[Federal Register Volume 71, Number 143 (Wednesday, July 26, 2006)]
[Proposed Rules]
[Pages 42326-42329]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E6-11908]


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NATIONAL CREDIT UNION ADMINISTRATION

12 CFR Part 703

RIN 3133-AD27


Permissible Investments for Federal Credit Unions

AGENCY: National Credit Union Administration (NCUA).

ACTION: Notice of proposed rulemaking.

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SUMMARY: NCUA is proposing to amend its investment rules to allow 
federal credit unions to enter into investment repurchase transactions 
in which the instrument consists of first-lien mortgage notes. The 
proposed amendment establishes a credit concentration limit, minimum 
credit rating, requirement for an independent assessment of market 
value, a maximum term, and custodial requirements for the transactions.

DATES: Comments must be received on or before September 25, 2006.

ADDRESSES: You may submit comments by any of the following methods 
(Please send comments by one method only):
     Federal eRulemaking Portal: http://www.regulations.gov. 
Follow the instructions for submitting comments.
     NCUA Web site: http://www.ncua.gov/RegulationsOpinionsLaws/proposed_regs/proposed_regs.html. Follow the 
instructions for submitting comments.
     E-mail: Address to [email protected]. Include ``[Your 
name] Comments on Parts 703 and 704 Permissible Investments for Federal 
Credit Unions'' in the e-mail subject line.
     Fax: (703) 518-6319. Use the subject line described above 
for e-mail.
     Mail: Address to Mary Rupp, Secretary of the Board, 
National Credit Union Administration, 1775 Duke Street, Alexandria, 
Virginia 22314-3428.
     Hand Delivery/Courier: Same as mail address.
    Public Inspection: All public comments are available on the 
agency's Web site at http://www.ncua.gov/RegulationsOpinionsLaws/comments as submitted, except as may not be possible for technical 
reasons. Public comments will not be edited to remove any identifying 
or contact information. Paper copies of comments may be inspected in 
NCUA's law library at 1775 Duke Street, Alexandria, Virginia 22314, by 
appointment weekdays between 9 a.m. and 3 p.m. To make an appointment, 
call (703) 518-6540 or send an e-mail to [email protected].

FOR FURTHER INFORMATION CONTACT:

[[Page 42327]]

    Technical Information: Jeremy Taylor, Senior Investments Officer, 
Office of Capital Markets and Planning, at the above address or 
telephone: (703) 518-6620.
    Legal Information: Moisette Green, Staff Attorney, Office of 
General Counsel, at the above address or telephone: (703) 518-6540.

SUPPLEMENTARY INFORMATION:

I. Background

    NCUA is proposing to amend its investment rules in Part 703 to 
permit federal credit unions (FCUs) to engage in investment repurchase 
transactions where the instruments purchased under an agreement to 
resell are mortgage notes, evidenced by participation certificates or 
trust receipts. Investment repurchase transactions are permissible 
investment activities for FCUs so long as any securities an FCU 
receives are permissible investments. 12 CFR 703.13(c)(1). Part 703, 
however, specifically excludes the purchase of real estate secured 
loans from its coverage, stating these purchases are governed by the 
eligible obligations rule. 12 CFR 701.23, 703.1(b)(2).
    The Federal Credit Union Act (Act) authorizes FCUs to invest in 
certain mortgage-backed and mortgage-related securities. 12 U.S.C. 
1757(15). For purposes of this rule, mortgage notes are transactions 
involving offers or sales of promissory notes secured by a first lien 
on a single parcel of improved real estate and participation interests 
in those notes originated by a financial institution that is examined 
and supervised by a federal or state authority or a mortgagee approved 
by the Department of Housing and Urban Development (HUD). 12 U.S.C. 
1757(15)(A); 15 U.S.C. 77d(5). NCUA recognizes that FCU authority under 
Sec.  107(15) of the Act is not limited to member notes, but has 
limited the exercise of this authority by regulation. See 12 CFR 
701.23; 53 FR 4843 (February 18, 1988).
    The Secondary Mortgage Market Enhancement Act of 1984 (SMMEA) 
amended the powers of federally chartered financial institutions and 
preempted state law to authorize investments in mortgage-backed 
securities. Public Law 98-440, 98 Stat. 1689 (1984). In 1984, Congress 
was concerned that traditional mortgage lenders were less willing or 
able to hold long-term, fixed rate mortgages in an environment of 
inflationary and interest rate pressures and failing thrifts. S. Rep. 
98-293 (1983). Federal and state statutes, however, restricted 
financial institutions from trading and investing in private mortgage-
related securities. For that reason, Congress liberalized those 
statutory restrictions, except for limitations imposed by federal 
regulators, to increase the flow of funds for housing by facilitating 
the private sector's participation in the secondary market for 
mortgages. S. Rep. 98-293 (1983); H. Rep. 98-994 (1983).
    SMMEA amended the Act to permit FCUs to invest in certain mortgages 
and privately issued mortgage-related securities. Specifically, SMMEA 
added Sec.  107(15)(A) to the Act, permitting FCUs to invest in 
securities that are offered and sold pursuant to section 4(5) of the 
Securities Act of 1933.\1\ 12 U.S.C. 1757(15); 15 U.S.C. 77d(5).
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    \1\ Securities under section 4(5) of the Securities Act of 1933 
are transactions involving offers or sales of promissory notes 
secured by a first lien on a single parcel of improved real estate 
and participation interests in those notes originated by a financial 
institution that is examined and supervised by a federal or state 
authority or a mortgagee approved by the Department of Housing and 
Urban Development (HUD). 12 U.S.C. 77d(5)(A). Transactions involving 
securities originated by federal or state-regulated financial 
institutions must be offered and sold at a minimum aggregate sales 
price per purchaser not less than $250,000, paid in cash within 60 
days of the sale, and bought for the purchaser's account only. 
Transactions between federal or state-regulated financial 
institutions or HUD-approved mortgagees must also meet these 
conditions of sale.
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    FCU authority under Sec.  107(15) is not specifically limited to 
member notes, but NCUA has continuing concerns about the breadth of the 
authority. An interpretation that is not limited to member loans would 
materially alter the nature of FCU asset powers and could authorize 
loans to nonmembers. Accordingly, the Board has limited the authority 
in Sec.  107(15)(A) by regulation. Under the eligible obligations rule, 
an FCU may purchase only the mortgage notes of its members or those 
needed to complete a pool of loans to be sold on the secondary market. 
12 CFR 701.23. NCUA is proposing to expand its policy by permitting 
FCUs to purchase mortgage notes, pursuant to Sec.  107(15)(A) of the 
Act, which will be sold back to the seller for settlement within 30 
days.

II. The Proposed Rule

    NCUA is proposing to permit the purchase of mortgage notes 
including those involving non-members, but only when the purchases are 
a part of an investment repurchase transaction. The Board recognizes 
the proposed amendment alters its earlier approach limiting the 
purchase of nonmember loans to those needed to complete a pool for sale 
on the secondary market. When NCUA implemented SMMEA in 1988, 
investment repurchase transactions were not prevalent in the home loan 
market. As the way housing is financed has evolved and the demand for 
housing increased, new methods to provide housing credit have 
developed. The Board believes broadening FCU authority to invest in 
mortgage notes furthers the secondary market and purposes of SMMEA.
    Investment repurchase transactions using mortgage loans typically 
involve mortgages that are in the process of securitization, and NCUA 
believes permitting FCUs to engage in these transactions furthers the 
purposes of SMMEA by funding third party mortgage warehouses. By 
mortgage warehouse, NCUA means the process of holding mortgage loans 
for a short time from origination to securitization before sale of the 
loans on the secondary market. Mortgage note repurchase transactions 
involve, first, the purchase of a mortgage note or pool of notes. The 
mortgage loans underlying the note are not limited to loans made to 
credit union members. The second step in the transaction is the resale 
of the mortgage note or notes back to the counterparty. The mortgage 
note will take the form either of a trust receipt \2\ or a 
participation certificate.\3\ The Board believes this second sale 
addresses the concern that the investment circumvents field of 
membership restrictions by requiring, as part of the transaction, that 
FCUs sell the mortgage note within a reasonably short period and will 
not continue to hold the underlying loans. This approach is 
substantially analogous to the current regulatory approach in the 
eligible obligations rule that permits FCUs to purchase nonmember 
mortgage loans to complete a pool for sale to the secondary market. 12 
CFR 701.23(b)(1)(iv).
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    \2\ A ``trust receipt'' is a receipt issued by a custodian bank 
to the Seller, evidencing that the Seller is the registered owner of 
a 100% undivided participation ownership interest in certain 
mortgage loans with attached endorsement issued in blank executed by 
the Seller.
    \3\ A ``participation certificate'' is a certificate issued to 
the Seller, evidencing that the Seller is the registered owner of a 
100% undivided participation ownership interest in certain mortgage 
loans with attached assignment in blank executed by the Seller.
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    This proposal to amend Sec.  703.14 to permit investment repurchase 
transactions using mortgage notes has six conditions. The six 
conditions address NCUA's safety and soundness concerns and include a 
credit concentration limit, minimum credit rating, independent 
assessment of market value, maximum term of the repurchase transaction, 
custodial requirements for the transactions, and undivided interests in 
mortgage notes. The proposed rule would limit aggregate

