[Federal Register Volume 80, Number 17 (Tuesday, January 27, 2015)]
[Proposed Rules]
[Pages 4340-4444]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2015-00947]



[[Page 4339]]

Vol. 80

Tuesday,

No. 17

January 27, 2015

Part II





National Credit Union Administration





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12 CFR Parts 700, 701, 702 et al.





Risk-Based Capital; Proposed Rule

  Federal Register / Vol. 80 , No. 17 / Tuesday, January 27, 2015 / 
Proposed Rules  

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NATIONAL CREDIT UNION ADMINISTRATION

12 CFR Parts 700, 701, 702, 703, 713, 723, and 747

RIN 3133-AD77


Risk-Based Capital

AGENCY: National Credit Union Administration (NCUA).

ACTION: Proposed rule.

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SUMMARY: The NCUA Board (Board) is seeking comment on a second proposed 
rule that would amend NCUA's current regulations regarding prompt 
corrective action (PCA) to require that credit unions taking certain 
risks hold capital commensurate with those risks. The proposal would 
restructure NCUA's PCA regulations and make various revisions, 
including amending the agency's current risk-based net worth 
requirement by replacing the current risk-based net worth ratio with a 
new risk-based capital ratio for federally insured natural person 
credit unions (credit unions). The proposal would also, in response to 
public comments received, make a number of changes to the original 
proposed rule that the Board published in the Federal Register on 
February 27, 2014. These changes include, among other things, exempting 
credit unions with up to $100 million in total assets from the new 
rule, lowering the risk-based capital ratio level required for an 
affected credit union to be classified as well capitalized from 10.5 
percent to 10 percent, lowering the risk weights for various classes of 
assets, removing interest rate risk components from the risk weights, 
and extending the implementation timeframe to January 1, 2019. These 
changes would substantially reduce the number of credit unions subject 
to the rule, reduce the impact on affected credit unions, and afford 
affected credit unions sufficient time to prepare for the rule's 
implementation.
    The proposed risk-based capital requirement set forth in this 
proposal would be more consistent with NCUA's risk-based capital 
measure for corporate credit unions and more comparable to the 
regulatory risk-based capital measures used by the Federal Deposit 
Insurance Corporation, Board of Governors of the Federal Reserve, and 
Office of the Comptroller of Currency (Other Banking Agencies).
    In addition, the proposed revisions would amend the risk weights 
for many of NCUA's current asset classifications; require higher 
minimum levels of capital for credit unions with concentrations of 
assets in real estate loans or commercial loans or higher levels of 
non-current loans; and set forth how NCUA can address a credit union 
that does not hold capital that is commensurate with its risk.
    The proposed revisions would also eliminate several provisions in 
NCUA's current PCA regulations, including provisions relating to the 
regular reserve account, risk-mitigation credits, and alternative risk 
weights. (For clarity, the ``current'' PCA regulations would remain in 
force until the effective date of a final risk-based capital rule.)

DATES: Comments must be received by April 27, 2015.

ADDRESSES: You may submit written comments, identified by RIN 3133-
AD77, 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: Risk-Based Capital'' in the email 
subject line.
     Fax: (703) 518-6319. Use the subject line described above 
for email.
     Mail: Address to Gerard Poliquin, Secretary of the Board, 
National Credit Union Administration, 1775 Duke Street, Alexandria, 
Virginia 22314-3428.
     Hand Delivery/Courier: Same as mail address.
    You can 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: Larry Fazio, Director, Office of 
Examination and Insurance, at (703) 518-6360; JeanMarie Komyathy, 
Director, Division of Risk Management, Office of Examination and 
Insurance, at (703) 518-6360; Steven Farrar, Loss/Risk Analyst, 
Division of Risk Management, Office of Examination and Insurance, at 
(703) 518-6393; John Shook, Loss/Risk Analyst, Division of Risk 
Management, Office of Examination and Insurance, at (703) 518-3799; Tom 
Fay, Senior Capital Markets Specialist, Division of Capital and Credit 
Markets, Office of Examination and Insurance, at (703) 518-1179; Rick 
Mayfield, Senior Capital Markets Specialist, Division of Capital and 
Credit Markets, Office of Examination and Insurance, at (703) 518-6501; 
or by mail at National Credit Union Administration, 1775 Duke Street, 
Alexandria, VA 22314.

SUPPLEMENTARY INFORMATION: 

I. Introduction
II. Legal Authority
III. Summary of the Original Proposal and This Proposal
IV. Section-by-Section Analysis
V. Effective Date
VI. Impact of this Proposed Rule
VII. Regulatory Procedures

I. Introduction

    NCUA's primary mission is to ensure the safety and soundness of 
federally insured credit unions. NCUA performs this function by 
examining and supervising all federal credit unions, participating in 
the examination and supervision of federally insured, state-chartered 
credit unions in coordination with state regulators, and insuring 
members' accounts at federally insured credit unions.\1\ In its role as 
administrator of the National Credit Union Share Insurance fund 
(NCUSIF), NCUA insures and regulates approximately 6,400 federally 
insured credit unions, holding total assets exceeding $1.1 trillion and 
representing approximately 99 million members.
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    \1\ Within the nine states that allow privately insured credit 
unions, approximately 133 state-chartered credit unions are 
privately insured and are not subject to NCUA regulation or 
oversight.
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    At its January 2014 meeting, the Board issued a proposed rule (the 
Original Proposal) \2\ to amend NCUA's PCA regulations, part 702. The 
Original Proposal sought to enhance risk sensitivity and address 
weaknesses in the existing regulatory capital framework for credit 
unions. The revisions in the Original Proposal included a new method 
for computing NCUA's risk-based requirement that would be more 
consistent with the risk-based capital ratio measure used for corporate 
credit unions \3\ and more comparable to the risk-based capital ratio 
measures used by the Other Banking Agencies.\4\ In general, this new 
method for computing NCUA's risk-based requirement would have adjusted 
the risk weights for many asset

[[Page 4341]]

classifications to lower the minimum risk-based capital ratio 
requirement for credit unions with lower-risk operations. Conversely, 
this new method would have required higher minimum levels of risk-based 
capital for credit unions with concentrations of assets in residential 
real estate loans or commercial loans, or high levels of non-current 
loans.
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    \2\ 79 FR 11183 (Feb. 27, 2014).
    \3\ See 12 CFR part 704.
    \4\ See 78 FR 55339 (Sept. 10, 2013).
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    In addition, due to the inherent limitations of any widely applied 
risk-based capital measurement system, the Original Proposal also 
included procedures for the Board to require an individual credit union 
to hold a higher level of risk-based capital where NCUA staff raised 
specific supervisory concerns regarding the credit union's condition. 
Finally, the Original Proposal eliminated the provisions of current 
Sec.  702.401(b) relating to transfers to the regular reserve account, 
current Sec.  702.106 regarding the standard calculation of the RBNW 
ratio requirement, current Sec.  702.107 regarding alternative 
components for the standard calculation, and current Sec.  702.108 
regarding the risk-mitigation credit.
    In response to the Original Proposal, the Board received over 2,000 
comments with many suggestions on how to improve the Original Proposal. 
The Board has reviewed the comments and determined that it was 
appropriate to issue a second proposed rule. The Board notes that, 
because this is a new proposed rule, it is not required to respond to 
any comments received on the Original Proposal. However, the Board 
believes it is important to address those comments, and has, therefore, 
included comment summaries and responses throughout the preamble to 
this proposal.
    The Board is now requesting comment on this second proposed rule 
regarding risk-based capital. Based largely on comments it received on 
the Original Proposal, the Board is proposing many improvements to the 
Original Proposal, including: (1) Amending the definition of 
``complex'' credit union by increasing the asset threshold from $50 
million to $100 million; (2) reducing the number of asset concentration 
thresholds for residential real estate loans and commercial loans 
(formerly classified as MBLS); (3) assigning one-to-four family non-
owner-occupied residential real estate loans the same risk weights as 
other residential real estate loans; (4) eliminating IRR from this 
proposed rule; (5) extending the implementation timeframe to January 1, 
2019; and (6) eliminating the Individual Minimum Capital Requirement 
(IMCR) provision. Among other things, these changes would substantially 
reduce the number of credit unions subject to the rule, and would 
afford affected credit unions sufficient time to prepare for the rule's 
full implementation. A full discussion of the impact of these and other 
changes in this proposed rule is contained in Impact of the Proposed 
Regulation part of the preamble below.
    As discussed in more detail below, the revisions in the Original 
Proposal and this proposal are intended to implement the statutory 
requirements of the Federal Credit Union Act (FCUA) and follow 
recommendations made by the Government Accountability Office (GAO).

II. Legal Authority

    In 1998, Congress enacted the Credit Union Membership Access Act 
(CUMAA).\5\ Section 301 of CUMAA added new section 216 to the FCUA,\6\ 
which requires the Board to adopt by regulation a system of PCA to 
restore the net worth of credit unions that become inadequately 
capitalized.\7\ Section 216(b)(1)(A) requires the Board to adopt by 
regulation a system of PCA for federally insured credit unions that is 
``consistent with'' section 216 of the FCUA and ``comparable to'' 
section 38 of the Federal Deposit Insurance Act (FDI Act).\8\ Section 
216(b)(1)(B) requires that the Board, in designing the PCA system, also 
take into account the ``cooperative character of credit unions'' (i.e., 
that credit unions are not-for-profit cooperatives that do not issue 
capital stock, must rely on retained earnings to build net worth, and 
have boards of directors that consist primarily of volunteers).\9\ In 
2000, the Board implemented the required system of PCA, primarily in 
part 702 of NCUA's regulations.\10\
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    \5\ Public Law 105-219, 112 Stat. 913 (1998).
    \6\ 12 U.S.C. 1790d.
    \7\ The risk-based net worth requirement for credit unions 
meeting the definition of ``complex'' was first applied on the basis 
of data in the Call Report reflecting activity in the first quarter 
of 2001. 65 FR 44950 (July 20, 2000). NCUA's risk-based net worth 
requirement has been largely unchanged since its implementation, 
with the following limited exceptions: Revisions were made to the 
rule in 2003 to amend the risk-based net worth requirement for MBLs, 
68 FR 56537 (Oct. 1, 2003); revisions were made to the rule in 2008 
to incorporate a change in the statutory definition of ``net 
worth,'' 73 FR 72688 (Dec. 1, 2008); revisions were made to the rule 
in 2011 to expand the definition of ``low-risk assets'' to include 
debt instruments on which the payment of principal and interest is 
unconditionally guaranteed by NCUA, 76 FR 16234 (Mar. 23, 2011); and 
revisions were made in 2013 to exclude credit unions with total 
assets of $50 million or less from the definition of ``complex'' 
credit union, 78 FR 4033 (Jan. 18, 2013).
    \8\ 12 U.S.C. 1790d(b)(1)(A); see also 12 U.S.C. 1831o (Section 
38 of the FDI Act setting forth the PCA requirements for banks).
    \9\ 12 U.S.C. 1790d(b)(1)(B).
    \10\ 12 CFR part 702; see also 65 FR 8584 (Feb. 18, 2000) and 65 
FR 44950 (July 20, 2000).
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    The purpose of section 216 of the FCUA is to ``resolve the problems 
of [federally] insured credit unions at the least possible long-term 
loss to the [NCUSIF].'' \11\ To carry out that purpose, Congress set 
forth a basic structure for PCA in section 216 that consists of three 
principal components: (1) A framework combining mandatory actions 
prescribed by statute with discretionary actions developed by NCUA; (2) 
an alternative system of PCA to be developed by NCUA for credit unions 
defined as ``new''; and (3) a risk-based net worth requirement to apply 
to credit unions that NCUA defines as ``complex.'' This proposed rule 
focuses primarily on principal components (1) and (3), although 
amendments to part 702 of NCUA's regulations relating to principal 
component (2) are also included as part of this proposal.
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    \11\ 12 U.S.C. 1790d(a)(1).
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    Among other things, section 216(c) of the FCUA requires NCUA to use 
a credit union's net worth ratio to determine its classification among 
five ``net worth categories'' set forth in the FCUA.\12\ Section 216(o) 
generally defines a credit union's ``net worth'' as its retained 
earnings balance,\13\ and a credit union's ``net worth ratio'' \14\ as 
the ratio of its net worth to its total assets.\15\ As a credit union's 
net worth ratio declines, so does its classification among the five net 
worth categories, thus subjecting it to an expanding range of mandatory 
and discretionary supervisory actions.\16\
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    \12\ Section 1790d(c).
    \13\ Section 1790d(o)(2).
    \14\ Throughout this document the terms ``net worth ratio'' and 
``leverage ratio'' are used interchangeably.
    \15\ Section 1790d(o)(3).
    \16\ Section 1790d(c) through (g); 12 CFR 702.204(a) and (b).
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    Section 216(d)(1) of the FCUA requires that NCUA's system of PCA 
include, in addition to the statutorily defined net worth ratio 
requirement applicable to federally insured natural-person credit 
unions, ``a risk-based net worth \17\ requirement for insured credit

