues and one from a research firm. The commenters appreciated 
the Board's willingness to issue a revised proposal. The comments to 
the revised proposed rule have greatly assisted the Board in drafting 
the final rule and will be discussed in the relevant section of the 
section-by-section analysis.

B. Section-by-Section Analysis

Natural Person Credit Union Investments, Section 703.100

    As in the initial proposed rule, the Board retained an increase in 
the limit on a natural person credit union's aggregate purchase of 
paid-in capital (PIC) and membership capital (MC) in one corporate to 2 
percent of the credit union's assets measured at the time of purchase. 
Additionally, the Board retained the limit on a credit union's 
aggregate purchase of PIC and MC in all corporates of 4 percent.
    Two commenters, both bank trade groups, noted continued opposition 
to the proposed increase. The commenters argued that it increases 
exposure to individual credit unions and raises the overall systemic 
risk. One commenter expressed support for the proposal but indicated 
the limit should be based on the natural person credit union's net 
worth rather than on its assets.
    The Board remains convinced the revised limits on natural person 
credit union investments in PIC and MC in an individual corporate and 
in the aggregate are in the best interest of the credit union system. 
These changes have been retained in the final rule.

Definitions, Section 704.2

Daily Average Net Assets (DANA)
    Although not specifically addressed in the rule, nineteen 
commenters continued to oppose the guidance on DANA issued by the 
Office of Corporate Credit Union (OCCU) in 2000 that was discussed in 
the preamble. Corporate Credit Union Guidance Letter No. 2000-03, 
August 30, 2000. The letter addressed the inclusion of future dated ACH 
items and uncollected cash letters that are perfectly matched on both 
the asset and liability sides of the balance sheet in the definition of 
DANA. As noted in the revised proposal, the issue is whether such 
transactions should be recorded on their settlement date (the date the 
funds are posted) or on the advice date (the date the corporate 
receives an advice indicating the funds will posted on a specific 
future date). 67 FR at 4270. All of the commenters on this issue noted 
their preference for recording these transactions on the settlement 
date.
    The commenters stated that, while the American Institute of 
Certified Public Accountants (AICPA) has not taken an official position 
on this specific issue, there exists professional accounting guidance 
supporting exclusion of future dated ACH transactions from the 
definition of DANA. For example, the Financial Accounting Standards 
Board (FASB) Statement of Financial Accounting Concept's No. 6--
Elements of Financial Statements defines liabilities as ``probable 
future sacrifices of economic benefits arising from present obligations 
of a particular entity to transfer assets or provide services to other 
entitles as a result of past transactions or events.'' FASB No. 6 goes 
on to state that an item is not a liability ``if the item involves a 
future sacrifice of assets that the entity will be obligated to make, 
but the events or circumstances that obligate the entity have not yet 
occurred.'' A number of commenters indicated they are under no legal 
obligation to pay the transactions on the advice date. Several 
commenters also noted that some corporates have received opinions from 
their CPA firms indicating accounting for such transactions as of the 
advice date is not in accordance with Generally Accepted Accounting 
Principles (GAAP).
    The Board believes it is important to have consistency among 
corporates, as well with the other financial regulators. To ensure 
NCUA's position on this issue is consistent with that taken by the 
other financial regulators, NCUA staff contacted the Federal Deposit 
Insurance Corporation, Office of the Comptroller of the Currency, 
Office of Thrift Supervision and the Federal Reserve Board. All of 
these financial regulators require their financial institutions to 
report future dated ACH transactions on their call reports as of the 
advice date. None of the financial regulators exclude future dated ACH 
transactions from their regulatory ratio calculations. As such, NCUA's 
position is consistent with the other financial regulators.
    The Board remains convinced that a corporate should report future 
dated ACH items and uncollected cash letters on the advice date for 
both regulatory and 5310 (Corporate Credit Union Call Report) reporting 
purposes. For other financial statement reporting, corporates should 
follow their CPA firm's guidance.

Capital, Section 704.3

    One commenter indicated the Board should not set a regulatory 
standard for each type of capital account, including retained earnings. 
The commenter suggests each corporate set its own limits for each type 
of capital it wants to hold. NCUA should just set a minimum overall 
capital level. Several commenters indicated that PIC should be counted 
equally with regular reserves and undivided earnings (RUDE) in all 
areas of the regulation.

[[Page 65641]]

    One commenter recommended limiting the aggregate amount of MC and 
PIC that can be used to satisfy the total capital requirement to 100 
percent of RUDE. One commenter indicated that the amount of MC that can 
be counted as ``core capital'' should be limited to 50 percent of 
retained earnings and PIC.
    The Board is not persuaded to revise the treatment of the various 
capital accounts. The Board believes there is a very important 
distinction between internally generated capital, retained earnings, 
and other types of capital accounts. The Board continues to believe an 
adequate level of internally generated capital is essential to avoid 
erosion of member confidence in the event losses occur. The final 
regulation provides an adequate capital structure and appropriate types 
of capital accounts for corporates.

Requirements for Membership Capital, Section, 704.3(b)

    The Board addresses the comments to this provision in conjunction 
with its discussion of the comments on Appendix A, Model Forms.

Requirements for Paid-in Capital, Section, 704.3(c)

    One commenter suggested removing the prohibition conditioning 
membership, services, or prices for services on a credit union's 
ownership of PIC. The commenter indicated that PIC is no longer 
considered a temporary measure to strengthen capital, and the same 
restriction is not placed on MC. The Board continues to believe it is 
in the best interest of natural person credit unions and their members 
to be able to obtain the most efficient and cost effective services 
available. The Board does not want, in effect, to force natural person 
credit unions to commit to a long-term PIC account as a means of 
obtaining service or membership. PIC was intended to be an additional 
means for corporates to strengthen their levels of capital. The Board 
believes a natural person credit union's decision to invest in PIC 
should be based on its commitment to the corporate, not a requirement 
to obtain services. Forcing natural person credit unions to obtain PIC 
as a condition of membership may have the unintended consequence of 
having them seek products and services outside the system.
    Fifteen commenters requested a ``grandfathering'' period ranging 
from 12 to 24 months on the implementation of the revised definition of 
PIC. While supportive of the change making PIC a perpetual, non-
cumulative dividend account, the commenters believe that immediate 
adoption of the definition might give a competitive advantage to those 
corporates that issued PIC under the existing regulatory definition. 
Several commenters noted that some corporates held off issuing PIC to 
see what the regulatory changes were before dedicating the time and 
expense to that endeavor.
    The Board views the issuance of PIC as a business decision for 
corporates. In response to the comments, the Board will permit 
corporates to issue PIC under the current definition of PIC until June 
30, 2003. The effective date of the revised definition of PIC is 
delayed until July 1, 2003.

Earnings Retention Requirement, Section, 704.3(i)

    Based on comments to the proposed rule, the Board in the revised 
proposal eliminated the requirement that established a minimum RUDE to 
moving DANA ratio of 2 percent. Three commenters opposed this action 
and requested the minimum RUDE ratio be reinstated.
    In place of a minimum RUDE ratio, the Board proposed an earnings 
retention requirement. Five commenters indicated they supported the 
intent of the earnings retention requirement, but not the proposal in 
full. Seven commenters opposed the earnings retention requirement.
    A number of commenters suggested the process for calculating the 
earnings retention ratio is virtually impossible because dividends are 
paid throughout the month on various accounts. Due to the timing of 
when financial statements are prepared, losses or expenses may not be 
fully appreciated until after dividends have already been paid. A 
corporate might pay dividends without realizing it had gone below the 2 
percent level.
    Four commenters indicated that PIC should be included with retained 
earnings in the earnings retention calculation. Another commenter 
suggested excluding the gains/losses on the sale of fixed assets and 
other non-operating gains/losses from the earnings retention 
calculation. One commenter suggested calculating the earnings retention 
requirement only on a quarterly basis, and another commenter suggested 
calculating on a year-to-year rather than month-to-month basis. One 
commenter believed that a total capital ratio alone would be sufficient 
for monitoring capital in corporate credit unions. Another commenter 
suggested that capital requirements for each corporate be based on the 
risk in that specific institution.
    Twenty-seven commenters objected to the dividend restrictions in 
Sec.  704.3(i)(5). Numerous commenters expressed concern that the 
dividend restrictions might give their competitors an advantage over 
credit union deposits. Many also expressed concern that natural person 
credit unions would seek riskier investments if they believed the 
corporate may be unable to pay dividends. This could result in a 
negative impact on the entire credit union system. Several commenters 
also noted that smaller natural person credit unions would be the most 
severely affected as they rely heavily on the dividends they earn from 
their deposits in corporates. Two commenters recommended that a 
corporate that falls below 2 percent be allowed to pay dividends, but 
be required to submit an earnings retention plan. Two other commenters 
objected to the dividend restrictions for state-chartered corporates 
because it moves control over undivided earnings out of the hands of 
the corporates and the state regulators and into the hands of the 
federal deposit insurer. One commenter noted that, even if NCUA were 
flexible in its approach to approving dividend payments, the perception 
of increased risk would have inflicted damage to the credit union 
network. Several commenters indicated that NCUA already has adequate 
regulatory and supervisory tools to ensure corporates build and 
maintain an appropriate level of capital.
    Ten commenters recommended the adoption of a credit-risk weighted 
capital requirement as the best means of measuring capital in corporate 
credit unions.
    The Board continues to believe that an earnings retention 
requirement is the appropriate means of ensuring adequate retained 
earnings on an ongoing basis. As noted in the preamble of the revised 
proposed rule, the Board is concerned that a minimum RUDE ratio may 
have the unintended consequence of limiting the traditional role of 
corporates as depositors of excess liquidity for natural person credit 
unions. The Board also believes, as stated numerous times in the past, 
that a credit-risk weighted capital requirement is not the best measure 
of risk in corporates. 67 FR at 44273.
    The Board agrees failure to pay dividends would have a dramatic 
impact on a corporate, its members, and, potentially, the entire credit 
union system. The intent of proposed Sec.  704.3(i)(5) was to ensure 
cooperative action between the corporate and NCUA and, if applicable, 
the state regulator in building retained earnings that have fallen 
below the minimum desired level. Therefore, the Board is persuaded that

[[Page 65642]]

Sec.  704.3(i)(5) should be revised to address the commenters' concerns 
while retaining the original intent of the proposed regulation. Any 
restriction on the payment of dividends has been eliminated from the 
final rule.
    The final rule requires operational management of corporates to 
notify the board of directors, supervisory committee, OCCU Director 
and, if applicable, the state regulator if the retained earnings ratio 
falls below 2 percent. Notification of the occurrence is sufficient if 
the decrease in the retained earnings ratio is due solely to the 
increase in moving DANA and the dollar amount of retained earnings has 
remained constant or increased. This places no additional burden on a 
corporate that has an influx of funds due to excess liquidity in 
natural person credit unions.
    If a corporate's retained earnings ratio declines below 2 percent 
due, in full or in part, to a decline in the dollar amount of retained 
earnings and the retained earnings ratio is not restored to at least 2 
percent by the next month end, the corporate will be required to submit 
a retained earnings action plan.
    The Board believes NCUA has sufficient supervisory authority over 
corporates, coupled with the notification and the retained earnings 
action plan requirements, to work with officials to address a decline 
in the retained earnings ratio below 2 percent in a timely and 
effective manner.
    The Board is satisfied that the existing retained earnings ratio 
calculation method is sufficient. The timing of the notification within 
10 calendar days is based on the date the determination is made that 
the retained earnings ratio has fallen below 2 percent. If necessary, 
the timing of the submission of a retained earnings action plan within 
30 calendar days is based on the next month end after the month in 
which the retained earnings ratio has fallen below 2 percent. In some 
cases, the determination may be made during the month, while in other 
cases the determination may not be made until after the books are 
closed at the end of the month.

