[Federal Register Volume 71, Number 244 (Wednesday, December 20, 2006)]
[Rules and Regulations]
[Pages 76122-76125]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E6-21662]


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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: Final rule.

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SUMMARY: NCUA is amending its investments rule to allow federal credit 
unions (FCUs) to enter into investment repurchase transactions in which 
the instrument consists of first-lien mortgage notes subject to certain 
limitations. The final rule expands FCU authority to invest in 
mortgage-related securities while addressing safety and soundness 
concerns associated with this new investment activity.

DATES: This rule is effective January 19, 2007.

[[Page 76123]]


FOR FURTHER INFORMATION CONTACT: Technical Information: Jeremy Taylor, 
Senior Investments Officer, Office of Capital Markets and Planning, at 
National Credit Union Administration, 1775 Duke Street, Alexandria, 
Virginia 22314, 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: 

A. Background

    In July 2006, NCUA proposed to amend its investment rules in Part 
703 to permit FCUs to engage in investment repurchase transactions in 
which the underlying instruments are mortgage notes evidenced by 
participation or trust receipts. 71 FR 42326 (July 26, 2006). The 
preamble to the proposed rule discussed the statutory authority, its 
legislative history, and NCUA regulatory implementation regarding FCU 
investment in mortgage-backed and mortgage-related securities. The 
Federal Credit Union Act (Act) permits FCUs to invest in securities 
offered and sold pursuant to section 4(5) of the Securities Act of 
1933. 12 U.S.C. 1757(15)(A); 15 U.S.C. 77d(5). The Board had limited 
this authority by regulation under the eligible obligations rule so 
that FCUs could only purchase 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. The proposal to amend Sec.  703.14 to permit 
mortgage note repurchase transactions contained six conditions to 
address safety and soundness concerns including a credit concentration 
limit, minimum credit rating, independent assessment of market value, 
maximum transaction term, custodial requirements, and undivided 
interests in mortgage notes. NCUA issued the proposed rule with a 60-
day comment period and requested comments on the plan to expand FCU 
investment authority, the conditions in the proposed rule, and whether 
a regulation permitting mortgage note repurchase transactions should 
contain additional criteria.

B. Public Comments and the Final Rule

    NCUA received comments from three credit unions, three trade 
associations, and one investment advisor on the proposed rule. Two 
commenters agreed with the use of independent, qualified agents to 
assess the market value of the mortgage notes and the requirements for 
undivided interests in the mortgage notes. Five commenters believed 
tri-party custodial arrangements would sufficiently identify the 
underlying loans in a mortgage note repurchase transaction. Four 
commenters stated the rule needed no additional underwriting criteria 
because the definition of the permissible securities in Sec.  
107(15)(A) includes the required criteria. Relying on reasons similar 
to those in the comments regarding underwriting criteria, five 
commenters contended the rule should not address the quality of the 
mortgage notes in repurchase transactions. All the commenters objected 
to the concentration limits, credit rating requirements, and maximum 
transaction term. The NCUA Board has considered carefully the three 
objections to the proposed rule.

Concentration Limits

    The proposed rule contained concentration limits of no more than 
25% of a participating FCU's net worth with any one counterparty and 
100% of its net worth with all counterparties. Commenters stated the 
proposed concentration limits are too restrictive. One commenter 
suggested the limits should be 50% of net worth per counterparty and a 
total limit similar to the FCU borrowing limit in Sec.  107(9) of the 
Act, i.e., 50% of paid-in and unimpaired capital and surplus. See 12 
U.S.C. 1757(9). Two others stated the existing requirements for 
investment repurchase transactions in Part 703 are sufficient and no 
additional limits are necessary for mortgage note repurchase 
transactions, unless an FCU's directors establishes them.
    NCUA investment rules currently require directors to develop 
investment policies that outline how FCUs will manage credit risk, 
including what counterparties an FCU will use, criteria for their 
selection, and the limits for investments with each counterparty. 12 
CFR 703.3. Additionally, Sec.  703.13(c) permits FCUs to enter into 
investment repurchase transactions so long as the underlying securities 
are permissible investments, and the investing FCU takes possession or 
is the recorded owner of the security, receives a daily assessment of 
the securities' market value, maintains adequate margins that reflect 
the risk and term of the transaction, and enters into signed contracts 
with the approved counterparties. The Board recognizes there is no 
concentration limit for investment repurchase agreements under Sec.  
703.13(c). These repurchase transactions involve permissible 
investments that are of high credit quality, for example, U.S. 
government securities, investment grade rated municipals, AA and AAA 
mortgage related securities, and securities issued or guaranteed by 
GSEs. In contrast, mortgage note repurchase agreements involve unrated 
mortgage notes.
    Additionally, the securities involved in Sec.  701.13(c) investment 
repurchase transactions typically have an active bid-ask market. 
Mortgage notes do not have an active bid-ask market, although the fair 
value of the mortgage notes may be estimated with reasonable accuracy. 
Thus, while the Board is comfortable that credit unions can set 
prudential margin requirements, mortgage notes may have less liquidity 
than other securities involved in repurchase transactions. Moreover, 
the Board notes the Office of the Comptroller of the Currency limits 
mortgage notes to no more than 25% of capital. See 12 U.S.C. 84(a)(2), 
(c)(4); 12 CFR 32.2(k)91)(iii), (n); 12 CFR 32.3.
    Thus, the Board having fully considered the comments on this issue 
has determined to maintain the concentration limits as proposed because 
it believes a 25% concentration limit per counterparty is no more 
restrictive than the limit for national banks and maintains this and 
the 100% limit for purposes of safety and soundness.