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unions that are complex, as defined by the Board . . . .'' \18\ Unlike 
the terms ``net worth'' and ``net worth ratio,'' the term ``risk-based 
net worth'' is not defined in the FCUA.\19\ Accordingly, when read 
together, sections 216(b)(1) and 216(d)(1) grant the Board broad 
authority to design PCA regulations, including a risk-based net worth 
requirement, so long as the regulations are comparable to the Other 
Banking Agencies' PCA requirements and consistent with the requirements 
of section 216 of the FCUA and the cooperative character of credit 
unions.
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    \17\ For purposes of this rulemaking, the term ``risk-based net 
worth requirement'' is used in reference to the statutory 
requirement for the Board to design a capital standard that accounts 
for variations in the risk profile of complex credit union. The 
terms ``risk-based capital ratio'' and ``risk-based capital ratio'' 
are used to refer to the specific standards this rulemaking proposes 
to function as criteria for the statutory risk-based net worth 
requirement. For example, this rulemaking's proposed risk-based 
capital ratio would replace the risk-based net worth ratio in the 
current rule. The term ``risk-based capital ratio'' is also used by 
the Other Banking Agencies and the international banking community 
when referring to the types of risk-based requirements that are 
addressed in this proposal. This change in terminology throughout 
the proposal would have no substantive effect on the requirements of 
the FCUA, and is intended only to reduce confusion for the reader.
    \18\ 12 U.S.C. 1790d(d)(1).
    \19\ See 12 U.S.C. 1790d(o) (Congress specifically defined the 
terms ``net worth'' and ``net worth ratio'' in the FCUA, but did not 
define the statutory term ``risk-based net worth.'').
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    The FCUA directs NCUA to base its definition of ``complex'' credit 
unions ``on the portfolios of assets and liabilities of credit 
unions.'' \20\ It also requires NCUA to design a risk-based net worth 
requirement to apply to such ``complex'' credit unions.\21\ The risk-
based net worth requirement must ``take account of any material risks 
against which the net worth ratio required for [a federally] insured 
credit union to be adequately capitalized [(six percent net worth 
ratio)] may not provide adequate protection.'' \22\ In the Senate 
Report on CUMAA, Congress expressed its intent with regard to the 
design of the risk-based requirement and the meaning of section 
216(d)(2) by providing:
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    \20\ 12 U.S.C. 1790d(d).
    \21\ Id.
    \22\ 12 U.S.C. 1790d(d)(2).

    The NCUA must design the risk-based net worth requirement to 
take into account any material risks against which the 6 percent net 
worth ratio required for a credit union to be adequately capitalized 
may not provide adequate protection. Thus the NCUA should, for 
example, consider whether the 6 percent requirement provides 
adequate protection against interest-rate risk and other market 
risks, credit risk, and the risks posed by contingent liabilities, 
as well as other relevant risks. The design of the risk-based net 
worth requirement should reflect a reasoned judgment about the 
actual risks involved.\23\
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    \23\ S. Rep. No. 193, 105th Cong., 2d Sess. 13 (1998).

    Section 216(c) of the FCUA requires that, if a credit union meets 
the definition of ``complex'' and its net worth ratio initially 
indicates that it meets or exceeds the net worth ratio requirement to 
be either ``adequately capitalized'' or ``well capitalized,'' the 
credit union must still satisfy the separate risk-based net worth 
requirement.\24\ Under the separate risk-based net worth requirement, 
the complex credit union must, in addition to meeting the statutory net 
worth ratio requirement, also meet or exceed the minimum risk-based net 
worth requirement that corresponds to either the adequately capitalized 
or well capitalized capital category in order to receive a capital 
classification of adequately capitalized or well capitalized, as the 
case may be.\25\ For example, if a complex credit union meets or 
exceeds the net worth ratio requirement to be classified as well 
capitalized, then it must also meet or exceed the corresponding risk-
based net worth requirement to be well capitalized.
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    \24\ 12 U.S.C. 1790d(c).
    \25\ The risk-based net worth requirement also indirectly 
impacts credit unions in the ``undercapitalized'' and lower net 
worth categories, which are required to operate under an approved 
net worth restoration plan. The plan must provide the means and a 
timetable to reach the ``adequately capitalized'' category. See 12 
U.S.C. 1790d(f)(5) and 12 CFR 702.206(c). However, for ``complex'' 
credit unions in the ``undercapitalized'' or lower net worth 
categories, the minimum net worth ratio ``gate'' to that category 
will be six percent or the credit union's risk-based net worth 
requirement, if higher than 6 percent. In that event, a complex 
credit union's net worth restoration plan will have to prescribe the 
steps a credit union will take to reach a higher net worth ratio 
``gate'' to that category. See 12 CFR 702.206(c)(1)(i)(A) and 12 
U.S.C. 1790d(c)(1)(A)(ii) and (c)(1)(B)(ii).
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    If any complex credit union meets or exceeds the net worth ratio 
requirement to be classified as well capitalized or adequately 
capitalized, but fails to meet the corresponding risk-based net worth 
requirement to be well capitalized or adequately capitalized, then the 
credit union's capital classification is determined based on the risk-
based net worth requirement. For example, if a complex credit union is 
classified as well capitalized based on its net worth ratio, but only 
meets the risk-based net worth requirement that corresponds with the 
adequately capitalized capital category, then that credit union's 
capital classification would be adequately capitalized. Similarly, if a 
complex credit union meets the risk-based net worth requirement to be 
well capitalized, but only meets the net worth ratio requirement to be 
undercapitalized, then that credit union's overall capital 
classification is undercapitalized. In either case, the credit union 
would be subject to any mandatory and discretionary supervisory actions 
applicable to its lowest capital classification category.\26\
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    \26\ 12 U.S.C. 1790d(c)(1)(c)(ii).
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    In response to the Original Proposal, some commenters questioned 
NCUA's legal authority to impose a risk-based net worth requirement on 
both well capitalized and adequately capitalized credit unions. NCUA's 
position is that the Board is authorized to do so under the FCUA. 
Section 216(c)(1)(A) specifically provides that, to be classified as 
well capitalized, a complex credit union must meet the statutory net 
worth ratio requirement and any applicable risk-based net worth 
requirement. Section 216(c)(1) provides, in relation to ``net worth 
categories,'' that: (1) An insured credit union is ``well capitalized'' 
if it has a net worth ratio of not less than 7 percent; and it meets 
any applicable risk-based net worth requirement under subsection (d) of 
this section; (2) an insured credit union is ``adequately capitalized'' 
if it has a net worth ratio of not less than 6 percent; and it meets 
any applicable risk-based net worth requirement under subsection (d) of 
this section; and (3) an insured credit union is ``undercapitalized'' 
if it has a net worth ratio of less than 6 percent; or it fails to meet 
any applicable risk-based net worth requirement under subsection (d) of 
this section.\27\ The language in components (1) and (2), when read in 
conjunction with the language in section 216(d), authorizes NCUA to 
impose risk-based net worth requirements on both well capitalized and 
adequately capitalized credit unions.
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    \27\ 12 U.S.C. 1790d(c)(1)(A)-(C) (emphasis added).
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    In addition, section 216(d)(2) of the FCUA sets forth specific 
requirements for the design of the risk-based net worth requirement 
mandated under section 216(d)(1).\28\ Specifically, section 216(d)(2) 
requires that the Board ``design the risk-based net worth requirement 
to take account of any material risks against which the net worth ratio 
required for an insured credit union to be adequately capitalized may 
not provide adequate protection.'' \29\ Under section 216(c)(1)(B) of 
the FCUA, the net worth ratio required for an insured credit union to 
be adequately capitalized is six percent.\30\ The plain language of 
section 216(d)(2) supports NCUA's interpretation that Congress intended 
for the Board to design a risk-based net worth requirement to take into 
account any material risks beyond those already addressed through the 
statutory 6 percent net worth ratio required for a

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credit union to be adequately capitalized.\31\
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    \28\ Id. at section 1790d(d).
    \29\ Id. at section 1790d(d)(2).
    \30\ Id. at section 1790d(c)(1)(B).
    \31\ See S. Rep. No. 193, 105th Cong., 2d Sess. (1998) 
(providing in relevant part: ``The NCUA must design the risk-based 
net worth requirement to take into account any material risks 
against which the 6 percent net worth ratio required for an insured 
credit union to be adequately capitalized may not provide adequate 
protection.'').
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    In other words, the language in section 216(d)(2) of the FCUA 
simply identifies the types of risks that NCUA's risk-based net worth 
requirement must address (i.e., those risks not already addressed by 
the statutory six percent net worth ratio requirement). It is a 
misinterpretation of section 216(d)(2) to argue, as some commenters 
have in response to the Original Proposal, that Congress' use of the 
term ``adequately capitalized'' in section 216(d)(2) somehow limits the 
Board's authority to impose a higher risk-based capital ratio level for 
well capitalized credit unions. Rather than prohibiting the Board from 
imposing a higher risk-based capital ratio level for well capitalized 
credit unions, section 216(d)(2) simply requires that the Board design 
the risk-based net worth requirement to take into account those risks 
not adequately addressed by the statute's six percent net worth ratio 
requirement. Thus, the plain language of section 216(d) does not 
support these commenters' interpretation.
    NCUA's interpretation of its legal authority to impose a risk-based 
net worth requirement on both well capitalized and adequately 
capitalized credit unions is further supported by the Other Banking 
Agencies' PCA statute and regulations.\32\ Section 38(c)(1)(A) of the 
FDI Act, upon which section 216 of the FCUA was modeled,\33\ requires 
that the Other Banking Agencies' ``relevant capital measures'' 
``include (i) a leverage limit; and (ii) a risk-based capital 
requirement.'' \34\ Despite Congress' use of the singular noun 
``requirement'' in section 38 of the FDI Act, the Other Banking 
Agencies' PCA regulations, which went into effect before Congress 
passed CUMAA, have long required that their regulated institutions meet 
different risk-based capital ratio levels to be classified as well 
capitalized, adequately capitalized, undercapitalized, or significantly 
undercapitalized. Therefore, by setting different risk-based capital 
ratio levels for credit unions to be adequately and well capitalized, 
NCUA's risk-based capital requirement would be consistent with the 
requirements of section 216 of the FCUA and would be ``comparable'' to 
the Other Banking Agencies' PCA regulations.
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    \32\ See 12 U.S.C. 1831o, and, e.g., 12 CFR 324.403(b).
    \33\ See S. Rep. No. 193, 105th Cong., 2d Sess., 12 (1998) 
(Providing in relevant part: ``New section 216 [of the FCUA] is 
modeled on section 38 of the Federal Deposit Insurance Act, which 
has applied to FDIC-insured depository institutions since 1992.'').
    \34\ 12 U.S.C. 1831o(c)(1)(A) (emphasis added).
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III. Summary of the Original Proposal and this Second Proposal

