[Federal Register Volume 74, Number 235 (Wednesday, December 9, 2009)]
[Proposed Rules]
[Pages 65210-65293]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E9-28219]



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Part II





National Credit Union Administration





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12 CFR Parts 702, 703, 704, et al.



Corporate Credit Unions; Proposed Rule

  Federal Register / Vol. 74 , No. 235 / Wednesday, December 9, 2009 / 
Proposed Rules  

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NATIONAL CREDIT UNION ADMINISTRATION

12 CFR Parts 702, 703, 704, 709, and 747

RIN 3133-AD58


Corporate Credit Unions

AGENCY: National Credit Union Administration (NCUA).

ACTION: Proposed rule.

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SUMMARY: NCUA is issuing proposed amendments to its rule governing 
corporate credit unions contained in part 704. The major revisions 
involve corporate credit union capital, investments, asset-liability 
management, governance, and credit union service organization (CUSO) 
activities. The amendments would establish a new capital scheme, 
including risk-based capital requirements; impose new prompt corrective 
action requirements; place various new limits on corporate investments; 
impose new asset-liability management controls; amend some corporate 
governance provisions; and limit a corporate CUSO to categories of 
services preapproved by NCUA. In addition, this proposal contains 
conforming amendments to part 702, Prompt Corrective Action (for 
natural person credit unions); part 703, Investments and Deposit 
Activities (for federal credit unions); part 747, Administrative 
Actions, Adjudicative Hearings, Rules of Practice and Procedure, and 
Investigations; and part 709, Involuntary Liquidation of Federal Credit 
Unions and Adjudication of Creditor Claims Involving Federally Insured 
Credit Unions. These amendments will strengthen individual corporates 
and the corporate credit union system as a whole.

DATES: Comments must be received on or before March 9, 2010.

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 Part 704 Corporate 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: Richard Mayfield, Capital Markets 
Specialist, Office of Corporate Credit Unions, at the address above or 
telephone: (703) 518-6642; Ross Kendall, Staff Attorney, Office of 
General Counsel (OGC), at the address above or telephone (703) 518-
6540; Paul Peterson, Director, Applications Section, OGC, at the 
address above or telephone (703) 518-6540; or Todd Miller, Regional 
Capital Market Specialist, Region V, at telephone (703) 409-4317.

SUPPLEMENTARY INFORMATION: 
    The NCUA's primary mission is to ensure the safety and soundness of 
federally-insured credit unions. NCUA performs this important public 
function by examining all federal credit unions, participating in the 
examination and supervision of federally-insured state chartered credit 
unions in coordination with state regulators, and insuring federally-
insured credit union members' accounts. In its statutory role as the 
administrator of the National Credit Union Share Insurance Fund 
(NCUSIF), the NCUA insures and supervises approximately 7,740 
federally-insured credit unions, representing 98 percent of all credit 
unions and approximately 89 million members.\1\
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    \1\ Within the fifty states, approximately 155 state-chartered 
credit unions are privately insured and are not subject to NCUA 
regulation or oversight.
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    Over 95 percent of natural person credit unions (NPCUs) belong to, 
and receive services from, corporate credit unions (corporates). There 
are 27 retail corporates that provide services directly to NPCUs, and 
there is one wholesale corporate, U.S. Central Federal Credit Union 
(U.S. Central), that provides services to many of the 27 retail 
corporates.
    The corporate system offers a broad range of support to NPCUs. The 
products and services provided by U.S. Central to retail corporates, 
and by retail corporates to NPCUs, include: Investment/deposit 
services, wire transfers, share draft processing and imaging, automated 
clearinghouse transactions (ACH) processing, automatic teller machine 
(ATM) processing, bill payment services and security safekeeping. The 
volume of payment systems-related transactions throughout the system 
annually runs into the millions and the dollar amounts associated with 
those transactions are in the billions each month. Corporates also 
serve as liquidity providers for NPCUs. Natural person credit unions 
invest excess liquidity in a corporate when the NPCU has lower loan 
demand and draw down the invested liquidity when loan demand increases. 
In sum, corporates provide NPCUs with convenient and quality services 
and expertise, all at a fair price. For many NPCUs, this is a 
combination that makes the corporate system a valuable resource and, 
for some smaller NPCUs, an essential resource.
    Federally-chartered corporates are governed by federal law and 
state chartered corporates by state law. In addition, all corporates 
that are federally-insured, or that accept share deposits from NPCU 
members that are federally insured, must comply with NCUA's part 704 
corporate credit union rule. 12 CFR part 704; Sec.  704.1, and 12 
U.S.C. 1766(a). This proposal contains significant changes to part 704 
and conforming changes to other parts of NCUA's rules. The changes 
include new investment limitations, asset-liability management 
requirements, capital standards, prompt corrective action requirements, 
corporate governance requirements, and CUSO requirements.
    Prior to drafting this proposal, the Board considered all of the 
existing part 704, but ultimately concluded that the rule provisions 
addressed in this proposal, and discussed below, were the provisions 
that needed modification. These modifications are intended not only to 
avert a repeat of the recent problems encountered in the corporate 
system but also to anticipate new problems that might occur. For 
example, while the recent corporate problems were caused in part by 
spread widening associated with perceptions of credit risk, the 
proposal requires a corporate conduct a new spread widening test that 
should demonstrate sensitivity to both credit risk and other potential 
market risks. Likewise, increased capital requirements and well-defined 
concentration limits protect not only

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against the types of risk that materialized in the past but also 
different risks that might materialize suddenly in the future.
    This preamble is organized in four sections as follows. Section I 
discusses the historical background leading up to the need for this 
rulemaking. Section II summarizes affected portions of the current 
corporate rule and the proposed changes to those portions. Section III 
contains a more complete analysis of the proposed changes with 
references to particular sections and paragraph numbers within part 
704. Section IV discusses various statutory requirements applicable to 
the rulemaking process.
    Section III, with its analysis of each proposed change to part 704, 
is particularly important. Included in subsection III.E are 
illustrations of how the various provisions of this proposal, if they 
had been applied to the corporate system in the past, would have 
drastically reduced the recent corporate losses. Section III looks not 
only to the past, but also the future. Specifically, subsection III.D. 
includes a discussion of how a hypothetical corporate might structure 
its balance sheet so as to achieve the proposed new capital 
requirements while at the same time complying with the various proposed 
investment and asset-liability limitations. The Board encourages 
commenters to take a very close look at the discussion in III.D. This 
discussion will help commenters to understand how the Board envisions 
the various elements of the proposal, working together, can permit the 
corporate system to return to a position of providing necessary 
services to natural person credit unions while ensuring the system 
operates within appropriate safety and soundness constraints. The Board 
invites comment on all aspects of Section III, including the viability 
of the assumptions employed by NCUA.

I. History of Current Issues in the Corporate System

I.A. Corporate System: Prior to 2000

    Up until the late 1990s, federally chartered corporates had a 
defined field of membership (FOM) serving a specific state or 
geographic region. Most state chartered corporates had national FOMs 
but primarily serviced the state in which they were incorporated. In 
1998, the NCUA Board began to approve national FOMs for federal 
corporates, in part to provide requested parity with state charters. 
Within a few years most corporates had a national FOM.
    NCUA's intention in allowing national FOMs was to provide NPCUs 
with the ability to select membership in a corporate that best met the 
needs of each NPCU in serving its members. The anticipated level of 
competition was expected to spur consolidation within the industry to 
build scale and improve efficiencies. In turn, this would build capital 
through increased earnings. While a few mergers occurred, one of the 
primary consequences of competition was to reduce margins on services 
and put pressure on the corporates to seek greater yields on their 
investments.

I.B. Corporate System: 2000 Through Mid-2007

    The investment provisions of NCUA's corporate regulation, located 
at 12 CFR part 704, have for many years permitted corporates to 
purchase private label mortgage-backed and mortgage-related securities 
(collectively referred to as MBS). Part 704, however, restricts most 
corporates (those without expanded investment authority) to investing 
in only the highest credit quality rated securities by at least one 
Nationally Recognized Statistical Rating Organization (NRSRO).\2\ 
Historically, highly rated securities have experienced minimal defaults 
and have been very liquid. Under NCUA rules, some corporates were 
permitted to exercise expanded investment authority and to purchase 
investment grade securities rated down to BBB because they had higher 
capital ratios, more highly trained personnel, and more capacity in 
their systems to monitor and model their portfolios. Even those 
corporates that had expanded credit risk authority, however, used it 
sparingly. In addition to being limited to securities with very high 
NRSRO ratings, corporates were required to perform a comprehensive 
credit analysis of the underlying collateral supporting the marketable 
security.
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    \2\ The term nationally recognized statistical rating 
organization (NRSRO) is used in federal and state statutes and 
regulations to confer regulatory benefits or prescribe requirements 
based on credit ratings issued by credit rating agencies identified 
by the Securities and Exchange Commission (SEC) as NRSROs. The 
Credit Rating Agency Reform Act of 2006 requires a credit rating 
agency seeking to be treated as an NRSRO to apply for, and be 
granted, registration with the SEC. See final SEC Rule, Oversight of 
Credit Rating Agencies Registered as Nationally Recognized 
Statistical Rating Organizations, at 72 FR 33564 (June 18, 2007).
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    Either through direct purchase, or indirectly through investments 
at U.S. Central, the corporate system became heavily invested in 
privately issued MBS. Between 2003 and mid-2007, the percentage of 
investments in MBS grew from 24 percent to 37 percent. At purchase, 
these securities provided the corporates with a modest increase in 
yield over traditional investments in other asset-backed securities 
(e.g., securitized credit card and auto receivables). The vast majority 
of MBS had high credit ratings (AA equivalent or above) and interest 
rates that reset on a monthly or quarterly basis, which closely matched 
the corporates' need to fund dividends on member shares.\3\ These 
features made MBS highly marketable and thus provided adequate 
liquidity to the corporates so they, in turn, could provide liquidity 
to their NPCU members.
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    \3\ Overnight share dividends repriced daily. Fixed rate share 
certificates were funded by investing in interest rate swaps. The 
swaps converted the variable rates paid by the MBS to fixed rates 
that could be used to pay the certificate dividends.
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    U.S. Central and Western Corporate Federal Credit Union (WesCorp) 
had the highest concentrations of MBS in the entire corporate 
system.\4\ The advent of national FOMs produced the competition that 
may, in turn, have helped generate these MBS concentrations. WesCorp 
was able to attract new NPCU members in part by offering dividend rates 
higher than other corporates. Consequently, it maintained an aggressive 
earnings strategy achieved by acquiring higher yielding (i.e., riskier, 
though still highly rated) MBS with greater amounts of credit risk. In 
direct response to WesCorp's market share success, other corporates 
likely pressured U.S. Central, their wholesale corporate, to pay 
higher, more competitive dividends which those corporates could pass 
along to their NPCU members. As a result, U.S. Central changed its 
portfolio strategy and also invested heavily in higher yielding MBS.
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    \4\ NCUA placed both USC and WesCorp into conservatorship in 
March 2009, as discussed further below.
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    NCUA communicated to corporates the need to establish reasonable 
concentration limits in their board policies. In January 2003, NCUA 
issued Corporate Credit Union Guidance Letter 2003-01, which expressly 
highlighted the risks associated with credit concentrations and 
specifically addressed the need for corporates to establish appropriate 
limitations within their credit risk management policies.
    During this timeframe, NCUA was also beginning to focus efforts on 
identifying and educating NPCUs on emerging risks associated with 
proper credit risk management of lending, including real estate 
lending, because of a nation-wide increase in alternative lending 
arrangements. Over the next few years, NCUA and the federal banking 
agencies worked cooperatively to provide numerous pieces of industry

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guidance on non-traditional mortgage products. NCUA warned of the 
potential adverse impact these types of loans could have on consumers 
and credit union balance sheets. Natural person credit unions have 
responded favorably to the supervision oversight of NCUA; to date, 
these types of mortgage loans represent less than 4 percent of all 
first mortgage loans outstanding in the credit union industry.
    In April 2007, several months before the distress in the mortgage 
market surfaced, NCUA issued Corporate Credit Union Guidance Letter No. 
2007-02, focusing on the various risks associated with MBS. This letter 
addressed MBS credit risk, liquidity risk, market value risk, and 
concentration risk, and by mid-2007 corporates had, by-and-large, 
ceased the purchase of private label MBS. Still, by the summer of 2007 
the MBS at the heart of the corporate problem were already on the books 
of U.S. Central and WesCorp. At that time, all their investments, 
including MBS, were still rated investment grade, and 98 percent were 
rated AA or higher. It was not until a year later (June 2008) that 
these corporates' MBS credit ratings began migrating downward, and even 
then 96 percent were still investment grade and 92 percent were still 
rated AA or better.

I.C. Corporate System: Mid-2007 Through Mid-2008

    Beginning mid-year 2007, real estate values declined across many 
markets in the U.S. and greater numbers of mortgages became delinquent 
leading to a greater number of foreclosures. The higher number of 
foreclosures further eroded housing prices, resulting in lower recovery 
of principal and even higher losses when the foreclosed properties were 
liquidated. This resulted in sharp price declines for MBS and a 
corresponding shallowing of the market as a flight to quality arose.
    Initially, market participants believed the market disturbance was 
limited to the subprime market and would be short-lived, and the 
performance of the senior credit positions in MBS, such as those 
primarily held by corporates, would not be at risk; however, that has 
proven not to be the case. By the end of 2007 and early into 2008, what 
started out as problems with sub-prime mortgages spread to Alt-A loans, 
option ARM loans, and finally to prime mortgage loans.\5\
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    \5\ Alt-A loans are between subprime and prime. Generally, the 
borrowers have good credit histories, but pay higher interest 
because of some other risk factor, such as low documentation or high 
loan-to-value ratio. Option ARM loans (option adjustable rate 
mortgages) allow the borrower to choose between different payment 
options period to period. Prime mortgage loans are considered high 
quality, with highly rated borrowers and other criteria indicating 
relatively low risk.
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    Some MBS were backed by underlying loans that had imprudent 
underwriting. These alternative mortgage loans were aggressively made 
to buyers in high-price home markets as a means to address home 
affordability.\6\ The weak credit fundamentals of the underlying 
mortgages, the inherent risk of the MBS structures, and the declining 
home market combined to severely affect the performance of MBS holdings 
of some corporates.
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    \6\ Very few, if any, of these problem loans that found their 
way into MBS pools were originated by credit unions.
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    MBS prices and marketability declined significantly. Even bonds 
that held AA ratings or higher were unable to be sold at prices close 
to par, discouraging investors, including corporates, from selling 
them. Corporates increasingly looked to borrowings to meet liquidity 
demands. By pledging their MBS assets as security, corporates were able 
to obtain financing from external lenders.
    In hindsight, it would have been preferable for the corporates to 
have sold their problem MBS in 2007. However, any sale following the 
MBS market dislocation in the summer of 2007 would have forced 
unrealized losses to become realized losses at a time when actual 
credit impairment of the underlying assets was viewed by many as 
unlikely. Absent a market of willing buyers, private label MBS 
increasingly could only be sold at a very severe discount (distressed 
prices)--causing losses even more significant than the accumulated 
unrealized losses on available-for-sale securities reflected on the 
financial statements. The conventional market wisdom at the time was 
that the problems in the MBS markets were temporary and it did not make 
economic sense to sell securities until market liquidity and 
counterparty trust improved.
    Conditions did not improve and as the MBS markets became more 
distressed and illiquid, the margin requirements set by lenders for MBS 
collateral pledged by their corporate credit union borrowers increased. 
The cost of primary borrowing sources available to corporates became 
prohibitively expensive as a result. Due to the continued price 
devaluation of MBS, the ability to borrow by pledging corporate 
investment portfolios diminished significantly, thereby increasing 
liquidity pressures. In turn, this reduced leverage diminished the 
yields paid by the corporates and made them less attractive. NPCUs 
began to invest part of their excess liquidity elsewhere, further 
increasing corporate liquidity concerns.
    In response to these concerns, NCUA directed corporates to consider 
a number of steps to ensure adequate sources of liquidity, including: 
encouraging the establishment of commercial paper and medium-term note 
programs; encouraging additional liquidity sources (both advised and 
committed); encouraging an increase in the number of repo transaction 
counterparties; encouraging membership in a Federal Home Loan Bank 
(FHLB); requiring independent third party stress test modeling of 
mortgage-related securities to determine if the securities would 
continue to cash flow; assisting U.S. Central to gain access to the 
Federal Reserve Board's discount window; and encouraging education and 
communication with their members about what was occurring in the 
financial market and how it was affecting their balance sheets. 
Corporates have done a good job of communicating these issues with 
their members and this did assist in preventing significant outflows of 
funds from the corporate system.
    On August 11, 2008, the Wall Street Journal published an article on 
the unrealized losses on available-for-sale securities in the corporate 
system. The article generated additional questions and concerns 
throughout the credit union industry and increased the possibility of a 
run on corporate shares. A run would have forced some corporates to 
sell their MBS at severely depressed prices, leading to loss of not 
only all the member capital in the affected corporates but also most 
member shares.\7\ The loss of these shares would have likely caused the 
failure of many member NPCUs and required numerous recapitalizations of 
the NCUSIF, with catastrophic effects on the credit union system as a 
whole.
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    \7\ The vast majority of shares in corporates are uninsured 
because the account balances are well above the $250,000 federal 
insurance limit.
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    Also in that August 2008 timeframe the media publicized problems 
with Fannie Mae, Freddie Mac, Bear Stearns, Countrywide, and numerous 
other financial entities. Liquidity in the global markets froze: 
liquidity had become not only expensive, but almost impossible to 
obtain. Unfortunately, these events coincided with seasonal liquidity 
demands placed by NPCUs on their corporates. Traditionally, NPCUs 
withdraw funds during August and September, and funds begin to flow 
back into the corporates in October. The

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tightening liquidity environment was of significant concern to NCUA and 
the corporate system, because corporates must maintain adequate 
liquidity to ensure the uninterrupted functioning of the payment 
systems.
    The potential loss of member confidence in their corporates, ever-
increasing concerns about the credit quality of MBS, and the seasonal 
liquidity outflows all created the ``perfect storm'' for the corporate 
system. NCUA was concerned that some corporates would be unable to meet 
the liquidity demands of their members in the short-term or be unable 
to fund payment systems activity. In addition, NCUA had indications of 
an exodus of NPCU funds from the corporate system due to a lack of 
confidence. Accordingly, in the fall of 2008 it became critical for 
NCUA to initiate dramatic action to bolster confidence in the 
corporates and ensure the continuing flow of liquidity in the credit 
union system. The NCUA's initial public actions involved liquidity 
support, while the Board intensified its contingency planning on 
related issues, including corporate capital and corporate 
restructuring.
    During the last half of calendar year 2008 NCUA took several 
actions, in tandem with the Central Liquidity Facility (CLF), to 
increase liquidity throughout the entire credit union system, 
especially within the corporates. These pro-liquidity actions included:
     Encouraging corporates with large unrealized losses on 
holdings of MBS to make application to the Federal Reserve Discount 
Window.
     Converting loans made by corporates to NPCUs to CLF-funded 
loans using funds borrowed by the CLF from the U.S. Treasury.
     Announcing and implementing the Temporary Corporate Credit 
Union Liquidity Guarantee Program (TCCULGP) on October 16, 2008. The 
TCCULGP is similar to the FDIC's Temporary Liquidity Guarantee Program 
announced by the FDIC on October 14, 2008. The TCCULGP provides a 100 
percent guarantee on certain new unsecured debt obligations issued by 
eligible corporates.
     Announcing and implementing the Credit Union System 
Investment Program (CU SIP) and the Credit Union Homeowners 
Affordability Relief Program (CU HARP). Both programs allow 
participating NPCUs to borrow funds from the CLF and invest those funds 
in CU SIP notes issued by corporates, injecting additional liquidity 
into the corporates and the entire credit union system. With the launch 
of CU HARP and CU SIP, NCUA provided about $8 billion of additional 
funding to corporates to pay down external borrowings.\8\
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    \8\ The SIP and HARP programs were key in providing liquidity to 
the corporates and the credit union system at this critical 
juncture. These two programs, and other CLF lending, would not have 
been possible without NCUA's advocacy the previous September for 
lifting the CLF cap.
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    The unrealized losses in the corporate system grew to nearly $18 
billion by year-end 2008. The severity of the MBS price declines and 
credit downgrades, along with the erosion of subordinated classes 
within the MBS structures held by corporates, required reconsideration 
by some corporate credit unions that all such fair value declines were 
temporary.\9\ In January, 2009, several corporates reported major 
realized losses and significant capital depletion, and it became 
apparent that the NCUA's liquidity assistance efforts by themselves 
would not be sufficient to stabilize the corporates. The NCUA Board 
continued its consideration of issues including corporate capital and 
corporate restructuring and, at its January 28, 2009, meeting, the NCUA 
Board took the following actions in furtherance of corporate 
stabilization:
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    \9\ The term ``subordinated'' means that the security will 
absorb credit losses in the underlying pool of loans before other, 
more senior, securities absorb credit losses. In general, the 
principal of the subordinated security will be exhausted before the 
more senior securities absorb any loss.
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     Approved issuance of a $1 billion NCUSIF capital note to 
U.S. Central as a result of pending realized losses on MBS and other 
asset-backed securities. This action was necessary to preserve 
confidence in U.S. Central, given its pivotal role in the corporate 
system, and maintain external sources of funding.
     Approved the Temporary Corporate Credit Union Share 
Guarantee Program (TCCUSGP), which guarantees uninsured shares at 
participating corporates through September 30, 2011. This program was 
vital in maintaining NPCU confidence in the corporate system.
     Authorized the engagement of Pacific Investment Management 
Company, L.L.C. (PIMCO), an independent third party, to conduct a 
comprehensive analysis of expected non-recoverable credit losses for 
distressed securities held by corporates. This information served to 
augment NCUA's previous analysis of potential losses to the NCUSIF and 
provided an independent assessment of the reliability of information 
provided by the corporates. The focus on non-recoverable credit losses 
rather than the higher and more volatile losses due to other market 
factors was consistent with the need to determine the actual loss 
exposure of the NCUSIF.
     Announced that losses to the NCUSIF associated with 
corporates would be several billion dollars, exceeding the NCUSIF's 
entire retained earnings and impairing each credit union's one percent 
capitalization deposit.
     Issued an Advance Notice of Public Rulemaking (ANPR) on 
restructuring the corporate rule. The sixty-day comment period expired 
in April 2009. NCUA received almost five hundred comment letters, 
providing suggestions on possible regulatory reforms for corporates and 
the corporate system.
    In March 2009, due to huge operating losses at U.S. Central and 
WesCorp, lack of sufficient capital, and for other reasons, the NCUA 
Board was forced to place these two corporates into conservatorship. 
The action protected retail credit union share deposits and the 
interests of the NCUSIF and helped clear the way for NCUA to take 
additional mitigating actions as they might become necessary.
    As of May 2009, NCUA estimated that losses to the NCUSIF associated 
with the troubles in the corporate system exceeded the entire equity in 
the Fund and impaired approximately 69 percent of the capitalization 
deposit that all federally insured credit unions maintain with the 
NCUSIF. These losses necessitated premium and deposit replenishment 
assessments that would, in total, cost insured credit unions an amount 
equal to almost one percent of their insured shares. Though the credit 
union system as a whole had the net worth to absorb these costs and 
remain well capitalized, the legal structure of the NCUSIF would have 
required that credit unions take all these insurance expense charges at 
once, which would result in a contraction of credit union lending and 
other services. This would come at a particularly difficult time, when 
it was vital that credit unions be a source of consumer confidence and 
continue to make credit available to support an economic recovery. In 
fact, the NCUA Board realized that such a large, sudden impact on 
credit unions' financial statements could further destabilize consumer 
confidence.
    The Board was committed to seeking the lowest cost option for 
stabilizing the corporate system, while also minimizing the adverse 
impact on natural person credit unions and their members so that credit 
unions could remain a vibrant and healthy sector of the U.S. financial 
system. In pursuit of these ends, the Board drafted legislation to 
create a Temporary Corporate Credit Union Stabilization Fund (CCUSF). 
The

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proposed CCUSF would borrow money from the Treasury for up to seven 
years and use the money to pay expenses associated with the ongoing 
problems in the corporate credit union system, such as the capital 
injection into U.S. Central. The primary purpose of this new CCUSF 
would be to spread over multiple years the costs to insured credit 
unions associated with the corporate credit union stabilization effort, 
and to ensure that the payment by insured credit unions of those costs 
was anti-cyclical, and not pro-cyclical.
    The Board sought Congressional support and passage of the CCUSF. On 
May 20, 2009, Congress enacted and the President signed into law the 
Helping Families Save Their Homes Act of 2009 (Helping Families Act), 
Public Law 111-22. Section 204 of the Helping Families Act created the 
sought-after CCUSF and provided NCUA with other helpful tools, such as 
increasing the authority of the NCUSIF and CCUSF to borrow from the 
Treasury and permitting the NCUSIF to assess premiums over as much as 8 
years to rebuild the equity ratio should the ratio fall below 1.20 
percent.
    Immediately following passage of this legislation, the NCUA Board 
took a series of actions establishing and implementing the CCUSF. On 
June 18, 2009, the Board obligated the CCUSF to accept assignment from 
the NCUSIF of the $1 billion capital note extended to U.S. Central 
executed on January 28, 2009. The Board also determined to legally 
obligate the CCUSF for any liability arising from the TCCUSGP (share 
guarantee) and TCCULGP (liquidity guarantee) programs. These steps 
effectively spread the cost of the corporate stabilization program for 
insured credit unions over multiple years.
    For more than a year, then, going back to the summer of 2008, the 
NCUA Board has worked a number of avenues to stabilize the corporate 
system, involving liquidity improvement and protection, capital 
injections, and spreading the costs to NPCUs of the stabilization 
program out over multiple years. These actions were critical to the 
near- and mid-term survival of the corporate system and to minimizing 
the potential costs to the NCUSIF and to the insured NPCUs obligated to 
the fund the NCUSIF. For the longer term, however, the Board believes 
it needs to address the structure of corporates and the corporate 
system and the investment, capital, and governance standards by which 
corporates operate. Accordingly, the Board has turned its attention to 
part 704, NCUA's corporate rule, and to the public comments that the 
Board solicited in response to its ANPR.

I.D. The Advance Notice of Proposed Rulemaking (ANPR)

    In January 2009, NCUA solicited public comment on whether 
comprehensive changes to the structure of the corporate system were 
warranted. 74 FR 6004 (Feb. 4, 2009). This corporate credit union ANPR 
sought comment on how best to define and structure the role of 
corporates in the credit union system, whether to modify the level of 
required capital for corporates, whether to modify or limit the range 
of permissible investments for corporates, whether to impose new 
standards and limits on asset-liability management and credit risk, and 
whether to make modifications in the area of corporate governance.
    NCUA received some 445 comments in response to the ANPR. More than 
370 of these comments came from natural person credit unions (NPCUs). 
Eighteen corporates, 27 state credit union leagues, four national trade 
associations, and the National Association of State Credit Union 
Supervisors also commented.
    NCUA reviewed these public comments closely and considered them 
carefully in drafting this proposed rule. Certain specific comments 
received in response to the ANPR are discussed in Section C below as 
they relate to particular proposed amendments.

II. Summary of Current Rule and Proposed Changes

    This proposal contains numerous changes to the current corporate 
rule. Some of these changes are short and straightforward, while others 
are more lengthy and complex. This Section II briefly summarizes the 
current part 704 provisions, and the proposed changes. Section III 
describes each proposed change in more detail.

II.A. Current Part 704 Capital Rules

    Currently, corporates have only one mandatory minimum capital 
requirement: They must maintain total capital--retained earnings, paid-
in capital (PIC), and membership capital accounts (MCAs)--in an amount 
equal to or greater than 4 percent of their moving daily average net 
assets.\10\ Failure by a corporate to meet this minimum capital ratio 
triggers the requirement to file a capital restoration plan with NCUA 
and may cause NCUA to issue a capital restoration directive and take 
other administrative action. Although Prompt Corrective Action (PCA) 
applies to NPCUs and to banking entities, PCA does not currently apply 
to corporates.\11\ The current rule also provides that retail 
corporates with a retained earnings ratio of less than two percent must 
increase their retained earnings by a certain amount each quarter, but 
this reserving requirement only applies to a wholesale corporate credit 
union if its retained earnings ratio falls below one percent.
---------------------------------------------------------------------------

    \10\ 12 CFR 704.3(d). Corporates have other capital-related 
requirements, such as a core capital ratio and a retained earnings 
ratio, but failure to meet these requirements only triggers future 
earnings retention requirements and does not trigger a capital 
restoration plan requirement.
    \11\ Section 216 of the Federal Credit Union Act establishes a 
PCA scheme for natural person credit unions. 12 U.S.C. 1790d. 
Paragraph (m) of Sec.  216 states specifically that the provisions 
of Sec.  216 are not applicable to corporate credit unions. Since 
corporate credit unions are different in form, function, and mission 
than natural person credit unions, the PCA scheme set forth in this 
proposal differs from that contained in Sec.  216 and its 
implementing regulation, 12 CFR Part 702. The legal authority for 
this proposed corporate PCA scheme is found in two different places. 
Section 120(a) of the Act, states, in pertinent part, that ``[A]ny 
central credit union chartered by the Board shall be subject to such 
rules, regulations, and orders as the Board deems appropriate * * * 
.'' 12 U.S.C. 1766(a). Section 201(b)(9) of the Act also requires 
that federally insured credit unions ``comply with the requirements 
of this [share insurance] title and of regulations prescribed by the 
Board thereto.'' 12 U.S.C. 1781(b)(9).
---------------------------------------------------------------------------

II.B. Proposed Amendments to Part 704 Capital Rules

    NCUA intends to change the corporate capital requirements to make 
them stronger and more consistent with the requirements of the banking 
regulators. For example, the other regulators employ three different 
minimum capital ratios, not one ratio like NCUA. The current corporate 
minimum capital ratio is also calculated differently from any of the 
three ratios employed by the other regulators.
    The proposal replaces the current four percent total capital ratio 
with a four percent leverage ratio, and limits the capital that can be 
used to calculate the leverage ratio to core, or Tier 1, capital, which 
would include only the more permanent forms of corporate capital. The 
proposal also includes new minimum risk-based capital ratios that are 
calculated based on risk-weighted assets. Failure to meet these minimum 
ratios will trigger a capital restoration plan requirement, potential 
capital restoration directives, and other, new prompt corrective action 
(PCA) provisions. The new PCA provisions are similar to those currently 
applicable to banks. The due process associated with the new PCA 
provisions is set out in a new subpart to part 747 of NCUA's rules.
    The proposal also refines the acceptable elements of corporate 
capital. For example, after an appropriate phase-in period a certain 
percentage of core

[[Page 65215]]

capital must be in the form of retained earnings. The timing and amount 
of this retained earnings requirement is discussed in detail in Section 
III below.
    The proposal will also toughen the requirements for Tier 2 capital 
accounts (i.e., MCAs) that can be used in part to satisfy the new total 
risk based capital ratio. Specifically, the current minimum three year 
requirement for MCAs will be lengthened to five years, and the 
adjustable balance type of MCA accounts will be eliminated.
    The proposal also renames the two types of contributed capital 
accounts (PIC and MCA) to render the names more descriptive of what 
they actually are. PIC is renamed as perpetual contributed capital 
(PCC), and MCAs are renamed as nonperpetual capital accounts (NCAs). 
The proposal further permits corporates to issue PCC and NCAs to both 
members and nonmembers.
    The proposal will eliminate the current prohibition on corporates 
requiring credit unions to contribute capital to obtain membership or 
receive services. It will also permit members to transfer corporate 
capital instruments they hold to third parties and will require 
corporates to facilitate such transfers.
    The proposal also eliminates the special treatment that wholesale 
corporates receive with regard to retained earnings reserving 
requirements. All corporates will be subject to the same requirements 
with regard to retained earnings.
    Finally, the proposal permits a corporate, at its option, to give 
new contributed capital priority over existing contributed capital.

II.C. Current Part 704 Investment Limitations

    Among other investment provisions, the current part 704:
     Requires that a corporate maintain an internal investment 
policy that includes reasonable and supportable concentration limits, 
including limits by investor type and sector, but does not prescribe 
standards for determining the reasonableness of those limits.
     Requires that the aggregate of all investments in any 
single obligor is limited to the greater of 50 percent of capital or $5 
million.
     Specifies, for permissible investment types, that the 
investment must be rated no lower than AA--by at least one Nationally 
Recognized Statistical Rating Organization (NRSRO) at time of purchase. 
The required rating may be lower for certain investment types if the 
corporate has expanded authorities. Additional requirements apply if 
the rating is subsequently lowered. Certain investment types, such as 
U.S. government securities and CUSO investments, are exempt from the 
NRSRO requirement.
     Specifically prohibits certain types of investments, 
including most derivatives, most stripped MBS (e.g., interest only 
strips and principal only strips), mortgage servicing rights, and 
residual interests in asset-backed securities (ABS).
     Does not address investments that are structured to be 
subordinate, in terms of potential credit losses, to other securities.

II.D. Proposed Amendments to Part 704 Investment Limitations

    The proposal will impose specific concentration limits by 
investment sector. Sectors include residential mortgage-backed 
securities, commercial mortgage-backed securities, student loan asset-
backed securities, automobile loan/lease asset-backed securities, 
credit card asset-backed securities, other asset-backed securities, 
corporate debt obligations, municipal securities, registered investment 
companies, and an all others category to account for the development of 
new investments types. The proposal further restricts the purchase of 
high-risk structured instruments that concentrate, and thus multiply, 
market risk exposures, such as investments that return a multiple of a 
particular market interest rate. These limits would be in addition to 
current limits on derivatives. The proposal would also limit 
subordinated positions in all sectors. This limit will reduce a 
corporate's credit risk by restricting its ability to purchase 
mezzanine residential mortgage-backed securities, as some corporates 
did, or other subordinated structured securities that are not the most 
senior security in terms of credit risk.
    The proposed changes would prohibit additional investment types 
that have proven problematic, such as collateralized debt obligations 
(CDOs) and Net Interest Margin (NIM) securities.
    The proposed changes would require that a corporate get multiple 
ratings from different NRSROs, and only use the lowest of the ratings, 
and require that ratings be used only to exclude an investment, not as 
authorization to include one. Credit ratings will not be a substitute 
for pre-purchase due diligence and ongoing risk monitoring. Downgrades 
below the minimum rating threshold will continue to trigger investment 
action plans. These provisions, along with the asset-liability 
management (ALM) provisions described below, will reduce reliance on 
NRSRO ratings.
    The proposal will eliminate the current Part II expanded investment 
authority, modify the current Part IV expanded authority on 
derivatives, and impose increased capital requirements to qualify for 
Part I and II expanded investment authorities.

II.E. Current Part 704 ALM Provisions

    The current part 704 requires that corporates maintain an internal 
ALM policy. The rule requires that as part of that policy the corporate 
do Net Economic Value (NEV) modeling to measure interest rate risk, but 
the rule does not have any other specific requirements relating to the 
risks of mismatches between asset and liability cash flows. The current 
part 704 requires that any corporate permitting early withdrawals on 
share certificates ``assess a market-based penalty sufficient to cover 
the estimated replacement cost of the certificate redeemed.'' The 
current rule does not establish any minimum amount of cash, or cash 
equivalents, that a corporate must, for liquidity purposes, maintain on 
hand at all times. The current rule limits a corporate's borrowing to 
the greater of 10 times capital or 50 percent of shares and capital, 
but does not place any additional limits on secured borrowings.

II.F. Proposed Amendments to Part 704 ALM Provisions

    The proposal would:
     Establish a maximum limit on the weighted average life of 
a corporate's aggregate assets.
     Establish limits on cash flow mismatches so as not to 
exceed an acceptable gap between the average life of assets and 
liabilities.
     Require additional testing for spread widening and net 
interest income (NII) modeling; including testing standards.
     Further limit a corporate's ability to pay a market-based 
redemption price to no more than par, thus eliminating the ability to 
pay a premium on early withdrawals.
     Require a corporate maintain a minimum amount of cash or 
cash equivalents to ensure sufficient liquidity protection for payment 
system operations.
     Restrict the use of secured borrowings for purposes other 
than liquidity needs.
    The effects of these new, proposed ALM provisions, as well as the 
investment provisions discussed in paragraph E. above, are illustrated 
in more detail in subsection III.D. below.

[[Page 65216]]

II.G. Current Part 704 Corporate Governance Provisions

    The current part 704 places limitations on board representation, 
including limits on the number of trade organization representatives. 
The current rule does not, however, place any experience or knowledge 
requirements on individual corporate directors. The current rule does 
not require any disclosure of executive compensation to the members of 
a corporate, nor does it place any limits on golden parachute severance 
packages for senior executives.\12\ The current part 704 does not limit 
the representation of corporate executives and officials on the boards 
of other corporates.
---------------------------------------------------------------------------

    \12\ The Internal Revenue Code, and state law, may require some 
disclosure for state chartered corporates, but not for federal 
charters.
---------------------------------------------------------------------------

II.H. Proposed Amendments to Part 704 Corporate Governance Provisions

    The proposed changes, after appropriate phase-in periods, would: 
\13\
---------------------------------------------------------------------------

    \13\ Some of these proposals are phased-in over time.
---------------------------------------------------------------------------

     Require that corporate directors currently hold a Chief 
Executive Officer (CEO), Chief Financial Officer (CFO), or Chief 
Operating Officer (COO) position, at their credit union or member 
entity.
     Require that all compensation agreements between a 
corporate and its senior executives and directors be disclosed to the 
members of the corporate upon request and at least once annually to the 
entire membership.
     Provide for disclosure of material increases in 
compensation related to corporate mergers.
     Prohibit certain golden parachute payments and related 
indemnification provisions.
     Require that a majority of all corporate boards (including 
USC) consist of representatives from natural person credit unions.
     Establish term limits on both corporate members and 
individuals serving as representatives of corporate members.
     Prohibit an individual from serving on the boards of more 
than one corporate at a time and prohibit an organizational entity from 
having two or more individual representatives on the board of a single 
corporate.

II.I. Miscellaneous Proposed Amendments to Part 704

    The proposal:
     Removes Sec.  704.19, which provided wholesale corporates 
with a lower retained earnings requirement than retail corporates.
     Restricts the total amount of investments and loans a 
corporate may accept from any single member.
     Requires that corporate CUSOs restrict their services to 
brokerage services, investment advisory services, and other categories 
of services as preapproved by NCUA.
     Expands the current requirement that corporate CUSOs agree 
to give NCUA access to books and records to include access to the 
CUSO's personnel and facilities.

III. Discussion and Analysis of Particular Proposed Amendments

    This proposed rule contains amendments to different sections and 
appendices in part 704. The following table summarizes the current 
organization of part 704, and where, when, and how the Board intends to 
amend that organization and substance.

------------------------------------------------------------------------
          Current part 704 Rule Provision                 Amended?
------------------------------------------------------------------------
704.1 Scope.......................................  No.
704.2 Definitions.................................  Yes. First amendment
                                                     effective upon
                                                     publication of
                                                     final rule. Second
                                                     amendment effective
                                                     one year after
                                                     publication of
                                                     final rule.
704.3 Corporate credit union capital..............  Yes. Removed and
                                                     replaced effective
                                                     one year after
                                                     publication of
                                                     final rule.
704.4 Board responsibilities......................  Yes. Effective one
                                                     year after
                                                     publication of
                                                     final rule, current
                                                     Board
                                                     responsibilities
                                                     moved to 704.13.
                                                     Effective one year
                                                     after publication
                                                     of final rule, new
                                                     704.4 (Prompt
                                                     corrective action)
                                                     added.
704.5 Investments.................................  Yes.
704.6 Credit risk management......................  Yes.
704.7 Lending.....................................  No.
704.8 Asset and liability management..............  Yes.
704.9 Liquidity management........................  Yes.
704.10 Investment action plan.....................  No.
704.11 Corporate CUSOs............................  Yes.
704.12 Permissible services.......................  No.
704.13 [Reserved].................................  Effective one year
                                                     after publication
                                                     of final rule,
                                                     current 704.4,
                                                     Board
                                                     responsibilities,
                                                     moved to 704.13. No
                                                     change to
                                                     substance.
704.14 Representation.............................  Yes.
704.15 Audit requirements.........................  No.
704.16 Contract/written agreements................  No.
704.17 State-chartered corporate credit unions....  No.
704.18 Fidelity bond coverage.....................  No.
704.19 Wholesale corporate credit unions..........  Yes. Current 704.19
                                                     removed. New
                                                     704.19, Disclosure
                                                     of executive and
                                                     director
                                                     compensation,
                                                     added.
704.20 None.......................................  Yes. New 704.20,
                                                     Golden parachute
                                                     and indemnification
                                                     payments, added.
Appendix A--Model Forms...........................  Yes. Renamed Capital
                                                     Prioritization and
                                                     Model Forms.
Appendix B--Expanded Authorities and Requirements.  Yes.
Appendix C--None..................................  Yes. Effective one
                                                     year after
                                                     publication of
                                                     final rule, new
                                                     Appendix C, Risk-
                                                     Based Capital
                                                     Credit Risk-Weight
                                                     Categories, added.
------------------------------------------------------------------------

    This section of the preamble discusses each of these proposed 
amendments in detail. This section generally follows the organization 
of part 704, that is, starting with the proposed capital (Sec.  704.3) 
and PCA (Sec.  704.4) amendments, then investments (Sec.  704.5) and 
credit risk (Sec.  704.6), then asset and liability management (Sec.  
704.8), then corporate

[[Page 65217]]

board representation Sec.  (704.14), and then the new sections relating 
to disclosure of executive and director compensation (Sec.  704.19) and 
golden parachutes and indemnification (Sec.  704.20).
    Many of the proposed amendments require new definitions that appear 
in Sec.  704.2, and the discussion of these definitions appears with 
the discussion of the associated substantive change to the corporate 
rule. The proposal includes amendments to the Appendices A and B, and 
adds a new Appendix C. Since Appendix B relates to investment 
authority, the proposed amendments to that appendix are discussed as 
part of the discussion of Sec.  704.5. Since Appendices A and C (on 
model forms and the risk-weighting of assets, respectively) relate to 
corporate capital, the changes to these appendices are discussed as 
part of the discussion of the proposed Sec.  704.3. The proposed 
addition of subpart L to part 747 provides the due process associated 
with the new PCA provision, and so is discussed as part of the Sec.  
704.4 discussion.
    The proposed changes to capital terminology in part 704 also 
necessitate conforming amendments to parts 702, 703, and 709, as 
discussed below.

III.A. Amendments to Part 704 Relating to Capital

Current Part 704 Capital Requirements
    Adequate capital is essential to the safe and sound operation of a 
corporate. It ensures that the corporate has a buffer against the 
losses associated with all the various risks associated with the 
investments and activities of a corporate.
    Currently, part 704 contains only one mandatory, minimum capital 
requirement: that corporates achieve and maintain a ratio of capital to 
moving daily average net assets of at least four percent. Part 704 
defines capital, generally, to include retained earnings, paid-in 
capital (PIC), and membership capital accounts (MCAs). The current 
capital requirements in part 704 differ in certain respects from the 
capital requirements that banking regulators impose on banks. For 
example, part 704 does not include any capital calculations based on 
risk-weighted assets. Part 704 also permits certain membership capital 
accounts to qualify as corporate capital where those same accounts 
would not satisfy the bank regulators' definition of capital. Part 704 
permits membership capital accounts with terms as short as three years, 
while banking regulators require such capital to have terms of at least 
five years. In addition, part 704 permits adjustable balance membership 
capital accounts; while banking regulators do not recognize any sort of 
adjustable balance accounts as capital.
Public Comment on the ANPR
    The ANPR discussed various approaches that NCUA is considering with 
respect to capital requirements for corporates and solicited comment on 
several aspects of this issue. For example, the agency asked whether it 
should establish a new leverage ratio consisting only of more permanent 
(core) capital and excluding MCAs; increase the required capital ratio 
to more than four percent; and implement changes that would result in 
redefining MCAs in line with accepted banking notions of capital. The 
agency asked whether it should establish new minimum capital ratios 
based on risk-weighted asset classifications, which could include the 
use of some form of membership capital. Another question presented for 
comment and discussion in the ANPR was whether natural person credit 
unions should maintain contributed capital as a prerequisite to 
obtaining services from a corporate.
    Comments about capital and capital requirements were wide ranging, 
reflecting the importance and difficulty of this issue. Many commenters 
believe there is a need for greater capital within the corporate system 
and for more sensitive measures of the necessary capital.
    Ninety-seven commenters addressed the question of whether the 
agency should establish a new required capital ratio consisting of core 
capital only and excluding membership capital accounts. Sixty-four 
favored such a new capital ratio while 33 opposed it. One hundred 
sixteen commenters discussed whether a corporate should be permitted to 
provide services only to members who contributed tier 1 capital; 82 
favored this restriction while 34 opposed it. Regarding the question of 
whether the required capital ratio should be increased, the vast 
majority of commenters--80 of 93--favored increasing the required 
capital ratio to more than four percent.
    Of the 58 commenters who addressed the topic of whether the agency 
should change the rules regarding the manner in which membership 
capital can be adjusted, 44 favored and 14 opposed rule changes in this 
area. On the question of whether the corporates should be subject to 
risk-based capital standards, the commenters were nearly unanimous, 
with 173 of 185 comments favoring risk-based capital standards for 
corporates.
    Commenters advocating greater capital requirements generally 
supported a phase-in period before any new requirements become 
effective. The corporate trade association and many corporates 
suggested that all corporates should attain a minimum Tier 1 core 
capital ratio of four percent using 12 month daily average net assets 
(DANA) by the end of 2010 and higher minimum core capital levels in the 
future based on Basel.\14\ These commenters also said the use of DANA 
is necessary to account for fluctuations in assets due to the cash flow 
seasonality of credit unions, although there were different views among 
the commenters about the appropriate length of DANA, ranging from three 
months to three years.
---------------------------------------------------------------------------

    \14\ The definitions of DANA, and moving DANA, are laid out and 
discussed further on in this preamble.
---------------------------------------------------------------------------

    Some commenters took the opposing view, suggesting that current 
capital requirements are adequate with proper oversight and risk 
management. One commenter noted that an increased capital contribution 
requirement would limit the flexibility of credit unions in dealing 
with the corporate system. Another commenter indicated that, with an 
appropriate limitation on the investment authority and range of 
permissible services offered by a corporate in a consolidated corporate 
network, current capital rules should be adequate.
    Other commenters advocated that NCUA require mandatory capital 
contributions by natural person credit unions as a condition of 
receiving services from a corporate. One corporate that supported 
mandatory capital for services stated that such a requirement would 
likely drive the regionalization of corporates as natural person credit 
unions would limit their corporate relationships to one nearby 
corporate. Some commenters, however, took the opposite view, believing 
mandatory capital contributions to be too limiting on the ability of 
credit unions to choose the corporate they want to do business with; 
these commenters suggested that the corporate simply charge higher 
service fees for members not contributing capital.
    Many of those commenters who discussed the issue of membership 
capital accounts (MCAs) supported the idea of making MCA conform to the 
accepted banking standard of Tier 2 capital, e.g., to require that it 
be a minimum of five year term or, if of indefinite term, subject to at 
least five years notice of withdrawal. Many commenters suggested that 
MCA contributions be tied to asset size and

[[Page 65218]]

also that NCUA mandate that corporates implement MCA with uniform 
characteristics, so that there would be less competition among the 
corporates for capital from NPCUs. Some commenters also stated that MCA 
withdrawals should only be permitted if the corporate would be in 
compliance with applicable capital standards after withdrawal. Some 
commenters expressed the opposite view, with one suggesting that 
withdrawal within six months of notice should be sufficient.
    Commenters who supported the idea of a risk-based approach to 
capital indicated that they believed that appropriately designed risk-
based capital requirements would encourage corporates to monitor and 
control their more risky investments and activities. Some of these 
commenters, however, stated that if NCUA restricts investment or other 
authorities of corporates through regulatory changes, then capital 
requirements should be less than that required of other institutions 
under Basel standards. Another commenter expressed doubt about the 
effectiveness of a risk-based system, noting that it did not alleviate 
or prevent the current difficulties being experienced in the banking 
sector.
Discussion of Proposed Capital Regulations
    A corporate's capital levels must be consistent with the risks 
associated with the activities in which a corporate engages. Linking 
the amount of a credit union's capital requirement to the overall 
riskiness of its assets is a more accurate method of ensuring that the 
credit union can afford to cover losses that may arise from such 
activities without becoming insolvent. The other federal banking 
regulators have adopted this risk-based approach to capital in a manner 
consistent with the international framework for capital standards 
established by the Basel Committee on Banking Supervision (commonly 
referred to as the Basel Supervisors Committee) in July, 1988 (Basel 
I), and as subsequently expanded upon in 2006 (Basel II).
    Activities that potentially have higher returns generally have such 
potential because of their higher risk of loss. Because higher risk/
return activities can exhaust a corporate's capital faster than lower 
risk/return activities, the Board believes corporates engaging in 
higher risk activities should hold more capital to protect the National 
Credit Union Share Insurance Fund and to provide appropriate incentives 
for prudent management. Likewise, institutions that engage in lower 
risk activities do not need as large a capital cushion and should be 
permitted to operate with a lower minimum capital requirement, 
consistent with protection of the insurance fund and the long-term 
safety of the credit union industry and the individual corporate.
    Unfortunately, it is not easy to develop a capital scheme that 
accounts for all possible risks and that requires only as much capital 
as is necessary to cover the potential losses associated with such 
risks. The Board has closely examined the efforts of the other 
regulators to develop a risk-based capital scheme. Those efforts are 
based, in large part, on the Basel Accords. A short discussion of those 
Accords and the related efforts of the banking regulators follows.
Summary of the Basel Accords
    A group of eleven industrialized nations, including the U.S., 
formed the Basel Committee to harmonize banking standards and 
regulations among the member nations. One of the Committee's tasks was 
to design standards that would provide a bank with sufficient capital 
in relation to the risks undertaken by the bank. In July of 1988, the 
Committee issued the International Convergence of Capital Measurements 
and Capital Standards, known informally as Basel I.
    Basel I created a risk-based capital scheme based on four pillars. 
The first pillar, constituents of capital, defined the elements of Tier 
1 and Tier 2 capital. The second pillar, asset risk weighting, provided 
for risk-weighting of asset classes into four categories: zero percent, 
20 percent, 50 percent, and 100 percent. The third pillar, target 
standard ratio, imposed an eight percent minimum risk-weighted capital 
ratio, at least half of which (four percent) must be Tier 1. Pillar 4, 
or transitional and implementing agreements, urged banking regulators 
to support these capital requirements with strong surveillance and 
enforcement. All of the major U.S. banking regulators subsequently 
adopted capital requirements based on Basel I.\15\
---------------------------------------------------------------------------

    \15\ References to banking regulators here mean the Federal 
Reserve (Fed), Office of the Comptroller of the Currency (OCC), 
Office of Thrift Supervision (OTS), and the Federal Deposit 
Insurance Corporation (FDIC).
---------------------------------------------------------------------------

    Basel I, however, was subject to significant domestic and 
international criticism. One criticism was that the risk-weightings 
only accounted for credit risk. In other words, Basel I did not provide 
a capital buffer for potential loss from other risks, such as 
operational risk, market risk, interest rate risk, legal risk, currency 
risk, and reputational risk.\16\ The U.S. banking regulators 
compensated for the capital requirements associated with these 
additional risks by imposing a separate capital ratio, the leverage 
ratio, which was not based on the credit risk-weighted assets but was 
based on total assets. Another criticism of Basel I was that the risk-
weightings were too broad and general, and that within a particular 
asset class individual assets should not all be risk-weighted at, say, 
50 percent, but should be classified with more specificity. For 
example, loans to corporations are of varying credit quality and should 
not all carry the same risk-weighting. Again, the leverage ratio helps 
compensate for this lack of granularity in credit-risk weighting. Also, 
Basel I did not account for new asset classes, such as the 
securitizations that were first making an appearance during the 1980s.
---------------------------------------------------------------------------

    \16\ ``Operational risk'' includes risks such as loss due to 
fraud and legal/compliance risk. ``Market risk'' includes losses due 
to general economic downturns and market fluctuations, but also 
sometimes includes the other enumerated risks (e.g., reputational 
and interest rate risk).
---------------------------------------------------------------------------

    Due in part to the criticisms of Basel I, the Basel Committee set 
to work on another agreement, the International Convergence of Capital 
Measurement and Capital Standards: A Revised Framework, which was 
finalized in 2006. This New Accord, also known as Basel II, greatly 
expands the scope, technicality, and depth of Basel I. Basel II 
provides for new approaches to credit risk; adapts to the 
securitization of bank assets; covers market, operational, and interest 
rate risk; and incorporates market based surveillance (market 
discipline) and regulation.
    Basel II has three pillars. Pillar one, minimum capital 
requirements, created a formula for risk-based capital that translates 
roughly into Reserves (capital) = (.08)(Risk-Weighted Assets) + 
(Operational Risk Reserves) + (Market Risk Reserves). Basel II provided 
alternative ways to calculate credit-risk weights and operational 
reserves.\17\ Pillar two, the supervisory review process, required that 
banking regulators provide significant oversight and enforcement of 
capital standards. Pillar three, market discipline, required

[[Page 65219]]

that banks make significant public disclosure of their investments and 
activities to help control risk through market discipline.
---------------------------------------------------------------------------

    \17\ The other banking agencies, in their July 2008 proposed 
rulemaking, listed six different Basel II methods for calculating 
the reserve requirements associated with credit and operational 
risk:
    Credit-Risk Weighting Methods:
    Standardized
    Foundation Internal ratings based
    Advanced internal ratings based
    Operation Risk Reserve Methods:
    Standarized
    Basic Indicator Approach (BIA)
    Advanced Measurement (AMA)
---------------------------------------------------------------------------

    The primary criticism of Basel II is the complexity associated with 
its more comprehensive, and more complex, risk and risk-weighting 
scheme.
Status of the Capital Schemes of the Banking Regulators
    As noted above, the primary banking regulators have adopted capital 
schemes based on Basel I, referred to here as the ``general risk-based 
capital rules.'' Since the completion of Basel II these regulators have 
published three important rulemakings related to capital.
     In September 2006, the banking regulators issued a 
proposed rule with Advanced Basel II risk standards and measurements. 
Generally, the proposal would have permitted banks to adopt their own 
methodology for calculating credit and operation risks, so long as the 
methodology complied with the three pillars of Basel II and the banks 
could justify the methodology to the regulators. In December 2007, the 
regulators finalized this Advanced Basel II rulemaking.\18\ Compliance 
with this Advanced methodology is mandatory for large banks (i.e., 
above $250 billion), and optional for all other banks.
---------------------------------------------------------------------------

    \18\ 72 FR 69288 (Dec. 7, 2007).
---------------------------------------------------------------------------

     In December 2006, the banking regulators published 
proposed improvements to the general risk-based capital rules, which 
they labeled as the Basel IA NPR.\19\ This Basel IA NPR stated: ``A 
banking organization would be able to elect to adopt these proposed 
revisions or remain subject to the Agencies' existing risk-based 
capital rules, unless it uses the Advanced Capital Adequacy Framework 
proposed in the notice of proposed rulemaking published in September 
2006.'' The banking regulators, however, never adopted these proposed 
improvements.
---------------------------------------------------------------------------

    \19\ 71 FR 77446 (Dec. 26, 2006).
---------------------------------------------------------------------------

     In July 2008, the banking agencies published a proposed 
Basel II rulemaking called the Standardized Framework.\20\ The preamble 
to this NPR noted that the ``[a]gencies have decided not to finalize 
the Basel IA NPR and to propose instead a new risk-based capital 
framework that would implement the Standardized Framework for credit 
risk, the Basic Indicator Approach for operational risk, and related 
disclosure requirements,'' and ``[m]any commenters felt the Basel II 
Standardized Framework is more risk sensitive than the Basel IA NPR and 
would more appropriately address the industry's economic concerns 
regarding domestic and international competitiveness.'' Under this 
proposed Basel II Standardized Framework banks that are not required to 
use the Basel II Advanced approach have the option of either continuing 
with existing (pre-Basel IA) general risk-based capital rules or opting 
into the new Basel II Standardized Framework. Also, regardless of 
whether a bank opts to continue under the Basel I rules or the Basel II 
Standardized Framework rules, the banking regulators indicated that 
they will continue to require a minimum leverage ratio as well as risk-
based capital ratios. As of October 2009, the banking regulators, 
however, had not adopted a final Basel II Standardized rulemaking.
---------------------------------------------------------------------------

    \20\ 73 FR 43983 (July 29, 2008).
---------------------------------------------------------------------------

    In determining how to amend the existing capital requirements of 
part 704 to meet the needs of corporates, NPCUs, and the NCUSIF, the 
Board concluded that the ideal would be a corporate capital scheme that 
provides sufficient capital protection against risk without undue 
complexity. The scheme needs to take into account the capital schemes 
of the banking regulators, so as to give external entities some comfort 
with the scheme, while including capital elements that account for the 
unique nature of corporate as member-owned cooperatives serving other 
member-owned cooperatives. The capital scheme must also account for the 
fact that corporates have limited means to raise capital because, for 
example, they cannot issue stock.
    The Advanced Basel II approach appears inappropriate for corporates 
at this time. The Advanced approach is more complex than necessary, and 
the other regulators do not require it for banks with less than $250 
billion in assets. The Standardized Basel II approach also appears 
inappropriate for corporates because the other regulators have not yet 
finalized their Standardized methodology and could make significant 
changes to that methodology. In addition, even when the other 
regulators do finalize their Basel II Standardized Framework, they will 
permit banks smaller than $250 billion in size to elect to continue 
under the Basel I rules. If NCUA adopted a Basel II Standardized 
Framework, NCUA would need to have both a Basel II and a Basel I rule 
for corporates to be consistent with the rules of the other 
regulators--which would add an additional level of complexity to the 
pending NCUA rulemaking. The Board has determined that, given this fact 
and the relative size of corporates and their activity base, the NCUA 
should adopt a corporate capital rule based on the existing general 
risk-based capital rules of the other regulators, that is, the Basel I 
rules. The Basel I standards, when combined with investment and ALM 
requirements that limit noncredit risk and a robust leverage ratio 
requirement, should ensure corporates have the capital they need to 
cover noncredit risks and to reserve for weaknesses in the Basel I 
credit risk methodology. The Board believes use of the existing Basel I 
format provides the best synthesis of capital requirements and ease of 
application.\21\
---------------------------------------------------------------------------

    \21\ To understand the length and complexity of the Basel I 
capital rules alone, the OTS Basel I capital provisions fill up 35 
full pages in the Code of Federal Regulations (CFR), and the OTS 
Prompt Corrective Action provisions fill up another 10 full CFR 
pages, for a total of 45 pages. These two OTS rulemakings together 
are twice as long as NCUA's entire corporate rule, Part 704, which 
fills up about 23 CFR pages. The proposed Basel II Standardized and 
the final Basel II Advanced rules are even longer.
---------------------------------------------------------------------------

    In crafting the proposed capital rule, NCUA closely examined the 
capital rules of the federal banking regulators. In particular, NCUA 
looked to the capital rules of the Office of the Comptroller of the 
Currency (OCC) and the Office of Thrift Supervision (OTS), the primary 
regulators of federally-chartered banks.\22\ The NCUA also looked to 
the capital rules of the Federal Deposit Insurance Corporation (FDIC) 
for state chartered nonmember banks, since both the NCUA and the FDIC 
function as federal account insurers.\23\ The Board adapted these 
rules, as much as possible, to the capital needs of corporates, in 
consonance with the differences between credit unions and banks and 
with a view toward simplification wherever possible.
---------------------------------------------------------------------------

    \22\ See 12 CFR part 567 (OTS Capital Rules) and 12 CFR part 3 
(OCC Capital Rules). The OTS rules were of particular interest the 
mutual savings banks regulated by the OTS, like credit unions, are 
structured as mutual organizations.
    \23\ See 12 CFR part 325 (FDIC capital rules).
---------------------------------------------------------------------------

    The NCUA also looked to the OTS' PCA regulations, and Section 38 of 
the Federal Deposit Insurance Act (FDIA), in drafting proposed 
regulations for corporates on the consequences of having inadequate 
capital.\24\ The proposed PCA regulations are discussed later in this 
preamble.
---------------------------------------------------------------------------

    \24\ 12 CFR 565 (OTS' Prompt Corrective Action rules); and 18 
U.S.C. 1831o (FDIA Prompt Corrective Action).
---------------------------------------------------------------------------

    The NCUA believes that corporates operating with adequate capital 
have more incentive and are better positioned to evaluate the potential 
risks and rewards inherent in various activities. Thus, a corporate 
operating with more than minimum amounts of capital may be permitted a 
wider range of activities

[[Page 65220]]

without as much direct regulatory restriction, subject only to 
supervisory review.
Structure of Proposed Capital Regulations
    The proposed changes to the capital requirements of part 704 affect 
three different sections.
    Proposed Sec.  704.3 establishes new risk-based and leveraged 
capital ratios and standards. The credit risk categories that are used 
in determining a corporate's risk-weighted assets appear in a proposed 
new Appendix C to part 704.
    Proposed amendments to Sec.  704.2 contain revised definitions of 
terms used in the capital standards. The permissible components of a 
corporate's capital base, including which items qualify as core 
capital, which items qualify as supplementary capital, and which items 
must be deducted in determining the corporate's capital base for 
purposes of the risk-based and leverage ratio standards are set forth 
in proposed Sec.  704.2.
    Proposed Sec.  704.4, prompt corrective action, outlines the 
potential consequences of a corporate's failure to meet any of its 
regulatory capital requirements.
Proposed Sec.  704.3 Corporate Credit Union Capital
Overview
    The proposed rule establishes three standards that a corporate must 
satisfy in order to meet its capital requirement: a leverage ratio of 
adjusted core capital to moving daily average net assets (DANA), a tier 
1 risk-based capital ratio of that same adjusted core capital over 
moving daily average net risk-based assets (DANRA), and a total risk-
based capital standard expressed as a percentage of total capital to 
moving DANRA.
    The two risk-based capital standards address the credit risk 
inherent in the assets in a corporate's investment portfolio and 
activities. Of course, there are other risks that are inherent in 
corporates and their portfolios and activities, such as market risk, 
interest rate risk, liquidity risk, and the risk of fraud. The leverage 
ratio requirement is intended to ensure that no matter how free from 
credit risk a corporate may be, it must maintain a minimum amount of 
capital measured in terms of its total assets as protection against 
risks other than credit risk. While there are other, important 
provisions of the existing corporate rule and the proposal that place 
limits around these noncredit risks, these risks still exist and are 
significant.\25\ Accordingly, a minimum leverage ratio requirement is 
essential.
---------------------------------------------------------------------------

    \25\ For example, the interest rate sensitivity analysis 
required by Sec.  704.8(d) of the current corporate rule controls 
for, but does not eliminate, interest rate risk. Likewise, the 
provisions in this proposed rule that would control the mismatch in 
the duration of a corporate's assets and liabilities would limit, 
but not eliminate, the risk of spread widening.
---------------------------------------------------------------------------

    These proposed capital measurements and associated minimums are 
similar to those described in Basel I and adopted by the federal 
banking regulators. There are some minor differences, reflecting the 
mutual organization of corporates and the unique role they play in the 
credit union system. For example, this proposal employs average asset 
calculations in the capital ratio denominators, and not the period-end 
assets employed by the banking regulators. This reflects the 
corporate's unique role as a liquidity provider, as discussed further 
below. The proposal also does not include a tangible capital or 
tangible equity requirement.\26\ On the other hand, the proposal does 
require that corporates build and maintain a certain amount of retained 
earnings to satisfy their minimum leverage ratio requirement.
---------------------------------------------------------------------------

    \26\ See, e.g., 12 CFR 567.2(a)(3).
---------------------------------------------------------------------------

Elements of Capital
    As discussed above, the current part 704 sets forth three different 
categories of capital: retained earnings, PIC, and MCAs. These elements 
of capital are divided by moving DANA to obtain the capital ratio. A 
corporate must maintain a minimum four percent capital ratio.
    MCAs are currently defined in part 704 as:

    [F]unds 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.

