[Federal Register Volume 67, Number 230 (Friday, November 29, 2002)]
[Proposed Rules]
[Pages 71113-71117]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-30089]


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NATIONAL CREDIT UNION ADMINISTRATION

12 CFR Part 702


Prompt Corrective Action; Net Worth Restoration Plans

AGENCY: National Credit Union Administration (NCUA).

ACTION: Proposed rule.

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SUMMARY: Pursuant to Congressional mandate, the National Credit Union 
Administration (NCUA) established a system of prompt corrective action 
consisting of statutory minimum capital standards for federally-insured 
credit unions and corresponding remedies to restore net worth. Among 
the remedies mandated by statute is the requirement to submit a net 
worth restoration plan for approval by NCUA. NCUA requests public 
comment on a proposal to allow approval of an abbreviated net worth 
restoration plan for qualifying credit unions whose net worth ratio has 
declined marginally below 6 percent because growth in assets outpaces 
growth in net worth.

DATES: Comments must be received on or before January 28, 2003.

ADDRESSES: Direct comments to Becky Baker, Secretary of the Board. Mail 
or hand-deliver comments to: National Credit Union Administration, 1775 
Duke Street, Alexandria, Virginia 22314-3428. You are encouraged to fax 
comments to (703) 518-6319 or e-mail comments to [email protected] 
instead of hand-delivering them. Whichever method you choose, please 
send comments by one method only.

FOR FURTHER INFORMATION CONTACT: Legal: Steven W. Widerman, Trial 
Attorney, Office of General Counsel, at the above address or by 
telephone: 703/518-6557. Technical: Jon Flagg, Loss/Risk Analysis 
Officer, Office of Examination and Insurance, at the above address or 
by telephone: 703/518-6378.

SUPPLEMENTARY INFORMATION: Except where noted, citations to part 702 in 
this rule refer to 12 CFR 702 et seq., as amended by the NCUA Board in 
a final rule found elsewhere in this volume of the Federal Register. 
Citations to part 702 are abbreviated to the section number only.

A. Background

1. Development of Part 702

    In 1998, the Credit Union Membership Access Act (``CUMAA''), Pub. 
L. No. 105-219, 112 Stat. 913 (1998), amended the Federal Credit Union 
Act to require NCUA to adopt by regulation a system of ``prompt 
corrective action'' (``PCA'') consisting of minimum capital standards 
and corresponding remedies to improve the net worth of federally-
insured ``natural person'' credit unions. 12 U.S.C. 1790d et seq.
    In 2000, the NCUA Board adopted part 702 and subpart L of part 747, 
establishing a comprehensive system of PCA. 12 CFR 702 et seq. Part 702 
combines mandatory supervisory actions prescribed by statute with 
discretionary supervisory actions developed by NCUA, all indexed to 
five statutory net worth categories. 65 FR 8560 (Feb. 18, 2000). A 
risk-based net worth (``RBNW'') component was subsequently integrated 
into part 702. 65 FR 44950 (July 20, 2000). Subpart L of part 747 
established an independent review process allowing affected credit 
unions and officials to challenge PCA decisions. 12 CFR 747.2001 et 
seq. (2000). Part 702 and subpart L of part 747 took effect August 7, 
2000, and first applied to activity in the fourth quarter of 2000. The 
RBNW component took effect January 1, 2001, and first applied (for 
quarterly Call Report filers) to activity in the first quarter of 2001.
    Since it was first adopted, part 702 has been amended three times. 
First, to incorporate limited technical corrections. 65 FR 55439 (Sept. 
14, 2000). Second, to delete sections made obsolete by adoption of a 
uniform quarterly schedule for filing Call Reports. 67 FR 12459 (March 
19, 2002). And finally, in a final rule adopted today, to incorporate a 
series of revisions and adjustments designed to improve and simplify 
the implementation of PCA. That final rule appears elsewhere in this 
volume of the Federal Register and is effective January 1, 2003.