A. The Important Role and Benefit of Capital

    Capital is the buffer that depository institutions, including 
credit unions, use to prevent institutional failure or dramatic 
deleveraging during times of strees. As evidenced by the recent 
recession, during a financial crisis a buffer can mean the difference 
between the survival or failure of a financial insitution. Financial 
crises are very costly, both to the economy in general and to 
individual depository institutions.\35\ While the onset of a financial 
crisis is inherently unpredictable, a review of the historical record 
over a range of countries and recent time periods has suggested that a 
significant crisis involving depository institutions occurs about once 
every 20 to 25 years, and has a typical cumulative discounted cost in 
terms of lost aggregate output relative to the precrisis trend of about 
60 percent of precrisis annual output.\36\ In other words, the typical 
crisis results in losses over time, relative to the precrisis trend 
economic growth, that amount to more than half of the economy's output 
before the onset of the crisis.
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    \35\ Credit unions play a sizable role in the U.S. depository 
system. Assets in the credit union system amount to more than $1.1 
trillion, roughly 8 percent of U.S. chartered depository institution 
assets (source: NCUA Calculation using the financial accounts of the 
United States, Federal Reserve Statistical Release Z.1, Table L.110, 
September 18, 2014). Data from the Federal Reserve indicate that 
credit unions account for about 12 percent of private consumer 
installment lending. (Source: NCUA calculations using data from the 
Federal Reserve Statistical Release G.19, Consumer Credit, September 
2014. Total consumer credit outstanding (not mortgages) was $3,246.8 
billion of which $826.2 billion was held by the federal government 
and $293.1 billion was held by credit unions. The 12 percent figure 
is the $293.1 billion divided by the total outstanding less the 
federal government total). Just over a third of households have some 
financial affiliation with a credit union. (Source: NCUA 
calculations using data from the Federal Reserve 2013 survey of 
Consumer Finance.) All Federal Reserve Statistical Releases are 
available at 
http:\\www.federalreserve.gov\econresdata\statisticsdata.htm.
    \36\ Basel Committee on Banking Supervision, An assessment of 
the long-term economic impact of stronger capital and liquidity 
requirements 3-4 (August 2010), available at http://www.bis.org/publ/bcbs173.pdf. These losses do not explicitly account for 
government interventions that ameliorated the observed economic 
impact. This is the median loss estimate.
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    The 2007-2009 financial crisis and the associated economic 
dislocations during the Great Recession were particularly costly to the 
United States in terms of lost output and jobs. Real GDP declined more 
than four percent, almost nine million jobs were lost, and the 
unemployment rate rose to 10 percent.\37\ The cited figures are just 
the direct losses. Compared to where the economy would have been had it 
followed the precrisis trend, the losses in terms of GDP and jobs would 
be higher. For example, using the results described in the previous 
paragraph as a guide, the cumulative loss of output from the recent 
financial crisis is roughly $10 trillion (2014 dollars).\38\ Other 
estimates of the total loss, derived using approaches different than 
described in the previous paragraph, are similar. For example, 
researchers at the Federal Reserve Bank of Dallas, using a different 
approach that achieved results within the same range, estimated a range 
of loss of $6 trillion to $14 trillion due to the crisis.\39\
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    \37\ The National Bureau of Economic Research Business Cycle 
Dating Committee defines the beginning date of the recession as 
December 2007 (2007Q4) and the ending date of the recession as June 
2009 (2009Q2). See the National Bureau of Economic Research Web 
site: http://www.nber.org/cycles/cyclesmain.html. The real GDP 
decline was calculated by NCUA using data for 2007Q4 and 2009Q2 from 
the National Income and Product Accounts, Bureau of Economic 
Analysis, U.S. Department of Commerce; see Table 1.1.3. Data are 
available at http://www.bea.gov/iTable/iTable.cfm?ReqID=9&step=1#reqid=9&step=1&isuri=1. Data accessed 
November 11, 2014. The jobs lost figure was calculated by NCUA using 
data from the Bureau of Labor Statistics (BLS), U.S. Department of 
Labor, Current Employment Statistics, CES Peak-Trough Tables. The 
statistic cited is the decline in total nonfarm employees from 
December 2007 through February 2010, which BLS defines as the trough 
of the employment series. Data available at: http://www.bls.gov/ces/cespeaktrough.htm and accessed on November 11, 2014. The 
unemployment rate was taken from the Bureau of Labor Statistics, 
U.S. Department of Labor, Current Population Survey, series 
LNS14000000. Accessed November 11, 2014 at http://data.bls.gov/pdq/SurveyOutputServlet. The unemployment rate peaked at 10 percent in 
October 2009.
    \38\ NCUA calculations based on from the National Income and 
Product Accounts, Bureau of Economic Analysis, U.S. Department of 
Commerce. Data from Table 1.1.6 show real GDP at $14.992 trillion in 
2007Q4 in chained 2009 dollars. Adjusting to 2014 dollars using the 
GDP price index and using the 60 percent loss figure cited yields an 
estimated loss of approximately $10 trillion in 2014 dollars. Data 
are available at http://www.bea.gov/iTable/iTable.cfm?ReqID=9&step=1#reqid=9&step=1&isuri=1.
    \39\ Tyler Atkinson, David Luttrell & Harvey Rosenblum, Fed. 
Reserve Bank of Dall, How Bad Was It? The Costs and Consequences of 
the 2007-2009 Financial Crisis (July 2013), available at https://dallasfed.org/assets/documents/research/staff/staff1301.pdf.
---------------------------------------------------------------------------

    Research using bank data across several countries and time periods 
indicates that higher levels of capital insulate financial institutions 
from the

[[Page 4344]]

effects of unexpected adverse developments in their asset portfolio or 
their deposit liabilities.\40\ For the financial system as a whole, 
research on the banking sector has shown that higher levels of capital 
can reduce the probability of a systemic crisis.\41\ By reducing the 
probability of a systemic financial crisis and insulating individual 
institutions from failure, higher capital requirements confer very 
large benefits to the overall economy.\42\ With the median long-term 
output loss associated with a crisis in the range of 60 percent of 
precrisis GDP, a one percentage point reduction in the probability of a 
crisis would add roughly 0.6 percent to GDP each year 
(permanently).\43\
---------------------------------------------------------------------------

    \40\ See An Assessment of the Long-Term Economic Impact of 
Stronger Capital and Liquidity Requirements, Basel Committee on 
Banking Supervision, August 2010. Pages 14-17. The study indicates 
that the seven percent TCE/RWA ratio is equivalent to a five percent 
ratio of equity to total assets. The average ratio of equity to 
total assets for the 14 largest OECD countries from 1980 to 2007 was 
5.3 percent.
    \41\ Id.
    \42\ Id.
    \43\ Id.
---------------------------------------------------------------------------

    While higher levels of capital can insulate depository institutions 
from adverse shocks, holding higher levels of capital does have costs, 
both to individual institutions and to the economy as a whole. For the 
most part, the largest cost associated with holding higher levels of 
capital, in the long term, is foregone opportunities; that is, from the 
loss of potential earnings from making loans, from the cost to bank 
customers and credit union members of higher loan rates and lower 
deposit rates, and the downstream costs from the customers' and 
members' reduced spending.\44\ Estimating the size of these effects is 
difficult. However, despite limitations on the ability to quantify 
these effects, the annual costs appear to be significantly smaller than 
the losses avoided by reducing the probability of a systemic crisis. 
For example, research using data on banking systems across developed 
countries indicates that a one percentage point increase in the capital 
ratio increases lending spreads (the spread between lending rates and 
deposit rates) by 13 basis points.\45\ The research also shows that the 
long-run reduction in output (real GDP) consistent with a one 
percentage point increase in the Tier 1 common equity \46\ to risks 
assets ratio would be on the order of 0.1 percent.\47\ Thus, it is 
clear that the relatively large potential long-term benefits of holding 
higher levels of capital outweigh the relatively small long-term costs.
---------------------------------------------------------------------------

    \44\ See An Assessment of the Long-Term Economic Impact of 
Stronger Capital and Liquidity Requirements, Basel Committee on 
Banking Supervision, August 2010. Pages 21-27.
    \45\ There are a number of simplifying assumptions involved in 
the calculation, including the assumption that banks fully pass 
through the increase in the cost of capital to their borrowers. See 
Basel Committee on Banking Supervision, An Assessment of the Long-
Term Economic Impact of Stronger Capital and Liquidity Requirements 
21-27 (Aug. 2010).
    \46\ Tier 1 common equity is made up of common stock, retained 
earnings, accumulated other comprehensive income, and some 
miscellaneous minority interests and common stock as part of an 
employee stock ownership plan.
    \47\ To be clear, the 0.1 percent figure represents the one-
time, long-term loss, which should be compared with the 60 percent 
loss potentially avoided by reducing the probability of a financial 
crisis by a little more than one percentage point. See An Assessment 
of the Long-Term Economic Impact of Stronger Capital and Liquidity 
Requirements, Basel Committee on Banking Supervision, August 2010. 
Pages 21-27.
---------------------------------------------------------------------------

    The recent financial crisis revealed a number of inadequacies in 
the current approach to capital requirements. Banks, in particular, 
experienced an elevated number of failures and the need for federal 
intervention in the form of capital infusions.\48\ As discussed in more 
detail below, credit unions also experienced elevated losses and the 
need for government intervention. The clear implication is that capital 
levels in these cases were inadequate, especially relative to the 
riskiness of the assets that some institutions were holding on their 
books.
---------------------------------------------------------------------------

    \48\ For a readable overview of the 2007-2008 financial crisis 
and the government response see, The Final Report of the 
Congressional Oversight Panel, Congressional Oversight Panel, March 
16, 2011. See also Ben S. Bernanke, ``Some Reflections on the Crisis 
and the Policy Response,'' Speech at the Russell Sage Foundation and 
The Century Foundation Conference on ``Rethinking Finance,'' New 
York, New York, April 13, 2012. Available at: http://www.federalreserve.gov/newsevents/speech/2012speech.htm.
---------------------------------------------------------------------------

    In a risk-based capital system, institutions that are holding 
assets that have historically shown higher levels of risk are generally 
required to hold more capital against those assets. At the same time, 
an institution's leverage ratio, which does not account for the 
riskiness of assets, can provide a baseline level of capital adequacy 
in the event that the approach to assigning risk weights does not 
capture all risks. A system including well-designed and well-calibrated 
risk-based capital standards is generally more efficient from the point 
of view of the overall economy, as well as for individual institutions. 
In general, risk-based capital standards increase capital requirements 
at those institutions whose asset portfolios have, on average, higher 
risk. Conversely, risk-based capital standards generally decrease the 
cost of holding capital for institutions whose strategies focus on 
lower risk activities. In that way, risk-based capital standards 
generate the benefits of helping to insulate the economy from financial 
crises, while also preventing some of the potential costs that would 
occur from holding unnecessarily high levels of capital at low-risk 
institutions.