Board Responsibilities, Section 704.4

    The revised proposed rule changed the term ``operating policies'' 
to ``policies'' throughout this section and changed the title of 
subsection (c) to ``Other requirements.'' The commenters supported this 
change and it has been retained as proposed.

Investments, Section 704.5

    The revised proposed rule deleted several investment related 
definitions no longer used in the regulation and amended the 
definitions of: Asset-backed security (ABS), Collateralized mortgage 
obligation (CMO), Forward settlement, Quoted market price, Mortgage 
related security, Regular-way settlement, Repurchase transaction, and 
Residual interest. One commenter suggested including the acronym 
``ABS'' in the title for asset-backed security. The Board agrees, and 
the final rule includes the acronym. No commenters objected to the 
other provisions, and they have been deleted or amended as proposed.
    Two commenters expressed concern about possible erroneous 
categorizations of home equity backed securities on the 5310 Call 
Report in light of the revised definitions of mortgage related security 
and asset-backed security. If there is any uncertainty about 
appropriate reporting, a corporate is encouraged to discuss the matter 
with its corporate examiner.
    One commenter suggested deleting the definitions of: Credit 
enhancement; Dealer bid indication; Industry recognized information 
provider; Matched; and Small business related security, if they are no 
longer used in the regulation. The Board agrees and is deleting the 
first four terms since they are no longer used but is retaining the 
definition of ``small business related security'' since that term is 
used in Sec.  704.5(h)(4).

Policies, Section 704.5(a)

    The revised proposed rule combined the policy requirements in this 
section and deleted ``if any'' from Sec.  704.5(a)(1) to clarify a 
corporate must have ``appropriate tests and criteria'' to evaluate 
investments it makes on an ongoing basis, as well as new investments. 
No comments were received on these provisions, and they have been 
retained as proposed.
    The revised proposed rule deleted the requirement in Sec.  
704.5(a)(2) that the investment policy address the marketing of 
liabilities to its members. No comments were received on this 
provision, and it is deleted in the final rule.
    The revised proposed rule added a requirement for a corporate to 
establish appropriate aggregate limits on limited liquidity 
investments. As with the initial proposed rule, the revised proposed 
rule defined ``limited liquidity investment'' to mean an investment 
without a quoted market price. The preamble specified ``limited 
liquidity investment'' means ``a private placement or funding 
agreement.'' 67 FR at 44274, 44285.
    One commenter did not object to the proposed definition and 
supported the proposed requirements for limited liquidity investments. 
Another commenter was concerned with the proposed definition. The 
commenter noted using the term ``quoted market price'' in the 
definition was problematic, since sales prices on most ABS and MBS are 
not publicly available and dealers do not post bid and asked quotes. 
The Board agrees and has revised the definition in the final rule so 
that it is consistent with the revised proposed preamble. The final 
rule limits ``limited liquidity investments'' to private placements and 
funding agreements. The requirements for limited liquidity investments 
are retained as proposed.
    Authorized Activities, Section 704.5(c)(5). The revised proposed 
rule clarified an ABS must be domestically issued. No comments were 
received on this provision, and it is retained as proposed.
    Section 704.5(c)(6). The revised proposed rule deleted this 
section, which provided specific authorization for CMOs. These 
investments are still authorized under Sec.  704.5(c)(1) and (5). No 
comments were received on this provision, and it is deleted in the 
final rule.
    Repurchase agreements, Section 704.5(d). The revised proposed rule 
made several changes to the requirements for repurchase agreements to 
conform them to current market practices. No comments were received on 
this provision, and it is retained as proposed.
    Securities lending, Section 704.5(e). The revised proposed rule 
made several nonsubstantive changes to the requirements for securities 
lending transactions to clarify the rule and conform it more closely to 
current market practices. No comments were received on this provision, 
and it is retained as proposed.
    Investment companies, Section 704.5(f). Section 704.5(f) of the 
revised proposed rule allows a corporate to invest in an investment 
company, for example, a mutual fund ``provided that the prospectus of 
the company restricts the investment portfolio to investments and 
investment transactions that are permissible for that corporate credit 
union.'' One commenter stated that the prospectus of an investment 
company does not restrict the investment portfolio of an investment 
company, and suggested that the quoted language be changed to read 
``provided that all investments and investment transactions, as 
described in the prospectus of the company, are permissible for that 
corporate credit union.'' The Board appreciates the issue

[[Page 65643]]

the commenter raises but does not believe a change is necessary.
    A mutual fund must file a registration statement with the 
Securities and Exchange Commission (SEC) on Form N-1A. The prospectus 
is Part A of Form N-1A. According to the SEC's instructions for 
completing Part A, the prospectus will ``describe the Fund's principal 
investment strategies, including the particular type or types of 
securities in which the Fund principally invests or will invest.'' SEC 
Final Rule, Registration Form Used by Open-End Management Companies 
(Item 4), 63 FR 13916, 13951, March 23, 1998.
    To the extent that a prospectus for a particular mutual fund only 
discloses the securities it ``principally'' invests in, the fund might 
hold other investments that are impermissible for the corporate credit 
union. This is unacceptable. A corporate may not own investments 
indirectly through a mutual fund that it is prohibited from owning 
directly.
    While the SEC's instructions on completing a prospectus do not 
require the prospectus disclose all permissible investment types, the 
instructions do not prohibit such disclosure either. Where the 
prospectus' description of investment types includes only investments 
permissible for corporates, and that it will not hold investments other 
than those described, the mutual fund will be permissible for the 
corporate.
    The Board also notes that Part B of the registration statement, the 
Statement of Additional Information (SAI), provides additional 
information about the mutual fund's investment policies and permissible 
investment types. For example, the SAI will ``[d]escribe any investment 
strategies, including a strategy to invest in a particular type of 
security, used by an investment adviser of the [mutual] fund in 
managing the fund that are not principal strategies * * *.'' Final 
Rule, Registration Form Used by Open-End Management Companies (Item 
12(b)), 63 FR 13916, 13956, March 23, 1998, (emphasis added). In 
addition, the SAI will ``[d]isclose, if applicable, the types of 
investments that a Fund may make while assuming [a temporary defensive 
position as described in the prospectus.]'' Id., Item 12(d).
    If a prospectus is not clear, a corporate should obtain the SAI on 
any particular mutual fund directly from the fund company. A fund's 
prospectus, when read in conjunction with the SAI, should provide 
sufficient information on the types of investments the fund may make 
and whether they are restricted to those permissible for the corporate.
    Prohibitions, Section 704.5(h). The revised proposed rule permitted 
trading securities but required transactions to be accounted for on a 
trade date basis and, in addition, no longer prohibited engaging in 
pair-off transactions and when-issued trading. The revised proposed 
rule retained the prohibitions on engaging in adjusted trading and 
short sales. No comments were received on these provisions and they are 
retained as proposed in the final rule.
    The revised proposed rule prohibited investments in residual 
interests in ABS, deleted the prohibition on commercial mortgage 
related securities, and moved the prohibition on the purchase of 
mortgage servicing rights from the investments section to the 
permissible services section. The Board notes that the prohibition on 
the purchase of mortgage servicing rights, as explained in the 
permissible services section, is being retained as an impermissible 
investment. One commenter agreed with the deletion of the prohibition 
on investments in commercial mortgage-related securities. The commenter 
noted the market for privately-issued commercial mortgage-related 
securities has become well-established in recent years. The Board 
agrees, and these provisions have been deleted or amended as proposed.

Credit Risk Management, Section 704.6

    The revised proposed rule defined ``obligor'' to mean the primary 
party obligated to repay an investment and excluded from the definition 
the originator of receivables underlying an asset-backed security, the 
servicer of such receivables, or an insurer of an investment. No 
comments were received on this definition, and it is retained as 
proposed.
    The revised proposed rule deleted the definitions of ``short-term 
investment'' and ``long-term investment'' since they are no longer 
used. The revised proposed rule also deleted the definition of 
``expected maturity,'' since that term was only used in the definitions 
of these deleted terms. No comments were received on these definitions, 
and they are deleted in the final rule.
    Policies, Section 704.6(a). The revised proposed rule amended the 
policy requirements to base credit limits on capital, rather than RUDE 
and PIC. A few commenters supported this provision. This provision is 
retained as proposed.
    The revised proposed rule deleted the requirement that the credit 
risk management policy address loan credit limits. The revised proposed 
rule added to the examples of concentrations of credit risk an 
``originator of receivables'' and an ``insurer.'' No comments were 
received on these provisions, and they are retained as proposed.
    Exemption, Section 704.6(b). The revised proposed rule required 
subordinated debt of government sponsored enterprises to meet the 
rule's credit risk management requirements. No comments were received 
on this provision, and it is retained as proposed.
    Concentration limits, Section 704.6(c). The revised proposed rule 
established a general credit 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. One commenter, 
a bank trade group, asserted these changes would increase concentration 
limits. It claimed without explanation that the proposed 50 percent of 
capital limit would not have the overall effect of reducing credit 
concentration limits from the prior limits as stated in the preamble to 
the proposed rule. 67 FR at 44275. The Board disagrees. Using July 2002 
month-end data for an unsecured obligation, the proposed 50 percent of 
capital limit, in comparison to the current limits, would decrease the 
corporate system's aggregate maximum investment in the unsecured 
obligations of a single obligor from $5.43 billion to $2.95 billion, 
reflecting a reduction in credit concentration of $2.48 billion. For 
secured obligations, there would be a large reduction because, unlike 
the revised proposal that had a limit of 50 percent of capital, 
corporates with Part I or Part II expanded authorities currently have 
no limitation.
    Eleven commenters opposed the general credit concentration limit as 
too restrictive. Some commenters noted there is a relatively small 
number of AAA rated obligors. Thus, the proposed limits could force 
increased aggregate exposure to lower quality credits. A number of 
these commenters suggested a general credit concentration limit of 100 
percent of capital on investments rated no lower than AA- (or 
equivalent) or A-1 (or equivalent). Two commenters recommended an 
increase to the credit concentration limit for investments rated AAA 
(or equivalent); one recommended a limit of 100 percent of capital. One 
commenter suggested differentiating between single obligor debt 
instruments and ABS or MBS, noting single obligor instruments, such as 
corporate debt instruments, are entirely dependent upon the performance 
of the issuing entity. Two commenters suggested NCUA generally 
reconsider the limits, with one suggesting NCUA permit a higher