    12 CFR 704.2. The proposed rule changes the nomenclature for MCAs, 
renaming them with a more descriptive title: nonperpetual contributed 
capital accounts (NCAs). This proposed retitling summarizes the 
substantive difference between MCAs and PIC and reflects that fact that 
the proposal will permit corporates to issue NCAs to both members and 
nonmembers.\27\ The proposal specifically defines NCAs as follows:
---------------------------------------------------------------------------

    \27\ PIC will also be retitled as perpetual contributed capital, 
as discussed further below.

    Nonperpetual capital means funds contributed by members or 
nonmembers that: are term certificates with a minimum term of five 
years or that have an indefinite term (i.e., no maturity) with a 
minimum withdrawal notice of five years; are available to cover 
losses that exceed retained earnings and perpetual contributed 
capital; are not insured by the NCUSIF or other share or deposit 
insurers; and cannot be pledged against borrowings. In the event the 
corporate is liquidated, the holders of nonperpetual capital 
accounts (NCAs) will claim equally. These claims will be subordinate 
to all other claims (including NCUSIF claims), except that any 
claims by the holders of perpetual contributed capital (PCC) will be 
---------------------------------------------------------------------------
subordinate to the claims of holders of NCAs.

    The currently permissible three-year term MCAs, and MCAs that are 
adjustable balance over a short period of time, are insufficiently 
permanent to meet the definition of capital as described in the Basel 
accords and as adopted by the federal banking regulators.\28\ To 
qualify as capital, the proposal requires that hybrid debt instruments 
such as nonperpetual contributed capital accounts (NCAs) be term 
instruments of an initial maturity of at least five years or, if 
structured as indefinite notice (or ``no maturity'') accounts, must 
have a notice period of at least five years.
---------------------------------------------------------------------------

    \28\ See, e.g., 12 CFR 3.100(f) (OCC requires minimum five year 
term).
---------------------------------------------------------------------------

    Accounts that can adjust automatically as permitted under the 
current rule on a periodic basis are also of insufficient permanency. A 
member can rapidly manipulate its share balances in a corporate, so NCA 
adjustments based on share balances have little permanency--and a 
member can even manipulate its asset size to some extent and so that 
measure also does not ensure the necessary capital permanency. The 
proposed redefinition of NCAs to eliminate adjustable balance accounts 
helps ensure permanency and so ensure that NCAs reflect the basic 
requirements of true capital. Although the proposal eliminates 
adjustable balance capital accounts, a corporate may enter into an 
agreement with a member where the member commits to providing 
additional capital if the member uses certain services or increases its 
shares at the corporate above a certain level.
    The current part 704 permits a corporate to issue paid-in capital 
to both members and nonmembers, but the membership capital account, as 
suggested by its name, is currently available only to members of the 
corporate. Corporates may, of course, borrow funds from various 
entities under various terms, and the Board believe that if a corporate 
issues long-term subordinate debt to nonmembers under terms and 
conditions identical to

[[Page 65221]]

the current membership capital, the corporate should be able to treat 
such nonmember subordinated debt as capital in the same manner it 
treats membership capital accounts. Accordingly, the proposal permits 
both members and nonmembers to invest in nonperpetual contributed 
capital accounts (NCAs).
    Currently, Part 704 Defines Paid-In Capital (PIC) as Follows:

    Paid-in capital means accounts or other interests of a corporate 
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.

    12 CFR 704.2. The proposal does not make any change to the 
definition of PIC except to rename PIC as perpetual contributed capital 
(PCC). To ensure that a corporate can function as a viable entity, it 
must be clear to creditors, both current and future, that capital in 
the form of PCC and NCAs protect the creditors against any losses borne 
by the corporates. Capital instruments, to perform their function as 
capital, must be depleted when needed to cover corporate losses.
    Accordingly, the proposal also adds the following definition of 
available to cover losses in Sec.  704.2 to clarify the meaning of that 
phrase:

    Available to cover losses that exceed retained earnings means 
that the funds are available to cover operating losses realized, in 
accordance with generally accepted accounting principles (GAAP), by 
the corporate credit union that exceed retained earnings. Likewise, 
available to cover losses that exceed retained earnings and 
perpetual contributed capital means that the funds are available to 
cover operating losses realized, in accordance with GAAP, by the 
corporate credit union that exceed retained earnings and perpetual 
contributed capital. Any such losses must be distributed pro rata at 
the time the loss is realized first among the holders of perpetual 
contributed capital accounts (PCC), and when all PCC is exhausted, 
then pro rata among all nonperpetual contributed capital accounts 
(NCAs), all subject to the optional prioritization in Appendix A of 
this Part. To the extent that any contributed capital funds are used 
to cover losses, the corporate credit union must not restore or 
replenish the affected capital accounts under any circumstances. In 
addition, contributed capital that is used to cover losses in a 
fiscal year previous to the year of liquidation has no claim against 
the liquidation estate.

    This language is similar to that used to define the phrase 
available to cover losses as it relates to secondary capital in NCUA's 
low income credit union rule. 12 CFR 701.34(b)(7).
    The proposal defines core capital as Generally Accepted Accounting 
Principles (GAAP) retained earnings, PCC, the retained earnings of any 
acquired credit union if the acquisition was a mutual combination, and 
certain minority interests in the equity accounts of CUSOs that are 
fully consolidated. This definition is the same as the current Sec.  
704.2 definition, with the addition of any minority interests in the 
equity accounts of CUSOs that are fully consolidated with the 
corporate. So, for example, if a corporate owned 90 percent of the 
equity in a CUSO, with 10 percent equity owned by third parties, and 
the corporate consolidated its financials with the CUSO, the corporate 
could include the remaining 10 percent minority interest in its Tier 1 
capital. This treatment is consistent with the treatment afforded such 
minority interests by the other regulators.\29\
---------------------------------------------------------------------------

    \29\ See, e.g., 12 CFR 567.5(a)(1)(iii) (OTS definition of Tier 
1 capital); 12 CFR part 3, Appendix A, Sec.  2(a)(3) (OCC definition 
of Tier 1 capital). ``[M]inority interests in the equity accounts of 
consolidated subsidiaries * * * [are] accorded Tier 1 treatment 
because, as a general rule, [they] represent equity that is freely 
available to absorb losses in operating subsidiaries.''' Todd 
Eveson, ``Financial and Bank Holding Company Issuance of Trust 
Preferred Securities,'' 6 N.C. Banking Inst. 315, 321 (2002).
---------------------------------------------------------------------------

    Also, the terms core capital and Tier 1 capital are used 
synonymously in this proposal.
    The proposal further defines supplementary capital as including 
certain portions of its NCAs, GAAP allowance for loan and lease losses, 
and net unrealized gains on available-for-sale equity securities with 
readily determinable fair values. During the last five years of an 
nonperpetual contributed capital account, the amount that may be 
considered supplementary capital is reduced, on a monthly basis, until 
the amount reaches zero when the account has only one year of life 
remaining, all as described in paragraph 704.3(b)(3). This reduction is 
consistent with the current corporate rule and the capital regulations 
of the other regulators. A corporate may also include its allowance for 
loan and lease losses in supplementary capital, up to a maximum of 1.25 
percent of risk-weighted assets. This is also consistent with the 
capital regulations of the other regulators. As noted by the OCC:

    The allowance for loan and lease losses is intended to absorb 
future losses. Although future losses may not be identified 
specifically at the time a provision is made, a presumption exists 
that losses are inherent in the loan and lease portfolio. The 
obvious link between the allowance and inherent losses in the loan 
and lease portfolio precludes it from qualifying as Tier 1 capital, 
which encompasses only the purest and most stable forms of capital. 
Furthermore, it is intended that the loan loss reserves which 
qualify for inclusion as Tier 2 capital will be general in nature. 
That is, any portion of the allowance for loan and lease losses 
which is ascribed to particular assets that have been identified as 
possessing a reasonable probability of some loss is not to be 
included as Tier 2 capital * * *. Beyond the clearly identified 
specific loan loss reserves, it is difficult to distinguish between 
the portion of the loan loss reserve that is freely available to 
absorb future losses within the portfolio and the portion that 
reflects likely losses on existing problem or troubled loans. 
However, a bank that maintains a relatively large allowance for loan 
and lease losses usually has a relatively greater incidence of 
identified asset quality problems in its loan and lease portfolio, 
and in this situation the entire allowance for loan and lease losses 
cannot be considered to be a true general reserve for the purposes 
of risk-based capital. Therefore, a standard percentage limitation, 
based on total risk-weighted assets, is the most reasonable method 
of eliminating the bulk of the non-qualifying loan loss reserves 
from banks' capital calculations. The figure of 1.25 percent of 
risk-weighted assets was determined on the basis of historical data 
* * *.

    54 FR 4168 (Jan. 27, 1989).
    The proposal also provides that a corporate may include 45 percent 
of its unrealized gains on available-for-sale equity securities in 
supplementary capital. Unrealized gains are unrealized holding gains, 
net of unrealized holding losses, calculated as the amount, if any, by 
which fair value exceeds historical cost. The proposal further provides 
that NCUA may disallow such inclusion in the calculation of 
supplementary capital if the NCUA determines that the securities are 
not prudently valued. Again, this is similar to how the other 
regulators define supplementary capital.\30\ Although it is unlikely 
that corporates will hold much in the way of equity securities, they 
might have some equity securities in CUSOs. Because the 45 percent 
limitation used by the banking regulators includes the effects of 
possible taxation upon sale, and corporates are not subject to income 
taxation, the Board invites comment on the proposed 45 percent 
limitation.\31\
---------------------------------------------------------------------------

    \30\ See, e.g., 12 CFR 567.5(a) (OTS capital rule).
    \31\ ``The Basel Accord also permits institutions to include up 
to 45 percent of the pretax net unrealized gains on equity 
securities in supplementary capital. As explained in the Basel 
Accord, the 55 percent discount is applied to the unrealized gains 
to reflect the potential volatility of this form of unrealized 
capital, as well as the tax liability charges that generally would 
be incurred if the unrealized gain were realized or otherwise taxed 
currently.'' 63 FR 46518 (Sept. 1, 1998) (Discussion of joint FDIC, 
OTS, and OCC capital rulemaking).
---------------------------------------------------------------------------

    The terms supplementary capital and Tier 2 capital are used 
synonymously in this preamble and the proposal.

[[Page 65222]]

Nonperpetual contributed capital is a form of Tier 2 capital.
    The use of core capital and supplementary capital, and their 
incorporation into the proposed minimum capital ratios, is discussed 
further in the following paragraph-by-paragraph summary of the proposed 
Sec.  704.3.
Paragraph-by-Paragraph Analysis of Sec.  704.3
Paragraph 704.3(a) Capital Requirements
    This proposed paragraph (a) requires a corporate to maintain, at 
all times, three minimum capital ratios. Paragraph (a)(1) requires all 
corporates maintain a leverage ratio of 4.0 percent or greater, a Tier 
1 risk-based capital ratio of 4.0 percent or greater, and a total risk-
based capital ratio of 8.0 percent or greater. Each of these ratios are 
further defined in Sec.  704.2 as discussed below. Paragraph 
704.3(a)(2) continues the existing requirement that a corporate have a 
capital plan in place to achieve and maintain the necessary capital. 
Paragraph (a)(3) requires that the corporate prepare and submit a 
retained earnings accumulation plan if, under certain circumstances 
described below, the corporate is not making sufficient progress in 
building the necessary retained earnings to satisfy its future minimum 
leverage ratio requirements.
Leverage Ratio
    The proposed leverage ratio is defined in the proposal as the 
adjusted core capital divided by moving DANA. As discussed above, the 
leverage ratio ensures that the corporate has adequate capital to 
provide for losses other than credit losses. Paragraph 704.3(a) 
requires a minimum leverage ratio of 4.0 percent. The capital 
numerator, and the asset denominator, of the leverage ratio are 
discussed below.
Leverage Ratio Denominator: Moving DANA
    The proposal employs moving DANA as the leverage ratio denominator.
    Moving DANA means the average of DANA for the month being measured 
and the previous eleven (11) months. DANA means the average of net 
assets calculated for each day during the period (which would be the 
previous month).
    Net assets means total assets less loans guaranteed by the NCUSIF 
and member reverse repurchase transactions. For its own account, a 
corporate's payables under reverse repurchase agreements and 
receivables under repurchase agreements may be netted out if the GAAP 
conditions for offsetting are met. Also, any amounts deducted from core 
capital in calculating adjusted core capital are also deducted from net 
assets.
    This is virtually the same denominator employed in the current part 
704 for the total capital ratio. The proposal includes a slight 
modification to make clear that any asset deducted from core capital to 
obtain adjusted core capital (i.e., the leverage ratio numerator) 
should likewise be deducted from the denominator.
    The proposed leverage ratio differs from that of the banking 
regulators in that the proposal uses a moving 12-month average of 
assets where the other regulators use period-end assets. The Board 
believes that the corporates, in their role as liquidity providers and 
liquidity managers for natural person credit unions, need some 
flexibility to handle seasonal variations in total assets--and moving 
DANA provides that flexibility. Proposed paragraph 704.3(e), however, 
empowers the NCUA, in appropriate cases, to direct that a particular 
corporate use period-end assets in its capital ratio calculations 
rather than moving DANA.
Leverage Ratio Numerator: Adjusted Core Capital
    As discussed above, core capital generally means the sum of a 
corporate's retained earnings, as calculated under GAAP, and perpetual 
contributed capital.\32\ To obtain adjusted core capital, the proposal 
requires the corporate to make several modifications to core capital.
---------------------------------------------------------------------------

    \32\ For a corporate that acquires another credit union in a 
mutual combination, core capital also includes the retained earnings 
of the acquired credit union, or of an integrated set of activities 
and assets, at the point of acquisition.
---------------------------------------------------------------------------

    First, the corporate must deduct an amount equal to the amount of 
the corporate's intangible assets that exceed one half percent of the 
corporate's moving DANA. Generally, intangible assets are difficult to 
value and highly volatile. In addition, many forms of intangible 
assets, such as goodwill, decline in value if an entity suffers losses, 
which is the point in time that the permanency of capital is most 
important. The other regulators have recognized these problems with 
intangible assets and so generally require banks to deduct problematic 
intangibles from both assets and capital when calculating core capital 
ratios. Corporates, however, do not generally maintain intangibles on 
their books. The Board, therefore, is proposing that intangibles of a 
de minimus amount (one half of one percent of total assets) may be 
treated just like other assets in the capital calculation. However, 
intangibles above this de minimus amount must be deducted from both 
core capital (the numerator of the capital ratios) and assets (the 
denominator). This treatment of intangibles is similar to the treatment 
given intangibles by the other regulators.\33\
---------------------------------------------------------------------------

    \33\ See, e.g., 12 CFR 567.5(a)(2) (OTS capital rule).
---------------------------------------------------------------------------

    The proposal, however, provides some flexibility on the treatment 
of intangibles. The NCUA, on its own initiative or upon application 
from a corporate, may direct that a particular corporate add some or 
all of these excess intangibles back into the corporate's adjusted core 
capital and associated assets. In making this determination, the NCUA 
will consider the volatility and permanency of the particular 
intangible and the overall financial condition of the particular 
corporate.
    Second, the corporate must deduct investments, both equity and 
debt, from consolidated CUSOs. To include these investments would 
overstate the amount of capital available to absorb losses in the 
consolidated entity. This treatment of these investments is similar to 
the treatment given these investments by the other regulators.\34\
---------------------------------------------------------------------------

    \34\ See, e.g., 12 CFR 567.5(a)(2)(iv) (OTS capital rule).
---------------------------------------------------------------------------

    Third, if the corporate credit union, on or after twelve months 
following the publication of the final rule, contributes new capital or 
renews existing capital to another corporate credit union, the 
corporate must deduct an amount equal to the aggregate of such new or 
renewed capital. Because the corporate universe is so small, and may 
get even smaller in the future, the Board is concerned that capital 
investment between two or more corporates can endanger the stability of 
the entire corporate system and, ultimately, the stability of the 
entire credit union system. Accordingly, this proposed deduction from 
corporate capital discourages capital investment between corporates. 
For example, without the deduction corporate A might place significant 
capital in corporate B, which then, in turn, might place significant 
capital in corporate C. Losses in corporate C might then cause 
corresponding losses in corporates A and B which, in turn, may have to 
pass some of those losses to their natural person credit union members. 
The Board invites comment on this proposed deduction from capital, 
including whether there should be an exception for de minimus member 
capital contributions between corporates and, if so, how that exception 
should be

[[Page 65223]]

defined. The Board notes that corporates will have some time to adapt 
to this deduction, since it will not be effective for 12 months and, 
even then, will not apply to preexisting capital accounts unless the 
account is renewed in some fashion (e.g., renewal of an NCA instrument 
upon maturity).
    The current part 704 encourages corporates to achieve and maintain 
retained earnings at 2 percent of assets, but does not actually require 
them to do so. The Board believes that some regulatory mechanism to 
force corporates to build retained earnings is necessary. In the long 
run, contributed capital like PCC is a supplement to retained earnings, 
but PCC is not an entirely adequate replacement for retained earnings. 
As demonstrated in the recent corporate crisis, the depletion of the 
contributed capital at corporates put severe, procyclical stress on 
their member natural person credit unions. While this situation cannot 
be entirely avoided in the future, it can be mitigated through retained 
earnings growth. Accordingly, the proposal requires that, after an 
appropriate phase-in period, a certain percentage of core capital 
consist of retained earnings.
    The initial adjustment to core capital, effective six years after 
the date of publication of the final rule, will require that a 
corporate deduct from core capital any amount of PCC that causes PCC 
minus retained earnings, all divided by moving daily average net assets 
(DANA), to exceed two percent. The effect of this provision is to 
require that, for a corporate to achieve the minimum four percent 
leverage ratio necessary for adequate capitalization, it must have at 
least 100 bp of retained earnings at the six year mark. The remaining 
300 bp in the ratio numerator may consist of either PCC or retained 
earnings. Similarly, to have a five percent leverage ratio at the six 
year mark and thus be well capitalized, a corporate must have 150 bp of 
retained earnings, and the remaining 350 bp in the ratio numerator may 
consist of PCC. This adjustment to core capital will, then, force 
corporates to work toward building their retained earnings.
    The Board, however, believes that, ideally, a corporate should 
continue to increase its retained earnings and reduce its reliance on 
contributed capital. The second adjustment to core capital, effective 
ten years after the date of publication of the final rule, will require 
that a corporate deduct from core capital any amount of PCC that causes 
PCC to exceed retained earnings. The effect of this provision is to 
require that, for a corporate to have a four percent leverage ratio at 
the ten year mark and thus be adequately capitalized, the corporate 
must have at least 200 bp of retained earnings. The remaining 200 bp in 
the ratio numerator may consist of PCC. Similarly, to have a five 
percent leverage ratio at the ten year mark and thus be adequately 
capitalized, a corporate must have 250 bp of retained earnings, and the 
remaining 250 bp in the ratio numerator may consist of PCC.
    Although the first explicit retained earnings requirement will not 
become effective for six years, the Board recognizes that corporates 
must work hard during the entire six year period to build retained 
earnings. Accordingly, paragraph 704.3(a)(3) provides that, beginning 
with the first call report submitted by the corporate three years after 
the date of the final rule:

    [A] corporate credit union must calculate and report the ratio 
of its retained earnings to its moving daily average net assets. If 
this ratio is less than 0.45 percent, the corporate credit union 
must, within 30 days, submit a retained earnings accumulation plan 
to the NCUA for NCUA's approval. The plan must contain a detailed 
explanation of how the corporate credit union will accumulate 
earnings sufficient to meet all its future minimum leverage ratio 
requirements, including specific semiannual milestones for 
accumulating retained earnings. If the corporate credit union fails 
to submit a plan acceptable to NCUA, or fails to comply with any 
element of a plan approved by NCUA, the corporate will immediately 
be classified as significantly undercapitalized or, if already 
significantly undercapitalized, as critically undercapitalized. The 
corporate credit union will be subject to all the associated prompt 
corrective actions under Sec.  704.4 of this part.

    The intent of this retained earnings accumulation plan (REAP) 
provision is to ensure that corporates strive for, and attain, retained 
earnings growth rates that are adequate to achieve 100 bp of retained 
earnings by the end of year six and 200 bp of retained earnings by the 
end of year ten.
    Adequate retained earnings are critical to the health of the 
corporate system going forward. It is the Board's intent that, if a 
corporate is subject to a REAP and fails to meet any of the established 
retained earnings milestones, NCUA will take decisive action under the 
prompt corrective action authorities of 704.4. Included among those 
authorities are replacement of the board and senior management, and 
liquidation, conservatorship or consolidation of the corporate. These 
actions are discretionary on NCUA's part under 704.4, however, and the 
NCUA Board requests comment on whether any such actions should be 
mandatory for a corporate that fails to meet its REAP requirements.
    In addition to the REAP provision in paragraph 704.8(a)(3) above, 
the proposal contains other tools to deal with corporates that are 
either unable, or unwilling, to build retained earnings at an adequate 
pace during the phase-in period. For example, proposed Sec.  704.3(d), 
discussed further below, permits the Board to establish different 
minimum capital requirements for individual corporates ``upon a 
determination that the corporate credit union's capital is or may 
become inadequate in view of the credit union's circumstances.'' 
Proposed Sec.  704.3(d)(2) (emphasis added). This provision also 
provides that ``higher capital levels may be appropriate when NCUA 
determines that * * * the credit union has failed to properly plan for, 
or execute, necessary retained earnings growth.'' Proposed Sec.  
704.3(d)(2)(ix). NCUA could use this particular tool, and other PCA 
tools, to address capital inadequacies, if any--even before the third 
anniversary of the final rule and the associated requirement to prepare 
a REAP.
Tier 1 Risk-Based Capital Ratio
    The proposal defines the Tier 1 risk-based capital ratio (T1RBCR) 
to mean the ratio of adjusted core capital to the moving daily average 
net risk-weighted assets. NCUA intends this ratio, along with the total 
risked-based capital ratio (TRBCR), to ensure that the corporate has 
sufficient capital to handle the credit risk associated with its 
investments and activities. The combination of the T1RBCR, and the 
TRBCR ratio discussed below, ensures that at least half of the capital 
used for purposes of protecting against losses associated with credit 
risk is the more permanent capital (i.e., core capital). The other 
portion of capital used to protect against credit risk may be Tier 2 
capital, also called supplementary capital, as discussed below in 
connection with the TRBCR.
T1RBCR Numerator: Adjusted Core Capital
    The capital numerator for the T1RBCR is adjusted core capital, the 
same as the numerator for the leverage ratio discussed above.
T1RBCR Denominator: Moving Daily Average Net Risk-Weighted Assets 
(DANRA)
    The moving DANRA means the average of daily average net risk-
weighted assets for the month being measured and the previous eleven 
(11) months.

[[Page 65224]]

    DANRA means the average of net risk-weighted assets calculated for 
each day during the period (which would be the previous month).
    Net risk-weighted assets means risk-weighted assets less CLF stock 
subscriptions, CLF loans guaranteed by the NCUSIF, U.S. Central CLF 
certificates, and member reverse repurchase transactions. For its own 
account, a corporate's payables under reverse repurchase agreements and 
receivables under repurchase agreements may be netted out if the GAAP 
conditions for offsetting are met. Also, any amounts deducted from core 
capital in calculating adjusted core capital are also deducted from net 
risk-weighted assets. To this point, this is similar to the moving DANA 
calculation in the denominator of the leverage ratio. However, the 
moving DANRA calculation required the use of risk-weighted assets, 
which are calculated as provided for in the proposed Appendix C of part 
704. This risk-weighting process is described in detail in the section 
of the preamble devoted to Appendix C.
Total Risked-Based Capital Ratio
    The total risk-based capital ratio means the ratio of total capital 
to moving DANRA.
    The denominator, moving DANRA, is the same as the denominator for 
the T1RBCR, as discussed above. The numerator, ``Total capital'' means 
the sum of a corporate's adjusted core capital and its supplementary 
capital less the corporate's equity investments not otherwise deducted 
when calculating adjusted core capital.
    Supplementary capital, or Tier 2 capital, generally means the sum 
of all the corporate's NCAs, except that at the beginning of each of 
the last five years of the life of an NCA instrument the amount that is 
eligible to be included as supplementary capital is reduced by 20 
percent of the original amount of that instrument (net of redemptions). 
While, as discussed above, the proposal adjusts the definition of NCAs 
to make these accounts more permanent and bring them in line with the 
Basel requirements for supplementary capital, the value of these NCAs 
as a buffer against losses as the NCAs approach their maturity or 
withdrawal date. The proposed amortization schedule tracks the 
amortization used by the banking regulators for supplementary capital 
that takes this hybrid debt instrument form.
Paragraph 704.3(b) Requirements for Nonperpetual Contributed Capital
    This proposed paragraph describes the NCA account terms and the 
various disclosure, transfer, and release requirements. This paragraph 
is similar to the existing 704.3(b), taking into account the change in 
NCA terms described above. The proposal also protects against the 
premature release of NCAs with the addition of the following new 
paragraph (b)(5):

    A corporate credit union may redeem nonperpetual contributed 
capital prior to maturity or the end of the notice period only with 
the prior approval of the NCUA.
Paragraph 704.3(c) Requirements for Perpetual Contributed Capital
    This paragraph describes the PCC account terms and the various 
disclosure, transfer, and release requirements. Again, this paragraph 
is similar to the existing 704.3(c). As with NCA, the proposal protects 
against the premature release of PCC by permitting a corporate to call 
PCC only with NCUA's prior approval.
Paragraph 704.3(d) Individual Minimum Capital Requirements
    Paragraph 704.3(d) provides that the NCUA may establish increased 
individual minimum capital requirements for a particular corporate upon 
a determination that the corporate's capital is or may become 
inadequate in view of the credit union's circumstances.
    The proposal provides several examples where a greater minimum 
capital requirement may be appropriate, such as where a corporate:
     Is receiving special supervisory attention;
     Has or is expected to have losses resulting in capital 
inadequacy;
     Has a high degree of exposure to interest rate risk, 
prepayment risk, credit risk, concentration risk, certain risks arising 
from nontraditional activities or similar risks, or a high proportion 
of off-balance sheet risk;
     Has poor liquidity or cash flow;
     Is growing, either internally or through acquisitions, at 
such a rate that supervisory problems are presented that are not dealt 
with adequately by other NCUA regulations or other guidance;
     May be adversely affected by the activities or condition 
of its CUSOs or other persons or credit unions with which it has 
significant business relationships, including concentrations of credit;
     Has a portfolio reflecting weak credit quality or a 
significant likelihood of financial loss, or that has loans or 
securities in nonperforming status or on which borrowers fail to comply 
with repayment terms;
     Has inadequate underwriting policies, standards, or 
procedures for its loans and investments;
     Has failed to properly plan for, or execute, necessary 
retained earnings growth; or
     Has a record of operational losses that exceeds the 
average of other, similarly situated corporates; has management 
deficiencies, including failure to adequately monitor and control 
financial and operating risks, particularly the risks presented by 
concentrations of credit and nontraditional activities; or has a poor 
record of supervisory compliance.
    When the NCUA determines that a different minimum capital 
requirement is necessary or appropriate for a particular corporate, 
including minimum capital relating to classification as significant or 
critically undercapitalization, the NCUA will notify the corporate in 
writing of its proposed minimum capital requirements; the schedule for 
compliance with the new requirement; and the specific causes for 
determining that the higher individual minimum capital requirement is 
necessary or appropriate for the corporate. The NCUA will forward the 
notifying letter to the appropriate state supervisor if a state-
chartered corporate would be subject to an individual minimum capital 
requirement.
    The responses of the corporate and appropriate state supervisor 
must be in writing and must be delivered to the NCUA within 30 days 
after the date on which the notification was received. The NCUA may 
extend or shorten the time period for good cause.
    The corporate's response must include any information that the 
credit union wants the NCUA to consider in deciding whether to 
establish or to amend an individual minimum capital requirement for the 
corporate, what the individual capital requirement should be, and, if 
applicable, what compliance schedule is appropriate for achieving the 
required capital level.
    After expiration of the response period, the NCUA will decide 
whether or not the proposed individual minimum capital requirement 
should be established for the corporate, or whether that proposed 
requirement should be adopted in modified form, based on a review of 
the corporate's response and other relevant information. Failure to 
provide an adequate response will constitute a legal basis for prompt 
corrective action under Sec.  704.4.

[[Page 65225]]

Paragraph 704.3(e) Reservation of Authority
    Financial organizations are constantly developing innovative 
transactions that may not fit well into the various risk-weight 
categories in Appendix C to part 704. New investment activities may 
nominally fit into a particular risk-weight category or credit 
conversion factor, but impose risks on the holder at levels that are 
not commensurate with the nominal risk-weight or credit conversion 
factor for the asset, exposure or instrument. Accordingly, the proposal 
clarifies NCUA's authority over corporates, on a case-by-case basis, to 
determine the appropriate risk-weight for assets and credit equivalent 
amounts and the appropriate credit conversion factor for off-balance 
sheet items in these circumstances. Specifically, the NCUA may:
     Disregard any transaction entered into by a corporate 
primarily for the purpose of reducing the minimum required amount of 
regulatory capital or otherwise evading the requirements of this 
section;
     Require a corporate to compute its capital ratios on the 
basis of period-end, rather than average, assets when it is appropriate 
to carry out the purposes of part 704;
     Notwithstanding the definitions of core and supplementary 
capital in the corporate rule, find that a particular asset or core or 
supplementary capital component has characteristics or terms that 
diminish its contribution to a corporate's ability to absorb losses and 
require the discounting or deduction of such asset or component from 
the computation of core, supplementary, or total capital;
     Notwithstanding Appendix C of this section, look to the 
substance of a transaction, find that the assigned risk-weight for any 
asset, or credit equivalent amount or credit conversion factor for any 
off-balance sheet item does not appropriately reflect the risks imposed 
on the corporate, and may require the corporate to apply another risk-
weight, credit equivalent amount, or credit conversion factor that the 
NCUA deems appropriate; and
     If Appendix C does not specifically assign a risk-weight, 
credit equivalent amount, or credit conversion factor to a particular 
asset or activity of the corporate, assign any risk-weight, credit 
equivalent amount, or credit conversion factor that it deems 
appropriate.
    Exercise of this authority by NCUA may result in a higher or lower 
risk-weight for an asset or credit equivalent amount or a higher or 
lower credit conversion factor for an off-balance sheet item. This 
reservation of authority explicitly recognizes NCUA's retention of 
sufficient discretion to ensure that corporates, as they become 
involved with new types of financial assets and activities, will be 
treated appropriately under the regulatory capital standards.
Applicable State Regulator
    Several paragraphs of this proposed Sec.  704.3 on capital, and the 
proposed Sec.  704.4 on prompt corrective action, refer to the 
applicable state regulator in connection with potential actions 
involving state chartered corporates. The proposal amends Sec.  704.2 
to define applicable state regulator as the prudential state regulator 
of a state chartered corporate.
Appendix A to Part 704--Capital Prioritization and Model Forms
    The current Appendix A to part 704, entitled Model Forms, contains 
forms that members provide the corporate on an annual basis 
acknowledging the terms and conditions of the members' PIC and MCA 
accounts. The proposal renames Appendix A as Capital Prioritization and 
Model Forms. The new Appendix A has two parts. Part II contains amended 
model disclosure forms. Part I is new, and reads as follows:

Part I--Optional Capital Prioritization

    Notwithstanding any other provision in this chapter, a corporate 
credit union, at its option, may determine that capital contributed 
to the corporate on or after [DATE 60 DAYS AFTER DATE OF PUBLICATION 
OF FINAL RULE IN FEDERAL REGISTER] will have priority, for purposes 
of availability to absorb losses and payout in liquidation, over 
capital contributed to the corporate before that date. The board of 
directors at a corporate credit union that desires to make this 
determination must:
    (a) On or before [DATE 60 DAYS AFTER DATE OF PUBLICATION OF 
FINAL RULE IN FEDERAL REGISTER], adopt a resolution implementing its 
determination.
    (b) Inform the credit union's members and NCUA, in writing and 
as soon as practicable after adoption of the resolution, of the 
contents of the board resolution.
    (c) Ensure the credit union uses the appropriate initial and 
periodic Model Form disclosures in Part II below.

    This option, if implemented by a corporate's board of directors, 
will give those entities that contribute new capital to the corporate 
starting 60 days after the publication of the final rule priority--in 
terms of availability to absorb losses and payout in liquidation--over 
those capital contributions made before that date. The purpose of this 
provision is to provide a tool for facilitating capital growth. The 
proposal amends the forms so that they are consistent with the proposed 
definitions of PCC and NCAs. These form changes include changing the 
notice and term of NCAs from three years to five years, eliminating 
references to adjustable balance NCAs, and describing in more detail 
the meanings of the phrase ``available to cover losses.'' Because this 
new option will be available to corporates before the other new capital 
provisions go into effect, including the nomenclature changes (that is, 
from PIC to PCC, and from MCAs to NCCs), the proposal expands the 
number of model forms in Part II from the two current forms to eight 
forms.
    The current paragraph (6) in the model forms reads as follows:

    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.

    It is possible, for example, that a solvent corporate could be 
voluntarily liquidated and that there could be some funds remaining 
after payment to creditors, uninsured shareholders, and the NCUSIF. It 
is also possible (although unlikely) that the value of the assets of an 
insolvent, involuntarily liquidated corporate credit union could 
increase between the date of liquidation and the date the assets are 
sold, and there could then be some funds in the liquidation estate 
remaining after payment to the creditors, uninsured shareholders, and 
the NCUSIF. In both of these cases, the NCA holders, and possibly the 
PCC holders, would receive a distribution \35\--but this is only true 
to the extent that the NCAs and PCCs were not used in a previous fiscal 
year to cover losses. Once used to cover losses, the NCAs and PCC are 
gone to the extent so used, and all possible claims related to those 
accounts, including liquidation-based claims, are extinguished. 
Accordingly, the proposal adds the following clarifying language to the 
end of each paragraph (6):

    \35\ This possibility is recognized in NCUA's involuntary 
liquidation rule. 12 CFR 709.5(b)(7) and (9).

    However, [NCAs or PCCs] that are used to cover losses in a 
fiscal year previous to the year of liquidation has no claim against 
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the liquidation estate.

    The proposal also adds a conforming amendment to NCUA's involuntary 
liquidation rule, 12 CFR 709.10, to reflect the option to give new 
contributed capital payout priority.

[[Page 65226]]

Appendix C to Part 704--Risk-Based Capital Ratios and Asset Risk-
Weightings
    A corporate's risk-based capital requirement is calculated based on 
the credit risk presented by both its on-balance sheet assets and off-
balance sheet commitments and obligations. With certain limited 
exceptions, the asset base of a corporate is determined on a 
consolidated basis, i.e., including its consolidated CUSOs. Assets are 
assigned a credit-risk weighting based upon their relative risk. Risk-
weights are generally tied to the nature of the underlying obligor.
    The risk-weightings range from zero percent for assets backed by 
the full faith and credit of the United States or that pose no credit 
risk to the corporate to 100 percent as the standard risk-weighting.
    Off-balance sheet commitments are converted to a ``credit 
equivalent'' amount by using a conversion factor intended to estimate 
the likelihood that the contingent obligation will result in an actual 
obligation of the corporate and the potential size of loss such items 
may result in. That amount is then risk-weighted according to the risk 
associated with the underlying obligor, just as an on-balance sheet 
asset would be. The amount of risk-weighted assets will then be 
multiplied by a credit risk capital requirement to determine the 
minimum amount of capital required for that corporate.
    The rule also sets forth the items that count as capital and that 
may be used to satisfy the risk-based capital requirement. ``Core 
capital,'' or ``tier 1 capital,'' includes items of a more permanent 
nature, such as PCC and GAAP retained earnings. Certain other items 
provide a somewhat lesser degree of protection, often because of their 
nonpermanent nature or their imposition of fixed obligations. These 
items are considered ``supplementary capital,'' or ``tier 2 capital,'' 
and include NCAs. Together, the sum of core and supplementary capital 
equal a corporate's ``total capital.''
    Although both core and supplementary capital may be used in meeting 
the risk-based capital requirement, the amount of supplementary capital 
that may be counted toward that requirement is limited to the amount of 
the credit union's core capital through the use of the T1RBC ratio. 
Additional limits are placed upon certain types of supplementary 
capital. These limits may restrict the extent to which these forms of 
supplementary capital may be used to satisfy the corporate's capital 
requirement. Items that are deducted from a corporate's asset base in 
determining its assets are also deducted from its capital.
On-Balance Sheet Assets
    The proposed amendments sets forth a system of risk-weighted assets 
similar to that used by the other federal banking regulators. Assets, 
in general, will be assigned to risk categories based on the degree of 
credit risk associated with the obligor or nature of the obligation. 
The categories include risk-weights of 0, 20, 50, and 100 percent.
    The 100 percent category is the standard risk category. Assets not 
specifically included in another category fall within this category. 
Items that are less risky than a ``standard risk asset'' because of the 
traditional financial strength of the obligor, the default history of 
the asset type, or the guarantee or security backing the asset are 
assigned to a lower risk category. This reflects the Board's 
determination, mirroring in many ways the implicit determinations made 
by the market, that such assets present lower risks.
    Risk-weighted assets are determined by taking the book value of 
each asset and multiplying it by the risk-weight assigned to it. 
Ownership interests in investment companies such as mutual funds are 
assigned risk-weights based upon the composition of the investment 
company's underlying portfolio of assets. The resulting values are 
added together to arrive at total risk assets. The amount of total risk 
assets is the amount against which the minimum capital requirement is 
applied.
Summary of Risk-Weights for On-Balance Sheet Assets
    Zero percent weighting (Category 1). This category, presenting, in 
the Board's estimation, a nearly non-existent level of credit risk, 
includes:
     Cash;
     Securities issued by and other direct claims on the U.S. 
Government or its agencies or the central government of an Organization 
for Economic Cooperation and Development (OECD) country;
     Notes and obligations issued by or guaranteed by the 
Federal Deposit Insurance Corporation or the National Credit Union 
Share Insurance Fund and backed by the full faith and credit of the 
United States Government;
     Deposit reserves at, claims on, and balances due from 
Federal Reserve Banks; the book value of paid-in Federal Reserve Bank 
stock;
     Assets directly and unconditionally guaranteed by the 
United States Government or its agencies, or the central government of 
an OECD country; and
     Certain claims on a qualifying securities firm that are 
collateralized by cash on deposit in the corporate or by securities 
issued or guaranteed by the United States Government or its agencies, 
or the central government of an OECD country.
    Twenty percent weighting (Category 2). This category contains items 
viewed as presenting a significantly lower level of risk than standard 
risk assets. It includes:
     Cash items in the process of collection;
     Assets conditionally guaranteed by the United States 
Government or its agencies, or the central government of an OECD 
country, or collateralized by securities issued or guaranteed by the 
United States government or its agencies, or the central government of 
an OECD country;
     Certain securities issued by the U.S. Government or its 
agencies which are not backed by the full faith and credit of the 
United States Government;
     Certain securities issued by United States Government-
sponsored agencies;
     Assets guaranteed by United States Government-sponsored 
agencies;
     Assets collateralized by the current market value of 
securities issued or guaranteed by United States Government-sponsored 
agencies;
     Claims guaranteed by a qualifying securities firm, subject 
to certain conditions;
     Claims representing general obligations of any public-
sector entity in an OECD country, and that portion of any claims 
guaranteed by any such public-sector entity;
     Balances due from and all claims on domestic depository 
institutions.
     The book value of paid-in Federal Home Loan Bank stock;
     Deposit reserves at, claims on, and balances due from the 
Federal Home Loan Banks;
     Assets collateralized by cash held in a segregated deposit 
account by the reporting corporate;
     Claims on, or guaranteed by, official multilateral lending 
institutions or regional development institutions in which the United 
States Government is a shareholder or contributing member; \36\
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    \36\ These institutions include, but are not limited to, the 
International Bank for Reconstruction and Development (World Bank), 
the Inter-American Development Bank, the Asian Development Bank, the 
African Development Bank, the European Investments Bank, the 
International Monetary Fund and the Bank for International 
Settlements.
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     Assets collateralized by the current market value of 
securities issued by

[[Page 65227]]

official multilateral lending institutions or regional development 
institutions in which the United States Government is a shareholder or 
contributing member;
     All claims on depository institutions incorporated in an 
OECD country, and all assets backed by the full faith and credit of 
depository institutions incorporated in an OECD country;
     Claims on, or guaranteed by depository institutions other 
than the central bank, incorporated in a non-OECD country, with a 
remaining maturity of one year or less; and
     Local currency claims conditionally guaranteed by central 
governments of non-OECD countries, to the extent the corporate has 
local currency liabilities in that country.
    Fifty percent risk-weighting (Category 3). This category contains 
assets considered to present a moderate level of credit risk as 
compared to standard risk assets. It includes:
     Revenue bonds issued by any public-sector entity in an 
OECD country for which the underlying obligor is a public-sector 
entity, but which are repayable solely from the revenues generated from 
the project financed through the issuance of the obligations;
     Qualifying mortgage loans and qualifying multifamily 
mortgage loans;
     Certain privately-issued mortgage-backed securities; and
     Qualifying residential construction loans.
    One hundred percent risk-weighting (Category 4). All assets not 
classified elsewhere or deducted from calculations of capital pursuant 
to Sec. Sec.  704.2 and 704.3 are assigned to this category, which 
comprises standard risk assets. This category includes:
     Consumer loans;
     Commercial loans;
     Home equity loans;
     Non-qualifying mortgage loans;
     Non-qualifying multifamily mortgage loans;
     Residential construction loans;
     Land loans;
     Nonresidential construction loans;
     Obligations issued by any state or any political 
subdivision thereof for the benefit of a private party or enterprise 
where that party or enterprise, rather than the issuing state or 
political subdivision, is responsible for the timely payment of 
principal and interest on the obligations;
     Debt securities not specifically risk-weighted in another 
category;
     Investments in fixed assets and premises;
     Servicing assets;
     Interest-only strips receivable, other than credit-
enhancing interest-only strips;
     Equity investments;
     The prorated assets of subsidiaries (except for the assets 
of consolidated CUSOs) to the extent such assets are included in 
adjusted total assets;
     All repossessed assets or assets that are more than 90 
days past due; and
     Intangible assets not specifically weighted in some other 
category.
    The term ``prorated assets'' means the total assets (as determined 
in the most recently available GAAP report) of a consolidated CUSO 
multiplied by the corporate credit union's percentage of ownership of 
that consolidated CUSO.
    Corporates may take indirect ownership of assets, such as through a 
mutual fund. The proposal provides that investments representing an 
indirect holding of a pool of assets are assigned to risk-weight 
categories based upon the risk-weight that would be assigned to each 
category of assets in the pool, and described various methods for 
achieving that result. In no case, however, will any such investment be 
assigned a total risk-weight of less than 20 percent.
    The proposal also recognizes that certain transactions or 
activities, such as derivatives transactions, may appear on corporate's 
balance sheet but are not specifically described in the Section II(a) 
on-balance sheet risk-weight categories. These items will be assigned 
risk-weights as described in Section II(b) or II(c) below, generally 
relating to off-balance sheet items.
Off-Balance Sheet Items
    The Board is also proposing to incorporate off-balance sheet items 
in its calculation of risk-weighted assets, using a method similar to 
that used by the federal banking regulators.
    Under the proposal, off-balance sheet items are incorporated into 
risk-weighted assets by first determining the on-balance sheet credit 
equivalent amounts for the items and then assigning the credit 
equivalent amounts to the appropriate risk category according to the 
obligor, or if relevant, the guarantor or the nature of the collateral.
    For many types of off-balance sheet transactions, the risk-weight 
is determined by a two-step process. First, the notional principal, or 
face value, amount of the off-balance sheet item is multiplied by a 
credit conversion factor to arrive at a balance sheet ``credit-
equivalent amount.'' The conversion factor is based upon the relative 
likelihood that a credit obligation will result from the commitment. 
The credit-equivalent amount is then assigned to the appropriate risk 
category depending upon the obligor (e.g., to the 20 percent risk 
category if guaranteeing an obligation of a depository institution). 
For certain off-balance sheet contracts, however, including interest 
and exchange rate contracts, credit equivalent amounts are determined 
by summing two amounts: the current exposure and the estimated 
potential future exposure.
Summary of Conversion Factors for Off-Balance Sheet Items
    Conversion factors--Group A--100 Percent. Direct credit substitutes 
are assigned to Group A. Direct credit substitutes are any irrevocable 
obligations in which a corporate has essentially the same credit risk 
as if it had made a direct loan to the obligor or account party. Direct 
credit substitutes include guarantees (or guarantee-type instruments) 
backing financial claims, such as outstanding securities, loans, and 
other financial obligations including those on behalf of CUSOs. Direct 
credit substitutes also include standby letters of credit, equivalent 
obligations, and forward agreements that are legally binding agreements 
(contractual obligations) to purchase assets with certain drawdowns at 
specified future dates.
    Asset sales with recourse, if not already included on the balance 
sheet, are treated in the same way as direct credit substitutes. Such 
sales will be treated as if they did not occur. Capital will be 
required against the full amount sold for assets sold with recourse. 
Retention of the subordinated portion of a senior/subordinated loan 
participation or package of loans will be treated in the same manner as 
an asset sale with recourse. The minimum amount of capital required 
against loans sold to an institution with full recourse is determined 
by the type of obligor.
    Group B--50 percent. This group includes transaction-related 
contingencies and unused commitments not falling within Group E. 
Transaction-related contingencies include performance bonds, 
performance standby letters of credit, warranties, and standby letters 
of credit related to particular transactions. These instruments are 
different from financial guarantee-type standby letters of credit in 
that they concern performance of nonfinancial or commercial contracts 
or undertakings. These instruments generally involve guaranteeing the 
account party's obligation to deliver a service or product in the 
conduct of its day-to-day business.
    A commitment is defined as any arrangement between an institution 
and its customer that legally obligates the institution to extend 
credit to the customer in the form of loans or leases.

[[Page 65228]]

It also includes such undertakings as overdraft transactions. Normally, 
a commitment involves a written contract or agreement, a commitment 
fee, or some other form of consideration.
    Commitments are included in risk-weighted assets regardless of 
whether they contain ``material adverse change'' clauses or other 
similar provisions. Commitments with material adverse change clauses 
are included in this category (rather than in a category carrying a 
smaller conversion factor) because they represent obligations that may 
involve risk if an institution funds the commitment before the 
customer's condition deteriorates, or before the deterioration is 
recognized. Moreover, while the Board does not wish to discourage the 
use of material adverse change clauses, some court decisions suggest 
that the presence of a material adverse change clause cannot 
necessarily be relied on to relieve an institution of its obligations 
pursuant to a commitment.
    Only the unused portion of a commitment is treated as an off-
balance sheet item. Amounts that are already drawn and outstanding 
under a commitment appear on the balance sheet; such amounts, 
therefore, will not be included as commitments for purposes of 
computing the risk-asset ratio.
    Group C--20 percent. Group C includes short-term, self-liquidating, 
trade-related contingencies that arise from the movement of goods, 
including commercial letters of credit and other documentary letters of 
credit collateralized by the underlying shipments.
    Group D--10 percent. Group D includes unused portions of eligible 
Asset-backed Commercial Paper (ABCP) liquidity facilities with an 
original maturity of one year or less. The ABCP risk-weighting 
treatment is similar to the risk-weighting employed by the other 
regulators. The proposal adds key terms related to the ABCP risk-
weighting to the definitions section. 12 CFR 704.2.
    Group E--Zero Percent. Group E includes unused commitments that are 
less than one year in maturity or that the corporate can, at its 
option, unconditionally (without cause) cancel. Facilities that, at the 
institution's option, are unconditionally cancelable at any time are 
not considered to be commitments, provided that the institution makes a 
separate credit decision before each drawdown under the facility. 
Unused retail credit card lines are deemed to fall under this group if 
the corporate has the unconditional option to cancel the card at any 
time.
    Group F--Off balance sheet contracts; interest rate and foreign 
exchange contracts. Credit equivalent amounts for these contracts, 
including interest-rate swaps, futures, over-the-counter options, 
interest-rate options purchased (caps, floors and collars), foreign 
exchange rate contracts, and forward rate agreements are determined by 
summing two amounts: the current exposure and the estimated potential 
future exposure.
    The current exposure (sometimes referred to as replacement cost) of 
a contract is derived from its market value. In most instances the 
initial market value of a contract is zero.\37\ A corporate should mark 
all of its rate contracts to market to reflect the current value of the 
transaction in light of changes in the market price of the contracts or 
in the underlying interest or exchange rates. Unless the market value 
of a contract is zero, one party will always have a positive mark-to-
market value for the contract, while the other party (counterparty) 
will have a negative mark-to-market value.
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    \37\ An options contract has a positive value at inception, 
which reflects the premium paid by the purchaser. The value of the 
option may be reduced due to market movements but it cannot become 
negative. Therefore, unless an option has zero value, the purchaser 
of the option contract will always have some credit exposure, which 
may be greater than or less than the original purchase price, and 
the seller of the option contract will never have credit exposure.
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    An institution holding a contract with a positive mark-to-market 
value is ``in-the-money,'' that is, it would have the right to receive 
payment from the counterparty if the contract were terminated. Thus, an 
institution that is in-the-money on a contract is exposed to 
counterparty credit risk, since the counterparty could fail to make the 
expected payment. The potential loss is equal to the cost of replacing 
the terminated contract with a new contract that would generate the 
same expected cash flows under the existing market conditions. 
Therefore, the in-the-money institution's current exposure on the 
contract is equal to the market value of the contract.
    An institution holding a contract with a negative mark-to-market 
value, on the other hand, is ``out-of-the-money'' on that contract, 
that is, if the contract were terminated, the institution would have an 
obligation to pay the counterparty. The institution with the negative 
mark-to-market value has no counterparty credit exposure because it is 
not entitled to any payment from the counterparty in the case of 
counterparty default. Consequently, a contract with a negative market 
value is assigned a current exposure of zero. A current exposure of 
zero is also assigned to a contract with a market value of zero, since 
neither party would suffer a loss in the event of contract termination. 
In summary, the current exposure of a rate contract equals either the 
positive market value of the contract or zero.
    The second part of the credit equivalent amount for rate contracts, 
the estimated potential future exposure (often referred to as the add-
on), is an amount that represents the potential future credit exposure 
of a contract over its remaining life. This exposure is calculated by 
multiplying the notional principal amount of the underlying contract by 
a credit conversion factor that is determined by the remaining maturity 
of the contract and the type of contract.
    The potential future credit exposure is calculated for all 
contracts, regardless of whether the mark-to-market value is zero, 
positive, or negative. For interest rate contracts with a remaining 
maturity of one year or less, the credit conversion factor is 0 percent 
and for those over one year, the factor is .5 percent. For exchange 
rate contracts with a maturity of one year of less, the factor is 1 
percent and for those over one year the factor is 5 percent. Because 
exchange rate contracts involve an exchange of principal upon maturity 
and are generally more volatile, they carry a higher conversion factor. 
No potential future credit exposure is calculated for single-currency 
interest-rate swaps in which payments are made based on two floating 
indices (basis swaps).
    The potential future exposure is then added to the current exposure 
to arrive at a credit equivalent amount.\38\ Each credit equivalent 
amount is then assigned to the appropriate risk category, according to 
the counterparty or, if relevant, the guarantor or the nature of the 
collateral. The maximum risk-weight applied to such rate contracts is 
50 percent.
---------------------------------------------------------------------------

    \38\ This method of determining credit equivalent amounts for 
rate contracts is known as the current exposure method, which is 
used by most banks under $250 billion in assets.
---------------------------------------------------------------------------

Netting and Risk-Based Capital Treatment of Off-Balance Sheet Contracts
    Netting arrangements are a means of improving efficiency and 
reducing counterparty credit exposure. Often referred to as master 
netting contracts, these arrangements typically provide for both 
payment and close-out netting.
    Payment netting provisions permit an institution to make payments 
to a counterparty on a net basis by offsetting payments it is obligated 
to make with

[[Page 65229]]

payments it is entitled to receive and, thus, to reduce its costs 
arising out of payment settlements. Close-out netting provisions permit 
the netting of credit exposures if a counterparty defaults or upon the 
occurrence of another event such as insolvency or bankruptcy. If such 
an event occurs, all outstanding contracts subject to the close-out 
provisions are terminated and accelerated, and their market values are 
determined. The positive and negative market values are then netted, or 
set off, against each other to arrive at a single net exposure to be 
paid by one party to the other upon final resolution of the default or 
other event.
    The potential for close-out netting provisions to reduce 
counterparty credit risk, by limiting an institution's obligation to 
the net credit exposure, depends upon the legal enforceability of the 
netting contract, particularly in insolvency or bankruptcy.
    Accordingly, the proposal permits a corporate, in determining its 
current credit exposure for multiple off-balance sheet rate contracts 
executed with a single counterparty, to net off-balance sheet rate 
contracts subject to a bilateral netting contract by offsetting 
positive and negative mark-to-market values, provided that the netting 
contract meets certain requirements, including that the bilateral 
netting contract creates a single, enforceable legal obligation for all 
individual off-balance sheet rate contracts covered by the 
contract.\39\ A bilateral netting contract that contains a walkaway 
clause is not eligible for netting for purposes of calculating the 
current credit exposure amount. A walkaway clause is a provision in a 
netting contract that permits the non-defaulting counterparty to make 
only limited payments, or no payments at all, to the estate of the 
defaulter even if the defaulter is a net creditor under the contract.
---------------------------------------------------------------------------

    \39\ The Basel Supervisors' Committee issued a consultative 
paper on April 30, 1993, proposing an expanded recognition of 
netting arrangements in the regulations based on Basel I. The paper 
is entitled ``The Prudential Supervision of Netting, Market Risks 
and Interest Rate Risk.'' The section applicable to netting is 
subtitled ``The Supervisory Recognition of Netting for Capital 
Adequacy Purposes.'' Specifically, the Basel proposal states that 
netting for risk-based capital purposes is permissible if (1) In the 
event of a counterparty's failure to perform due to default, 
bankruptcy or liquidation, the corporate's claim (or obligation) 
would be to receive (or pay) only the net value of the sum of 
unrealized gains and losses on included transactions; (2) the 
banking entity has obtained written and reasoned legal opinions 
stating that in the event of legal challenge, the netting would be 
upheld in all relevant jurisdictions; and (3) the entity has 
documentation and procedures in place to ensure that the netting 
arrangements are kept under review in light of changes in relevant 
law. These criteria are contained in the proposed rule.
---------------------------------------------------------------------------

    Certain off-balance sheet rate contracts are not subject to the 
above calculation, and therefore, are not part of the denominator of a 
corporate's risk-based capital ratio. These include a foreign exchange 
rate contract with an original maturity of 14 calendar days or less; 
any interest rate or foreign exchange rate contract that is traded on 
an exchange requiring the daily payment of any variations in the market 
value of the contract; and certain asset-backed commercial paper 
programs.
Recourse Obligations, Direct Credit Substitutes, and Certain Other 
Positions
    The proposed rule provides additional risk-weighting provisions for 
recourse obligations, direct credit substitutes, and certain other 
positions. These terms generally relate to asset securitization and 
associated securities. A discussion of asset securitization follows.
    Asset securitization is the process by which loans or other credit 
exposures are pooled and reconstituted into securities, with one or 
more classes or positions, that may then be sold. Securitization 
provides an efficient mechanism for depository institutions to buy and 
sell loan assets or credit exposures and thereby to increase the 
organization's liquidity.\40\
---------------------------------------------------------------------------

    \40\ For purposes of this discussion, references to 
``securitization'' also include structured finance transactions or 
programs and synthetic transactions that generally create stratified 
credit risk positions, which may or may not be in the form of a 
security, whose performance is dependent upon a pool of loans or 
other credit exposures. Synthetic transactions bundle credit risks 
associated with on-balance sheet assets and off-balance sheet items 
and resell them into the market. For examples of synthetic 
securitization structures, see Banking Bulletin 99-43, November 15, 
1999 (OCC).
---------------------------------------------------------------------------

    Securitizations typically carve up the risk of credit losses from 
the underlying assets and distribute it to different parties. The 
``first dollar,'' or most subordinate, loss position is first to absorb 
credit losses; the most ``senior'' investor position is last to absorb 
losses; and there may be one or more loss positions in between 
(``second dollar'' loss positions). Each loss position functions as a 
credit enhancement for the more senior positions in the structure.
    For residential mortgages sold through certain Federally-sponsored 
mortgage programs, a Federal government agency or Federal government-
sponsored enterprise (GSE) guarantees the securities sold to investors 
and may assume the credit risk on the underlying mortgages. However, 
many of today's asset securitization programs involve assets that are 
not Federally supported in any way. Sellers of these privately 
securitized assets therefore often provide other forms of credit 
enhancement--that is, they take first or second dollar loss positions--
to reduce investors' credit risk.
    A seller may provide this credit enhancement itself through 
recourse arrangements. The proposed rule uses the term ``recourse'' to 
refer to the credit risk that a banking organization or credit union 
retains in connection with the transfer of its assets. Banks and credit 
unions have long provided recourse in connection with sales of whole 
loans or loan participations; today, recourse arrangements frequently 
are also associated with asset securitization programs. Depending on 
the type of securitization transaction, the sponsor of a securitization 
may provide a portion of the total credit enhancement internally, as 
part of the securitization structure, through the use of excess spread 
accounts, overcollateralization, retained subordinated interests, or 
other similar on-balance sheet assets. When these or other on-balance 
sheet internal enhancements are provided, the enhancements are 
``residual interests'' for regulatory capital purposes. Such residual 
interests are a form of recourse.
    A seller may also arrange for a third party to provide credit 
enhancement in an asset securitization.\41\ If the third-party 
enhancement is provided by another banking organization, that 
organization assumes some portion of the assets' credit risk. In this 
final rule, all forms of third-party enhancements, i.e., all 
arrangements in which a banking organization assumes credit risk from 
third-party assets or other claims that it has not transferred, are 
referred to as ``direct credit substitutes.'' \42\ The economic 
substance of the credit risk from providing a direct credit substitute 
can be identical to its credit risk from retaining recourse on assets 
transferred.
---------------------------------------------------------------------------

    \41\ As used in this proposed rule, the terms ``credit 
enhancement'' and ``enhancement'' refer to both recourse 
arrangements, including residual interests, and direct credit 
substitutes.
    \42\ For purposes of this rule, purchased credit-enhancing 
interest-only strips are also ``residual interests.''
---------------------------------------------------------------------------

    Many asset securitizations use a combination of recourse and third-
party enhancements to protect investors from credit risk. When third-
party enhancements are not provided, the transferring entity often 
retains credit risk on the assets transferred.