B. Why did the Board issue the Original Proposal?

    The Original Proposal would have amended NCUA's risk-based net 
worth requirements to be more comparable to the Other Banking Agencies' 
regulations, as required by the FCUA.\49\ In 2013, the Other Banking 
Agencies issued final rules materially updating the risk-based capital 
requirements for insured banks.\50\ These changes to the Other Banking 
Agencies' risk-based capital requirements, the weaknesses in NCUA's 
current risk-based net worth ratio requirement exposed by the recession 
of 2007-2009, and the fact that NCUA's risk-based net worth requirement 
had not been meaningfully updated since 2002, prompted the Board to 
reconsider NCUA's current risk-based net worth ratio requirement and 
other aspects of NCUA's current PCA regulations. In so doing, the Board 
was also guided by specific recommendations to update NCUA's PCA 
regulations made by GAO in its January 2012 review of NCUA's system of 
PCA.\51\
---------------------------------------------------------------------------

    \49\ See 12 U.S.C. 1790d(b)(1)(A)(ii) (Requiring that the NCUA's 
system of PCA be ``comparable'' to the PCA requirements in section 
1831o of the Federal Deposit Insurance Act).
    \50\ 78 FR 55339 (Sept. 10, 2013) (The FDIC published an interim 
final rule regarding regulatory capital for their regulated 
institutions separately from the Other Banking Agencies.) and 78 FR 
62017 (Oct. 11, 2013) (The Office of the Comptroller of the Currency 
and the Board of Governors of the Federal Reserve System later 
published a regulatory capital final rule for their regulated 
institutions, which is consistent with the requirements in the 
FDIC's IFR.).
    \51\ See U.S. Govt. Accountability Office, GAO-12-247, Earlier 
Actions Are Needed to Better Address Troubled Credit Unions, (Jan. 
2012) available at http://www.gao.gov/products/GAO-12-247.
---------------------------------------------------------------------------

    The Board issued the Original Proposal to enhance risk sensitivity 
and address weaknesses in the existing regulatory capital framework for 
credit unions. Under the current rule, only two credit unions are 
required to hold more capital as a result of the required risk-based 
net worth ratio measure. The Board emphasized that capital and risk 
operate synchronously, and that credit union senior management, boards, 
and regulators are all accountable for ensuring that appropriate 
capital levels are in place based on the credit union's risk exposure. 
The Original Proposal reflected the Board's initial effort to establish 
a system for assigning risk

[[Page 4345]]

weights that was more indicative of the potential risks existing within 
credit unions. Accordingly, the Original Proposal was intended to help 
credit unions better absorb losses and establish a safer, more 
resilient, and more stable credit union system that could weather 
periods of financial stress, thereby reducing risks to the NCUSIF.
    The recent economic crisis highlighted the need for a sound system 
of capital requirements to address risk. From 2008 through 2012, 27 
credit unions with assets greater than $50 million (the current 
threshold for applicability of the risk-based net worth requirement) 
failed at a cost of $728 million to the NCUSIF,\52\ due in large part 
to holding inadequate levels of capital relative to the levels of risk 
associated with their assets and operations. In many cases, the capital 
deficiencies relative to elevated risk levels were identified by 
examiners and communicated through the examination process to officials 
at these credit unions.\53\ Although the credit union officials were 
provided with notice of the capital deficiencies, they ignored the 
supervisory concerns or did not act in a timely manner to address the 
concerns raised. Furthermore, NCUA's ability to take enforcement 
actions to address supervisory concerns in a timely manner was cited by 
GAO as limited under NCUA's current regulations. As a result, over a 
dozen very large consumer credit unions, and numerous smaller ones, 
were in danger of failing and required extensive NCUA intervention, 
financial assistance, or both, along with increased reserve levels for 
the NCUSIF.\54\ The Original Proposal sought to incorporate the lessons 
learned from those failures, and near failures, and better account for 
risks not addressed by NCUA's current PCA rule.
---------------------------------------------------------------------------

    \52\ These figures are based on data collected by NCUA 
throughout the crisis, and do not include the costs associated with 
failures of corporate credit unions.
    \53\ See, e.g., OIG-13-10, Material Loss Review of Chetco 
Federal Credit Union (October 1, 2013), OIG-13-05, Material Loss 
Review of Telesis Community Credit Union (March 15, 2013), OIG-10-
15, Material Loss Review of Ensign Federal Credit Union, (Sept. 23, 
2010), OIG-10-03, Material Loss Reviews of Cal State 9 Credit union 
(April 14, 2010).
    \54\ As most of these credit unions are still active 
institutions, or have merged into other active institutions, NCUA 
cannot provide additional details publicly.
---------------------------------------------------------------------------

    The Board notes that, in general, most credit unions with over $100 
million in assets (the proposed new threshold for applicability of the 
risk-based capital ratio measure) hold capital well above the statutory 
net worth ratio for credit unions to be classified as well capitalized, 
as shown in the following table.\55\
---------------------------------------------------------------------------

    \55\ This statement and the majority of the related analysis in 
this section is specific to credit unions with $100 million in 
assets or greater, unless otherwise noted, as this proposed rule 
would only apply to credit unions at or above this level.

                                    Number of Credit Unions with Assets of at Least $100 Million, by Net Worth Ratio
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                     2006       2007       2008       2009       2010       2011       2012       2013
--------------------------------------------------------------------------------------------------------------------------------------------------------
Net Worth Ratio:
    Less than 6 percent.........................................          3          5         10         42         35         16         11          7
    6 percent to 7 percent......................................          8          7         32         63         44         35         17          9
    7 percent to 8 percent......................................         39         42        109        188        162        152        138        103
    8 percent to 9 percent......................................        123        109        185        248        243        256        269        234
    9 percent to 10 percent.....................................        193        197        213        244        289        299        293        305
    10 percent to 11 percent....................................        205        217        212        192        192        213        231        257
    Greater than 11 percent.....................................        628        642        522        388        404        430        478        540
                                                                 ---------------------------------------------------------------------------------------
        Total...................................................      1,199      1,219      1,283      1,365      1,369      1,401      1,437      1,455
--------------------------------------------------------------------------------------------------------------------------------------------------------

    Many credit unions hold additional capital as a cushion against an 
unexpected adverse shock that might drive their net worth ratios below 
the well capitalized level. Because credit unions primarily generate 
capital only through retained earnings, there is an added incentive to 
hold higher levels of capital. Most banks, however, also hold capital 
in excess of their required well capitalized thresholds and on par with 
total capital levels held by credit unions, despite having the ability 
to raise capital outside of retained earnings.\56\ This suggests that 
strong capital levels serve an important purpose for financial 
institutions despite any associated cost of the capital.
---------------------------------------------------------------------------

    \56\ The aggregate core capital (leverage) ratio for all FDIC-
insured institutions as of December 2013 was 9.41 percent. FDIC 
Quarterly, 2014, Volume 8, No. 1.
---------------------------------------------------------------------------

    As shown in the table below, at year end 2013, 119 credit unions, 
or 7.3 percent of all credit unions with assets greater than $100 
million in assets, exhibited a net worth ratio below eight percent. Of 
that 7.3 percent of credit unions, all were either already below the 
seven percent well capitalized threshold or were only slightly above, 
so they were vulnerable to falling below the well capitalized level 
with only a modest shock to their net income. Call report data as of 
December 31, 2013, indicates that these 119 credit unions hold assets 
of $68.7 billion, which is more than seven percent of all credit union 
assets (see table below).

                 Percentage Distribution of Total Assets of Credit Unions with Assets of at Least $100 Million, by Net Worth Ratio \57\
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                     2006       2007       2008       2009       2010       2011       2012       2013
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                          Percent
                                                                 ---------------------------------------------------------------------------------------
Net Worth Ratio:
    Less than 6 percent.........................................        0.1        0.2        1.4        2.6        2.6        0.5        0.4        0.3
    6 percent to 7 percent......................................        0.8        1.0        5.9        7.5        1.6        2.5        0.5        0.2
    7 percent to 8 percent......................................        4.9        5.8       10.9       13.6       15.3       12.6        9.1        6.8
    8 percent to 9 percent......................................       12.5       12.4       15.7       19.2       18.5       16.7       19.1       12.5
    9 percent to 10 percent.....................................       18.2       21.6       23.2       24.8       28.1       24.5       21.1       22.9

[[Page 4346]]

 
    10 percent to 11 percent....................................       16.3       18.2       15.3       12.3       12.3       20.4       23.9       19.0
    Greater than 11 percent.....................................       47.1       40.8       27.6       20.0       21.6       22.8       25.8       38.3
                                                                 ---------------------------------------------------------------------------------------
        Total Assets, billions $................................      582.4      628.1      686.3      760.1      790.2      839.4      901.7      945.4
--------------------------------------------------------------------------------------------------------------------------------------------------------

    The table below shows that credit unions falling below the seven 
percent well capitalized net worth ratio requirement tend to contract 
their asset base. By contrast, over the same period, credit unions that 
did not fall below the seven percent well capitalized net worth ratio 
requirement experienced annualized asset growth of almost seven 
percent.
---------------------------------------------------------------------------

    \57\ Data based on year end Call Report data.