[[Page 65644]]

percentage concentration limit for investments rated AA (double A flat) 
or higher.
    As the Board noted in the revised proposed rule, the Board believes 
this 50 percent limit is the most credit exposure a corporate should 
prudently take in investment-grade quality investments. Id. The Board 
continues to believe the corporate network must exercise caution in 
placing membership capital at risk, and these provisions are retained 
as proposed.
    Section 704.6(c)(2) of the revised proposed rule provided 
exceptions to the general credit concentration rule. For repurchase and 
securities lending transactions, the proposed limit was 200 percent of 
capital. Investments in corporate CUSOs were subject to the limitations 
in Sec.  704.11. Investments in wholesale corporate credit unions and 
aggregate investments in other corporates were exempt. One commenter 
recommended limiting the exemption to wholesale corporates. The 
commenter asserted it was difficult to envision efficiencies for 
corporates investing in other non-wholesale corporates. As stated in 
the preamble to the revised proposal, the Board continues to believe 
that the benefits to the corporate system of applying this exemption to 
all corporates outweigh any potential concerns, and the Board is 
retaining the exemption in the final rule. 67 FR at 44275.
    Revised proposed Sec.  704.6(c)(3) deems an investment as 
``nonconforming'' if it fails a credit concentration requirement 
because of a reduction in capital following the purchase of that 
investment. A corporate is required to exercise reasonable efforts to 
bring nonconforming investments into conformity within 90 days. 
Investments that remain nonconforming for 90 days are deemed to 
``fail'' a requirement, and a corporate will have to comply with the 
requirements in Sec.  704.10. No comments were received on this 
provision, and it is retained as proposed.
    Two commenters recommended deleting Sec.  704.6(c)(4), since 
proposed Sec.  704.6(c)(3) addressed the same issue. The Board notes 
that Sec.  704.6(c)(4) was deleted in the revised proposed rule and 
will remain deleted in the final rule.
    Credit ratings, Section 704.6(d). This section reduced the 
applicable credit rating to AA- (or equivalent) for investments with 
long-term ratings and A-1 (or equivalent) for investments with short-
term ratings. The revised proposed rule triggered the investment action 
plan requirements of Sec.  704.10 if at least two ratings were 
downgraded and a corporate had relied on more than one rating to meet 
the minimum credit rating requirements at the time of purchase.
    A state-chartered corporate supported this proposal, but believed 
additional investment authority was needed. The corporate noted its 
state supervisory authority permitted investment in all investment 
grade categories. Further, the commenter noted typical cash market 
practice for repurchase transactions is to require investment grade 
securities; the commenter noted it is more difficult to arrange 
repurchase agreements at favorable rates if the securities must be 
restricted to those with ratings in the top grades of the investment 
grade categories.
    As noted in the preamble to the revised proposed rule, in light of 
the substantial flexibility already provided to corporates, the Board 
remains convinced a base level corporate should not be permitted to 
acquire more than limited credit risk exposure. Expanded authority 
provisions allow a broader spectrum of credit risk, and require 
increased due diligence by corporates that obtain such authority. 67 FR 
at 44276. Thus, this section is retained as proposed.
    The proposed rule clarified investments in a corporate or a CUSO do 
not require a rating. One commenter recommended corporates be permitted 
to invest in other non-wholesale corporates only if that corporate had 
a credit rating from at least one nationally recognized statistical 
rating organization (NRSRO). It is not current market practice for 
corporates to obtain depositor ratings. While an NRSRO rating is a 
useful tool for investors to evaluate credit risk, it is no substitute 
for due diligence. The Board is convinced a corporate should be 
permitted to decide whether to purchase shares or deposits in another 
corporate. Thus, this provision is retained as proposed.
    One commenter requested clarification of ratings relied upon ``at 
the time of purchase.'' The commenter noted this might mean either the 
trade or settlement date. The commenter asserted industry practice was 
to assign an assumed rating for new-issue securities and not to provide 
an official rating until settlement date. The commenter suggested there 
was the potential for a corporate to be unable to purchase new-issue 
securities until settlement date when the official rating was assigned 
if the interpretation of ``at the time of purchase'' were trade date. 
The Board agrees industry practice is to assign an assumed rating for 
new-issue securities and not to provide an official rating until 
settlement date. However, the Board understands it is also industry 
practice that purchase offers are contingent on assignment of the 
assumed rating. This means a purchasing corporate could refuse delivery 
on the settlement date if a security did not receive the bargained for 
rating. Thus, ``at the time of purchase'' means the security must have 
either an official permissible rating on the trade date if purchase is 
not contingent on receipt of an official permissible rating or, for a 
new issue, an assumed permissible rating on the trade date and an 
official permissible rating on the settlement date.
    To avoid confusion regarding the investment watch list requirements 
of Sec.  704.6(e)(1), the revised proposed rule clarified in Sec.  
704.6(d)(4) that it is applicable only when the corporate relied upon 
more than one rating to meet the minimum credit rating requirements at 
the time of purchase. If there is a subsequent downgrade below the 
minimum requirement, then the investment must be placed on the 
investment watch list.
    One commenter recommended a technical change in Sec.  704.6(d)(4) 
to delete the words ``any rating that'' following ``investment watch 
list'' and to substitute ``any investment for which a rating.'' The 
Board agrees, and the final rule reflects that substitution.
    Reporting and documentation, Section 704.6(e). The revised proposed 
rule clarified that requirements for annual approval apply to each 
credit limit with each obligor or transaction counterparty. No comments 
were received on this provision, and it is retained as proposed.

Lending, Section 704.7

    Section 704.7(c)(1) and (2). Currently, the aggregate secured and 
unsecured loan and line of credit limits to any one member credit union 
are based on the higher of a percentage of capital or a percentage of 
RUDE and PIC. The Board proposed basing the loan limits on a percentage 
of capital and eliminating the option of basing them on a percentage of 
RUDE and PIC. The Board received no comments on this section and has 
adopted this change in the final rule.
    Section 704.7(c) and (d) and Appendix B to Part 704 reference 
``irrevocable'' loans and lines of credit. In the revised proposed 
rule, the Board deleted the modifier ``irrevocable'' while clarifying 
in the preamble that the loan and line of credit limits apply to both 
``irrevocable'' and ``revocable'' loans and lines of credit. One 
commenter objected to the deletion of the word ``irrevocable'' in the 
revised proposed rule. This commenter

[[Page 65645]]

suggested re-inserting either ``irrevocable'' or ``committed'' in the 
final rule so that the limits do not apply to uncommitted lines of 
credit. The Board's intent is that the aggregate limits apply to all 
loans and lines of credit and, therefore, the Board is retaining the 
deletion in the final rule.
    Section 704.7(d). This section addresses ``Loans to nonmembers'' 
and is subdivided into two subsections: Credit unions and Corporate 
CUSOs. A commenter suggested part 704 should not distinguish between 
corporate and natural person credit union CUSOs. This commenter 
recommended expanding Sec.  704.7 to address loans to natural person 
credit union CUSOs rather than requiring those loans to comply with 
part 723. The rationale was that the part 723 collateral requirements 
put corporates at a disadvantage in the marketplace for natural person 
credit union CUSO related activities. In the final rule, the Board does 
not expand Sec.  704.7 to address loans to natural person credit union 
CUSOs. The Board believes that the exceptions should only apply to loan 
limits for corporate CUSOs because these entities are wholly or 
partially owned by corporates. Also, loans to corporate CUSOs are 
currently required to comply with part 723's aggregate limits and most 
of that regulation's due diligence requirements.
    Section 704.7(e)(3). This provision of the revised proposal, like 
the current rule, provides a partial exemption from the member business 
loan rule if a loan or line of credit to an ``Other member'' is fully 
guaranteed by a credit union or fully secured by U.S. Treasury or 
agency securities. One commenter requested clarification as to whether 
cash or shares are also included as permissible collateral to secure a 
loan, line of credit or letter of credit. Loans secured by cash or 
shares, rather than qualifying for a partial exemption, are not member 
business loans and, therefore, are not subject to any of the 
requirements of part 723. 12 CFR 723.1(b)(2).
    Revised proposed Sec.  704.7(e) clarified the applicability of the 
member business loan rule in part 723 to loans granted by a corporate. 
The Board did not receive any comments on this revision and, therefore, 
the Board retained this clarification in the final rule.
    Revised proposed Sec.  704.7(g) expanded the provision governing 
loan participations between corporates to include a requirement that a 
corporate execute a master participation loan agreement before the 
purchase or the sale of a participation loan. In conjunction with this 
requirement, the Board deleted the language that a participation loan 
agreement may be executed at any time before, during, or after the 
disbursement. No comments were received on this section, and this 
requirement is retained in the final rule.
    The Board proposed allowing corporates to participate in loans with 
member natural person credit unions but only as an expanded Part V 
authority and with certain limitations. One commenter indicated 
proposed Part V authority should be a permissible activity for all 
corporates. The rationale was that, since natural person credit unions 
are permitted to engage in this activity, it is not a regulatory 
concern for NCUA. This commenter also stated that state law on 
participation lending should govern state-chartered corporates. As 
stated in the preamble to the proposed rule, since the Board believes 
``a number of corporates do not exhibit a level of infrastructure 
commensurate with the risks associated with this activity,'' corporates 
should apply for approval before entering into loan participations with 
natural person credit unions. 66 FR at 48748. For these reasons, the 
final rule only allows corporates with Part V authority to engage in 
participation lending with natural person credit unions. These safety 
and soundness concerns apply to state-chartered corporates as well as 
federal corporates. Another commenter recommended the Board grandfather 
corporates who have received a waiver to engage in participation 
lending with member natural person credit unions. The Board agrees and 
corporates with existing waivers continue to have the authority to 
enter into loan participations to the extent previously granted without 
applying for Part V authority.
    One commenter recommended expanding Part V to permit a wholesale 
corporate to join with its member corporate in participating in a loan 
that the wholesale corporate is permitted to purchase in its own right 
from a nonmember natural person credit union. The Board believes it 
needs additional time to study this issue, which is being raised for 
the first time in response to the revised proposed rule. The Board 
notes that, after additional study, it may be open to considering this 
activity as permissible either by amending the regulation to expand 
Part V or as a waiver to Part V.
    Finally, the Board proposed reorganizing the lending section to 
make it easier to read. No commenter objected to the reorganization and 
the final rule incorporates these changes.