[[Page 65230]]

Risk Management of Exposures Arising From Securitization Activities
    While asset securitization can enhance both credit availability and 
profitability, managing the risks associated with this activity can 
pose significant challenges. The risks involved, while not new to 
banking organizations and credit unions, may be less obvious and more 
complex than the risks of traditional lending. Specifically, 
securitization can involve credit, liquidity, operational, legal, and 
reputational risks in concentrations and forms that may not be fully 
recognized by management or adequately incorporated into a credit 
union's risk management systems.
Risk-Weighting of Direct Credit Substitutes and Recourse Obligations 
(Including Residual Interests and Credit Enhancing IO Strips)
    The proposal defines four key terms: direct credit substitute, 
recourse obligations, residual interests, and credit enhancing interest 
only (IO) strips. The proposal defines a direct credit substitute as 
any arrangement in which a corporate assumes, in form or in substance, 
credit risk associated with an on-balance sheet or off-balance sheet 
asset or exposure that was not previously owned by the corporate 
(third-party asset) and the risk assumed by the corporate exceeds the 
pro rata share of the corporate's interest in the third-party 
asset.\43\
---------------------------------------------------------------------------

    \43\ If a corporate has no claim on the third-party asset, then 
the corporate's assumption of any credit risk is a direct credit 
substitute. As stated in the definition, direct credit substitutes 
include:
    (1) Financial standby letters of credit that support financial 
claims on a third party that exceed a corporate's pro rata share in 
the financial claim;
    (2) Guarantees, surety arrangements, credit derivatives, and 
similar instruments backing financial claims that exceed a 
corporate's pro rata share in the financial claim;
    (3) Purchased subordinated interests that absorb more than their 
pro rata share of losses from the underlying assets, including any 
tranche of asset backed securities that is not the most senior 
tranche;
    (4) Credit derivative contracts under which the corporate 
assumes more than its pro rata share of credit risk on a third-party 
asset or exposure;
    (5) Loans or lines of credit that provide credit enhancement for 
the financial obligations of a third party;
    (6) Purchased loan servicing assets if the servicer is 
responsible for credit losses or if the servicer makes or assumes 
credit-enhancing representations and warranties with respect to the 
loans serviced. Servicer cash advances as defined in this section 
are not direct credit substitutes;
    (7) Clean-up calls on third party assets. However, clean-up 
calls that are 10 percent or less of the original pool balance and 
that are exercisable at the option of the corporate are not direct 
credit substitutes; and
    (8) Liquidity facilities that provide support to asset-backed 
commercial paper (other than eligible ABCP liquidity facilities).
---------------------------------------------------------------------------

    The proposal generally defines recourse obligations as a 
corporate's retention, in form or in substance, of any credit risk 
directly or indirectly associated with an asset it has sold (in 
accordance with Generally Accepted Accounting Principles) that exceeds 
a pro rata share of that corporate's claim on the asset. A recourse 
obligation typically arises when a corporate transfers assets in a sale 
and retains an explicit obligation to repurchase assets or to absorb 
losses due to a default on the payment of principal or interest or any 
other deficiency in the performance of the underlying obligor or some 
other party. Recourse may also exist implicitly if a corporate provides 
credit enhancement beyond any contractual obligation to support assets 
it has sold.\44\
---------------------------------------------------------------------------

    \44\ As stated in the definition, recourse obligations include:
    (1) Credit-enhancing representations and warranties made on 
transferred assets;
    (2) Loan servicing assets retained pursuant to an agreement 
under which the corporate will be responsible for losses associated 
with the loans serviced. Servicer cash advances as defined in this 
section are not recourse obligations;
    (3) Retained subordinated interests that absorb more than their 
pro rata share of losses from the underlying assets;
    (4) Assets sold under an agreement to repurchase, if the assets 
are not already included on the balance sheet;
    (5) Loan strips sold without contractual recourse where the 
maturity of the transferred portion of the loan is shorter than the 
maturity of the commitment under which the loan is drawn;
    (6) Credit derivatives that absorb more than the corporate's pro 
rata share of losses from the transferred assets;
    (7) Clean-up calls on assets the corporate has sold. However, 
clean-up calls that are 10 percent or less of the original pool 
balance and that are exercisable at the option of the corporate are 
not recourse arrangements; and
    (8) Liquidity facilities that provide support to asset-backed 
commercial paper (other than eligible ABCP liquidity facilities).
---------------------------------------------------------------------------

    As stated above, the primary difference between direct credit 
substitutes and recourse obligations is that recourse obligations 
involve the assumption of credit risk associated with assets that the 
corporate once owned but transferred, while direct credit substitutes 
involve the assumption of credit risk related to assets that the 
corporate does not own. Both direct credit substitutes and recourse 
obligations, however, can involve similar, and significant, credit 
risk. Accordingly the proposal outlines the same general process (with 
some exceptions) for risk-weighting both direct credit substitutes and 
recourse obligations.
    The proposal requires that the corporate multiply the full amount 
of the credit-enhanced assets for which the corporate directly or 
indirectly retains or assumes credit risk by a 100 percent conversion 
factor. The corporate will then assign this credit equivalent amount to 
the risk-weight category appropriate to the obligor in the underlying 
transaction, after considering any associated guarantees or collateral, 
in accordance with the risk-weight categories in Section II(a) of the 
Appendix. The proposal states that, for a direct credit substitute that 
is an on-balance sheet asset (e.g., a purchased subordinated security), 
a corporate must use the amount of the direct credit substitute and the 
full amount of the asset it supports, i.e., all the more senior 
positions in the structure). This means, for example, that if a 
corporate invests in a senior mezzanine security that supports a more 
senior tranche, the corporate must use the full amount of the supported 
tranche, without regard for the existence or not of tranches 
subordinate to the mezzanine tranche. This can result in a risk-
weighting several times greater than the risk-weighting for the most 
senior tranche.
    There are two subsets of recourse obligations that receive special 
treatment for risk-weighting purposes: residual interests and credit 
enhancing interest only strips. In addition, in some asset transfers 
the transferring entity might retain two or more different recourse 
obligations on the same transferred assets, and the rule provides for a 
special risk-weighting calculation in this case. These situations are 
discussed further below.
    The proposal defines residual interests, a form of recourse 
obligation, as any on-balance sheet asset that:
    (1) Represents an interest (including a beneficial interest) 
created by a transfer that qualifies as a sale (in accordance with 
Generally Accepted Accounting Principles) of financial assets, whether 
through a securitization or otherwise; and
    (2) Exposes a corporate to credit risk directly or indirectly 
associated with the transferred asset that exceeds a pro rata share of 
that corporate's claim on the asset, whether through subordination 
provisions or other credit enhancement techniques.
    Residual interests generally include credit-enhancing interest-only 
strips, spread accounts, cash collateral accounts, retained 
subordinated interests (and other forms of overcollateralization), and 
similar assets that function as a credit enhancement. Residual 
interests further include those exposures that, in substance, cause the 
corporate to retain the credit risk of an asset or exposure that had 
qualified as a residual interest before it was sold. While residual 
interests generally do not include assets purchased from a third

[[Page 65231]]

party, the definition does include a credit-enhancing interest-only 
strip that is acquired in any asset transfer as a residual interest.
    The proposal provides that a corporate must maintain risk-based 
capital for a residual interest equal to the face amount of the 
residual interest, even if the amount of risk-based capital that must 
be maintained exceeds the full risk-based capital requirement for the 
assets transferred. For residual interests in the form of credit 
enhancing interest only strips, the rule further provides that a 
corporate must maintain risk-based capital equal to the remaining 
amount of the strip (emphasis added) even if the amount of risk-based 
capital that must be maintained exceeds the full risk-based capital 
requirement for the assets transferred.
    Where a corporate transfers assets, and holds both a residual 
interest (including a credit-enhancing interest-only strip) and another 
recourse obligation in connection with that transfer, the corporate 
must maintain risk-based capital equal to the greater of the risk-based 
capital requirement for the residual interest or the full risk-based 
capital requirement for the assets transferred.
Ratings-Based Approach to Risk-Weighting
    In lieu of the general risk-weighting approach described above, the 
proposal would allow a corporate to employ a ratings based approach to 
certain asset-backed securities, direct credit substitutes, or residual 
interests.
    To apply a ratings based approach to one of these particular 
assets, the asset must generally be a traded position, and if a long 
term position, must be rated by an NRSRO as one grade below investment 
grade or better or, if a short-term position, must be publicly rated by 
an NRSRO as investment grade or better.\45\ To obtain the risk-weighted 
asset amount, the corporate will multiply the face amount of the asset 
by the appropriate risk-weight determined in accordance with Table A or 
B below:
---------------------------------------------------------------------------

    \45\ The proposal defines a traded position as a position 
retained, assumed, or issued in connection with a securitization 
that is rated by a NRSRO, where there is a reasonable expectation 
that, in the near future, the rating will be relied upon by:
    (1) Unaffiliated investors to purchase the security; or
    (2) An unaffiliated third party to enter into a transaction 
involving the position, such as a purchase, loan, or repurchase 
agreement.
    Also, if two or more NRSROs assign ratings to a traded position, 
the corporate must use the lowest rating to determine the 
appropriate risk-weight category.

                                 Table A
------------------------------------------------------------------------
                                                            Risk-weight
                Long-term rating category                  (in percent)
------------------------------------------------------------------------
Highest or second highest investment grade..............              20
Third highest investment grade..........................              50
Lowest investment grade.................................             100
One category below investment grade.....................             200
------------------------------------------------------------------------


                                 Table B
------------------------------------------------------------------------
                                                            Risk-weight
               Short-term rating category                  (in percent)
------------------------------------------------------------------------
Highest investment grade................................              20
Second highest investment grade.........................              50
Lowest investment grade.................................             100
------------------------------------------------------------------------

    The proposal also permits certain asset-backed securities (ABS), 
direct credit substitutes, and recourse obligations that do not meet 
the definition of ``traded position'' to be risk-weighted based on 
NRSRO ratings category under certain circumstances.\46\
---------------------------------------------------------------------------

    \46\ A position that is not traded is eligible for the ratings 
based risk-weighting if:
    (1) The position is a recourse obligation, direct credit 
substitute, residual interest, or asset- or mortgage-backed security 
extended in connection with a securitization and is not a credit-
enhancing interest-only strip;
    (2) More than one NRSRO rate the position;
    (3) All of the NRSROs that provide a rating rate a long term 
position as one grade below investment grade or better or a short 
term position as investment grade. If the NRSROs assign different 
ratings to the position, the corporate must use the lowest rating to 
determine the appropriate risk-weight category;
    (4) The NRSROs base their ratings on the same criteria that they 
use to rate securities that are traded positions; and
    (5) The ratings are publicly available.
---------------------------------------------------------------------------

Use of Ratings Based Approach to Assets That Are Not Specifically Rated 
by an NRSRO
    The proposal provides that, in certain circumstances, a corporate 
may use the ratings based approach for asset-backed securities, direct 
credit substitutes, or residual interests that are not specifically 
rated by an NRSRO.
    If the asset is senior or preferred in all features to a particular 
traded position, including collateralization and maturity, the 
corporate may risk-weight the face amount of the senior position under 
the ratings based approach using Tables A and B above based on the 
NRSRO rating of the traded position, subject to supervisory guidance. 
The corporate must satisfy NCUA that this treatment is appropriate.
    An asset created in connection with a securitization is eligible 
for a ratings-based risk-weighting treatment in accordance with Table C 
below if the asset is not rated by an NRSRO, is not a residual 
interest, and meets one of three different, alternative standards for 
internal ratings described below.

                                 Table C
------------------------------------------------------------------------
                                                            Risk-weight
                     Rating category                       (in percent)
------------------------------------------------------------------------
Investment grade........................................             100
One category below investment grade.....................             200
------------------------------------------------------------------------

    A direct credit substitute, but not a purchased credit-enhancing 
interest-only strip, is eligible for the a ratings based risk-weighting 
under Table C if the asset is created in connection with an asset-
backed commercial paper program sponsored by the corporate and the 
rating is generated by an appropriate internal credit risk rating 
system.\47\
---------------------------------------------------------------------------

    \47\ The proposed rule provides that such internal credit risk 
rating systems typically:
    (1) Are an integral part of the corporate's risk management 
system that explicitly incorporates the full range of risks arising 
from the corporate's participation in securitization activities;
    (2) Link internal credit ratings to measurable outcomes, such as 
the probability that the position will experience any loss, the 
expected loss on the position in the event of default, and the 
degree of variance in losses in the event of default on that 
position;
    (3) Separately consider the risk associated with the underlying 
loans or borrowers, and the risk associated with the structure of 
the particular securitization transaction;
    (4) Identify gradations of risk among ``pass'' assets and other 
risk positions;
    (5) Use clear, explicit criteria to classify assets into each 
internal rating grade, including subjective factors;
    (6) Employ independent credit risk management or loan review 
personnel to assign or review the credit risk ratings;
    (7) Include an internal audit procedure to periodically verify 
that internal risk ratings are assigned in accordance with the 
corporate's established criteria;
    (8) Monitor the performance of the assigned internal credit risk 
ratings over time to determine the appropriateness of the initial 
credit risk rating assignment, and adjust individual credit risk 
ratings or the overall internal credit risk rating system, as 
needed; and
    (9) Make credit risk rating assumptions that are consistent 
with, or more conservative than, the credit risk rating assumptions 
and methodologies of NRSROs.
---------------------------------------------------------------------------

    A recourse obligation or direct credit substitute, but not a 
residual interest, is eligible for a ratings based risk-weighting under 
Table C if the asset is created in connection with a structured finance 
program and an NRSRO has reviewed the terms of the program and stated a 
rating for positions associated with the program.\48\ If the program 
has

[[Page 65232]]

options for different combinations of assets, standards, internal or 
external credit enhancements and other relevant factors, and the NRSRO 
specifies ranges of rating categories to them, the corporate may apply 
the rating category applicable to the option that corresponds to the 
corporate's position. To rely on this sort of program rating, the 
corporate must demonstrate to NCUA's satisfaction that the credit risk 
rating assigned to the program meets the same standards generally used 
by NRSROs for rating traded positions. The corporate must also 
demonstrate to NCUA's satisfaction that the criteria underlying the 
assignments for the program are satisfied by the particular position.
    A recourse obligation or direct credit substitute, but not a 
residual interest, is eligible for a ratings based risk-weighting under 
Table C if the asset is created in connection with a structured 
financing program and the corporate uses an acceptable credit 
assessment computer program to determine the rating of the position. An 
NRSRO must have developed the computer program and the corporate must 
demonstrate to NCUA's satisfaction that the ratings under the program 
correspond credibly and reliably with the rating of traded 
positions.\49\
---------------------------------------------------------------------------

    \48\ Under the proposal, a corporate may use a rating obtained 
from a rating agency for unrated direct credit substitutes or 
recourse obligations (but not residual interests) in structured 
finance programs that satisfy specifications set by the rating 
agency. The corporate would need to demonstrate that the rating 
meets the same rating standards generally used by the rating agency 
for rating traded positions. In addition, the corporate must also 
demonstrate to the NCUA's satisfaction that the criteria underlying 
the rating agency's assignment of ratings for the program are 
satisfied for the particular direct credit substitute or recourse 
exposure.
    To use this approach, a corporate must demonstrate to the NCUA 
that it is reasonable and consistent with the standards of this 
final rule to rely on the rating of positions in a securitization 
structure under a program in which the corporate participates if the 
sponsor of that program has obtained a rating. This aspect of the 
final rule is most likely to be useful to corporates with limited 
involvement in securitization activities. In addition, some banking 
entities extensively involved in securitization activities already 
rely on ratings of the credit risk positions under their 
securitization programs as part of their risk management practices. 
Such corporates also could rely on such ratings under this final 
rule if the ratings are part of a sound overall risk management 
process and the ratings reflect the risk of non-traded positions to 
the corporates.
    This approach can be used to qualify a direct credit substitute 
or recourse obligation (but not a residual interest) for a risk-
weight of 100 percent or 200 percent of the face value of the 
position under the ratings-based approach, but not for a risk-weight 
of less than 100 percent.
    \49\ The NCUA will also allow corporates, particularly those 
with limited involvement in securitization activities, to rely on 
qualifying credit assessment computer programs that the rating 
agencies have developed to rate otherwise unrated direct credit 
substitutes and recourse obligations (but not residual interests) in 
asset securitizations.
    To qualify for use by a corporate for risk-based capital 
purposes, a computer program's credit assessments must correspond 
credibly and reliably to the rating standards of the rating agencies 
for traded positions in securitizations. A corporate must 
demonstrate the credibility of the computer program in the financial 
markets, which would generally be shown by the significant use of 
the computer program by investors and other market participants for 
risk assessment purposes. A corporate must also demonstrate the 
reliability of the program in assessing credit risk.
    A corporate may use a computer program for purposes of applying 
the ratings-based approach under this final rule only if the 
corporate satisfies NCUA that the program results in credit 
assessments that credibly and reliably correspond with the ratings 
of traded positions by the rating agencies. The corporate should 
also demonstrate to the NCUA's satisfaction that the program was 
designed to apply to its particular direct credit substitute or 
recourse exposure and that it has properly implemented the computer 
program.
---------------------------------------------------------------------------

Other Limitations on Risk-Based Capital Requirements
    The proposal contains some miscellaneous limitations on the risk-
based capital requirements. There is a low-level exposure provision 
that limits the maximum risk-based capital requirement to the maximum 
contractual loss exposure, even where risk-based capital requirement as 
calculated under Appendix C might exceed that amount. There is a 
provision that limits the amount of risk-based capital to support 
mortgage-related securities or participation certificates retained in a 
mortgage loan swap. There is a provision that eliminates double 
counting of assets for purposes of risk-weighting. Finally, there is a 
provision that requires the corporate to risk-weight recourse 
obligations and direct credit substitutes retained or assumed by a 
corporate on the obligations of CUSOs in which the corporate has an 
equity investment in accordance with this Section II(c), unless the 
corporate's equity investment is deducted from credit union's capital 
and assets under Sec.  704.2 and Sec.  704.3.

III.B. Amendments to Part 704 Relating to Prompt Corrective Action

Proposed Sec.  704.4 Prompt Corrective Action
    Section 38 of the Federal Deposit Insurance Act (12 U.S.C. 1831o) 
(Section 38) contains a framework that applies to every insured banking 
institution a system of supervisory actions indexed to the capital 
level of the individual institution. The purpose of this ``prompt 
corrective action'' (PCA) statutory provision is to ``resolve the 
problems of insured depository institutions at the least possible long-
term loss to the [Federal Deposit Insurance Corporation's] deposit 
insurance fund.'' Section 216 of the Federal Credit Union Act (12 
U.S.C. 1790d) (Section 216) contains a similar PCA provision, and NCUA 
has implemented Section 216 through regulations in part 702. 12 CFR 
part 702. Section 216 of the FCUA, however, is not applicable to 
corporates, and neither is part 702. 12 U.S.C. 1790d(m); 12 CFR 
702.1(c). The Board has determined, however, that some sort of 
regulatory PCA regime is appropriate for corporates, and this proposal 
sets forth such a regime.
    Corporates have a wider variety of powers than natural person 
credit unions, including some powers that are more like bank powers. 
Accordingly, this proposed PCA rule, to be located at Sec.  704.4 of 
NCUA's corporate rule, contains elements from both Section 38 of the 
FDIA and Section 216 of the FCUA, and their various implementing 
regulations. Part 747 of NCUA's rules describes the rules and 
procedures for various hearings and recommendations, and subpart L sets 
forth the procedures for the issuance, review, and enforcement of 
orders imposing PCA on natural person credit unions. The proposal 
contains a new subpart M in part 747 that contains similar procedures 
for corporate PCA.
    The proposal establishes five categories of corporate capital 
classification: well capitalized, adequately capitalized, 
undercapitalized, significantly undercapitalized, and critically 
undercapitalized. The proposal deems a corporate, generally, to be 
``well capitalized'' if the institution significantly exceeds the 
required minimum level for each relevant capital measure; ``adequately 
capitalized'' if the institution meets the required minimum level for 
each relevant capital measure; ``undercapitalized'' if the institution 
fails to meet the required minimum level for any relevant capital 
measure; ``significantly undercapitalized'' if the institution is 
significantly below the required minimum level for any relevant capital 
measure; or ``critically undercapitalized'' if the institution is 
critically below the required minimum level for any relevant capital 
measure.
    Capital ratios alone, of course, are not fully indicative of the 
capital strength of an institution. In particular, in proposing these 
minimum capital levels, the NCUA is aware that a corporate can have 
capital ratios above the specified minimums for the well capitalized 
and adequately capitalized categories while still exhibiting unsafe and 
unsound characteristics. One reason for this dichotomy is that capital 
is a lagging indicator of problems of insured depository institutions, 
and use of

[[Page 65233]]

moving DANA and DANRA exacerbates this lag.
    Accordingly, a corporate might be subject to a written order or 
directive that establishes higher capital levels for that institution. 
NCUA is proposing that for a corporate to be well capitalized, it must 
not be subject to any written capital order or directive.\50\ This 
proposal reflects the view that a corporate that is subject to a 
written capital directive does not have capital that significantly 
exceeds the required minimum level for the relevant capital measures.
    The proposal also gives the NCUA discretion to downgrade, where 
appropriate, a ``well capitalized'' corporate by one category and 
require an ``adequately capitalized'' or ``undercapitalized'' corporate 
to comply with supervisory actions as if it were in the next lower 
category. Additionally, the NCUA may, for good cause, modify the 
minimum capital ratio percentages for purposes of determining the 
appropriate PCA capital category for a particular corporate credit 
union. The proposal further clarifies that NCUA continues to have 
available all other non-PCA supervisory tools traditionally used to 
supervise corporates, and the agency intends to use these tools as 
appropriate in supervising corporates. These tools include appropriate 
enforcement actions and supervisory follow-up measures based upon the 
corporate's overall condition and the existence of any financial, 
operational, or other supervisory weaknesses, irrespective of the 
corporate's capital category for purposes of the prompt corrective 
action provisions of the proposal.
---------------------------------------------------------------------------

    \50\ This would include capital orders, capital directives, and 
cease and desist orders related to capital.
---------------------------------------------------------------------------

    Finally, the proposal prohibits a corporate from disseminating to 
third-parties its capital category, except where permitted by NCUA or 
otherwise provided by statute or regulation. This also prohibits 
corporates from advertising their capital category.
    A paragraph-by-paragraph summary of the PCA proposal follows.
Paragraph 704.4(a) Purpose
    This proposed paragraph establishes that the principal purpose of 
PCA is to define, for corporates that are not adequately capitalized, 
the capital measures and capital levels that are used for determining 
appropriate supervisory actions. The proposal also establishes 
procedures for submission and review of capital restoration plans and 
for issuance and review of capital directives, orders, and other 
supervisory directives. In the case of a state-chartered corporate 
credit union, the proposal provides that NCUA will consult with, and 
seek to work cooperatively with, the appropriate State official before 
taking any discretionary PCA actions.
Paragraph 704.4(b) Scope
    This paragraph establishes that the PCA section applies to 
corporates, including officers, directors, and employees. The paragraph 
clarifies that the section does not limit the authority of the NCUA in 
any way to take supervisory actions to address unsafe or unsound 
practices, deficient capital levels, violations of law, unsafe or 
unsound conditions, or other practices. It generally prohibits a 
corporate from stating in any advertisement or promotional material its 
capital category or that the NCUA has assigned the corporate to a 
particular category. The proposal also requires newly chartered 
corporates to submit to NCUA a draft plan that sets forth how the 
corporate will solicit contributed capital and build retained earnings.
Paragraph 704.4(c) Notice of Capital Category
    This paragraph describes the effective date of change in capital 
category, which is important in terms of triggering various time-
sensitive actions. The paragraph provides that that the effective date 
will be the most recent date that a 5310 Financial Report is required 
to be filed with the NCUA; a final NCUA report of examination is 
delivered to the corporate; or written notice is provided by the NCUA 
to the corporate that its capital category has changed.
    The rule also provides that a corporate must provide the NCUA with 
written notice that an adjustment to the corporate's capital category 
may have occurred no later than 15 calendar days following the date 
that any material event has occurred that would cause the corporate to 
be placed in a lower capital category from the category assigned to the 
corporate on the basis of the corporate's most recent call report or 
report of examination. After receiving this notice, or on its own 
initiative, the NCUA will determine whether to change the capital 
category of the corporate and will notify the corporate of the NCUA's 
determination.
Paragraph 704.4(d) Capital Measures and Capital Category Definitions
    This paragraph restates the relevant capital measures from proposed 
Sec.  704.3, that is the total risk-based capital ratio, the tier 1 
risk-based capital ratio, and the leverage ratio. The paragraph then 
defines the five PCA capital categories in terms of these ratios.
    The proposal provides that a corporate is ``well capitalized'' if 
it has a total risk-based capital ratio of 10.0 percent or greater, a 
Tier 1 risk-based capital ratio of 6.0 percent or greater, a leverage 
ratio of 5.0 percent or greater, and is not subject to any written 
agreement, order, capital directive, or prompt corrective action 
directive issued by NCUA to meet and maintain a specific capital level 
for any capital measure. A corporate must satisfy all four of these 
criteria to be considered well capitalized.
    The proposal provides that a corporate is ``adequately 
capitalized'' if the corporate has a total risk-based capital ratio of 
8.0 percent or greater, a Tier 1 risk-based capital ratio of 4.0 
percent or greater, a leverage ratio of 4.0 percent or greater, and 
does not meet the definition of a well capitalized corporate. A 
corporate must satisfy all four of these criteria to be considered 
adequately capitalized.
    The proposal provides that a corporate is ``undercapitalized'' if 
the corporate has a total risk-based capital ratio that is less than 
8.0 percent, or has a Tier 1 risk-based capital ratio that is less than 
4.0 percent, or has a leverage ratio that is less than 4.0 percent. 
Failure to achieve any one of these three minimum percentages will 
cause the corporate to be undercapitalized.
    The proposal provides that a corporate is ``significantly 
undercapitalized'' if the corporate has a total risk-based capital 
ratio that is less than 6.0 percent, or a Tier 1 risk-based capital 
ratio that is less than 3.0 percent, or a leverage ratio that is less 
than 3.0 percent. Again, failure to achieve any one percentage will 
cause the corporate to be significantly undercapitalized.
    The proposal provides that a corporate is ``critically 
undercapitalized'' if the corporate has a total risk-based capital 
ratio that is less than 4.0 percent, or a Tier 1 risk-based capital 
ratio that is less than 2.0 percent, or a leverage ratio that is less 
than 2.0 percent. Again, failure to achieve any one of percentages will 
cause the corporate to be critically undercapitalized.
    The proposal provides NCUA with authority to reclassify a 
corporate's capital category based on supervisory criteria other than 
capital. One such criteria is a determination by NCUA that the 
corporate received a less-than-satisfactory rating (i.e., three or 
lower) for any rating category (other than in a rating category 
specifically addressing

[[Page 65234]]

capital adequacy) under the Corporate Risk Information System (CRIS) 
rating system and has not corrected the conditions that served as the 
basis for the less than satisfactory rating. In this case, the NCUA may 
reclassify a well capitalized corporate as adequately capitalized, and 
may require an adequately capitalized or undercapitalized corporate to 
comply with certain mandatory or discretionary supervisory actions as 
if the corporate were in the next lower capital category. NCUA may also 
downgrade the capital category of a well capitalized, adequately 
capitalized, or undercapitalized corporate by one category if the NCUA 
determines that the corporate is otherwise in an unsafe or unsound 
condition.
    In both situations, however, the NCUA must offer the corporate 
notice and opportunity to be heard before carrying out such a 
supervisory downgrade. The procedures, which include the opportunity 
for a hearing, are described in paragraph 704.4(h) and the proposed 
subpart M of part 747.
Paragraph 704.4(e) Capital Restoration Plans
    The proposal requires that any corporate that is downgraded to 
undercapitalized, or a lower capital category, must file a capital 
restoration plan with the NCUA.
    The capital restoration plan must include all of the information 
required to be filed under paragraph (k)(2)(ii). This information 
includes the steps the corporate will take to become adequately 
capitalized; the levels of capital to be attained during each year in 
which the plan will be in effect; how the corporate will comply with 
the other PCA restrictions or requirements then in effect under this 
section; the types and levels of activities in which the corporate will 
engage; and other information as the NCUA may require. All financial 
data in the plan must be prepared in accordance with the instructions 
provided on the call report. A corporate required to submit a capital 
restoration plan as the result of a reclassification of the corporate 
for supervisory reasons must also include a description of the steps 
the corporate will take to correct the unsafe or unsound condition or 
practice.
    The capital restoration plan must be filed with the NCUA within 45 
days of the date that the corporate receives notice or is deemed to 
have notice that the corporate is undercapitalized, significantly 
undercapitalized, or critically undercapitalized, unless the NCUA 
notifies the corporate of a different filing period. An adequately 
capitalized corporate that has been reclassified for supervisory 
reasons is not, however, required to submit a capital restoration plan 
solely by virtue of the reclassification. Also, a corporate that has 
already submitted and is operating under a capital restoration plan is 
not required to submit an additional capital restoration plan based on 
a revised calculation of its capital measures or a reclassification 
unless the NCUA requests one.
    A corporate that is undercapitalized and that fails to submit a 
timely, written capital restoration plan will be subject to all of the 
provisions of this section applicable to significantly undercapitalized 
corporates.
    Within 60 days after receiving a capital restoration plan under 
this section, the NCUA will provide written notice to the corporate of 
whether it has approved the plan. The NCUA may extend this time period.
    If NCUA does not approve a capital restoration plan, the corporate 
must submit a revised capital restoration plan, when directed to do so 
and within the time specified by the NCUA. An undercapitalized 
corporate is subject to the provisions of Sec.  704.4 applicable to 
significantly undercapitalized credit unions until it has submitted, 
and NCUA has approved, a capital restoration plan. If NCUA directs that 
the corporate submit a revised plan, it must do so in time frame 
specified by NCUA.
    Any undercapitalized corporate that fails in any material respect 
to implement a capital restoration plan will be subject to all of the 
provisions of Sec.  704.4 applicable to significantly undercapitalized 
corporates. A corporate that has filed an approved capital restoration 
plan may, after prior written notice to and approval by the NCUA, amend 
the plan to reflect a change in circumstance. Until such time as NCUA 
has approved a proposed amendment, the corporate must implement the 
capital restoration plan as approved prior to the proposed amendment.
Paragraph 704.4(f) Mandatory and Discretionary Supervisory Actions
    The proposal provides for certain mandatory supervision actions 
depending on a corporate's capital category. Many of these provisions 
are incorporated by cross reference to paragraph 704.4(k).
Provisions Applicable to All Corporates
    Paragraph (k)(1) provides that a corporate is prohibited, unless it 
obtains NCUA's prior written approval, from making any capital 
distribution, including payment of dividends on perpetual contributed 
capital or nonperpetual contributed capital accounts if, after making 
the distribution, the institution would be undercapitalized.
Provisions Applicable to Undercapitalized, Significantly 
Undercapitalized, and Critically Undercapitalized Corporates
    Upon being categorized as undercapitalized, significantly 
undercapitalized, or critically undercapitalized, a corporate will be 
subject to the following conditions and restrictions.
    The corporate must submit an acceptable capital restoration plan to 
the NCUA. The corporate must not permit its DANA during any calendar 
month to exceed its moving DANA unless the NCUA has accepted the 
corporate's capital restoration plan and any increase in total assets 
is consistent with the plan. The corporate also must not, directly or 
indirectly, acquire any interest in any entity, establish or acquire 
any additional branch office, or engage in any new line of business 
unless the NCUA determines that the proposed action is consistent with 
and will further the achievement of the plan.
    The NCUA will also closely monitor the corporate for compliance 
with capital standards, capital restoration plans and activities.
    Additional provisions applicable to significantly undercapitalized 
corporates and undercapitalized corporates that fail to submit and 
implement acceptable capital restoration plans.
    If a corporate is significantly undercapitalized, or is 
undercapitalized and has failed to submit and implement a capital 
restoration plans acceptable to the NCUA, the corporate is prohibited 
from doing any of the following without the prior written approval of 
the NCUA:
     Paying any bonus or profit-sharing to any senior executive 
officer.
     Providing compensation to any senior executive officer at 
a rate exceeding that officer's average rate of compensation (excluding 
bonuses and profit-sharing) during the 12 calendar months preceding the 
calendar month in which the corporate became undercapitalized.
    The NCUA will not grant approval with respect to a corporate that 
has failed to submit an acceptable capital restoration plan.
    If a corporate is significantly undercapitalized, or is 
undercapitalized and has failed to submit and implement a capital 
restoration plans acceptable to

[[Page 65235]]

the NCUA, the NCUA may also take one or more of the following actions:
     Requiring recapitalization, through requiring the 
corporate to seek and obtain additional contributed capital, requiring 
the corporate to increase its rate of earnings retention, or requiring 
the corporate to combine with another insured depository institution, 
if one or more grounds exist for appointing a conservator or 
liquidating agent for the institution.
     Further restricting the corporate's transactions with 
affiliates.
     Restricting the interest rates that the corporate pays on 
shares and deposits to the prevailing rates of interest on deposits of 
comparable amounts and maturities in the region where the institution 
is located, as determined by the NCUA.
     Restricting the corporate's asset growth more stringently 
than required under paragraph (k)(2)(iii), or requiring the corporate 
to reduce its total assets.
     Requiring the corporate or any of its CUSOs to alter, 
reduce, or terminate any activity that the NCUA determines poses 
excessive risk to the corporate.
     Ordering a new election for the corporate's board of 
directors.
     Requiring the corporate to dismiss from office any 
director or senior executive officer who had held office for more than 
180 days immediately before the corporate became undercapitalized.
     Requiring the corporate to employ qualified senior 
executive officers (who, if the NCUA so specifies, will be subject to 
approval by the NCUA).
     Requiring the corporate to divest itself of or liquidate 
any interest in any CUSO or other entity if the NCUA determines that 
the entity is in danger of becoming insolvent or otherwise poses a 
significant risk to the corporate.
     Conserve or liquidate the corporate if NCUA determines the 
corporate has no reasonable prospect of becoming adequately 
capitalized.
     Requiring the corporate to take any other action that the 
NCUA determines will better carry out the purpose of this section than 
any of the actions described in this paragraph.
    The NCUA may also impose one or more of the restrictions applicable 
to critically undercapitalized corporates, discussed below, if the NCUA 
determines that those restrictions are necessary to carry out the 
purpose of this section.
Additional Provisions Applicable to Critically Undercapitalized 
Corporates
    In addition to the provisions described above for undercapitalized 
and significantly undercapitalized corporates, the proposal provides 
that corporates that are critically undercapitalized are subject to 
additional requirements and restrictions.
    A critically undercapitalized corporate must not, beginning 60 days 
after becoming critically undercapitalized, make any payment of 
dividends on contributed capital or any payment of principal or 
interest on the corporate's subordinated debt unless the NCUA 
determines that the exception would further the purpose of this 
section. Interest, although not payable, may continue to accrue under 
the terms of any subordinated debt to the extent otherwise permitted by 
law. Dividends on contributed capital do not, however, continue to 
accrue.
    The NCUA will, by order, restrict the activities of any critically 
undercapitalized corporate and prohibit any such corporate from doing 
any of the following without the NCUA's prior written approval:
     Entering into any material transaction other than in the 
usual course of business, including any investment, expansion, 
acquisition, sale of assets, or other similar action.
     Extending credit for any highly leveraged transaction.
     Amending the corporate's charter or bylaws, except to the 
extent necessary to carry out any other requirement of any law, 
regulation, or order.
     Making any material change in accounting methods.
     Paying excessive compensation or bonuses.
     Paying interest on new or renewed liabilities at a rate 
that would increase the corporate's weighted average cost of funds to a 
level significantly exceeding the prevailing rates of interest on 
insured deposits in the corporate's normal market areas.
    With regard to the phrase ``significantly exceeding the prevailing 
rates,'' the prevailing effective yields of interest are the effective 
yields on insured deposits (or shares) of comparable maturities offered 
by other insured depository institutions in the market area in which 
the corporate is soliciting shares. A market area is any readily 
defined geographic area in which the rates offered by any one insured 
depository institution operating in the area may affect the rates 
offered by other institutions operating in the same area. For a 
corporate, the market could be a national market.
    The NCUA may also, at any time, conserve or liquidate a critically 
undercapitalized corporate or require such a corporate to combine, in 
whole or part, with another institution. NCUA will consider, not later 
than 90 days after a corporate becomes critically undercapitalized, 
whether NCUA should liquidate or conserve the institution.
Paragraph 704.4(g) Directives To Take Prompt Corrective Action
    The proposed rule states that the NCUA will provide an 
undercapitalized, significantly undercapitalized, or critically 
undercapitalized corporate prior written notice of the NCUA's intention 
to issue a directive requiring such corporate to take actions or to 
follow restrictions described in this part. Proposed Sec.  747.3002 of 
this chapter, discussed below, prescribes the notice content and 
associated process.
Paragraph 704.4(h) Procedures for Reclassifying a Corporate Based on 
Criteria Other Than Capital
    This provides that when the NCUA intends to reclassify a corporate 
or subject it to the supervisory actions applicable to the next lower 
capitalization category based on an unsafe or unsound condition or 
practice the NCUA will provide the credit union with prior written 
notice of such intent. Proposed Sec.  747.3003 of this chapter, 
discussed below, prescribes the notice content and associated process.
Paragraph 704.4(i) Order To Dismiss a Director or Senior Executive 
Officer
    This provides that when the NCUA issues and serves a directive on a 
corporate requiring it to dismiss from office any director or senior 
executive officer, the NCUA will also serve upon the person the 
corporate is directed to dismiss (Respondent) a copy of the directive 
(or the relevant portions, where appropriate) and notice of the 
Respondent's right to seek reinstatement. Proposed Sec.  747.3004 of 
this chapter, discussed below, prescribes the content of the notice of 
right to seek reinstatement and the associated process.
Paragraph 704.4(j) Enforcement of Directives
    This proposed paragraph cross references proposed Sec.  747.3005, 
discussed below, on the process for enforcement of directives.
Paragraph 704.4(k) Remedial Actions Towards Undercapitalized, 
Significantly Undercapitalized, and Critically Undercapitalized 
Corporates
    This proposed paragraph describes the various PCA remedial actions, 
discussed in detail in the section of paragraph 704.4(f) above.

[[Page 65236]]

Proposed Subpart M of Part 747--Issuance, Review and Enforcement of 
Orders Imposing Prompt Corrective Action on Corporates
    Proposed subpart M of part 747 provides an affected corporate, and 
its officials and employees, with due process related to certain NCUA 
actions taken under proposed Sec.  704.4 establishing PCA for 
corporates. Proposed subpart M is similar to the current subpart L, 
which sets forth the applicable due process for natural person credit 
union PCA under part 702 of NCUA's rules. 12 CFR part 702. A section-
by-section analysis of subpart M follows.
Section 747.3001 Scope
    Section 747.3001 establishes an independent process for appealing 
certain NCUA decisions to impose PCA under part 704.4. In the case of 
state charted corporates seeking independent review under subpart M, 
this section provides that the parties (i.e., NCUA and corporate and/or 
a dismissed director or officer) will serve upon the appropriate State 
official the documents filed or issued in connection with a proceeding 
under subpart M.
Section 747.3002 Discretionary Supervisory Actions (DSAs)
    Section 747.3002 provides for prior notice and an opportunity to be 
heard before a DSA is imposed. The NCUA Board must give advance notice 
of its intention to impose a DSA, 12 CFR 747.3002(a)(1), except when 
necessary to further the purpose of PCA. 12 CFR 747.3002(a)(2). The 
corporate may then challenge the proposed action in writing and request 
that the DSA not be imposed or be modified. 12 CFR 747.3002(c). The 
corporate, however, is not entitled to a hearing. The NCUA, or an 
independent person designated by the NCUA, may then decide not to issue 
the directive or to issue it as proposed or as modified, 12 CFR 
747.3002(d); and that decision is final. A corporate which already is 
subject to a DSA may request reconsideration and rescission due to 
changed circumstances. 12 CFR 747.3002(f).
    In general, this system avoids involving panels or councils in the 
appeal process, and expanding it beyond an opportunity to be heard in 
writing, because this would undermine the overall objective of PCA, 
that is, to take prompt action. On the other hand, a time limit, as 
contained in the proposal, for the NCUA to decide on requests to 
modify, to not issue, or to rescind DSAs is appropriate. Accordingly, 
the rule includes in Sec.  747.3002(f) the safeguard that if NCUA fails 
to decide a request to modify or rescind an existing DSA within 60 
days, that DSA will be deemed modified or rescinded.
Section 747.3003 Reclassification to Lower Capitalization Category
    The NCUA is authorized to reclassify a corporate to the next lower 
capital category on grounds of an unsafe or unsound practice or 
condition, provided the corporate is first given notice and an 
opportunity for a hearing. 12 CFR 704.4(d)(3). In such cases, 
therefore, Sec.  747.3003 requires the NCUA to give notice of the 
NCUA's intention to reclassify a corporate, 12 CFR 747.3003(a), and 
describe the practice(s) and/or condition(s) justifying 
reclassification. 12 CFR 747.3003(b). The corporate may then challenge 
the reclassification, provide evidence supporting its position, and 
request an informal hearing and the opportunity to present witnesses. 
12 CFR 747.3003(c).
    If the corporate requests a hearing, an informal hearing will be 
conducted by a presiding officer designated by the NCUA. 12 CFR 
747.3003(d). At the hearing, the corporate or its counsel may introduce 
relevant documents, present oral argument, and, if authorized, present 
witnesses. 12 CFR 747.3003(e). The presiding officer then makes a 
recommended decision to the NCUA, 12 CFR 747.3003(e)(4), who then 
issues a final decision whether to reclassify the corporate. 12 CFR 
747.3003(f).
Section 747.3004 Dismissal of Director or Senior Executive Officer
    The NCUA is authorized to issue a DSA directing a corporate to 
dismiss a director or senior executive officer. 12 CFR 
704.4(k)(3)(ii)(F). In such cases, Sec.  747.3004 requires the NCUA 
Board to serve the dismissed person with a copy of the directive issued 
to the corporate, accompanied by a notice of the right to seek 
reinstatement by the NCUA Board. 12 CFR 747.3004(a)-(b). That person 
may then challenge the dismissal and request for reinstatement, and may 
request an informal hearing and the opportunity to present witness 
testimony.\51\ 12 CFR 747.3004(c). The dismissal remains in effect 
while the request for reinstatement is pending. 12 CFR 747.3004(g).
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    \51\ The corporate directed to dismiss a director or officer may 
not seek reinstatement of the dismissed director or officer under 
Sec.  747.3004, but that corporate may challenge the directive under 
Sec.  747.3002.
---------------------------------------------------------------------------

    If a hearing is requested, an NCUA-designated presiding officer 
conducts the hearing under procedures identical to those which Sec.  
747.3003 prescribes in cases of reclassification, with two exceptions. 
First, the dismissed person bears the burden of proving that his or her 
continued employment would materially strengthen the corporate's 
ability to become ``adequately capitalized'' or to correct an unsafe or 
unsound condition, as the case may be. 12 CFR 747.3004(e)(4). Second, 
if the NCUA's final decision is to deny reinstatement, it must provide 
reasons for its decision. 12 CFR 747.3004(f).
Section 747.3005 Enforcement of Orders Imposing Prompt Corrective 
Action
    When a corporate fails to comply with a mandatory supervisory 
action (MSA) or DSA, the NCUA Board may apply to the appropriate U.S. 
District Court to enforce that action. 12 CFR 747.3005(a). 
Alternatively, the NCUA Board may assess a civil money penalty against 
a corporate (and any institution-affiliated party acting in concert 
with it) which violates or fails to comply with an MSA or DSA, or fails 
to implement an approved capital restoration plan. 12 CFR 747.3005(b). 
Finally, subpart M allows the NCUA Board to enforce an MSA or DSA under 
Sec.  704.4 ``through any other judicial or administrative proceeding 
authorized by law.'' 12 CFR 747.3005(c).
Phase-in of Proposed Capital and PCA Requirements
    The Board intends to phase-in the proposed capital and PCA 
requirements over time. Details about the proposed phase-in are 
contained in subsection III.D. below.

III.C. Amendments to Part 704 Relating to Corporate Investments and 
Asset-Liability Management

    The proposal contains amendments to the part 704 investment 
authorities. These proposed amendments work in conjunction with the 
asset-liability management provisions of the regulation to prevent 
excessive concentrations of risk. By limiting investment types and 
concentrations in combination with more comprehensive risk assessment 
requirements, the proposal establishes a more rigorous framework for 
identifying, measuring, monitoring, and controlling a corporate's 
balance sheet risks--and does so in a manner consistent with the avowed 
conservative principles of corporate credit union mission.
    In formulating the proposed changes to investment authorities and 
asset-liability management, NCUA incorporated lessons learned from both 
its recent experience with corporate

[[Page 65237]]

investment portfolios and their associated losses, as well as comments 
received from the ANPR. NCUA determined that three major risk 
conditions were the primary contributors to the current losses in the 
corporate system: (1) Excessive investment sector concentrations; (2) 
excessive average-life mismatches between assets and liabilities; and 
(3) excessive concentrations in subordinated securities, including 
mezzanine securities.
    The proposed revisions to the investment and asset-liability 
provisions of the corporate rule restrict these risk conditions in the 
aggregate through the use of limits tied to a corporate credit union's 
capital. The intent of the proposed revisions is to provide a framework 
that allows for a level of risk-taking necessary to support the 
profitability of a corporate but which will be continuously and 
adequately supported by the corporate's capital. Sufficient capital 
prevents losses from adversely affecting corporate members and the 
entire credit union industry. As illustrated in more detail in 
subsection III.E. below, the proposed revisions, had they been in place 
prior to 2007, would have significantly reduced the current losses in 
the corporate system.
    NCUA believes that placing restrictions on investment authorities 
without concomitant limits on asset-liability management could still 
result in corporate credit unions assuming excessive risk positions. 
Accordingly, members of the public are encouraged to consider the 
combined effects of the revised investment and asset-liability 
management authorities and restrictions when submitting comments to 
NCUA.
    In addition to the amendments to part 704 investment authorities, 
NCUA also intends to revise corporate credit union reporting 
requirements on the 5310. The goal of the additional reporting 
requirements will be for readers to have a clear and comprehensive view 
of the financial condition of corporate credit unions. Likely additions 
and modifications to the current 5310 will include: (1) Credit ratings 
and sector concentrations by book and market value; (2) average lives 
and durations, spread and effective, of a corporate credit unions 
assets and liabilities; and (3) additional disclosure on pricing 
sources and pricing level.
Section 704.5 Investments
    The current Sec.  704.5 describes permissible corporate investments 
and the limits on those investments. Corporate investment authority is 
somewhat different than the investment authority for natural person 
federal credit unions.
    One hundred thirty eight commenters responded to the ANPR question 
on whether corporate investments should be limited to those permissible 
for natural person credit unions. Thirty-four commenters were in favor 
of the proposal, but 104 were opposed. The NCUA Board agrees with the 
commenters opposed to limiting corporate credit union investment 
authorities to those provided to natural person credit unions. 
Corporate credit unions and natural person credit unions have different 
balance sheet dynamics and business models and serve different types of 
members. As such, an alignment of investment authorities for the sake 
of parity may not be prudent. Ninety-four commenters discussed the 
question of prohibiting specific investment authorities. Sixty-three 
supported some prohibitions, while 31 did not. The NCUA Board concurs 
with the commenters that some investment types that are permissible 
under the current regulation are not appropriate for corporate credit 
unions.
    Accordingly, the proposal amends paragraph 704.5(h) to prohibit 
corporate credit unions from making investments in collateralized debt 
obligations and net interest margin securities.
    Collateralized debt obligations (CDOs) are defined in Sec.  704.2 
as a debt security collateralized by mortgage- and asset-backed 
securities or corporate obligations in the form of loans or debt. Net 
interest margin securities (NIMs) are defined in Sec.  704.2 as 
securities collateralized by residual interests in (1) collateralized 
mortgage obligations, (2) real estate mortgage investment conduits, or 
(3) asset-backed securities. Residual interests are further defined in 
Sec.  704.2 as the ownership interest in remainder cash flows from a 
CMO or ABS transaction after payments due bondholders and trust 
administrative expenses have been satisfied.
    Both CDOs and NIMs have concentrated risk attributes (i.e., they 
are highly leveraged by design) and complex cash flow rule structures 
that make them susceptible to excessive losses. These high-risk 
investments are also inherently less liquid and more price volatile 
than other investments backed by similar collateral, making them 
inappropriate investments for corporate credit unions.
    Although Re-REMICs are technically collaterized debt obligations, 
the proposal excludes senior tranches of Re-REMICs consisting of senior 
mortgage- and asset-backed securities from the CDO definition. 
Accordingly, these Re-REMICs, which do not have the excessive risk 
characteristics of other CDOs, are permissible investments provided 
they fall within the other investment and asset-liability restrictions 
of the rule.
Mortgage-Related Securities
    The proposal eliminates the phrase mortgage-related security (MRS) 
from part 704 because it is unnecessary and potentially confusing. The 
current part 704 permits corporates to invest in domestic asset backed 
securities, a term which includes mortgage-backed securities (MBS), 
that is, a type of security backed by first or second mortgages on real 
estate upon which is located a dwelling, mixed residential and 
commercial structure, a residential manufactured home, or a commercial 
structure. 12 CFR 704.5(c)(5), 704.2 (definition of ABS and MBS). MRS 
are a limited subset of MBS, and so references to MBS, and not MRS, are 
appropriate in the corporate rule.\52\ Of course, a corporate may not 
invest in any MBS, or any other ABS, unless the security satisfies the 
other requirements of part 704, including the minimum NRSRO rating 
requirements and the prohibitions on certain investments, such as 
strips, residuals, CDOs, and NIMs. 12 CFR 704.5(h).
---------------------------------------------------------------------------

    \52\ Natural person federal credit unions may invest in MRS, as 
permitted by 12 U.S.C. 1757(15), but are generally not permitted to 
invest in ABS or MBS that are not also MRS.
---------------------------------------------------------------------------

Expanded Investment Authorities
    The current part 704 provides that corporates that meet certain 
requirements may qualify for expanded investment authorities. Those 
expanded authorities, currently labeled as Base-plus, Part I, Part II, 
Part III, Part IV, and Part V, are described in Appendix B of part 704. 
Base-plus expanded authority permits slightly greater declines in NEV 
when subjected to interest rate shocks. Part I expanded authority 
allows for the purchase of certain investments with lower NRSRO 
ratings, provides for additional categories of permissible investments, 
and permits greater declines in NEV when subject to interest rate 
shocks. Part II expanded authority is similar to Part I, but provides 
even more leeway. Parts III, IV, and V relate to foreign investments, 
derivative transactions, and loan participation authority, 
respectively.
    The ANPR sought comments on the continued need for expanded 
authorities for corporate credit unions. Of the 164 commenters who 
discussed the topic of expanded authorities, 110 deemed expanded 
authorities appropriate and necessary for corporate credit unions, 
while 54 commenters

[[Page 65238]]

thought the expanded authorities should be reduced or eliminated. 
Seventy-five of these commenters discussed whether NCUA should change 
the eligibility requirements and/or require periodic requalification 
for expanded authorities, with 68 commenters favoring changes and seven 
opposed.
    Many commenters opposed to expanded authorities suggested that 
reliance on the authorities is a large contributor to the current 
problems facing corporate credit unions. Many of these commenters 
believe the authorities are no longer beneficial or necessary. Other 
commenters argued that the current economic problems confronting the 
corporate system were not, in fact, caused by reliance on expanded 
authorities.
    Supporters of expanded authorities noted that corporates must be 
allowed to earn a return on their investments above their cost of funds 
and the use of expanded authorities, when properly done, facilitates 
this level of return and benefits the entire credit union system. Some 
of these commenters suggested that NCUA should consider even broader 
investment authorities for corporate credit unions. These commenters 
argue that the current limits on corporate credit union investment 
authority require a corporate to overexpose itself to securities backed 
by mortgages, auto loans, and credit card receivables, which forces 
concentration into the same products that natural person credit unions 
are exposed to and increases risk throughout the credit union industry.
    Many of those supporting the continuation of expanded authorities 
stated that NCUA should adopt stronger capital requirements and more 
conservative concentration limits to help manage the associated risks. 
Additional suggestions included enhanced safety and soundness 
oversight, establishment of education and experience standards for 
corporate staff who oversee investments, and ongoing requalification of 
corporates that have been approved for expanded authority. Commenters 
strongly supported risk-based capital levels commensurate with any 
additional investment risk associated with the use of expanded 
authorities.
    The NCUA Board agrees that expanded authorities for corporate 
credit unions do offer benefits to the entire credit union system. The 
Board does, however, believe stronger controls in this area are 
appropriate. Accordingly, the proposed rule revises the qualification 
criteria, and elements of, Base-plus and Part I authority, and 
eliminates the current Part II authority.
    To qualify for Part I authority, the proposal adds a requirement 
that a corporate achieve and maintain a leverage ratio of at least six 
percent, meaning that its tier 1 capital, divided by its moving DANA, 
must equal or exceed six percent.
    Part I currently permits investments with lower NRSRO ratings, and, 
to control for credit risk, proposed paragraph (e) limits the aggregate 
investments purchased under the authority of Part I to the lower of 500 
percent of capital or 25 percent of assets. Paragraph (b) of Part I 
also currently permits qualifying corporates to engage in repurchase 
and securities lending agreements in an amount up to 300 percent of 
capital with any one counterparty, but the proposal removes this 
provision, thus limiting all such transactions to 200 percent of 
capital. 12 CFR 704.6(c)(2)(i).
    The current rule further also provides that, as part of the 
interest rate shock test, a Part I corporate's NEV may decline as much 
as 28 percent if the corporate has a minimum capital ratio of at least 
five percent and as much as 35 percent if the corporate has a minimum 
capital ratio of at least six percent. The proposal, after a 12 month 
phase-in, replaces the capital ratio with the new leverage ratio, and 
replaces 5 and 6 percent with 7 and 8 percent, respectively. The 
proposal makes similar changes to Part I authority with regard to the 
new Asset-Liability NEV test, discussed further in connection with the 
amendments to Sec.  704.8 below.
    The proposal also eliminates Part II authority (which permits 
investments down to the lowest investment grade) in its entirety. In 
the past, corporates did not use much of the Part II authority they 
had, and those corporates that did use the authority generally used it 
only to continue to hold downgraded investments and avoid divestiture. 
Prices of securities also tend to drop precipitously once an 
investment's credit rating falls to non-investment grade, so it is 
prudent to avoid the threat that a further single credit category 
downgrade might lead to additional impairment of asset values.
    The proposal also modifies the current Part IV authority on 
derivatives to ensure that corporates do not use derivatives to take on 
additional risk, but only use derivatives to mitigate interest rate and 
credit risk or to create structured products equivalent to what a 
corporate could purchase directly.
    Due to the elimination of Part II, the proposal renumbers the 
current Parts III, IV, and V authorities as Parts II, III, and IV, 
respectively. Also, a corporate that currently qualifies for a 
particular expanded authority may continue to use that authority 
without seeking requalification if the corporate meets the new 
requirements in the final rule. For Parts I and II, those new 
requirements include a six percent minimum total capital ratio, and, 
one year after publication of the final rule in the Federal Register, a 
six percent minimum leverage ratio.
Investments in Investment Companies
    Paragraph (f) currently permits a corporate credit union to invest 
in an investment company registered with the Securities and Exchange 
Commission under the Investment Company Act of 1940 where the 
prospectus restricts the investment portfolio to investments and 
investment transactions that are permissible for that corporate credit 
union to engage in directly. The proposal amends the paragraph to 
permit investment in collective investment funds maintained by a 
national bank or a mutual savings bank subject to the same requirement 
that the fund limit its investment and investment transactions to those 
that are permissible direct investments for corporates.
Miscellaneous Revisions to Investment Definitions
    The proposal contains several miscellaneous revisions, and 
additions, to the investment definitions.
    The proposal adds a definition of Nationally Recognized Statistical 
Rating Organization (NRSRO) that recognizes that NRSROs are 
designations made by the United States Securities and Exchange 
Commission. The proposal amends the definitions of derivatives 
contract, equity investment, and equity security so that they stand 
alone without external cross-references. The proposal eliminates 
references to regular way settlement, and the definition of that term, 
in favor of a simpler reference to investment settlement. The proposal 
amends the definition of residual interest to clarify that it 
represents the ownership interest in certain cash flows.
Section 704.6 Credit Risk Management
    The current Sec.  704.6 includes a single obligor concentration 
limit. The rule also requires that a corporate have a credit risk 
management policy that addresses certain concentrations of risk, but 
does not dictate sector concentrations. Additionally, the current rule 
requires that all corporate investments, other than in another 
corporate or a CUSO, have a credit rating from at least one NRSRO of no

[[Page 65239]]

lower than AA--for long term ratings and A-1 for short term ratings.
    There was strong support among the ANPR commenters for additional 
regulation of concentration limits. Seventy-nine of 89 commenters 
favored adoption of stronger concentration limits. Some commenters, 
however, expressed concern about the possibility that sector limits 
could actually force corporates to over-diversify into the more risky 
sectors and thus increase risk.
    The current rule generally limits investments in any single obligor 
to 50 percent of capital or $5 million, whichever is greater. 12 CFR 
704.6(c). The proposed rule reduces this 50 percent single obligor 
limit to 25 percent.
    The Board believes the current, general limit of 50 percent of 
capital is too high and presents excessive potential risk to corporate 
credit unions. The 25 percent limit encourages risk diversification, 
alleviates excessive concentration of risk exposure with any one 
obligor, and protects corporate credit unions' ongoing ability to serve 
as liquidity providers.
    The Board also believes that the current rule has not resulted in 
effective corporate policies on sector investment concentrations. 
Accordingly, the proposed rule adds a new paragraph 704.6(d) 
establishing explicit regulatory concentration limits by discreet 
investment sector.
    The proposed sector concentration limits are divided into ten asset 
classes: (1) Residential mortgage-backed securities; (2) commercial 
mortgage-backed securities; (3) Federal Family Education Loan Program 
(FFELP) student loan asset-backed securities; (4) private student loan 
asset-backed securities; (5) auto loan/lease asset-backed securities; 
(6) credit card asset-backed securities; (7) other asset-backed 
securities; (8) corporate debt obligations; (9) municipal securities; 
and (10) registered investment companies. The proposal also adds 
several related definitions to Sec.  704.2. Mortgage-backed security 
(MBS) means a security backed by first or second mortgages secured by 
real estate upon which is located a dwelling, mixed residential and 
commercial structure, residential manufactured home, or commercial 
structure. Commercial MBS means an MBS collateralized primarily by 
multi-family and commercial property loans. Residential MBS means an 
MBS collateralized primarily by residential mortgage loans. The 
proposal also modifies the existing definition of asset-backed security 
(ABS) to clarify that, generally, MBS are a type of ABS.
    The maximum amount of a corporate's investment in each of these ten 
sectors is limited to a certain multiple of capital: Either the lower 
of 500 percent of capital or 25 percent of assets, or the lower of 
1,000 percent of capital or 50 percent of assets. In formulating the 
proposed sector concentration limits, the Board considered various 
factors. For example, the Board wanted to ensure adequate 
diversification of investments across a range of asset types considered 
appropriate for the stable liquidity, NEV and capital levels expected 
to be maintained by corporates. The Board also wanted to ensure, 
however, that the sectors and sector limits did not force a corporate 
to ``overdiversify.'' In other words, the Board wanted to permit a 
corporate to concentrate in two or three less risky sectors, or to 
avoid investing in certain sectors altogether, if that was the 
corporate's desired course of action.
    Accordingly, the rule places a lower of 1,000 percent of capital 
limitation or 50 percent of assets on each of these three sectors: 
corporate debt obligations, municipal securities, FFELP student loan 
asset-backed securities, and registered investment companies, and 
places a more restrictive limit of the lower of 500 percent of capital 
or 25 percent of assets on the other sectors. The higher limits for 
corporate debt obligations and municipal securities allow a corporate 
the flexibility and option to invest away from securitized bonds, if 
they choose to do so. The higher limit for FFELP student loan asset-
backed securities is appropriate since the U.S. Department of Education 
reinsures a vast majority of the underlying student loan balances. The 
lower of 500 percent of capital limits or 25 percent of assets for the 
remaining sectors ensure that a corporate has prudent diversification 
when investing in non-government securities. Both USC and WesCorp, the 
two conserved corporates, would have had substantially less losses if 
non-government residential mortgage-backed securities had been limited 
to the lower of 500 percent of capital or 25 percent of assets, working 
in conjunction with the proposed subordinated security limitations 
prior to 2007. The hypothetical effect of this concentration limit, and 
other aspects of the proposed rule, on U.S. Central's and WesCorp's 
historical balance sheets is discussed in more detail in subsection 
III.E. below.
    Sector concentration limits ensure that the composition of the 
investment portfolio is consistently more diversified across various 
asset types. The asset classes and concentration limits are necessarily 
broad to allow for various portfolio mixtures and changing market 
factors. While the limits allow for significant portions of the 
investment portfolio to be placed in a specific asset type, they are 
restrictive enough to force any particular corporate to hold multiple 
asset types at all times. These sector concentration limits--when 
combined with the tighter single obligor, short weighted average life, 
and limited subordinated securities restrictions--substantially reduce 
the threat of excessive credit risk to corporate earnings and capital.
    The Board invites comment on whether there should be additional 
concentration sublimits in any of these sectors. For example, the Board 
is interested in whether it should impose further limits on corporate 
debt obligations by industry of the obligor.
    In addition to the 1,000 percent of capital or 50 percent of assets 
for registered investment companies (i.e., mutual funds), the corporate 
must identify the underlying assets in each fund. The corporate must 
then categorize each asset into one of the other nine sectors and 
include those assets when calculating compliance with those sector 
limits. If current data on the underlying assets is not readily 
available, the corporate can use the most recent available data. Also, 
a corporate may only invest in a registered investment if the fund's 
prospectus limits the fund to investments otherwise permissible for 
direct corporate investment.
    The proposal also includes a catchall sector in paragraph 
704.6(d)(2). A corporate credit union must limit its aggregate holdings 
in any investments that do not fall within one of the ten sectors above 
to the lower of 100 percent of capital or five percent of assets. To 
provide flexibility for the development and use by corporates of new 
investment types, the NCUA may approve a higher limit in appropriate 
cases.
    The proposal excludes certain assets entirely from both the 
proposed sector concentration limits and the single obligor 
concentration limit, including fixed assets, loans, investments in 
CUSOs, investments issued by the United States or its agencies or its 
government sponsored enterprises, and investments fully guaranteed or 
insured as to principal and interest by the United States or its 
agencies. Investments in other federally-insured credit unions, 
deposits in other depository institutions, and investment repurchase 
agreements are also excluded from the sector concentration limits but 
not the single obligor concentration limit.