2. Request for Comments

    The concept of an abbreviated net worth restoration plan (``NWRP'') 
was first raised in the proposed rule that preceded the final rule that 
the NCUA Board has adopted today. 67 FR 38431 (June 4, 2002). While no 
specific

[[Page 71114]]

proposal was introduced, the NCUA Board invited public comment on the 
concept of what was then referred to as ``safe harbor'' approval of an 
NWRP to benefit credit unions that fall marginally short of 
``adequately capitalized'' primarily because asset growth outstrips 
income growth. Id. at 38437. The proposed rule described the concept in 
broad terms as ``notice of certain criteria established by regulation 
that, when met, will assure approval.''
    NCUA received sixteen public comments on the ``safe harbor'' 
concept. Fourteen commenters generally supported the concept, 
suggesting various criteria for eligibility and for plan contents. 
Regarding eligibility, six commenters suggested a minimum net worth 
ratio for a ``safe harbor'' NWRP: one suggested ``just under'' 6 
percent; two suggested 5.5 percent; two suggested 5 percent; one 
suggested 3 percent. In contrast, one commenter insisted there should 
be no minimum net worth ratio required for eligibility. Two commenters 
urged that a credit union should be eligible only if asset growth was 
not induced by above market rates on shares and deposits, or only in 
extraordinary circumstances. A banking industry trade association 
believed the concept was at odds with CUMAA. Finally, two commenters 
suggested that a ``safe harbor'' NWRP should not be subject to 
automatic revocation if its goals are not met.
    Regarding the contents of a ``safe harbor'' NWRP, a commenter 
suggested requiring net worth to improve within two quarters. Another 
suggested setting a required return on average assets that would 
restore net worth within 3 years. One commenter advocated an earnings 
retention requirement of 80 to 180 basis points per year, depending on 
how far below six percent the credit union's net worth ratio had 
fallen.
    Another urged that a plan should be accepted if a credit union's 
earnings are positive, but its net worth ratio remained flat in some 
quarters due to continued asset growth not induced by above market 
rates.
    Some commenters seemed to equate the concept of ``safe harbor'' 
approval with the notion of automatic approval of any form of NWRP that 
the NCUA Board might adopt as an alternative to the standard NWRP that 
part 702 now requires. However, as the prior proposed rule confirmed, 
id. at 38437, CUMAA requires NCUA to ensure, as a prerequisite for 
approval, that an NWRP of any kind ``is based on realistic assumptions 
and is likely to succeed in restoring * * * net worth.'' 12 U.S.C. 
1790d(f)(5). ``Safe harbor'' approval was a misnomer to the extent that 
it implied, incorrectly, that NCUA would abdicate this statutory 
responsibility. Through this notice, the NCUA Board invites public 
comment on a specific proposal--styled a ``1st tier net worth 
restoration plan''--to permit qualifying ``undercapitalized'' credit 
unions to submit for approval an abbreviated NWRP.
    To facilitate consideration of the public's views, we ask 
commenters to address only the proposal for a ``1st tier net worth 
restoration plan.'' Also, we urge commenters to recognize that, while 
given substantial discretion in certain areas of PCA, NCUA lacks the 
authority to override or expand by regulation the requirements, 
limitations and definitions that CUMAA expressly prescribed. See 12 
U.S.C. 1790d(n). For example, NCUA lacks the discretion to abandon the 
statutory ``realistic assumptions'' criterion for approving an NWRP. 12 
U.S.C. 1790d(f)(5). This rulemaking will not address proposals that 
would require NCUA to exceed the scope of its statutory authority.