Asset and Liability Management, Section 704.8

    The revised proposed rule deleted the term ``net interest income'' 
because it is no longer used in the regulation and amended the 
definitions of ``net economic value (NEV)'' and ``fair value.'' NEV 
means the fair value of assets minus the fair value of liabilities. The 
amended definition excluded from liabilities both PIC and MC, rather 
than excluding only PIC. One commenter again urged that all off balance 
sheet financial derivatives remain in the definition of NEV. As the 
Board explained in the revised preamble, for purposes of NEV 
measurement, GAAP does not require accounting for immaterial positions 
in financial derivatives on balance sheets. 67 FR at 44277.
    The commenter also recommended limiting the aggregate amount of MC 
and PIC included in total capital to not more than 100 percent of RUDE 
in any NEV-related requirements. This would limit the aggregate amount 
of MC and PIC excluded from liabilities for purposes of NEV 
calculations to not more than retained earnings, resulting in NEV 
limits based on a percentage of two times the fair value of retained 
earnings. If a corporate were to realize a loss of substantially all of 
retained earnings, but not MC or PIC, the commenter's proposal would 
require a corporate without net unrealized gains to eliminate all 
interest rate risk. The Board does not believe this is the most 
advisable course of action to re-establish earnings. Instead, the Board 
has proposed conservative NEV limits based on capital, rather than a 
subset of capital. Under the Board's formulation, a loss of 
substantially all of retained earnings reduces the level of interest 
rate risk permitted, but does not require a corporate to eliminate all 
interest rate risk. Therefore, these provisions are deleted or amended 
as proposed.
    The Board has made a technical change to the revised proposed 
definition of ``fair value.'' In the first sentence of the definition 
``other than in'' is changed to ``as opposed to.''
    Policies, Section 704.8(a)(2). The revised proposed rule eliminated 
the redundancies with Sec.  704.5(a) and changed the term ``current 
NEV'' to ``base case NEV'' to provide uniform usage throughout the 
regulation. No commenters addressed these provisions, and they are 
deleted or modified as proposed.
    Section 704.8(a)(5). The revised proposed rule deleted the 
requirement for a policy limit on decline in net income. One commenter 
supported this

[[Page 65646]]

deletion, and it is deleted in the final rule.
    Section 704.8(a)(6). The revised proposed rule added a requirement 
for the asset and liability management policy to address the tests used 
before purchase, to include an estimate of the impact of proposed 
investments on the percentage decline in NEV, as compared to the base 
case NEV. One commenter opposed this requirement. The commenter 
advocated the tests should be reviewed as a supervisory issue. As noted 
in the preamble to the revised proposed rule, this provision is 
intended to require a corporate to establish an ongoing process to 
identify, estimate, monitor and control interest rate risk between the 
periodic complete NEV analyses. 67 FR at 44277. The Board believes a 
corporate's board should establish policy parameters for this process 
and has retained this section as proposed.
    Penalty for early withdrawals, Section 704.8(c). The revised 
proposed rule clarified that the minimum penalty for early certificate/
share withdrawal, if early withdrawal is permitted, must be reasonably 
related to the rate that the corporate would be required to offer to 
attract funds for a similar term with similar characteristics. The 
preamble noted a gain does not appear consistent with the notion of a 
penalty for early withdrawal. 67 FR at 44278.
    No commenters addressed the text of the revised proposed rule, 
however, nine commenters objected to the statement in the preamble that 
a gain does not appear consistent with the notion of a penalty for 
early withdrawal. Id. The commenters asserted a gain could be paid on 
early withdrawal of a share certificate and still meet the requirement 
of a penalty for early withdrawal. The commenters noted this is 
consistent with the ``mark to market'' premise of a penalty sufficient 
to cover the estimated replacement cost of the redeemed certificate. 
The commenters also noted the need to be competitive with alternative 
instruments that could provide members with liquidity and gains, 
without the need to increase the balance sheet of both the corporate 
and the member by a share secured loan if a gain could not be paid.
    The Board does not believe that the concept of a penalty can be 
equated with the payment of a gain and reiterates that a gain is not 
permissible in conjunction with a penalty for early withdrawal. In 
addition, the Board is concerned that contractual provisions for 
redemption of a deposit at a gain may have the unintended consequence 
of encouraging a run on a substantially impaired corporate by members 
seeking to obtain gains. The Board acknowledges holders of debt 
securities may freely transact with third-party participants in the 
secondary market at a price that may result in a gain to the holder. 
However, debt security issuers typically are not subject to repurchase 
demands by debt holders. This is because the holder of a typical debt 
security does not have the right to put the debt to the issuer at a 
market price.
    Interest rate sensitivity analysis, Section 704.8(d). The revised 
proposal deleted the requirement to conduct net interest income 
simulations. One commenter supported the elimination of the requirement 
for net interest income simulations, and it is deleted in the final 
rule.
    The revised proposed rule deleted the word ``Treasury'' to permit 
evaluation of the impact of shocks in appropriate yield curves on its 
NEV and NEV ratio, since the market has moved away from the Treasury 
yield curve as a benchmark. No comments were received on this 
provision, and it is amended as proposed.
    Section 704.8(d)(1)(i). The revised proposed rule increased from 
two to three percent the minimum base case NEV ratio that triggers 
monthly interest rate sensitivity analysis testing. One commenter 
suggested setting the trigger at four percent, rather than three 
percent, since the base case NEV ratio for most corporates will 
increase significantly because of the new definition of NEV.
    The Board is comfortable with a three percent NEV trigger for 
monthly testing in base corporates, in large measure because the 
corporate system has improved its ability to identify, measure, monitor 
and control interest rate risk since the existing regulation was 
adopted. In addition, the estimation requirements of amended Sec.  
704.8(a)(6) typically provide adequate information for a base corporate 
with a minimum base case NEV ratio of at least three percent to monitor 
and control interest rate risk between complete periodic reevaluations. 
The Board recognizes base case NEV ratios are likely to increase 
substantially under the amended definition of NEV. The section is 
retained as proposed.
    Section 704.8(d)(1)(ii) limited a corporate's risk exposure to 
levels that do not result in any NEV ratio resulting from the specified 
parallel shock tests, or a base case NEV ratio, of less than two 
percent, rather than the current one percent. No comments were received 
on this provision, and it is retained as proposed.
    Section 704.8(d)(1)(iii). The proposal reduced the NEV decline 
limit for a base corporate from 18 to 15 percent. This represented an 
increased level of risk compared to the current rule, since the 
proposal excluded MCs from liabilities and, therefore, increased the 
base case NEV.
    Two commenters recommended the Board retain the 18 percent limit: 
one noted this represented little interest rate risk and the other was 
not aware of any significant deterioration of a base corporate because 
of interest rate risk. In contrast, one commenter suggested reducing 
the NEV decline limit to 10 percent, to avoid increasing the amount of 
interest rate risk permitted.
    As noted in the preamble to the revised proposed rule, the Board is 
comfortable with the increased risk because the corporate system has 
improved its ability to measure interest rate risk since the existing 
regulation was adopted. 67 FR at 44278. In addition, the estimation 
requirements of amended Sec.  704.8(a)(6) provide adequate information 
for a corporate to monitor and control interest rate risk between 
complete periodic reevaluations. The Board does not believe it is 
prudent to increase the amount of interest rate risk that a base 
corporate may undertake further than the proposed 15 percent decline in 
NEV. Corporates meeting the requirements for expanded authority 
provisions are permitted to undertake additional interest rate risk. 
Thus, this section is retained as proposed.
    Section 704.8(d)(2). The revised proposed rule required all 
corporates to assess annually whether it is appropriate to conduct 
periodic, additional, interest rate risk tests. These additional tests 
formerly were triggered based on the level of unmatched embedded 
options. No comments were received on this provision, and it is 
retained as proposed.
    Regulatory Violations and Policy Violations, Section 704.8(e) and 
(f). The revised proposed changes were non-substantive, grammatical 
amendments and also designated the OCCU Director to respond to 
regulatory violations. No comments were received on these sections, and 
they are retained as proposed.

Divestiture, Section 704.10

    The Board did not propose any changes to this provision; however, 
because of confusion concerning this provision, the Board proposed 
retitling it ``Investment Action Plan.'' This change clarifies that 
divestiture is not the only remedy available under this section. No 
commenters opposed the title change; however, five commenters objected 
to the current inclusion of derivative contracts under the

[[Page 65647]]

divestiture requirements of this section. They stated that these 
contracts are not investments and should not be subject to this 
provision. The commenters noted that these contracts are not freely 
tradable between third parties, as is the case with traditional 
investment instruments, and the cost for a corporate to ``unwind'' a 
derivative contract can be excessive.
    The Board has consistently interpreted derivatives as subject to 
the requirements for investments. 12 CFR parts 703 and 704. Further, 
the Board believes these transactions should be subject to the 
requirements for an investment action plan because of the credit risk 
of the counterparty. Risk mitigation within the contract will have a 
significant impact on the Board's willingness to allow the corporate to 
hold instruments where the issuing entity has been downgraded. The 
Board is aware there are costs involved in unwinding a derivative 
contract and will review each plan submitted by a corporate weighing 
the costs of unwinding the derivative versus the risks associated with 
holding it. In addition, the Board has added clarifying language to 
Appendix B, Part IV to clarify how Sec.  704.10 applies to derivative 
contracts. The Board remains convinced that corporates should not be 
allowed to hold financial contracts or investments from counterparties 
with excessive levels of credit risk and so will continue to interpret 
derivatives as investments under this provision. The Board is revising 
the title as proposed.

Corporate CUSOs, Section 704.11

    The revised proposed rule added new due diligence requirements for 
corporates' loans to corporate CUSOs. These requirements were taken 
from the member business loan rule. No commenters commented on this 
provision and the Board is adopting it in the final rule.
    The revised proposed rule maintains a limit of 15 percent of 
capital for investments in corporate CUSOs, increases the aggregate 
limit for loans and investments to 30 percent of capital, and retains 
the additional 15 percent for loans that are fully secured. One 
commenter objected stating the proposal was too limiting. Another 
commenter suggested clarifying that the 30 percent aggregate limit for 
loans and investments does not include the additional 15 percent for 
loans that are fully secured. The Board believes the increased limits 
strike the appropriate balance between added flexibility and safety and 
soundness and is retaining them as proposed in the final rule. The 
Board notes that the 30 percent aggregate limit does not include the 
additional 15 percent for loans that are fully secured.
    The preamble to the revised proposed rule explained that the 
current audit requirements in Sec.  704.11(d)(3) do not require a 
separate CPA audit for wholly owned CUSOs. This modification mirrored 
the practice that is currently permissible for natural person CUSOs. 63 
FR 10743, 10747, March 5, 1998. Six commenters suggested that this 
exemption be stated in the regulation and it also apply to majority 
owned CUSOs. The Board agrees and the final regulation states that a 
wholly owned or majority owned CUSO is not required to obtain a 
separate annual audit if it is included in the corporate's consolidated 
audit.
    Based on a request from six commenters, the revised proposal 
amended Sec.  704.11(b) so that it mirrors Sec.  712.6 of the natural 
person CUSO rule. Section 704.11(b) prohibits a corporate from 
acquiring control directly or indirectly of another ``financial 
institution'' and Sec.  712.6 prohibits a natural person credit union 
from acquiring control directly or indirectly of another ``depository 
financial institution.'' One commenter questioned the authority of the 
Board to limit ``financial institution'' with the modifier 
``depository.'' The Board's long-standing interpretation of financial 
institution is that it means a deposit taking institution. 51 FR 10353, 
10354, March 26, 1986. This interpretation has been reflected in the 
natural person CUSO rule since 2001 and the Board believes adopting it 
in the corporate CUSO rule is appropriate. 66 FR 40575, August 3, 2001. 
This commenter also objected to the current prohibition on a corporate 
investing in the shares, stocks or obligations of a CUSO that is a 
financial institution. The commenter notes that this prohibition is 
broader than either the limitation in the Federal Credit Union (FCU) 
Act or the natural person CUSO regulation that only prohibit 
``acquir[ing] control directly or indirectly'' and do not prohibit 
``invest[ing]'' in a financial institution. 12 U.S.C. 1757(7)(I); 12 
CFR 712.6. The Board agrees and is deleting this prohibition from the 
final rule.
    The revised proposal clarified that the aggregate limit of Sec.  
723.16, the member business loan rule, applies to loans to CUSOs. No 
comments were received on this clarification and the Board is retaining 
it in the final rule.