[[Page 65240]]

    The proposal amends paragraph 704.6(d)(4), renumbered to 
704.6(f)(5), to clarify that if any investment group or asset class 
fails the single obligor, or sector, concentration limit, at the time 
of purchase or after the time of purchase, then all the investments of 
that obligor, or in that asset class, are subject to the investment 
rule's investment action plan requirements. 12 CFR 704.10. Although the 
new sector concentration limits and changes to the single obligor 
concentration limit are effective immediately, they will not require 
automatic divestiture of any existing asset held by a corporate credit 
union on the effective date of the rule. Accordingly, the Board does 
not believe that corporate credit unions need a transition period 
before the sector concentration limits become effective.
    In addition to the new obligor and sector concentration limits, the 
proposal adds a new paragraph 704.6(e) that further limits a 
corporate's investments in subordinated securities. Holders of 
subordinated debt are accorded a low priority in the event of 
insolvency and liquidation. Subordinated securities present greater 
credit risk, liquidity risk, price volatility, and ratings volatility 
than more senior securities. All these factors combine to make any 
significant concentration in subordinated securities inappropriate for 
a corporate's portfolio. Accordingly, the proposal limits a corporate's 
aggregate investment in subordinated securities to the lower of 400 
percent of capital or 20 percent of assets and the amount of 
subordinated securities in any single asset sector to the lower of 100 
percent of capital or 5 percent of assets.
    The proposal includes the following definition of subordinated 
security to Sec.  704.2:

    Subordinated security means a security that has a junior claim 
on the underlying collateral or assets to other securities in the 
same issuance. If a security is junior to only to money market fund 
eligible securities in the same issuance, the former security is not 
subordinated for purposes of this definition.

    This definition covers all support tranches, including senior 
mezzanine tranches. The definition also includes securities with 
performance ``triggers'' that could cause the security to assume a 
junior claim position.
    The proposed limitations on subordinated securities, working in 
conjunction with the proposed sector limitations on non-government 
residential MBS, would have--assuming both limits had been in effect 
prior to 2007--prevented a substantial amount of the current MBS losses 
experiences by U.S. Central and WesCorp. This is explained in greater 
detail in subsection III.E. below.
    The current paragraph 704.6(d) provides that all corporate 
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). Many ANPR commenters expressed 
support for decreased reliance on NRSRO ratings, with 89 of 122 
commenters in favor of tighter regulation in this area. Some of these 
commenters suggested requiring a consensus of three NRSROs, and some 
suggested requiring that ratings only be used for the purpose of 
excluding investments, not including them, in an investment portfolio.
    The Board believes that credit ratings constitute potentially 
useful information about credit risk, but expects corporates to avoid 
reliance on individual ratings or NRSROs as a primary criterion of 
purchase suitability. Several provisions of this proposal act to reduce 
the effect of NRSRO reliance, including the new sector concentration 
limits and the limits on subordinated securities, discussed above, and 
the restrictions on average-life mismatches discussed later in this 
section.
    The proposal also amends the current paragraph 704.5(d), and 
renumbers it as 704.5(f), to place two new, specific limits on the use 
of NRSROs. First, the proposal requires a corporate use the lowest 
available NRSRO rating for compliance purposes. NRSRO rating changes 
may lag changes in the financial condition of the entity or instrument 
being rated, particularly in the case of downgrades, and so the 
corporate should be required to respond to the first such NRSRO 
downgrade. Second, the proposal requires that a minimum of 90 percent 
of a corporate's investment holdings, by book value, must be rated by 
at least two NRSROs. This will ensure ratings diversification, will 
further reduce reliance on individual NRSROs, and will result in a more 
timely identification of credit problems with particular investments. 
The proposal also requires that a corporate monitor any new post-
purchase NRSRO ratings on investments it holds.
    Finally, the proposal requires that a corporate address, in its 
policies, the treatment of concentration risk related to servicers of 
receivables, collateral type, and tranche priority.
Sec.  704.8 Asset and Liability Management
    The current Sec.  704.8 contains several asset-liability management 
(ALM) provisions. The rule requires a corporate establish an asset and 
liability management committee, charge a market-based penalty on early 
withdrawals sufficient to cover replacement cost of a redeemed 
certificate, adopt a written ALM policy that includes modeling for 
interest rate risk (IRR) sensitivity and affect on net economic value 
(NEV), and assess on an annual basis whether the corporate should do 
additional NEV modeling. 12 CFR 704.8.
    The ANPR proposed a number of possible actions to further reduce 
the level of risk in corporate credit union balance sheets, including 
the implementation of cash flow duration requirements and additional, 
mandatory stress testing. Of the 104 comments directed to this issue, 
94 supported some action in this area. The NCUA Board generally agrees 
with these commenters and is proposing several new ALM requirements in 
an effort to better identify, measure, monitor and control future risk.
Maximum Redemption Value for Share Certificates
    While not specifically addressed in the ANPR, the Board recognizes 
the need for more stability within the liabilities on a corporate 
credit union's balance sheet. While the current rule requires market-
based early withdrawal penalties, the liquidity problems faced by 
corporates can be exacerbated by permitting members to redeem 
certificates a premium, that is, a price higher than book value. 
Accordingly, the proposal amends paragraph 704.8(b) to permit 
redemption at the lesser of book value plus accrued dividends or the 
value based on a market-based penalty sufficient to cover the estimated 
replacement cost of the certificate redeemed.
Limiting the Average-Life Mismatches Between Assets and Liabilities
    To the extent that a corporate maintains a mismatch between the 
average life of its assets and liabilities, it becomes exposed to 
several forms of market risk. A corporate credit union that buys 
floating rate securities may have minimal exposure to changes in the 
level of the Treasury yield curve but may have significant risk 
exposure to changes in credit spreads (a change in yields on non-
Treasury instruments relative to market Treasury yields). For example, 
when a depository invests its assets in a long-term, floating rate 
security rather than in a short-term security, and the depository is 
funded with overnight deposits, it is exposed to additional credit 
spread risk whenever the market spread relationship on that

[[Page 65241]]

instrument changes vis-[agrave]-vis Treasury securities. Short of 
default, the price decline of a long-term security is likely to be 
greater than that of a short-term security, given a deteriorating 
credit outlook for the issuer.
    The Board intends to restrict any mismatch between the principal 
cash flows of assets and liabilities so as to limit the degree of 
credit spread duration to which a corporate credit union is exposed. In 
lieu of capturing the repricing risk, the Board decided to limit the 
base case average-life mismatch between assets and liabilities as well 
as the change in base case mismatch for given changes in market 
spreads.
    Net economic value (NEV) has traditionally been used by the NCUA to 
measure interest rate risk (IRR) on a corporate credit union's balance 
sheet. NCUA adopted the IRR NEV measurement requirement in response to 
excessive interest rate risks taken in the early to mid 1990's by 
corporate credit unions. IRR NEV proved to be an effective tool of 
measuring interest rate risk during periods of relative asset price 
stability, prior to mid-2007, while providing a less effective 
measurement of credit spread risk when market values of assets suffered 
from the systemic shock that began in mid-2007. Accordingly, the Board 
is now proposing a new paragraph 704.8(e) to require average life (AL) 
mismatch NEV modeling in addition to the existing IRR NEV modeling. The 
new AL NEV modeling will help ensure appropriate matching of asset and 
liability cash-flow durations.
    Proposed paragraph 704.8(e) requires an AL NEV stress test to 
measure the economic impact on capital resulting from a credit spread 
widening of 300 bp. These spread increases would be applied to both 
assets and liabilities. The corporate will examine the effect on its 
absolute NEV and the volatility of its NEV (how much NEV changes for a 
given stress) in a manner similar to the current Sec.  704.8(d) IRR NEV 
modeling. Specifically, a corporate must limit its risk so that, when 
the spread widening shock is applied, its NEV ratio does not decline 
below 2 percent and the NEV itself does not decline more than 15 
percent. The proposal specifies that all investments must be tested, 
excluding derivatives and equity investments, and that all borrowings 
and shares must be tested, but not contributed capital.
    The proposed rule will also add a new paragraph 704.8(f) with a 
separate spread widening test that assumes a 50 percent slowdown in 
prepayment speeds. This additional test will force a corporate to 
structure its assets and liabilities so that, when the spread widening 
shock is applied, its NEV ratio does not decline below 1 percent and 
the NEV itself does not decline more than 25 percent. This additional 
test will help determine if a potential extension of a corporate's 
average life mismatch is within an acceptable limit.
    For example, consider a corporate with a five percent base case 
NEV. Applying the Sec.  704.8(e) base AL NEV test, the proposed 
regulatory limits--that is, that the NEV ratio not decline below two 
percent and the NEV itself not decline more than 15 percent--will 
permit this corporate to operate with an approximate average-life 
mismatch of up to 0.25 years. Applying the Sec.  704.8(f) AL NEV test 
with its 50 percent slowdown in prepayment speeds, the proposed 
regulatory limits--that is, that the NEV ratio not decline below 1 
percent and the NEV itself not decline more than 25 percent--will 
permit this corporate an additional mismatch extension of up to 0.2 
years. These proposed AL NEV tests, of course, are designed to permit 
greater average-life mismatches as a corporate's base case NEV level 
moves higher, just as with the current IRR NEV modeling.
    The proposed rule employs a conservative approach when NEV testing 
for dealing with assets and liabilities with embedded options. The rule 
imposes conservative treatment of non-mandatory issuer options, i.e., 
issuer call options, by assuming they are not exercised. Additionally, 
the proposed rule balances this conservative approach against the lack 
of a requirement for a corporate to shorten liabilities based on 
anticipated or potential early redemption of share certificates. The 
NCUA, however, will be monitoring the issuance of liabilities with long 
maturities and short calls to determine if they are issued to 
manipulate NEV measures and may, among other things, mandate a greater 
capital requirement. See the proposed Sec.  704.3(e).
    New paragraphs (e)(2) and (f)(2) also require corporates to measure 
the effect that failed triggers, e.g., delinquency triggers and 
cumulative loss triggers, have on average-life NEVs. Many non-
government mortgage-backed securities, and other securitized 
securities, redirect cash-flows if delinquencies or losses increase to 
a predetermined level because of a failed trigger. The effects of the 
redirected cash-flows should be measured and understood by corporate 
credit unions.
    Below are two examples that illustrate both the current IRR NEV 
calculation and the proposed, new average life (AL) NEV calculation 
using a simplified corporate balance sheet. These examples are intended 
to provide the reader with a better understanding the current and 
proposed rules.

Sample Corporate Credit Union ``A'' Balance Sheet \53\
---------------------------------------------------------------------------

    \53\ This is a simplified balance sheet and simplified examples. 
Each corporate credit union will likely, depending on its particular 
balance sheet, need to employ more granular information and 
sophisticated modeling.

----------------------------------------------------------------------------------------------------------------
                                                     Weighted
                                                   average life      Modified        Par value     Market value
                                                      (years)        duration
----------------------------------------------------------------------------------------------------------------
Assets:
    Private Label MBS (2).......................               2           0.083      $1,000,000      $1,000,000
    ABS (3).....................................             1.5             0.8       2,000,000       2,000,000
    Corporate Bonds & Member Loans (3)..........             1.5            0.90       3,000,000       3,000,000
    Cash and Cash Equivalent Investments (1)....             0.1             0.1       3,850,000       3,850,000
    Capital Instruments (PCC or NCA) (2)........               3           0.083          50,000          50,000
    Property....................................             N/A             N/A          50,000          50,000
    CUSO Equity.................................             N/A             N/A          50,000          50,000
                                                 ---------------------------------------------------------------

[[Page 65242]]

 
        Total (Capital Notes and Property not               1.01            0.48      10,000,000      10,000,000
         included in WAL and duration)..........
                                                 ===============================================================
Liabilities:
    Overnight and Short-Term Deposits (1).......             0.1             0.1       7,500,000       7,500,000
    Long-Term Certificates (1)..................             1.0            0.95       1,500,000       1,500,000
    Borrowings (2)..............................             2.0            0.24         450,000         450,000
                                                 ---------------------------------------------------------------
        Total...................................            0.34            0.24       9,500,000       9,500,000
                                                 ===============================================================
Base Case NEV...................................  ..............  ..............  ..............         500,000
Capital Instruments (PCC or NCA) (2)............               3           0.083          50,000          50,000
Retained Earnings...............................             N/A             N/A         450,000         450,000
----------------------------------------------------------------------------------------------------------------
1--Fixed Rate, 2--Floating Rate, and 3--both Fixed and Floating Rate.

    The sample balance sheet is for a corporate credit union with NEV 
ratio (base case NEV/Fair market value of assets) of 5 percent. The 
current IRR NEV requires the corporate credit union to evaluate the 
impact of an instantaneous, permanent, and parallel shock of the yield 
curve of plus and minus 100, 200, and 300 bp on its IRR NEV ratio and 
IRR NEV volatility. Corporate credit unions must consider the effects 
on prepayment speeds when performing the rate shocks. Results of the 
rate shocks must not result in NEV ratio declining below 2 percent or a 
decline of NEV (NEV volatility) of more than 15 percent (expanded 
authorities allow for greater NEV volatility). A corporate credit union 
must also include the effects of interest rate derivative exposure when 
performing the rate shocks.

Corporate Credit Union A: 300 bp Increase in Interest Rates

----------------------------------------------------------------------------------------------------------------
                                       Weighted
                                     average life      Modified        Par value     Market value
                                        (years)        duration
--------------------------------------------------------------------------------------------------
Assets:
    Private Label MBS (2).........            3.00           0.083      $1,000,000        $997,510
    ABS (3).......................            1.70           0.900       2,000,000       1,946,000
    Corporate Bonds & Member Loans            1.50           0.900       3,000,000       2,919,000
     (3)..........................
    Cash and Cash Equivalent                  0.10           0.100       3,850,000       3,838,450
     Investments (1)..............
    Capital Instruments (PCC or               3.00           0.083          50,000          49,876
     NCA) (2).....................
    Property......................             N/A             N/A          50,000          50,000
    CUSO Equity...................             N/A             N/A          50,000          50,000
                                   -----------------------------------------------------------------------------
        Total (Capital Notes and              1.16           0.500      10,000,000       9,850,836
         Property not included in
         WAL and duration)........
                                   =============================================================================
Liabilities:
    Overnight and Short-Term                  0.10            0.10       7,500,000       7,477,500
     Deposits (1).................
    Long-Term Certificates (1)....            1.00            0.95       1,500,000       1,457,250
    Borrowings (2)................            2.00            0.24         500,000         496,400
                                   -----------------------------------------------------------------------------
        Total.....................            0.34            0.24       9,500,000       9,431,150
                                   =============================================================================
+300 Basis Point NEV..............  ..............  ..............  ..............         419,686
Capital Instruments (PCC or NCA)              3.00           0.083          50,000          50,000
 (2)..............................
Retained Earnings.................             N/A             N/A         450,000         450,000
----------------------------------------------------------------------------------------------------------------
1--Fixed Rate, 2--Floating Rate, and 3--both Fixed and Floating Rate.

    In the example above, Corporate A is shocked with a 300 basis point 
(bp) increase in interest rates. Its IRR NEV ratio falls to 4.26 
percent ($419, 686/$9,850,836) and the plus 300 basis point IRR NEV 
volatility is 14.80 percent ([5.00% - 4.26%]/5.00%). Corporate A would 
have been within regulatory compliance since its IRR NEV ratio still 
exceeds 2 percent and its NEV volatility was lower than 15 percent.
    The plus 300 bp shock above assumed that prepayment speeds for 
amortizing securities would slow in an up rate scenario. The slowdown 
in prepayment speeds would account for the extended average lives and 
durations in the MBS and ABS holdings.
    The proposed AL NEV measure uses the framework of the IRR NEV, but 
modifies it to measure and limit the mismatch of average lives of the 
assets and liabilities related to a corporate's shares, certificates, 
and borrowings. A 300 basis point credit spread widening, as opposed to 
changes in interest rates, is used to shock the portfolio and determine 
if the average life mismatch between assets and liabilities is 
excessive for the corporate credit union's base net economic value. The 
proposal requires that the spread widening not result in NEV ratio 
declining below 2 percent or the NEV volatility of more than 15 percent

[[Page 65243]]

(expanded authorities allow for greater IRR NEV volatility). The 
proposal also requires a secondary AL NEV test with a 50 percent 
slowdown in prepayment speeds to determine if a corporate has excessive 
average life extension risk.

Corporate Credit Union A: 300 bp Spread Widening

----------------------------------------------------------------------------------------------------------------
                                                     Weighted
                                                   average life      Modified        Par value     Market value
                                                      (years)        duration
----------------------------------------------------------------------------------------------------------------
Assets:
    Private Label MBS (2).......................            2.00           0.083      $1,000,000        $943,600
    ABS (3).....................................            1.50            0.80       2,000,000       1,915,200
    Corporate Bonds & Member Loans (3)..........            1.50            0.90       3,000,000       2,872,700
    Cash and Cash Equivalent Investments (1)....            0.10            0.10       3,850,000       3,838,450
    Capital Instruments (PCC or NCA) (2)........             N/A             N/A          50,000          50,000
    Property....................................             N/A             N/A          50,000          50,000
    CUSO Equity.................................             N/A             N/A          50,000          50,000
                                                 ---------------------------------------------------------------
        Total (Capital Notes and Property not               1.01            0.48      10,000,000       9,719,950
         included in WAL and duration)..........
                                                 ===============================================================
Liabilities:
    Overnight and Short-Term Deposits (1).......            0.10            0.10       7,500,000       7,477,500
    Long-Term Certificates (1)..................            1.00            0.95       1,500,000       1,457,250
    Borrowings (2)..............................            2.00            0.24         450,000         425,000
                                                 ---------------------------------------------------------------
        Total...................................            0.34            0.24       9,500,000       9,359,750
                                                 ===============================================================
+300 Basis Point NEV............................  ..............  ..............  ..............         360,200
Capital Instruments (PCC or NCA) (2)............            3.00           0.083          50,000          50,000
Retained Earnings...............................             N/A             N/A         450,000         450,000
----------------------------------------------------------------------------------------------------------------
1--Fixed rate, 2--Floating Rate, and 3--both Fixed and Floating Rate.

    In the example above, we see that, after a 300 bp spread widening, 
Corporate A's AL NEV ratio is 3.71 percent ($360,200/$9,719,950) and 
its AL NEV volatility is 25.80 percent ([5.00% - 3.71%]/5.00%). So 
Corporate A would have been within regulatory compliance with regard to 
its AL NEV ratio, but the corporate would have failed the AL NEV 
volatility portion of the proposed requirement.
    This secondary AL NEV measurement that assumes a 50 percent 
slowdown in prepayment speeds helps model the effect of extension risk 
on the average life mismatches between assets and liabilities. Slower 
prepayment speeds will extend securities that amortize based on the 
payments of the underlying collateral. Securities with more sensitivity 
to changes in prepayment speeds will suffer greater declines in value 
when applying the spread widening and prepayment speed slowdown, all 
else being equal. The proposal permits additional volatility in this 
particular AL NEV test, from 15 percent to 25 percent (expanded 
authorities allow for greater AL NEV volatility in the 50 percent 
slowdown in prepayment speed measure), and also allows for a lower 
minimum NEV ratio requirement of 1 percent.
    These new AL NEV measurements, unlike the IRR NEV measurement, do 
not include the effect of interest rate derivatives and capital note 
assets. Interest rate derivatives are excluded because they do not have 
principal cash flows. Capital instruments are also excluded from AL NEV 
calculations unless the associated cash inflows or outflows have a 
fixed date, i.e., they are without rolling or perpetual maturities.
    The Board specifically invites comment on the proposed AL NEV 
limits as well as the assumptions used by NCUA in creating the 
hypothetical corporate portfolio used to model the effect of those 
limits.
Net Interest Income Modeling
    The ANPR asked about additional testing by corporate credit unions 
to ensure adequate monitoring of the impact of changing market 
conditions on the overall balance sheet. For example, the ANPR asked 
about net interest income (NII), that is, the difference between a 
corporate's revenues on its assets and the cost of servicing its 
liabilities, and how NII is affected by changing interest rates. A 
large majority of commenters who addressed this issue supported 
incorporating NII modeling into the corporate rule.
    The Board believes that NII modeling adds an additional, needed 
measurement of projected future earnings in multiple interest rate 
scenarios. Proper and realistic NII modeling will assist corporate 
management with its budgeting process and will provide an interest rate 
risk measurement tool if base case NEV declines sharply due to external 
market shocks. Accordingly, the proposal adds a new paragraph 704.8(g) 
requiring NII modeling. Corporates must model NII at least once each 
quarter, using multiple interest rate environments extended over a 
period of at least two years.
Two-Year Average Life
    In addition to the proposed spread widening and NII modeling, the 
Board is proposing a new paragraph 704.8(h) that will limit the 
weighted average life (WAL) of a corporate's assets to two years. A 
corporate credit union must test its assets at least once a month for 
compliance with this WAL limitation and report noncompliance to the 
NCUA immediately. In calculating its average life, the proposal 
requires that a corporate assume that issuer options will not be 
exercised.
    The Board believes that an excessive asset average life is 
inconsistent with a corporate's primary mission and subjects the 
corporate to unnecessary risks. The Board proposes to use a two year 
limit because that should give corporate adequate flexibility to manage 
their business while maintaining a risk profile consistent with the 
corporate mission.
Calculation of Duration at the Individual Asset/Liability Level
    The proposal adds a new paragraph 704.8(i) that requires a 
corporate calculate the effective duration and

[[Page 65244]]

spread duration for each of its assets and liabilities where the values 
of these are affected by changes in interest rates or credit spreads. 
While the NEV tests described above implicitly require such calculation 
at the individual asset or liability level, the Board believes it 
important to state this requirement explicitly. This information about 
individual assets and liabilities will enable the credit union's 
auditors, board of directors, and NCUA examiners to determine if the 
corporate is performing these granular calculations correctly, 
particularly for those assets and liabilities that have embedded 
optionality resulting in more complex calculations.
Violations of NEV and NII Tests or Limits on Average Life of Assets
    Proposed paragraph 704.8(j) has specific requirements pertaining to 
violations of the NEV and NII testing and the requirement to maintain 
an average asset life of two years or less.
    If a corporate's decline in NEV, base case NEV ratio, or any other 
NEV ratio resulting from the IRR and AL NEV tests in 704.6 violates the 
associated regulatory limits, and the corporate cannot adjust its 
balance sheet so as to satisfy those limits within ten calendar days 
after detecting the violation, then operating management of the 
corporate credit union must immediately report this information to its 
board of directors, supervisory committee, and the NCUA.
    If the corporate's regulatory violation persists for 30 or more 
calendar days, the corporate must submit an action plan to NCUA and is 
also subject to PCA reclassification. Immediately following the 30th 
day the corporate must submit a detailed, written action plan to the 
NCUA that sets forth the time needed and means by which the corporate 
intends to correct the violation and, if the NCUA determines that the 
plan is unacceptable, the corporate must immediately restructure its 
balance sheet to bring the exposure back within compliance or adhere to 
an alternative course of action determined by the NCUA. If the 
corporate is currently categorized as adequately capitalized or well 
capitalized for purposes of Sec.  704.4 (prompt corrective action), the 
corporate will be immediately recategorized as undercapitalized until 
the violation is corrected. If the corporate is already in some 
undercapitalized category, the corporate will be reclassified as one 
category lower. The corporate must comply with all the PCA provisions 
relating to undercapitalization until such time as the corporate 
demonstrates to the satisfaction of the NCUA that the regulatory 
violation is corrected.
    The proposal treats violation of the two-year average asset life 
requirement, and the NII testing requirement, in a similar fashion. 
Violations that persist for ten or more days must be reported as 
described above, and violations that persist for 30 or more days 
require the submission of an action plan to NCUA and a potential 
downgrade in PCA capital category.
Limitations on Investments From Single Member or Other Entity
    The Board is concerned about risks to both individual corporates 
and individual natural person credit unions that arise from placing 
undue reliance on a single entity. For example, if a corporate relies 
too heavily on investments from one member, that member might decide to 
remove its funds which could cause severe liquidity problems at the 
corporate. Similarly, if a natural person credit union (NPCU) has too 
much money invested in a particular corporate, the NPCU is exposed to 
credit risk and, potentially, liquidity risk from that lack of 
diversification.
    Accordingly, the proposal adds a new paragraph (k) to Sec.  704.8 
that prohibits the corporate from accepting from a member or other 
entity any investment, including shares, loans, PCC, or NCAs, if, 
following that investment, the aggregate of all investments from that 
entity in the corporate would exceed ten percent of the corporate's 
moving daily average net assets. The purpose of this provision is to 
prevent a corporate from being too exposed to any particular member or 
other entity in the event that the entity should suddenly decide to 
reduce its investments in the corporate.
    The concentration limit in proposed paragraph (j) will not become 
effective for 30 months so as to allow affected corporates a deliberate 
and orderly transition. At the conclusion of this 30-month phase-in, an 
affected entity may not make new investments or new loans, or renew 
existing loans, or reinvest shares or dividends in the corporate, if 
the aggregate of all the entity's investments in the corporate 
immediately following such a transaction would exceed the 10 percent 
limit.
Sec.  704.9 Liquidity Management
    The corporate system provides essential payment systems support to 
many NPCUs, but the current corporate rule says nothing about 
maintaining adequate liquidity to support the corporate's payment 
systems obligations. The proposal amends paragraph 704.9(a) to require 
that corporates demonstrate accessibility to sources of internal and 
external liquidity and that they keep a sufficient amount of cash and 
cash equivalents on hand to support their payment systems obligations.
    The current rule places the following aggregate limitation on 
corporate borrowing:

    A corporate credit union may borrow up to 10 times capital or 50 
percent of shares (excluding shares created by the use of member 
reverse repurchase agreements) and capital, whichever is greater. 
CLF borrowings and borrowed funds created by the use of member 
reverse repurchase agreements are excluded from this limit * * *.

    12 CFR 704.9(b). The proposal modifies this aggregate limit to 
restrict corporate borrowing to the lower of ten times capital or 50 
percent of capital and shares.
    The Board also believes that corporates should be limited in their 
ability borrow on a secured basis for other than liquidity purposes. As 
demonstrated by recent events, secured borrowing can create additional 
risks for the corporate and the NCUSIF. Secured lenders require 
collateral to be valued at market and they impose an additional haircut 
(margin) to ensure the borrowing is fully and continuously 
collateralized. Market shocks can create short-term market values that 
are below long-term intrinsic values and which can magnify potential 
losses if collateral were to be seized and sold as permitted by the 
lending agreements.
    Accordingly, the proposal permits secured borrowing for 
nonliquidity purposes only if the corporate is well capitalized, that 
is, its core capital exceeds five percent of its moving DANA. The 
proposal further restricts such borrowing to an amount equal to the 
difference between the corporate's core capital and five percent of its 
moving DANA.
    Beyond the aggregate borrowing limit, the proposal does not 
restrict the amount of secured borrowing a corporate may do for 
liquidity purposes. The proposal does, however, restrict the maturity 
of any secured borrowing for liquidity purposes to a maximum of 30 
days. This maturity limit will not preclude a corporate from renewing 
liquidity-related borrowings on a rolling basis.
    These limits on aggregate borrowing and secured borrowing should 
help mitigate the consequences of future adverse market events for the 
corporates and the NCUSIF.

III.D. Phase-in of Part 704 Capital and PCA Requirements

    The Board understands that the proposed amendments to Part 704

[[Page 65245]]

capital regulations are complex and that many corporates would not meet 
the targets upon issuance of the final rule. Instead of an immediate 
implementation, the Board proposes to phase-in the new capital and PCA 
requirements over a ten-year period of time. Most of the new provisions 
will be effective after one year, the minimum leverage ratio 
requirement will become effective after three years, and the provisions 
related to minimum retained earnings will become effective in the sixth 
through tenth years. This subsection III.D. discusses the phase-in and 
demonstrates how a hypothetical corporate might, while complying with 
the proposed investment and asset liability limitations described 
above, generate sufficient earnings to meet the capital requirements by 
the end of the phase-in periods.
    None of the new provisions related to capital and PCA will be 
effective for a period of one year following the publication of the 
final rule in the Federal Register. During this time period, corporates 
must continue to comply with the existing Sec.  704.3 capital ratio 
requirement and its associated capital definitions, within the guidance 
provided by NCUA. Also, while the Board will delay the effective date 
of the proposed capital and PCA requirements, the Board expects each 
corporate to begin calculating and reporting its new capital ratios 
upon publication of the final rule.
    Beginning with the first anniversary of the final rule publication 
corporates will be subject to, and must be in compliance with, all of 
the new risk-based capital provisions and PCA provisions and their 
associated definitions. Between the first and third anniversaries, the 
corporate will continue to comply with the existing minimum total 
capital ratio in addition to the new risk-based capital ratios. The 
proposal accomplishes this transition to the new leverage ratio by 
employing an interim definition of leverage ratio in Sec.  704.2, from 
the first to the third anniversaries, that tracks the current rule's 
minimum total capital ratio. Corporates will have several methods, or 
combination of methods, to achieve compliance with these new capital 
requirements prior to the third anniversary, including decreasing 
aggregate assets or portfolio risk or increasing NCAs, PCC, or retained 
earnings.
    Beginning with the third anniversary, corporates will be subject 
to, and must be in compliance with, the new leverage ratio; however, 
corporates will not yet need to comply with the additional requirement 
that retained earnings constitute a specified minimum part of core 
capital for purposes of the capital ratios.\54\ Corporates will have 
several methods, or combination of methods, to satisfy this new minimum 
leverage ratio prior to the seventh anniversary, including decreasing 
assets or increasing PCC or retained earnings.
---------------------------------------------------------------------------

    \54\ Beginning on the third anniversary, corporates that are not 
making adequate progress in accumulating retained earnings will have 
to submit a retained earnings accumulation plan, as described in 
proposed Sec.  704.3(a)(3).
---------------------------------------------------------------------------

    Beginning with the sixth anniversary, corporates will be subject 
to, and must be in compliance with, the retained earnings part of the 
various capital ratios. Most importantly, the corporates must have at 
least 100bp of retained earnings to satisfy the adequately-capitalized 
four percent minimum leverage ratio, and 150bp of retained earnings to 
achieve a five percent leverage ratio and be considered well 
capitalized. Corporates can only achieve this retained earnings 
requirement by decreasing assets or increasing retained earnings.
    In proposing this phase-in plan the Board analyzed (1) the current 
capital position of the various corporates, (2) the earning ability of 
the corporates, and (3) the impact and uncertainty associated with the 
existing, troubled MBS (discussed further below). The Board believes 
this phase-in period will encourage corporates to improve their capital 
base without encouraging overly aggressive strategies to accumulate 
retained earnings or solicit high cost capital. The Board invites 
comment on the reasonableness of the proposed phase-in plan and the 
following analysis.
Results--Current Capital Positions
    NCUA analyzed each corporate's current capital under the proposed 
capital standards based upon 5310 data from August 2009. NCUA adjusted 
retail corporate credit union capital levels based on known losses at 
U.S. Central. After this adjustment, 18 retail corporates have zero 
retained earnings. Nine of the 18 face a complete elimination of PCC 
accounts and a partial elimination of existing NCA. Additional Other 
Than Temporary Impairment (OTTI) losses at U.S. Central may increase 
the number of corporates that fall into this category.
    In certain cases, the data in the current 5310 reports do not 
contain the precision necessary to make an exact calculation. For 
example, the private label mortgage securities lack details to 
determine the precise risk-weight. NCUA used 50 percent, but a portion 
of these instruments will carry higher risk-weights in certain 
corporates. NCUA also made some assumptions with respect to the risk-
weights of derivative portfolios. An accurate risk-weight in these 
cases requires the assignment of a risk-weight at the transaction 
level.
    Under the proposed capital standards, only two of the 28 corporates 
would be considered well capitalized or adequately capitalized today, 
while 16 of 28 corporates would be considered critically 
undercapitalized. Only two corporates would currently meet the minimum 
four percent leverage ratio requirement.
    The 18 retail corporates that have zero retained earnings will face 
a significant challenge in meeting the four percent leverage ratio 
requirement. At the end of year six they will need to have retained 
earnings equal to 1.0 percent of DANA. This will require earnings in 
the range of 0.15-0.2 percent of DANA, depending on asset growth. This 
will require adjustments to business plans and will limit the ability 
of these corporates to grow.
    NCUA created a number of scenarios for recapitalization of the 
corporate system over this period. In all recapitalization scenarios, 
retained earnings growth is critical, particularly given the new 
investment and ALM limitations contained in the proposal. The ability 
to grow retained earnings is so critical that, before proceeding with 
the capital phase-in discussion, it is important to first discuss the 
ability of a corporate to grow its retained earnings under the 
proposal.
Ability to Grow Retained Earnings Under the Proposed Investment and ALM 
Limitations
    As discussed above, to be adequately capitalized under the new 
capital rules will require a minimum leverage ratio of four percent 
(400 bp), consisting of a combination of PCC and retained earnings and 
measured in relation to 12-month DANA. One hundred of these 400 bp 
must, by the end of year six, consist of retained earnings. While NCUA 
believes it is essential to build retained earnings as a component of 
capital, it also considered whether this prescribed target was 
reasonable and attainable. Accordingly, NCUA staff analyzed the ability 
of a hypothetical corporate to obtain 100 bp of retained earnings 
within six years (measured in relation to 12-month DANA).
    Assuming no retained earnings to start, and no asset growth, the 
corporate would have to earn about 17 bp of net income each year to 
reach this target. There are many variables that can impact actual 
earning, and there will be variability in specific corporate credit

[[Page 65246]]

unions' abilities to meet this target. Nonetheless, NCUA determined 
that, within reasonable assumptions for future earnings and expenses, a 
corporate credit union could generate the minimum annual earnings 
necessary to reach the retained earnings target.
    The table below presents a sample corporate portfolio with one 
possible investment mix. This particular portfolio of investments 
adheres to the proposed limits for investment concentrations and 
weighted average asset life (WAL).\55\
---------------------------------------------------------------------------

    \55\ The investment concentration limits appear in proposed 
Sec.  704.6(d). The two-year limit on weighted average asset life 
appears in proposed Sec.  704.8(h). These limits are discussed in 
greater detail earlier in this preamble.

                                                   Investments
----------------------------------------------------------------------------------------------------------------
                                                                                  Total weighted
                             Sector                                  Portfolio     average life     LIBOR/EDSF
                                                                    percentage        (years)         spread
----------------------------------------------------------------------------------------------------------------
FFELP Student Loan ABS..........................................              20           1.000              25
Private Student Loan ABS........................................              10           0.500             200
Auto ABS........................................................              20           0.600              25
Credit Card ABS.................................................              10           1.000              30
Other ABS.......................................................              10           0.300              10
Overnight Investments...........................................              30           0.003               0
                                                                 -----------------------------------------------
    Total.......................................................             100           0.501              34
----------------------------------------------------------------------------------------------------------------

    In structuring this table, NCUA estimated interest income from 
current investment market data. Additionally:
     Spreads were obtained from Wall Street research, dealer 
offerings and Wall Street contacts for mid-October 2009.
     All ABS spreads are for AAA senior bonds.
     Overnight Investments include excess Fed Reserves, Repo 
and Overnight Corporate Deposits.
    In preparing this analysis, NCUA also assumed the following 
corporate liabilities. Funding costs were approximated using a sample 
of current corporate credit union offerings.

                                                   Liabilities
----------------------------------------------------------------------------------------------------------------
                                                                                  Total weighted
                              Type                                     Total       average life     LIBOR/EDSF
                                                                    percentage        (years)         spread
----------------------------------------------------------------------------------------------------------------
Overnight Shares................................................              30           0.003               0
Term Certificates...............................................              70           0.500               0
ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½
    Total.......................................................             100           0.351               0
----------------------------------------------------------------------------------------------------------------

    This liability mix, when combined with the assets above and 
assuming the corporate has 4 percent NEV and total capital, also 
satisfies the proposed asset liability cash flow mismatch sensitivity 
test.\56\
---------------------------------------------------------------------------

    \56\ The cash flow mismatch limit appears in proposed Sec.  
704.8(e). In the example, the mismatch of about 0.16 years (0.501 
minus 0.351) equates to about two months. At four percent NEV, this 
two-month mismatch satisfies the requirement that the NEV ratio not 
decline below two percent, and the percentage decline in NEV not 
exceed fifteen percent, when spread widens 300 bp as specified in 
paragraphs 704.8(e)(1)(ii) and (iii). Again, this particular limit 
is discussed in more detail earlier in this preamble.
---------------------------------------------------------------------------

    As demonstrated in the two tables above, this asset-liability mix 
is capable of generating a net interest income of 34 bp a year under 
the limitations of the proposed regulation. Using June 2009 corporate 
system averages for pro forma income and expenses would produce the 
following net income from operations: \57\
---------------------------------------------------------------------------

    \57\ NCUA derived the non-interest income and expenses from 
recent aggregate corporate system 5310 data.

        Pro Forma Income Using January-June 2009 System Averages
------------------------------------------------------------------------
                                                              Percent
------------------------------------------------------------------------
Net Interest Income.....................................            0.34
Other Income............................................            0.17
                                                         ---------------
    Total Operating Income..............................            0.51
    Total Operating Expenses............................            0.30
    Net Income From Operations..........................            0.21
------------------------------------------------------------------------

    The pro forma income projections above indicate that a corporate 
can, in fact, grow retained earnings at or above 20 bp a year and so 
achieve income from operations sufficient to build 100 bp of retained 
earnings in five to six years (assuming no asset growth).
    In addition to the considerations discussed above, there are other 
factors that can positively affect a corporate's ability to build 
retained earnings. For example, a modest assumption of interest rate 
risk usually generates a stable and positive return. A slight mismatch 
between the modified duration of assets and liabilities can generate a 
source of positive spread between sources and uses of funds without 
creating an excessive exposure of earnings or capital at risk or 
assuming too much interest rate risk. Investments purchased during 
periods of upward sloping yield curves (i.e., when longer maturities 
have a higher yield than shorter maturities) usually generate 
additional earnings consistent with a modest level of interest rate 
risk. To the extent that the yield curve maintains its slope over the 
life of the investment, net interest income improves as investment 
average lives shorten and the book yield

[[Page 65247]]

is higher versus current market yields for comparable securities with 
the same remaining average life. This ``roll down'' effect can also 
occur due to lower benchmark yields and/or tighter credit spreads. 
Corporates also have some pricing power in service pricing or dividends 
paid that can positively affect the building of retained earnings.
    Conversely, there are factors that may negatively affect a 
corporate's ability to build retained earnings. Future net interest 
investment income may be diminished by tighter credit spreads if a 
corporate doesn't have the ability to lower the dividend rates it pays, 
and an inverted yield curve may also have negative implication on a 
corporate's ability to build retained earnings.
    Finally, NCUA realizes that some corporates may have difficulty at 
first in restructuring their existing portfolios to meet the 
requirements of the new regulation, particularly with regard to the new 
cash flow mismatch and WAL limitations. NCUA has the authority, in 
appropriate cases and within the context of a carefully crafted 
investment action plan, to permit individual corporates to operate 
outside these limitations while illiquid legacy investments amortize. 
Of course, to the extent that legacy investments have credit issues, 
and the corporate is forced to recognize OTTI, this OTTI will have a 
negative effect on the corporate's retained earnings growth.

Results: Projected Capital Positions

    Having established that it is possible for a corporate to fashion a 
balance sheet that facilitates earnings growth under the proposed 
investment and ALM limitations, NCUA used a mix of earnings, growth, 
and capital contribution assumptions to build scenarios further 
analyzing the ability of corporates to reach adequate capitalization by 
year seven.
    The different mix types lead NCUA to four scenarios, entitled A 
through D (for analysis cataloging only). In all scenarios, NCUA 
assumed that PCC and NCA would be used only to the extent that they 
qualify for inclusion in the proposed capital measures. In determining 
the pool of available PCC and NCA investments available, NCUA used an 
average asset size for natural person credit unions and applied that to 
the number of current members in each corporate. NCUA also assumed an 
equal amount of PCC and NCA accounts in all of the scenarios.
    The scenario assumptions and results are summarized below.
    1. ``A'' Case Assumptions--NCUA assumed that corporates would have 
zero growth beyond recapitalization deposits and annual earnings equal 
to 0.2 percent of DANA (20 bp). NCUA assumed that natural person credit 
unions would voluntarily recapitalize the corporate system at 
historical rates of 0.4 percent of assets.
    2. ``B'' Case Assumptions--NCUA assumed that corporates would have 
zero growth beyond recapitalization deposits, and annual earnings equal 
to 0.1 percent of DANA (10 bp). NCUA also assumed that existing natural 
person credit unions would voluntarily recapitalize the corporate 
system at historical rates of 0.4 percent of assets.
    3. ``C'' Case Assumptions--NCUA assumed that natural person credit 
unions would not voluntarily recapitalize the corporate system at 
historical rates. This scenario assumes that natural person credit 
unions would limit capital investments in the corporate system to 0.2 
percent of assets. In the case of U.S. Central, the assumption was that 
other corporates would invest in capital accounts at one-half of 
historical levels. In this scenario, DANA and risk-weighted assets were 
reduced by 4 percent of each year, and earnings are 0.2 percent of 
DANA.
    4. ``D'' Case Assumptions--NCUA assumed that corporates would have 
zero growth beyond recapitalization deposits for the first 3 years. 
Annual earnings would equal 0.2 percent of DANA and natural person 
credit unions would voluntarily recapitalize the corporate system at 
historical rates of 0.4 percent of assets. In year 4, DANA was 
immediately reduced by one third.
    The table below illustrates the number of corporates that would 
achieve adequate capitalization, by year, over the next 7 years, under 
the various case assumptions.

----------------------------------------------------------------------------------------------------------------
                                                     Year     Year     Year     Year     Year     Year     Year
                                                     one      two     three     four     five     six     seven
----------------------------------------------------------------------------------------------------------------
``A'' Case.......................................        5        6        7        8       24       25       25
``B'' Case.......................................        5        5        5        7        7        7        8
``C'' Case.......................................        4        5        6        6       18       21       24
``D'' Case.......................................        5        6        7       23       24       24       26
----------------------------------------------------------------------------------------------------------------

    A discussion about the results of each scenario follows.
    The A case scenario would result in 25 of the 28 corporates 
reaching an adequate level of capitalization within six years. With 
zero growth and .2 percent of earnings each year, a corporate's 
retained earnings reaches the minimum 100 bp requirement by year five. 
Three of the corporates fail to meet the aggregate capital requirements 
by year six because their current assets and numbers of members produce 
a pool of available PPC and NCA accounts that is inadequate for these 
three corporates. It is possible that one or more of these three 
corporates would become adequately capitalized if they are able to 
obtain an appropriate level of PPC accounts.
    Under the B case assumptions, 21 corporates (i.e., 28 minus seven) 
are unable to reach an adequate capitalization level within six years 
and 20 are unable to reach an adequate capitalization level within 
seven years. These institutions will need to further adjust assets, or 
adjust earnings to insure that return on DANA is significantly in 
excess 0.1 percent, or obtain member capital investments at amounts 
greater than historical industry averages.
    The C case assumes a 0.2 percent earnings level but also assumes 
that natural person credit unions will not be willing to recapitalize 
the corporates at historical levels. In this scenario DANA shrinks by 
four percent each year, to correspond with the reduced availability of 
capital instruments. Seven of the 28 corporates are unable to reach 
adequate capital levels in the first six years. This scenario 
illustrates that at least a majority of corporates may still reach 
adequate capital levels even if natural person credit unions reduce the 
historic amount of capital invested in the corporate system. On the 
other hand, some corporates may find it difficult to achieve adequate 
capital levels if their natural person credit unions refuse to provide 
near historic levels of capital funding. The alternative for these 
corporates is to reduce assets.
    The ``D'' case scenario represents another possible strategy. A 
corporate may attempt to maintain current assets, generate retained 
earnings on the current asset base for several years and

[[Page 65248]]

then shrink the balance sheet before the final leverage ratio 
requirement becomes effective. All but four corporates would reach 
adequate capitalization under this scenario by the end of year six. 
Implementation of this scenario may be challenging as it is difficult 
to shrink assets by this magnitude on the basis of rates alone. The 
corporate's members would need to actively assist the corporate for it 
to succeed in this strategy.
    These particular scenarios do not reflect NCUA's classification of 
any specific corporate or its expected capital position during the 
phase-in period. Each corporate will need to complete a similar 
analysis with assumptions more specific to its own business plans and 
based on its own members' potential PCC and NCA contributions. Also, 
this analysis only goes out to seven years, and does not incorporate 
the final leverage requirement, effective at ten years, that PCC count 
only to the extent it is matched dollar for dollar by retained 
earnings. Corporates that meet the six year leverage requirement should 
be well-positioned to meet the ten year requirement, but numerical 
projections beyond six or seven years rely on too many assumptions to 
carry significant meaning.
    These scenarios also make clear that many corporates will struggle 
to achieve the minimum capital ratios over the proposed phase in 
period. The minimum leverage ratio will be the most difficult ratio for 
corporates to achieve because improvements in this ratio require the 
corporate credit union to both solicit permanent capital and build 
retained earnings. But if corporates were limited to earnings only, and 
not able to solicit capital, many would not be able to reach the 
adequately capitalized level for a significant number of years--in some 
cases, twenty or more years.
Phase-In of Capital Provisions (Conclusion)
    The most likely capital outcome for each corporate will depend on a 
number of factors unique to that corporate. These factors include the 
ability to raise capital from existing members and the level of 
earnings that the corporate is able to achieve. Achieving these new 
capital requirements may also require a corporate make significant 
changes in historic business plans and in the way it prices its 
services and deposit products.
    Still, NCUA believes that well-managed corporates that have 
financial support from their members can in fact reach their capital 
targets within the proposed phase-in period. For a corporate that lacks 
good management or significant member support, however, these capital 
goals may not be achievable. Those corporates that struggle to grow 
their earnings or to convince members to invest capital will need to 
shrink their balance sheets, look for potential merger partners, or 
both.
    In addition to general comments on the proposed capital phase-in, 
NCUA invites individual corporates to provide additional modeling 
information related to the effect of the proposed phase-in period on 
that corporate.

III.E. Proposed Rule: Hypothetical Effect on Recent Losses at WesCorp 
and U.S. Central

    As discussed above, the primary purpose of these proposed changes 
to part 704 is to mitigate future risks to the corporate system so that 
the system can continue to provide valuable services to NPCUs in a safe 
and sound manner. Although the focus of the proposal is forward 
looking, NCUA realizes that it cannot avoid, to some extent, a look 
backwards. Accordingly, this subsection III.E. illustrates the 
hypothetical effects of the proposed rule on the balance sheets of 
WesCorp and U.S. Central as those entities existed in June 2007. NCUA 
chose WesCorp and U.S. Central for this illustration since their risk 
positions account for the vast majority of projected losses in the 
corporate system.
    The following chart illustrates the effect of the proposed 
investment sector limits on the permissible amount of total non-agency 
residential mortgage backed securities (RMBS): \58\
---------------------------------------------------------------------------

    \58\ Proposed Sec.  704.6(d). NCUA used post-June June 2007 
statistics where the June 2007 statistics were not available. The 
use of more recent statistics understates loss exposure and, 
therefore, understates the effects the proposed rule would have had 
on projected losses if it had been in effect.

----------------------------------------------------------------------------------------------------------------
                                                  Non-agency     Proposed rule
                                                 RMBS percent      limit as         Exposure reduction under
                   Corporate                      of capital      percent of           proposed rule \59\
                                                    (2007)          capital
----------------------------------------------------------------------------------------------------------------
WesCorp.......................................            990%            500%  Approximately 50%.
U.S. Central \60\.............................          1,040%            500%  More than 50%.
----------------------------------------------------------------------------------------------------------------

    Non-agency RMBS produced almost 100 percent of projected losses and 
OTTI in the corporate credit union system. Had it been in effect, the 
proposed rule would have limited the exposure to this sector by 
approximately 50 percent for WesCorp and U.S. Central. Using projected 
losses and the assumption that security selection would have been 
comparable in quality to what they hold now, WesCorp and U.S. Central 
losses would have been cut in half.
---------------------------------------------------------------------------

    \59\ The proposed Sec.  704.5(h) also prohibits Net Interest 
Margin securities (NIMs) and collateralized debt obligations (CDOs), 
and these are included in the loss projections and exposure 
reductions. Additionally, contributed capital by corporate credit 
unions in U.S. Central is excluded from the projected loss number 
since the losses are directly related to OTTI taken on non-agency 
RMBS at U.S. Central.
    \60\ Sandlot Funding assets are included due to the subsequent 
reconsolidation on U.S. Central's balance sheet and recent 
accounting changes related to ABCP conduits.
---------------------------------------------------------------------------

    The following chart illustrates the effect of the proposed limit on 
the permissible amount of subordinated non-agency residential mortgage 
backed securities: \61\
---------------------------------------------------------------------------

    \61\ Proposed Sec.  704.6(e).

----------------------------------------------------------------------------------------------------------------
                                                                       Proposed rule
                                            Subordinated non-agency      limit as      Exposure reduction under
                Corporate                 RMBS as percent of capital    percent of           proposed rule
                                                    (2007)                capital
----------------------------------------------------------------------------------------------------------------
WesCorp.................................  More than 600%............            100%  More than 80%.
U.S. Central............................  More than 150%............            100%  More than 30%.
----------------------------------------------------------------------------------------------------------------


[[Page 65249]]

    Subordinated non-agency RMBS produced approximately 70 percent of 
the combined projected losses and OTTI in WesCorp and U.S. Central.\62\ 
The proposed rule would have lowered the exposure to subordinated non-
agency RMBS by more than 80 percent in WesCorp and more than 30 percent 
in U.S. Central. Using projected losses and the assumption that 
security selection would have been comparable in quality, WesCorp's 
losses would have been reduced by more than 75 percent and U.S. 
Central's losses would have been reduced by more than 15 percent.
---------------------------------------------------------------------------

    \62\ Subordinated securities include senior mezzanine tranches.
---------------------------------------------------------------------------

    Combining the effects of the non-agency RMBS sector limitations, 
the subordinated non-agency RMBS, and the CDO and NIM prohibitions, 
aggregate WesCorp losses would have been reduced by approximately 80 
percent and U.S. Central losses would have been reduced by 
approximately 45 percent. The following chart illustrates the effect of 
the proposed cash flow weighted average life (WAL) mismatch limit under 
the proposed rule: \63\
---------------------------------------------------------------------------

    \63\ Proposed Sec.  704.8(e). As discussed above, the proposed 
rule also limits WAL mismatches based on three factors: (1) Current 
base net economic value (NEV); (2) Investment authorities, and; (3) 
Total capital. Furthermore, the proposed rule requires WALs be 
measured assuming: (1) issuer options are not exercised; and (2) 
further tests and limits for a slowdown in prepayment speeds are 
conducted.

--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                                                   Minimum estimated WAL
                                      Investment portfolio                            Estimated asset and      Proposed rule's          reduction of
             Corporate                     WAL (2007)             Liability WAL          liability WAL       approximate limit on   investment WAL under
                                                                                            mismatch             WAL mismatch          proposed rule
--------------------------------------------------------------------------------------------------------------------------------------------------------
WesCorp............................  2.88 years............  0.97 years............  1.91 years...........  0.40 years...........  1.51 years.
U.S. Central.......................  2.93 years............  0.93 years............  2.00 years...........  0.30 years...........  1.70 years.
--------------------------------------------------------------------------------------------------------------------------------------------------------

    The proposal also limits the WAL of the aggregate investment 
portfolio to two years. Had they been in place, these proposed 
restrictions on the maximum average WAL mismatch and the absolute 
maximum investment WAL would have reduced the amount of liquidity risk 
and credit risk in the WesCorp and U.S. Central portfolios. The shorter 
average lives would have produced much quicker principal paydowns and 
shorter maturities than WesCorp and U.S. Central experienced since June 
2007, strengthening system liquidity. Furthermore, the resulting 
shorter average lives, combined with the limits on WAL extension risk, 
would have lowered the risk in the allowable RMBS portfolio due to more 
stable cash flow characteristics.\64\
---------------------------------------------------------------------------

    \64\ As discussed above, proposed Sec.  704.8(f) contains an 
mismatch test that requires the corporate to assume a 50% slowdown 
in payment speeds.
---------------------------------------------------------------------------

    NCUA is comfortable that these provisions of the proposed rule, 
taken together, would have resulted in significantly lower corporate 
losses had they been in effect prior to the recent credit crisis. The 
reduced losses would have protected corporate credit unions with 
capital in U.S. Central from some, if not all, of the losses from 
depleted capital. Additionally, WesCorp's members would have seen lower 
write-downs of their capital in Wescorp, and WesCorp would have not 
caused any loss to the NCUSIF--and thus no losses to credit unions that 
were not WesCorp members.

III.F. Amendments to Part 704 Related to the Structure of the Corporate 
System

    At present, the corporate system consists of twenty-seven 
corporates that provide retail service and support to natural person 
credit unions and one wholesale corporate that provides products and 
services only to the retail corporates. The ANPR discussed this 
configuration and solicited comment about whether this two-tier 
structure continues to make sense in the current marketplace. The ANPR 
asked what the role of the wholesale corporate should be and whether 
there should be any differentiation in powers and authorities between 
retail and wholesale corporates.
    A slight majority of the commenters believe the two-tiered 
corporate system, with a network of retail corporates and a single 
wholesale corporate, U.S. Central, is outdated and unnecessary. Many 
commenters believe this two-tier structure has resulted in an 
aggregation of excessive risk at the top tier and that U.S. Central 
duplicates the investment and payment services that large retail 
corporates can provide at competitive cost and with greater 
diversification of risk. Some commenters stated the wholesale tier is 
redundant, inefficient, led to too much concentrated risk, and has 
resulted in the creation of an entity that has become ``too big to 
fail.'' Others stated that elimination of the two-tiered system may 
lead to a necessary consolidation of the corporate credit union system, 
resulting in a system in which corporates are more economically viable.
    Other commenters, predominantly smaller credit unions, believe that 
the wholesale tier is beneficial and necessary. Smaller credit unions 
believe that the level of services and support they receive from 
corporates, including investment expertise, is not readily available to 
them in the outside marketplace. Some of these commenters felt that the 
existence of U.S. Central created efficiencies in the system and that 
U.S. Central had the greatest level of investment expertise available 
to the system. Supporters of the status quo, however, typically felt 
greater regulatory oversight, risk mitigation, and higher capital 
standards for corporates were still necessary.
Existing Sec.  704.19--Wholesale Corporate Credit Unions
    The Board believes that having a third tier in the credit union 
system presents both an element of inefficiency and a systemic risk 
multiplier effect. The inefficiency arises from the added cost of 
having two layers of intermediation for the goods and services extended 
by the wholesale corporate through its retail corporate members to 
their natural person credit union members. The multiplier on risk 
results from the fact that each dollar of loss in excess of retained 
earnings at the wholesale level can result in as much two additional 
dollars of loss for the rest of the system: One dollar lost at the 
retail corporate level and one at the natural person credit union 
level.\65\ Accordingly, the Board is moving towards eliminating 
regulatory and policy distinctions between wholesale and retail 
corporates.
---------------------------------------------------------------------------

    \65\ See, e.g., Retail Corporates Apply U.S. Central Capital 
Losses, Credit Union Times, August 3, 2009, at www.cutimes.com.
---------------------------------------------------------------------------

    The existing Sec.  704.19 provides that wholesale corporates must 
strive to obtain a one percent retained earnings ratio, as opposed to 
the existing Sec.  704.3(i), which requires that all other corporates 
strive to retain a two percent retained earnings ratio. The proposed 
capital revisions to Sec.  704.3 eliminate the

[[Page 65250]]

need for any earnings retention requirement. To ensure that the new 
capital requirements apply equally to both wholesale and retail 
corporates, the proposal eliminates both the current paragraph 704.3(i) 
and current Sec.  704.19. The proposal also eliminate the unnecessary 
term ``wholesale corporate credit union'' from the definitions in Sec.  
704.2.
    To further facilitate the elimination of the third tier, the 
proposal also amends the existing part 704 provisions on board 
representation to require that the board of every corporate have a 
majority of its members comprised of representatives of natural person 
credit unions. As a result, no corporate in the system will ever again 
be captive to other corporates. This amendment, and the associated 
transition period, are discussed in more detail below in connection 
with the proposed corporate governance amendments applicable to all 
corporates.
    The Board has also directed OCCU to eliminate any distinctions 
between corporates in field of membership (FOM) policy, and so retail 
corporates will be allowed to offer services to other corporates and 
U.S. Central will be allowed to provide services to natural person 
credit unions.

III.G. Amendments to Part 704 Related to Corporate CUSOs

    Part 704 currently permits corporates to invest in and lend to 
credit union service organizations (corporate CUSOs). A corporate CUSO 
is defined as an entity that is at least partly owned by a corporate 
credit union; primarily serves credit unions; restricts its services to 
those related to the normal course of business of credit unions; and is 
structured as a corporation, limited liability company, or limited 
partnership under state law. 12 CFR 704.11(a). Part 704 does not list 
the permissible activities for corporate CUSOs, unlike part 712, which 
does list the permissible activities for the CUSOs of natural person 
FCUs. 12 CFR 712.5(b).
    The Board believes it is appropriate to tighten NCUA oversight over 
the activities of corporate CUSOs. A corporate CUSO may serve hundreds 
or even thousands of natural person credit unions, and so its 
activities can affect the entire credit union system. Additionally, as 
the corporate credit union system evolves in the coming years, some of 
the services that are currently accomplished in-house at a corporate 
may migrate to a corporate CUSO. The movement of these activities could 
increase the systemic risk associated with corporate CUSOs, and NCUA 
wants to ensure it has some oversight and control of these activities.
    Accordingly, the proposal amends Sec.  704.11 to require that, 
generally, a corporate CUSO must agree that it will limit is services 
to brokerage services, investment advisory services, and other 
categories of services as preapproved by NCUA and published on NCUA's 
Web site. A CUSO that desires to engage in an activity not preapproved 
by NCUA can apply to NCUA for that approval.
    The current paragraph 704.11(e) prohibits a corporate CUSO from 
acquiring 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. The proposal retains this prohibition, but moves it 
paragraph 704.11(g), which sets forth the contents of the mandatory 
written agreement between ever corporate and its CUSOs. The proposal 
also adds two other requirements to this mandatory agreement. First, 
the proposal requires the CUSO agree to expanded access for auditors, 
the corporate's directors, and NCUA. Currently, the CUSO must agree to 
permit access to the CUSO's ``books, records, and other pertinent 
documentation,'' and the proposal expands this access to: ``personnel, 
facilities, equipment, books, records, and any other documentation that 
the auditor, directors, or NCUA deem pertinent.'' Second, the proposal 
prescribes that the CUSO specifically agree to abide by all the 
requirements set forth in Sec.  704.11.
    The current paragraph 704.11(b) places limits on the aggregate 
amount of a corporate's investments in, and loans to, a CUSO. The 
proposal does not contain any changes to these limits. Still, data 
available to NCUA indicates that the level of corporate investment in 
CUSOs is significantly less than these 704.11(b) limits would allow, 
based on November 2008 corporate capital levels. The Board invites 
comment on whether, in the final rule, it should reduce the CUSO 
investment and loan limits in the current 704.11(b).