 Growth in Assets at Credit Unions With More Than $100 Million in Assets
                                  \58\
------------------------------------------------------------------------
Growth over the four quarters after  Growth over the four quarters where
 a  decline in the net  worth ratio    the net worth ratio did not fall
              below 7%                             below 7%
------------------------------------------------------------------------
                     -4.3%                                +6.8%
------------------------------------------------------------------------

    Unlike banks that can issue other forms of capital like common 
stock, credit unions that need to raise additional capital when faced 
with a capital shortfall generally have no choice except to reduce 
member dividends or other interest payments, raise lending rates, or 
cut non-interest expenses in an attempt to direct more income to 
retained earnings.\59\ Thus, the first round impact of falling or low 
capital levels at credit unions is likely a direct reduction in credit 
union members' access to credit or interest bearing accounts. Hence, an 
important policy objective of capital standards is to ensure that 
financial institutions build sufficient capital to continue functioning 
as financial intermediaries during times of stress without government 
intervention or assistance.
---------------------------------------------------------------------------

    \58\ Based on Call Report data, using annualized growth 2007 Q4-
2013 Q4.
    \59\ Low-income designated credit unions can issue secondary 
capital accounts that count as net worth for PCA purposes. As of 
June 30, 2014, there are 2,107 low-income designated credit unions. 
Given the nature (e.g., size) of these credit unions and the types 
of instruments they can offer, however, there is often a very 
limited market for these accounts.
---------------------------------------------------------------------------

    NCUA's analysis of credit union Call Report data from 2006 forward, 
as detailed below, also makes it clear that higher capital levels keep 
credit unions from becoming undercapitalized during periods of economic 
stress. The table below summarizes the changes in the net worth ratio 
that occurred during the recent economic crisis. Of credit unions with 
a net worth ratio of less than eight percent in the fourth quarter of 
2006, 80 percent fell below seven percent at some time during the 
financial crisis and its immediate aftermath. Of credit unions with 8 
percent to 10 percent net worth ratios in the fourth quarter of 2006, 
just under 33 percent fell below seven percent during the crisis 
period. However, of credit unions that entered the crisis with at least 
10 percent net worth ratios, less than five percent fell below the 
seven percent well capitalized standard during the crisis or its 
immediate aftermath.

      Distribution of Net Worth Ratios of Credit Unions With at Least $100 Million in Assets by Lowest Net Worth Ratio During the Financial Crisis
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                    Lowest Net Worth Ratio between 2007Q1 and 2010Q4
                                                              ------------------------------------------------------------------------------------------
                                                                                                                                              Number of
                                                                   <6%          6-7%         7-8%        8-10%        >=10%        Total        credit
                                                                                                                                                unions
--------------------------------------------------------------------------------------------------------------------------------------------------------
Net Worth Ratio in 2006Q4
    <8 percent...............................................         44.0         36.0         20.0          0.0          0.0        100.0           50
    8-10 percent.............................................         13.0         19.6         38.0         29.4          0.0        100.0          316
    >=10 percent.............................................          1.9          2.8          9.4         38.8         47.1        100.0          830
--------------------------------------------------------------------------------------------------------------------------------------------------------

    Similarly, the table below shows how credit unions with at least 
$100 million in assets in the fourth quarter of 2006 fared during the 
five years after the fourth quarter of 2007, which was the period that 
encompassed the Great Recession. The table shows that the credit unions 
that survived the crisis and recession had higher net worth ratios 
going into the Great Recession. In particular, credit unions with more 
than $100 million in assets before the crisis began, but failed during 
the crisis, had a median precrisis net worth ratio of less than nine 
percent, while similarly sized institutions that survived the crisis 
had, on average, precrisis net worth ratios in excess of 11 percent.

[[Page 4347]]



                     Characteristics of FICUs With Assets > $100 Million at the End of 2006 by Five Year Survival Beginning 2007 Q4
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                              Median
                                                                         -------------------------------------------------------------------------------
                                                             Number of                                                                        Member
                                                           institutions                      Net Worth     Loan to Asset    Real Estate   Business  Loan
                                                                            Assets ($M)        Ratio           Ratio        Loan Share         Share
                                                                                             (percent)       (percent)       (percent)       (percent)
--------------------------------------------------------------------------------------------------------------------------------------------------------
Failures................................................              27           162.7            8.97            84.0            58.0             8.3
Survivors...............................................            1138           237.9           11.20            71.0            49.0             0.7
--------------------------------------------------------------------------------------------------------------------------------------------------------
Survivorship is determined based on whether a FICU stopped filing a Call Report over the five years starting in the fourth quarter of 2007. Failures
  exclude credit unions that merged or voluntarily liquidated. Note: All failures had precrisis net worth ratios in excess of seven percent.

    Aside from demonstrating the differences in the capital positions 
of credit unions that failed from those that did not fail, the table 
above highlights two additional considerations. First, the table shows 
that other performance indicators were different between the two groups 
of credit unions. In particular, the survivors had a lower median loan-
to-asset ratio, a lower median share of total loans in real estate 
loans, and a lower share of member business loans in their overall loan 
portfolio.
    A key limitation of the leverage ratio is that it is a lagging 
indicator because it is based largely on accounting standards. 
Accounting figures are point-in-time values largely based on historical 
performance to date. Further, the leverage ratio does not discriminate 
between low-risk and high-risk assets or changes in the composition of 
the balance sheet. A risk-based capital ratio measure is more 
prospective in that, as a credit union makes asset allocation choices, 
it drives capital requirements before losses occur and capital levels 
decline. The differences in indicators between the failure group and 
the survivors in the table above demonstrate that factors in addition 
to capital levels play an important role in preventing failure. For 
example, all of the failures listed in the table above had net worth 
ratios in excess of the well capitalized level at the end of 2006. The 
severe weakness of NCUA's current risk-based net worth requirement is 
further demonstrated by the fact that, of the 27 credit unions that 
failed during the Great Recession, only two of those credit unions were 
considered less than well capitalized due to the existing RBNW 
requirement.\60\ A well designed risk-based capital ratio standard 
would have been more successful in helping credit unions avoid failure 
precisely because such standards are targeted at activities that result 
in elevated risk.
---------------------------------------------------------------------------

    \60\ See table above (referencing the 27 failures of credit 
unions over $100 million in assets).
---------------------------------------------------------------------------

    The need for a risk-based capital standard beyond a leverage ratio 
is further supported when considering a more comprehensive review of 
credit union failures. The figures below present data from NCUA's 
review of the 192 credit union failures that occurred over the past 10 
years and indicates that 160 failed credit unions had net worth ratios 
greater than seven percent two years prior to their failure. Further, 
the failed credit unions exhibited a 12 percent average net worth ratio 
two years prior to their failure.

[[Page 4348]]

[GRAPHIC] [TIFF OMITTED] TP27JA15.004

[GRAPHIC] [TIFF OMITTED] TP27JA15.005

    The table above shows that credit unions with high net worth ratios 
can and have failed, demonstrating that a leverage ratio alone has not 
always proven to be an adequate predictor of a credit union's future 
viability. However,

[[Page 4349]]

a more robust risk-based capital standard would reflect the presence of 
elevated balance sheet risk sooner, and in relevant cases would improve 
a credit union's odds of survival.
    A recession or other source of financial stress poses more 
difficulties for credit unions with limited capital options and with 
capital levels lower than what their risks warrant. A capital shortfall 
reduces a credit union's ability to effectively serve its members. At 
the same time, the shortfall can cascade to the rest of the credit 
union system through the NCUSIF, potentially affecting an even broader 
number of credit union members. Credit unions are an important source 
of consumer credit and a capital shortfall that affects the credit 
union system could reduce general consumer access to credit for 
millions of credit union members. \61\ Accordingly, a risk-based 
capital rule that is effective in requiring credit unions with low 
capital ratios and a large share of high-risk assets to hold more 
capital relative to their risk profile, while limiting the burden on 
already well capitalized credit unions, should provide positive net 
benefits to the credit union system and the United States economy. 
Improved resilience enhances credit unions' ability to function during 
periods of financial stress and reduce risks to the NCUSIF.
---------------------------------------------------------------------------

    \61\ Credit unions play a sizable role in the U.S. depository 
system. Assets in the credit union system amount to more than $1.1 
trillion, roughly eight percent of U.S. chartered depository 
institution assets (source: NCUA calculation using the financial 
accounts of the United States, Federal Reserve Statistical Release 
Z.1, Table L.110, September 18, 2014). Data from the Federal Reserve 
indicate that credit unions account for about 12 percent of private 
consumer installment lending. (Source: NCUA calculations using data 
from the Federal Reserve Statistical Release G.19, Consumer Credit, 
September 2014. Total consumer credit outstanding (not mortgages) 
was $3,246.8 billion of which $826.2 billion was held by the federal 
government and $293.1 billion was held by credit unions. The 12 
percent figure is the $293.1 billion divided by the total 
outstanding less the federal government total). Just over a third of 
households have some financial affiliation with a credit union. 
(Source: NCUA calculations using data from the Federal Reserve 2013 
survey of Consumer Finance.) All Federal Reserve Statistical 
Releases are available at 
http:\\www.federalreserve.gov\econresdata\statisticsdata.htm.
---------------------------------------------------------------------------

    The Original Proposal reflected the Board's objective of modifying 
the existing system for assigning risk weights to make it more 
indicative of the risks in credit unions. The Board intended it to help 
credit unions better absorb losses and establish a safer, more 
resilient, and more stable credit union system. However, as noted 
below, the Board believes the Original Proposal can be improved and is, 
therefore, issuing this second proposal.

C. What significant changes would the Original Proposal have made?

    The Original Proposal would have changed the current risk-based net 
worth requirement applicable to complex credit unions (which was then 
defined as credit unions with more than $50 million in assets). In 
particular, the Original Proposal would have replaced the current risk-
based net worth ratio measure with a new risk-based capital ratio 
measure that would have been more comparable to the risk-based capital 
requirement in the Other Banking Agencies' regulations. NCUA's capital 
requirements and PCA supervisory actions for ``new'' credit unions and 
credit unions with $50 million or less in assets would have remained 
largely unchanged, with a few exceptions.
    The Board intended the change in the risk-based capital methodology 
in the Original Proposal to improve the comparability of risk-based 
capital ratios across financial institutions. Compared to the current 
risk-based net worth ratio measure, the methodology under the Original 
Proposal would have provided a more common measure both of credit union 
capital available to absorb losses and of asset risk. Moreover, the use 
of a consistent framework for assigning risk weights would have 
resulted in better comparability and improved understanding between all 
types of federally insured financial institutions, and would have 
increased the correlation between required capital levels and risk.
    The Original Proposal would have replaced the current method used 
by credit unions to apply risk weights to their assets with a new risk-
based capital ratio measure that is more commonly applied to depository 
institutions worldwide. The proposed risk-based capital ratio measure 
was the percentage of a credit union's capital available to cover 
losses, divided by the credit union's defined risk weighted asset base.
    Under the current rule, the numerator of the RBNW ratio is ``net 
worth'' as defined in section 216(o)(2).\62\ However, as discussed in 
the Legal Authority section of this preamble, the FCUA gives the Board 
broad discretion in designing the risk-based capital requirement.\63\ 
Thus, the Original Proposal would have broadened the definition of the 
risk-based capital ratio numerator.
---------------------------------------------------------------------------

    \62\ See the definition of ``net worth'' at 12 U.S.C. 
1790d(o)(2)(A) through (C).
    \63\ See section 1790d(d)(2) (Recognizing the limitations of the 
net worth ratio, Congress directed the Board to develop a risk-based 
net worth requirement that ``take[s] account of any material risks 
against which the net worth ratio . . . may not provide adequate 
protection.'').
---------------------------------------------------------------------------