B. Proposal for ``1st Tier Net Worth Restoration Plan''

    The proposed rule permits an ``eligible'' federally-insured credit 
union to submit for NCUA approval a ``1st tier net worth restoration 
plan'' (``1st tier NWRP'') if the credit union falls marginally below 
``adequately capitalized'' because asset growth, driven primarily by 
share and deposit growth, outpaces growth in net worth.\1\
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    \1\ Citations to proposed new subsection (c) of Sec.  702.206 
are preceded by the word ``New'' and refer to the rule text below. 
If proposed subsection (c) is adopted, the final rule will 
redesignate current subsections (c) through (i) as new subsections 
(d) through (j), respectively.
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1. Eligible Credit Unions

    To be eligible to file a 1st tier NWRP, the proposed rule 
establishes historical net worth, performance, and growth criteria. The 
three eligibility criteria are designed to qualify only those credit 
unions that historically are profitable and have become marginally 
``undercapitalized'' primarily because of uninduced share growth.
    To be eligible, a credit union must meet two net worth criteria. 
First, a credit union must have a minimum net worth ratio of 5.50% as 
measured using the quarter-end balance of total assets per Sec.  
702.2(k)(1)(iv). New Sec.  702.206(c)(1)(A)(i).\2\ As in the case of an 
RBNW requirement, Sec.  702.2(k)(2), when measuring current quarter net 
worth for eligibility purposes, there is no choice among the four 
methods otherwise available to calculate the total assets denominator 
of the net worth ratio. 702.2(k)(1). If there is an applicable RBNW 
requirement, the credit union's net worth ratio may not be more than 50 
basis points (0.50 percent) below the RBNW requirement. New Sec.  
702.206(c)(1)(A)(ii).
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    \2\ A credit union whose net worth ratio is between 5.50 and 
5.99% based on the quarter-end balance of total assets may find that 
calculating its net worth ratio using a daily, monthly or quarterly 
average of total assets, Sec.  702.2(k)(1)(i)-(iii), will yield a 
net worth ratio of 6 percent or better. In that event, the credit 
union will not be ``undercapitalized''--at least temporarily--and 
thus will not be required to file any NWRP.
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    Second, for each of the three prior quarters, a credit union must 
have achieved a net worth ratio of at least 6 percent. New Sec.  
702.206(c)(1)(B)(i). In contrast to measuring current quarter net worth 
by quarter-end total assets, for each of the three prior quarters a 
credit union may elect among any of the four methods of calculating the 
total assets denominator of the net worth ratio. If that credit union 
is subject to a RBNW requirement, it also must have met that 
requirement in each of the three prior quarters. New Sec.  
702.206(c)(1)(B)(ii).
    A credit union also must meet a performance criterion: for the 
current and each of the three preceding quarters, a credit union must 
have increased the dollar amount of its net worth by 60 basis points 
(0.60 percent) annual return on average assets (``ROAA''). New Sec.  
702.206(c)(1)(C)(i). The ROAA is derived from a credit union's ROAA 
``key ratio'' in its most recent Financial Performance Report, unless a 
more recently filed Call Report corrects earlier data. See NCUA, User's 
Guide for NCUA's Financial Performance Report at 3, 8 (form 8008, 2002 
ed.). The 60 basis point ROAA reflects the approximate mean of 
individual credit unions' ROAA as of June 2002.
    Finally, a credit union must meet a growth criterion: for the 
period combining the current and three preceding quarters, ending total 
asset growth may not exceed 110% of the growth in net worth plus shares 
and deposits.\3\ New Sec.  702.206(c)(1)(C)(ii). The 110% ceiling is 
based on growth in net worth, shares and deposits--and excludes growth 
in borrowings--to narrowly restrict the amount of growth supported by 
borrowings of a credit union with a net worth ratio below 6 percent. A 
credit union that grows

[[Page 71115]]

through substantial borrowings will be required to file a standard 
NWRP.
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    \3\ For example, assume the four quarters in question cover the 
calendar year 2002. Compare the difference between 12/31/01 and 12/
31/02 quarter-end total assets with the difference between 12/31/01 
and 12/31/02 quarter-end net worth plus shares and deposits. To be 
eligible, the difference in total assets cannot exceed the 
difference in net worth plus shares and deposits by more than 10 
percent.
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    Together, these eligibility criteria would allow 57.25% annualized 
asset growth for one quarter, causing a credit union's net worth ratio 
to fall from 6 percent to 5.50 percent, provided that its ROAA is 60 
basis points.\4\ An annual rate of asset growth greater than 57.25% 
would reduce a credit union's net worth ratio from 6 percent to below 
5.50 percent, necessitating the further supervisory oversight that a 
longer term, standard NWRP provides.
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    \4\ A 57.25% annualized rate of growth represents growth of 
approximately 12%, compounded, per quarter.
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    A credit union that meets the three eligibility criteria must file 
its 1st tier NWRP within the same 45-day period that Sec.  702.206(a) 
prescribes for filing a standard NWRP. New Sec.  702.206(c). And as 
explained below, an eligible credit union receives a single opportunity 
to seek NCUA approval of a 1st tier NWRP. New Sec.  702.206(c)(4)(A).