III.H. Amendments to Part 704 Related to Corporate Governance

    As noted in the ANPR, corporate management requires a high level of 
sophistication and expertise. Successful corporate management also 
requires performance and practices that instill and inspire confidence 
by the membership in the integrity of those in positions of leadership 
and responsibility. With this proposal, NCUA intends to improve 
corporate governance standards and elevate confidence in corporate 
leadership, thereby supporting and strengthening the corporate system. 
As more fully developed below, the proposed rule sets out new 
provisions in the following areas:
     Qualifications for corporate directorship, including term 
limits and NPCU representation;
     Transparency of senior executive and director compensation 
arrangements; and
     Restrictions on certain severance and indemnification 
payments for senior executive officers.
Sec.  704.14 Representation
Qualifications of Directors
    Corporate credit unions are complex entities that can, and do, have 
a significant impact on the functioning of the entire credit union 
system. The ANPR solicited comment on whether changes to the corporate 
rule are necessary to ensure a corporate credit union's governing board 
possesses the requisite degree of knowledge and expertise. One hundred 
fifty-seven commenters responded to NCUA's request for comment on this 
subject, and nearly three-quarters of these commenters--112--supported 
additional qualification standards for corporate directors.
    Sophisticated corporate investment and operation strategies require 
directors with adequate levels of knowledge and experience to 
understand and provide oversight for these strategies. NCUA believes 
that the recent crisis in the corporate system was attributable, in 
part, to a failure on the part of the some corporate boards to 
understand the extent of the risk embedded in their balance sheets.
    Those commenters who supported regulatory director qualifications 
thought such qualifications would ensure corporates are governed by 
knowledgeable individuals who are up-to-date on the most recent 
developments in the credit union system. Some commenters said that 
board candidates should be limited to either chief executive officers 
(CEOs) or chief financial officers (CFOs) of member credit unions. 
There was also some support that directors be required to obtain 
periodic training or continuing education. Other commenters suggested 
that the issue of director qualification be left to the discretion of 
the individual corporate and not be mandated by regulation. Some 
commenters said that, with respect to state charters, this issue is a 
function of state law and regulation. Others said that nothing 
presently prevents a board of directors from

[[Page 65251]]

retaining outside experts to assist its understanding on any issue that 
board may determine.
    Some of those opposed to imposing minimum director qualifications 
stated that an emphasis on education may disqualify certain persons who 
have valuable experience, skills, or talents not attributable to formal 
education. Others opposed to regulatory qualifications noted that such 
qualifications are no assurance against the recurrence of the current 
corporate system problems, with one noting that all of the various 
proposed qualifications existed on a voluntary basis at one or more 
corporates, and those governance techniques had not protected those 
corporates from the effects of the current economic downturn.
    Corporates have evolved into complicated entities with key roles in 
the credit union system. The Board believes, therefore, that 
individuals seeking a position on a corporate board should exhibit a 
minimum level of knowledge and expertise. Accordingly, the proposal 
adds a new paragraph 704.14(a)(2) to require, as qualification for 
directorship, that all candidates must currently hold the equivalent of 
a CEO, CFO, or chief operating officer (COO) position at the member 
institution (typically, though not always, a natural person credit 
union). The proposal phases this requirement in by applying it only to 
candidates at the time of election or reelection, and making the 
effective date of the proposal some four months after the effective 
date of the rule.
    In lieu of such an experience requirement, the Board considered 
proposing that directors of corporates be required to obtain formal 
training on an annual or other periodic basis as a condition of service 
on a corporate board. The Board determined not to include that 
requirement in the proposal for a couple of reasons. First, as noted 
above, the Board believes limiting director eligibility to persons 
currently holding a CEO, CFO or COO position will help ensure qualified 
candidates are chosen for board positions. In addition, the Board does 
not believe it a good use of examiner resources to analyze training 
attendance records, the sufficiency of a particular corporate's 
training standards, or the effectiveness of the training.
    Although the Board has determined not to impose by regulation a 
specific, and mandatory, training requirement, the Board believes 
director training is important and corporates should encourage such 
training. In 2005, NCUA stated:

    In today's environment directors must have considerable 
knowledge and devote sufficient time to have an adequate 
understanding of a corporate's operations. In many cases directors 
may need extensive training in the corporate's unique operations 
(i.e., sophisticated investments and asset liability management). 
The information provided by management is normally extensive and 
complex. Directors need to dedicate a significant amount of effort 
to becoming familiar with these concepts.

    Corporate Credit Union Guidance Letter 2005-02 (April 5, 2005). 
These training principles are just as valid today as back in 2005. The 
standard FCU bylaws also state that FCUs will establish ``a policy to 
address training for newly elected and incumbent directors and 
volunteer officials in areas such as ethics and fiduciary 
responsibility, regulatory compliance, and accounting * * *.'' Standard 
FCU Bylaws, Art. VI, Sec.  6(d)(2006). Although corporates are not 
governed by these FCU bylaws, the Board could incorporate similar 
language into the standard corporate bylaws. The Board solicits comment 
as to whether such a change to the corporate bylaws would be 
appropriate.
    Term Limits and Other Board Restrictions. The ANPR also solicited 
comment on whether NCUA should impose term limits for service on a 
corporate board. The majority of those who offered a comment, on this 
issue, 80 out of 145, supported the concept of corporate term limits. 
Those supporting term limits generally stated this would help to 
eliminate complacency on boards and ensure that corporates were run by 
the best qualified individuals. Others, in opposition to the idea, 
advocated that NCUA not impose mandatory term limits by regulation. One 
corporate opposed director term limits but supported term limits on 
officer positions within the board to ensure ``adequate change in 
leadership while retaining experienced directors.'' Others who opposed 
term limits generally felt that this disrupted continuity and reduced 
efficiency by creating a continuous need to train new directors.
    The Board has determined that some form of term limit will be 
beneficial. New directors are more likely, generally, than old 
directors to ask questions about existing policies and to generate 
suggestions for improvement. This, in turn, should help ensure that 
corporate policies are subject to continuous review and evaluation. 
Accordingly, the proposal adds a new paragraph 704.14(a)(3) to impose a 
six-year limit on continuous service as a corporate director.
    Generally, corporate directors serve for staggered three-year 
terms, as provided in Art. VII, Sec.  2, Corporate Credit Union Bylaws 
(2003), and the Board intends, for sitting directors, to phase in this 
new term limit requirement without undue disruption. Accordingly, the 
proposal would not require any current director to step down before the 
current term ends, regardless of the length of time served before the 
rule became effective. Instead, the proposal provides that no 
individual may stand for election to the board if, at the end of the 
term for which the individual seeks election, he or she would have 
served for more than six consecutive years as a director. Corporates 
should ensure that directors who run for reelection following the 
effective date of this rule will, in fact, be able to complete their 
entire term without exceeding the six-year term limit.
    The rule also clarifies that, for purposes of calculating term 
limits, service on the board is determined by reference to the 
corporate member on whose behalf the individual is serving, and not 
simply by the number of years the particular individual has served. 
Thus, for example, if the CEO of an NPCU has served on the board of a 
corporate for six years, the CFO or COO of that NPCU may not follow on 
to the board in the next succeeding term. For purposes of the rule, all 
individuals representing a single member are treated as a single 
individual.
    Given the importance of the role corporate directors fulfill in 
establishing the overall policy and direction for corporate credit 
unions, the Board is concerned that those individuals who are chosen 
for this role be in a position to devote the degree of time and 
attention necessary to effectively discharge their responsibilities. 
Accordingly, the proposed rule would establish that no individual may 
be elected or appointed to the board of one corporate while serving at 
the same time as a member of any other corporate credit union board. 
This restriction will help ensure that directors are undivided in their 
loyalty to the corporate for which they are serving and are not 
distracted from attending to the needs of their institution because of 
competing demands arising from another corporate.
    The proposal would also prohibit any member of a corporate from 
having more than one of its officers sitting on the board of the 
corporate at one time. This provision will prevent a corporate from 
being dominated by any single member.

[[Page 65252]]

Representation by Natural Person Credit Unions
    As discussed above, the Board intends to eliminate the distinction 
between wholesale and retail corporates. Accordingly, the proposal adds 
a new paragraph 704.14(a)(4) requiring that a majority of a corporate's 
directors, including the chair of the board, must serve on the board as 
representatives of natural person credit union members. Retail 
corporates should already satisfy this governance requirement. The 
proposal, however, delays the effective date of this provision for 
three years to allow U.S. Central, the only wholesale corporate, time 
to meet this new governance requirement.
    Because of the addition of the new subparagraphs 704.14(a)(2), (3), 
and (4), as discussed above, the proposal renumbers the remaining 
subparagraphs of paragraph 704.14(a).
Sec.  704.19 Disclosure of Executive and Director Compensation
    As noted in the ANPR, part 704 does not currently require any 
disclosure by a corporate to its members of senior executive 
compensation arrangements. The response to the ANPR contained a few 
comments on compensation transparency. Some who commented noted that 
disclosure of corporate compensation should be subject to the same 
guidance as applies to natural person credit unions. One commenter said 
corporates should provide transparency through existing filing 
requirements, such as the Internal Revenue Service Form 990--required 
for state charters, but not federal charters. Another commenter argued 
that executive compensation and disclosure of salary and benefit 
information have no bearing on the current crisis. This commenter 
stated that a number of publicly traded companies, each with their 
management compensation packages fully disclosed to the public, have 
gone bankrupt during this current crisis.
    Debate over disclosure of credit union compensation has been 
ongoing for years. For example, in November 2005, Congress and the 
Government Accountability Office (GAO) raised questions about the lack 
of transparency regarding credit union senior executive compensation. 
In response, the NCUA undertook the Member Service Assessment Pilot 
Program to study, among other issues, the transparency of senior 
executive compensation. On November 3, 2006, NCUA completed its study 
and issued the Member Service Assessment Pilot Program: A Study of 
Federal Credit Union Service (MSAP), which recommended NCUA consider 
alternatives requiring FCUs to make periodic disclosure of executive 
compensation to their members.
    Soon after the issuance of the MSAP, GAO also recommended ``the 
Chairman of NCUA take action to ensure that information on federal 
credit union executive compensation is available to credit union 
members and the public for review and inspection.'' GAO, Credit Unions: 
Transparency Needed on Who Credit Unions Serve and on Senior Executive 
Compensation Arrangements (GAO-07-29) (2006). The Board created an 
outreach task force which, although not focused specifically on 
corporate issues, did consider and make some recommendations focused on 
compensation transparency and related issues. One OTF recommendation 
was that NCUA ``promulgate a regulation requiring federal credit unions 
and federal corporate credit unions to annually disclose individual 
senior executive officer compensation to their members.'' Report to the 
NCUA Board from the Outreach Task Force, p. 71, available at http://www.ncua.gov/ReportAndPlans/plans-and-reports/2008/OutreachTFReport-022608.pdf.
    Addressing compensation disclosure requires a balancing of privacy 
interests against the ownership and financial interests of members. The 
basic question presented is whether an increased level of transparency 
would strengthen cooperative principles and accountability, and if so, 
whether those benefits outweigh the damage to individual privacy 
interests of the affected executives. In the corporate context 
particularly, the Board believes this balance can and should be struck 
in favor of increased transparency and disclosure to members. The 
member-owners of a corporate credit union have a strong financial 
interest in the corporate. The typical corporate member has large 
investments in the corporate and much of this investment is at risk, 
either in the form of perpetual contributed capital, nonperpetual 
contributed capital, or uninsured shares. The corporate member needs to 
have this investment properly managed and protected. Accordingly, the 
member wants the corporate to provide proper financial incentives to 
its managers and official to do a good job while ensuring that the 
corporate is also properly expending its funds--and both these 
interests are affected by compensation paid to corporate executives and 
officials. Corporate managers and officials, of course, do have privacy 
interests in their compensation, but those interests diminish the more 
senior the manager and the more responsibility the manager or official 
has for the performance of the corporate and for the attendant 
protection of the financial interests of the corporate's owners. In 
sum, the Board believes the interests that corporate members have in 
this compensation information outweighs any privacy interests the 
senior managers may have in that information.\66\
---------------------------------------------------------------------------

    \66\ The financial interests of corporate members in their 
corporate are likely to be more significant than the financial 
interests of natural person members in their natural person credit 
union, because natural persons are less likely to have significant 
amounts of at-risk investments in their credit union than are 
members of corporates.
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    Accordingly, the proposal contain a new Sec.  704.19 requiring 
corporates to provide to its members certain information about the 
compensation and benefits of senior executive officers and directors. 
Given the importance Congress and GAO placed on the disclosures 
required in IRS Form 990 (an annual informational filing required of 
many tax-exempt entities, including state chartered credit unions), 
much of Sec.  704.19 mirrors the Form 990 information and access 
process. For purposes of the rule, however, the Board has concluded 
that completion of the Form 990 is not sufficient. The IRS determines 
the form and content of the Form 990 disclosure and so that may change 
in the future. In addition, even though Form 990 data is publicly 
available, the affirmative disclosure required by this proposal 
provides for greater transparency to members.
    A paragraph-by-paragraph discussion of the new Sec.  704.19 
follows.
    Proposed paragraph 704.19(a) requires each corporate to prepare and 
maintain the annual disclosure of executive and director compensation. 
As currently proposed, the rule would allow a corporate to choose the 
disclosure format it considers most appropriate, for example, through 
the use of a narrative, table, or chart. NCUA solicits comment on the 
question of whether the rule should specify the form that the 
disclosure should take, including, for example, the identification of 
specific categories that must be used, such as direct salary, bonus, 
deferred compensation, etc. In any case, the disclosure must 
specifically identify senior executive personnel by name, job title, 
and compensation. To the extent that members of the board of directors 
also receive compensation in exchange for or as an incident to their 
service on the board, the rule specifies that the corporate must 
disclose that compensation as well.
    As discussed more fully below, the definition of compensation

[[Page 65253]]

encompasses all benefits provided by the corporate to its senior 
executives or directors. The Board believes that, to be accurate, the 
disclosure must ascribe a dollar value to each component of 
compensation, and the proposed rule specifically requires this. The 
proposal contemplates each corporate will prepare the disclosure at 
approximately the same time each year, much like an annual tax filing. 
If senior executive or director compensation changes during the course 
of a year, a corporate will not be required to prepare a new or amended 
disclosure. In some instances requiring only an annual disclosure may 
result in some lag in updated information, but such a disclosure 
requirement more closely resembles the reporting made in annual tax 
filings for state chartered credit unions and lessens the disclosure 
burden on the corporate.
    Proposed paragraph 704.19(b) provides that any member may obtain a 
copy of the most current disclosure, and all disclosures for the 
previous three years, on request made to the corporate in person or in 
writing. The corporate must provide the disclosure(s), at no cost to 
the requesting member, within five business days of receiving the 
request. In addition, the corporate must distribute the most current 
disclosure to all its members at least once a year, either in the 
annual report or in some other manner of the corporate's choosing.
    The Board considered whether to impose some type of non-disclosure 
requirement on members as a condition to receiving the information, but 
ultimately determined not to impose such a condition, given the 
difficulty in enforcing such a requirement. The compensation 
information, however, is likely to be of interest only to members, and 
the Board anticipates that members will not likely disseminate the 
information to nonmembers.
    Proposed paragraph 704.19(c) clarifies that a corporate may 
supplement the required disclosure, at its option, with information may 
put the disclosures in appropriate context. For example, a corporate 
could provide members with salary surveys, a discussion of compensation 
in relation to other credit union expenses, or compensation information 
from similarly sized credit unions or financial institutions.
    In the case of merger, the Board is concerned that prospective 
merger partners may seek to improperly influence the deliberations of 
management or the board at a corporate seeking to merge. One way to 
deal with the potential for improper activity is transparency. 
Accordingly, proposed paragraph 704.19(d) provides that, where a 
corporate is considering a merger with another corporate, any 
arrangement resulting in a material increase in compensation (i.e., an 
increase in current compensation of more than 15 percent or $10,000, 
whichever is greater) for any senior executive officer or director of 
the merging corporate must be included in the annual disclosure form. 
In addition, the proposal specifies that corporates must describe in 
the merger plan submitted to the NCUA any financial arrangements 
providing for a material increase in compensation for any senior 
executive officer or director. The Board intends that all arrangements, 
formal and informal, be covered by this disclosure requirement. The 
scope of disclosure includes both arrangements that are written and 
those not immediately reduced to writing, as well as arrangements 
involving the deferred receipt of compensation.
    Where a merging credit union is federally chartered, the proposal 
would also require an affirmative disclosure of the existence of a 
material increase in compensation to its members before their vote on 
the merger. State law governs whether members of a state-chartered 
credit union are entitled to vote; therefore, NCUA is only proposing 
this latter requirement for federally chartered corporate credit 
unions.
    Section 704.2 contains two proposed definitions relating to the 
scope of the Sec.  704.19 disclosures. First, the proposal eliminates 
the current definition of senior management employee, a term no longer 
used in part 704, and replaces that definition with a definition of 
senior executive officer as:

    [A] chief executive officer, any assistant chief executive 
officer (e.g., any assistant president, any vice president or any 
assistant treasurer/manager), and the chief financial officer 
(controller). This term also includes employees of any entity hired 
to perform the functions described above.

    This definition is similar to that currently used in Sec.  701.14 
of NCUA's rules. 12 CFR 701.14. Second, since the Board believes it is 
important for complete accuracy to require disclosure of all forms of 
executive compensation, the proposal defines compensation as:

    [A]ll salaries, fees, wages, bonuses, severance payments paid, 
current year contributions to employee benefit plans (for example, 
medical, dental, life insurance, and disability), current year 
contributions to deferred compensation plans and future severance 
payments, including payments in connection with a merger or similar 
combination (whether or not funded; whether or not vested; and 
whether or not the deferred compensation plan is a qualified plan 
under Section 401(a) of the IRS Code). Compensation also includes 
expense accounts and other allowances (for example, the value of the 
personal use of housing, automobiles or other assets owned by the 
corporate credit union; expense allowances or reimbursements that 
recipients must report as income on their separate income tax 
return; payments made under indemnification arrangements; and 
payments made for the benefit of friends or relatives). In 
calculating required compensation disclosures, reasonable estimates 
may be used if precise cost figures are not readily available.

    The Board is also concerned about the possibility of ``reverse'' 
mergers, where a larger credit union merges into a smaller credit union 
and the officers and directors of the merging entity assume control of 
the continuing entity. Accordingly, the Board invites comment about 
whether, and under what circumstances, the requirement to disclose 
merger-related compensation should be extended to the officers and 
directors of the continuing credit union as well as the merging credit 
union.
Sec.  704.20 Limitations on Golden Parachute and Indemnification 
Provisions
    Section 2523 of the Comprehensive Thrift and Bank Fraud Prosecution 
and Taxpayer Recovery Act of 1990 \67\ (Fraud Act) amended the Federal 
Credit Union Act (Act) by adding a new section 206(t). Public Law 101-
647, section 2523(b) (1990). Section 206(t) provides that ``[t]he Board 
may prohibit or limit, by regulation or order, any golden parachute 
payment or indemnification payment.'' 12 U.S.C. 1786(t)(1).
---------------------------------------------------------------------------

    \67\ The Comprehensive Thrift and Bank Fraud Prosecution and 
Taxpayer Recovery Act of 1990 is title XXV of the Crime Control Act 
of 1990, S. 3266, which was passed by Congress on October 27, 1990 
and signed into law on November 29, 1990.
---------------------------------------------------------------------------

    Accordingly, the proposal adds a new Sec.  704.20 to NCUA's 
corporate rule that prohibits golden parachutes, that is, payments made 
to an institution affiliated party (IAP) that are contingent on the 
termination of that person's employment and received when the corporate 
making the payment is troubled, undercapitalized, or insolvent. The 
proposal also prohibits a corporate, regardless of its financial 
condition, from paying or reimbursing an IAP's legal and other 
professional expenses incurred in administrative or civil proceedings 
instituted by NCUA or the appropriate state regulatory authority.
    The new Sec.  704.20 will be effective immediately upon the 
finalization of this rule. These limitations will apply to all new 
employment contracts entered into on or after that date, as well as

[[Page 65254]]

existing contracts that are renewed or modified in any way after that 
date.
    A paragraph-by-paragraph summary of the proposed Sec.  704.20 
follows:
Paragraph 704.20(a) Definitions
    This proposal contains several definitions. The key definitions are 
discussed further below.
Paragraph 704.20(b) Golden Parachute Payments Prohibited
    The proposal provides, generally, that no corporate credit union 
will make or agree to make any golden parachute payment, that is, a 
payment to an institution-affiliated party (IAP) that is contingent on 
the termination of that person's employment and received when the 
corporate making the payment is troubled, as defined in Sec.  
701.14(b)(4) of NCUA's rules. 12 CFR 701.14(b)(4); see also 12 U.S.C. 
1790a; 12 U.S.C. 1786(r) (definition of IAP). The proposal also 
prohibits golden parachute payments in the event a corporate has become 
insolvent or ``undercapitalized'' for prompt corrective action 
purposes. See proposed Sec.  704.4. This prohibition is intended to 
prevent IAPs who are substantially responsible for the troubled 
condition of a corporate from receiving an unwarranted benefit.
    The proposed definition of golden parachute would also exclude 
certain payments pursuant to certain bona fide deferred compensation 
plans. Although the rule text is necessarily complex, the proposal 
provides that, in general, a plan funded by earned but deferred 
compensation is allowed. Also, certain types of elective plans are 
allowed if they are funded, were in effect more than one year prior to 
any of the events described in Sec.  701.14(b)(4) of NCUA rules, and 
the party is vested in the plan. For example, payments made pursuant to 
qualified retirement plans; nondiscriminatory severance pay plans; 
benefit plans required by state statute, and death benefit arrangements 
would not be prohibited. Payments made pursuant to these exclusions, 
however, are generally limited in amount to 12 months of base salary.
Paragraph 704.20(c) Prohibited Indemnification Payments
    Section 206(t) of the Act authorizes NCUA to prohibit or limit 
indemnification payments. 12 U.S.C. 1786(t)(5). The Act defines a 
prohibited indemnification payment as a payment by a corporate for the 
benefit of an IAP for any liability or legal expense sustained in 
connection with an administrative or civil enforcement action that 
results in a final order or settlement pursuant to which the IAP is 
assessed a civil money penalty, removed from office, prohibited from 
participating in the conduct of the affairs of an insured credit union, 
or required to cease and desist from or take any affirmative action 
described in Sec.  206 of the FCU Act. 12 U.S.C. 1786. Accordingly, the 
proposed paragraph 704.20(d) generally prohibits a corporate, 
regardless of its financial condition, from paying or reimbursing an 
IAP's legal and other professional expenses incurred in proceedings 
instituted by NCUA or the appropriate state regulatory authority. 
Paragraph 704.20(e), discussed below, describes when a corporate can 
proceed to indemnify an IAP.
Paragraph 704.20(d) Permissible Golden Parachute Payments
    The Board has determined that in certain, limited circumstances 
payments that otherwise satisfy the definition of golden parachute 
payments should be permitted. The proposal includes three exceptions to 
the general prohibition on golden parachutes:
     One exception permits the insertion of a golden parachute 
payment provision into an employment contract when a corporate which is 
already in troubled condition needs to hire a senior manager with 
expertise to help put the corporate back on a sound financial footing 
(the ``white knight'' exception). Without this white knight exception, 
a troubled corporate may not be able to attract qualified senior 
management. Before employing the white knight exception to make a 
payment, a corporate must notify and obtain the written permission of 
the Board.
     Another exception permits reasonable severance 
arrangements in the context of a merger for the management of the 
merging corporate. The merger must be unassisted, that is, at no cost 
to the NCUA; and any severance payments made cannot exceed twelve 
months salary. In addition, the NCUA Board must review and approve the 
payment in advance.
     Finally, there is a general exception that permits 
severance arrangements on an exceptional basis where the NCUA Board 
determines the payment is appropriate.
    In applying to NCUA for any of the three exceptions above, the 
corporate credit union must assert to NCUA its belief that the IAP does 
not bear any responsibility for the troubled condition of the 
corporate. Specifically, the corporate must demonstrate that it does 
not possess, and is not aware of, any information that provides a 
reasonable basis to believe that:
     The IAP has committed any fraudulent act or omission, 
breach of trust or fiduciary duty, or insider abuse with regard to the 
corporate credit union that has had or is likely to have a material 
adverse effect on the corporate credit union;
     The IAP is substantially responsible for the insolvency 
of, the appointment of a conservator or liquidating agent for, or the 
troubled condition of the corporate credit union;
     The IAP has materially violated any applicable federal or 
state banking law or regulation that has had or is likely to have a 
material effect on the corporate credit union; or
     The IAP has violated or conspired to violate certain 
specified criminal provisions of the United States Code.
    In determining whether to grant an application for any of these 
exceptions, the Board may also consider:
     Whether, and to what degree, the IAP was in a position of 
managerial or fiduciary responsibility;
     The length of time the IAP was affiliated with the 
corporate credit union, and the degree to which the proposed payment 
represents a reasonable payment for services rendered over the period 
of employment; and
     Any other factors or circumstances which would indicate 
that the proposed payment would be contrary to the intent of section 
206(t) of the Act.
Paragraph 704.20(e) Permissible Indemnification Payments
    Broadly speaking, Congress intended through the Fraud Act to limit 
the ability of IAPs who are responsible for losses sustained by an 
insured depository institution to avoid the consequences of that 
responsibility. Where, however, that responsibility has not yet been 
finally established, the Board does not intend to categorically 
prohibit corporates from advancing funds to pay or reimburse IAP's for 
reasonable legal or other professional expenses incurred in defending 
against an administrative or civil action brought by NCUA. Accordingly, 
paragraph 704.20(e) prescribes certain circumstances under which 
indemnification payments may be made.
    The proposed rule provides that indemnification payments may be 
made where the corporate's board of directors makes a good faith 
determination, after due investigation, that:
     The IAP acted in good faith and in a manner he/she 
believed to be in the best interests of the corporate credit union;

[[Page 65255]]

     The payment of such expenses will not materially adversely 
affect the corporate credit union's safety and soundness;
     The indemnification payments ultimately do not become 
prohibited indemnification payments as defined in 704.20(a), that is, 
the administrative action does not result in a civil money penalty, 
removal order, or cease and desist order against the IAP; and
     The IAP agrees in writing to reimburse the corporate 
credit union, to the extent not covered by payments from insurance, for 
that portion of the advanced indemnification payments, if any, which 
subsequently becomes prohibited indemnification payments.
    The proposed rule does permit a corporate to purchase commercial 
insurance policies or fidelity bonds, at a reasonable cost, to pay the 
future potential cost of defending an administrative proceeding or 
civil action. Such insurance cannot pay for any penalty or judgment 
against an IAP but may pay restitution to the corporate or its 
liquidating agent.
Paragraph 704.20(f) Filing Instructions
    This paragraph provides procedures for corporate credit unions to 
request Board permission to make nondiscriminatory severance plan 
payments and golden parachute payments described in paragraph 
704.20(d).
Paragraph 704.20(g) Applicability in the Event of Liquidation or 
Conservatorship
    This paragraph clarifies how the restrictions in this section 
function in the event of conservatorship or liquidation. Any consent or 
approval of a golden parachute payment granted under the provisions of 
this part by the Board will not in any way bind any liquidating agent 
or conservator for a failed corporate credit union and will not in any 
way obligate the liquidating agent or conservator to pay any claim or 
obligation pursuant to any golden parachute, severance, indemnification 
or other agreement.
Compensation Disclosure and Prohibition of Golden Parachutes: 
Application to Natural Person Credit Unions; Consideration of TARP 
Limitations
    At this time, the Board is primarily concerned with recent problems 
exposed by the corporate financial crisis, including corporate 
governance problems. Accordingly, the Board intends to apply the 
requirements of proposed Sec.  704.19 and 704.20 only to corporates, 
and not to natural person credit unions.\68\
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    \68\ Natural person federal credit unions may provide for 
indemnification of officers and directors as set forth at Sec.  
701.33 of NCUA. To the extent that this proposed Sec.  704.20 
conflicts with Sec.  701.33 or any other federal law or regulation, 
or state law or regulation (for state-chartered corporates), the 
corporate must comply with Sec.  704.20. See 12 CFR 704.1.
---------------------------------------------------------------------------

    The Board also notes that its proposals (i.e., on disclosure of 
compensation and prohibition of golden parachutes and indemnification 
arrangements) differ from the requirements in the Treasury's recent 
final rule applicable to entities receiving federal assistance under 
the Troubled Asset Relief Program (TARP) program. 74 FR 28394 (June 15, 
2009). The Treasury rule imposes several substantive limits on senior 
executive compensation, including limits on bonuses and the use of 
compensation plans that would encourage earnings manipulation to 
enhance executive compensation. The Treasury rule also requires 
affected entities establish a compensation committee comprised of 
independent directors, prepare a written policy on luxury expenditures, 
disclose certain types of perquisites, and eliminate tax gross ups. The 
Board does not believe adoption of the Treasury approach for all 
corporate credit unions is necessary or desirable at this time, 
although the Board reserves the right to impose similar conditions in 
the future on any credit union that receives assistance from the 
NCUSIF.

IV. Regulatory Procedures

IV.A. 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 $10 million 
in assets). The proposal only applies to corporates, all but one of 
which has assets well in excess of $10 million. Accordingly, the 
proposed amendments will not have a significant economic impact on a 
substantial number of small credit unions and, therefore, a regulatory 
flexibility analysis is not required.

IV.B. Paperwork Reduction Act

    The Paperwork Reduction Act of 1995 (PRA) applies to rulemakings in 
which an agency by rule creates a new paperwork burden on regulated 
entities or modifies an existing burden. 44 U.S.C. 3507(d). For 
purposes of the PRA, a paperwork burden may take the form of a either a 
reporting or a recordkeeping requirement, both referred to as 
information collections. The Office of Management and Budget (OMB) has 
approved the current information collection requirements in part 704 
and assigned them control number 3133-0129.
    The proposed changes to part 704 modify existing information 
collection requirements and impose new information collection 
requirements. As required by the PRA, NCUA is submitting a copy of this 
proposed regulation to the Office of Management and Budget (OMB) for 
its review and approval. Persons interested in submitting comments with 
respect to the information collection aspects of the proposed rule 
should submit them to the OMB at the address noted below.
Estimated PRA Burden: Capital and PCA Requirements
    NCUA has determined that the following capital and PCA aspects of 
the proposed rule either modify or create new information collection 
requirements:
     The current rule imposes an obligation on a corporate to 
prepare and submit a capital restoration plan in the event the 
corporate's capital falls below certain specified measures. The 
proposed rule creates several new capital standards and requirements, 
and thereby increases the potential for additional circumstances under 
which a capital restoration plan, or revisions to a plan already 
submitted, may be required.
     Beginning with the first call report submitted by a 
corporate three years after the date of the final rule, if the ratio of 
the corporate's retained earnings to moving daily average net assets is 
less than .45 percent, the corporate must prepare and submit to NCUA a 
retained earnings accumulation plan. The plan must explain how the 
corporate intends to accumulate earnings sufficient to meet the minimum 
leverage ratio requirements established by the rule within the time 
frames set forth in the rule.
     The proposal generally requires a corporate to obtain the 
prior approval of NCUA before permitting the early redemption of any 
contributed capital.
     The proposal requires a corporate to notify NCUA within 
fifteen days after any material event has occurred that would cause the 
corporate to be placed in a lower capital category from the category 
assigned to it on the basis of the corporate's most recent call report 
or report of examination.
    The NCUA estimates the burden associated with these capital and PCA 
information collections as follows.

[[Page 65256]]

    The new capital standards will apply uniformly to all twenty-eight 
corporates. NCUA estimates that approximately twenty corporates will be 
required to prepare new or revised capital restoration plans in the 
coming year, and that the effort to prepare or revise a plan will 
involve fifty hours: 20 corporates x 50 hours = 1,000 total hours.
    NCUA estimates that three corporates will be required to prepare 
retained earnings accumulation plans, and that the effort to prepare 
such a plan will involve fifty hours: 3 corporates x 50 hours = 150 
total hours.
    NCUA estimates ten corporates may have to notify NCUA about 
requests to redeem contributed capital, but that the burden of 
preparing and sending such a notice would be minimal: 10 corporates x 1 
hour = 10 hours.
    Similarly, NCUA anticipates that ten corporates may be required to 
notify NCUA about changes affecting their category under the prompt 
corrective action provisions of the rule; again, the burden of 
preparing the notice is minimal: 10 corporates x 1 hour = 10 hours.
Estimated PRA Burden: Investment Requirements
    With respect to investments, the proposal requires that at least 90 
percent of a corporate's investments have NRSRO ratings, increasing the 
associated PRA burden.
    The change applies to all corporates, and NCUA estimates that all 
twenty-eight will be required to acquire additional ratings as part of 
their due investment due diligence. This effort should entail a minimal 
expenditure of time: 28 corporates x 2 hours = 56 hours.
    Given the change in how NRSRO ratings are used, NCUA estimates that 
approximately ten corporates will encounter downgrades affecting their 
investments, which will trigger new investment action plans or amended 
investment action plans. Developing an investment action plan can take 
as much as twenty hours, with the following burden: 10 corporates x 20 
hours = 200 hours.
Estimated PRA Burden: ALM Requirements
    With respect to asset and liability management, the proposal 
requires new spread widening and net interest income testing, which are 
information collections. The additional testing, which must be done at 
least quarterly, will be required of and affect all corporates. The 
proposal also requires a corporate to calculate and record the 
effective and spread durations for individual assets and liabilities to 
support the test results. NCUA estimates that burden hours associated 
with compliance with this requirement would be as follows:
    28 corporates x 168 hours (total for the four new tests per year) = 
4,704 hours.
Estimated PRA Burden: New CUSO Procedures
    The current rule does not set out categories of approved CUSO 
activity for corporate CUSOs, but instead simply indicates that CUSOs 
must primarily serve credit unions and may engage in activity that is 
related to the business of credit unions. Under the proposal, a 
corporate will be required to obtain the approval from the NCUA for 
proposed CUSO activities, except for brokerage services and investment 
advisory services, which are specifically pre-approved. Once an 
activity has been approved, NCUA will publish that fact on its Web site 
and the activity will thereafter be considered pre-approved for other 
CUSOs. NCUA estimates that two hours will be sufficient for corporates 
to prepare approval requests, and NCUA anticipates that twelve such 
requests will be made.
Estimated PRA Burden: Corporate Governance Requirements
    With respect to corporate governance, the proposal requires:
     Corporates prepare and disseminate to members a disclosure 
document outlining the compensation arrangements for senior level 
employees.
     Merging corporates include certain compensation 
information in their filings with the NCUA and their notices to their 
members.
     Corporates obtain NCUA approval before making certain 
golden parachute payments.
    These information collections would apply to all twenty-eight 
corporates. NCUA estimates that compliance with the annual compensation 
disclosure requirement will take approximately ten hours: 28 corporates 
x 10 hours = 280 hours.
    NCUA estimates that four corporates will merge with other 
corporates each year, with another entity, and that preparing the 
required notice and disclosure forms will take 5 hours: 4 corporates x 
5 hours = 20 hours.
    NCUA also estimates that four corporates will need to solicit NCUA 
approval in advance of making a severance or golden parachute payment 
within the scope of the proposed rule, and that preparing the request 
for approval may take four hours: 4 corporates x 4 hours = 16 hours.
Summary of Collection Burden
    NCUA estimates the total information collection burden represented 
by the proposal, calculated on an annual basis, as follows:
    Capital restoration plans: 20 corporates x 50 hours = 1,000 hours.
    Retained earnings accumulation plans: 3 corporates x 50 hours = 150 
hours.
    Notice of intent to redeem contributed capital: 10 corporates x 1 
hour = 10 hours.
    Notice of PCA category change: 10 corporates x 1 hour = 10 hours.
    Ratings procurement: 28 corporates x 2 hours = 56 hours.
    Investment action plans: 10 corporates x 20 hours = 200 hours.
    ALM testing: 28 corporates x 168 hours = 4,704 hours.
    CUSO approval requests: 12 corporates x 2 hours = 24 hours.
    Compensation disclosures: 28 corporates x 10 hours = 280 hours.
    Merger related disclosures: 4 corporates x 5 hours = 20 hours.
    Requests to make golden parachute and severance payments: 4 
corporates x 4 hours = 16 hours.
    Total Burden Hours: 6,470 hours.
    NCUA previously estimated the burden associated with the current 
rule, and approved by OMB under control number 3133-0129, at about 
2,434 hours per corporate, and, for 31 corporates, a total burden of 
75,454 hours. The number of corporates has since dropped from 31 to 28, 
reducing the estimated burden under the current rule to about 68,152 
hours. As discussed above, the proposal would add about 6,470 hours to 
the current burden, bringing the total burden covered by OMB control 
number 3133-0129 to about 74,622 hours.
    NCUA does not anticipate that compliance with any of the new 
information collection aspects of the proposed rule will require that 
corporates purchase any additional equipment or hire any additional 
staff. Accordingly, existing maintenance and service costs to 
corporates are likewise unaffected, and there should be no additional 
depreciation expense, since all corporates should be able to implement 
the new requirements using existing systems, equipment, and personnel. 
The proposal may require some corporates to incur additional marginal 
costs associated with the enhanced ALM testing requirements, to the 
extent that they are not already conducting these tests, and a few 
corporates will incur additional expense

[[Page 65257]]

associated with obtaining required credit ratings for certain 
investments. NCUA estimates the labor cost associated with this 
compliance at approximately $50 per hour. Multiplying this figure by 
the number of additional hours estimated for these burden categories 
yields an additional financial burden associated with the proposed rule 
of $8,500 per corporate.
    The NCUA considers comments by the public on this proposed 
collection of information in:
     Evaluating whether the proposed collection of information 
is necessary for the proper performance of the functions of the NCUA, 
including whether the information will have a practical use;
     Evaluating the accuracy of the NCUA's estimate of the 
burden of the proposed collection of information, including the 
validity of the methodology and assumptions used;
     Enhancing the quality, usefulness, and clarity of the 
information to be collected; and
     Minimizing the burden of collection of information on 
those who are to respond, including through the use of appropriate 
automated, electronic, mechanical, or other technological collection 
techniques or other forms of information technology; e.g., permitting 
electronic submission of responses.
    The Paperwork Reduction Act requires OMB to make a decision 
concerning the collection of information contained in the proposed 
regulation between 30 and 60 days after publication of this document in 
the Federal Register. Therefore, a comment to OMB is best assured of 
having its full effect if OMB receives it within 30 days of 
publication. This does not affect the deadline for the public to 
comment to the NCUA on the proposed regulation.
    Comments should be sent to: Office of Information and Regulatory 
Affairs, OMB, New Executive Office Building, Washington, DC 20503; 
Attention: NCUA Desk Officer, with a copy to Mary Rupp, Secretary of 
the Board, National Credit Union Administration, 1775 Duke Street, 
Alexandria, Virginia 22314-3428.

IV.C. 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.'' NCUA has plenary 
statutory authority to regulate corporate credit unions. 12 U.S.C. 
1766(a). Further, the risk of loss to federally-insured credit unions 
and the NCUSIF due to corporate activities are concerns of national 
scope. The proposed rule, if adopted, would apply to all corporates 
that accept funds from federally-insured credit unions, including some 
state chartered credit unions. NCUA believes that the protection of 
corporate credit unions, federally-insured credit unions, and 
ultimately the NCUSIF, warrants application of the proposed rule to all 
corporates.
    The proposed rule does not impose additional costs or burdens on 
the states or affect the states' ability to discharge traditional state 
government functions. NCUA has determined that this proposal may have 
an occasional effect on the states, on the relationship between the 
national government and the states, or on the distribution of power and 
responsibilities among the various levels of government. However, the 
potential risk to the NCUSIF without the proposed changes justifies any 
such effects.

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

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

List of Subjects

12 CFR Part 702

    Credit unions, Reporting and recordkeeping requirements.

12 CFR Part 703

    Credit unions, Investments.

12 CFR Part 704

    Credit unions, Corporate credit unions, Reporting and recordkeeping 
requirements.

12 CFR Part 709

    Credit unions, Liquidations.

12 CFR Part 747

    Credit unions, Administrative practices and procedures.

    By the National Credit Union Administration Board on November 
19, 2009.
Mary F. Rupp,
Secretary of the Board.

    Accordingly, NCUA proposes to amend 12 CFR parts 702, 703, 704, 
709, and 747 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. Effective [DATE 12 MONTHS AFTER DATE OF PUBLICATION OF FINAL 
RULE IN THE FEDERAL REGISTER], revise paragraph (d) of Sec.  702.105 to 
read as follows:


Sec.  702.105  Weighted-average life of investments.

* * * * *
    (d) Capital in mixed-ownership Government corporations and 
corporate credit unions. For capital stock in mixed-ownership 
Government corporations, as defined in 31. U.S.C. 9101(2), and 
perpetual and nonperpetual contributed capital in corporate credit 
unions, as defined in 12 CFR 704.2, the weighted-average life is 
defined as greater than one (1) year, but less than or equal to three 
years;
* * * * *

PART 703--INVESTMENTS AND DEPOSIT ACTIVITIES

    3. The authority citation for part 703 continues to read as 
follows:

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

    4. Effective [DATE 12 MONTHS AFTER DATE OF PUBLICATION OF FINAL 
RULE IN THE FEDERAL REGISTER], revise paragraph (b) of Sec.  703.14 to 
read as follows:


Sec.  703.14  Permissible investments.

* * * * *
    (b) Corporate credit union shares or deposits. A Federal credit 
union may purchase shares or deposits in a corporate credit union, 
except where the NCUA Board has notified it that the corporate credit 
union is not operating in compliance with part 704 of this chapter. A 
Federal credit union's aggregate amount of perpetual and nonperpetual 
contributed capital, as defined in part 704 of this chapter, in one 
corporate credit union is limited to two percent of the federal credit 
union's assets measured at the time of investment or adjustment. A 
Federal credit union's aggregate amount of contributed capital in all 
corporate credit unions is limited to four percent

[[Page 65258]]

of assets measured at the time of investment or adjustment.
* * * * *

PART 704--CORPORATE CREDIT UNIONS

    5. The authority citation for part 704 continues to read as 
follows:

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

    6. Revise Sec.  704.2 to read as follows:


Sec.  704.2  Definitions.

    Adjusted trading means any method or transaction whereby a 
corporate credit union sells a security to a vendor at a price above 
its current market price and simultaneously purchases or commits to 
purchase from the vendor another security at a price above its current 
market price.
    Asset-backed security (ABS) means a security that is primarily 
serviced by the cashflows of a discrete pool of receivables or other 
financial assets, either fixed or revolving, that by their terms 
convert into cash within a finite time period plus any rights or other 
assets designed to assure the servicing or timely distribution of 
proceeds to the security holders. Mortgage-backed securities are a type 
of asset-backed security.
    Available to cover losses that exceed retained earnings means that 
the funds are available to cover operating losses realized, in 
accordance with generally accepted accounting principles (GAAP), by the 
corporate credit union that exceed retained earnings. Likewise, 
available to cover losses that exceed retained earnings and paid-in 
capital means that the funds are available to cover operating losses 
realized, in accordance with GAAP, by the corporate credit union that 
exceed retained earnings and perpetual contributed capital. Any such 
losses must be distributed pro rata at the time the loss is realized 
first among the holders of paid-in capital accounts (PIC), and when all 
PIC is exhausted, then pro rata among all membership capital accounts 
(MCAs), all subject to the optional prioritization described in 
Appendix A of this Part. To the extent that any contributed capital 
funds are used to cover losses, the corporate credit union must not 
restore or replenish the affected capital accounts under any 
circumstances. In addition, contributed capital that is used to cover 
losses in a fiscal year previous to the year of liquidation has no 
claim against the liquidation estate.
    Capital means the sum of a corporate credit union's retained 
earnings, paid-in capital, and membership capital. For a corporate 
credit union that acquires another credit union in a mutual 
combination, capital includes the retained earnings of the acquired 
credit union, or of an integrated set of activities and assets, at the 
point of acquisition.
    Capital ratio means the corporate credit union's capital divided by 
its moving daily average net assets.
    Collateralized debt obligation (CDO) means a debt security 
collateralized by mortgage-backed securities, asset-backed securities, 
or corporate obligations in the form of loans or debt. Senior tranches 
of Re-REMIC's consisting of senior mortgage- and asset-backed 
securities are excluded from this definition.
    Collateralized mortgage obligation (CMO) means a multi-class 
mortgage-backed security.
    Core capital means the sum of the corporate credit union's retained 
earnings and paid-in capital.
    Commercial mortgage-backed security (CMBS) means a mortgage-backed 
security collateralized primarily by multi-family and commercial 
property loans.
    Compensation means all salaries, fees, wages, bonuses, severance 
payments paid, current year contributions to employee benefit plans 
(for example, medical, dental, life insurance, and disability), current 
year contributions to deferred compensation plans and future severance 
payments, including payments in connection with a merger or similar 
combination (whether or not funded; whether or not vested; and whether 
or not the deferred compensation plan is a qualified plan under Section 
401(a) of the IRS Code). Compensation also includes expense accounts 
and other allowances (for example, the value of the personal use of 
housing, automobiles or other assets owned by the corporate credit 
union; expense allowances or reimbursements that recipients must report 
as income on their separate income tax return; payments made under 
indemnification arrangements; and payments made for the benefit of 
friends or relatives). In calculating required compensation 
disclosures, reasonable estimates may be used if precise cost figures 
are not readily available.
    Contributed capital means either paid-in capital or membership 
capital accounts.
    Core capital means the sum of:
    (1) Retained earnings as calculated under GAAP;
    (2) Paid-in capital; and
    (3) The retained earnings of any acquired credit union, or of an 
integrated set of activities and assets, calculated at the point of 
acquisition, if the acquisition was a mutual combination.
    Core capital ratio means the corporate credit union's core capital 
divided by its moving daily average net assets.
    Corporate credit union means an organization that:
    (1) Is chartered under Federal or state law as a credit union;
    (2) Receives shares from and provides loan services to credit 
unions;
    (3) Is operated primarily for the purpose of serving other credit 
unions;
    (4) Is designated by NCUA as a corporate credit union;
    (5) Limits natural person members to the minimum required by state 
or federal law to charter and operate the credit union; and
    (6) Does not condition the eligibility of any credit union to 
become a member on that credit union's membership in any other 
organization.
    Daily average net assets means the average of net assets calculated 
for each day during the period.
    Derivatives means a financial contract whose value is derived from 
the values of one or more underlying assets, reference rates, or 
indices of asset values or reference rates. Derivative contracts 
include interest rate derivative contracts, exchange rate derivative 
contracts, equity derivative contracts, commodity derivative contracts, 
credit derivative contracts, and any other instrument that poses 
similar counterparty credit risks.
    Dollar roll means the purchase or sale of a mortgage-backed 
security to a counterparty with an agreement to resell or repurchase a 
substantially identical security at a future date and at a specified 
price.
    Embedded option means a characteristic of certain assets and 
liabilities which gives the issuer of the instrument the ability to 
change the features such as final maturity, rate, principal amount and 
average life. Options include, but are not limited to, calls, caps, and 
prepayment options.
    Equity investments means investments in real property and equity 
securities.
    Equity security means any security representing an ownership 
interest in an enterprise (for example, common, preferred, or other 
capital stock) or the right to acquire (for example, warrants and call 
options) or dispose of (for example, put options) an ownership interest 
in an enterprise at fixed or determinable prices. However, the term 
does not include convertible debt or preferred stock that by its terms 
either must be redeemed by the issuing

[[Page 65259]]

enterprise or is redeemable at the option of the investor.
    Exchangeable collateralized mortgage obligation means a class of a 
collateralized mortgage obligation (CMO) that, at the time of purchase, 
represents beneficial ownership interests in a combination of two or 
more underlying classes of the same CMO structure. The holder of an 
exchangeable CMO may pay a fee and take delivery of the underlying 
classes of the CMO.
    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.
    Federal funds transaction means a short-term or open-ended 
unsecured transfer of immediately available funds by one depository 
institution to another depository institution or entity.
    Foreign bank means an institution which is organized under the laws 
of a country other than the United States, is engaged in the business 
of banking, and is recognized as a bank by the banking supervisory 
authority of the country in which it is organized.
    Immediate family member means a spouse or other family member 
living in the same household.
    Limited liquidity investment means a private placement or funding 
agreement.
    Member reverse repurchase transaction means an integrated 
transaction in which a corporate credit union purchases a security from 
one of its member credit unions under agreement by that member credit 
union to repurchase the same security at a specified time in the 
future. The corporate credit union then sells that same security, on 
the same day, to a third party, under agreement to repurchase it on the 
same date on which the corporate credit union is obligated to return 
the security to its member credit union.
    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-backed security (MBS) means a security backed by first or 
second mortgages secured by real estate upon which is located a 
dwelling, mixed residential and commercial structure, residential 
manufactured home, or commercial structure.
    Moving daily average net assets means the average of daily average 
net assets for the month being measured and the previous eleven (11) 
months.
    Mutual combination means a transaction or event in which a 
corporate credit union acquires another credit union, or acquires an 
integrated set of activities and assets that is capable of being 
conducted and managed as a credit union.
    Nationally Recognized Statistical Rating Organization (NRSRO) means 
any entity that has applied for, and been granted permission, to be 
considered an NRSRO by the United States Securities and Exchange 
Commission.
    NCUA means NCUA Board (Board), unless the particular action has 
been delegated by the Board.
    Net assets means total assets less loans guaranteed by the NCUSIF 
and member reverse repurchase transactions. For its own account, a 
corporate credit union's payables under reverse repurchase agreements 
and receivables under repurchase agreements may be netted out if the 
GAAP conditions for offsetting are met.
    Net economic value (NEV) means the fair value of assets minus the 
fair value of liabilities. All fair value calculations must include the 
value of forward settlements and embedded options. Paid-in capital, and 
the unamortized portion of membership capital, that is, the portion 
that qualifies as capital for purposes of any of the total capital 
ratio, is excluded from liabilities for purposes of this calculation. 
The NEV ratio is calculated by dividing NEV by the fair value of 
assets.
    Net interest margin security means a security collateralized by 
residual interests in collateralized mortgage obligations, residual 
interests in real estate mortgage investment conduits, or residual 
interests in other asset-backed securities.
    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.
    Official means any director or committee member.
    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.
    Pair-off transaction means a security purchase transaction that is 
closed out or sold at, or prior to, the settlement or expiration date.
    Quoted market price means a recent sales price or a price based on 
current bid and asked quotations.
    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.
    Residential properties means houses, condominiums, cooperative 
units, and manufactured homes. This definition does not include boats 
or motor homes, even if used as a primary residence, or timeshare 
properties.
    Residential mortgage-backed security (RMBS) means a mortgage-backed 
security collateralized primarily by residential mortgage loans.
    Residual interest means the ownership interest in 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 part, 
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. For a 
corporate credit union that acquires another credit union in a mutual 
combination, the numerator of the retained earnings ratio also includes 
the retained earnings of the acquired credit union, or of an integrated 
set of activities and assets, at the point of acquisition.

[[Page 65260]]

    Section 107(8) institution means an institution described in 
Section 107(8) of the Federal Credit Union Act (12 U.S.C. 1757(8)).
    Securities lending means lending a security to a counterparty, 
either directly or through an agent, and accepting collateral in 
return.
    Senior executive officer mean a chief executive officer, any 
assistant chief executive officer (e.g., any assistant president, any 
vice president or any assistant treasurer/manager), and the chief 
financial officer (controller). This term also includes employees of 
any entity hired to perform the functions described above.
    Settlement date means the date originally agreed to by a corporate 
credit union and a counterparty for settlement of the purchase or sale 
of a security.
    Short sale means the sale of a security not owned by the seller.
    Small business related security means a security as defined in 
section 3(a)(53) of the Securities Exchange Act of 1934 (15 U.S.C. 
78c(a)(53)), e.g., a security that is rated in 1 of the 4 highest 
rating categories by at least one nationally recognized statistical 
rating organization, and represents an interest in one or more 
promissory notes or leases of personal property evidencing the 
obligation of a small business concern and originated by an insured 
depository institution, insured credit union, insurance company, or 
similar institution which is supervised and examined by a Federal or 
State authority, or a finance company or leasing company. This 
definition does not include Small Business Administration securities 
permissible under Sec. 107(7) of the Act.
    State means any one of the several states of the United States of 
America, the District of Columbia, Puerto Rico, and the territories and 
possessions of the United States.
    Stripped mortgage-backed security means a security that represents 
either the principal-only or interest-only portion of the cash flows of 
an underlying pool of mortgages.
    Subordinated security means a security that has a junior claim on 
the underlying collateral or assets to other securities in the same 
issuance. If a security is junior only to money market fund eligible 
securities in the same issuance, the former security is not 
subordinated for purposes of this definition.
    Total assets means the sum of all a corporate credit union's assets 
as calculated under GAAP.
    Total capital means the sum of a corporate credit union's core 
capital and its membership capital accounts.
    Trade date means the date a corporate credit union originally 
agrees, whether orally or in writing, to enter into the purchase or 
sale of a security.
    Trigger means an event in a securitization that will redirect cash-
flows if predefined thresholds are breached. Examples of triggers are 
delinquency and cumulative loss triggers.
    Weighted average life means the weighted-average time to the return 
of a dollar of principal, calculated by multiplying each portion of 
principal received by the time at which it is expected to be received 
(based on a reasonable and supportable estimate of that time) and then 
summing and dividing by the total amount of principal.
    When-issued trading means the buying and selling of securities in 
the period between the announcement of an offering and the issuance and 
payment date of the securities.
    7. Effective [DATE 12 MONTHS AFTER PUBLICATION OF FINAL RULE IN THE 
FEDERAL REGISTER], revise Sec.  704.2 to read as follows:


Sec.  704.2  Definitions.