    The Board chose to take this approach to provide a more comparable 
measure of capital across all financial institutions and to better 
account for those related elements of the financial statement that are 
available to cover losses and protect the NCUSIF. Under the Original 
Proposal, the risk-based capital ratio numerator essentially started 
with the generally accepted accounting principles (GAAP) definition of 
equity (which is broader than the statutory definition of ``net 
worth''), adding the allowance for loan and lease losses (ALLL) account 
subject to some limitations, and deducting goodwill, intangible assets, 
and the NCUSIF deposit. In addition, to more accurately reflect capital 
available to absorb losses, this broader definition of the risk-based 
capital ratio numerator would have contributed over 50 basis points, on 
average, to credit unions' risk-based capital ratio.
    With regard to the denominator for the risk-based capital ratio, 
Congress recognized that operating a credit union involves taking and 
managing a variety of risks. As stated previously, the FCUA mandates 
that NCUA's risk-based net worth requirement ``take account of any 
material risks against which the net worth ratio required for [a 
federally] insured credit union to be adequately capitalized may not 
provide adequate protection.'' \64\ In the Senate Report on CUMAA, 
Congress expressed its intent with regard to the design of the risk-
based net worth requirement by directing NCUA to ``consider whether the 
6 percent [net worth ratio] requirement provides adequate protection 
against interest-rate risk and other market risks, credit risk, and the 
risks posed by contingent liabilities, as well as other relevant 
risks.'' \65\
---------------------------------------------------------------------------

    \64\ Id.
    \65\ S. Rep. No. 193, 105th Cong., 2d Sess. 13 (1998).
---------------------------------------------------------------------------

    The risk-based net worth ratio measure in NCUA's current PCA 
regulation, which has not been substantially updated since 2002, was 
designed to primarily address credit risk, concentration risk, interest 
rate risk (IRR), and liquidity risk. The current rule does this through 
the assignment of risk weights to different types of assets based on 
the predominant form of risk that is associated with the asset type. 
Loans and investments make up the vast majority (88 percent based on 
December 2013 Call Report data) of credit union assets and, therefore, 
are the primary variables for the denominator of a credit

[[Page 4350]]

union's current risk-based net worth ratio.
    Under the current rule, most types of loans have risk weights based 
on credit risk. Concentration risk and IRR are incorporated for real 
estate loans and member business loans (MBLs) using a tiered risk 
weight framework. As a credit union's concentration in these loans 
increases, incrementally higher levels of capital are required. This 
requirement was intended to provide capital to protect against the 
concentration risk and IRR inherent in a long duration and/or complex 
whole loan portfolio with limited liquidity.\66\
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    \66\ Concentration risk is mainly accounted for in commercial 
and real estate loans because, historically, this is where credit 
unions have experienced concentration and IRR problems. These types 
of assets are longer and/or provide fewer options and greater 
challenges in managing, restructuring, or selling such portfolios. 
Cash flows for shorter-term loans, like auto loans, are typically 
much less susceptible to changing rates; and portfolios customarily 
cash flow fast enough to mitigate concentration and IRR concerns.
---------------------------------------------------------------------------

    The Original Proposal would have maintained a very similar risk 
weight structure for loans, with a few exceptions. The Original 
Proposal would have effectively reduced the capital required for a 
credit union to hold first-lien residential real estate loans, and 
raised the capital required to hold junior-lien residential real estate 
loans, consumer loans, and MBLs.
    The current rule, as opposed to this second proposal, assigns risk 
weights to most types of investments based on their IRR and liquidity 
risk. The rationale for doing so was that most credit unions maintain 
liquidity in their investment portfolio. For credit unions with high 
loan volume involving long-term fixed rate products, the investment 
portfolio can exacerbate the interest rate and liquidity risks involved 
in meeting member lending and deposit preferences. NCUA's current rule, 
unlike this second proposal, assigns risk weights to most investments 
based on their weighted average life, with the weights generally 
calibrated to the projected loss in value of a U.S. Treasury security 
if interest rates increased by 300 basis points. The Original Proposal 
would have retained this approach to assigning investment risk weights. 
However, the Original Proposal would have effectively reduced the 
capital required for investments with weighted average lives of less 
than five years, and increased the capital required for investments 
with weighted average lives of greater than five years.
    The Original Proposal was intentionally designed to parallel the 
current approach to applying risk weights to assets using existing 
information contained in the Call Report, thereby minimizing transition 
costs and associated reporting burdens. In comparison to the current 
risk-based net worth ratio method however, the originally proposed 
risk-based capital ratio method would have included a greater number of 
exposure categories for purposes of calculating a credit union's risk-
weighted assets. Thus, the Original Proposal would have required that 
some additional data be collected on the Call Report. However, this 
additional data would not have represented a material increase to the 
burden of completing the Call Report. Further, under the Original 
Proposal, the rule would have provided an 18-month implementation 
period for credit unions to adjust their systems to account for the 
additional data items that would have been collected in the Call 
Report.
    The way in which the risk-based net worth ratio functions in 
relation to the net worth categories under the current rule could 
result in a credit union's capital classification declining directly 
from well capitalized to undercapitalized if it fails to meet the 
required risk-based net worth ratio level.\67\ The Original Proposal 
would have modified this approach by requiring credit unions to meet 
different risk-based capital ratio levels for the well capitalized 
(10.5 percent) and adequately capitalized (eight percent) categories. 
This formulation would have been comparable with the Other Banking 
Agencies' capital rules,\68\ and would have encouraged (but did not 
require) credit unions to build capital sufficient to absorb losses and 
prevent precipitous declines in their overall capital classification. 
In addition to providing greater comparability with the Other Banking 
Agencies' rules, the different threshold levels also would have 
resulted in a risk-based net worth requirement that could have 
effectively addressed any ``outlier'' credit unions and encouraged them 
to accumulate additional capital.
---------------------------------------------------------------------------

    \67\ Per the FCUA, ``undercapitalized'' is the lowest PCA 
category in which a failure to meet the risk-based net worth 
requirement can result.
    \68\ See, e.g., 12 CFR 324.10, 324.11 and 324.403.
---------------------------------------------------------------------------

    The Original Proposal would have generally retained the definition 
of ``complex'' in the current rule so the proposed changes to the risk-
based net worth requirement would have applied to all credit unions 
with over $50 million in total assets.\69\
---------------------------------------------------------------------------

    \69\ 78 FR 4032 (Jan. 18, 2013).
---------------------------------------------------------------------------

D. Public Comments on the Original Proposal

    The Board received 2,056 public comments on the Original Proposal 
from credit unions, trade associations, state credit union leagues, 
state supervisory authorities, public officials (including current and 
former members of the U.S. Congress), Federal Home Loan Banks, credit 
union members, and other interested parties. Because this is a new 
proposed rule, the Board notes it is not required to respond to any 
comments received on the Original Proposal. However, the Board believes 
it is important to address all relevant comments. Therefore, the Board 
has included comment summaries and responses throughout the preamble to 
this proposal.
    Overall, while some commenters supported the concept of adopting 
risk-based capital standards for complex credit unions that were more 
comparable to those applicable to banks, most commenters opposed the 
Original Proposal, particularly those requirements that the commenters 
believed exceeded the requirements imposed on banks.
    Most commenters also expressed concerns about the potential costs 
and burdens of various aspects of the Original Proposal. A significant 
number of commenters argued that new risk-based capital standards were 
not necessary at this time, particularly given the success of consumer 
credit unions during the recent financial crisis. A number of 
commenters also requested that the Board withdraw the Original Proposal 
and reissue a proposal for another round of public comments with 
significant revisions to the risk weights. Many commenters also asked 
for additional time to implement the new requirements and adjust their 
balance sheets.
    The Board responds to the significant comments received on the 
Original Proposal throughout this preamble. More detailed discussions 
on the comments received on particular aspects of the Original 
Proposal, and NCUA's responses to those comments, are primarily 
provided in the section-by-section analysis part of the preamble.
General Comments on Application of Risk-Based Capital Standards to 
Credit Unions
    The Board received over 2,000 comments regarding the application of 
risk-based capital standards to credit unions under the Original 
Proposal. A majority of the commenters stated that NCUA's current risk-
based net worth ratio standard is working well,

[[Page 4351]]

particularly given that the credit union industry survived the recent 
financial crisis, and that maintaining the current system is far 
preferable to adopting the Original Proposal. Some commenters stated 
they were opposed to imposing a more sophisticated risk-based capital 
framework on credit unions. Other commenters stated they appreciated 
NCUA's efforts to keep the new requirements relatively simple and to 
minimize the implementation burden on affected institutions. A 
substantial number of other commenters agreed that updates to NCUA's 
risk-based net worth regulations were necessary to keep up with what 
other financial institutions are doing, but did not agree with certain 
aspects of the Original Proposal. Other commenters stated that some 
form of risk-based capital calculation was prudent to reward those 
institutions that do not stretch too hard for earnings or put their 
members' deposits at extraordinary risk. A significant number of 
commenters specifically suggested that the rule be amended to match the 
risk-based capital requirement for banks, the Basel III risk-based 
capital standards, or both. Other commenters suggested that the 
structure and performance of credit unions suggests that the risk 
weights should be less stringent than the risk weights applied to 
banks. Still other commenters suggested that instead of focusing on the 
past failures of credit unions, the Board should be focused on the 
successes of credit unions and issue regulations that help credit 
unions achieve success.
    The Board received a significant number of comments questioning 
whether the proposal would actually serve to protect the NCUSIF and 
make the industry safer and sounder. A number of commenters stated that 
the proposal essentially represented a de facto assumption of important 
balance sheet management decisions by NCUA for purposes of protecting 
the NCUSIF at the expense of the current prerogatives and interests of 
individual credit unions and their members. Commenters contended that 
since the implicit incentives in the proposal are the same for every 
credit union, over the long run, the Original Proposal would cause 
credit unions to become less financially diverse, which would increase 
the vulnerability of the industry and NCUSIF to some future widespread 
economic adversity. Commenters stated that credit unions are in the 
risk business by nature and that the proposal was too focused on a 
number-generated, one-size-fits-all solution. Other commenters 
requested that the Board be mindful that the risk weights that are 
adopted in the rule could ultimately drive which types of products and 
services are offered by credit unions.
    Some commenters suggested NCUA include a risk-capital model 
calculation as part of the examination process, similar to NCUA 
requirements for other types of modeling such as the model required for 
IRR testing. Those commenters suggested that the results of the risk-
based capital model could be used to identify ``potential risk'' by 
examiners and credit union boards, calling for additional scrutiny in 
the exam, instead of prescribing a rule that is assumed to quantify 
``actual'' risk.
    A small number of commenters suggested that the Other Banking 
Agencies are all leaning toward simply using a simplified leverage 
ratio to account for risks.
Justification and Supporting Analysis
    A number of commenters commented on the Board's justification and 
analysis supporting the need for a proposed rule. Commenters suggested 
the proposal was arbitrary and developed without feedback from the 
credit union industry. Other commenters suggested that the Board should 
have provided stakeholders with a more thorough discussion of how the 
proposal would fit into NCUA's regulatory framework, including recently 
issued final rules regarding liquidity risk, IRR, and stress testing 
and capital planning. Commenters stated there was no credible analysis 
available in the Original Proposal to suggest credit unions overall are 
unlikely to perform well under the current PCA system, which already 
includes a risk-based net worth requirement. Others commented that the 
proposal provided no evidence that this rule would help members.
    Commenters suggested the Board did not sufficiently take into 
account the unique nature of credit unions and the financial 
performance and distinctive structure of credit unions in developing 
the proposal. They argued this was problematic because the Board is 
required to take into account the unique nature of credit unions in 
designing a system of PCA, and that by failing to sufficiently account 
for credit union differences and the lower level of risk that credit 
unions demonstrate as a result led to a proposal that would require 
well-managed credit unions to hold too much capital. Others suggested 
that the proposal failed to consider how the use of bank style capital 
levels could adversely impact credit unions. There were those who felt 
that the Board should propose a rule only if NCUA has prepared a 
reasoned determination that the rule's benefits justify its costs. They 
suggested that any benefits in terms of reduced NCUSIF losses would be 
minor at best and the very real costs of unnecessarily high capital 
requirements would be substantial. Commenters also suggested that the 
proposal was not tailored to impose the least burden.
    The Board received a number of comments on the basis provided for 
the proposed rule. Commenters suggested the proposal should have been 
based on historical perspectives, and stated that based on their own 
analysis the proposal would have avoided few if any past credit union 
failures. One commenter stated that only 1.1 percent of credit unions 
with more than $50 million in assets have failed in the six-and-a-half 
years since the beginning of the worst financial crisis and recession 
in 80 years. The commenter did, however, acknowledge that the proposed 
system would have been more effective than the current system in 
identifying credit unions that subsequently failed.
    One commenter suggested that the Board's justification that the 
proposal seeks to incorporate lessons learned from past failures of 
credit unions to hold sufficient levels of capital despite warnings 
from NCUA examiners was unsupportable because NCUA and state officials 
have various supervisory enforcement measures at their disposal (e.g., 
preliminary warning letters, letters of understanding and agreement, 
and cease and desist orders) to force a credit union to improve the 
alignment between its risk exposures and its available capital.
    A significant number of commenters questioned the Board's 
supporting analysis for various aspects of the proposal. Commenters 
suggested that the empirical foundation provided for the proposed risk 
weights was not sufficient. Other commenters stated that the Board 
should provide additional justification and more clarity as to why the 
proposed risk weights differ from those for other community financial 
institutions. Many commenters stated they would like an opportunity to 
review and comment on empirical data, but that they were not provided 
sufficient information to understand how the metrics behind the 
proposal were determined and how historic losses contributed to each 
calculation. One commenter suggested that NCUA should expand its 
research horizons to include data-sourcing outside the natural-person 
credit union space, claiming the Original Proposal contained several 
examples where ``uncertain'' conclusions were drawn from insufficient 
data or those where