Permissible Services, Section 704.12

    The revised proposal listed eight broad categories of permissible 
financial services for corporates with examples under each category. 
This was modeled after the broad categories in parts 712 and 721. The 
Board received no comments on this provision, except as to its 
applicability to state-chartered corporates, and is retaining it in the 
final as proposed.
    The revised proposal, at the commenters' suggestion, added a 
provision similar to the provisions in parts 712 and 721 concerning 
adding new permissible services. It permits corporates to petition the 
Board to add a new service to Sec.  704.12 and encourages them to seek 
an advisory opinion from the Office of General Counsel (OGC) on whether 
a proposed service is already covered by one of the authorized 
categories before filing a petition. The rule does not require a 
corporate to come to OGC for an opinion every time it wants to provide 
a service not specifically listed as an example under a broad category. 
An opinion from OGC is recommended if there is doubt as to whether a 
specific service falls within one of the broad categories. In those 
situations, a corporate that does not consult with OGC runs the risk of 
engaging in an impermissible activity and being subject to supervisory 
action. Six commenters objected to or requested clarification on the 
applicability of this provision to state-chartered corporates. The 
commenters suggest that, at a minimum, since a state-chartered 
corporate's authority to engage in an activity is derived from its 
state statute and not the FCU Act, the appropriate approach for state 
charters is to request a waiver, rather than a rule change, to add an 
activity that may be impermissible for federal corporates. The Board 
would then base its decision to grant or deny the waiver on any safety 
and soundness concerns it has with the proposed activity. The Board 
agrees with the commenters and is revising the final rule to reflect a 
waiver process for state-chartered corporates.
    The revised proposal deleted the requirement that services to 
nonmember natural person credit unions through a correspondent services 
agreement could only be provided to those natural person credit unions' 
branch offices in the corporate's geographic field of membership. In 
addition, the revised proposal clarified that a correspondent services 
agreement is an agreement between two corporates for one of the 
corporates to provide services to the members of the other. One 
commenter reiterated its objection to the clarification that 
correspondent services can only be provided through an agreement with 
another corporate credit union. The Board remains committed to the 
fundamental principle that credit

[[Page 65648]]

unions, including corporates, are formed to serve their members and is 
adopting the requirements in the revised proposal for correspondent 
services in the final rule.
    The revised proposal also moved the current prohibition on the 
purchase of ``mortgage servicing rights'' from the investment section 
to this section and renamed it ``loan servicing rights.'' The Board has 
reconsidered removing this prohibition from the investment section. The 
Board will retain the prohibition in the investment section to clarify 
that this is not a permissible investment. It will also include the 
prohibition in this section. Although this activity is a permissible 
service for natural person credit unions under limited circumstances, 
the Board has safety and soundness concerns with corporates engaging in 
this activity, and will continue to prohibit this service for 
corporates.
    One commenter suggested clarifying that the prohibition on the 
purchase of loan servicing rights does not apply if a corporate has the 
authority to purchase loans and the purchase of servicing rights are in 
conjunction with that purchase. The Board agrees that the purchase of 
servicing rights in conjunction with the purchase of a loan is not 
prohibited.

Fixed Assets, Section 704.13

    The revised proposal eliminated this section. No commenters 
commented on this change. Therefore, the revised proposal reflects this 
change.

Representation, Section 704.14

    The revised proposal clarified the meaning of the term ``credit 
union trade association'' in Sec.  704.14(a) by adding to the 
regulation the definition of ``credit union trade association'' that 
was in the preamble to the prior final rule. 59 FR 59357, 59358, 
November 17, 1994. The thirteen commenters that commented on this 
clarification objected to adding a definition of ``credit union trade 
association.'' The commenters erroneously perceived this as a change 
and stated that it unnecessarily limited the pool of qualified 
applicants and is not needed in light of the recusal provisions in 
Sec.  704.14(d). The commenters stated that the restrictive definition 
ignores the reality that natural person CEOs on corporate boards are 
often the most active in the credit union community serving multiple 
roles at the chapter, league and national level. Several of these 
commenters suggested amending the definition so that it is not so 
limiting. They suggested only including the state credit union leagues 
of the state in which the corporate is headquartered. One commenter 
fails to see how loyalty is divided if the chair serves on the board of 
an affinity group such as a defense, automotive or educational trade 
association. This commenter suggests only prohibiting state or multi-
state leagues.
    The Board continues to believe that the chairman of the board of a 
corporate should not serve simultaneously as an officer, director or 
employee of a national credit union trade association. As the Board 
stated when this provision was originally drafted, ``the chair should 
be an individual whose loyalty is in no way divided between the 
corporate credit union and a trade association.'' 59 FR 59357, 59358, 
November 17, 1994 (emphasis added). The Board, however, agrees that the 
definition is broader than is necessary to accomplish its objective of 
having a chair ``whose loyalty is in no way divided'' and is deleting 
from the prohibition ``and their affiliates and service organizations, 
and local, state, and national special interest credit union 
associations and organizations.''
    The revised proposal amended the requirement in Sec.  704.14(a) 
that both federal and state-chartered corporates comply with federal 
corporate bylaws governing election procedures. All corporates will 
have to comply with Sec.  704.14(a) governing election procedures but 
state-chartered corporates will not have to comply with federal 
corporate bylaws. No commenters commented on this amendment. The Board 
is retaining this change in the final rule.

Wholesale Corporate Credit Unions, Section 704.19

    The revised proposed rule eliminated the proposed 1 percent minimum 
RUDE ratio requirement and replaced it with an earnings retention 
requirement when the retained earnings ratio falls below 1 percent.
    Three commenters addressed the earnings retention requirement. One 
commenter disagreed with the proposal stating despite the two-tier 
corporate structure, the earnings retention requirement should be the 
same as established for retail corporates. This commenter is concerned 
with the potential for a significant financial crisis in the credit 
union industry if a wholesale corporate fails. The Board remains 
convinced a separate wholesale corporate earnings retention requirement 
is appropriate based upon the corporate system's tiered capital 
structure.
    One commenter expressed concern with the earnings retention 
requirement being met by either the current month or rolling 3-month 
calculation. This commenter believes wholesale corporates should be 
permitted to meet the earnings retention requirement based on a rolling 
12-month average as presently permitted for reserve transfers. The 
Board believes sufficient flexibility for meeting the earnings 
retention requirement exists by using either the current month or 
rolling 3-month calculation. The Board notes the OCCU Director may 
approve a decrease in the earnings retention amount in the rare event a 
lesser amount is necessary to avoid a significant adverse impact upon a 
wholesale corporate.
    One commenter stated the .15 percent per annum earnings retention 
requirement when the retained earnings ratio is less than 1 percent and 
the core capital ratio is less than 3 percent neither considers the 
tiering of reserves in the corporate system nor the narrow margins 
necessary for a wholesale corporate to offer competitive investment 
products. This commenter believes the earnings retention factor should 
be .10 percent per annum when the retained earnings ratio is less than 
1 percent and the core capital ratio is less than 3 percent. The Board 
is not persuaded by this argument. The Board considers wholesale 
corporates subject to .15 percent per annum earnings retention 
requirement to be thinly capitalized. The Board believes wholesale 
corporates have numerous options available to reduce the earnings 
retention requirement if the .15 percent per annum earnings retention 
requirement is too onerous. For example, wholesale corporates can issue 
additional PIC to increase the core capital ratio to at least 3 percent 
or they can use off balance sheet activities to shrink their balance 
sheet.
    Two commenters disagreed with the payment of dividend language in 
revised proposed Sec.  704.19(b)(5) for many of the same reasons 
commenters opposed the language contained in revised proposed Sec.  
704.3(i)(5) for retail corporates. One commenter recommended 
substituting a notification provision for the current language. The 
Board agrees and, for the reasons stated in Sec.  704.3, the final rule 
replaces the limitations on the payment of dividends with notification 
and restoration plan requirements.

Appendix A to Part 704--Model Forms

    The revised proposal added language to the model forms to clarify 
the treatment of MC and PIC in the event of the merger, liquidation, or 
charter conversion of a member credit union or the corporate credit 
union. Six commenters raised objections to the

[[Page 65649]]

proposed clarifications. The commenters expressed concern that the 
additional requirements, rather than being a clarification to the 
existing language, alter the contractual agreement between the 
corporate and its members. A number of commenters also noted the 
additional language might create potential legal, regulatory, and 
operational problems. One commenter recommended leaving the added 
language in Appendix A and making the additional disclosure voluntary. 
Several commenters noted that natural person credit unions are not 
bound by part 704, nor is a continuing entity in the event of a charter 
conversion. Further, the commenters contended that, in the case of a 
liquidation or charter conversion, the member holding the MC or PIC 
account ceases to exist. As the entity no longer exists, its membership 
automatically terminates and its shares, including MC and PIC, should 
be paid out in accordance with applicable law. The commenters argued 
the model forms conflict with the Corporate Federal Credit Union 
Bylaws, and they may also conflict with applicable state laws for 
state-chartered credit unions. Several commenters indicated the 
existing language was adequate and it should be left up to each 
corporate to determine how to handle MC in the event of a merger, 
liquidation, or charter conversion based on its own capital management 
plan and applicable laws and regulations.
    The Board does not believe the language added to Appendix A and to 
the requirements for MC in Sec.  704.3(b)(3) create any additional 
legal, regulatory, or operational problems. The current regulation 
requires all MC accounts to have a minimum three-year notice. 12 CFR 
704.2. The regulation does not provide any exceptions to the three-year 
notice requirement. The clarifying language has been added because OCCU 
has received inquiries as to how to handle MC in the event of merger, 
liquidation or charter conversion.
    In the event of a merger, the existence of the MC should be 
identified as part of the due diligence process. The continuing credit 
union has the right to put the MC on notice. If the continuing credit 
union is a member of the corporate, an adjusted balance account may be 
adjusted at the next adjustment period. If the account is not an 
adjusted balance account, the continuing credit union would not be in 
violation of Sec.  703.100, as that section specifically states the 
measure is assets ``at the time of purchase'' of the MC. In the event 
of a charter conversion, as with a merger, the existence and 
requirements of the MC should be identified during the due diligence 
leading up to a charter conversion. The new entity may place the MC on 
notice and collect the funds at the end of the three-year notice 
period. In the event of a liquidation, the Liquidating Agent may submit 
a request to the OCCU Director to allow the corporate to release the 
funds before the end of the three-year notice period.
    The existing regulation is very specific that the only means by 
which a credit union may obtain its funds in an MC account is after the 
three-year notice or if it sells it to another credit union with the 
concurrence of the corporate. 12 CFR 704.2. The language was drafted to 
provide as much ``permanence'' to the three-year accounts as possible 
so they could be considered as capital. The regulatory requirements in 
the corporate rule and the contractual provisions of the MC concerning 
the three-year notice requirement do not conflict with the general 
provision in the Corporate Federal Credit Union Bylaws governing 
withdrawal of shares. Article III, Section 5 of the bylaws states a 
corporate's board may not require a member to give more than 60 days 
notice of intent to withdraw. This general withdrawal provision is not 
intended to apply to accounts that the member is contractually 
obligated to maintain for a period in excess of 60 days. Based on the 
requirements of current Sec.  704.2, there should be no outstanding MC 
with conditions that would cause legal, regulatory, or operational 
concerns due to the addition of the clarifying language.
    One commenter suggested revising the wording of Sec.  704.3(b)(5) 
by changing the words ``credit union'' to ``another member'' to permit 
one member of the corporate to sell its MC to another member rather 
than only to a credit union in the corporate's field of membership. The 
Board concurs with the recommendation and has adopted this change in 
the final rule.