    Adjusted core capital means core capital modified as follows:
    (1) Deduct an amount equal to the amount of the corporate credit 
union's intangible assets that exceed one half percent of the corporate 
credit union's moving daily average net assets, but the NCUA, on its 
own initiative, upon petition by the applicable state regulator, or 
upon application from a corporate credit union, may direct that a 
particular corporate credit union add some or all of these excess 
intangibles back to the credit union's adjusted core capital;
    (2) Deduct investments, both equity and debt, in consolidated 
credit union service organizations (CUSOs);
    (3) If the corporate credit union, on or after [DATE 12 MONTHS 
AFTER DATE OF PUBLICATION OF FINAL RULE IN THE FEDERAL REGISTER], 
contributes new capital or renews an existing capital contribution to 
another corporate credit union, deduct an amount equal to the aggregate 
of such new or renewed capital;
    (4) Beginning on [DATE 72 MONTHS AFTER DATE OF PUBLICATION OF FINAL 
RULE IN THE FEDERAL REGISTER], and ending on [DATE 120 MONTHS AFTER 
DATE OF PUBLICATION OF FINAL RULE IN THE FEDERAL REGISTER], deduct any 
amount of perpetual contributed capital (PCC) that causes PCC minus 
retained earnings, all divided by moving daily net average assets, to 
exceed two percent; and
    (5) Beginning after [DATE 120 MONTHS AFTER DATE OF PUBLICATION OF 
FINAL RULE IN THE FEDERAL REGISTER], deduct any amount of PCC that 
causes PCC to exceed retained earnings.
    Adjusted total capital means total capital modified as follows: To 
the extent that nonperpetual contributed capital accounts are included 
in total capital, and the sum of those NCAs exceeds the aggregate of 
the corporate's PCC and retained earnings, the corporate will exclude 
the excess from adjusted total capital.
    Adjusted trading means any method or transaction whereby a 
corporate credit union sells a security to a vendor at a price above 
its current market price and simultaneously purchases or commits to 
purchase from the vendor another security at a price above its current 
market price.
    Applicable state regulator means the prudential state regulator of 
a state chartered corporate credit union.
    Asset-backed commercial paper program (ABCP program) means a 
program that primarily issues commercial paper that has received a 
credit rating from an NRSRO and that is backed by assets or other 
exposures held in a bankruptcy-remote special purpose entity. The term 
sponsor of an ABCP program means a corporate credit union that:
    (1) Establishes an ABCP program;
    (2) Approves the sellers permitted to participate in an ABCP 
program;
    (3) Approves the asset pools to be purchased by an ABCP program; or
    (4) Administers the ABCP program by monitoring the assets, 
arranging for debt placement, compiling monthly reports, or ensuring 
compliance with the program documents and with the program's credit and 
investment policy.
    Asset-backed security (ABS) means a security that is primarily 
serviced by the cashflows of a discrete pool of receivables or other 
financial assets, either fixed or revolving, that by their terms 
convert into cash within a finite time period plus any rights or other 
assets designed to assure the servicing or timely distribution of 
proceeds to the security holders. Mortgage-backed securities are a type 
of asset-backed security.
    Available to cover losses that exceed retained earnings means that 
the funds are available to cover operating losses realized, in 
accordance with generally accepted accounting principles (GAAP), by the 
corporate credit union that exceed retained earnings. Available to 
cover losses that exceed retained

[[Page 65261]]

earnings and perpetual contributed capital means that the funds are 
available to cover operating losses realized, in accordance with GAAP, 
by the corporate credit union that exceed retained earnings and 
perpetual contributed capital. Any such losses must be distributed pro 
rata at the time the loss is realized first among the holders of 
perpetual contributed capital accounts (PCC), and when all PCC is 
exhausted, then pro rata among all nonperpetual contributed capital 
accounts (NCAs), all subject to the optional prioritization described 
in Appendix A of this Part. To the extent that any contributed capital 
funds are used to cover losses, the corporate credit union must not 
restore or replenish the affected capital accounts under any 
circumstances. In addition, contributed capital that is used to cover 
losses in a fiscal year previous to the year of liquidation has no 
claim against the liquidation estate.
    Capital means the same as total capital, defined below.
    Capital ratio means the corporate credit union's capital divided by 
its moving daily average net assets.
    Collateralized debt obligation (CDO) means a debt security 
collateralized by mortgage-backed securities, asset-backed securities, 
or corporate obligations in the form of loans or debt. Senior tranches 
of Re-REMIC's consisting of senior mortgage- and asset-backed 
securities are excluded from this definition.
    Collateralized mortgage obligation (CMO) means a multi-class 
mortgage-backed security.
    Commercial mortgage-backed security (CMBS) means a mortgage-backed 
security collateralized primarily by multi-family and commercial 
property loans.
    Compensation means all salaries, fees, wages, bonuses, severance 
payments paid, current year contributions to employee benefit plans 
(for example, medical, dental, life insurance, and disability), current 
year contributions to deferred compensation plans and future severance 
payments, including payments in connection with a merger or similar 
combination (whether or not funded; whether or not vested; and whether 
or not the deferred compensation plan is a qualified plan under Section 
401(a) of the IRS Code). Compensation also includes expense accounts 
and other allowances (for example, the value of the personal use of 
housing, automobiles or other assets owned by the corporate credit 
union; expense allowances or reimbursements that recipients must report 
as income on their separate income tax return; payments made under 
indemnification arrangements; and payments made for the benefit of 
friends or relatives). In calculating required compensation 
disclosures, reasonable estimates may be used if precise cost figures 
are not readily available.
    Consolidated Credit Union Service Organization (Consolidated CUSO) 
means any corporation, partnership, business trust, joint venture, 
association or similar organization in which a corporate credit union 
directly or indirectly holds an ownership interest (as permitted by 
Sec.  704.11 of this Part) and the assets of which are consolidated 
with those of the corporate credit union for purposes of reporting 
under Generally Accepted Accounting Principles (GAAP). Generally, 
consolidated CUSOs are majority-owned CUSOs.
    Contributed capital means either perpetual or nonperpetual 
contributed capital.
    Core capital means the sum of:
    (1) Retained earnings as calculated under GAAP;
    (2) Perpetual contributed capital;
    (3) The retained earnings of any acquired credit union, or of an 
integrated set of activities and assets, calculated at the point of 
acquisition, if the acquisition was a mutual combination; and
    (4) Minority interests in the equity accounts of CUSOs that are 
fully consolidated. However, minority interests in consolidated ABCP 
programs sponsored by a corporate credit union are excluded from the 
credit unions' core capital or total capital base if the corporate 
credit union excludes the consolidated assets of such programs from 
risk-weighted assets pursuant to Appendix C of this Part.
    Core capital ratio means the corporate credit union's core capital 
divided by its moving daily average net assets.
    Corporate credit union means an organization that:
    (1) Is chartered under Federal or state law as a credit union;
    (2) Receives shares from and provides loan services to credit 
unions;
    (3) Is operated primarily for the purpose of serving other credit 
unions;
    (4) Is designated by NCUA as a corporate credit union;
    (5) Limits natural person members to the minimum required by state 
or federal law to charter and operate the credit union; and
    (6) Does not condition the eligibility of any credit union to 
become a member on that credit union's membership in any other 
organization.
    Credit-enhancing interest-only strip means an on-balance sheet 
asset that, in form or in substance:
    (1) Represents the contractual right to receive some or all of the 
interest due on transferred assets; and
    (2) Exposes the corporate credit union to credit risk directly or 
indirectly associated with the transferred assets that exceeds its pro 
rata share of the corporate credit union's claim on the assets whether 
through subordination provisions or other credit enhancement 
techniques.
    NCUA reserves the right to identify other cash flows or related 
interests as a credit-enhancing interest-only strip. In determining 
whether a particular interest cash flow functions as a credit-enhancing 
interest-only strip, NCUA will consider the economic substance of the 
transaction.
    Daily average net assets means the average of net assets calculated 
for each day during the period.
    Daily average net risk-weighted assets means the average of net 
risk-weighted assets calculated for each day during the period.
    Derivatives means a financial contract whose value is derived from 
the values of one or more underlying assets, reference rates, or 
indices of asset values or reference rates. Derivative contracts 
include interest rate derivative contracts, exchange rate derivative 
contracts, equity derivative contracts, commodity derivative contracts, 
credit derivative contracts, and any other instrument that poses 
similar counterparty credit risks.
    Dollar roll means the purchase or sale of a mortgage-backed 
security to a counterparty with an agreement to resell or repurchase a 
substantially identical security at a future date and at a specified 
price.
    Eligible ABCP liquidity facility means a legally binding commitment 
to provide liquidity support to asset-backed commercial paper by 
lending to, or purchasing assets from any structure, program or conduit 
in the event that funds are required to repay maturing asset-backed 
commercial paper and that meets the following criteria:
    (1)(i) At the time of the draw, the liquidity facility must be 
subject to an asset quality test that precludes funding against assets 
that are 90 days or more past due or in default; and
    (ii) If the assets that the liquidity facility is required to fund 
against are assets or exposures that have received a credit rating by a 
Nationally Recognized Statistical Rating Organization (NRSRO) at the 
time the inception of the facility, the facility can be used to fund 
only those assets or exposures that are rated investment grade by an 
NRSRO at the time of funding; or

[[Page 65262]]

    (2) If the assets that are funded under the liquidity facility do 
not meet the criteria described in paragraph (1) of this definition, 
the assets must be guaranteed, conditionally or unconditionally, by the 
United States Government, its agencies, or the central government of an 
Organization for Economic Cooperation and Development OECD country.
    Embedded option means a characteristic of certain assets and 
liabilities which gives the issuer of the instrument the ability to 
change the features such as final maturity, rate, principal amount and 
average life. Options include, but are not limited to, calls, caps, and 
prepayment options.
    Equity investment means an investment in real property and equity 
securities.
    Equity security means any security representing an ownership 
interest in an enterprise (for example, common, preferred, or other 
capital stock) or the right to acquire (for example, warrants and call 
options) or dispose of (for example, put options) an ownership interest 
in an enterprise at fixed or determinable prices. However, the term 
does not include convertible debt or preferred stock that by its terms 
either must be redeemed by the issuing enterprise or is redeemable at 
the option of the investor.
    Exchangeable collateralized mortgage obligation means a class of a 
collateralized mortgage obligation (CMO) that, at the time of purchase, 
represents beneficial ownership interests in a combination of two or 
more underlying classes of the same CMO structure. The holder of an 
exchangeable CMO may pay a fee and take delivery of the underlying 
classes of the CMO.
    Fair value means the amount at which an instrument could be 
exchanged in a current, arm's-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.
    Federal funds transaction means a short-term or open-ended 
unsecured transfer of immediately available funds by one depository 
institution to another depository institution or entity.
    Foreign bank means an institution which is organized under the laws 
of a country other than the United States, is engaged in the business 
of banking, and is recognized as a bank by the banking supervisory 
authority of the country in which it is organized.
    Immediate family member means a spouse or other family member 
living in the same household.
    Intangible assets means assets considered to be intangible assets 
under GAAP. These assets include, but are not limited to, core deposit 
premiums, purchased credit card relationships, favorable leaseholds, 
and servicing assets (mortgage and non-mortgage). Interest-only strips 
receivable are not intangible assets under this definition.
    Leverage ratio means, before [DATE 36 MONTHS AFTER DATE OF 
PUBLICATION OF FINAL RULE IN THE FEDERAL REGISTER], the ratio of 
adjusted total capital to moving daily average net assets.
    Leverage ratio means, on or after [DATE 36 MONTHS AFTER DATE OF 
PUBLICATION OF FINAL RULE IN THE FEDERAL REGISTER], the ratio of 
adjusted core capital to moving daily average net assets.
    Limited liquidity investment means a private placement or funding 
agreement.
    Member reverse repurchase transaction means an integrated 
transaction in which a corporate credit union purchases a security from 
one of its member credit unions under agreement by that member credit 
union to repurchase the same security at a specified time in the 
future. The corporate credit union then sells that same security, on 
the same day, to a third party, under agreement to repurchase it on the 
same date on which the corporate credit union is obligated to return 
the security to its member credit union.
    Mortgage-backed security (MBS) means a security backed by first or 
second mortgages secured by real estate upon which is located a 
dwelling, mixed residential and commercial structure, residential 
manufactured home, or commercial structure.
    Moving daily average net assets means the average of daily average 
net assets for the month being measured and the previous eleven (11) 
months.
    Moving daily average net risk-weighted assets means the average of 
daily average net assets risk-weighted for the month being measured and 
the previous eleven (11) months.
    Mutual combination means a transaction or event in which a 
corporate credit union acquires another credit union, or acquires an 
integrated set of activities and assets that is capable of being 
conducted and managed as a credit union.
    Nationally Recognized Statistical Rating Organization (NRSRO) means 
any entity that has applied for, and been granted permission, to be 
considered an NRSRO by the United States Securities and Exchange 
Commission.
    NCUA means NCUA Board (Board), unless the particular action has 
been delegated by the Board.
    Net assets means total assets less loans guaranteed by the NCUSIF 
and member reverse repurchase transactions. For its own account, a 
corporate credit union's payables under reverse repurchase agreements 
and receivables under repurchase agreements may be netted out if the 
GAAP conditions for offsetting are met. Also, any amounts deducted from 
core capital in calculating adjusted core capital are also deducted 
from net assets.
    Net economic value (NEV) means the fair value of assets minus the 
fair value of liabilities. All fair value calculations must include the 
value of forward settlements and embedded options. Perpetual 
contributed capital, and the unamortized portion of nonperpetual 
contributed capital that is, the portion that qualifies as capital for 
purposes of any of the minimum capital ratios, is excluded from 
liabilities for purposes of this calculation. The NEV ratio is 
calculated by dividing NEV by the fair value of assets.
    Net interest margin security means a security collateralized by 
residual interests in collateralized mortgage obligations, residual 
interests in real estate mortgage investment conduits, or residual 
interests in other asset-backed securities.
    Net risk-weighted assets means risk-weighted assets less Central 
Liquidity Facility (CLF) stock subscriptions, CLF loans guaranteed by 
the NCUSIF, U.S. Central CLF certificates, and member reverse 
repurchase transactions. For its own account, a corporate credit 
union's payables under reverse repurchase agreements and receivables 
under repurchase agreements may be netted out if the GAAP conditions 
for offsetting are met. Also, any amounts deducted from core capital in 
calculating adjusted core capital are also deducted from net risk-
weighted assets.
    Nonperpetual capital means funds contributed by members or 
nonmembers

[[Page 65263]]

that: are term certificates with a minimum term of five years or that 
have an indefinite term (i.e., no maturity) with a minimum withdrawal 
notice of five years; are available to cover losses that exceed 
retained earnings and perpetual contributed capital; are not insured by 
the NCUSIF or other share or deposit insurers; and cannot be pledged 
against borrowings. In the event the corporate is liquidated, the 
holders of nonperpetual capital accounts (NCAs) will claim equally. 
These claims will be subordinate to all other claims (including NCUSIF 
claims), except that any claims by the holders of perpetual contributed 
capital (PCC) will be subordinate to the claims of holders of NCAs.
    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.
    Official means any director or committee member.
    Pair-off transaction means a security purchase transaction that is 
closed out or sold at, or prior to, the settlement or expiration date.
    Perpetual contributed capital (PCC) 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. In the 
event the corporate is liquidated, any claims made by the holders of 
perpetual contributed capital will be subordinate to all other claims 
(including NCUSIF claims).
    Quoted market price means a recent sales price or a price based on 
current bid and asked quotations.
    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.
    Residential properties means houses, condominiums, cooperative 
units, and manufactured homes. This definition does not include boats 
or motor homes, even if used as a primary residence, or timeshare 
properties.
    Residential mortgage-backed security (RMBS) means a mortgage-backed 
security collateralized primarily by residential mortgage loans.
    Residual interest means the ownership interest in 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 part, 
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.
    Risk-weighted assets means a corporate credit union's risk-weighted 
assets as calculated in accordance with Appendix C of this part.
    Section 107(8) institution means an institution described in 
Section 107(8) of the Federal Credit Union Act (12 U.S.C. 1757(8)).
    Securities lending means lending a security to a counterparty, 
either directly or through an agent, and accepting collateral in 
return.
    Securitization means the pooling and repackaging by a special 
purpose entity of assets or other credit exposures that can be sold to 
investors. Securitization includes transactions that create stratified 
credit risk positions whose performance is dependent upon an underlying 
pool of credit exposures, including loans and commitments.
    Senior executive officer mean a chief executive officer, any 
assistant chief executive officer (e.g., any assistant president, any 
vice president or any assistant treasurer/manager), and the chief 
financial officer (controller). This term also includes employees of 
any entity hired to perform the functions described above.
    Settlement date means the date originally agreed to by a corporate 
credit union and a counterparty for settlement of the purchase or sale 
of a security.
    Short sale means the sale of a security not owned by the seller.
    Small business related security means a security as defined in 
section 3(a)(53) of the Securities Exchange Act of 1934 (15 U.S.C. 
78c(a)(53)), e.g., a security that is rated in 1 of the 4 highest 
rating categories by at least one nationally recognized statistical 
rating organization, and represents an interest in one or more 
promissory notes or leases of personal property evidencing the 
obligation of a small business concern and originated by an insured 
depository institution, insured credit union, insurance company, or 
similar institution which is supervised and examined by a Federal or 
State authority, or a finance company or leasing company. This 
definition does not include Small Business Administration securities 
permissible under Sec. 107(7) of the Act.
    State means any one of the several states of the United States of 
America, the District of Columbia, Puerto Rico, and the territories and 
possessions of the United States.
    Stripped mortgage-backed security means a security that represents 
either the principal-only or interest-only portion of the cash flows of 
an underlying pool of mortgages.
    Subordinated security means a security that has a junior claim on 
the underlying collateral or assets to other securities in the same 
issuance. If a security is junior only to money market fund eligible 
securities in the same issuance, the former security is not 
subordinated for purposes of this definition.
    Supplementary Capital means the sum of the following items:
    (1) Nonperpetual capital accounts, as amortized under Sec.  
704.3(b)(3);
    (2) Allowance for loan and lease losses calculated under GAAP to a 
maximum of 1.25 percent of risk-weighted assets; and
    (3) Forty-five percent of unrealized gains on available-for-sale 
equity securities with readily determinable fair values. Unrealized 
gains are unrealized holding gains, net of unrealized holding losses, 
calculated as the amount, if any, by which fair value exceeds 
historical cost. The NCUA may disallow such inclusion in the 
calculation of supplementary capital if the NCUA determines that the 
securities are not prudently valued.
    Tier 1 capital means adjusted core capital.
    Tier 2 capital means supplementary capital.
    Tier 1 risk-based capital ratio means the ratio of Tier 1 capital 
to the moving daily average net risk-weighted assets.
    Total assets means the sum of all a corporate credit union's assets 
as calculated under GAAP.
    Total capital means the sum of a corporate credit union's adjusted 
core capital and its supplementary capital, less the corporate credit 
union's equity investments not otherwise deducted when calculating 
adjusted core capital.
    Total risk-based capital ratio means the ratio of total capital to 
moving daily net risk-weighted assets.
    Trade date means the date a corporate credit union originally 
agrees, whether orally or in writing, to enter into the purchase or 
sale of a security.
    Trigger means an event in a securitization that will redirect cash-
flows if predefined thresholds are breached. Examples of triggers are

[[Page 65264]]

delinquency and cumulative loss triggers.
    Weighted average life means the weighted-average time to the return 
of a dollar of principal, calculated by multiplying each portion of 
principal received by the time at which it is expected to be received 
(based on a reasonable and supportable estimate of that time) and then 
summing and dividing by the total amount of principal.
    When-issued trading means the buying and selling of securities in 
the period between the announcement of an offering and the issuance and 
payment date of the securities.
    8. Effective [DATE 12 MONTHS AFTER DATE OF PUBLICATION OF FINAL 
RULE IN THE FEDERAL REGISTER], revise Sec.  704.3 to read as follows:


Sec.  704.3  Corporate credit union capital.

    (a) Capital requirements. (1) A corporate credit union must 
maintain at all times:
    (i) A leverage ratio of 4.0 percent or greater;
    (ii) A Tier 1 risk-based capital ratio of 4.0 percent or greater; 
and
    (iii) A total risk-based capital ratio of 8.0 percent or greater.
    (2) To ensure it meets its capital requirements, a corporate credit 
union must develop and ensure implementation of written short- and 
long-term capital goals, objectives, and strategies which provide for 
the building of capital consistent with regulatory requirements, the 
maintenance of sufficient capital to support the risk exposures that 
may arise from current and projected activities, and the periodic 
review and reassessment of the capital position of the corporate credit 
union.
    (3) Beginning with the first call report submitted on or after 
[DATE 36 MONTHS AFTER DATE OF PUBLICATION OF THE FINAL RULE IN THE 
FEDERAL REGISTER], a corporate credit union must calculate and report 
to NCUA the ratio of its retained earnings to its moving daily average 
net assets. If this ratio is less than 0.45 percent, the corporate 
credit union must, within 30 days, submit a retained earnings 
accumulation plan to the NCUA for NCUA's approval. The plan must 
contain a detailed explanation of how the corporate credit union will 
accumulate earnings sufficient to meet all its future minimum leverage 
ratio requirements, including specific semiannual milestones for 
accumulating retained earnings. If the corporate credit union fails to 
submit a plan acceptable to NCUA, or fails to comply with any element 
of a plan approved by NCUA, the corporate will immediately be 
classified as significantly undercapitalized or, if already 
significantly undercapitalized, as critically undercapitalized. The 
corporate credit union will be subject to all the associated prompt 
corrective actions under Sec.  704.4.
    (b) Requirements for nonperpetual contributed capital accounts 
(NCA)--(1) Form. NCA funds may be in the form of a term certificate or 
a no-maturity notice account.
    (2) Disclosure. The terms and conditions of a nonperpetual 
contributed 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 NCA 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 all entities with NCAs. The 
certification must be maintained in the corporate credit union's files 
and be available for examiner review.
    (3) Five-year remaining maturity. When a no-maturity NCA has been 
placed on notice, or a term account has a remaining maturity of less 
than five years, the corporate will reduce the amount of the account 
that can be considered as nonperpetual contributed capital by a 
constant monthly amortization that ensures the 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 an NCA being amortized, 
not just the remaining non-amortized portion, is available to absorb 
losses in excess of the sum of retained earnings and perpetual 
contributed 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. Nonperpetual contributed capital may not be released 
due solely to the merger, charter conversion, or liquidation of the 
account holder. In the event of a merger, the capital account transfers 
to the continuing entity. In the event of a charter conversion, the 
capital account transfers to the new institution. In the event of 
liquidation, the corporate may release a member capital account to 
facilitate the payout of shares, but only with the prior written 
approval of the NCUA.
    (5) Redemption. A corporate credit union may redeem NCAs prior to 
maturity or prior to the end of the notice period only with the prior 
approval of the NCUA and, for state chartered corporate credit unions, 
the approval of the appropriate state regulator.
    (6) Sale. A member may transfer its interest in a nonperpetual 
contributed capital account to a third party member or nonmember.
    (7) Merger. In the event of a merger of a corporate credit union, 
nonperpetual capital will transfer to the continuing corporate credit 
union. The minimum five-year notice period for withdrawal of no-
maturity capital remains in effect.
    (c) Requirements for perpetual contributed capital (PCC)--(1) 
Disclosure. The terms and conditions of any perpetual contributed 
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. Perpetual contributed 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 perpetual contributed 
capital transfers to the continuing credit union. In the event of a 
charter conversion, the perpetual contributed capital transfers to the 
new institution. In the event of liquidation, the perpetual contributed 
capital may be released to facilitate the payout of shares with NCUA's 
prior written approval.
    (3) Callability. A corporate credit union may call perpetual 
contributed capital instruments only with the prior approval of the 
NCUA and, for state chartered corporate credit unions, the applicable 
state regulator. Perpetual contributed capital accounts are callable on 
a pro-rata basis across an issuance class.
    (4) Perpetual contributed capital. PA corporate credit union may 
issue perpetual contributed capital to both members and nonmembers.
    (5) The holder of a PCC instrument may freely transfer its 
interests in the instrument to a third party member or nonmember.
    (d) Individual minimum capital requirements.
    (1) General. The rules and procedures specified in this paragraph 
apply to the establishment of an individual minimum capital requirement 
for a corporate credit union that varies from any of the risk-based 
capital requirement(s) or leverage ratio requirements that would 
otherwise apply to the corporate credit union under this part.

[[Page 65265]]

    (2) Appropriate considerations for establishing individual minimum 
capital requirements. Minimum capital levels higher than the risk-based 
capital requirements or the leverage ratio requirement under this part 
may be appropriate for individual corporate credit unions. The NCUA may 
establish increased individual minimum capital requirements, including 
modification of the minimum capital requirements related to being 
either significantly and critically undercapitalized for purposes of 
Sec.  704.4 of this part, upon a determination that the corporate 
credit union's capital is or may become inadequate in view of the 
credit union's circumstances. For example, higher capital levels may be 
appropriate when NCUA determines that:
    (i) A corporate credit union is receiving special supervisory 
attention;
    (ii) A corporate credit union has or is expected to have losses 
resulting in capital inadequacy;
    (iii) A corporate credit union has a high degree of exposure to 
interest rate risk, prepayment risk, credit risk, concentration risk, 
certain risks arising from nontraditional activities or similar risks, 
or a high proportion of off-balance sheet risk including standby 
letters of credit;
    (iv) A corporate credit union has poor liquidity or cash flow;
    (v) A corporate credit union is growing, either internally or 
through acquisitions, at such a rate that supervisory problems are 
presented that are not dealt with adequately by other NCUA regulations 
or other guidance;
    (vi) A corporate credit union may be adversely affected by the 
activities or condition of its CUSOs or other persons or entities with 
which it has significant business relationships, including 
concentrations of credit;
    (vii) A corporate credit union with a portfolio reflecting weak 
credit quality or a significant likelihood of financial loss, or has 
loans or securities in nonperforming status or on which borrowers fail 
to comply with repayment terms;
    (viii) A corporate credit union has inadequate underwriting 
policies, standards, or procedures for its loans and investments;
    (ix) A corporate credit union has failed to properly plan for, or 
execute, necessary retained earnings growth, or
    (ix) A corporate credit union has a record of operational losses 
that exceeds the average of other, similarly situated corporate credit 
unions; has management deficiencies, including failure to adequately 
monitor and control financial and operating risks, particularly the 
risks presented by concentrations of credit and nontraditional 
activities; or has a poor record of supervisory compliance.
    (3) Standards for determination of appropriate individual minimum 
capital requirements. The appropriate minimum capital levels for an 
individual corporate credit union cannot be determined solely through 
the application of a rigid mathematical formula or wholly objective 
criteria. The decision is necessarily based, in part, on subjective 
judgment grounded in agency expertise. The factors to be considered in 
NCUA's determination will vary in each case and may include, for 
example:
    (i) The conditions or circumstances leading to the determination 
that a higher minimum capital requirement is appropriate or necessary 
for the corporate credit union;
    (ii) The exigency of those circumstances or potential problems;
    (iii) The overall condition, management strength, and future 
prospects of the corporate credit union and, if applicable, its 
subsidiaries, affiliates, and business partners;
    (iv) The corporate credit union's liquidity, capital and other 
indicators of financial stability, particularly as compared with those 
of similarly situated corporate credit unions; and
    (v) The policies and practices of the corporate credit union's 
directors, officers, and senior management as well as the internal 
control and internal audit systems for implementation of such adopted 
policies and practices.
    (4) Procedures--(i) In the case of a state chartered corporate 
credit union, NCUA will consult with the appropriate state regulator 
when considering imposing a new minimum capital requirement.
    (ii) When the NCUA determines that a minimum capital requirement is 
necessary or appropriate for a particular corporate credit union, it 
will notify the corporate credit union in writing of its proposed 
individual minimum capital requirement; the schedule for compliance 
with the new requirement; and the specific causes for determining that 
the higher individual minimum capital requirement is necessary or 
appropriate for the corporate credit union. The NCUA shall forward the 
notifying letter to the appropriate state supervisor if a state-
chartered corporate credit union would be subject to an individual 
minimum capital requirement.
    (iii) The corporate credit union's response must include any 
information that the credit union wants the NCUA to consider in 
deciding whether to establish or to amend an individual minimum capital 
requirement for the corporate credit union, what the individual capital 
requirement should be, and, if applicable, what compliance schedule is 
appropriate for achieving the required capital level. The responses of 
the corporate credit union and appropriate state supervisor must be in 
writing and must be delivered to the NCUA within 30 days after the date 
on which the notification was received. The NCUA may extend the time 
period for good cause. The time period for response by the insured 
corporate credit union may be shortened for good cause:
    (A) When, in the opinion of the NCUA, the condition of the 
corporate credit union so requires, and the NCUA informs the corporate 
credit union of the shortened response period in the notice;
    (B) With the consent of the corporate credit union; or
    (C) When the corporate credit union already has advised the NCUA 
that it cannot or will not achieve its applicable minimum capital 
requirement.
    (iv) Failure by the corporate credit union to respond within 30 
days, or such other time period as may be specified by the NCUA, may 
constitute a waiver of any objections to the proposed individual 
minimum capital requirement or to the schedule for complying with it, 
unless the NCUA has provided an extension of the response period for 
good cause.
    (v) After expiration of the response period, the NCUA will decide 
whether or not the proposed individual minimum capital requirement 
should be established for the corporate credit union, or whether that 
proposed requirement should be adopted in modified form, based on a 
review of the corporate credit union's response and other relevant 
information. The NCUA's decision will address comments received within 
the response period from the corporate credit union and the appropriate 
state supervisor (if a state-chartered corporate credit union is 
involved) and will state the level of capital required, the schedule 
for compliance with this requirement, and any specific remedial action 
the corporate credit union could take to eliminate the need for 
continued applicability of the individual minimum capital requirement. 
The NCUA will provide the corporate credit union and the appropriate 
state supervisor (if a state-chartered corporate credit union is 
involved) with a written decision on the individual minimum capital 
requirement, addressing the substantive comments made by the corporate 
credit union and setting forth the decision and the basis for that 
decision. Upon receipt of this decision by the corporate credit

[[Page 65266]]

union, the individual minimum capital requirement becomes effective and 
binding upon the corporate credit union. This decision represents final 
agency action.
    (4) Failure to comply. Failure to satisfy any individual minimum 
capital requirement, or to meet any required incremental additions to 
capital under a schedule for compliance with such an individual minimum 
capital requirement, will constitute a basis to take action as 
described in Sec.  704.4.
    (5) Change in circumstances. If, after a decision is made under 
paragraph (b)(3)(iv) of this section, there is a change in the 
circumstances affecting the corporate credit union's capital adequacy 
or its ability to reach its required minimum capital level by the 
specified date, the NCUA may amend the individual minimum capital 
requirement or the corporate credit union's schedule for such 
compliance. The NCUA may decline to consider a corporate credit union's 
request for such changes that are not based on a significant change in 
circumstances or that are repetitive or frivolous. Pending the NCUA's 
reexamination of the original decision, that original decision and any 
compliance schedule established in that decision will continue in full 
force and effect.
    (e) Reservation of authority.
    (1) Transactions for purposes of evasion. The NCUA may disregard 
any transaction entered into primarily for the purpose of reducing the 
minimum required amount of regulatory capital or otherwise evading the 
requirements of this section.
    (2) Period-end versus average figures. The NCUA reserves the right 
to require a corporate credit union to compute its capital ratios on 
the basis of period-end, rather than average, assets when the NCUA 
determines appropriate to carry out the purposes of this part.
    (3) Reservation of authority. (i) Notwithstanding the definitions 
of core and supplementary capital in paragraph (d) of this section, the 
NCUA may find that a particular asset or core or supplementary capital 
component has characteristics or terms that diminish its contribution 
to a corporate credit union's ability to absorb losses, and the NCUA 
may require the discounting or deduction of such asset or component 
from the computation of core, supplementary, or total capital.
    (ii) Notwithstanding Appendix C of this Part, the NCUA will look to 
the substance of a transaction and may find that the assigned risk-
weight for any asset, or credit equivalent amount or credit conversion 
factor for any off-balance sheet item does not appropriately reflect 
the risks imposed on the corporate credit union. The NCUA may require 
the corporate credit union to apply another risk-weight, credit 
equivalent amount, or credit conversion factor that NCUA deems 
appropriate.
    (iii) If Appendix C does not specifically assign a risk-weight, 
credit equivalent amount, or credit conversion factor to a particular 
asset or activity of the corporate credit union, the NCUA may assign 
any risk-weight, credit equivalent amount, or credit conversion factor 
that it deems appropriate. In making this determination, NCUA will 
consider the risks associated with the asset or off-balance sheet item 
as well as other relevant factors.
    (4) Where practicable, the NCUA will consult with the appropriate 
state regulator before taking any action under this paragraph (e) that 
involves a state chartered corporate credit union.


Sec.  704.4  [Redesignated as Sec.  704.13]

    9. Redesignate Sec.  704.4, Board responsibilities, as Sec.  
704.13.
    10. Effective [DATE 12 MONTHS AFTER THE DATE OF PUBLICATION OF THE 
FINAL RULE IN THE FEDERAL REGISTER], add a new Sec.  704.4 to read as 
follows:


Sec.  704.4  Prompt Corrective Action.

    (a) Purpose. The principal purpose of this section is to define, 
for corporate credit unions that are not adequately capitalized, the 
capital measures and capital levels that are used for determining 
appropriate supervisory actions. This section establishes procedures 
for submission and review of capital restoration plans and for issuance 
and review of capital directives, orders, and other supervisory 
directives. In the case of a state-chartered corporate credit union, 
NCUA will consult with, and seek to work cooperatively with, the 
appropriate state regulator before taking any discretionary actions 
under this section.
    (b) Scope. This section applies to corporate credit unions, 
including officers, directors, and employees.
    (1) This section does not limit the authority of NCUA in any way to 
take supervisory actions to address unsafe or unsound practices, 
deficient capital levels, violations of law, unsafe or unsound 
conditions, or other practices. The NCUA may take action under this 
section independently of, in conjunction with, or in addition to any 
other enforcement action available to the NCUA, including issuance of 
cease and desist orders, approval or denial of applications or notices, 
assessment of civil money penalties, or any other actions authorized by 
law.
    (2) Unless permitted by the NCUA or otherwise required by law, no 
corporate credit union may state in any advertisement or promotional 
material its capital category under this part or that the NCUA has 
assigned the corporate credit union to a particular category.
    (3) Any group of credit unions applying for a new corporate credit 
union charter will submit, as part of the charter application, a 
detailed draft plan for soliciting contributed capital and building 
retained earnings. The draft plan will include specific levels of 
contributed capital and retained earnings and the anticipated 
timeframes for achieving those levels. The Board will review the draft 
plan and modify it as necessary. If the Board approves the plan, the 
Board will include any necessary waivers of this section or part.
    (c) Notice of capital category. (1) Effective date of determination 
of capital category. A corporate credit union will be deemed to be 
within a given capital category as of the most recent date:
    (i) A 5310 Financial Report is required to be filed with the NCUA;
    (ii) A final NCUA report of examination is delivered to the 
corporate credit union; or
    (iii) Written notice is provided by the NCUA to the corporate 
credit union that its capital category has changed as provided in 
paragraphs (c)(2) or (d)(3) of this section.
    (2) Adjustments to reported capital levels and category--
    (i) Notice of adjustment by corporate credit union. A corporate 
credit union must provide the NCUA with written notice that an 
adjustment to the corporate credit union's capital category may have 
occurred no later than 15 calendar days following the date that any 
material event has occurred that would cause the corporate credit union 
to be placed in a lower capital category from the category assigned to 
the corporate credit union for purposes of this section on the basis of 
the corporate credit union's most recent call report or report of 
examination.
    (ii) Determination by the NCUA to change capital category. After 
receiving notice pursuant to paragraph (c)(1) of this section, or on 
its own initiative, the NCUA will determine whether to change the 
capital category of the corporate credit union and will notify the 
corporate credit union of the NCUA's determination.
    (d) Capital measures and capital category definitions. (1) Capital

[[Page 65267]]

measures. For purposes of this section, the relevant capital measures 
are:
    (i) The total risk-based capital ratio;
    (ii) The Tier 1 risk-based capital ratio; and
    (iii) The leverage ratio.
    (2) Capital categories. For purposes of this section, a corporate 
credit union is:
    (i) Well capitalized if the corporate credit union:
    (A) Has a total risk-based capital ratio of 10.0 percent or 
greater; and
    (B) Has a Tier 1 risk-based capital ratio of 6.0 percent or 
greater; and
    (C) Has a leverage ratio of 5.0 percent or greater; and
    (D) Is not subject to any written agreement, order, capital 
directive, or prompt corrective action directive issued by NCUA to meet 
and maintain a specific capital level for any capital measure.
    (ii) Adequately capitalized if the corporate credit union:
    (A) Has a total risk-based capital ratio of 8.0 percent or greater; 
and
    (B) Has a Tier 1 risk-based capital ratio of 4.0 percent or 
greater; and
    (C) Has:
    (1)A leverage ratio of 4.0 percent or greater; and
    (2) Does not meet the definition of a well capitalized corporate 
credit union.
    (iii) Undercapitalized if the corporate credit union:
    (A) Has a total risk-based capital ratio that is less than 8.0 
percent; or
    (B) Has a Tier 1 risk-based capital ratio that is less than 4.0 
percent; or
    (C) Has a leverage ratio that is less than 4.0 percent.
    (iv) Significantly undercapitalized if the corporate credit union 
has:
    (A) A total risk-based capital ratio that is less than 6.0 percent; 
or
    (B) A Tier 1 risk-based capital ratio that is less than 3.0 
percent; or
    (C) A leverage ratio that is less than 3.0 percent.
    (v) Critically undercapitalized if the corporate credit union has:
    (A) A total risk-based capital ratio that is less than 4.0 percent; 
or
    (B) A Tier 1 risk-based capital ratio that is less than 2.0 
percent; or
    (C) A leverage ratio that is less than 2.0 percent.
    (3) Reclassification based on supervisory criteria other than 
capital. Notwithstanding the elements of paragraph (d)(2) of this 
section, the NCUA may reclassify a well capitalized corporate credit 
union as adequately capitalized, and may require an adequately 
capitalized or undercapitalized corporate credit union to comply with 
certain mandatory or discretionary supervisory actions as if the 
corporate credit union were in the next lower capital category, in the 
following circumstances:
    (i) Unsafe or unsound condition. The NCUA has determined, after 
notice and opportunity for hearing pursuant to paragraph (h)(1) of this 
section, that the corporate credit union is in an unsafe or unsound 
condition; or
    (ii) Unsafe or unsound practice. The NCUA has determined, after 
notice and an opportunity for hearing pursuant to paragraph (h)(1) of 
this section, that the corporate credit union received a less-than-
satisfactory rating (i.e., three or lower) for any rating category 
(other than in a rating category specifically addressing capital 
adequacy) under the Corporate Risk Information System (CRIS) rating 
system and has not corrected the conditions that served as the basis 
for the less than satisfactory rating. Ratings under this paragraph 
(d)(3)(ii) refer to the most recent ratings (as determined either on-
site or off-site by the most recent examination) of which the corporate 
credit union has been notified in writing.
    (4) The NCUA may, for good cause, modify any of the percentages in 
paragraph (d)(2) of this section as described in Sec.  704.3(d).
    (e) Capital restoration plans. (1) Schedule for filing plan--
    (i) In general. A corporate credit union must file a written 
capital restoration plan with the NCUA within 45 days of the date that 
the corporate credit union receives notice or is deemed to have notice 
that the corporate credit union is undercapitalized, significantly 
undercapitalized, or critically undercapitalized, unless the NCUA 
notifies the corporate credit union in writing that the plan is to be 
filed within a different period. An adequately capitalized corporate 
credit union that has been required pursuant to paragraph (d)(3) of 
this section to comply with supervisory actions as if the corporate 
credit union were undercapitalized is not required to submit a capital 
restoration plan solely by virtue of the reclassification.
    (ii) Additional capital restoration plans. Notwithstanding 
paragraph (e)(1)(i) of this section, a corporate credit union that has 
already submitted and is operating under a capital restoration plan 
approved under this section is not required to submit an additional 
capital restoration plan based on a revised calculation of its capital 
measures or a reclassification of the institution under paragraph 
(d)(3) of this section unless the NCUA notifies the corporate credit 
union that it must submit a new or revised capital plan. A corporate 
credit union that is notified that it must submit a new or revised 
capital restoration plan must file the plan in writing with the NCUA 
within 45 days of receiving such notice, unless the NCUA notifies the 
corporate credit union in writing that the plan is to be filed within a 
different period.
    (2) Contents of plan. All financial data submitted in connection 
with a capital restoration plan must be prepared in accordance with the 
instructions provided on the call report, unless the NCUA instructs 
otherwise. The capital restoration plan must include all of the 
information required to be filed under paragraph (k)(2)(ii) of this 
section. A corporate credit union required to submit a capital 
restoration plan as the result of a reclassification of the corporate 
credit union pursuant to paragraph (d)(3) of this section must include 
a description of the steps the corporate credit union will take to 
correct the unsafe or unsound condition or practice.
    (3) Failure to submit a capital restoration plan. A corporate 
credit union that is undercapitalized and that fails to submit a 
written capital restoration plan within the period provided in this 
section will, upon the expiration of that period, be subject to all of 
the provisions of this section applicable to significantly 
undercapitalized credit unions.
    (4) Review of capital restoration plans. Within 60 days after 
receiving a capital restoration plan under this section, the NCUA will 
provide written notice to the corporate credit union of whether it has 
approved the plan. The NCUA may extend this time period.
    (5) Disapproval of capital plan. If the NCUA does not approve a 
capital restoration plan, the corporate credit union must submit a 
revised capital restoration plan, when directed to do so, within the 
time specified by the NCUA. An undercapitalized corporate credit union 
is subject to the provisions applicable to significantly 
undercapitalized credit unions until it has submitted, and NCUA has 
approved, a capital restoration plan. If the NCUA directs that the 
corporate submit a revised plan, it must do so in time frame specified 
by the NCUA.
    (6) Failure to implement a capital restoration plan. Any 
undercapitalized corporate credit union that fails in any material 
respect to implement a capital restoration plan will be subject to all 
of the provisions of this section applicable to significantly 
undercapitalized institutions.
    (7) Amendment of capital plan. A corporate credit union that has 
filed an approved capital restoration plan may, after prior written 
notice to and

[[Page 65268]]

approval by the NCUA, amend the plan to reflect a change in 
circumstance. Until such time as NCUA has approved a proposed 
amendment, the corporate credit union must implement the capital 
restoration plan as approved prior to the proposed amendment.
    (f) Mandatory and discretionary supervisory actions. (1) Mandatory 
supervisory actions.--
    (i) Provisions applicable to all corporate credit unions. All 
corporate credit unions are subject to the restrictions contained in 
paragraph (k)(1) of this section on capital distributions.
    (ii) Provisions applicable to undercapitalized, significantly 
undercapitalized, and critically undercapitalized corporate credit 
unions. Immediately upon receiving notice or being deemed to have 
notice, as provided in paragraph (c) or (e) of this section, that the 
corporate credit union is undercapitalized, significantly 
undercapitalized, or critically undercapitalized, the corporate credit 
union will be subject to the following provisions of paragraph (k) of 
this section:
    (A) Restricting capital distributions (paragraph (k)(1));
    (B) NCUA monitoring of the condition of the corporate credit union 
(paragraph (k)(2)(i));
    (C) Requiring submission of a capital restoration plan (paragraph 
(k)(2)(ii));
    (D) Restricting the growth of the corporate credit union's assets 
(paragraph (k)(2)(iii)); and
    (E) Requiring prior approval of certain expansion proposals 
(paragraph (k)(2)(iv)).
    (iii) Additional provisions applicable to significantly 
undercapitalized, and critically undercapitalized corporate credit 
unions. In addition to the requirement described in paragraph (f)(1) of 
this section, immediately upon receiving notice or being deemed to have 
notice that the corporate credit union is significantly 
undercapitalized, or critically undercapitalized, or that the corporate 
credit union is subject to the provisions applicable to corporate 
credit unions that are significantly undercapitalized because the 
credit union failed to submit or implement in any material respect an 
acceptable capital restoration plan, the corporate credit union will 
become subject to the provisions of paragraph (k)(3)(iii) of this 
section that restrict compensation paid to senior executive officers of 
the institution.
    (iv) Additional provisions applicable to critically 
undercapitalized corporate credit unions. In addition to the provisions 
described in paragraphs (f)(1)(ii) and (f)(1)(iii) of this section, 
immediately upon receiving notice or being deemed to have notice that 
the corporate credit union is critically undercapitalized, the 
corporate credit union will become subject to these additional 
provisions of paragraph (k) of this section:
    (A) Restricting the activities of the corporate credit union 
((k)(5)(i)); and
    (B) Restricting payments on subordinated debt of the corporate 
credit union ((k)(5)(ii)).
    (2) Discretionary supervisory actions. In taking any action under 
paragraph (k) of this section that is within the NCUA's discretion to 
take in connection with a corporate credit union that is deemed to be 
undercapitalized, significantly undercapitalized or critically 
undercapitalized, or has been reclassified as undercapitalized, or 
significantly undercapitalized; or an action in connection with an 
officer or director of such corporate credit union; the NCUA will 
follow the procedures for issuing directives under paragraphs (g) and 
(i) of this section.
    (g) Directives to take prompt corrective action. The NCUA will 
provide an undercapitalized, significantly undercapitalized, or 
critically undercapitalized corporate credit union prior written notice 
of the NCUA's intention to issue a directive requiring such corporate 
credit union to take actions or to follow proscriptions described in 
this part. Section 747.3002 of this chapter prescribes the notice 
content and associated process.
    (h) Procedures for reclassifying a corporate credit union based on 
criteria other than capital. When the NCUA intends to reclassify a 
corporate credit union or subject it to the supervisory actions 
applicable to the next lower capitalization category based on an unsafe 
or unsound condition or practice the NCUA will provide the credit union 
with prior written notice of such intent. Section 747.3003 of this 
chapter prescribes the notice content and associated process.
    (i) Order to dismiss a Director or senior executive officer. When 
the NCUA issues and serves a directive on a corporate credit union 
requiring it to dismiss from office any director or senior executive 
officer under paragraphs (k)(3) of this section, the NCUA will also 
serve upon the person the corporate credit union is directed to dismiss 
(Respondent) a copy of the directive (or the relevant portions, where 
appropriate) and notice of the Respondent's right to seek 
reinstatement. Section 747.3004 of this chapter prescribes the content 
of the notice of right to seek reinstatement and the associated 
process.
    (j) Enforcement of directives. Section 747.3005 of this chapter 
prescribes the process for enforcement of directives.
    (k) Remedial actions towards undercapitalized, significantly 
undercapitalized, and critically undercapitalized corporate credit 
unions. (1) Provision applicable to all corporate credit unions. A 
corporate credit union is prohibited, unless it obtains NCUA's prior 
written approval, from making any capital distribution, including 
payment of dividends on perpetual and nonperpetual contributed capital 
accounts if, after making the distribution, the institution would be 
undercapitalized.
    (2) Provisions applicable to undercapitalized corporate credit 
unions.
    (i) Monitoring required. The NCUA will--
    (A) Closely monitor the condition of any undercapitalized corporate 
credit union;
    (B) Closely monitor compliance with capital restoration plans, 
restrictions, and requirements imposed under this section; and
    (C) Periodically review the plan, restrictions, and requirements 
applicable to any undercapitalized corporate credit union to determine 
whether the plan, restrictions, and requirements are achieving the 
purpose of this section.
    (ii) Capital restoration plan required.
    (A) Any undercapitalized corporate credit union must submit an 
acceptable capital restoration plan to the NCUA.
    (B) The capital restoration plan will--
    (1) Specify--
    (i) The steps the corporate credit union will take to become 
adequately capitalized;
    (ii) The levels of capital to be attained during each year in which 
the plan will be in effect;
    (iii) How the corporate credit union will comply with the 
restrictions or requirements then in effect under this section; and
    (iv) The types and levels of activities in which the corporate 
credit union will engage; and
    (2) Contain such other information as the NCUA may require.
    (C) The NCUA will not accept a capital restoration plan unless the 
NCUA determines that the plan--
    (1) Complies with paragraph (k)(2)(ii)(B) of this section;
    (2) Is based on realistic assumptions, and is likely to succeed in 
restoring the corporate credit union's capital; and
    (3) Would not appreciably increase the risk (including credit risk, 
interest-

[[Page 65269]]

rate risk, and other types of risk) to which the corporate credit union 
is exposed; and
    (iii) Asset growth restricted. An undercapitalized corporate credit 
union must not permit its daily average net assets during any calendar 
month to exceed its moving daily average net assets unless--
    (A) The NCUA has accepted the corporate credit union's capital 
restoration plan; and
    (B) Any increase in total assets is consistent with the plan.
    (iv) Prior approval required for acquisitions, branching, and new 
lines of business. An undercapitalized corporate credit union must not, 
directly or indirectly, acquire any interest in any entity, establish 
or acquire any additional branch office, or engage in any new line of 
business unless the NCUA has accepted the corporate credit union's 
capital restoration plan, the corporate credit union is implementing 
the plan, and the NCUA determines that the proposed action is 
consistent with and will further the achievement of the plan.
    (v) Discretionary safeguards. The NCUA may, with respect to any 
undercapitalized corporate credit union, take one or more of the 
actions described in paragraph (k)(3)(ii) of this section if the NCUA 
determines those actions are necessary to carry out the purpose of this 
section.
    (3) Provisions applicable to significantly undercapitalized 
corporate credit unions and undercapitalized corporate credit unions 
that fail to submit and implement capital restoration plans.
    (i) In general. This paragraph applies with respect to any 
corporate credit union that--
    (A) Is significantly undercapitalized; or
    (B) Is undercapitalized and--
    (1) Fails to submit an acceptable capital restoration plan within 
the time allowed by the NCUA under paragraph (e)(1) of this section; or
    (2) Fails in any material respect to implement a plan accepted by 
the NCUA.
    (ii) Specific actions authorized. The NCUA may take one or more of 
the following actions:
    (A) Requiring recapitalization.
    (1) Requiring the corporate credit union to seek and obtain 
additional contributed capital.
    (2) Requiring the corporate credit union to increase its rate of 
earnings retention.
    (3) Requiring the corporate credit union to combine, in whole or 
part, with another insured depository institution, if one or more 
grounds exist under this section or the Federal Credit Union Act for 
appointing a conservator or liquidating agent.
    (B) Restricting any ongoing or future transactions with affiliates.
    (C) Restricting interest rates paid.
    (1) In general. Restricting the rates of dividends and interest 
that the corporate credit union pays on shares and deposits to the 
prevailing rates on shares and deposits of comparable amounts and 
maturities in the region where the institution is located, as 
determined by the NCUA.
    (2) Retroactive restrictions prohibited. Paragraph (k)((3)(ii)(C) 
of this section does not authorize the NCUA to restrict interest rates 
paid on time deposits or shares made before (and not renewed or 
renegotiated after) the date the NCUA announced the restriction.
    (D) Restricting asset growth. Restricting the corporate credit 
union's asset growth more stringently than in paragraph (k)(2)(iii) of 
this section, or requiring the corporate credit union to reduce its 
total assets.
    (E) Restricting activities. Requiring the corporate credit union or 
any of its CUSOs to alter, reduce, or terminate any activity that the 
NCUA determines poses excessive risk to the corporate credit union.
    (F) Improving management. Doing one or more of the following:
    (1) New election of Directors. Ordering a new election for the 
corporate credit union's board of Directors.
    (2) Dismissing Directors or senior executive officers. Requiring 
the corporate credit union to dismiss from office any Director or 
senior executive officer who had held office for more than 180 days 
immediately before the corporate credit union became undercapitalized.
    (3) Employing qualified senior executive officers. Requiring the 
corporate credit union to employ qualified senior executive officers 
(who, if the NCUA so specifies, will be subject to approval by the 
NCUA).
    (G) Requiring divestiture. Requiring the corporate credit union to 
divest itself of or liquidate any interest in any entity if the NCUA 
determines that the entity is in danger of becoming insolvent or 
otherwise poses a significant risk to the corporate credit union;
    (H) Conserve or liquidate the corporate credit union if NCUA 
determines the credit union has no reasonable prospect of becoming 
adequately capitalized; and
    (I) Requiring other action. Requiring the corporate credit union to 
take any other action that the NCUA determines will better carry out 
the purpose of this section than any of the actions described in this 
paragraph.
    (iii) Senior executive officers' compensation restricted.
    (A) In general. The corporate credit union is prohibited from doing 
any of the following without the prior written approval of the NCUA:
    (1) Pay any bonus or profit-sharing to any senior executive 
officer.
    (2) Provide compensation to any senior executive officer at a rate 
exceeding that officer's average rate of compensation (excluding 
bonuses and profit-sharing) during the 12 calendar months preceding the 
calendar month in which the corporate credit union became 
undercapitalized.
    (B) Failing to submit plan. The NCUA will not grant approval with 
respect to a corporate credit union that has failed to submit an 
acceptable capital restoration plan.
    (iv) Discretion to impose certain additional restrictions. The NCUA 
may impose one or more of the restrictions prescribed by regulation 
under paragraph (k)(5) of this section if the NCUA determines that 
those restrictions are necessary to carry out the purpose of this 
section.
    (4) More stringent treatment based on other supervisory criteria.
    (i) In general. If the NCUA determines, after notice and an 
opportunity for hearing as described in subpart M of part 747 of this 
chapter, that a corporate credit union is in an unsafe or unsound 
condition or deems the corporate credit union to be engaging in an 
unsafe or unsound practice, the NCUA may--
    (A) If the corporate credit union is well capitalized, reclassify 
the corporate credit union as adequately capitalized;
    (B) If the corporate credit union is adequately capitalized (but 
not well capitalized), require the corporate credit union to comply 
with one or more provisions of paragraphs (k)(1) and (k)(2) of this 
section, as if the corporate credit union were undercapitalized; or
    (C) If the corporate credit union is undercapitalized, take any one 
or more actions authorized under paragraph (k)(3)(ii) of this section 
as if the corporate credit union were significantly undercapitalized.
    (ii) Contents of plan. Any plan required under paragraph (k)(4)(i) 
of this section will specify the steps that the corporate credit union 
will take to correct the unsafe or unsound condition or practice. 
Capital restoration plans, however, will not be required under 
paragraph (k)(4)(i)(B) of this section.

[[Page 65270]]

    (5) Provisions applicable to critically undercapitalized corporate 
credit unions.
    (i) Activities restricted. Any critically undercapitalized 
corporate credit union must comply with restrictions prescribed by the 
NCUA under paragraph (k)(6) of this section.
    (ii) Payments on contributed capital and subordinated debt 
prohibited. A critically undercapitalized corporate credit union must 
not, beginning no later than 60 days after becoming critically 
undercapitalized, make any payment of dividends on contributed capital 
or any payment of principal or interest on the corporate credit union's 
subordinated debt unless the NCUA determines that an exception would 
further the purpose of this section. Interest, although not payable, 
may continue to accrue under the terms of any subordinated debt to the 
extent otherwise permitted by law. Dividends on contributed capital do 
not, however, continue to accrue.
    (iii) Conservatorship, liquidation, or other action. The NCUA may, 
at any time, conserve or liquidate any critically undercapitalized 
corporate credit union or require the credit union to combine, in whole 
or part, with another institution. NCUA will consider, not later than 
90 days after a corporate credit union becomes critically 
undercapitalized, whether NCUA should liquidate, conserve, or combine 
the institution.
    (6) Restricting activities of critically undercapitalized corporate 
credit unions. To carry out the purpose of this section, the NCUA will, 
by order--
    (i) Restrict the activities of any critically undercapitalized 
corporate credit union; and
    (ii) At a minimum, prohibit any such corporate credit union from 
doing any of the following without the NCUA's prior written approval:
    (A) Entering into any material transaction other than in the usual 
course of business, including any investment, expansion, acquisition, 
sale of assets, or other similar action.
    (B) Extending credit for any transaction NCUA determines to be 
highly leveraged.
    (C) Amending the corporate credit union's charter or bylaws, except 
to the extent necessary to carry out any other requirement of any law, 
regulation, or order.
    (D) Making any material change in accounting methods.
    (E) Paying compensation or bonuses NCUA determines to be excessive.
    (F) Paying interest on new or renewed liabilities at a rate that 
would increase the corporate credit union's weighted average cost of 
funds to a level significantly exceeding the prevailing rates of 
interest on insured deposits in the corporate credit union's normal 
market areas.
    11. Revise Sec.  704.5 to read as follows:


Sec.  704.5  Investments.

    (a) Policies. A corporate credit union must operate according to an 
investment policy that is consistent with its other risk management 
policies, including, but not limited to, those related to credit risk 
management, asset and liability management, and liquidity management. 
The policy must address, at a minimum:
    (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.
    (b) General. All investments must be U.S. dollar-denominated and 
subject to the credit policy restrictions set forth in Sec.  704.6.
    (c) Authorized activities. A corporate credit union may invest in:
    (1) Securities, deposits, and obligations set forth in Sections 
107(7), 107(8), and 107(15) of the Federal Credit Union Act, 12 U.S.C. 
1757(7), 1757(8), and 1757(15), except as provided in this section;
    (2) Deposits in, the sale of federal funds to, and debt obligations 
of corporate credit unions, Section 107(8) institutions, and state 
banks, trust companies, and mutual savings banks not domiciled in the 
state in which the corporate credit union does business;
    (3) Corporate CUSOs, as defined in and subject to the limitations 
of Sec.  704.11;
    (4) Marketable debt obligations of corporations chartered in the 
United States. This authority does not apply to debt obligations that 
are convertible into the stock of the corporation; and
    (5) Domestically-issued asset-backed securities.
    (d) Repurchase agreements. A corporate credit union may enter into 
a repurchase agreement provided that:
    (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;
    (2) The repurchase securities are legal investments for that 
corporate credit union;
    (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. Such contracts must address any supplemental terms 
and conditions necessary to meet the specific requirements of this 
part. Third party arrangements must be supported by tri-party contracts 
in which the repurchase securities are priced and reported daily and 
the tri-party agent ensures compliance; and
    (e) Securities Lending. A corporate credit union may enter into a 
securities lending transaction provided that:
    (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;
    (2) The collateral is a legal investment for that corporate credit 
union;
    (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), or 
a collective investment fund maintained by a national bank under 12 CFR 
9.18 or a mutual savings bank under 12 CFR 550.260, provided that the 
company or fund prospectus restricts the investment portfolio to 
investments and investment transactions that are permissible for that 
corporate credit union.
    (g) Investment settlement. A corporate credit union may only 
contract for the purchase or sale of an investment if the transaction 
is settled on a delivery versus payment basis within 60 days for 
mortgage-backed securities, within 30 days for new issues (other than 
mortgage-backed securities), and within three days for all other 
securities.

[[Page 65271]]

    (h) Prohibitions. A corporate credit union is prohibited from:
    (1) Purchasing or selling derivatives, except for embedded options 
not required under GAAP to be accounted for separately from the host 
contract or forward sales commitments on loans to be purchased by the 
corporate credit union;
    (2) Engaging in trading securities unless accounted for on a trade 
date basis;
    (3) Engaging in adjusted trading or short sales; and
    (4) Purchasing mortgage servicing rights, small business related 
securities, residual interests in collateralized mortgage obligations, 
residual interests in real estate mortgage investment conduits, or 
residual interests in asset-backed securities; and
    (5) Purchasing net interest margin securities;
    (6) Purchasing collateralized debt obligations; and
    (7) Purchasing stripped mortgage-backed securities (SMBS), or 
securities that represent interests in SMBS, except as described in 
subparagraphs (i) and (iii) below.
    (i) A corporate credit union may invest in exchangeable 
collateralized mortgage obligations (exchangeable CMOs) representing 
beneficial ownership interests in one or more interest-only classes of 
a CMO (IO CMOs) or principal-only classes of a CMO (PO CMOs), but only 
if:
    (A) At the time of purchase, the ratio of the market price to the 
remaining principal balance is between .8 and 1.2, meaning that the 
discount or premium of the market price to par must be less than 20 
points;
    (B) The offering circular or other official information available 
at the time of purchase indicates that the notional principal on each 
underlying IO CMO should decline at the same rate as the principal on 
one or more of the underlying non-IO CMOs, and that the principal on 
each underlying PO CMO should decline at the same rate as the 
principal, or notional principal, on one or more of the underlying non-
PO CMOs; and
    (C) The credit union investment staff has the expertise dealing 
with exchangeable CMOs to apply the conditions in paragraphs 
(h)(5)(i)(A) and (B) of this section.
    (ii) A corporate credit union that invests in an exchangeable CMO 
may exercise the exchange option only if all of the underlying CMOs are 
permissible investments for that credit union.
    (iii) A corporate credit union may accept an exchangeable CMO 
representing beneficial ownership interests in one or more IO CMOs or 
PO CMOs as an asset associated with an investment repurchase 
transaction or as collateral in a securities lending transaction. When 
the exchangeable CMO is associated with one of these two transactions, 
it need not conform to the conditions in paragraphs (h)(5)(i)(A) or (B) 
of this section.
    (i) Conflicts of interest. A corporate credit union's officials, 
employees, and immediate family members of such individuals, may not 
receive pecuniary consideration in connection with the making of an 
investment or deposit by the corporate credit union. Employee 
compensation is exempt from this prohibition. All transactions not 
specifically prohibited by this paragraph must be conducted at arm's 
length and in the interest of the corporate credit union.
    (j) Grandfathering. A corporate credit union's authority to hold an 
investment is governed by the regulation in effect at the time of 
purchase. However, all grandfathered investments are subject to the 
requirements of Sec. Sec.  704.8 and 704.9.
    12. Revise Sec.  704.6 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:
    (1) The approval process associated with credit limits;
    (2) Due diligence analysis requirements;
    (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, 
servicer of receivables, insurer, industry type, sector type, 
geographic, collateral type, and tranche priority).
    (b) Exemption. The limitations and requirements of this section do 
not apply to certain assets, whether or not considered investments 
under this part, including fixed assets, individual loans and loan 
participation interests, investments in CUSOs, investments that are 
issued or fully guaranteed as to principal and interest by the U.S. 
government or its agencies or its sponsored enterprises (excluding 
subordinated debt), and investments that are fully insured or 
guaranteed (including accumulated dividends and interest) by the NCUSIF 
or the Federal Deposit Insurance Corporation.
    (c) Issuer Concentration limits-- (1) General rule. The aggregate 
of all investments in any single obligor is limited to 25 percent of 
capital or $5 million, whichever is greater.
    (2) Exceptions.
    (i) Aggregate investments in repurchase and securities lending 
agreements with any one counterparty are limited to 200 percent of 
capital;
    (ii) Investments in non-money market registered investment 
companies are limited to 50 percent of capital in any single obligor;
    (iii) Investments in money market registered investment companies 
are limited to 100 percent of capital in any single obligor; and
    (iv) Investments in corporate CUSOs are subject to the limitations 
of Sec.  704.11.
    (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 
non-conforming. 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) Sector Concentration Limits. (1) A corporate credit union must 
establish sector limits that do not exceed the following maximums:
    (i) Residential mortgage-backed securities--the lower of 500 
percent of capital or 25 percent of assets;
    (ii) Commercial mortgage-backed securities--the lower of 500 
percent of capital or 25 percent of assets;
    (iii) FFELP student loan asset-backed securities--the lower of 1000 
percent of capital or 50 percent of assets;
    (iv) Private student loan asset-backed securities--the lower of 500 
percent of capital or 25 percent of assets;
    (v) Auto loan/lease asset-backed securities--the lower of 500 
percent of capital or 25 percent of assets;
    (vi) Credit card asset-backed securities--the lower of 500 percent 
of capital or 25 percent of assets;
    (vii) Other asset-backed securities not listed in paragraphs (ii) 
through (vi)--the lower of 500 percent of capital or 25 percent of 
assets;
    (viii) Corporate debt obligations--the lower of 1000 percent of 
capital or 50 percent of assets; and

[[Page 65272]]

    (ix) Municipal securities--the lower of 1000 percent of capital or 
50 percent of assets.
    (2) Registered investment companies--A corporate credit union must 
limit its investment in registered investment companies to the lower of 
1000 percent of capital or 50 percent of assets. In addition to 
applying the limit in this paragraph (d)(2), a corporate credit union 
must also include the underlying assets in each registered investment 
company in the relevant sectors described in paragraph (d)(1) of this 
section when calculating those sector limits.
    (3) A corporate credit union will limit its aggregate holdings in 
any investments not described in paragraphs (d)(1) or (d)(2) to the 
lower of 100 percent of capital or 5 percent of assets. The NCUA may 
approve a higher percentage in appropriate cases.
    (4) The following investments are also excluded from the 
concentration limits in paragraphs (d)(1), (d)(2), and (d)(3): 
Investments in other federally insured credit unions, deposits in other 
depository institutions, and investment repurchase agreements.
    (e) Subordinated securities. A corporate credit union may not hold 
subordinated securities in excess of the lower of 100 percent of 
capital or 5 percent of assets in any single investment sector 
described in paragraphs (d)(1) and (d)(2) or in excess of the lower of 
400 percent of capital or 20 percent of assets in all investment 
sectors described in paragraph (d).
    (f) Credit ratings.--(1) All investments, other than in another 
depository institution, must have an applicable credit rating from at 
least one nationally recognized statistical rating organization 
(NRSRO). At a minimum, 90 percent of all such investments, by book 
value, must have a rating by at least two NRSROs. Corporate credit 
unions may use either public or nonpublic NRSRO ratings to satisfy this 
requirement.
    (2) At the time of purchase, investments with long-term ratings 
must be rated no lower than AA- (or equivalent) by every NRSRO that 
provides a publicly available long-term rating on that investment, and 
investments with short-term ratings must be rated no lower than A-1 (or 
equivalent) by every NRSRO that provides a publicly available short-
term rating on that investment. If the corporate credit union obtains a 
nonpublic NRSRO rating, that rating must also be no lower than AA-, or 
A-1, for long-term and short-term ratings, respectively.
    (3) All 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. Corporate credit unions must 
identify and monitor any new post-purchase NRSRO ratings on investments 
they hold.
    (4) Investments are subject to the requirements of Sec.  704.10 if:
    (i) An NRSRO that rates the investment downgrades that rating, 
after purchase, below the minimum rating requirements of this part; or
    (ii) The investment is part of an asset class or group of 
investments that exceeds the sector or obligor concentration limits of 
this section.
    (g) 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.
    13. Revise Sec.  704.8 to read as follows:


Sec.  704.8  Asset and liability management.

    (a) Policies. A corporate credit union must operate according to a 
written asset and liability management policy which addresses, at a 
minimum:
    (1) The purpose and objectives of the corporate credit union's 
asset and liability activities;
    (2) The maximum allowable percentage decline in net economic value 
(NEV), compared to base case NEV;
    (3) The minimum allowable NEV ratio;
    (4) Policy limits and specific test parameters for the NEV 
sensitivity analysis requirements set forth in paragraphs (d), (e), and 
(f) of this section;
    (5) The modeling of indexes that serve as references in financial 
instrument coupon formulas; and
    (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), (e)(1)(i), and (f)(1)(i) of this section may be used as a 
basis of estimation.
    (b) Asset and liability management committee (ALCO). A corporate 
credit union's ALCO must have at least one member who is also a member 
of the board of directors. The ALCO must review asset and liability 
management reports on at least a monthly basis. These reports must 
address compliance with Federal Credit Union Act, NCUA Rules and 
Regulations (12 CFR chapter VII), and all related risk management 
policies.
    (c) Penalty for early withdrawals. A corporate credit union that 
permits early share certificate withdrawals must redeem at the lesser 
of book value plus accrued dividends or the value based on a market-
based penalty sufficient to cover the estimated replacement cost of the 
certificate redeemed. 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) Interest rate sensitivity analysis. (1) A corporate credit 
union must:
    (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 bp 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:
    (i) Changes in the shape of the Treasury yield curve;
    (ii) Adjustments to prepayment projections used for amortizing 
securities to consider the impact of

[[Page 65273]]

significantly faster/slower prepayment speeds; and
    (iii) Adjustments to volatility assumptions to consider the impact 
that changing volatilities have on embedded option values.
    (e) Cash flow mismatch sensitivity analysis.
    (1) A corporate credit union must:
    (i) Evaluate the risk in its balance sheet by measuring, at least 
quarterly, the impact of an instantaneous spread widening of both asset 
and liabilities by 300 basis points, assuming that issuer options will 
not be exercised, 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 (e)(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) All investments must be tested, excluding derivatives and 
equity investments. All borrowings and shares must be tested, but not 
contributed capital.
    (3) A corporate credit union must also test for the effects of 
failed triggers on its NEV and NEV ratios while testing the cash flow 
sensitivity analysis.
    (f) Cash flow mismatch sensitivity analysis with 50 percent 
slowdown in prepayment speeds. (1) A corporate credit union must:
    (i) Evaluate the risk in its balance sheet by measuring, at least 
quarterly, the impact of an instantaneous spread widening of both asset 
and liabilities by 300 basis points, assuming that issuer options will 
not be exercised and prepayment speeds will slow by 50 percent, on its 
NEV and NEV ratio. If the base case NEV ratio falls below 2 percent at 
the last testing date, these tests must be calculated at least monthly 
until the base case NEV ratio again exceeds 2 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 (f)(1)(i) of this section below 1 percent; and
    (iii) Limit its risk exposures to levels that do not result in a 
decline in NEV of more than 25 percent.
    (2) All investments must be tested, excluding derivatives and 
equity investments. All borrowings and shares must be tested, but not 
contributed capital.
    (3) A corporate credit union must also test for the effects of 
failed triggers on its NEV and NEV while testing the cash flow 
sensitivity analysis.
    (g) Net interest income modeling. A corporate credit union must 
perform net interest income (NII) modeling to project earnings in 
multiple interest rate environments for a period of no less than 2 
years. NII modeling must, at minimum, be performed quarterly.
    (h) Weighted average asset life. The weighted average life (WAL) of 
a corporate credit union's investment portfolio, excluding derivative 
contracts and equity investments, may not exceed 2 years. A corporate 
credit union must test its investments at least quarterly for 
compliance with this WAL limitation. When calculating its WAL, a 
corporate credit union must assume that no issuer options will be 
exercised.
    (i) Effective and spread durations. A corporate credit union must 
measure at least once a quarter the effective duration and spread 
durations of each of its assets and liabilities, where the values of 
these are affected by changes in interest rates or credit spreads.
    (j) Regulatory violations. (1) (i) If a corporate credit union's 
decline in NEV, base case NEV ratio or any NEV ratio resulting from the 
tests set forth in paragraphs (d), (e), and (f) of this section violate 
the limits established in those paragraphs, or the corporate credit 
union is unable to satisfy the tests in paragraphs (g) and (h) of this 
section; and
    (ii) The corporate cannot adjust its balance sheet so as to satisfy 
the requirements of paragraph (d), (e), (f), (g), or (h) of this 
section within 10 calendar days after detecting the violation, then:
    (iii) The operating management of the corporate credit union must 
immediately report this information to its board of directors, 
supervisory committee, and the NCUA.
    (2) If any violation described in paragraph (j)(1)(i) persists for 
30 or more calendar days, the corporate credit union:
    (i) Must immediately submit a detailed, written action plan to the 
NCUA that sets forth the time needed and means by which it intends to 
correct the violation and, if the NCUA determines that the plan is 
unacceptable, the corporate credit union must immediately restructure 
its balance sheet to bring the exposure back within compliance or 
adhere to an alternative course of action determined by the NCUA; and
    (ii) If presently categorized as adequately capitalized or well 
capitalized for PCA purposes, immediately be recategorized as: 
Undercapitalized until the violation is corrected, and
    (iii) If presently less than adequately capitalized, immediately be 
downgraded one additional capital category.
    (k) Overall limit on business generated from individual credit 
unions. On or after [DATE 30 MONTHS AFTER DATE OF PUBLICATION OF FINAL 
RULE IN THE FEDERAL REGISTER], a corporate credit union is prohibited 
from accepting from a member or other entity any investment, including 
shares, loans, PCC, or NCAs if, following that investment, the 
aggregate of all investments from that member or entity in the 
corporate would exceed 10 percent of the corporate credit union's 
moving daily average net assets.
    14. Revise Sec.  704.9 to read as follows:


Sec.  704.9  Liquidity management.

