[Federal Register Volume 77, Number 187 (Wednesday, September 26, 2012)]
[Proposed Rules]
[Pages 59144-59146]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2012-23644]


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NATIONAL CREDIT UNION ADMINISTRATION

12 CFR Part 703

RIN 3133-AE06


Investment and Deposit Activities

AGENCY: National Credit Union Administration (NCUA).

ACTION: Proposed rule with request for comments.

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SUMMARY: The NCUA Board (Board) proposes to amend its investment 
regulation to allow federal credit unions (FCUs) to purchase Treasury 
Inflation Protected Securities (TIPS). This proposed amendment adds 
TIPS to the list of permissible investments for FCUs in part 703. The 
Board believes TIPS will provide FCUs with an additional investment 
portfolio risk management tool that can be useful in an inflationary 
economic environment.

DATES: Comments must be received on or before November 26, 2012.

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/Legal/Regs/Pages/PropRegs.aspx. Follow the instructions for submitting comments.
     Email: Address to [email protected]. Include ``[Your 
name] Comments on Proposed Rule 703, Investment and Deposit 
Activities'' in the email subject line.
     Fax: (703) 518-6319. Use the subject line described above 
for email.
     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: You may view all public comments on NCUA's Web 
site at http://www.ncua.gov/Legal/Regs/Pages/PropRegs.aspx as 
submitted, except for those we cannot post for technical reasons. NCUA 
will not edit or remove any identifying or contact information from the 
public comments submitted. You may inspect paper copies of comments in 
NCUA's law library at 1775 Duke Street, Alexandria, Virginia 22314, by 
appointment weekdays between 9:00 a.m. and 3:00 p.m. To make an 
appointment, call (703) 518-6546 or send an email to [email protected].

FOR FURTHER INFORMATION CONTACT: Frank Kressman, Associate General 
Counsel, Office of General Counsel, at the above address or telephone 
(703) 518-6540, or J. Owen Cole, Jr., Director, Division of Capital 
Markets, Office of Examination and Insurance, at the above address or 
telephone (703) 518-6360.

SUPPLEMENTARY INFORMATION:

I. Background
II. Regulatory Procedures

I. Background

A. Why is the NCUA Board proposing this rule?

    The Board is proposing this rule because, after extensive research 
and analysis as discussed more fully below, it believes TIPS can be a 
valuable risk management tool for FCUs. The Board also believes FCUs 
have the ability to manage the risks associated with TIPS and can 
benefit from including them in their overall investment portfolio. In 
addition to analyzing the nature and performance of TIPS in the 
marketplace, NCUA has monitored FCU usage of TIPS through a long-term 
investment pilot program. The results of the pilot program are 
consistent with the Board's opinion that TIPS are an appropriate 
investment for FCUs and can be a valuable portfolio management tool 
when there are inflationary risks in the economy.
    Accordingly, for the reasons discussed above, NCUA proposes to make 
TIPS permissible under part 703.

B. What is a TIPS?

    TIPS \1\ is a security issued by the U.S. Department of the 
Treasury, Bureau of Public Debt, which is readily available to 
investors. TIPS differ from other securities by providing protection 
against inflation. The principal of a TIPS increases with inflation and 
decreases with deflation, as measured by the Bureau of Labor 
Statistic's Consumer Price Index (CPI).\2\ When a TIPS matures, the 
holder is paid the adjusted principal or original principal, whichever 
is greater. TIPS pay interest twice a year at a fixed rate. The rate is 
applied to the adjusted principal, so, like the principal, interest 
payments rise with inflation and fall with deflation. In a deflationary 
period, it is possible to experience a contractual decline in the 
principal balance, which is not an event of default.
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    \1\ To learn more about TIPS, see the U.S. Department of the 
Treasury, Bureau of Public Debt Web site at: http://www.treasurydirect.gov/indiv/research/indepth/tips/res_tips.htm.
    \2\ The CPI program produces monthly data on changes in the 
prices paid by urban consumers for a representative basket of goods 
and services. To learn more about how the CPI is produced, see the 
Bureau of Labor Statistics ``Frequently Asked Questions'' on CPI, 
found at: http://www.bls.gov/cpi/cpifaq.htm.
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C. Analysis of TIPS and Part 703

Overview
    TIPS are currently a prohibited investment under part 703 because 
they reprice their value in response to changes in the CPI, and the CPI 
is a prohibited index for variable rate