Appendix B to Part 704--Expanded Authorities and Requirements

    In the revised proposed rule the Board proposed changes to: expand 
permissible credit ratings on investments; permit corporates that pre-
commit to a higher level of capital the option of a higher level of 
interest rate risk; ease the requirements for corporates to participate 
in risk reducing derivative activities; and permit corporates to 
participate in loan participations with natural person credit unions. 
In addition, the revised proposal eliminated the proposed requirement 
for corporates to update the self assessment plan originally submitted 
for expanded authority. No comments were received objecting to the 
removal of this requirement and it is retained as proposed.
Base-Plus
    In the revised proposed rule, the Board proposed a maximum NEV 
decline of 20 percent. Several commenters believed the limit should 
remain at its current 25 percent level, and one commenter believed the 
level should be decreased. The Board remains convinced that the 
proposed level is appropriate given the requirement of monthly NEV 
analysis. The Board is adopting the limits from the revised proposed 
rule.
Parts I and II
    In the revised proposed rule, the Board proposed NEV decline limits 
based on capital levels. Several commenters opposed the proposed limits 
recommending the limits remain at current levels, and one commenter 
recommended lower levels. The Board has greater confidence in the 
ability of the corporate credit unions to model their balance sheets 
accurately; therefore, the limits were proposed at levels where the 
corporates can manage their balance sheets without taking excessive 
levels of risk. The Board was not convinced to change the levels either 
up or down; therefore, the Board is adopting the limits from the 
revised proposed rule.
    The Board will permit 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 or 6 percent, respectively.
    In the revised proposed rule, the Board proposed limits for the 
aggregate credit exposure to a single obligor at 50 percent of capital. 
Several commenters objected that the 50 percent of capital general 
concentration limit was too restrictive, particularly for corporates 
with expanded authorities. The commenters recommended increasing 
concentration limits to 100 percent, particularly for long-term 
instruments rated not lower than AA- and short-term investments rated 
no lower than A-1. The Board continues to believe this limit is the 
most credit exposure a corporate should prudently take in investment 
quality investments.
    In the revised proposed rule, the Board established a 300 percent 
of capital limit for Part I, and 400 percent limit for Part II on 
aggregate investments in repurchase and securities lending agreements 
with any one counterparty. Several commenters objected to the

[[Page 65650]]

limits stating that these levels will significantly reduce their 
existing limits. The Board continues to believe the proposed levels are 
prudent given the secured nature of the activity and the increased 
requirements for credit analysis for Part I and II corporates; however, 
the Board believes increasing the limits beyond those proposed would 
raise safety and soundness concerns. The Board is adopting the limits 
as proposed in the revised proposed rule.
    In the revised proposed rule, the Board tied minimum capital 
ratings of short-term investments to a minimum issuer long-term rating. 
One commenter contended that the requirement tying short-term and long-
term ratings together is not representative of credit risks in the 
marketplace because long-term and short-term credit ratings should be 
assessed independently. The Board remains convinced that the overall 
credit quality of the issuer must fall within the limits of this rule 
and is adopting the proposed requirements.
Part II
    The Board proposed lowering the minimum credit rating requirement 
for a long-term investment (including asset-backed securities) to BBB 
(flat). Three commenters recommended that BBB (flat) concentration 
limit be reduced to 25 percent and the concentration limit for AAA 
rated investments be increased to 100 percent of total capital. One 
commenter recommended the concentration limit for AAA rated investments 
be set at 75 percent for Part I and 100 percent for Part II. One 
commenter stated that corporates with higher levels of expanded 
authority have demonstrated the ability to manage the risks inherent in 
these lower rated instruments. The commenter also noted that corporates 
are in the business of managing risk. One commenter was opposed to 
permitting any investment in BBB (flat) rated securities. Based on the 
comments and further analysis of the risk, the Board believes the limit 
for BBB+ and BBB (flat) rated instruments with Part II authority should 
be reduced from the revised proposed rule level of 50 percent to 25 
percent of capital. The Board agrees with the commenters that 
corporates with Part I or II authority do have additional credit 
monitoring capabilities allowing them to move down the credit scale and 
this authority requires the additional infrastructure stipulated in 
this rule and its appendixes.
Part III
    In response to the proposed rule, several commenters noted that 
Part III granted preference to foreign banks over other foreign 
counterparties. The revised proposal permitted corporates to purchase 
investments from any approved entity with an acceptable NRSRO rating 
within a country with an acceptable country rating. This change allowed 
corporates greater flexibility in managing their investments. No 
comments were received and the Board is adopting this change as 
proposed.
    In addition, the revised proposal incorporated the changes from the 
proposed rule. No comments were received and, for the reasons stated in 
the revised proposal, the Board is adopting these changes as proposed. 
67 FR at 44283.
Part IV
    Part IV expanded authorities have been restructured to provide more 
flexibility among corporates seeking to use derivatives to reduce risk. 
The current rule requires corporates to have either Part I or II 
expanded authorities to qualify for Part IV. The proposal removed 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, the corporate in its application must detail the 
specific types of derivatives they may utilize. The Board believes that 
derivative transactions, used properly, reduce risk to the institution 
and its members.
    In the revised proposed rule, the Board broadened the authority of 
corporates to enter into derivative transactions by adding government 
sponsored enterprises, member credit unions, and entities fully 
guaranteed by an entity with a minimum permissible rating for a 
comparable term investment. No negative comments were received, and the 
Board is adopting this change as proposed.
    Several commenters noted that the revised proposed rule should 
state that Part III expanded authority was required for a corporate to 
enter into derivative contracts with a foreign counterparty. The Board 
has amended Part IV to clarify this.
    In the revised proposed rule, Part IV (b)(1) detailed the 
requirements for counterparty credit ratings. Several commenters noted 
in their comments on Sec.  704.10 that derivatives are not investments; 
therefore Section 704.10 should not apply. As previously stated, the 
Board has consistently interpreted derivatives as investments for 
purposes of parts 703 and 704. In addition, the Board believes that 
without credit mitigation within the contract, these instruments may 
present excessive levels of credit risk if a counterparty is 
downgraded. Therefore, Part IV is amended to clarify that compliance 
with Sec.  704.10 is required if the counterparty is downgraded below 
permissible levels.

Delegations of Authority

    Although not in the initial proposed rule, the Board, in an effort 
to streamline the regulatory approval process, has delegated to the 
OCCU Director in the revised proposal, the authority to act on its 
behalf in Sec. Sec.  704.3(e), (g) and (i); 704.8(e); 704.10; 704.15; 
and 704.19(b).

Technical Correction

    The Board has revised the wording in Sec.  704.18(e) to conform to 
the new terminology in part 704.

C. 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 corporates, all of which have 
assets well in excess of $1 million. The final 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 final regulation does not increase 
paperwork requirements under the Paperwork Reduction Act of 1995 and 
regulations of the Office of Management and Budget. NCUA currently has 
OMB clearance for part 704's collection requirements (OMB No. 3133-
0129).

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

[[Page 65651]]

unions and the NCUSIF caused by actions of corporates are concerns of 
national scope. The final rule will help assure that proper safeguards 
are in place to ensure the safety and soundness of corporates.
    The rule 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 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 rule may have an occasional direct effect 
on the states, on the relationship between the national government and 
the states, or on the distribution of power and responsibilities among 
the various levels of government. However, the potential risk to the 
NCUSIF without the final 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 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. The regulatory change is 
understandable and imposes minimal regulatory burden. NCUA requested 
comments on whether the proposed rule was understandable and minimally 
intrusive if implemented as proposed. No comments were received.

Small Business Regulatory Enforcement Fairness Act

    The Small Business Regulatory Enforcement Fairness Act of 1996 
(Pub. L. 104-121) provides generally for congressional review of agency 
rules. A reporting requirement is triggered in instances where NCUA 
issues a final rule as defined by Section 551 of the Administrative 
Procedure Act. 5 U.S.C. 551. The Office of Management and Budget is 
reviewing whether this rule is a major rule for purposes of the Small 
Business Regulatory Enforcement Fairness Act of 1996.

List of Subjects

12 CFR Part 703

    Credit unions, Investments.

12 CFR Part 704

    Credit unions, Reporting and recordkeeping requirements, Surety 
bonds.

    By the National Credit Union Administration Board on October 17, 
2002.
Becky Baker,
Secretary of the Board.

    Accordingly, NCUA amends 12 CFR parts 703 and 704 as follows:

PART 703--INVESTMENT AND DEPOSIT ACTIVITIES

    1. The authority citation for part 703 continues 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 amount 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 investment or adjustment. Your aggregate 
amount 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 investment or adjustment. 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 continues 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'', ``credit enhancement'', 
``dealer bid indication'', ``expected maturity'', ``industry recognized 
information provider'', ``long term investment'', ``market price'', 
``matched'', ``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'', ``reserves and undivided 
earnings'', ``short-term investment'', and ``trade association'';
    b. Revise the definitions of ``capital'', ``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 definition heading and the last sentence, and ``net economic value 
(NEV)'' by revising the second and third sentences; and
    d. Add new definitions for ``core capital'', ``core capital 
ratio'', ``limited liquidity investment'', ``obligor'', ``quoted market 
price'', ``retained earnings'', and ``retained earnings ratio''.


Sec.  704.2  Definitions.

* * * * *
    Asset-backed security (ABS) * * * This definition excludes mortgage 
related securities.
    Capital means the sum of a corporate credit union's retained 
earnings, paid-in capital, and membership capital.
* * * * *
    Collateralized mortgage obligation (CMO) means a multi-class 
mortgage related security.
    Core capital means the corporate credit union's retained earnings 
and paid-in capital.
    Core capital ratio means the corporate credit union's core capital 
divided by its moving daily average net assets.
* * * * *
    Fair value means the amount at which an instrument could be 
exchanged in a current, arms-length transaction between willing 
parties, as opposed to 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.
* * * * *

[[Page 65652]]

    Limited liquidity investment means a private placement or funding 
agreement.
* * * * *
    Membership capital means funds contributed by members that: are 
adjustable balance with a minimum withdrawal notice of 3 years or are 
term certificates with a minimum term of 3 years; are available to 
cover losses that exceed retained earnings and paid-in capital; are not 
insured by the NCUSIF or other share or deposit insurers; and cannot be 
pledged 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 that is rated in one of the two highest rating categories by 
at least one nationally recognized statistical rating organization.
* * * * *
    Net economic value (NEV) * * * All fair value calculations must 
include the value of forward settlements and embedded options. The 
amortized portion of membership capital and paid-in capital, which do 
not qualify 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: are perpetual, non-cumulative dividend accounts; are 
available to cover losses that exceed retained earnings; are not 
insured by the NCUSIF or other share or deposit insurers; and cannot be 
pledged 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.
    Retained earnings means the total of the corporate credit union's 
undivided earnings, reserves, and any other appropriations designated 
by management or regulatory authorities. For purposes of this 
regulation, retained earnings does not include the allowance for loan 
and lease losses account, accumulated unrealized gains and losses on 
available for sale securities, or other comprehensive income items.
    Retained earnings ratio means the corporate credit union's retained 
earnings divided by its moving daily average net assets.
* * * * *

    5. Amend Sec.  704.3 as follows:
    a. Amend paragraph (a) by revising the paragraph heading;
    b. Redesignate paragraphs (d) through (g) as paragraphs (e) through 
(h) and paragraph (b) as paragraph (d);
    c. Remove paragraph (c);
    d. Add paragraphs (b), (c), and (i); and
    e. Revise redesignated paragraphs (e) heading, (e)(1) introductory 
text, (e)(2) and (e)(3)(iii) and (f).