    (a) General. In the management of liquidity, a corporate credit 
union must:
    (1) Evaluate the potential liquidity needs of its membership in a 
variety of economic scenarios;
    (2) Regularly monitor and demonstrate accessibility to sources of 
internal and external liquidity;
    (3) Keep a sufficient amount of cash and cash equivalents on hand 
to support its payment system obligations;
    (4) Demonstrate that the accounting classification of investment 
securities is consistent with its ability to meet potential liquidity 
demands; and
    (5) Develop a contingency funding plan that addresses alternative 
funding strategies in successively deteriorating liquidity scenarios. 
The plan must:
    (i) List all sources of liquidity, by category and amount, that are 
available to service an immediate outflow of funds in various liquidity 
scenarios;
    (ii) Analyze the impact that potential changes in fair value will 
have on the disposition of assets in a variety of interest rate 
scenarios; and
    (iii) Be reviewed by the board or an appropriate committee no less 
frequently than annually or as market or business conditions dictate.
    (b) Borrowing limits. A corporate credit union may borrow up to the 
lower of 10 times capital or 50 percent of capital and shares 
(excluding shares created by the use of member reverse repurchase 
agreements).
    (1) Secured borrowings. A corporate credit union may borrow on a 
secured basis for liquidity purposes, but the maturity of the borrowing 
may not exceed 30 days. Only a credit union with core capital in excess 
of five percent of its moving DANA may borrow on a secured basis for

[[Page 65274]]

nonliquidity purposes, and the outstanding amount of secured borrowing 
for nonliquidity purposes may not exceed an amount equal to the 
difference between core capital and five percent of moving DANA.
    (2) Exclusions. CLF borrowings and borrowed funds created by the 
use of member reverse repurchase agreements are excluded from this 
limit.
    15. Revise Sec.  704.11 to read as follows:


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

    (a) A corporate CUSO is an entity that:
    (1) Is at least partly owned by a corporate credit union;
    (2) Primarily serves credit unions;
    (3) Restricts its services to those related to the normal course of 
business of credit unions as specified in paragraph (e) of this 
section; and
    (4) Is structured as a corporation, limited liability company, or 
limited partnership under state law.
    (b) Investment and loan limitations. (1) The aggregate of all 
investments in member and non-member 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.
    (c) Due diligence. A corporate credit union must comply with the 
due diligence requirements of Sec. Sec.  723.5 and 723.6(f) through (j) 
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). Permissible activities. A corporate CUSO must agree to limit 
its activities to:
    (1) Brokerage services,
    (2) Investment advisory services, and
    (3) Other categories of services as approved in writing by NCUA and 
published on NCUA's Web site.
    (f) An official of a corporate credit union which has invested in 
or loaned to a corporate CUSO may not receive, either directly or 
indirectly, any salary, commission, investment income, or other income, 
compensation, or consideration from the corporate CUSO. This 
prohibition also extends to immediate family members of officials.
    (g) Prior to making an investment in or loan to a corporate CUSO, a 
corporate credit union must obtain a written agreement that the CUSO:
    (1) Will follow GAAP;
    (2) Will provide financial statements to the corporate credit union 
at least quarterly;
    (3) Will 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;
    (4) Will not 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;
    (5) Will allow the auditor, board of directors, and NCUA complete 
access to its personnel, facilities, equipment, books, records, and any 
other documentation that the auditor, directors, or NCUA deem 
pertinent; and
    (6) Will comply with all the requirements of this section.
    (h) Corporate credit union authority to invest in or loan to a CUSO 
is limited to that provided in this section. A corporate credit union 
is not authorized to invest in or loan to a CUSO under part 712 of this 
chapter.
    16. Revise Sec.  704.14 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:
    (1) At least a majority of directors, including the chair of the 
board, must serve on the board as representatives of member credit 
unions;
    (2) On or after [DATE 4 MONTHS AFTER DATE OF PUBLICATION OF FINAL 
RULE IN THE FEDERAL REGISTER], only individuals who currently hold the 
position of chief executive officer, chief financial officer, or chief 
operating officer at a member may seek election or re-election to the 
board;
    (3) No individual may be elected to the board if, at the expiration 
of the term to which the individual is seeking election, the individual 
will have served as a director for more than six consecutive years. For 
purposes of calculating the six-year period, any consecutive prior 
service on the board by representatives of the same corporate member 
must be counted as though the individual seeking election had fulfilled 
that service. Accordingly, a corporate member may not circumvent the 
term limit provisions by putting forward a new candidate for 
directorship after one or more of its prior representatives has served 
on the board for six consecutive years;
    (4) No individual may be elected or appointed to serve on the board 
if, after such election or appointment, the individual would be a 
director at more than one corporate credit union;
    (5) No individual may be elected or appointed to serve on the board 
if, after such election or appointment, any member of the corporate 
credit union would have more than one representative on the board of 
the corporate;
    (6) The chair of the board may not serve simultaneously as an 
officer, director, or employee of a credit union trade association;
    (7) A majority of directors may not serve simultaneously as 
officers, directors, or employees of the same credit union trade 
association or its affiliates (not including chapters or other subunits 
of a state trade association);
    (8) For purposes of meeting the requirements of paragraphs (a)(6) 
and (a)(7) of this section, an individual may not serve as a director 
or chair of the board if that individual holds a subordinate employment 
relationship to another employee who serves as an officer, director, or 
employee of a credit union trade association;
    (9) In the case of a corporate credit union whose membership is 
composed of more than 25 percent non credit unions, the majority of 
directors serving as representatives of member credit unions, including 
the chair, must be

[[Page 65275]]

elected only by member credit unions, and
    (10) After [DATE 36 MONTHS AFTER DATE OF PUBLICATION OF THE FINAL 
RULE IN THE FEDERAL REGISTER], at least a majority of directors of 
every corporate credit union, including the chair of the board, must 
serve on the board as representatives of natural person credit union 
members.
    17. Revise Sec.  704.19 to read as follows:


Sec.  704.19  Disclosure of executive and director compensation.

    (a) Annual disclosure. Corporate credit unions must annually 
prepare and maintain a disclosure of the compensation, in dollar terms, 
of each senior executive officer and director.
    (b) Availability of disclosure. Any member may obtain a copy of the 
most current disclosure, and all disclosures for the previous three 
years, on request made in person or in writing. The corporate credit 
union must provide the disclosure(s), at no cost to the member, within 
five business days of receiving the request. In addition, the corporate 
must distribute the most current disclosure to all its members at least 
once a year, either in the annual report or in some other manner of the 
corporate's choosing.
    (c) Supplemental information. In providing the disclosure required 
by this section, a corporate credit union may also provide 
supplementary information to put the disclosure in context, for 
example, salary surveys, a discussion of compensation in relation to 
other credit union expenses, or compensation information from similarly 
sized credit unions or financial institutions.
    (d) Special rule for mergers. With respect to any merger involving 
a corporate credit union that would result in a material increase in 
compensation, i.e., an increase of more than 15 percent or $10,000, 
whichever is greater, for any senior executive officer or director of 
the merging corporate, the corporate must: (i) describe the 
compensation arrangement in the merger plan documents submitted to NCUA 
for approval of the merger, pursuant to Sec.  708b of this part; and 
(ii) in the case of any federally chartered corporate credit union, 
describe the compensation arrangement in the materials provided to the 
membership of the merging credit union before the member vote on 
approving the merger.
    18. Add a new Sec.  704.20 to read as follows:


Sec.  704.20  Limitations on golden parachute and indemnification 
payments.

    (a) Definitions. The following definitions apply for this section:
    (1) Board means the National Credit Union Administration Board.
    (2) Benefit plan means any plan, contract, agreement or other 
arrangement which is an ``employee welfare benefit plan'' as that term 
is defined in section 3(1) of the Employee Retirement Income Security 
Act of 1974, as amended (29 U.S.C. 1002(1)), or other usual and 
customary plans such as dependent care, tuition reimbursement, group 
legal services or cafeteria plans; provided however, that such term 
does not include any plan intended to be subject to paragraphs 
(a)(4)(iv)(C) and (E) of this section.
    (3) Bona fide deferred compensation plan or arrangement means any 
plan, contract, agreement or other arrangement whereby:
    (i) An institution-affiliated party (IAP) voluntarily elects to 
defer all or a portion of the reasonable compensation, wages or fees 
paid for services rendered which otherwise would have been paid to the 
IAP at the time the services were rendered (including a plan that 
provides for the crediting of a reasonable investment return on such 
elective deferrals) and the corporate credit union either:
    (A) Recognizes compensation expense and accrues a liability for the 
benefit payments according to Generally Accepted Accounting Principles 
(GAAP); or
    (B) Segregates or otherwise sets aside assets in a trust which may 
only be used to pay plan and other benefits, except that the assets of 
such trust may be available to satisfy claims of the institution's or 
holding company's creditors in the case of insolvency; or
    (ii) A corporate credit union establishes a nonqualified deferred 
compensation or supplemental retirement plan, other than an elective 
deferral plan described in paragraph (a)(3)(i) of this section:
    (A) Primarily for the purpose of providing benefits for certain 
IAPs in excess of the limitations on contributions and benefits imposed 
by sections 415, 401(a)(17), 402(g) or any other applicable provision 
of the Internal Revenue Code of 1986 (26 USC 415, 401(a)(17), 402(g)); 
or
    (B) Primarily for the purpose of providing supplemental retirement 
benefits or other deferred compensation for a select group of 
directors, management or highly compensated employees (excluding 
severance payments described in paragraph (4)(ii)(E) of this section 
and permissible golden parachute payments described in Sec.  704.20(d); 
and
    (iii) In the case of any nonqualified deferred compensation or 
supplemental retirement plans as described in paragraphs (a)(3)(i) and 
(ii) of this section, the following requirements will apply:
    (A) The plan was in effect at least one year prior to any of the 
events described in paragraph (a)(4)(ii) of this section;
    (B) Any payment made pursuant to such plan is made in accordance 
with the terms of the plan as in effect no later than one year prior to 
any of the events described in paragraph (a)(4)(ii) of this section and 
in accordance with any amendments to such plan during such one year 
period that do not increase the benefits payable thereunder;
    (C) The IAP has a vested right, as defined under the applicable 
plan document, at the time of termination of employment to payments 
under such plan;
    (D) Benefits under such plan are accrued each period only for 
current or prior service rendered to the employer (except that an 
allowance may be made for service with a predecessor employer);
    (E) Any payment made pursuant to such plan is not based on any 
discretionary acceleration of vesting or accrual of benefits which 
occurs at any time later than one year prior to any of the events 
described in paragraph (a)(4)(ii) of this section;
    (F) The corporate credit union has previously recognized 
compensation expense and accrued a liability for the benefit payments 
according to GAAP or segregated or otherwise set aside assets in a 
trust which may only be used to pay plan benefits, except that the 
assets of such trust may be available to satisfy claims of the 
corporate credit union's creditors in the case of insolvency; and
    (G) Payments pursuant to such plans must not be in excess of the 
accrued liability computed in accordance with GAAP.
    (4) Golden parachute payment means any payment (or any agreement to 
make any payment) in the nature of compensation by any corporate credit 
union for the benefit of any current or former IAP pursuant to an 
obligation of such corporate credit union that:
    (i) Is contingent on, or by its terms is payable on or after, the 
termination of such IAP's primary employment or affiliation with the 
corporate credit union; and
    (ii) Is received on or after, or is made in contemplation of, any 
of the following events:

[[Page 65276]]

    (A) The insolvency (or similar event) of the corporate that is 
making the payment; or
    (B) The appointment of any conservator or liquidating agent for 
such corporate credit union; or
    (C) A determination by the Board or the appropriate state 
supervisory authority (in the case of a corporate credit union 
chartered by a state) respectively, that the corporate credit union is 
in a troubled condition; or
    (D) The corporate credit union is undercapitalized, as defined in 
Sec.  704.4; or
    (E) The corporate credit union is subject to a proceeding to 
terminate or suspend its share account insurance; and
    (iii) Is payable to an IAP whose employment by or affiliation with 
the corporate is terminated at a time when the corporate credit union 
by which the IAP is employed or with which the IAP is affiliated 
satisfies any of the conditions enumerated in paragraphs (a)(4)(ii)(A) 
through (E) of this section, or in contemplation of any of these 
conditions.
    (iv) Exceptions. The term golden parachute payment does not 
include:
    (A) Any payment made pursuant to a pension or retirement plan which 
is qualified (or is intended within a reasonable period of time to be 
qualified) under section 401 of the Internal Revenue Code of 1986 (26 
U.S.C. Sec.  401); or
    (B) Any payment made pursuant to a benefit plan as that term is 
defined in paragraph (a)(2) of this section; or
    (C) Any payment made pursuant to a bona fide deferred compensation 
plan or arrangement as defined in paragraph (a)(3) of this section; or
    (D) Any payment made by reason of death or by reason of termination 
caused by the disability of an IAP; or
    (E) Any payment made pursuant to a nondiscriminatory severance pay 
plan or arrangement which provides for payment of severance benefits to 
all eligible employees upon involuntary termination other than for 
cause, voluntary resignation, or early retirement; provided, however, 
that no employee will receive any such payment which exceeds the base 
compensation paid to such employee during the twelve months (or such 
longer period or greater benefit as the Board will consent to) 
immediately preceding termination of employment, resignation or early 
retirement, and such severance pay plan or arrangement must not have 
been adopted or modified to increase the amount or scope of severance 
benefits at a time when the corporate credit union was in a condition 
specified in paragraph (4)(ii) of this section or in contemplation of 
such a condition without the prior written consent of the Board; or
    (F) Any severance or similar payment which is required to be made 
pursuant to a state statute which is applicable to all employers within 
the appropriate jurisdiction (with the exception of employers that may 
be exempt due to their small number of employees or other similar 
criteria); or
    (G) Any other payment which the Board determines to be permissible 
in accordance with Sec.  704.20(d).
    (5) Institution-affiliated party (IAP) means any individual meeting 
the criteria specified in Sec.  206(r) of the Act (12 U.S.C. Sec.  
1786(r)).
    (6) Liability or legal expense means:
    (i) Any legal or other professional fees and expenses incurred in 
connection with any claim, proceeding, or action;
    (ii) The amount of, and any cost incurred in connection with, any 
settlement of any claim, proceeding, or action; and
    (iii) The amount of, and any cost incurred in connection with, any 
judgment or penalty imposed with respect to any claim, proceeding, or 
action.
    (7) Nondiscriminatory means that the plan, contract or arrangement 
in question applies to all employees of a corporate credit union who 
meet reasonable and customary eligibility requirements applicable to 
all employees, such as minimum length of service requirements. A 
nondiscriminatory plan, contract or arrangement may provide different 
benefits based only on objective criteria such as salary, total 
compensation, length of service, job grade or classification, which are 
applied on a proportionate basis (with a variance in severance benefits 
relating to any criterion of plus or minus ten percent) to groups of 
employees consisting of not less than the lesser of 33 percent of 
employees or 1,000 employees.
    (8) Payment means:
    (i) Any direct or indirect transfer of any funds or any asset;
    (ii) Any forgiveness of any debt or other obligation;
    (iii) The conferring of any benefit, including but not limited to 
stock options and stock appreciation rights; or
    (iv) Any segregation of any funds or assets, the establishment or 
funding of any trust or the purchase of or arrangement for any letter 
of credit or other instrument, for the purpose of making, or pursuant 
to any agreement to make, any payment on or after the date on which 
such funds or assets are segregated, or at the time of or after such 
trust is established or letter of credit or other instrument is made 
available, without regard to whether the obligation to make such 
payment is contingent on:
    (A) The determination, after such date, of the liability for the 
payment of such amount; or
    (B) The liquidation, after such date, of the amount of such 
payment.
    (9) Prohibited indemnification payment means any payment (or any 
agreement or arrangement to make any payment) by any corporate credit 
union for the benefit of any person who is or was an IAP of such 
corporate credit union, to pay or reimburse such person for any civil 
money penalty, judgment or other liability or legal expense resulting 
from any administrative or civil action instituted by the Board or any 
appropriate state regulatory authority that results in a final order or 
settlement pursuant to which such person:
    (i) Is assessed a civil money penalty;
    (ii) Is removed from office or prohibited from participating in the 
conduct of the affairs of the corporate credit union; or
    (iii) Is required to cease and desist from or take any affirmative 
action described in Section 206 of the Act with respect to such 
corporate credit union.
    (iv) Exceptions. The term prohibited indemnification payment does 
not include any reasonable payment by a corporate credit union that:
    (A) is used to purchase any commercial insurance policy or fidelity 
bond, provided that such insurance policy or bond must not be used to 
pay or reimburse an IAP for the cost of any judgment or civil money 
penalty assessed against such person in an administrative proceeding or 
civil action commenced by NCUA or the appropriate state supervisory 
authority (in the case of a state chartered corporate), but may pay any 
legal or professional expenses incurred in connection with such 
proceeding or action or the amount of any restitution to the corporate 
credit union or its liquidating agent; or
    (B) represents partial indemnification for legal or professional 
expenses specifically attributable to particular charges for which 
there has been a formal and final adjudication or finding in connection 
with a settlement that the IAP has not violated certain laws or 
regulations or has not engaged in certain unsafe or unsound practices 
or breaches of fiduciary duty, unless the administrative action or 
civil proceeding has resulted in a final prohibition order against the 
IAP.
    (10) Troubled Condition means that the corporate credit union:

[[Page 65277]]

    (i) Has been assigned:
    (A) A 4 or 5 Corporate Risk Information System (CRIS) rating by 
NCUA in either the Financial Risk or Risk Management composites, in the 
case of a federal corporate credit union, or
    (B) An equivalent 4 or 5 CRIS rating in either the Financial Risk 
or Risk Management composites by the state supervisor in the case of a 
federally insured, state-chartered corporate credit union in a state 
that has adopted the CRIS system, or an equivalent 4 or 5 CAMEL 
composite rating by the state supervisor in the case of a federally 
insured, state-chartered corporate credit union in a state that uses 
the CAMEL system, or
    (C) A 4 or 5 CRIS rating in either the Financial Risk or Risk 
Management composites by NCUA based on core work papers received from 
the state supervisor in the case of a federally insured, state-
chartered credit union in a state that does not use either the CRIS or 
CAMEL system. In this case, the state supervisor will be notified in 
writing by the Director of the Office of Corporate Credit Unions that 
the corporate credit union has been designated by NCUA as a troubled 
institution; or
    (ii) has been granted assistance as outlined under Sections 208 or 
216 of the Federal Credit Union Act.
    (b) Golden parachute payments prohibited.
    No corporate credit union will make or agree to make any golden 
parachute payment, except as otherwise provided in this section.
    (c) Prohibited indemnification payments. No corporate credit union 
will make or agree to make any prohibited indemnification payment, 
except as provided in this section.
    (d) Permissible golden parachute payments. (1) A corporate credit 
union may agree to make or may make a golden parachute payment if and 
to the extent that:
    (i) Such an agreement is made in order to hire a person to become 
an IAP either at a time when the corporate credit union satisfies or in 
an effort to prevent it from imminently satisfying any of the criteria 
set forth in Sec.  (a)(4)(ii), and the Board, consents in writing to 
the amount and terms of the golden parachute payment. Such consent by 
the Board must not improve the IAP's position in the event of the 
insolvency of the corporate credit union since such consent can neither 
bind a liquidating agent nor affect the provability of claims in 
liquidation. In the event that the institution is placed into 
conservatorship or liquidation, the conservator or the liquidating 
agent, as the case may be, will not be obligated to pay the promised 
golden parachute and the IAP will not be accorded preferential 
treatment on the basis of such prior approval; or
    (ii) Such a payment is made pursuant to an agreement which provides 
for a reasonable severance payment, not to exceed twelve months salary, 
to an IAP in the event of a merger with another corporate credit union; 
provided, however, that a corporate credit union must obtain the 
consent of the Board, before making such a payment and this paragraph 
(d)(1)(iii) does not apply to any merger between corporates that 
results from an assisted transaction as described in section 208 of the 
Act (12 U.S.C. 1788) or the corporate credit union being placed into 
conservatorship or liquidation; or
    (iii) The Board, with the written concurrence of the appropriate 
state supervisory authority (in the case of a state-chartered 
corporate), determines that such a payment or agreement is permissible.
    (2) A corporate credit union making a request pursuant to 
paragraphs (d)(1)(i) through (iii) of this section must demonstrate 
that it does not possess and is not aware of any information, evidence, 
documents or other materials which would indicate that there is a 
reasonable basis to believe, at the time such payment is proposed to be 
made, that:
    (i) The IAP has committed any fraudulent act or omission, breach of 
trust or fiduciary duty, or insider abuse with regard to the corporate 
credit union that has had or is likely to have a material adverse 
effect on the corporate credit union;
    (ii) The IAP is substantially responsible for the insolvency of, 
the appointment of a conservator or liquidating agent for, or the 
troubled condition, as defined by Sec.  701.14(b)(4), of the corporate 
credit union;
    (iii) The IAP has materially violated any applicable federal or 
state banking law or regulation that has had or is likely to have a 
material effect on the corporate credit union; and
    (iv) The IAP has violated or conspired to violate section 215, 656, 
657, 1005, 1006, 1007, 1014, 1032, or 1344 of title 18 of the United 
States Code, or section 1341 or 1343 of such title affecting a 
federally insured financial institution as defined in title 18 of the 
United States Code.
    (3) In making a determination under paragraphs (d)(1)(i) through 
(iii) of this section, the Board may consider:
    (i) Whether, and to what degree, the IAP was in a position of 
managerial or fiduciary responsibility;
    (ii) The length of time the IAP was affiliated with the corporate 
credit union, and the degree to which the proposed payment represents a 
reasonable payment for services rendered over the period of employment; 
and
    (iii) Any other factors or circumstances which would indicate that 
the proposed payment would be contrary to the intent of section 206(t) 
of the Act or this part.
    (e) Permissible indemnification payments. (1) A corporate credit 
union may make or agree to make reasonable indemnification payments to 
an IAP with respect to an administrative proceeding or civil action 
initiated by NCUA or a state regulatory authority if:
    (i) The corporate credit union's board of directors, in good faith, 
determines in writing after due investigation and consideration that 
the institution-affiliated party acted in good faith and in a manner 
he/she believed to be in the best interests of the institution;
    (ii) The corporate credit union's board of directors, in good 
faith, determines in writing after due investigation and consideration 
that the payment of such expenses will not materially adversely affect 
the institution's or holding company's safety and soundness;
    (iii) The indemnification payments do not constitute prohibited 
indemnification payments as that term is defined in Sec.  704.20(c); 
and
    (iv) The IAP agrees in writing to reimburse the corporate credit 
union, to the extent not covered by payments from insurance or bonds 
purchased pursuant to Sec.  704.20(a)(9)(iv)(A), for that portion of 
the advanced indemnification payments which subsequently become 
prohibited indemnification payments, as defined in Sec.  704.20(a)(9).
    (2) An IAP seeking indemnification payments must not participate in 
any way in the board's discussion and approval of such payments; 
provided, however, that such IAP may present his/her request to the 
board and respond to any inquiries from the board concerning his/her 
involvement in the circumstances giving rise to the administrative 
proceeding or civil action.
    (3) In the event that a majority of the members of the board of 
directors are named as respondents in an administrative proceeding or 
civil action and request indemnification, the remaining members of the 
board may authorize independent legal counsel to review the 
indemnification request and provide the remaining members of the board 
with a written opinion of counsel as to whether the conditions 
delineated in paragraph (e)(1) of this section have

[[Page 65278]]

been met. If independent legal counsel opines that said conditions have 
been met, the remaining members of the board of directors may rely on 
such opinion in authorizing the requested indemnification.
    (4) In the event that all of the members of the board of directors 
are named as respondents in an administrative proceeding or civil 
action and request indemnification, the board will authorize 
independent legal counsel to review the indemnification request and 
provide the board with a written opinion of counsel as to whether the 
conditions delineated in paragraph (e)(1) of this section have been 
met. If independent legal counsel opines that said conditions have been 
met, the board of directors may rely on such opinion in authorizing the 
requested indemnification.
    (f) Filing instructions. Requests to make excess nondiscriminatory 
severance plan payments pursuant to Sec.  704.20(a)(4)(iv)(E) and 
golden parachute payments permitted by Sec.  704.20(d) must be 
submitted in writing to the Board. The request must be in letter form 
and must contain all relevant factual information as well as the 
reasons why such approval should be granted.
    (g) Applicability in the event of liquidation or conservatorship. 
The provisions of this part, or any consent or approval granted under 
the provisions of this part by the Board, will not in any way bind any 
liquidating agent or conservator for a failed corporate credit union 
and will not in any way obligate the liquidating agent or conservator 
to pay any claim or obligation pursuant to any golden parachute, 
severance, indemnification or other agreement. Claims for employee 
welfare benefits or other benefits that are contingent, even if 
otherwise vested, when a liquidating agent or conservator is appointed 
for any corporate credit union, including any contingency for 
termination of employment, are not provable claims or actual, direct 
compensatory damage claims against such liquidating agent or 
conservator. Nothing in this part may be construed to permit the 
payment of salary or any liability or legal expense of any IAP contrary 
to 12 U.S.C. 1786(t)(3).
    19. Revise Appendix A to part 704 to read as follows:

Appendix A to Part 704--Capital Prioritization and Model Forms

Part I--Optional Capital Prioritization

    Notwithstanding any other provision in this chapter, a corporate 
credit union, at its option, may determine that capital contributed 
to the corporate on or after [DATE 60 DAYS AFTER DATE OF PUBLICATION 
OF FINAL RULE IN FEDERAL REGISTER] will have priority, for purposes 
of availability to absorb losses and payout in liquidation, over 
capital contributed to the corporate before that date. The board of 
directors at a corporate credit union that desires to make this 
determination must:
    (a) On or before [DATE 60 DAYS AFTER DATE OF PUBLICATION OF 
FINAL RULE IN FEDERAL REGISTER], adopt a resolution implementing its 
determination.
    (b) Inform the credit union's members and NCUA, in writing and 
as soon as practicable after adoption of the resolution, of the 
contents of the board resolution.
    (c) Ensure the credit union uses the appropriate initial and 
periodic Model Form disclosures in Part II below.

Part II--Model Forms

    Part II contains model forms intended for use by corporate 
credit unions to aid in compliance with the capital disclosure 
requirements of Sec.  704.3 and Part I of this Appendix.

Model Form A

Terms and Conditions of Membership Capital Account

    Note: This form is for use before [DATE 12 MONTHS AFTER 
PUBLICATION OF FINAL RULE IN THE FEDERAL REGISTER] in the 
circumstances where the credit union has determined NOT to give 
newly issued capital priority over older capital as described in 
Part I of this Appendix.

    (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.
    (8) If an adjusted balance account--: The membership capital 
balance will be adjusted--(1 or 2)--time(s) annually in relation to 
the member credit union's--(assets or other measure)--as of-- 
(date(s))--. If a term certificate--: The membership capital account 
is a term certificate that will mature on--(date)--.
    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.

Model Form B

Terms and Conditions of Membership Capital Account

    Note: This form is for use before [DATE 12 MONTHS AFTER 
PUBLICATION OF FINAL RULE IN THE FEDERAL REGISTER] in the 
circumstances where the credit union has determined THAT IT WILL 
give newly issued capital priority over older capital as described 
in Part I of this Appendix.

    (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)(a) Membership capital that is issued on or after [DATE 60 
DAYS AFTER DATE OF PUBLICATION OF FINAL RULE IN FEDERAL REGISTER], 
is available to cover losses that exceed retained earnings, 
contributed capital issued before [DATE 60 DAYS AFTER DATE OF 
PUBLICATION OF FINAL RULE IN FEDERAL REGISTER], and perpetual 
capital issued on or after [DATE 60 DAYS AFTER DATE OF PUBLICATION 
OF FINAL RULE IN FEDERAL REGISTER]. Any such losses will be 
distributed pro rata, at the time the loss is realized, among 
membership capital account holders with accounts issued on or after 
[DATE 60 DAYS AFTER DATE OF PUBLICATION OF FINAL RULE IN FEDERAL 
REGISTER]. To the extent that NCA funds are used to cover losses, 
the corporate credit union is prohibited from restoring or 
replenishing the affected accounts under any circumstances.
    (b) Membership capital that is issued before [DATE 60 DAYS AFTER 
DATE OF

[[Page 65279]]

PUBLICATION OF FINAL RULE IN FEDERAL REGISTER] is available to cover 
losses that exceed retained earnings and perpetual capital issued 
before [DATE 60 DAYS AFTER DATE OF PUBLICATION OF FINAL RULE IN 
FEDERAL REGISTER]. Any such losses will be distributed pro rata, at 
the time the loss is realized, among membership capital account 
holders with accounts issued before [DATE 60 DAYS AFTER DATE OF 
PUBLICATION OF FINAL RULE IN FEDERAL REGISTER]. To the extent that 
NCA funds are used to cover losses, the corporate credit union is 
prohibited from restoring or replenishing the affected accounts 
under any circumstances.
    (c) Attached to this disclosure is a statement that describes 
the amount of NCA the credit union has with the corporate credit 
union in each of the categories described in paragraphs (5)(a) and 
(5)(b) above.
    (6) If the corporate credit union is liquidated:
    (a) Membership capital accounts issued on or after [DATE 60 DAYS 
AFTER DATE OF PUBLICATION OF FINAL RULE IN FEDERAL REGISTER] are 
payable only after satisfaction of all liabilities of the 
liquidation estate including uninsured obligations to shareholders 
and the NCUSIF, but not including contributed capital accounts 
issued before [DATE 60 DAYS AFTER DATE OF PUBLICATION OF FINAL RULE 
IN FEDERAL REGISTER] and perpetual capital accounts issued on or 
after [DATE 60 DAYS AFTER DATE OF PUBLICATION OF FINAL RULE IN 
FEDERAL REGISTER]. However, membership capital that is used to cover 
losses in a fiscal year previous to the year of liquidation has no 
claim against the liquidation estate.
    (b) Membership capital accounts issued before [DATE 60 DAYS 
AFTER DATE OF PUBLICATION OF FINAL RULE IN FEDERAL REGISTER], are 
payable only after satisfaction of all liabilities of the 
liquidation estate including uninsured obligations to shareholders 
and the NCUSIF, but not including perpetual capital accounts issued 
before [DATE 60 DAYS AFTER DATE OF PUBLICATION OF FINAL RULE IN 
FEDERAL REGISTER]. However, membership capital that is used to cover 
losses in a fiscal year previous to the year of liquidation has no 
claim against the liquidation estate.
    (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.
    (8) If an adjusted balance account--: The membership capital 
balance will be adjusted--(1 or 2)--time(s) annually in relation to 
the member credit union's--(assets or other measure)--as of-- 
(date(s))--. If a term certificate--: The membership capital account 
is a term certificate that will mature on--(date)--.
    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.

Model Form C

Terms and Conditions of Nonperpetual Contributed Capital

    Note: This form is for use on and after [DATE 12 MONTHS AFTER 
PUBLICATION OF FINAL RULE IN THE FEDERAL REGISTER] in the 
circumstances where the credit union has determined NOT to give 
newly issued capital priority over older capital as described in 
Part I of this Appendix. Also, corporate credit unions should ensure 
that existing membership capital accounts that do not meet the 
qualifying conditions for nonperpetual contributed capital are 
modified so as to meet those conditions.

Terms and Conditions of Nonperpetual Contributed Capital Account

    (1) A nonperpetual contributed capital account is not subject to 
share insurance coverage by the NCUSIF or other deposit insurer.
    (2) A nonperpetual contributed 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 nonperpetual 
contributed capital account transfers to the continuing credit 
union. In the event of a charter conversion, the nonperpetual 
contributed capital account transfers to the new institution. In the 
event of liquidation, the nonperpetual contributed capital account 
may be released to facilitate the payout of shares with the prior 
written approval of NCUA.
    (3) If the nonperpetual contributed capital account is a notice 
account, a member credit union may withdraw the nonperpetual 
contributed capital with a minimum of five years' notice. If the 
nonperpetual contributed capital account is a term instrument it may 
be redeemed only at maturity. The corporate credit union may not 
redeem any account prior to the expiration of the notice period, or 
maturity, without the prior written approval of the NCUA.
    (4) Nonperpetual contributed capital cannot be used to pledge 
borrowings.
    (5) Nonperpetual contributed capital is available to cover 
losses that exceed retained earnings and perpetual contributed 
capital. Any such losses will be distributed pro rata among 
nonperpetual contributed capital account holders at the time the 
loss is realized. To the extent that NCA funds are used to cover 
losses, the corporate credit union is prohibited from restoring or 
replenishing the affected accounts under any circumstances.
    (6) Where the corporate credit union is liquidated, nonperpetual 
contributed capital accounts are payable only after satisfaction of 
all liabilities of the liquidation estate including uninsured 
obligations to shareholders and the NCUSIF. However, nonperpetual 
contributed capital that is used to cover losses in a fiscal year 
previous to the year of liquidation has no claim against the 
liquidation estate.
    (7) Where the corporate credit union is merged into another 
corporate credit union, the nonperpetual contributed capital account 
will transfer to the continuing corporate credit union. For notice 
accounts, the five-year notice period for withdrawal of the 
nonperpetual contributed capital account will remain in effect. For 
term accounts, the original term will remain in effect.
    (8) If a term certificate--: The nonperpetual contributed 
capital account is a term certificate that will mature on--(date)--
(insert date with a minimum five-year original maturity).
    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 nonperpetual 
contributed 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 nonperpetual contributed capital accounts. The certification 
must be maintained in the corporate credit union's files and be 
available for examiner review.

Model Form D

Terms and Conditions of Nonperpetual Contributed Capital

    Note: This form is for use before [DATE 12 MONTHS AFTER 
PUBLICATION OF FINAL RULE IN THE FEDERAL REGISTER] in the 
circumstances where the credit union has determined THAT IT WILL 
give newly issued capital priority over older capital as described 
in Part I of this Appendix. Also, corporate credit unions should 
ensure that existing membership capital accounts that do not meet 
the qualifying conditions for nonperpetual contributed capital are 
modified so as to meet those conditions.

Terms and Conditions of Nonperpetual Contributed Capital Account

    (1) A nonperpetual contributed capital account is not subject to 
share insurance coverage by the NCUSIF or other deposit insurer.
    (2) A nonperpetual contributed 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 nonperpetual 
contributed capital account transfers to the continuing credit 
union. In the event of a charter conversion, the nonperpetual 
contributed capital account transfers to the new institution. In the 
event of liquidation, the nonperpetual contributed capital account 
may be released to facilitate

[[Page 65280]]

the payout of shares with the prior written approval of NCUA.
    (3) If the nonperpetual contributed capital account is a notice 
account, a member credit union may withdraw the nonperpetual 
contributed capital with a minimum of five years' notice. If the 
nonperpetual contributed capital account is a term instrument it may 
be redeemed only at maturity. The corporate credit union may not 
redeem any account prior to the expiration of the notice period, or 
maturity, without the prior written approval of the NCUA.
    (4) Nonperpetual contributed capital cannot be used to pledge 
borrowings.
    (5)(a) Nonperpetual contributed capital that is issued on or 
after [DATE 60 DAYS AFTER DATE OF PUBLICATION OF FINAL RULE IN 
FEDERAL REGISTER] is available to cover losses that exceed retained 
earnings, all contributed capital issued before [DATE 60 DAYS AFTER 
DATE OF PUBLICATION OF FINAL RULE IN FEDERAL REGISTER], and 
perpetual capital issued on or after [DATE 60 DAYS AFTER DATE OF 
PUBLICATION OF FINAL RULE IN FEDERAL REGISTER]. Any such losses will 
be distributed pro rata, at the time the loss is realized, among 
nonperpetual contributed capital account holders with accounts 
issued on or after [DATE 60 DAYS AFTER DATE OF PUBLICATION OF FINAL 
RULE IN FEDERAL REGISTER]. To the extent that NCA funds are used to 
cover losses, the corporate credit union is prohibited from 
restoring or replenishing the affected accounts under any 
circumstances.
    (b) Nonperpetual contributed capital that is before [DATE 60 
DAYS AFTER DATE OF PUBLICATION OF FINAL RULE IN FEDERAL REGISTER], 
is available to cover losses that exceed retained earnings and 
perpetual capital issued before [DATE 60 DAYS AFTER DATE OF 
PUBLICATION OF FINAL RULE IN FEDERAL REGISTER]. Any such losses will 
be distributed pro rata, at the time the loss is realized, among 
nonperpetual contributed capital account holders with accounts 
issued before [DATE 60 DAYS AFTER DATE OF PUBLICATION OF FINAL RULE 
IN FEDERAL REGISTER]. To the extent that NCA funds are used to cover 
losses, the corporate credit union is prohibited from restoring or 
replenishing the affected accounts under any circumstances.
    (c) Attached to this disclosure is a statement that describes 
the amount of NCA the credit union has with the corporate credit 
union in each of the categories described in paragraphs (5)(a) and 
(5)(b) above.
    (6) If the corporate credit union is liquidated:
    (a) Nonperpetual contributed capital accounts issued on or after 
[DATE 60 DAYS AFTER DATE OF PUBLICATION OF FINAL RULE IN FEDERAL 
REGISTER] are payable only after satisfaction of all liabilities of 
the liquidation estate including uninsured obligations to 
shareholders and the NCUSIF, but not including contributed capital 
accounts issued before [DATE 60 DAYS AFTER DATE OF PUBLICATION OF 
FINAL RULE IN FEDERAL REGISTER] or perpetual capital accounts issued 
on or after [DATE 60 DAYS AFTER DATE OF PUBLICATION OF FINAL RULE IN 
FEDERAL REGISTER]. However, nonperpetual contributed capital that is 
used to cover losses in a fiscal year previous to the year of 
liquidation has no claim against the liquidation estate.
    (b) Nonperpetual contributed capital accounts issued before 
[DATE 60 DAYS AFTER DATE OF PUBLICATION OF FINAL RULE IN FEDERAL 
REGISTER] are payable only after satisfaction of all liabilities of 
the liquidation estate including uninsured obligations to 
shareholders and the NCUSIF, but not including perpetual capital 
accounts issued before [DATE 60 DAYS AFTER DATE OF PUBLICATION OF 
FINAL RULE IN FEDERAL REGISTER]. However, nonperpetual contributed 
capital that is used to cover losses in a fiscal year previous to 
the year of liquidation has no claim against the liquidation estate.
    (7) Where the corporate credit union is merged into another 
corporate credit union, the nonperpetual contributed capital account 
will transfer to the continuing corporate credit union. For notice 
accounts, the five-year notice period for withdrawal of the 
nonperpetual contributed capital account will remain in effect. For 
term accounts, the original term will remain in effect.
    (8) If a term certificate--: The nonperpetual contributed 
capital account is a term certificate that will mature on--(date)--
(insert date with a minimum five-year original maturity).
    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 nonperpetual 
contributed 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 nonperpetual contributed capital accounts. The certification 
must be maintained in the corporate credit union's files and be 
available for examiner review.

Model Form E

Terms and Conditions of Paid-In Capital

    Note:  This form is for use before [DATE 12 MONTHS AFTER 
PUBLICATION OF FINAL RULE IN THE FEDERAL REGISTER] in the 
circumstances where the credit union has determined NOT to give 
newly issued capital priority over older capital as described in 
Part I of this Appendix.

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. 
The corporate must also obtain NCUA's approval before the corporate 
calls any paid-in capital.
    (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.

Model Form F

Terms and Conditions of Paid-In Capital

    Note:  This form is for use before [DATE 12 MONTHS AFTER 
PUBLICATION OF FINAL RULE IN THE FEDERAL REGISTER] in the 
circumstances where the credit union has determined THAT IT WILL 
give newly issued capital priority over older capital as described 
in Part I of this Appendix.

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. 
The corporate must also obtain NCUA's approval before the corporate 
calls any paid-in capital.
    (4) Paid-in capital cannot be used to pledge borrowings.
    (5) Availability to cover losses.
    (a) Paid-in capital issued before [DATE 60 DAYS AFTER DATE OF 
PUBLICATION OF FINAL RULE IN FEDERAL REGISTER] is

[[Page 65281]]

available to cover losses that exceed retained earnings. Any such 
losses must be distributed pro rata, at the time the loss is 
realized, among holders of paid-in capital issued before [DATE 60 
DAYS AFTER DATE OF PUBLICATION OF FINAL RULE IN FEDERAL REGISTER]. 
To the extent that paid-in capital funds are used to cover losses, 
the corporate credit union is prohibited from restoring or 
replenishing the affected accounts under any circumstances.
    (b) Paid-in capital issued on or after [DATE 60 DAYS AFTER DATE 
OF PUBLICATION OF FINAL RULE IN FEDERAL REGISTER] is available to 
cover losses that exceed retained earnings and any contributed 
capital issued before [DATE 60 DAYS AFTER DATE OF PUBLICATION OF 
FINAL RULE IN FEDERAL REGISTER]. Any such losses must be distributed 
pro rata, at the time the loss is realized, among holders of paid-in 
capital issued on or after [DATE 60 DAYS AFTER DATE OF PUBLICATION 
OF FINAL RULE IN FEDERAL REGISTER]. To the extent that paid-in 
capital funds are used to cover losses, the corporate credit union 
is prohibited from restoring or replenishing the affected accounts 
under any circumstances.
    (c) Attached to this disclosure is a statement that describes 
the amount of perpetual capital the credit union has with the 
corporate credit union in each of the categories described in 
paragraphs (5)(a) and (5)(b) above.
    (6) Where the corporate credit union is liquidated:
    (a) Paid-in capital accounts issued on or after [DATE 60 DAYS 
AFTER DATE OF PUBLICATION OF FINAL RULE IN FEDERAL REGISTER] are 
payable only after satisfaction of all liabilities of the 
liquidation estate including uninsured obligations to shareholders 
and the NCUSIF, but not including contributed capital accounts 
issued before [DATE 60 DAYS AFTER DATE OF PUBLICATION OF FINAL RULE 
IN FEDERAL REGISTER]. However, paid-in capital that is used to cover 
losses in a fiscal year previous to the year of liquidation has no 
claim against the liquidation estate.
    (b) Paid-in capital accounts issued before [DATE 60 DAYS AFTER 
DATE OF PUBLICATION OF FINAL RULE IN FEDERAL REGISTER] are payable 
only after satisfaction of all liabilities of the liquidation estate 
including uninsured obligations to shareholders and the NCUSIF, 
nonperpetual accounts issued before [DATE 60 DAYS AFTER DATE OF 
PUBLICATION OF FINAL RULE IN FEDERAL REGISTER] and contributed 
capital accounts issued on or after [DATE 60 DAYS AFTER DATE OF 
PUBLICATION OF FINAL RULE IN FEDERAL REGISTER]. However, paid-in 
capital that is used to cover losses in a fiscal year previous to 
the year of liquidation has no claim against the liquidation estate.
    (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.

Model Form G

Terms and Conditions of Perpetual Contributed Capital

    Note:  This form is for use on and after [DATE 12 MONTHS AFTER 
PUBLICATION OF FINAL RULE IN THE FEDERAL REGISTER] in the 
circumstances where the credit union has determined NOT to give 
newly issued capital priority over older capital as described in 
Part I of this Appendix. Also, capital previously issued under the 
nomenclature ``paid-in capital'' is considered perpetual contributed 
capital.

    (1) A perpetual contributed capital account is not subject to 
share insurance coverage by the NCUSIF or other deposit insurer.
    (2) A perpetual contributed 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 perpetual 
contributed capital account transfers to the continuing credit 
union. In the event of a charter conversion, the perpetual 
contributed capital account transfers to the new institution. In the 
event of liquidation, the perpetual contributed 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. 
The corporate must also obtain the prior, written approval of the 
NCUA before releasing any perpetual contributed capital funds.
    (4) Perpetual contributed capital cannot be used to pledge 
borrowings.
    (5) Perpetual contributed capital is perpetual maturity and 
noncumulative dividend.
    (6) Perpetual contributed capital is available to cover losses 
that exceed retained earnings. Any such losses must be distributed 
pro rata among perpetual contributed capital holders at the time the 
loss is realized. To the extent that perpetual contributed capital 
funds are used to cover losses, the corporate credit union is 
prohibited from restoring or replenishing the affected accounts 
under any circumstances.
    (7) Where the corporate credit union is liquidated, perpetual 
contributed capital accounts are payable only after satisfaction of 
all liabilities of the liquidation estate including uninsured 
obligations to shareholders and the NCUSIF, and nonperpetual 
contributed capital holders. However, perpetual contributed capital 
that is used to cover losses in a fiscal year previous to the year 
of liquidation has no claim against the liquidation estate.
    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 perpetual contributed 
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.

Model Form H

Terms and Conditions of Perpetual Contributed Capital

    Note:  This form is for use before [DATE 12 MONTHS AFTER 
PUBLICATION OF FINAL RULE IN THE FEDERAL REGISTER] in the 
circumstances where the credit union has determined THAT IT WILL 
give newly issued capital priority over older capital as described 
in Part I of this Appendix. Also, capital previously issued under 
the nomenclature ``paid-in capital'' is considered perpetual 
contributed capital.

    (1) A perpetual contributed capital account is not subject to 
share insurance coverage by the NCUSIF or other deposit insurer.
    (2) A perpetual contributed 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 perpetual 
contributed capital account transfers to the continuing credit 
union. In the event of a charter conversion, the perpetual 
contributed capital account transfers to the new institution. In the 
event of liquidation, the perpetual contributed 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. 
The corporate must also obtain the prior, written approval of the 
NCUA before releasing any perpetual contributed capital funds.
    (4) Perpetual contributed capital cannot be used to pledge 
borrowings.
    (5) Perpetual contributed capital is perpetual maturity and 
noncumulative dividend.
    (6) Availability to cover losses.
    (a) Perpetual contributed capital issued before [DATE 60 DAYS 
AFTER DATE OF PUBLICATION OF FINAL RULE IN FEDERAL REGISTER] is 
available to cover losses that exceed retained earnings. Any such 
losses must be distributed pro rata, at the time the loss is 
realized, among holders of perpetual contributed capital issued 
before [DATE 60 DAYS AFTER DATE OF PUBLICATION OF FINAL RULE IN 
FEDERAL REGISTER]. To the extent that perpetual contributed capital 
funds are used to cover losses, the corporate credit union is 
prohibited from restoring or replenishing the affected accounts 
under any circumstances.
    (b) Perpetual contributed capital issued on or after [DATE 60 
DAYS AFTER DATE OF PUBLICATION OF FINAL RULE IN FEDERAL REGISTER] is 
available to cover losses that exceed retained earnings and any 
contributed capital issued before [DATE 60 DAYS AFTER DATE OF 
PUBLICATION OF FINAL RULE IN FEDERAL REGISTER]. Any such losses must 
be distributed pro rata, at the time the loss is realized, among 
holders of perpetual contributed capital issued on or after [DATE 60 
DAYS AFTER DATE OF PUBLICATION OF FINAL RULE IN

[[Page 65282]]

FEDERAL REGISTER]. To the extent that perpetual contributed capital 
funds are used to cover losses, the corporate credit union is 
prohibited from restoring or replenishing the affected accounts 
under any circumstances.
    (c) Attached to this disclosure is a statement that describes 
the amount of perpetual capital the credit union has with the 
corporate credit union in each of the categories described in 
paragraphs (6)(a) and (6)(b) above.
    (7) Where the corporate credit union is liquidated:
    (a) Perpetual contributed capital accounts issued on or after 
[DATE 60 DAYS AFTER DATE OF PUBLICATION OF FINAL RULE IN FEDERAL 
REGISTER] are payable only after satisfaction of all liabilities of 
the liquidation estate including uninsured obligations to 
shareholders and the NCUSIF, but not including contributed capital 
accounts issued before [DATE 60 DAYS AFTER DATE OF PUBLICATION OF 
FINAL RULE IN FEDERAL REGISTER]. However, perpetual contributed 
capital that is used to cover losses in a fiscal year previous to 
the year of liquidation has no claim against the liquidation estate.
    (b) Perpetual contributed capital accounts issued before [DATE 
60 DAYS AFTER DATE OF PUBLICATION OF FINAL RULE IN FEDERAL REGISTER] 
are payable only after satisfaction of all liabilities of the 
liquidation estate including uninsured obligations to shareholders 
and the NCUSIF, nonperpetual capital accounts issued before [DATE 60 
DAYS AFTER DATE OF PUBLICATION OF FINAL RULE IN FEDERAL REGISTER], 
and all contributed capital accounts issued on or after [DATE 60 
DAYS AFTER DATE OF PUBLICATION OF FINAL RULE IN FEDERAL REGISTER]. 
However, perpetual contributed capital that is used to cover losses 
in a fiscal year previous to the year of liquidation has no claim 
against the liquidation estate.
    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 perpetual contributed 
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.

    21. Revise Appendix B to Part 704 to read 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, or Part IV of this Appendix, a 
corporate credit union must evaluate monthly the changes in NEV, NEV 
ratio, and WAL for the tests set forth in paragraphs (d)(1)(i), 
(e)(1((i), (f)(1)(i), and (h) of Sec.  704.8.

Base-Plus

    A corporate that has met the requirements for this Base-plus 
authority may, in performing the rate stress tests set forth in 
704.8(d)(1)(i) and (e)(1)(i), allow its NEV to decline as much as 20 
percent, and in performing the rate stress tests set forth in 
704.8(f)(1)(i), allow its NEV to decline as much as 30 percent.

Part I

    (a) A corporate credit union that has met all the requirements 
established by NCUA for this Part I, including a minimum capital 
ratio of at least six percent, 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) In performing the rate stress tests set forth in Sec.  
704.8(d) and (e), 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 seven percent 
minimum capital ratio and is specifically approved by NCUA; or
    (3) 35 percent if the corporate credit union has an eight 
percent minimum capital ratio and is specifically approved by NCUA.
    (c) In performing the rate stress tests set forth in Sec.  
704.8(f), the NEV of a corporate credit union that has met the 
requirements of this Part I may decline as much as:
    (1) 30 percent;
    (2) 38 percent if the corporate credit union has a seven percent 
minimum capital ratio and is specifically approved by NCUA; or
    (3) 45 percent if the corporate credit union has an eight 
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.
    (e) The aggregate total of investments purchased under the 
authority of Part I (a)(1) and Part I (a)(2) may not exceed the 
lower of 500 percent of the corporate credit union's capital or 25 
percent of assets.
    (f) On or after [DATE 12 MONTHS AFTER DATE OF PUBLICATION OF 
FINAL RULE IN FEDERAL REGISTER], corporate credit unions will 
substitute ``leverage ratio'' for ``capital ratio'' wherever it 
appears in Part I.

Part II

    (a) A corporate credit union that has met the requirements of 
Part I of this Appendix and the additional requirements established 
by NCUA for Part II may invest in:
    (1) Debt obligations of a foreign country;
    (2) Deposits and debt obligations of foreign banks or 
obligations guaranteed by these banks;
    (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 III

    (a) A corporate credit union that has met the requirements 
established by NCUA for this Part III may enter into derivative 
transactions specifically approved by NCUA to:
    (1) Create structured products;
    (2) Mitigate interest rate risk and credit risk on 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 II expanded

[[Page 65283]]

authority and the counterparty rating must be no lower than the 
minimum permissible rating for a comparable term investment under 
Part II 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 IV

    A corporate credit union that has met all the requirements 
established by NCUA for this Part IV may participate in loans with 
member natural person credit unions as approved by the NCUA 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 NCUA.
    22. Add a new Appendix C to Part 704 to read as follows:

Appendix C to Part 704--Risk-Based Capital Credit Risk-Weight 
Categories

Table of Contents

I. Introduction
    (a) Scope
    (b) Definitions
II. Risk-Weightings
    (a) On-balance sheet assets
    (b) Off-balance sheet activities
    (c) Recourse obligations, direct credit substitutes, and certain 
other positions

Part I: Introduction

    Section I.
    (a) Scope.
    (1) This Appendix explains how a corporate credit union must 
compute its risk-weighted assets for purposes of determining its 
capital ratios.
    (2) Risk-weighted assets equal risk-weighted on-balance sheet 
assets (computed under Section II(a) of this Appendix), plus risk-
weighted off-balance sheet activities (computed under Section II(b) 
of this Appendix), plus risk-weighted recourse obligations, direct 
credit substitutes, and certain other positions (computed under 
Section II(c) of this Appendix).
    (3) Assets not included (i.e., deducted from capital) for 
purposes of calculating capital under part 704 are not included in 
calculating risk-weighted assets.
    (4) Although this Appendix describes risk-weightings for various 
assets and activities, this Appendix does not provide authority for 
corporate credit unions to invest in or purchase any particular type 
of asset or to engage in any particular type of activity. A 
corporate credit union must have other identifiable authority for 
any investment it makes or activity it engages in.
    (b) Definitions.
    The following definitions apply to this Appendix. Additional 
definitions, applicable to this entire Part, are located in Sec.  
704.2 of this Part.
    Cash items in the process of collection means checks or drafts 
in the process of collection that are drawn on another depository 
institution, including a central bank, and that are payable 
immediately upon presentation; U.S. Government checks that are drawn 
on the United States Treasury or any other U.S. Government or 
Government-sponsored agency and that are payable immediately upon 
presentation; broker's security drafts and commodity or bill-of-
lading drafts payable immediately upon presentation; and unposted 
debits.
    Commitment means any arrangement that obligates a corporate 
credit union to:
    (1) Purchase loans or securities;
    (2) Extend credit in the form of loans or leases, participations 
in loans or leases, overdraft facilities, revolving credit 
facilities, home equity lines of credit, eligible ABCP liquidity 
facilities, or similar transactions.
    Depository institution means a financial institution that 
engages in the business of providing financial services; that is 
recognized as a bank or a credit union by the supervisory or 
monetary authorities of the country of its incorporation and the 
country of its principal banking operations; that receives deposits 
to a substantial extent in the regular course of business; and that 
has the power to accept demand deposits. In the United States, this 
definition encompasses all federally insured offices of commercial 
banks, mutual and stock savings banks, savings or building and loan 
associations (stock and mutual), cooperative banks, credit unions, 
and international banking facilities of domestic depository 
institutions. Bank holding companies and savings and loan holding 
companies are excluded from this definition. For the purposes of 
assigning risk-weights, the differentiation between OECD depository 
institutions and non-OECD depository institutions is based on the 
country of incorporation. Claims on branches and agencies of foreign 
banks located in the United States are to be categorized on the 
basis of the parent bank's country of incorporation.
    Direct credit substitute means an arrangement in which a 
corporate credit union assumes, in form or in substance, credit risk 
associated with an on-balance sheet or off-balance sheet asset or 
exposure that was not previously owned by the corporate credit union 
(third-party asset) and the risk assumed by the corporate credit 
union exceeds the pro rata share of the corporate credit union's 
interest in the third-party asset. If a corporate credit union has 
no claim on the third-party asset, then the corporate credit union's 
assumption of any credit risk is a direct credit substitute. Direct 
credit substitutes include:
    (1) Financial standby letters of credit that support financial 
claims on a third party that exceed a corporate credit union's pro 
rata share in the financial claim;
    (2) Guarantees, surety arrangements, credit derivatives, and 
similar instruments backing financial claims that exceed a corporate 
credit union's pro rata share in the financial claim;
    (3) Purchased subordinated interests that absorb more than their 
pro rata share of losses from the underlying assets, including any 
tranche of asset-backed securities that is not the most senior 
tranche;
    (4) Credit derivative contracts under which the corporate credit 
union assumes more than its pro rata share of credit risk on a 
third-party asset or exposure;
    (5) Loans or lines of credit that provide credit enhancement for 
the financial obligations of a third party;
    (6) Purchased loan servicing assets if the servicer is 
responsible for credit losses or if the servicer makes or assumes 
credit-enhancing representations and warranties with respect to the 
loans serviced. Servicer cash advances as defined in this section 
are not direct credit substitutes;
    (7) Clean-up calls on third party assets. However, clean-up 
calls that are 10 percent or less of the original pool balance and 
that are exercisable at the option of the corporate credit union are 
not direct credit substitutes; and
    (8) Liquidity facilities that provide support to asset-backed 
commercial paper (other than eligible ABCP liquidity facilities).
    Exchange rate contracts means cross-currency interest rate 
swaps; forward foreign exchange rate contracts; currency options 
purchased; and any similar instrument that, in the opinion of the 
NCUA, may give rise to similar risks.
    Face amount means the notational principal, or face value, 
amount of an off-balance sheet item or the amortized cost of an on-
balance sheet asset.
    Financial asset means cash or other monetary instrument, 
evidence of debt, evidence of an ownership interest in an entity, or 
a contract that conveys a right to receive or exchange cash or 
another financial instrument from another party.
    Financial standby letter of credit means a letter of credit or 
similar arrangement that represents an irrevocable obligation to a 
third-party beneficiary:
    (1) To repay money borrowed by, or advanced to, or for the 
account of, a second party (the account party); or
    (2) To make payment on behalf of the account party, in the event 
that the account party fails to fulfill its obligation to the 
beneficiary.
    OECD-based country means a member of that grouping of countries 
that are full members of the Organization for Economic Cooperation 
and Development (OECD) plus countries that have concluded special 
lending arrangements with the International

[[Page 65284]]