[[Page 42328]]

investments in mortgage note repurchase transactions to 25% of an FCU's 
net worth with any one counterparty and to 100% of its net worth with 
all counterparties.\4\ The counterparty in a mortgage note repurchase 
transaction could not have any outstanding debt with a long-term rating 
lower than A- or its equivalent or a short-term rating lower than A-1 
or its equivalent at the time of a repurchase transaction. An FCU would 
have to use an independent, qualified agent to obtain an assessment of 
market value when complying with the requirement to receive a daily 
assessment of the market value of the repurchase securities. The 
maximum term of a mortgage note repurchase transaction would be limited 
to 30 days. Additionally, mortgage note repurchase transactions would 
be conducted using tri-party custodial agreements. Undivided interests 
in mortgage notes would be required.
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    \4\ The proposed 25% concentration limit is similar to the limit 
governing a national bank's investment in a mortgate note repurchase 
transaction. A national bank's mortgage note repurchase transaction 
is treated as a loan and is limited to 15% of capital, unless the 
bank can demonstrate the mortgage note is readily marketable 
collateral, in which case an additional extension is permitted, 
limited to 10% of capital. See 12 U.S.C. 84(a)(2), (c)(4); 12 CFR 
32.2(k)(1)(iii), (n), and 32.3. An FCU's lending limit to one member 
is 10% of shares plus post-closing, undivided earnings. 12 U.S.C. 
1757(5)(A)(x); 12 CFR 700.2(j), 701.21(c)(5). The proposed 25% 
concentration limit is modeled after the limit governing a national 
bank's investment in asset-backed securities, which is 25% of a 
bank's capital and surplus. 12 CFR 1.3(f).
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    The proposed amendment to Sec.  703.14, permissible investments, 
would operate in conjunction with Sec.  703.13(c), permissible 
investment activities. The amendment to Sec.  703.14 creates additional 
requirements for investment repurchase transactions when mortgage notes 
are the underlying instruments. For instance, an FCU must obtain the 
daily assessment required under Sec.  703.13(c)(1) from an 
``independent qualified agent,'' defined as an agent independent of an 
investment repurchase counterparty that does not receive a transaction 
fee from the counterparty and has at least two years experience 
assessing the value of loans.
    Additionally, all the requirements of Sec.  703.13(c) would apply 
to the amendments to Sec.  703.14. In other words, FCUs investing in 
mortgage note repurchase transactions must maintain adequate margins 
that reflect a risk assessment of the mortgage notes and the term of 
the transactions pursuant to Sec.  703.13(c)(1). Further, under Sec.  
703.3, federal credit unions must establish an investment policy that 
includes the characteristics of investments the FCU may make, a risk 
management plan, a description of who has investment authority and the 
extent of that authority, and other investment management information. 
FCUs must ensure those with investment authority are qualified by 
education or experience to assess the risk characteristics of 
investments and investment transactions.
    NCUA requests comments on the conditions for FCU participation in 
the market for mortgage note repurchase transactions. NCUA also 
requests commenters address the specific questions below:
    1. By what means can the party investing in mortgage note 
repurchase agreements easily identify the underlying loans, and is it 
necessary to require more than a tri-party custodial arrangement to 
accomplish this? If so what additional requirements should be 
identified?
    2. What minimum underwriting criteria, if any, should the rule 
address?
    3. What requirements, if any, should the rule address regarding the 
quality of the mortgage notes and their monitoring?
    4. The proposed minimum long-term credit rating for the 
counterparty is higher than has been previously included in Part 703 
for municipal securities. Given that the mortgage note repurchase 
transactions are typically short term, should the agency consider 
excluding long-term credit requirements for counterparties in mortgage 
note repurchase transactions?
    By permitting FCUs to invest in mortgage loans as a part of a 
repurchase transaction, NCUA is not permitting FCUs to purchase first 
lien mortgage loans to nonmembers. Mortgage note repurchase 
transactions involve loans granted and serviced by a third party that 
agrees to repurchase the securities at a set price at the end of a 
specific term. NCUA continues to believe that permitting FCUs to buy 
nonmember mortgage notes outright is inconsistent with the purposes of 
the Act. Additionally, the purchase of nonmember mortgage loans 
presents a greater credit risk as an investment because mortgage notes 
do not need to be rated, and NCUA could not set standards to manage the 
risks of these investments effectively. NCUA believes, however, FCUs 
can safely manage repurchase transactions. Requirements are presented 
in the rule to address safety and soundness concerns relating to 
mortgage note repurchase transactions. NCUA requests comments on the 
effect permitting investment repurchase transactions using mortgage 
notes may have on the safety and soundness of FCUs, the feasibility of 
the proposed standards for risk management, and the ability of FCUs to 
manage these investments safely.