2. Contents of 1st Tier NWRP

    The proposed rule has two content requirements for a 1st tier NWRP. 
First, a plan must include a realistic pro forma projection of growth 
in total assets, shares, ROAA and net worth ratio over the next four 
quarters, that will result in a net worth ratio of at least 6 percent 
and meet any applicable RBNW requirement. New Sec.  702.206(c)(2)(A). 
The duration of a 1st tier NWRP is four quarters. Second, a plan must 
include a statement describing how the credit union will control 
exposure to market and institution risks arising from any new 
activities that it plans to undertake over the next four quarters. New 
Sec.  702.206(c)(2)(B). The following table illustrates the ROAA a 
credit union would need to achieve to restore net worth from 5.50 to 6 
percent over four quarters while offsetting given annual growth rates:

           Table A.--ROAA Required To Restore Net Worth to 6% While Offsetting Annualized Asset Growth
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Return on average assets (in basis points)..........         60          70          80          90         100
Annual rate of asset growth.........................      1.72%       3.45%       5.21%       7.35%       8.78%
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    As suggested above, a more detailed standard NWRP typically would 
be appropriate when the annual rate of asset growth is projected to 
exceed the capacity of the offsetting ROAA to restore net worth to 6 
percent and to meet an applicable RBNW requirement over four quarters.
    There are three principal differences between the content 
requirements of a standard NWRP and those of a 1st tier NWRP. First, a 
standard plan must include complete pro forma financial statements 
covering a minimum of two years, whereas a 1st tier plan requires four 
quarters of pro forma projections of total assets, shares and deposits, 
return on average assets and net worth. Second, a standard plan 
requires the credit union to specify what steps it will take to meet 
its schedule of quarterly net worth targets. In contrast, a 1st tier 
NWRP does not address what steps the credit union will take to become 
``adequately capitalized'' at the end of the term of the plan. Finally, 
a standard NWRP requires those steps to extend beyond the term of the 
plan to ensure that the credit union remains at least ``adequately 
capitalized'' thereafter for four consecutive calendar quarters. Id. In 
contrast, a 1st tier plan does not address the credit union's net worth 
after the end of the term of the plan.

3. Criteria for Approval

    For an NWRP to be approved, CUMAA requires NCUA to determine that 
it ``is based on realistic assumptions and is likely to succeed in 
restoring the net worth of the credit union.'' 12 U.S.C. 1790d(f)(5). 
To avoid any suggestion that a 1st tier NWRP will be exempt from this 
statutory mandate, the proposed rule clarifies that approval is subject 
to NCUA's case-by-case determination that the growth rate and ROAA 
projected for the credit union rest on realistic assumptions that are 
likely to succeed in restoring its net worth ratio to 6 percent and 
satisfying any applicable RBNW requirement at the end of the term of 
the plan. New Sec. Sec.  702.206(c)(3), 702.206(c)(2)(A).
    Under the proposed rule, a 1st tier NWRP would be evaluated under 
the existing approval criteria that apply to a standard NWRP. Sec.  
702.206(d). First, NCUA would determine whether an NWRP satisfied the 
content requirements of the proposed rule. Second, NCUA would review 
the plan's growth and ROAA projections to ensure that they are 
supported by ``realistic assumptions.'' To that end, the projections 
will be compared to historical growth and performance measures. Third, 
absent evidence to the contrary, NCUA would presume that a 1st tier 
NWRP would not unreasonably increase the credit union's exposure to 
risk. As part of the three-step evaluation, NCUA may consider the risk 
presented by any new activities the credit union plans to undertake and 
by other supervisory information. New Sec.  702.206(c)(2)(B). This 
would include, for example, information from examination reports or 
insurance reviews, as well as CAMEL codes (e.g., no composite ``4''s or 
``5''s).
    Once the evaluation is completed, NCUA would follow the same 
schedule for decision and notification that applies to standard NWRPs. 
Sec.  702.206(f). Absent safety and soundness concerns, a 1st tier NWRP 
that meets the content requirements discussed above and that is 
determined by NCUA to be based on ``realistic assumptions'' should 
receive prompt approval.\5\
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    \5\ Like a standard NWRP, once a 1st tier NWRP is approved, the 
credit union will no longer be subject to the statutory restriction 
on asset growth, 12 U.S.C. 1790d(g)(1)(A), but will still be 
required to comply with CUMAA's two other mandatory supervisory 
actions--the earnings retention requirement, id. Sec.  170d(e), and 
the restriction on MBLs, id. Sec.  1790d(g)(2).
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4. Requirement To File Standard NWRP