Credit Rating Requirement

    Commenters also objected to the proposed requirement that the 
counterparty to a mortgage note repurchase agreement have a long-term 
credit rating no lower than A-(or its equivalent). While mortgage note 
repurchase transactions generally have a short term, parties may 
rollover the transactions and enter into subsequent transactions, 
thereby creating a longer term of exposure to the counterparty. It is 
prudent to review the long-term rating of debt issued by the 
counterparty when rolling over repurchase transactions. Economically, 
the credit exposure in a mortgage note repurchase transaction may be 
somewhat similar to an investment grade asset-backed security (ABS) if 
debt of the issuing entity has been rated investment grade or if the 
mortgage note is guaranteed by an entity with investment grade debt. 
There is a distinction, however, in that an investment grade ABS is in 
and of itself highly rated, and the participant is relying on a credit 
rating of debt that is not applicable to the mortgage note as an 
indicator of the likelihood of default of the counterparty. Thus, the 
Board reasons that single A-(the third highest of the four long-term 
investment grades), rather than BBB-(the lowest category of investment 
grade), is a prudent and appropriate safety and soundness standard.
    While the final rule retains the requirement for long- and short-
term

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credit ratings as in the proposed rule, the final rule modifies the 
requirement by allowing a third party, that has the required credit 
rating, to fully guarantee the mortgage note repurchase transaction of 
a counterparty that does not meet the requirement. This modification 
reflects market practice in which a parent company guarantees mortgage 
note repurchase transactions of its subsidiary. Accordingly, the final 
rule requires a counterparty to have acceptably rated debt or that a 
party with acceptably rated debt guarantee the transaction.

Maximum Transaction Term

    Finally, commenters contended that the maximum term of a mortgage 
note repurchase transaction should be longer than, as proposed, 30 
days. Commenters pointed out investors in the current market have kept 
repurchase agreements short due to the uncertain interest rate 
environment and abnormal yield curve. Commenters stated the market to 
finance whole loans traditionally mirrors the overall holding period of 
45 to 90 days for securitization. Additionally, commenters believe the 
concentration limits and credit quality of the counterparty are 
sufficient safeguards given the aggregate size of mortgage note 
repurchase transactions. The Board is persuaded that a 90-day 
transaction is consistent with market practice and creates no 
additional safety and soundness risks. Therefore, the maximum 
transaction term in the final rule is modified to 90 days.
    While this final rule amends Sec.  703.14 to create additional 
requirements for investment repurchase transactions when mortgage notes 
are the underlying instruments, FCUs must still comply with the 
requirements of Sec.  703.13(c). For instance, an FCU must obtain the 
daily assessment required under Sec.  703.13(c)(1). In addition, 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 under Sec.  703.13(c)(1).

C. 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 NCUSIF. 
Accordingly, the Board determines 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, Public Law 105-277, 112 Stat. 2681 (1998).

Small Business Regulatory Enforcement Fairness Act

    The Small Business Regulatory Enforcement Fairness Act of 1996, 
Pub. L. 104-121 (SBREFA), 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 APA. 5 
U.S.C. 551. NCUA has requested a SBREFA determination from the Office 
of Management and Budget, which is pending. As required by SBREFA, NCUA 
will file the appropriate reports with Congress and the General 
Accounting Office so that the final rule may be reviewed.

List of Subjects in 12 CFR Part 703

    Credit unions, Investments, Repurchase transactions.

    By the National Credit Union Administration Board on December 
14, 2006.
Mary F. Rupp,
Secretary of the Board.

0
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

0
1. The authority citation for part 703 is continues to read:

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


0
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;
* * * * *

0
3. Amend Sec.  703.2 by adding the definition of ``independent 
qualified agent'' alphabetically 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 mortgage loans.
* * * * *

0
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

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counterparty, or a party fully guaranteeing the transaction, must have 
outstanding debt with a long-term rating no lower than A-or its 
equivalent and outstanding debt with a short-term rating, if any, no 
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 90 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. E6-21662 Filed 12-19-06; 8:45 am]
BILLING CODE 7535-01-P