[[Page 4352]]

research was halted due to the burdensome process of data collection. 
The commenter suggested that often these data sources are limited to 
natural-person credit unions, many of which have little exposure to the 
asset classes in question.
    Another commenter suggested that the stated purpose of the proposal 
was to mitigate losses to the NCUSIF that could result from inadequate 
capital, but that GAO and NCUA's Office of Inspector General (OIG) 
reports demonstrate that deficiencies in the examination process 
contributed substantially to losses during the financial crisis, and 
that such deficiencies continue to be a significant factor in more 
recent credit unions failures. That commenter suggested that instead of 
focusing on a risk-based capital requirement for credit unions to 
contain NCUSIF losses, the Board should be improving examiner training 
so that agency field staff can more readily identify material risks 
without increasing the agency's budget, which is funded by credit 
unions.
    A significant number of commenters expressed concerns regarding the 
justification and explanation of how credit risks as well as interest 
rate, concentration, liquidity, operational, market risks, and other 
types of risk were addressed in the proposed rule. Commenters 
questioned the Board's justification for including IRR and 
concentration risk in the proposed risk weights for investments, real 
estate loans, and member business loans. A small number of commenters 
suggested that there was no explanation of which portion of the 
proposed risk weight is intended to address each of these risk 
elements, and that, as a result, the risk weights did not reflect a 
reasoned judgment about the actual risks involved.
Competitive Concerns and Concerns Related to the Unique Nature of 
Credit Unions
    The Board received a significant number of comments expressing 
concerns that the proposed rule would have put credit unions at a 
competitive disadvantage to banks. A majority of the commenters 
suggested that the differences between NCUA's proposed risk weights and 
the Other Banking Agencies' capital rules would have constrained the 
healthy growth of the credit union industry. Commenters suggested that 
the statutory seven percent net worth requirement to be classified as 
well capitalized was set artificially high by Congress to slow the 
growth of credit unions and that the proposed rule would build on that 
artificially high net worth requirement and further slow the growth of 
credit unions, putting credit unions at a further disadvantage to 
banks. A significant number of commenters stated that the competitive 
disadvantages in the proposed rule could incentivize many credit unions 
to switch to bank charters. Other commenters suggested that NCUA's 
proposed risk-based capital ratios were much more volatile than the 
risk weights under the Other Banking Agencies' rule, and that the 
proposed risk weights for some investments were excessively punitive 
and should be changed to match the risk weights used in Basel \70\ and 
the Other Banking Agencies' calculations. Still others suggested that 
it would be appropriate for NCUA to establish new risk-based capital 
ratio levels only when the leverage ratio requirements for credit 
unions to be adequately and well capitalized were lowered.
---------------------------------------------------------------------------

    \70\ Basel 1 (First Capital Accord) established minimum capital 
standards (1998). Basel II established the three pillar framework 
(first issued in 2004). Basel III is the most recent and builds upon 
Basel II pillars and enhances the core principles (first issued in 
2010).
---------------------------------------------------------------------------

    A small number of commenters stated that they appreciated that the 
Board kept the proposed risk-based capital calculation less complicated 
than the banking risk-based capital calculation.
    A substantial number of commenters suggested that it was not 
appropriate for the Board to adopt the framework of the Basel system in 
the proposal and also take parts from NCUA's current PCA regulation 
that bear no relationship to Basel. A substantial number of commenters 
stated that neither Basel III nor the Other Banking Agencies rules 
attempt to capture IRR, liquidity risk, market risk, or operational 
risk in their risk weights, and that Basel III and the Other Banking 
Agencies' capital rules are only designed to take into account credit 
risk. Many commenters stated that adopting either the Basel III format 
or the Other Banking Agencies' risk weights accurately would give both 
NCUA and the credit union industry credibility to all outside parties. 
Other commenters suggested that, because of these and other 
differences, the proposal was not ``comparable'' with the Other Banking 
Agencies' rules, which is a requirement of the FCUA.
    A substantial number of commenters stated that the structure and 
performance of credit unions suggests that the risk weights should be 
less stringent than the risk weights applied to banks. Other commenters 
suggested that the proposed risk-based capital standards for credit 
unions are comparable to FDIC standards, but that they fail to take 
into account the unique characteristics of the credit union system as 
required by the FCUA. Commenters noted that unlike banks, credit unions 
do not have capital stock and cannot go to outside investors to seek 
equity capital to fuel growth or shore up capital ratios in times of 
stress. They stated that the rule and associated risk weights should 
recognize that sources of capital within the credit union industry are 
not as easily acquired as capital sources for banks. A number of 
commenters stated that if Congress had intended credit unions to be 
subject to the same requirements as banks it would have said so, and 
suggested that the Board should stop treating credit unions like banks 
and judging them by return on investment, and instead judge them on how 
effectively they deliver on their mission and make a distinctive impact 
relative to their resources.
    One commenter suggested that the rule should be based on three 
principles: (1) Risk weights should generally be similar to those 
applied to community banks in the United States; (2) for those assets 
where credit union loss experience is historically lower than bank loss 
rates, credit union risk weights should be at or below bank risk 
weights; and (3) concentration risk and IRR should not be incorporated 
into the risk-based capital system, but instead, should be addressed in 
the regulatory, examination and supervision process.
    Another commenter claimed that the risk weights established by FDIC 
do not exceed 100 percent so NCUA's rule should not establish levels 
over 100 percent as it would impede growth and preclude credit unions 
from generating net income.
    Commenters suggested that the differences between proposed risk 
weights and banks' rules would encourage credit unions to make consumer 
loans by discouraging credit unions from making other types of loans, 
such as mortgage loans, MBLs, or agricultural loans. Others suggested 
that the proposed rule would have forced all credit unions into a bank 
model that would have required them to pay less, charge more, and 
increase fees. Other commenters suggested that the proposed risk 
weights could drive many credit unions to a ``cookie cutter'' balance 
sheet where each credit union has the same percentage of total assets 
allocated to specific loan types, which could force a high percentage 
of credit unions into less profitable asset growth and make it 
challenging to differentiate themselves from competitors.

[[Page 4353]]

    Commenters suggested that credit unions generally operate as 
portfolio lenders, making and holding high-quality consumer and 
residential real estate loans that serve their members and improve 
their communities, and that credit unions often carry significantly 
less exposure to volatile product lines such as acquisition development 
and construction loans, commercial real estate, and complex derivatives 
products.
    Commenters added that credit unions also face stringent regulatory 
restrictions on their investment powers, and as a result, natural-
person credit unions fared substantially better during the recent 
financial crisis than many other entities, including banks. Those 
commenters concluded that an appropriate risk-based capital requirement 
would reflect these important differences with a streamlined program 
that recognizes credit unions as strong counter-cyclical lenders while 
bolstering safety and soundness through meaningful benchmarks and 
access to supplemental capital.
Impacts
    The Board received a substantial number of comments concerning the 
impact that the Original Proposal would have had on credit unions. In 
general, most of these commenters expressed concern that the Original 
Proposal would have had a material adverse impact on individual credit 
unions and the entire credit union industry. This section outlines 
these concerns.
    A majority of commenters stated that the proposed risk-based 
capital requirement would weaken credit unions' ability to build the 
capital cushions they need to protect themselves against risk and would 
hamper credit unions' ability to grow and provide services to their 
members. Other commenters stated that the Original Proposal would 
constrain future investments by credit unions and, thus, would limit 
credit unions' ability to provide certain services, better loan rates, 
and dividends to their members. Others expressed concern that the 
proposal would impede growth and deter lending among credit unions, 
even those with demonstrated long-term ability to manage risk and net 
worth.
    Many commenters stated that the Original Proposal seemed to be a 
reaction to the Great Recession and that the Board should further 
consider the Original Proposal's impact on the future of the credit 
union industry. Commenters suggested that the proposed requirement to 
hold a higher capital-to-asset ratio would cause credit union asset 
growth to stagnate and decline over the long term, for any given rate 
of return on assets, and that the Board should try to quantify these 
costs and weigh them against the uncertain benefits of minor reductions 
in the relative cost of credit union failures. Using the rule that the 
sustainable asset growth rate is equal to the return on equity, or 
Asset Growth Rate = ROA/Capital Ratio, some commenters estimated that 
asset growth for credit unions would slow to eight percent under the 
Original Proposal, or 1.1 percent lower than the asset growth rate 
would be without the Original Proposal.
    Commenters stated that because credit unions can only build capital 
through retained earnings, the Original Proposal could severely limit 
credit unions' ability to grow, to increase the products and services 
they provide to their members, and to help their local communities 
prosper. They also suggested that the Original Proposal may actually 
reduce credit unions' ability to absorb losses, given their limited 
access to capital markets.
    A number of commenters stated that the low risk weights applied to 
consumer loans and the high risk weights applied to first-lien mortgage 
loans, mortgage servicing rights, and subordinate-lien mortgage loans 
would push credit unions to make more consumer loans and fewer mortgage 
loans, despite a significant demand for real estate lending services at 
some credit unions. Other commenters stated that the Original Proposal 
would induce credit unions to focus on risk-based capital instead of 
growth in real capital. Still other commenters suggested the proposed 
risk weights would penalize non-consumer lending, which could force 
small credit unions to only make consumer loans on very low margins, a 
strategy that would not survive in the future.
    One commenter suggested that the Original Proposal did not properly 
account for the effect of economic downturns on credit unions, and that 
it would be difficult or impossible for downgraded credit unions to 
rebuild following an economic downturn.
    A substantial number of commenters suggested that NCUA 
underestimated the adverse effect of the Original Proposal. They 
maintained that the Board understated the number of credit unions whose 
net worth would have decreased to just barely over well capitalized or 
adequately capitalized levels. One commenter suggested that, under the 
Original Proposal, approximately 1,000 credit unions would be required 
to raise $4 billion in additional capital. Other commenters proffered 
that the Original Proposal would require the credit union industry to 
hold an additional $6.5 billion to $7 billion dollars in additional 
capital to retain the same buffers that exist today and still be 
considered well capitalized. Commenters suggested that the Board 
considered only the narrowest interpretation of the Original Proposal's 
impact, ignoring the immediate and long-term effects that it would have 
on individual credit unions and the entire credit union system. They 
stated that credit unions cannot easily manage their capital to the 
exact dollar level that equates to NCUA's proposed standards, and that 
credit unions typically strive to maintain sufficient space or buffers 
between their actual net worth ratios and the minimum required levels 
to be well capitalized because of the significant consequences of not 
meeting the net worth standards. According to the commenters, credit 
unions choosing to regain their buffer would only have three choices: 
(1) Rebalance their assets, recognizing an opportunity cost when they 
forego higher earnings, which would diminish their ability to grow; (2) 
ration services, stifling asset and membership growth; or (3) require 
members to pay more, resulting in fewer member benefits and increased 
competition from banks.
    Commenters added that the Original Proposal would require many 
credit unions to adjust their capital levels to maintain current 
margins above the well capitalized threshold, at the same time as 
earnings at credit unions continue to be squeezed by low interest 
rates, downward pressure on other revenue streams, and moderate loan 
growth. They argued that these adjustments would pressure credit 
unions, already suffering from low to moderate loan-to-share ratios, to 
decrease their assets by curbing lending in an attempt to comply with 
the new requirements.
    A significant number of commenters stated that the Original 
Proposal would cause the reallocation of credit union capital toward 
less productive uses. One commenter suggested that, for some credit 
unions, the Original Proposal would increase the amount of capital 
required to be well capitalized above the current level of seven 
percent of total assets, positing that 10.5 percent of risk assets 
amounts to more than seven percent of total assets for most credit 
unions, depending on the ratio of risk assets to total assets. The 
commenter assumed that, across all potentially affected credit unions, 
the total amount of capital necessary to be well capitalized would 
increase by $7.6 billion, or, in other words, that the Original 
Proposal would increase the