    There are three circumstances in which a credit union that is 
eligible to file a 1st tier NWRP will be required to file a standard 
NWRP instead. First, unlike a credit union that files a standard NWRP, 
the proposed rule gives an eligible credit union a single opportunity 
to submit a 1st tier NWRP for approval. If that plan is not approved, 
the credit union will then be required to file a standard NWRP under 
Sec.  702.206(b), within the time period provided in Sec.  702.206(g). 
New Sec.  702.206(c)(3)(A).
    Second, a continuing decline in net worth ratio while operating 
under an approved 1st tier NWRP will trigger the requirement to file a 
standard NWRP. The proposed rule requires a credit union to file a 
standard NWRP if, during the term of an approved 1st tier NWRP, its net 
worth ratio declines below 5.5% or declines more than 50 basis points 
below an applicable RBNW requirement. New Sec.  702.206(c)(4)(B). A 
more detailed, standard NWRP will enable NCUA to assess the adequacy of 
a credit union's plans to address the

[[Page 71116]]

causes of a decline in net worth ratio below 5.5%, and to assess more 
thoroughly the increase in risk to the National Credit Union Share 
Insurance Fund.
    Finally, the proposed rule requires a credit union to file a 
standard NWRP under Sec.  702.206(b) if, at the end of the term of its 
1st tier NWRP (i.e., at the fourth quarter-end), it has failed to 
restore its net worth ratio to 6 percent and to meet any applicable 
RBNW requirement. New Sec.  702.206(c)(4)(C). Once that credit union 
triggers the requirement to file a standard NWRP, it will not be 
eligible to file another 1st tier NWRP until it is no longer operating 
under a standard plan.\6\
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    \6\ In contrast, a credit union that succeeds in restoring its 
net worth in the second quarter of a 1st tier NWRP, and that stays 
``adequately capitalized'' for the third and fourth quarters of the 
plan, will become eligible, in the first quarter after that plan 
ends, to file another 1st tier NWRP if it declines below 
``adequately capitalized.'' By the quarter after the original 1st 
tier NWRP ends, that credit union will have been ``adequately 
capitalized'' in each of the three preceding quarters. New Sec.  
702.206(c)(1)(B).
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Regulatory Procedures

Regulatory Flexibility Act

    The Regulatory Flexibility Act requires NCUA to prepare an analysis 
describing any significant economic impact a proposed regulation may 
have on a substantial number of small credit unions (primarily those 
under $1 million in assets). The proposed rule expedites implementation 
of the existing system of PCA mandated by Congress. 12 U.S.C. 1790d. 
The NCUA Board has determined and certifies that the proposed rule, if 
adopted, will not have a significant economic impact on a substantial 
number of small credit unions. Thus, a Regulatory Flexibility Analysis 
is not required.

Paperwork Reduction Act

    NCUA has determined that the proposed rule would not increase 
paperwork requirements under the Paperwork Reduction Act of 1995 and 
regulations of the Office of Management and Budget. Control number 
3133-0161 has been issued for part 702 and will be displayed in the 
table at 12 CFR part 795.