Monetary Fund (IMF) associated with the IMF's General Arrangements 
to Borrow. This term excludes any country that has rescheduled its 
external sovereign debt within the previous five years. A 
rescheduling of external sovereign debt generally would include any 
renegotiation of terms arising from a country's inability or 
unwillingness to meet its external debt service obligations, but 
generally would not include renegotiations of debt in the normal 
course of business, such as a renegotiation to allow the borrower to 
take advantage of a decline in interest rates or other change in 
market conditions.
    Original maturity means, with respect to a commitment, the 
earliest date after a commitment is made on which the commitment is 
scheduled to expire (i.e., it will reach its stated maturity and 
cease to be binding on either party), provided that either:
    (1) The commitment is not subject to extension or renewal and 
will actually expire on its stated expiration date; or
    (2) If the commitment is subject to extension or renewal beyond 
its stated expiration date, the stated expiration date will be 
deemed the original maturity only if the extension or renewal must 
be based upon terms and conditions independently negotiated in good 
faith with the member at the time of the extension or renewal and 
upon a new, bona fide credit analysis utilizing current information 
on financial condition and trends.
    Performance-based standby letter of credit means any letter of 
credit, or similar arrangement, however named or described, which 
represents an irrevocable obligation to the beneficiary on the part 
of the issuer to make payment on account of any default by a third 
party in the performance of a nonfinancial or commercial obligation. 
Such letters of credit include arrangements backing subcontractors' 
and suppliers' performance, labor and materials contracts, and 
construction bids.
    Prorated assets means the total assets (as determined in the 
most recently available GAAP report but in no event more than one 
year old) of a consolidated CUSO multiplied by the corporate credit 
union's percentage of ownership of that consolidated CUSO.
    Qualifying mortgage loan means a loan that:
    (1) Is fully secured by a first lien on a one-to four-family 
residential property;
    (2) Is underwritten in accordance with prudent underwriting 
standards, including standards relating the ratio of the loan amount 
to the value of the property (LTV ratio), as presented in the 
Interagency Guidelines for Real Estate Lending Policies, 57 FR 62890 
(December 31, 1992). A nonqualifying mortgage loan that is paid down 
to an appropriate LTV ratio (calculated using value at origination, 
appraisal obtained within the prior six months, or updated value 
using an automated valuation model) may become a qualifying loan if 
it meets all other requirements of this definition;
    (3) Maintains an appropriate LTV ratio based on the amortized 
principal balance of the loan; and
    (4) Is performing and is not more than 90 days past due.
    If a corporate credit union holds the first and junior lien(s) 
on a residential property and no other party holds an intervening 
lien, the transaction is treated as a single loan secured by a first 
lien for the purposes of determining the LTV ratio and the 
appropriate risk-weight under Appendix C. Also, a loan to an 
individual borrower for the construction of the borrower's home may 
be included as a qualifying mortgage loan.
    Qualifying multifamily mortgage loan means a loan secured by a 
first lien on multifamily residential properties consisting of 5 or 
more dwelling units, provided that:
    (1) The amortization of principal and interest occurs over a 
period of not more than 30 years;
    (2) The original minimum maturity for repayment of principal on 
the loan is not less than seven years;
    (3) When considering the loan for placement in a lower risk-
weight category, all principal and interest payments have been made 
on a timely basis in accordance with its terms for the preceding 
year;
    (4) The loan is performing and not 90 days or more past due;
    (5) The loan is made in accordance with prudent underwriting 
standards; and
    (6) If the interest rate on the loan does not change over the 
term of the loan, the current loan balance amount does not exceed 80 
percent of the value of the property securing the loan, and for the 
property's most recent fiscal year, the ratio of annual net 
operating income generated by the property (before payment of any 
debt service on the loan) to annual debt service on the loan is not 
less than 120 percent, or in the case of cooperative or other not-
for-profit housing projects, the property generates sufficient cash 
flows to provide comparable protection to the institution; or
    (7) If the interest rate on the loan changes over the term of 
the loan, the current loan balance amount does not exceed 75 percent 
of the value of the property securing the loan, and for the 
property's most recent fiscal year, the ratio of annual net 
operating income generated by the property (before payment of any 
debt service on the loan) to annual debt service on the loan is not 
less than 115 percent, or in the case of cooperative or other not-
for-profit housing projects, the property generates sufficient cash 
flows to provide comparable protection to the institution.
    For purposes of paragraphs (6) and (7) of this definition, the 
term value of the property means, at origination of a loan to 
purchase a multifamily property, the lower of the purchase price or 
the amount of the initial appraisal, or if appropriate, the initial 
evaluation. In cases not involving purchase of a multifamily loan, 
the value of the property is determined by the most current 
appraisal, or if appropriate, the most current evaluation.
    In cases where a borrower refinances a loan on an existing 
property, as an alternative to paragraphs (3), (6), and (7) of this 
definition:
    (1) All principal and interest payments on the loan being 
refinanced have been made on a timely basis in accordance with the 
terms of that loan for the preceding year; and
    (2) The net income on the property for the preceding year would 
support timely principal and interest payments on the new loan in 
accordance with the applicable debt service requirement.
    Qualifying residential construction loan, also referred to as a 
residential bridge loan, means a loan made in accordance with sound 
lending principles satisfying the following criteria:
    (1) The builder must have substantial project equity in the home 
construction project;
    (2) The residence being constructed must be a 1-4 family 
residence sold to a home purchaser;
    (3) The lending entity must obtain sufficient documentation from 
a permanent lender (which may be the construction lender) 
demonstrating that the home buyer intends to purchase the residence 
and has the ability to obtain a permanent qualifying mortgage loan 
sufficient to purchase the residence;
    (4) The home purchaser must have made a substantial earnest 
money deposit;
    (5) The construction loan must not exceed 80 percent of the 
sales price of the residence;
    (6) The construction loan must be secured by a first lien on the 
lot, residence under construction, and other improvements;
    (7) The lending credit union must retain sufficient undisbursed 
loan funds throughout the construction period to ensure project 
completion;
    (8) The builder must incur a significant percentage of direct 
costs (i.e., the actual costs of land, labor, and material) before 
any drawdown on the loan;
    (9) If at any time during the life of the construction loan any 
of the criteria of this rule are no longer satisfied, the corporate 
must immediately recategorize the loan at a 100 percent risk-weight 
and must accurately report the loan in the corporate's next 
quarterly call report;
    (10) The home purchaser must intend that the home will be owner-
occupied;
    (11) The home purchaser(s) must be an individual(s), not a 
partnership, joint venture, trust corporation, or any other entity 
(including an entity acting as a sole proprietorship) that is 
purchasing the home(s) for speculative purposes; and
    (12) The loan must be performing and not more than 90 days past 
due.
    The NCUA retains the discretion to determine that any loans not 
meeting sound lending principles must be placed in a higher risk-
weight category. The NCUA also reserves the discretion to modify 
these criteria on a case-by-case basis provided that any such 
modifications are not inconsistent with the safety and soundness 
objectives of this definition.
    Qualifying securities firm means:
    (1) A securities firm incorporated in the United States that is 
a broker-dealer that is registered with the Securities and Exchange 
Commission (SEC) and that complies with the SEC's net capital 
regulations (17 CFR 240.15c3(1)); and
    (2) A securities firm incorporated in any other OECD-based 
country, if the corporate credit union is able to demonstrate that 
the securities firm is subject to consolidated supervision and 
regulation (covering its subsidiaries, but not necessarily its 
parent

[[Page 65285]]

organizations) comparable to that imposed on depository institutions 
in OECD countries. Such regulation must include risk-based capital 
requirements comparable to those imposed on depository institutions 
under the Accord on International Convergence of Capital Measurement 
and Capital Standards (1988, as amended in 1998).
    Recourse means a corporate credit union's retention, in form or 
in substance, of any credit risk directly or indirectly associated 
with an asset it has sold (in accordance with Generally Accepted 
Accounting Principles) that exceeds a pro rata share of that 
corporate credit union's claim on the asset. If a corporate credit 
union has no claim on a asset it has sold, then the retention of any 
credit risk is recourse. A recourse obligation typically arises when 
a corporate credit union transfers assets in a sale and retains an 
explicit obligation to repurchase assets or to absorb losses due to 
a default on the payment of principal or interest or any other 
deficiency in the performance of the underlying obligor or some 
other party. Recourse may also exist implicitly if a corporate 
credit union provides credit enhancement beyond any contractual 
obligation to support assets it has sold. Recourse obligations 
include:
    (1) Credit-enhancing representations and warranties made on 
transferred assets;
    (2) Loan servicing assets retained pursuant to an agreement 
under which the corporate credit union will be responsible for 
losses associated with the loans serviced. Servicer cash advances as 
defined in this section are not recourse obligations;
    (3) Retained subordinated interests that absorb more than their 
pro rata share of losses from the underlying assets;
    (4) Assets sold under an agreement to repurchase, if the assets 
are not already included on the balance sheet;
    (5) Loan strips sold without contractual recourse where the 
maturity of the transferred portion of the loan is shorter than the 
maturity of the commitment under which the loan is drawn;
    (6) Credit derivatives that absorb more than the corporate 
credit union's pro rata share of losses from the transferred assets;
    (7) Clean-up calls on assets the corporate credit union has 
sold. However, clean-up calls that are 10 percent or less of the 
original pool balance and that are exercisable at the option of the 
corporate credit union are not recourse arrangements; and
    (8) Liquidity facilities that provide support to asset-backed 
commercial paper (other than eligible ABCP liquidity facilities). 
Replacement cost means, with respect to interest rate and exchange-
rate contracts, the loss that would be incurred in the event of a 
counterparty default, as measured by the net cost of replacing the 
contract at the current market value. If default would result in a 
theoretical profit, the replacement value is considered to be zero. 
This mark-to-market process must incorporate changes in both 
interest rates and counterparty credit quality.
    Residential properties means houses, condominiums, cooperative 
units, and manufactured homes. This definition does not include 
boats or motor homes, even if used as a primary residence, or 
timeshare properties.
    Residual interest means any on-balance sheet asset that:
    (1) Represents an interest (including a beneficial interest) 
created by a transfer that qualifies as a sale (in accordance with 
Generally Accepted Accounting Principles) of financial assets, 
whether through a securitization or otherwise; and
    (2) Exposes a corporate credit union to credit risk directly or 
indirectly associated with the transferred asset that exceeds a pro 
rata share of that corporate credit union's claim on the asset, 
whether through subordination provisions or other credit enhancement 
techniques.
    Residual interests generally include credit-enhancing interest-
only strips, spread accounts, cash collateral accounts, retained 
subordinated interests (and other forms of overcollateralization), 
and similar assets that function as a credit enhancement. Residual 
interests further include those exposures that, in substance, cause 
the corporate credit union to retain the credit risk of an asset or 
exposure that had qualified as a residual interest before it was 
sold. Residual interests generally do not include assets purchased 
from a third party, but a credit-enhancing interest-only strip that 
is acquired in any asset transfer is a residual interest.
    Corporate credit unions will use this definition of the term 
``residual interests,'' and not the definition in Sec.  704.2, for 
purposes of applying this Appendix.
    Risk participation means a participation in which the 
originating party remains liable to the beneficiary for the full 
amount of an obligation (e.g., a direct credit substitute), 
notwithstanding that another party has acquired a participation in 
that obligation.
    Risk-weighted assets means the sum total of risk-weighted on-
balance sheet assets, as calculated under Section II(a) of this 
Appendix, and the total of risk-weighted off-balance sheet credit 
equivalent amounts. The total of risk-weighted off-balance sheet 
credit equivalent amounts equals the risk-weighted off-balance sheet 
activities as calculated under Section II(b) of this Appendix plus 
the risk-weighted recourse obligations, risk-weighted direct credit 
substitutes, and certain other risk-weighted positions as calculated 
under Section II(c) of this Appendix.
    Servicer cash advance means funds that a residential mortgage 
servicer advances to ensure an uninterrupted flow of payments, 
including advances made to cover foreclosure costs or other expenses 
to facilitate the timely collection of the loan. A servicer cash 
advance is not a recourse obligation or a direct credit substitute 
if:
    (1) The servicer is entitled to full reimbursement and this 
right is not subordinated to other claims on the cash flows from the 
underlying asset pool; or
    (2) For any one loan, the servicer's obligation to make 
nonreimbursable advances is contractually limited to an 
insignificant amount of the outstanding principal amount on that 
loan.
    Structured financing program means a program where receivable 
interests and asset-or mortgage-backed securities issued by multiple 
participants are purchased by a special purpose entity that 
repackages those exposures into securities that can be sold to 
investors. Structured financing programs allocate credit risk, 
generally, between the participants and credit enhancement provided 
to the program.
    Traded position means a position retained, assumed, or issued in 
connection with a securitization that is rated by a NRSRO, where 
there is a reasonable expectation that, in the near future, the 
rating will be relied upon by:
    (1) Unaffiliated investors to purchase the security; or
    (2) An unaffiliated third party to enter into a transaction 
involving the position, such as a purchase, loan, or repurchase 
agreement.
    Unconditionally cancelable means, with respect to a commitment-
type lending arrangement, that the corporate credit union may, at 
any time, with or without cause, refuse to advance funds or extend 
credit under the facility.
    United States Government or its agencies means an 
instrumentality of the U.S. Government whose debt obligations are 
fully and explicitly guaranteed as to the timely payment of 
principal and interest by the full faith and credit of the United 
States Government.
    United States Government-sponsored agency or corporation means 
an agency or corporation originally established or chartered to 
serve public purposes specified by the United States Congress but 
whose obligations are not explicitly guaranteed by the full faith 
and credit of the United States Government.

Part II: Risk-Weightings

    Section II.
    (a) On-balance sheet assets.
    Except as provided in Section II(b) of this Appendix, risk-
weighted on-balance sheet assets are computed by multiplying the on-
balance sheet asset amounts times the appropriate risk-weight 
categories. The risk-weight categories are:
    (1) Zero percent Risk-Weight (Category 1).
    (i) Cash, including domestic and foreign currency owned and held 
in all offices of a corporate credit union or in transit. Any 
foreign currency held by a corporate credit union must be converted 
into U.S. dollar equivalents;
    (ii) Securities issued by and other direct claims on the U.S. 
Government or its agencies (to the extent such securities or claims 
are unconditionally backed by the full faith and credit of the 
United States Government) or the central government of an OECD 
country;
    (iii) Notes and obligations issued or guaranteed by the Federal 
Deposit Insurance Corporation or the National Credit Union Share 
Insurance Fund and backed by the full faith and credit of the United 
States Government;
    (iv) Deposit reserves at, claims on, and balances due from 
Federal Reserve Banks;
    (v) The book value of paid-in Federal Reserve Bank stock;
    (vi) That portion of assets directly and unconditionally 
guaranteed by the United States Government or its agencies, or the 
central government of an OECD country.
    (viii) Claims on, and claims guaranteed by, a qualifying 
securities firm that are

[[Page 65286]]

collateralized by cash on deposit in the corporate credit union or 
by securities issued or guaranteed by the United States Government 
or its agencies, or the central government of an OECD country. To be 
eligible for this risk-weight, the corporate credit union must 
maintain a positive margin of collateral on the claim on a daily 
basis, taking into account any change in a corporate credit union's 
exposure to the obligor or counterparty under the claim in relation 
to the market value of the collateral held in support of the claim.
    (2) 20 percent Risk-Weight (Category 2).
    (i) Cash items in the process of collection;
    (ii) That portion of assets conditionally guaranteed by the 
United States Government or its agencies, or the central government 
of an OECD country,
    (iii) That portion of assets collateralized by the current 
market value of securities issued or guaranteed by the United States 
government or its agencies, or the central government of an OECD 
country;
    (iv) Securities (not including equity securities) issued by and 
other claims on the U.S. Government or its agencies which are not 
backed by the full faith and credit of the United States Government;
    (v) Securities (not including equity securities) issued by, or 
other direct claims on, United States Government-sponsored agencies;
    (vi) That portion of assets guaranteed by United States 
Government-sponsored agencies;
    (vii) That portion of assets collateralized by the current 
market value of securities issued or guaranteed by United States 
Government-sponsored agencies;
    (viii) Claims on, and claims guaranteed by, a qualifying 
securities firm, subject to the following conditions:
    (A) A qualifying securities firm must have a long-term issuer 
credit rating, or a rating on at least one issue of long-term 
unsecured debt, from a NRSRO. The rating must be in one of the three 
highest investment grade categories used by the NRSRO. If two or 
more NRSROs assign ratings to the qualifying securities firm, the 
corporate credit union must use the lowest rating to determine 
whether the rating requirement of this paragraph is met. A 
qualifying securities firm may rely on the rating of its parent 
consolidated company, if the parent consolidated company guarantees 
the claim.
    (B) A collateralized claim on a qualifying securities firm does 
not have to comply with the rating requirements under paragraph (a) 
if the claim arises under a contract that:
    (1) Is a reverse repurchase/repurchase agreement or securities 
lending/borrowing transaction executed using standard industry 
documentation;
    (2) Is collateralized by debt or equity securities that are 
liquid and readily marketable;
    (3) Is marked-to-market daily;
    (4) Is subject to a daily margin maintenance requirement under 
the standard industry documentation; and
    (5) Can be liquidated, terminated or accelerated immediately in 
bankruptcy or similar proceeding, and the security or collateral 
agreement will not be stayed or avoided under applicable law of the 
relevant jurisdiction. For example, a claim is exempt from the 
automatic stay in bankruptcy in the United States if it arises under 
a securities contract or a repurchase agreement subject to section 
555 or 559 of the Bankruptcy Code (11 U.S.C. 555 or 559), a 
qualified financial contract under section 207(c)(8) of the Federal 
Credit Union Act (12 U.S.C. 1787(c)(8)) or section 11(e)(8) of the 
Federal Deposit Insurance Act (12 U.S.C. 1821(e)(8)), or a netting 
contract between or among financial institutions under sections 401-
407 of the Federal Deposit Insurance Corporation Improvement Act of 
1991 (12 U.S.C. 4401-4407), or Regulation EE (12 CFR part 231).
    (C) If the securities firm uses the claim to satisfy its 
applicable capital requirements, the claim is not eligible for a 
risk-weight under this paragraph II(a)(2)(viii);
    (ix) Claims representing general obligations of any public-
sector entity in an OECD country, and that portion of any claims 
guaranteed by any such public-sector entity;
    (x) Balances due from and all claims on domestic depository 
institutions. This includes demand deposits and other transaction 
accounts, savings deposits and time certificates of deposit, federal 
funds sold, loans to other depository institutions, including 
overdrafts and term federal funds, holdings of the corporate credit 
union's own discounted acceptances for which the account party is a 
depository institution, holdings of bankers acceptances of other 
institutions and securities issued by depository institutions, 
except those that qualify as capital;
    (xi) The book value of paid-in Federal Home Loan Bank stock;
    (xii) Deposit reserves at, claims on and balances due from the 
Federal Home Loan Banks;
    (xiii) Assets collateralized by cash held in a segregated 
deposit account by the reporting corporate credit union;
    (xiv) Claims on, or guaranteed by, official multilateral lending 
institutions or regional development institutions in which the 
United States Government is a shareholder or contributing member; 
\69\
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    \69\ These institutions include, but are not limited to, the 
International Bank for Reconstruction and Development (World Bank), 
the Inter-American Development Bank, the Asian Development Bank, the 
African Development Bank, the European Investments Bank, the 
International Monetary Fund and the Bank for International 
Settlements.
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    (xv) That portion of assets collateralized by the current market 
value of securities issued by official multilateral lending 
institutions or regional development institutions in which the 
United States Government is a shareholder or contributing member.
    (xvi) All claims on depository institutions incorporated in an 
OECD country, and all assets backed by the full faith and credit of 
depository institutions incorporated in an OECD country. This 
includes the credit equivalent amount of participations in 
commitments and standby letters of credit sold to other depository 
institutions incorporated in an OECD country, but only if the 
originating bank remains liable to the member or beneficiary for the 
full amount of the commitment or standby letter of credit. Also 
included in this category are the credit equivalent amounts of risk 
participations in bankers' acceptances conveyed to other depository 
institutions incorporated in an OECD country. However, bank-issued 
securities that qualify as capital of the issuing bank are not 
included in this risk category;
    (xvii) Claims on, or guaranteed by depository institutions other 
than the central bank, incorporated in a non-OECD country, with a 
remaining maturity of one year or less;
    (xviii) That portion of local currency claims conditionally 
guaranteed by central governments of non-OECD countries, to the 
extent the corporate credit union has local currency liabilities in 
that country.
    (3) 50 percent Risk-Weight (Category 3).
    (i) Revenue bonds issued by any public-sector entity in an OECD 
country for which the underlying obligor is a public-sector entity, 
but which are repayable solely from the revenues generated from the 
project financed through the issuance of the obligations;
    (ii) Qualifying mortgage loans and qualifying multifamily 
mortgage loans;
    (iii) Privately-issued mortgage-backed securities (i.e., those 
that do not carry the guarantee of the U.S. government, U.S. 
government agency, or U.S. government sponsored enterprise) 
representing an interest in qualifying mortgage loans or qualifying 
multifamily mortgage loans. If the security is backed by qualifying 
multifamily mortgage loans, the corporate credit union must receive 
timely payments of principal and interest in accordance with the 
terms of the security. Payments will generally be considered timely 
if they are not 30 days past due; and
    (iv) Qualifying residential construction loans.
    (4) 100 percent Risk-Weight (Category 4).
    All assets not specified above or deducted from calculations of 
capital pursuant to Sec.  704.2 and Sec.  704.3 of this part, 
including, but not limited to:
    (i) Consumer loans;
    (ii) Commercial loans;
    (iii) Home equity loans;
    (iv) Non-qualifying mortgage loans;
    (v) Non-qualifying multifamily mortgage loans;
    (vi) Residential construction loans;
    (vii) Land loans;
    (viii) Nonresidential construction loans;
    (ix) Obligations issued by any state or any political 
subdivision thereof for the benefit of a private party or enterprise 
where that party or enterprise, rather than the issuing state or 
political subdivision, is responsible for the timely payment of 
principal and interest on the obligations, e.g., industrial 
development bonds;
    (x) Debt securities not specifically risk-weighted in another 
category;
    (xi) Investments in fixed assets and premises;
    (xii) Servicing assets;
    (xiii) Interest-only strips receivable, other than credit-
enhancing interest-only strips;
    (xiv) Equity investments;
    (xv) The prorated assets of subsidiaries (except for the assets 
of consolidated CUSOs) to the extent such assets are included in 
adjusted total assets;

[[Page 65287]]

    (xvi) All repossessed assets or assets that are more than 90 
days past due; and
    (xix) Intangible assets not specifically weighted in some other 
category.
    (5) Indirect ownership interests in pools of assets. Assets 
representing an indirect holding of a pool of assets, e.g., mutual 
funds, are assigned to risk-weight categories under this section 
based upon the risk-weight that would be assigned to the assets in 
the portfolio of the pool. An investment in shares of a mutual fund 
whose portfolio consists primarily of various securities or money 
market instruments that, if held separately, would be assigned to 
different risk-weight categories, generally is assigned to the risk-
weight category appropriate to the highest risk-weighted asset that 
the fund is permitted to hold in accordance with the investment 
objectives set forth in its prospectus. The corporate credit union 
may, at its option, assign the investment on a pro rata basis to 
different risk-weight categories according to the investment limits 
in its prospectus. In no case will an investment in shares in any 
such fund be assigned to a total risk-weight less than 20 percent. 
If the corporate credit union chooses to assign investments on a pro 
rata basis, and the sum of the investment limits of assets in the 
fund's prospectus exceeds 100 percent, the corporate credit union 
must assign the highest pro rata amounts of its total investment to 
the higher risk categories. If, in order to maintain a necessary 
degree of short-term liquidity, a fund is permitted to hold an 
insignificant amount of its assets in short-term, highly liquid 
securities of superior credit quality that do not qualify for a 
preferential risk-weight, such securities will generally be 
disregarded in determining the risk-weight category into which the 
corporate credit union's holding in the overall fund should be 
assigned. The prudent use of hedging instruments by a mutual fund to 
reduce the risk of its assets will not increase the risk-weighting 
of the mutual fund investment. For example, the use of hedging 
instruments by a mutual fund to reduce the interest rate risk of its 
government bond portfolio will not increase the risk-weight of that 
fund above the 20 percent category. Nonetheless, if the fund engages 
in any activities that appear speculative in nature or has any other 
characteristics that are inconsistent with the preferential risk-
weighting assigned to the fund's assets, holdings in the fund will 
be assigned to the 100 percent risk-weight category.
    (6) Derivatives. Certain transactions or activities, such as 
derivatives transactions, may appear on corporate's balance sheet 
but are not specifically described in the Section II(a) on-balance 
sheet risk-weight categories. These items will be assigned risk-
weights as described in Section II(b) or II(c) below.
    (b) Off-balance sheet items.
    Except as provided in Section II(c) of this Appendix, risk-
weighted off-balance sheet items are determined by the following 
two-step process. First, the face amount of the off-balance sheet 
item must be multiplied by the appropriate credit conversion factor 
listed in this Section II(b). This calculation translates the face 
amount of an off-balance sheet exposure into an on- balance sheet 
credit-equivalent amount. Second, the credit-equivalent amount must 
be assigned to the appropriate risk-weight category using the 
criteria regarding obligors, guarantors, and collateral listed in 
Section II(a) of this Appendix. The following are the credit 
conversion factors and the off-balance sheet items to which they 
apply.
    (1) 100 percent credit conversion factor (Group A).
    (i) Risk participations purchased in bankers' acceptances;
    (ii) Forward agreements and other contingent obligations with a 
certain draw down, e.g., legally binding agreements to purchase 
assets at a specified future date. On the date a corporate credit 
union enters into a forward agreement or similar obligation, it 
should convert the principal amount of the assets to be purchased at 
100 percent as of that date and then assign this amount to the risk-
weight category appropriate to the obligor or guarantor of the item, 
or the nature of the collateral;
    (iii) Indemnification of members whose securities the corporate 
credit union has lent as agent. If the member is not indemnified 
against loss by the corporate credit union, the transaction is 
excluded from the risk-based capital calculation. When a corporate 
credit union lends its own securities, the transaction is treated as 
a loan. When a corporate credit union lends its own securities or is 
acting as agent, agrees to indemnify a member, the transaction is 
assigned to the risk-weight appropriate to the obligor or collateral 
that is delivered to the lending or indemnifying institution or to 
an independent custodian acting on their behalf; and
    (iv) Unused portions of ABCP liquidity facilities that do not 
meet the definition of an eligible ABCP liquidity facility. The 
resulting credit equivalent amount is assigned to the risk category 
appropriate to the assets to be funded by the liquidity facility 
based on the assets or the obligor, after considering any collateral 
or guarantees, or external credit ratings under paragraph II(c)(3) 
of this Appendix, if applicable.
    (2) 50 percent credit conversion factor (Group B).
    (i) Transaction-related contingencies, including, among other 
things, performance bonds and performance-based standby letters of 
credit related to a particular transaction;
    (ii) Unused portions of commitments (including home equity lines 
of credit and eligible ABCP liquidity facilities) with an original 
maturity exceeding one year except those listed in paragraph 
II(b)(5) of this Appendix. For eligible ABCP liquidity facilities, 
the resulting credit equivalent amount is assigned to the risk 
category appropriate to the assets to be funded by the liquidity 
facility based on the assets or the obligor, after considering any 
collateral or guarantees, or external credit ratings under paragraph 
II(c)(3) of this Appendix, if applicable; and
    (iii) Revolving underwriting facilities, note issuance 
facilities, and similar arrangements pursuant to which the corporate 
credit union's CUSO or member can issue short-term debt obligations 
in its own name, but for which the corporate credit union has a 
legally binding commitment to either:
    (A) Purchase the obligations the member is unable to sell by a 
stated date; or
    (B) Advance funds to its member, if the obligations cannot be 
sold.
    (3) 20 percent credit conversion factor (Group C). Trade-related 
contingencies, i.e., short-term, self-liquidating instruments used 
to finance the movement of goods and collateralized by the 
underlying shipment. A commercial letter of credit is an example of 
such an instrument.
    (4) 10 percent credit conversion factor (Group D). Unused 
portions of eligible ABCP liquidity facilities with an original 
maturity of one year or less. The resulting credit equivalent amount 
is assigned to the risk category appropriate to the assets to be 
funded by the liquidity facility based on the assets or the obligor, 
after considering any collateral or guarantees, or external credit 
ratings under paragraph II(c)(3) of this Appendix, if applicable;
    (5) Zero percent credit conversion factor (Group E). (i) Unused 
portions of commitments with an original maturity of one year or 
less, except for eligible ABCP liquidity facilities;
    (ii) Unused commitments with an original maturity greater than 
one year, if they are unconditionally cancelable at any time at the 
option of the corporate credit union and the corporate credit union 
has the contractual right to make, and in fact does make, either:
    (A) A separate credit decision based upon the borrower's current 
financial condition before each drawing under the lending facility; 
or
    (B) An annual (or more frequent) credit review based upon the 
borrower's current financial condition to determine whether or not 
the lending facility should be continued; and
    (iii) The unused portion of retail credit card lines or other 
related plans that are unconditionally cancelable by the corporate 
credit union in accordance with applicable law.
    (6) Off-balance sheet contracts; interest rate and foreign 
exchange rate contracts (Group F).--
    (i) Calculation of credit equivalent amounts. The credit 
equivalent amount of an off-balance sheet interest rate or foreign 
exchange rate contract that is not subject to a qualifying bilateral 
netting contract in accordance with paragraph II(b)(6)(ii) of this 
Appendix is equal to the sum of the current credit exposure, i.e., 
the replacement cost of the contract, and the potential future 
credit exposure of the off-balance sheet rate contract. The 
calculation of credit equivalent amounts is measured in U.S. 
dollars, regardless of the currency or currencies specified in the 
off-balance sheet rate contract.
    (A) Current credit exposure. The current credit exposure of an 
off-balance sheet rate contract is determined by the mark-to-market 
value of the contract. If the mark-to-market value is positive, then 
the current credit exposure equals that mark-to-market value. If the 
mark-to-market value is zero or negative, then the current exposure 
is zero. In determining its current credit exposure for multiple 
off-balance sheet rate contracts executed with a single 
counterparty, a

[[Page 65288]]

corporate credit union may net positive and negative mark-to-market 
values of off-balance sheet rate contracts if subject to a bilateral 
netting contract as provided in paragraph II(b)(6)(ii) of this 
Appendix.
    (B) Potential future credit exposure. The potential future 
credit exposure of an off-balance sheet rate contract, including a 
contract with a negative mark-to-market value, is estimated by 
multiplying the notional principal by a credit conversion 
factor.\70\ Corporate credit unions, subject to examiner review, 
should use the effective rather than the apparent or stated notional 
amount in this calculation. The conversion factors are: \71\
---------------------------------------------------------------------------

    \70\ For purposes of calculating potential future credit 
exposure for foreign exchange contracts and other similar contracts, 
in which notional principal is equivalent to cash flows, total 
notional principal is defined as the net receipts to each party 
falling due on each value date in each currency.
    \71\ No potential future credit exposure is calculated for 
single currency interest rate swaps in which payments are made based 
upon two floating rate indices, so-called floating/floating or basis 
swaps; the credit equivalent amount is measured solely on the basis 
of the current credit exposure.

------------------------------------------------------------------------
                                        Interest rate   Foreign exchange
         Remaining maturity               contracts      rate contracts
                                         (percents)        (percents)
------------------------------------------------------------------------
One year or less....................               0.0               1.0
Over one year.......................               0.5               5.0
------------------------------------------------------------------------

     (ii) Off-balance sheet rate contracts subject to bilateral 
netting contracts. In determining its current credit exposure for 
multiple off-balance sheet rate contracts executed with a single 
counterparty, a corporate credit union may net off-balance sheet 
rate contracts subject to a bilateral netting contract by offsetting 
positive and negative mark-to-market values, provided that:
    (A) The bilateral netting contract is in writing;
    (B) The bilateral netting contract creates a single legal 
obligation for all individual off-balance sheet rate contracts 
covered by the bilateral netting contract. In effect, the bilateral 
netting contract provides that the corporate credit union has a 
single claim or obligation either to receive or pay only the net 
amount of the sum of the positive and negative mark-to-market values 
on the individual off-balance sheet rate contracts covered by the 
bilateral netting contract. The single legal obligation for the net 
amount is operative in the event that a counterparty, or a 
counterparty to whom the bilateral netting contract has been validly 
assigned, fails to perform due to any of the following events: 
default, insolvency, bankruptcy, or other similar circumstances;
    (C) The corporate credit union obtains a written and reasoned 
legal opinion(s) representing, with a high degree of certainty, that 
in the event of a legal challenge, including one resulting from 
default, insolvency, bankruptcy or similar circumstances, the 
relevant court and administrative authorities would find the 
corporate credit union's exposure to be the net amount under:
    (1) The law of the jurisdiction in which the counterparty is 
chartered or the equivalent location in the case of noncorporate 
entities, and if a branch of the counterparty is involved, then also 
under the law of the jurisdiction in which the branch is located;
    (2) The law that governs the individual off-balance sheet rate 
contracts covered by the bilateral netting contract; and
    (3) The law that governs the bilateral netting contract;
    (D) The corporate credit union establishes and maintains 
procedures to monitor possible changes in relevant law and to ensure 
that the bilateral netting contract continues to satisfy the 
requirements of this section; and
    (E) The corporate credit union maintains in its files 
documentation adequate to support the netting of an off-balance 
sheet rate contract.\72\
---------------------------------------------------------------------------

    \72\ By netting individual off-balance sheet rate contracts for 
the purpose of calculating its credit equivalent amount, a corporate 
credit union represents that documentation adequate to support the 
netting of an off-balance sheet rate contract is in the corporate 
credit union's files and available for inspection by the NCUA. Upon 
determination by the NCUA that a corporate credit union's files are 
inadequate or that a bilateral netting contract may not be legally 
enforceable under any one of the bodies of law described in 
paragraphs II(b)(5)(ii) of this Appendix, the underlying indivudual 
off-balance sheet rate contracts may not be netted for the purposes 
of this section.
---------------------------------------------------------------------------

    (iii) Walkaway clause. A bilateral netting contract that 
contains a walkaway clause is not eligible for netting for purposes 
of calculating the current credit exposure amount. The term 
``walkaway clause'' means a provision in a bilateral netting 
contract that permits a nondefaulting counterparty to make a lower 
payment than it would make otherwise under the bilateral netting 
contract, or no payment at all, to a defaulter or the estate of a 
defaulter, even if the defaulter or the estate of the defaulter is a 
net creditor under the bilateral netting contract.
    (iv) Risk-weighting. Once the corporate credit union determines 
the credit equivalent amount for an off-balance sheet rate contract, 
that amount is assigned to the risk-weight category appropriate to 
the counterparty, or, if relevant, to the nature of any collateral 
or guarantee. Collateral held against a netting contract is not 
recognized for capital purposes unless it is legally available for 
all contracts included in the netting contract. However, the maximum 
risk-weight for the credit equivalent amount of such off-balance 
sheet rate contracts is 50 percent.
    (v) Exceptions. The following off-balance sheet rate contracts 
are not subject to the above calculation, and therefore, are not 
part of the denominator of a corporate credit union's risk-based 
capital ratio:
    (A) A foreign exchange rate contract with an original maturity 
of 14 calendar days or less; and
    (B) Any interest rate or foreign exchange rate contract that is 
traded on an exchange requiring the daily payment of any variations 
in the market value of the contract.
    (C) Asset-backed commercial paper programs.
    (1) A corporate credit union that qualifies as a primary 
beneficiary and must consolidate an ABCP program that is a variable 
interest entity under Generally Accepted Accounting Principles may 
exclude the consolidated ABCP program assets from risk-weighted 
assets if the corporate credit union is the sponsor of the ABCP 
program.
    (2) If a corporate credit union excludes such consolidated ABCP 
program assets from risk-weighted assets, the corporate credit union 
must assess the appropriate risk-based capital requirement against 
any exposures of the corporate credit union arising in connection 
with such ABCP programs, including direct credit substitutes, 
recourse obligations, residual interests, liquidity facilities, and 
loans, in accordance with sections II(a), II(b), and II(c) of this 
Appendix.
    (3) If a corporate credit union bank has multiple overlapping 
exposures (such as a program-wide credit enhancement and a liquidity 
facility) to an ABCP program that is not consolidated for risk-based 
capital purposes, the corporate credit union is not required to hold 
duplicative risk-based capital under this part against the 
overlapping position. Instead, the corporate credit union should 
apply to the overlapping position the applicable risk-based capital 
treatment that results in the highest capital charge.
    (c) Recourse obligations, direct credit substitutes, and certain 
other positions.
    (1) In general. Except as otherwise permitted in this Section 
II(c), to determine the risk-weighted asset amount for a recourse 
obligation or a direct credit substitute (but not a residual 
interest):
    (i) Multiply the full amount of the credit-enhanced assets for 
which the corporate credit union directly or indirectly retains or 
assumes credit risk by a 100 percent conversion factor. (For a 
direct credit substitute that is an on-balance sheet asset (e.g., a 
purchased subordinated security), a corporate credit union must use 
the amount of the direct credit substitute and the full amount of 
the asset it supports, i.e., all the more senior positions in the 
structure); and

[[Page 65289]]

    (ii) Assign this credit equivalent amount to the risk-weight 
category appropriate to the obligor in the underlying transaction, 
after considering any associated guarantees or collateral. Section 
II(a) lists the risk-weight categories.
    (2) Residual interests. Except as otherwise permitted under this 
Section II(c), a corporate credit union must maintain risk-based 
capital for residual interests as follows:
    (i) Credit-enhancing interest-only strips. A corporate credit 
union must maintain risk-based capital for a credit-enhancing 
interest-only strip equal to the remaining amount of the strip even 
if the amount of risk-based capital that must be maintained exceeds 
the full risk-based capital requirement for the assets transferred.
    (ii) Other residual interests. A corporate credit union must 
maintain risk-based capital for a residual interest (excluding a 
credit-enhancing interest-only strip) equal to the face amount of 
the residual interest, even if the amount of risk-based capital that 
must be maintained exceeds the full risk-based capital requirement 
for the assets transferred.
    (iii) Residual interests and other recourse obligations. Where a 
corporate credit union holds a residual interest (including a 
credit-enhancing interest-only strip) and another recourse 
obligation in connection with the same transfer of assets, the 
corporate credit union must maintain risk-based capital equal to the 
greater of:
    (A) The risk-based capital requirement for the residual interest 
as calculated under Section II(c)(2)(i) through (ii) of this 
Appendix; or
    (B) The full risk-based capital requirement for the assets 
transferred, subject to the low-level recourse rules under Section 
II(c)(5) of this Appendix.
    (3) Ratings-based approach--(i) Calculation. A corporate credit 
union may calculate the risk-weighted asset amount for an eligible 
position described in Section II(c)(3)(ii) of this section by 
multiplying the face amount of the position by the appropriate risk-
weight determined in accordance with Table A or B of this section.

                                 Table A
------------------------------------------------------------------------
                                                           Risk-weight
               Long term rating category                   (In percent)
------------------------------------------------------------------------
Highest or second highest investment grade.............               20
Third highest investment grade.........................               50
Lowest investment grade................................              100
One category below investment grade....................              200
------------------------------------------------------------------------


                                 Table B
------------------------------------------------------------------------
                                                           Risk-weight
               Short term rating category                  (In percent)
------------------------------------------------------------------------
Highest investment grade...............................               20
Second highest investment grade........................               50
Lowest investment grade................................              100
------------------------------------------------------------------------

     (ii) Eligibility.
    (A) Traded positions. A position is eligible for the treatment 
described in paragraph II(c)(3)(i) of this Appendix if:
    (1) The position is a recourse obligation, direct credit 
substitute, residual interest, or asset- or mortgage-backed security 
and is not a credit-enhancing interest-only strip;
    (2) The position is a traded position; and
    (3) The NRSRO has rated a long term position as one grade below 
investment grade or better or a short term position as investment 
grade. If two or more NRSROs assign ratings to a traded position, 
the corporate credit union must use the lowest rating to determine 
the appropriate risk-weight category under paragraph (3)(i).
    (B) Non-traded positions. A position that is not traded is 
eligible for the treatment described in paragraph(3)(i) if:
    (1) The position is a recourse obligation, direct credit 
substitute, residual interest, or asset- or mortgage-backed security 
extended in connection with a securitization and is not a credit-
enhancing interest-only strip;
    (2) More than one NRSRO rate the position;
    (3) All of the NRSROs that rate the position rate it as no lower 
than one grade below investment grade (for long term position) or no 
lower than investment grade (for short term investments). If the 
NRSROs assign different ratings to the position, the corporate 
credit union must use the lowest rating to determine the appropriate 
risk-weight category under paragraph (3)(i);
    (4) The NRSROs base their ratings on the same criteria that they 
use to rate securities that are traded positions; and
    (5) The ratings are publicly available.
    (C) Unrated senior positions. If a recourse obligation, direct 
credit substitute, residual interest, or asset- or mortgage-backed 
security is not rated by an NRSRO, but is senior or preferred in all 
features to a traded position (including collateralization and 
maturity), the corporate credit union may risk-weight the face 
amount of the senior position under paragraph (3)(i) of this 
section, based on the rating of the traded position, subject to 
supervisory guidance. The corporate credit union must satisfy NCUA 
that this treatment is appropriate. This paragraph (3)(i)(c) applies 
only if the traded position provides substantive credit support to 
the unrated position until the unrated position matures.
    (4) Certain positions that are not rated by NRSROs. (i) 
Calculation. A corporate credit union may calculate the risk-
weighted asset amount for eligible position described in paragraph 
II(c)(4)(ii) of this section based on the corporate credit union's 
determination of the credit rating of the position. To risk-weight 
the asset, the corporate credit union must multiply the face amount 
of the position by the appropriate risk-weight determined in 
accordance with Table C of this section.

                                 Table C
------------------------------------------------------------------------
                                                           Risk-weight
                    Rating category                        (In percent)
------------------------------------------------------------------------
Investment grade.......................................              100
One category below investment grade....................              200
------------------------------------------------------------------------

     (ii) Eligibility. A position extended in connection with a 
securitization is eligible for the treatment described in paragraph 
II(c)(4)(i) of this section if it is not rated by an NRSRO, is not a 
residual interest, and meets the one of the three alternative 
standards described in paragraphs (A), (B), or (C) below:
    (A) Position rated internally. A direct credit substitute, but 
not a purchased credit-enhancing interest-only strip, is eligible 
for the treatment described under paragraph II(c)(4)(i) of this 
Appendix, if the position is assumed in connection with an asset-
backed commercial paper program sponsored by the corporate credit 
union. Before it may rely on an internal credit risk rating system, 
the corporate must demonstrate to NCUA's satisfaction that the 
system is adequate. Acceptable internal credit risk rating systems 
typically:
    (1) Are an integral part of the corporate credit union's risk 
management system that explicitly incorporates the full range of 
risks arising from the corporate credit union's participation in 
securitization activities;
    (2) Link internal credit ratings to measurable outcomes, such as 
the probability that the position will experience any loss, the 
expected loss on the position in the event of default, and the 
degree of variance in losses in the event of default on that 
position;
    (3) Separately consider the risk associated with the underlying 
loans or borrowers, and the risk associated with the structure of 
the particular securitization transaction;
    (4) Identify gradations of risk among ``pass'' assets and other 
risk positions;
    (5) Use clear, explicit criteria to classify assets into each 
internal rating grade, including subjective factors;
    (6) Employ independent credit risk management or loan review 
personnel to assign or review the credit risk ratings;
    (7) Include an internal audit procedure to periodically verify 
that internal risk ratings are assigned in accordance with the 
corporate credit union's established criteria;
    (8) Monitor the performance of the assigned internal credit risk 
ratings over time to determine the appropriateness of the initial 
credit risk rating assignment, and adjust individual credit risk 
ratings or the overall internal credit risk rating system, as 
needed; and
    (9) Make credit risk rating assumptions that are consistent 
with, or more conservative than, the credit risk rating assumptions 
and methodologies of NRSROs.
    (B) Program ratings.
    (1) A recourse obligation or direct credit substitute, but not a 
residual interest, is eligible for the treatment described in 
paragraph II(c)(4)(i) of this Appendix, if the position is retained 
or assumed in connection with a structured finance program and an 
NRSRO has reviewed the terms of the program and stated a rating for 
positions associated with the program. If the program has options 
for different combinations of assets, standards, internal or 
external credit enhancements and other relevant factors, and the 
NRSRO specifies ranges of rating categories to them, the corporate 
credit union may apply the rating category applicable to the option 
that corresponds to the corporate credit union's position.

[[Page 65290]]

    (2) To rely on a program rating, the corporate credit union must 
demonstrate to NCUA's satisfaction that the credit risk rating 
assigned to the program meets the same standards generally used by 
NRSROs for rating traded positions. The corporate credit union must 
also demonstrate to NCUA's satisfaction that the criteria underlying 
the assignments for the program are satisfied by the particular 
position.
    (3) If a corporate credit union participates in a securitization 
sponsored by another party, NCUA may authorize the corporate credit 
union to use this approach based on a program rating obtained by the 
sponsor of the program.
    (C) Computer program. A recourse obligation or direct credit 
substitute, but not a residual interest, is eligible for the 
treatment described in paragraph II(c)(4)(i) of this Appendix, if 
the position is extended in connection with a structured financing 
program and the corporate credit union uses an acceptable credit 
assessment computer program to determine the rating of the position. 
An NRSRO must have developed the computer program and the corporate 
credit union must demonstrate to NCUA's satisfaction that the 
ratings under the program correspond credibly and reliably with the 
rating of traded positions.
    (5) Limitations on risk-based capital requirements--
    (i) Low-level exposure rule. If the maximum contractual exposure 
to loss retained or assumed by a corporate credit union is less than 
the effective risk-based capital requirement, as determined in 
accordance with this Section II(c), for the assets supported by the 
corporate credit union's position, the risk-based capital 
requirement is limited to the corporate credit union's contractual 
exposure less any recourse liability account established in 
accordance with Generally Accepted Accounting Principles. This 
limitation does not apply when a corporate credit union provides 
credit enhancement beyond any contractual obligation to support 
assets it has sold.
    (ii) Mortgage-related securities or participation certificates 
retained in a mortgage loan swap. If a corporate credit union holds 
a mortgage-related security or a participation certificate as a 
result of a mortgage loan swap with recourse, it must hold risk-
based capital to support the recourse obligation and that percentage 
of the mortgage-related security or participation certificate that 
is not covered by the recourse obligation. The total amount of risk-
based capital required for the security (or certificate) and the 
recourse obligation is limited to the risk-based capital requirement 
for the underlying loans, calculated as if the corporate credit 
union continued to hold these loans as an on-balance sheet asset.
    (iii) Related on-balance sheet assets. If an asset is included 
in the calculation of the risk-based capital requirement under this 
Section II(c) and also appears as an asset on the corporate credit 
union's balance sheet, the corporate credit union must risk-weight 
the asset only under this Section II(c), except in the case of loan 
servicing assets and similar arrangements with embedded recourse 
obligations or direct credit substitutes. In that case, the 
corporate credit union must separately risk-weight the on-balance 
sheet servicing asset and the related recourse obligations and 
direct credit substitutes under this section, and incorporate these 
amounts into the risk-based capital calculation.
    (6) Obligations of CUSOs. All recourse obligations and direct 
credit substitutes retained or assumed by a corporate credit union 
on the obligations of CUSOs in which the corporate credit union has 
an equity investment are risk-weighted in accordance with this 
Section II(c), unless the corporate credit union's equity investment 
is deducted from credit union's capital and assets under Sec.  704.2 
and Sec.  704.3.

PART 709--INVOLUNTARY LIQUIDATION OF FEDERAL CREDIT UNIONS AND 
ADJUDICATION OF CREDITOR CLAIMS INVOLVING FEDERALLY INSURED CREDIT 
UNIONS IN LIQUIDATION

    23. The authority citation for part 709 continues to read as 
follows:

    Authority: 12 U.S.C. 1757, 1766, 1767, 1786(h), 1787, 1788, 
1789, 1789a.
    24. Revise paragraphs (b)(7) and (b)(9) of Sec.  709.5 to read as 
follows:


Sec.  709.5  Payout priorities in involuntary liquidation.

* * * * *
    (b) * * *
    (7) in a case involving liquidation of a corporate credit union, 
holders of nonperpetual contributed capital accounts or instruments, 
subject to the capital priority option described in Appendix A of Part 
704 of this chapter;
* * * * *
    (9) in a case involving liquidation of a corporate credit union, 
holders of perpetual contributed capital instruments, subject to the 
capital priority option described in Appendix A of this chapter;
* * * * *

PART 747--ADMINISTRATIVE ACTIONS, ADJUDICATIVE HEARINGS, RULES OF 
PRACTICE AND PROCEDURE, AND INVESTIGATIONS

    25. The authority citation for part 747 continues to read as 
follows:

    Authority: 12 U.S.C. 1766, 1782, 1784, 1786, 1787; 42 U.S.C. 
4012a; Pub. L. 101-410; Pub. L. 104-134.
    26. Add a new subpart M to part 747 to read as follows:
Subpart M--Issuance, Review and Enforcement of Orders Imposing Prompt 
Corrective Action on Corporate Credit Unions
Sec.
747.3001 Scope.
747.3002 Review of orders imposing discretionary supervisory action.
747.3003 Review of order reclassifying a corporate credit union on 
safety and soundness criteria.
747.3004 Review of order to dismiss a director or senior executive 
officer.
747.3005 Enforcement of directives.
747.3006 Conservatorship or liquidation of critically 
undercapitalized corporate credit union.

Subpart M--Issuance, Review and Enforcement of Orders Imposing 
Prompt Corrective Action on Corporate Credit Unions


Sec.  747.3001  Scope.

    (a) Independent review process. The rules and procedures set forth 
in this subpart apply to corporate credit unions, which are subject to 
discretionary supervisory actions under section 704.4 of this chapter 
and to reclassification under Sec.  704.4(d)(3) of this chapter, to 
facilitate prompt corrective action, and to senior executive officers 
and directors of such corporate credit unions who are dismissed 
pursuant to a discretionary supervisory action imposed under section 
704.4 of this chapter. Section 747.3002 of this subpart provides an 
independent appellate process to challenge such decisions.
    (b) Notice to State officials. With respect to a State-chartered 
corporate credit union under Sec. Sec.  747.3002, 747.3003 and 747.3004 
of this subpart, any notices, directives and decisions on appeal served 
upon a corporate credit union, or a dismissed director or officer 
thereof, by the NCUA will also be served upon the appropriate State 
official. Responses, requests for a hearing and to present witnesses, 
requests to modify or rescind a discretionary supervisory action and 
requests for reinstatement served upon the NCUA by a corporate credit 
union, or any dismissed director or officer of a corporate credit 
union, will also be served upon the appropriate State official.


Sec.  747.3002  Review of orders imposing discretionary supervisory 
action.

    (a) Notice of intent to issue directive.--
    (1) Generally. Whenever the NCUA intends to issue a directive 
imposing a discretionary supervisory action under Sec. Sec.  
704.4(k)(2)(v) and 704.4(k)(3) of this chapter on a corporate credit 
union classified ``undercapitalized'' or lower, the NCUA will give the 
corporate credit union prior notice of the proposed action and an 
opportunity to respond.
    (2) Immediate issuance of directive without notice. The NCUA may 
issue a directive to take effect immediately under paragraph (a)(1) of 
this section

[[Page 65291]]

without notice to the corporate credit union if the NCUA finds it 
necessary in order to carry out the purposes of Sec.  704.4 of this 
chapter. A corporate credit union that is subject to a directive which 
takes effect immediately may appeal the directive in writing to the 
NCUA Board (Board). Such an appeal must be received by the Board within 
14 calendar days after the directive was issued, unless the Board 
permits a longer period. Unless ordered by the NCUA, the directive will 
remain in effect pending a decision on the appeal. The Board will 
consider any such appeal, if timely filed, within 60 calendar days of 
receiving it.
    (b) Contents of notice. The NCUA's notice to a corporate credit 
union of its intention to issue a directive imposing a discretionary 
supervisory action will state:
    (1) The corporate credit union's capital measures and capital 
category classification;
    (2) The specific restrictions or requirements that the Board 
intends to impose, and the reasons therefore;
    (3) The proposed date when the discretionary supervisory action 
would take effect and the proposed date for completing the required 
action or terminating the action; and
    (4) That a corporate credit union must file a written response to a 
notice within 14 calendar days from the date of the notice, or within 
such shorter period as the Board determines is appropriate in light of 
the financial condition of the corporate credit union or other relevant 
circumstances.
    (c) Contents of response to notice. A corporate credit union's 
response to a notice under paragraph (b) of this section must:
    (1) Explain why it contends that the proposed discretionary 
supervisory action is not an appropriate exercise of discretion under 
this section;
    (2) Request the Board to modify or to not issue the proposed 
directive; and
    (3) Include other relevant information, mitigating circumstances, 
documentation, or other evidence in support of the corporate credit 
union's position regarding the proposed directive.
    (d) NCUA Board consideration of response. The Board, or an 
independent person designated by the Board to act on the Board's 
behalf, after considering a response under paragraph (c) of this 
section, may:
    (1) Issue the directive as originally proposed or as modified;
    (2) Determine not to issue the directive and to so notify the 
corporate credit union; or
    (3) Seek additional information or clarification from the corporate 
credit union or any other relevant source.
    (e) Failure to file response. A corporate credit union which fails 
to file a written response to a notice of the Board's intention to 
issue a directive imposing a discretionary supervisory action, within 
the specified time period, will be deemed to have waived the 
opportunity to respond, and to have consented to the issuance of the 
directive.
    (f) Request to modify or rescind directive. A corporate credit 
union that is subject to an existing directive imposing a discretionary 
supervisory action may request in writing that the Board reconsider the 
terms of the directive, or rescind or modify it, due to changed 
circumstances. Unless otherwise ordered by the Board, the directive 
will remain in effect while such request is pending. A request under 
this paragraph which remains pending 60 days following receipt by the 
Board is deemed granted.


Sec.  747.3003  Review of order reclassifying a corporate credit union 
on safety and soundness criteria.

    (a) Notice of proposed reclassification based on unsafe or unsound 
condition or practice. When the Board proposes to reclassify a 
corporate credit union or subject it to the supervisory actions 
applicable to the next lower capitalization category pursuant to Sec.  
704.4(d)(3) of this chapter (such action hereinafter referred to as 
``reclassification''), the Board will issue and serve on the corporate 
credit union reasonable prior notice of the proposed reclassification.
    (b) Contents of notice. A notice of intention to reclassify a 
corporate credit union based on unsafe or unsound condition or practice 
will state:
    (1) The corporate credit union's current capital ratios and the 
capital category to which the corporate credit union would be 
reclassified;
    (2) The unsafe or unsound practice(s) and/or condition(s) 
justifying reasons for reclassification of the corporate credit union;
    (3) The date by which the corporate credit union must file a 
written response to the notice (including a request for a hearing), 
which date will be no less than 14 calendar days from the date of 
service of the notice unless the Board determines that a shorter period 
is appropriate in light of the financial condition of the corporate 
credit union or other relevant circumstances; and
    (4) That a corporate credit union which fails to--
    (i) File a written response to the notice of reclassification, 
within the specified time period, will be deemed to have waived the 
opportunity to respond, and to have consented to reclassification;
    (ii) Request a hearing will be deemed to have waived any right to a 
hearing; and
    (iii) Request the opportunity to present witness testimony will be 
deemed have waived any right to present such testimony.
    (c) Contents of response to notice. A corporate credit union's 
response to a notice under paragraph (b) of this section must:
    (1) Explain why it contends that the corporate credit union should 
not be reclassified;
    (2) Include any relevant information, mitigating circumstances, 
documentation, or other evidence in support of the corporate credit 
union's position;
    (3) If desired, request an informal hearing before the Board under 
this section; and
    (4) If a hearing is requested, identify any witness whose testimony 
the corporate credit union wishes to present and the general nature of 
each witness's expected testimony.
    (d) Order to hold informal hearing. Upon timely receipt of a 
written response that includes a request for a hearing, the Board will 
issue an order commencing an informal hearing no later than 30 days 
after receipt of the request, unless the corporate credit union 
requests a later date. The hearing will be held in Alexandria, 
Virginia, or at such other place as may be designated by the Board, 
before a presiding officer designated by the Board to conduct the 
hearing and to recommend a decision.
    (e) Procedures for informal hearing.--(1) The corporate credit 
union may appear at the hearing through a representative or through 
counsel. The corporate credit union will have the right to introduce 
relevant documents and to present oral argument at the hearing. The 
corporate credit union may introduce witness testimony only if 
expressly authorized by the Board or the presiding officer. Neither the 
provisions of the Administrative Procedure Act (5 U.S.C. 554-557) 
governing adjudications required by statute to be determined on the 
record nor the Uniform Rules of Practice and Procedure (12 CFR part 
747) will apply to an informal hearing under this section unless the 
Board orders otherwise.
    (2) The informal hearing will be recorded, and a transcript will be 
furnished to the corporate credit union

[[Page 65292]]

upon request and payment of the cost thereof. Witnesses need not be 
sworn, unless specifically requested by a party or by the presiding 
officer. The presiding officer may ask questions of any witness.
    (3) The presiding officer may order that the hearing be continued 
for a reasonable period following completion of witness testimony or 
oral argument to allow additional written submissions to the hearing 
record.
    (4) Within 20 calendar days following the closing of the hearing 
and the record, the presiding officer will make a recommendation to the 
Board on the proposed reclassification.
    (f) Time for final decision. Not later than 60 calendar days after 
the date the record is closed, or the date of receipt of the corporate 
credit union's response in a case where no hearing was requested, the 
Board will decide whether to reclassify the corporate credit union, and 
will notify the corporate credit union of its decision. The decision of 
the Board will be final.
    (g) Request to rescind reclassification. Any corporate credit union 
that has been reclassified under this section may file a written 
request to the Board to reconsider or rescind the reclassification, or 
to modify, rescind or remove any directives issued as a result of the 
reclassification. Unless otherwise ordered by the Board, the corporate 
credit union will remain reclassified, and subject to any directives 
issued as a result, while such request is pending.


Sec.  747.3004  Review of order to dismiss a director or senior 
executive officer.

    (a) Service of directive to dismiss and notice. When the Board 
issues and serves a directive on a corporate credit union requiring it 
to dismiss from office any director or senior executive officer under 
Sec. Sec.  704.4(g) and 704.4(k)(3) of this chapter, the Board will 
also serve upon the person the corporate credit union is directed to 
dismiss (Respondent) a copy of the directive (or the relevant portions, 
where appropriate) and notice of the Respondent's right to seek 
reinstatement.
    (b) Contents of notice of right to seek reinstatement. A notice of 
a Respondent's right to seek reinstatement will state:
    (1) That a request for reinstatement (including a request for a 
hearing) must be filed with the Board within 14 calendar days after the 
Respondent receives the directive and notice under paragraph (a) of 
this section, unless the Board grants the Respondent's request for 
further time;
    (2) The reasons for dismissal of the Respondent; and
    (3) That the Respondent's failure to--
    (i) Request reinstatement will be deemed a waiver of any right to 
seek reinstatement;
    (ii) Request a hearing will be deemed a waiver of any right to a 
hearing; and
    (iii) Request the opportunity to present witness testimony will be 
deemed a waiver of the right to present such testimony.
    (c) Contents of request for reinstatement. A request for 
reinstatement in response to a notice under paragraph (b) of this 
section must:
    (1) Explain why the Respondent should be reinstated;
    (2) Include any relevant information, mitigating circumstances, 
documentation, or other evidence in support of the Respondent's 
position;
    (3) If desired, request an informal hearing before the Board under 
this section; and
    (4) If a hearing is requested, identify any witness whose testimony 
the Respondent wishes to present and the general nature of each 
witness's expected testimony.
    (d) Order to hold informal hearing. Upon receipt of a timely 
written request from a Respondent for an informal hearing on the 
portion of a directive requiring a corporate credit union to dismiss 
from office any director or senior executive officer, the Board will 
issue an order directing an informal hearing to commence no later than 
30 days after receipt of the request, unless the Respondent requests a 
later date. The hearing will be held in Alexandria, Virginia, or at 
such other place as may be designated by the Board, before a presiding 
officer designated by the Board to conduct the hearing and recommend a 
decision.
    (e) Procedures for informal hearing.--(1) A Respondent may appear 
at the hearing personally or through counsel. A Respondent will have 
the right to introduce relevant documents and to present oral argument 
at the hearing. A Respondent may introduce witness testimony only if 
expressly authorized by the Board or by the presiding officer. Neither 
the provisions of the Administrative Procedure Act (5 U.S.C. 554-557) 
governing adjudications required by statute to be determined on the 
record nor the Uniform Rules of Practice and Procedure (12 CFR part 
747) apply to an informal hearing under this section unless the Board 
orders otherwise.
    (2) The informal hearing will be recorded, and a transcript will be 
furnished to the Respondent upon request and payment of the cost 
thereof. Witnesses need not be sworn, unless specifically requested by 
a party or the presiding officer. The presiding officer may ask 
questions of any witness.
    (3) The presiding officer may order that the hearing be continued 
for a reasonable period following completion of witness testimony or 
oral argument to allow additional written submissions to the hearing 
record.
    (4) A Respondent will bear the burden of demonstrating that his or 
her continued employment by or service with the corporate credit union 
would materially strengthen the corporate credit union's ability to--
    (i) Become ``adequately capitalized,'' to the extent that the 
directive was issued as a result of the corporate credit union's 
capital classification category or its failure to submit or implement a 
capital restoration plan; and
    (ii) Correct the unsafe or unsound condition or unsafe or unsound 
practice, to the extent that the directive was issued as a result of 
reclassification of the corporate credit union pursuant to Sec.  
704.4(d)(3) of this chapter.
    (5) Within 20 calendar days following the date of closing of the 
hearing and the record, the presiding officer will make a 
recommendation to the Board concerning the Respondent's request for 
reinstatement with the corporate credit union.
    (f) Time for final decision. Not later than 60 calendar days after 
the date the record is closed, or the date of the response in a case 
where no hearing was requested, the Board will grant or deny the 
request for reinstatement and will notify the Respondent of its 
decision. If the Board denies the request for reinstatement, it will 
set forth in the notification the reasons for its decision. The 
decision of the Board will be final.
    (g) Effective date. Unless otherwise ordered by the Board, the 
Respondent's dismissal will take and remain in effect pending a final 
decision on the request for reinstatement.


Sec.  747.3005  Enforcement of directives.

    (a) Judicial remedies. Whenever a corporate credit union fails to 
comply with a directive imposing a discretionary supervisory action, or 
enforcing a mandatory supervisory action under section 704.4 of this 
chapter, the Board may seek enforcement of the directive in the 
appropriate United States District Court pursuant to 12 U.S.C. 
1786(k)(1).
    (b) Administrative remedies--(1) Failure to comply with directive. 
Pursuant to 12 U.S.C. 1786(k)(2)(A), the Board may assess a civil money 
penalty against any corporate credit union that violates or otherwise 
fails to comply with any final directive issued under section 704.4 of 
this chapter, or against

[[Page 65293]]

any institution-affiliated party of a corporate credit union (per 12 
U.S.C. 1786(r)) who participates in such violation or noncompliance.
    (2) Failure to implement plan. Pursuant to 12 U.S.C. 1786(k)(2)(A), 
the Board may assess a civil money penalty against a corporate credit 
union which fails to implement a capital restoration plan under Sec.  
704.4(e) of this chapter, regardless whether the plan was published.
    (c) Other enforcement action. In addition to the actions described 
in paragraphs (a) and (b) of this section, the Board may seek 
enforcement of the directives issued under section 704.4 of this 
chapter through any other judicial or administrative proceeding 
authorized by law.


Sec.  747.3006  Conservatorship or liquidation of critically 
undercapitalized corporate credit union.

    Notwithstanding any other provision of this title, the NCUA may, 
without any administrative due process, immediately place into 
conservatorship or liquidation any corporate credit union that has been 
categorized as critically undercapitalized.

[FR Doc. E9-28219 Filed 12-8-09; 8:45 am]
BILLING CODE 7535-01-P