Sec.  704.3  Corporate credit union capital.

    (a) Capital plan. * * *
    (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.
    (i) The initial disclosure 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; and
    (ii) The annual disclosure notice must be signed by the chair of 
the corporate credit union. The chair must 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.
    (3) Three-year remaining maturity. When a membership capital 
account has been placed on notice or has a remaining maturity of less 
than 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 one year before the end of the notice period. The full 
balance of a membership capital account being amortized, not just the 
remaining non-amortized portion, is available to absorb losses in 
excess of the sum of retained 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 
liquidation, the membership capital may be released to facilitate the 
payout of shares with the prior written approval of the OCCU Director.
    (5) Sale. A member may sell its membership capital to another 
member 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 transfers to the continuing corporate credit union. 
The minimum three-year notice period for withdrawal of membership 
capital remains 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 its capital 
plan.

[[Page 65653]]

    (iii) Notice of withdrawal. Upon 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.
    (9) Grandfathering. Membership capital issued before the effective 
date of this regulation is exempt from the limitation of Sec.  
704.3(b)(8)(i).
    (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 
and 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.
    (2) 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. In the event of liquidation, the 
paid-in capital may be released to facilitate the payout of shares with 
the prior written approval of the OCCU Director.
    (3) 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.
    (4) 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.
    (5) Merger. In the event of a merger of a corporate credit union, 
paid-in capital shall transfer to the continuing corporate credit 
union.
    (6) Paid-in capital. 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.
    (7) Grandfathering. A corporate credit union's authority to include 
paid-in capital as a component of capital is governed by the regulation 
in effect at the time the paid-in capital was issued. When a 
grandfathered paid-in capital instrument has a remaining maturity of 
less than 3 years, the amount that may be considered paid-in capital 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 grandfathered paid-in capital being amortized, not just the 
remaining non-amortized portion, is available to absorb losses in 
excess of retained earnings until the funds are released by the 
corporate credit union at maturity.
* * * * *
    (e) Individual capital ratio requirement--(1) When significant 
circumstances or events warrant, the OCCU Director 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:
* * * * *
    (2) When the OCCU Director determines that a different minimum 
capital ratio is necessary or appropriate for a particular corporate 
credit union, he or she will notify the corporate credit union in 
writing of the proposed capital ratio and the date by which the capital 
ratio must be reached. The OCCU Director also will provide an 
explanation of why the proposed capital ratio is considered necessary 
or appropriate.
    (3) * * *
    (iii) After the close of the corporate credit union's response 
period, the OCCU Director 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 must be reached. 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.
    (f) Failure to maintain minimum capital ratio requirement. When a 
corporate credit union's capital ratio falls below the minimum required 
by paragraphs (d) or (e) 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 the OCCU 
Director within 10 calendar days.
* * * * *
    (i) Earnings retention requirement. A corporate credit union must 
increase retained earnings if the prior month-end retained earnings 
ratio is less than 2 percent.
    (1) Its retained earnings must increase:
    (i) During the current month, by an amount equal to or greater than 
the monthly earnings retention amount; or
    (ii) During the current and prior two months, by an amount equal to 
or greater than the quarterly earnings retention amount.
    (2) Earnings retention amounts are calculated as follows:
    (i) The monthly earnings retention amount is determined by 
multiplying the earnings retention factor by the prior month-end moving 
daily average net assets; and
    (ii) The quarterly earnings retention amount is determined by 
multiplying the earnings retention factor by moving daily average net 
assets for each of the prior three month-ends.
    (3) The earnings retention factor is determined as follows:
    (i) If the prior month-end retained earnings ratio is less than 2 
percent and the core capital ratio is less than 3 percent, the earnings 
retention factor is .15 percent per annum; or
    (ii) If the prior month-end retained earnings ratio is less than 2 
percent and the core capital ratio is equal to or greater than 3 
percent, the earnings retention factor is .10 percent per annum.
    (4) The OCCU Director may approve a decrease to the earnings 
retention amount if it is determined a lesser amount is necessary to 
avoid a significant adverse impact upon a corporate credit union.
    (5) Operating management of the corporate credit union must notify 
its board of directors, supervisory committee, the OCCU Director and, 
if applicable, the state regulator within 10 calendar days of 
determining that the retained earnings ratio has declined below 2 
percent. If the decline in the retained earnings ratio is due, in full 
or in part, to a decline in the dollar amount of retained earnings and 
the retained earnings ratio is not restored to at least 2 percent by 
the next month end, a retained earnings action plan is required to be 
submitted within 30 calendar days.
    (6) The retained earnings action plan must be submitted to the OCCU 
Director and, if applicable, the state regulator and, at a minimum, 
include the following:
    (i) Reasons why the dollar amount of retained earnings has 
decreased;

[[Page 65654]]

    (ii) Description of actions to be taken to increase the dollar 
amount of retained earnings within specific time frames; and
    (iii) Monthly balance sheet and income projections, including 
assumptions, for the next 12-month period.

    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);
    d. Revise redesignated paragraphs (d)(3) and the first sentence of 
(d)(4);
    e. Add paragraph (h)(4); and
    f. Add at the end of paragraph (c)(4) after the ``;'' an ``and.''


Sec.  704.5  Investments.

    (a) * * *
    (1) Appropriate tests and criteria for evaluating investments and 
investment transactions before purchase; and
    (2) Reasonable and supportable concentration limits for limited 
liquidity investments in relation to capital.
* * * * *
    (c) * * *
    (5) Domestically-issued asset-backed securities.
    (d) * * *
    (1) The corporate credit union, directly or through its agent, 
receives written confirmation of the transaction, and either takes 
physical possession or control of the repurchase securities or is 
recorded as owner of the repurchase securities through the Federal 
Reserve Book-Entry Securities Transfer System;
* * * * *
    (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 first priority 
security interest in the collateral by taking physical possession or 
control of the collateral, or is recorded as owner of the collateral 
through the Federal Reserve Book-Entry Securities Transfer System;
* * * * *
    (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 trading securities unless accounted for on a trade 
date basis;
    (3) Engaging in adjusted trading or short sales; and
    (4) Purchasing stripped mortgage-backed securities, mortgage 
servicing rights, small business related securities, or residual 
interests in CMOs or asset-backed securities.
* * * * *

    8. Amend Sec.  704.6 by revising paragraph (a) introductory text 
and paragraphs (a)(3), (a)(4) and (b) 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 
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 NCUSIF 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. An investment that fails a requirement of this 
section because of a subsequent reduction in capital will be deemed 
nonconforming. A corporate credit union is required to exercise 
reasonable efforts to bring nonconforming investments into conformity 
within 90 calendar days. Investments that remain nonconforming for 90 
calendar days will be deemed to fail a requirement of this section and 
the corporate credit union will have to comply 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, investments with long-term ratings 
must be rated no lower than AA- (or equivalent) and investments with 
short-term ratings 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.

[[Page 65655]]

    (4) When two or more ratings are relied upon to meet the 
requirements of this part at the time of purchase, the board or an 
appropriate committee must place on the Sec.  704.6(e)(1) investment 
watch list any investment for which a rating is downgraded below the 
minimum rating requirements of this part.
    (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) At least annually, a written 
evaluation of each credit limit with each obligor or transaction 
counterparty must be prepared and formally approved by the board or an 
appropriate committee. At least monthly, the board or an appropriate 
committee must receive an investment 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 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 one member 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, lines of credit and letters 
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 not excluded under Sec.  723.1(b) of this chapter 
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 U.S. 
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 paragraphs (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 ``; and'' at the end of redesignated paragraph (a)(5) in 
place of the period;
    d. Add paragraph (a)(6);
    e. Revise redesignated paragraphs (a)(2), (e) and (f);
    f. Add a sentence to the end of paragraph (c); and
    g. Revise paragraphs (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 estimate the 
impact of investments on the percentage decline in NEV, compared to 
base case NEV. The most recent NEV analysis, as determined under 
paragraph (d)(1)(i) of this section may be used as a basis of 
estimation.
* * * * *
    (c) * * * This means the minimum penalty must be reasonably related 
to the rate that the corporate credit union would be required to offer 
to attract funds for a similar term with similar characteristics.
    (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 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 15 percent.
    (2) A corporate credit union must assess annually if it should 
conduct periodic additional tests to address market factors that may 
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 the OCCU Director. If any violation persists 
for 30 calendar days, the corporate credit

[[Page 65656]]

union must submit a detailed, written action plan to the OCCU Director 
that sets forth the time needed and means by which it intends to 
correct the violation. If the OCCU Director determines that the plan is 
unacceptable, the corporate credit union must immediately restructure 
the balance sheet to bring the exposure back within compliance or 
adhere to an alternative course of action determined by the OCCU 
Director.
    (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.

    10a. Amend Sec.  704.10 by revising the section heading and the 
first sentence of paragraph (a) to read as follows:


Sec.  704.10  Investment action plan.

    (a) Any corporate credit union in possession of an investment, 
including a derivative, that fails to meet a requirement of this part 
must, within 30 calendar days of the failure, report the failed 
investment to its board of directors, supervisory committee and the 
OCCU Director. * * *
* * * * *

    11. Amend Sec.  704.11 by revising paragraph (b), redesignating 
paragraphs (c) through (e) as paragraphs (f) through (h), adding 
paragraphs (c), (d) and (e) and revising redesignated paragraph (g)(3) 
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 member and nonmember corporate CUSOs must not exceed 15 
percent of a corporate credit union's capital.
    (2) The aggregate of all investments in and loans to member and 
nonmember corporate CUSOs must not exceed 30 percent of a corporate 
credit union's capital. A corporate credit union may lend 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.
    (3) If the limitations in paragraphs (b)(1) and (b)(2) 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.
    (4) The aggregate of all loans to corporate CUSOs must comply with 
the aggregate limit of Sec.  723.16 of this chapter. This requirement 
does not apply to loans excluded under Sec.  723.1(b).
    (c) Due diligence. A corporate credit union must comply with the 
due diligence requirements of Sec. Sec.  723.5 and 723.6(f) through (l) 
of this chapter for all loans to corporate CUSOs. This requirement does 
not apply to loans excluded under Sec.  723.1(b).
    (d) Separate entity. (1) A corporate CUSO must be operated as an 
entity separate from a corporate credit union.
    (2) A corporate credit union investing in or lending to a corporate 
CUSO must obtain a written legal opinion that concludes 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 
depository financial institution or to invest in shares, stocks, or 
obligations of an insurance company, trade association, liquidity 
facility, or similar organization.
* * * * *
    (g) * * *
    (3) Obtain an annual CPA opinion audit and provide a copy to the 
corporate credit union. A wholly owned or majority owned CUSO is not 
required to obtain a separate annual audit if it is included in the 
corporate credit union's annual consolidated audit; and
* * * * *

    12. Revise Sec.  704.12 to read as follows:


Sec.  704.12  Permissible services.