[[Page 59145]]

instruments. Under Sec.  703.14(a), an FCU is permitted to invest in a 
variable rate instrument as long as the rate is tied to a domestic 
interest rate.\3\ 12 CFR 703.14(a).
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    \3\ (a) Variable rate investment. A Federal credit union may 
invest in a variable rate investment, as long as the index is tied 
to domestic interest rates and not, for example, to foreign 
currencies, foreign interest rates, or domestic or foreign commodity 
prices, equity prices, or inflation rates. For purposes of this 
part, the U.S. dollar-denominated London Interbank Offered Rate 
(LIBOR) is a domestic interest rate.
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    The purpose of this provision is to reduce the basis risk between 
the interest earned on assets and the dividends paid on shares.\4\ 
Generally, deposit/share rates for financial institutions, including 
credit unions, are responsive to market interest rates. As market rates 
change, so do the deposit/share rates. Thus, if an FCU invests in a 
variable rate instrument with an index tied to market rates, the spread 
between the asset's income stream and the share dividends paid should 
remain relatively constant. This protects the FCU's earnings in times 
of rate volatility, especially in periods of rising rates.
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    \4\ Basis risk is a common form of risk incurred by financial 
institutions, including credit unions. Basis risk is the variability 
between two or more indices (e.g., equity barometers such as the S&P 
500, and interest rate indices such as the 1-year Treasury rate) 
that serve as benchmarks for valuing financial institution assets 
and liabilities.
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    However, there is not always a perfect correlation between market 
interest rates and deposit/share rates. This can result in greater 
volatility for an FCU if it does not take action to manage this basis 
risk.
Why TIPS Should Be Permissible
    As noted, FCUs are permitted to invest in variable rate instruments 
where the index is tied to a domestic interest rate. Common domestic 
interest rates include the Fed Funds rate, Treasury rates, and LIBOR. 
Despite the common label ``domestic interest rate,'' each of these 
rates is not perfectly correlated with the others. There is certainly 
some measure of correlation, but an FCU can be exposed to earnings 
variability if it invests in variable rate assets tied to one rate, 
LIBOR rates for example, and prices its shares on another, Treasury 
rates for example.
    Historically, the Board has prohibited variable rate instruments 
tied to non-domestic rate indices because of the basis risk for FCUs. 
While the Board remains concerned about basis risk, it recognizes that 
FCUs now have greater access to advanced asset-liability management 
tools that can identify and measure basis risk, and are therefore 
better equipped to manage such risk associated with adding CPI as a 
permissible index.
[GRAPHIC] [TIFF OMITTED] TP26SE12.000

    Allowing FCUs to hold TIPS in their investment portfolios adds no 
credit risk and allows them the option of minimizing the need for 
accurate inflation forecasting as a way to maintain the real value of 
their investment portfolios.

D. Caution in Investing in TIPS

    The Board believes the authority to invest in TIPS for the purpose 
of protecting against inflation risk can be a valuable part of an 
effective risk management program for FCUs that understand the risks. 
TIPS may not be appropriate for all FCUs. As with any investment, the 
decision to purchase TIPS should be based upon sound due diligence and 
a demonstrated effectiveness in managing risk. This proposal authorizes 
FCUs to purchase TIPS only. Other similar securities based on inflation 
indices currently available or available in the future that are not 
issued by the United States Treasury Department are not authorized by 
this rule. The current TIPS pilot program will expire in the event this 
proposal is eventually finalized by the Board.

II. Regulatory Procedures

Regulatory Flexibility Act

    The Regulatory Flexibility Act requires NCUA to prepare an analysis 
to describe any significant economic impact a proposed rule may have on 
a substantial number of small entities (primarily those under ten 
million dollars in assets). This proposed rule reduces compliance 
burden and extends regulatory relief while maintaining existing safety 
and soundness standards. NCUA has determined this proposed rule will 
not have a significant economic impact on a substantial number of small 
credit unions.

[[Page 59146]]

Paperwork Reduction Act

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

Executive Order 13132

    Executive Order 13132 encourages independent regulatory agencies to 
consider the impact of their actions on state and local interests. 
NCUA, an independent regulatory agency as defined in 44 U.S.C. 3502(5), 
voluntarily complies with the executive order to adhere to fundamental 
federalism principles. This proposed rule would not have a substantial 
direct effect on the states, on the relationship between the national 
government and the states, or on the distribution of power and 
responsibilities among the various levels of government. NCUA has 
determined that this proposed rule does not constitute a policy that 
has federalism implications for purposes of the executive order.

List of Subjects

12 CFR Part 703

    Credit unions, Investments.

    By the National Credit Union Administration Board on September 
20, 2012.
Mary Rupp,
Secretary of the Board.

    For the reasons discussed above, NCUA proposes to amend 12 CFR part 
703 as follows:

PART 703--INVESTMENT AND DEPOSIT ACTIVITES

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

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

    2. Revise Sec.  703.14(a) to read as follows:


Sec.  703.14  Permissible investments.

    (a) Variable rate investment. A federal credit union may invest in 
a variable rate investment, as long as the index is tied to domestic 
interest rates and not, for example, to foreign currencies, foreign 
interest rates, or domestic or foreign commodity prices, equity prices, 
or inflation rates with the exception of Treasury Inflation Protected 
Securities. For purposes of this part, the U.S. dollar-denominated 
London Interbank Offered Rate (LIBOR) is a domestic interest rate.

[FR Doc. 2012-23644 Filed 9-25-12; 8:45 am]
BILLING CODE 7535-01-P