III. Regulatory Procedures

Regulatory Flexibility Act

    The Regulatory Flexibility Act requires NCUA to prepare an analysis 
to describe any significant economic impact a rule may have on a 
substantial number of small entities, those credit unions with less 
than ten million dollars in assets. The proposed rule involves the 
permissibility of certain investment repurchase transactions for FCUs 
and is grounded in NCUA concerns about the safety and soundness of the 
transactions and their potential effects on FCUs and the National 
Credit Union Share Insurance Fund. Accordingly, the Board has 
determined and certifies that this proposed rule does not have a 
significant economic impact on a substantial number of small credit 
unions and that a Regulatory Flexibility Analysis is not required.

Paperwork Reduction Act

    NCUA has determined that this rule will not increase paperwork 
requirements under the Paperwork Reduction Act of 1995 and regulations 
of the Office of Management and Budget.

Executive Order 13132

    Executive Order 13132 encourages independent regulatory agencies to 
consider the impact of their actions on state and local interests. In 
adherence to fundamental federalism principles, NCUA, an independent 
regulatory agency as defined in 44 U.S.C. 3502(5), voluntarily complies 
with the executive order. This rule will not have substantial direct 
effects 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. NCUA has 
determined that this rule does not constitute a policy that has 
federalism implications for purposes of the executive order.

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 the Treasury and General Government 
Appropriations Act, 1999, Pub. L. 105-277, 112 Stat. 2681 (1998).

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Agency Regulatory Goal

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

List of Subjects in 12 CFR Part 703

    Credit unions, Investments, Reporting and recordkeeping 
requirements.

    By the National Credit Union Administration Board on July 20, 
2006.
Mary F. Rupp,
Secretary of the Board.

    For the reasons set forth in the preamble, the Board amends 12 CFR 
part 703 as set forth below:

PART 703--INVESTMENT AND DEPOSIT ACTIVITIES

    1. The authority citation for part 703 is continues to read:

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

    2. Amend Sec.  703.1 by revising paragraph (b)(2) to read as 
follows:


Sec.  703.1  Purpose and scope.

* * * * *
    (b) * * *
    (2) The purchase of real estate-secured loans pursuant to Section 
107(15)(A) of the Act, which is governed by Sec.  701.23 of this 
chapter, except those real estate-secured loans purchased as a part of 
an investment repurchase transaction, which is governed by Sec. Sec.  
703.13 and 703.14 of this chapter;
* * * * *
    3. Amend Sec.  703.2 by adding the definition of ``independent 
qualified agent'' alphabetically between the definitions of ``immediate 
family member'' and ``industry-recognized information provider'' to 
read as follows:


Sec.  703.2  Definitions.

* * * * *
    Independent qualified agent means an agent independent of an 
investment repurchase counterparty that does not receive a transaction 
fee from the counterparty and has at least two years experience 
assessing the value of loans.
* * * * *
    4. Amend Sec.  703.14 by adding new paragraph (h) to read as 
follows:


Sec.  703.14  Permissible investments.

* * * * *
    (h) Mortgage note repurchase transactions. A federal credit union 
may invest in securities that are offered and sold pursuant to section 
4(5) of the Securities Act of 1933, 15 U.S.C. 77d(5), only as a part of 
an investment repurchase agreement under Sec.  703.13(c), subject to 
the following conditions:
    (1) The aggregate of the investments with any one counterparty is 
limited to 25 percent of the credit union's net worth and 100 percent 
of its net worth with all counterparties;
    (2) At the time a federal credit union purchases the securities, 
the counterparty cannot have debt with a long-term rating lower than A- 
or its equivalent, or a short-term rating lower than A-1 or its 
equivalent;
    (3) The federal credit union must obtain a daily assessment of the 
market value of the securities under Sec.  703.13(c)(1) using an 
independent qualified agent;
    (4) The mortgage note repurchase transaction is limited to a 
maximum term of 30 days;
    (5) All mortgage note repurchase transactions will be conducted 
under tri-party custodial agreements; and
    (6) A federal credit union must obtain an undivided interest in the 
securities.

 [FR Doc. E6-11908 Filed 7-25-06; 8:45 am]
BILLING CODE 7535-01-P