Executive Order 13132

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

Treasury and General Government Appropriations Act, 1999

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

Agency Regulatory Goal

    NCUA's goal is clear, understandable regulations that impose a 
minimal regulatory burden. A purpose of the proposed rule is to improve 
and simplify the existing system of PCA. We request your comments on 
whether the proposed rule is understandable and minimally intrusive if 
implemented as proposed.

List of Subjects in 12 CFR Part 702

    Credit unions, Reporting and recordkeeping requirements.

    By the National Credit Union Administration Board on November 
21, 2002.
Becky Baker,
Secretary of the Board.
    For the reasons set forth above, 12 CFR part 702 is proposed to be 
amended as follows:

PART 702--PROMPT CORRECTIVE ACTION

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

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

    2. Amend Sec.  702.206 as follows:
    a. Redesignate current paragraphs (c) through (i) as new paragraphs 
(d) through (j) respectively.
    b. Add new paragraph (c) to read as follows:


Sec.  702.206  Net worth restoration plans.

* * * * *
    (c) 1st tier net worth restoration plan. In lieu of subparagraph 
(b) of this section, an eligible federally-insured credit union may 
elect to file a 1st tier NWRP within the time provided in paragraph (a) 
of this section, as follows:
    (1) Eligibility. A federally-insured credit union is eligible to 
file a 1st tier NWRP if--
    (i) For the current quarter--
    (A) Its net worth ratio is not less than five and one-half percent 
(5.50%) as measured using the quarter-end balance of total assets per 
Sec.  702.2(k)(1)(iv); or
    (B) It fails to meet any applicable risk-based net worth 
requirement by not more than 50 basis points (0.50%); and
    (ii) For each of the three prior quarters--
    (A) It had a net worth ratio of at least 6 percent (6.0%) as 
measured using any method of measuring total assets available under 
Sec.  702.2(k)(1); or
    (B) It met any applicable RBNW requirement; and
    (iii) For the current and three preceding quarters--
    (A) The dollar amount of its net worth increased, on average, by at 
least the equivalent of 60 basis points (0.60%) return on average 
assets as reflected in the credit union's Financial Performance Report; 
and
    (B) Growth in ending total assets for the four-quarter period did 
not exceed one hundred ten percent (110%) of growth in the sum of net 
worth, shares and deposits for that period.
    (2) Contents. A 1st tier NWRP must--
    (i) Include pro forma projections of total assets, shares and 
deposits, return on average assets and net worth, covering the next 
four quarters and resulting in a net worth ratio that restores the 
credit union to at least ``adequately capitalized'' at the end of the 
fourth quarter; and
    (ii) Describe how the credit union will control exposure to risk 
from any new activities over the next four quarters.
    (3) Approval. A 1st tier NWRP will not be approved unless it meets 
the content requirements set forth in paragraph (c)(2) of this section 
and satisfies the approval criteria prescribed in paragraphs (d)(2) and 
(d)(3) of this section.
    (4) Filing of standard plan. An eligible federally-insured credit 
union must file a standard NWRP as provided by paragraph (b) of this 
section, within the period provided in paragraph (a) of this section, 
if either--
    (i) Plan not approved. The 1st tier NWRP that the credit union 
initially submits is not approved;
    (ii) Declining net worth. The credit union's net worth ratio, while 
it is operating within the term of an approved 1st tier NWRP, declines 
either--

[[Page 71117]]

    (A) Below five and one-half percent (5.50%) as measured using the 
quarter-end balance of total assets per Sec.  702.2(k)(1)(iv); or
    (B) More than 50 basis points (0.50%) below an applicable risk-
based net worth requirement; or
    (iii) Net worth not restored. The credit union is not classified at 
least ``adequately capitalized'' at the end of the term of its 1st tier 
NWRP.
* * * * *
[FR Doc. 02-30089 Filed 11-27-02; 8:45 am]
BILLING CODE 7535-01-P