    (a) Preapproved services. A corporate credit union may provide to 
members the preapproved services set out in this section. NCUA may at 
any time, based upon supervisory, legal, or safety and soundness 
reasons, limit or prohibit any preapproved service. The specific 
activities listed within each preapproved category are provided as 
illustrations of activities permissible under the particular category, 
not as an exclusive or exhaustive list.
    (1) Correspondent services agreement. 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 the other corporate credit 
union or its members.
    (2) Credit and investment services. Credit and investment services 
are advisory and consulting activities that assist the member in 
lending or investment management. These services may include loan 
reviews, investment portfolio reviews and investment advisory services.
    (3) Electronic financial services. Electronic financial services 
are any services, products, functions, or activities that a corporate 
credit union is otherwise authorized to perform, provide or deliver to 
its members but performed through electronic means. Electronic services 
may include automated teller machines, online transaction processing 
through a website, website hosting services, account aggregation 
services, and internet access services to perform or deliver products 
or services to members.
    (4) Excess capacity. Excess capacity is the excess use or capacity 
remaining in facilities, equipment or services that: a corporate credit 
union properly invested in or established, in good faith, with the 
intent of serving its members; and it reasonably anticipates will be 
taken up by the future expansion of services to its members. A 
corporate credit union may sell or lease the excess capacity in 
facilities, equipment or services, such as office space, employees and 
data processing.
    (5) Liquidity and asset and liability management. Liquidity and 
asset and liability management services are any services, functions or 
activities that assist the member in liquidity and balance sheet 
management. These services may include liquidity planning and balance 
sheet modeling and analysis.
    (6) Operational services. Operational services are services 
established to deliver financial products and services that enhance 
member service and promote safe and sound operations. Operational 
services may include tax payment, electronic fund transfers and 
providing coin and currency service.
    (7) Payment systems. Payment systems are any methods used to 
facilitate the movement of funds for transactional purposes. Payment

[[Page 65657]]

systems may include Automated Clearing House, wire transfer, item 
processing and settlement services.
    (8) Trustee or custodial services. Trustee services are services in 
which the corporate credit union is authorized to act under a written 
trust agreement to the extent permitted under part 724 of this chapter. 
Custodial and safekeeping services are services a corporate credit 
union performs on behalf of its member to act as custodian or 
safekeeper of investments.
    (b) Procedure for adding services that are not preapproved. To 
provide a service to its members that is not preapproved by NCUA:
    (1) A federal corporate credit union must request approval from 
NCUA. The request must include a full explanation and complete 
documentation of the service and how the service relates to a corporate 
credit union's authority to provide services to its members. The 
request must be submitted jointly to the OCCU Director and the 
Secretary of the Board. The request will be treated as a petition to 
amend Sec.  704.12 and NCUA will request public comment or otherwise 
act on the petition within a reasonable period of time. Before engaging 
in the formal approval process, a corporate credit union should seek an 
advisory opinion from NCUA's Office of General Counsel as to whether a 
proposed service is already covered by one of the authorized categories 
without filing a petition to amend the regulation; and
    (2) A state-chartered corporate credit union must submit a request 
for a waiver that complies with Sec.  704.1(b) to the OCCU Director.
    (c) Prohibition. A corporate credit union is prohibited from 
purchasing loan servicing rights.


Sec.  704.13  [Removed and Reserved]

    13. Remove and reserve Sec.  704.13.

    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, a 
credit union trade association includes but is not limited to, state 
credit union leagues and league service corporations and national 
credit union trade associations.
* * * * *


Sec.  704.18  [Amended]

    15. Amend Sec.  704.18(e)(1), including the table, by removing the 
words ``reserve ratio'' wherever they appear and adding in their place, 
the words ``core capital ratio'' and removing the words ``reserves and 
undivided'' wherever they appear adding in their place, the word 
``retained.''

    16. Amend Sec.  704.19 by revising paragraph (b) and removing 
paragraph (c) as follows:


Sec.  704.19  Wholesale corporate credit unions.

* * * * *
    (b) Earnings retention requirement. A wholesale corporate credit 
union must increase retained earnings if the prior month-end retained 
earnings ratio is less than 1 percent.
    (1) Its retained earnings must increase:
    (i) During the current month, by an amount equal to or greater than 
the monthly earnings retention amount; or
    (ii) During the current and prior two months, by an amount equal to 
or greater than the quarterly earnings retention amount.
    (2) Earnings retention amounts are calculated as follows:
    (i) The monthly earnings retention amount is determined by 
multiplying the earnings retention factor by the prior month-end moving 
daily average net assets; and
    (ii) The quarterly earnings retention amount is determined by 
multiplying the earnings retention factor by moving daily average net 
assets for each of the prior three month-ends.
    (3) The earnings retention factor is determined as follows:
    (i) If the prior month-end retained earnings ratio is less than 1 
percent and the core capital ratio is less than 3 percent, the earnings 
retention factor is .15 percent per annum; or
    (ii) If the prior month-end retained earnings ratio is less than 1 
percent and the core capital ratio is equal to or greater than 3 
percent, the earnings retention factor is .075 percent per annum.
    (4) The OCCU Director may approve a decrease to the earnings 
retention amount set forth in this section if it is determined a lesser 
amount is necessary to avoid a significant adverse impact upon a 
wholesale corporate credit union.
    (5) Operating management of the wholesale corporate credit union 
must notify its board of directors, supervisory committee, OCCU 
Director and, if applicable, the state regulator within 10 calendar 
days of determining the retained earnings ratio has declined below 1 
percent. If the decline in the retained earnings ratio is due in full 
or in part, to a decline in the dollar amount of retained earnings and 
the retained earnings ratio is not restored to at least 1 percent by 
the next month end, a retained earnings action plan is required to be 
submitted within 30 calendar days.
    (6) The retained earnings action plan must be submitted to the OCCU 
Director and, if applicable, the state regulator and, at a minimum, 
include the following:
    (i) Reasons why the dollar amount of retained earnings has 
decreased;
    (ii) Description of actions to be taken to increase the dollar 
amount of retained earnings within specific time frames; and
    (iii) Monthly balance sheet and income projections, including 
assumptions for the ensuing 12-month period.

    17. 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.  
704.3.

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 
retained 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 will transfer 
to the continuing corporate credit union. The three-year notice 
period for withdrawal of the membership capital account will remain 
in effect.

[[Page 65658]]

    (8) {If an adjusted balance account{time} : 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{time} : The membership capital account is a term 
certificate that will mature on ------(date)------.
    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 
retained 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 will transfer to 
the continuing corporate credit union.
    (8) Paid-in capital is perpetual maturity and noncumulative 
dividend.
    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.


    18. 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 Appendix if it meets the applicable 
requirements of Part 704 and Appendix B, fulfills additional 
management, infrastructure, and asset and liability requirements, 
and receives NCUA's written approval. Additional guidance is set 
forth 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 credit union of the 
reason(s) 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 deficiency.

Minimum Requirement

    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 evaluate monthly the changes 
in NEV and the NEV ratio for the tests set forth in Sec.  
704.8(d)(1)(i).

Base-Plus

    A corporate that has met the requirements for this Base-plus 
authority may, in performing the rate stress tests set forth in 
Sec.  704.8(d)(1)(i), allow its NEV to decline as much as 20 
percent.

Part I

    (a) A corporate credit union that has met the requirements for 
this Part I may:
    (1) Purchase investments with long-term ratings no lower than A- 
(or equivalent);
    (2) Purchase investments with short-term ratings no lower than 
A-2 (or equivalent), provided that the issuer has a long-term rating 
no lower than A- (or equivalent) or the investment is a 
domestically-issued asset-backed security;
    (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; and
    (5) Enter into a dollar roll transaction.
    (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 that has met the 
requirements of this Part I may decline as much as:
    (1) 20 percent;
    (2) 28 percent if the corporate credit union has a 5 percent 
minimum capital ratio and is specifically approved by NCUA; or
    (3) 35 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 II

    (a) A corporate credit union that has met the requirements for 
this Part II may:
    (1) Purchase investments with long-term ratings no lower than 
BBB (flat) (or equivalent). The aggregate of all investments rated 
BBB+ (or equivalent) or lower in any single obligor is not to exceed 
25 percent of capital;
    (2) Purchase investments with short-term ratings no lower than 
A-2 (or equivalent), provided that the issuer has a long-term rating 
no lower than BBB (flat) (or equivalent) or the investment is a 
domestically issued asset-backed security;
    (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; and
    (5) Enter into a dollar roll transaction.
    (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) 20 percent;
    (2) 28 percent if the corporate credit union has a 5 percent 
minimum capital ratio and is specifically approved by NCUA; or
    (3) 35 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 that has met the 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;
    (2) Deposits and debt obligations of foreign banks or 
obligations guaranteed by these banks;

[[Page 65659]]

    (3) Marketable debt obligations of foreign corporations. This 
authority does not apply to debt obligations that are convertible 
into the stock of the corporation; and
    (4) Foreign issued asset-backed securities.
    (b) All foreign investments are subject to the following 
requirements:
    (1) Investments must be rated no lower than the minimum 
permissible domestic rating under the corporate credit union's Part 
I or Part II authority;
    (2) A sovereign issuer, and/or the country in which an obligor 
is organized, must have a long-term foreign currency (non-local 
currency) debt rating no lower than AA- (or equivalent);
    (3) For each approved foreign bank line, the corporate credit 
union must identify the specific banking centers and branches to 
which it will lend funds;
    (4) Obligations of any single foreign obligor may not exceed 50 
percent of capital; and
    (5) Obligations in any single foreign country may not exceed 250 
percent of capital.

Part IV

    (a) A corporate credit union that 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 sheets of its members.
    (b) Credit Ratings:
    (1) All derivative transactions are subject to the following 
requirements:
    (i) If the counterparty is domestic, the counterparty rating 
must be no lower than the minimum permissible rating for comparable 
term permissible investments; and
    (ii) If the counterparty is foreign, the corporate must have 
Part III expanded authority and the counterparty rating must be no 
lower that the minimum permissible rating for a comparable term 
investment under Part III Authority.
    (iii) Any rating(s) relied upon to meet the requirements of this 
part must be identified at the time the transaction is entered into 
and must be monitored for as long as the contract remains open.
    (iv) Section 704.10 of this part if:
    (A) 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
    (B) 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.
    (2) Exceptions. Credit ratings are not required for derivative 
transactions with:
    (i) Domestically chartered credit unions;
    (ii) U.S. government sponsored enterprises; or
    (iii) Counterparties if the transaction is fully guaranteed by 
an entity with a minimum permissible rating for comparable term 
investments.

Part V

    A corporate credit union that has met the requirements for this 
Part V may participate in loans with member natural person credit 
unions as approved by the OCCU Director and subject to the 
following:
    (a) The maximum aggregate amount of participation loans with any 
one member credit union must not exceed 25 percent of capital; and
    (b) The maximum aggregate amount of participation loans with all 
member credit unions will be determined on a case-by-case basis by 
the OCCU Director.


Sec. Sec.  704.3, 704.10, 704.15  [Amended]

    19. In addition to the amendments set forth above, in 12 CFR part 
704 remove the acronym ``NCUA'' wherever it appears and add in their 
place, the words ``the OCCU Director'' in the following places:
    a. Redesignated Sec.  704.3(e)(3)(i) and (ii), (g)(2)(v) and 
(g)(3).
    b. Section 704.10(a) introductory text, (b) and (c).
    c. Section 704.15(a) and (b).

[FR Doc. 02-26902 Filed 10-24-02; 8:45 am]
BILLING CODE 7535-01-P