[[Page 4354]]

well capitalized net worth ratio requirement an average of 0.76 
percent, from seven percent to 7.76 percent.
    A number of commenters also noted their concern that the Original 
Proposal would force many credit unions out of business.
    A significant number of commenters expressed concern that the 
Original Proposal would curtail MBL activities. They stated that the 
Original Proposal unfairly penalized credit unions that are exempt from 
the MBL limits in Sec.  107A of the FCUA.\71\ Other commenters 
suggested that the Original Proposal would stifle the strategic 
business plans of credit unions that specialize in MBLs to grow their 
assets with additional commercial and real estate loans. They also 
stated that the Original Proposal would drive down MBL activity in 
rural areas because credit unions specializing in MBLs, particularly in 
agricultural loans and/or loans secured by farm land, cannot diversify 
their portfolio by providing other types of loans not needed by their 
members. Others stated that the proposed risk weights for MBLs would 
discriminate against credit unions that serve underserved and credit-
challenged Americans--taxi drivers, farmers, and those in faith-based 
credit unions. Commenters suggested that, in order to increase their 
risk-based capital ratios required under the Original Proposal, credit 
unions may feel forced to reduce mortgage and business lending or 
increase loan rates and fees. They stated that the Original Proposal 
would have a negative effect on agricultural lending, farming 
communities, and credit union members, particularly those in rural and 
low-income areas. A number of commenters urged the Board to further 
consider the economic impact and consequences of reduced liquidity and 
financing for families and small businesses. Others argued that the 
Original Proposal would eliminate credit unions' business models 
centering on mortgage lending.
---------------------------------------------------------------------------

    \71\ 12 U.S.C. 1757a.
---------------------------------------------------------------------------

    Commenters suggested that the proposed risk weights would 
discourage well capitalized credit unions from engaging in mergers of 
undercapitalized credit unions because the Original Proposal would 
force credit unions into less profitable asset growth. Other commenters 
maintained that the reduction of credit unions' capital margin or 
cushion would negatively impact credit unions' ability to merge, and 
would permit only the largest credit unions to merge with smaller 
credit unions. Still others suggested that the Original Proposal would 
encourage mergers of credit unions not meeting the risk-based 
requirements.
    A substantial number of commenters stated that the Original 
Proposal would have a direct negative impact on credit union service 
organizations (CUSOs) by discouraging investment in CUSOs, thereby 
forcing many credit unions to limit services to their members.
    Commenters feared that the Original Proposal would result in 
stricter scrutiny by examiners, which would increase NCUA's examination 
and supervision costs and, therefore, the costs borne by credit union 
members. Other commenters suggested that NCUA already has a large 
examination and oversight budget to eliminate risk to the NCUSIF; they 
contended the Original Proposal did not sufficiently address the 
aggregate costs of these initiatives to credit union members. According 
to these commenters, the impact of the Original Proposal on credit 
union members, in the form of excessive supervision and lost earnings 
due to overcapitalization, could itself pose a risk to the NCUSIF.
    Some commenters shared their belief that the Original Proposal 
would reduce lending in dramatic ways and stifle the economy. Other 
commenters asserted that the Original Proposal would decrease member 
benefits, such as patronage dividends and reduced expenses. A number of 
commenters stated that the Original Proposal failed to consider impacts 
on businesses and the economy, particularly on small businesses that 
rely on credit unions for credit. Several commenters suggested that the 
Original Proposal would force some credit unions away from their 
missions to serve member in predominantly rural and low-income fields 
of membership.
    A small number of commenters encouraged the Board to follow the 
cost-benefit analysis blueprint established by Executive Orders 13563 
and 13579. Doing so, they argued, would allow meaningful, cumulative 
analysis that would result in a more coherent rule with fewer harmful, 
unintended consequences for the American economy.
    A number of commenters expressed significant concerns about the 
Original Proposal's negative impact on the growth and viability of 
small credit unions. They suggested that the Original Proposal would 
inhibit the growth of credit unions that are developing from small 
credit unions (less than $50 million) to medium-size credit unions ($50 
million-$99 million). Other commenters suggested it would reduce the 
monetary and other support that larger credit unions historically have 
provided to their smaller counterparts. They noted that some small 
credit unions depend on grants, scholarships, and training 
opportunities funded by larger credit unions. If these larger credit 
unions were compelled to change their loan and investment portfolios, 
or are required to adjust their capital, those commenters concluded 
their income levels would decline, thereby rendering it more difficult 
for them to fund as many opportunities for small credit unions. One 
credit union with less than $10 million in assets asserted that it 
would be adversely affected by the proposed change in the capital 
reserves requirement.
    Other commenters suggested that the Original Proposal imposed 
unnecessary regulatory burdens that would impede small credit unions' 
ability to serve their members. A substantial number of commenters 
stated that small credit unions not classified as ``complex'' and not 
subject to the risk-based capital requirement would still be negatively 
affected because the Original Proposal estimated the paperwork burdens 
include over 160 hours of work for credit unions, which is significant 
for small credit unions with limited resources. Other commenters 
suggested that small credit unions would suffer significantly due to 
the complexity of this regulation and its implementation costs. Many 
commenters stated that small credit unions cannot survive under the 
current regulatory burdens. Others foresaw potentially disastrous 
consequences if this regulation were pushed down to small credit 
unions. An official at one small credit union asserted that the 
Original Proposal would affect its strategic planning as it approached 
$50 million in assets. Another commenter stated that, as a credit union 
with under $50 million in assets, it was concerned about the 
uncertainty of how the Original Proposal would affect privately insured 
credit unions.
Other Concerns
    Several commenters expressed concerns that the proposal did not 
provide for input from state regulators who may have a different view 
or approach from that of NCUA. Other commenters suggested that the 
proposal was developed with no involvement or dialogue with state 
regulators. Commenters suggested that the Board should ensure that NCUA 
properly implements directives in the FCU Act and coordinates with 
state officials in implementing risk-based requirements and PCA.

[[Page 4355]]

E. What are the primary changes the Board has included in this 
proposal?

    Similar to the Original Proposal, this proposal would replace the 
method currently used by credit unions to apply risk weights to their 
assets with a new risk-based capital ratio measure that is more 
comparable to that applied to depository institutions worldwide. The 
proposed risk-based capital ratio measure would be the percentage of a 
credit union's capital available to cover losses, divided by the credit 
union's defined risk-weighted asset base.
    As noted in the introduction, this proposed rule would make 
substantial modifications to the Original Proposal to address specific 
concerns that were raised by commenters regarding the proposal's cost, 
complexity, and burden. These changes would include: (1) Amending the 
definition of ``complex'' credit union by increasing the asset 
threshold from $50 million to $100 million; (2) reducing the number of 
asset concentration thresholds for residential real estate loans and 
commercial loans (formerly classified as MBLS); (3) assigning one-to-
four family non-owner-occupied residential real estate loans the same 
risk weights as other residential real estate loans; (4) eliminating 
IRR from this proposed rule; (5) extending the implementation timeframe 
to January 1, 2019; and (6) eliminating the Individual Minimum Capital 
Requirement (IMCR) provision. Among other things, these changes would 
substantially reduce the number of credit unions subject to the rule, 
and would afford affected credit unions sufficient time to prepare for 
the rule's full implementation. A full discussion of the impact of 
these and other changes in this proposed rule is contained in Impact of 
the Proposed Regulation part of the preamble below.
    As discussed previously, the FCUA gives NCUA broad discretion in 
designing the risk-based net worth requirement. Thus, this proposal 
would incorporate a broadened definition of capital to be used as the 
numerator in calculating the proposed new risk-based capital ratio 
measure. The Board is proposing this change to provide a more 
comparable measure of capital across all financial institutions and to 
better account for related elements of the financial statement that are 
available to cover losses and protect the NCUSIF. This broader 
definition of capital would more accurately reflect the amount of 
capital that is available at a credit union to absorb losses. On 
average, it would increase a credit union's risk-based capital ratio by 
over 50 basis points as discussed in more detail below.
    The Board agrees with the various comments received on the Original 
Proposal that suggested the allowance for loan and lease losses (ALLL) 
account should be included in its entirety in the risk-based capital 
ratio numerator (that is, not subject to a 1.25 percent cap), and that 
goodwill and other intangible assets specifically related to a 
supervisory merger that occurs before the Board finalizes its risk-
based capital ratio rule should be included in the risk-based capital 
ratio numerator for some period of time before being excluded 
(approximately 10 years after any final rule is published in the 
Federal Register). For a more detailed discussion on these and the 
other proposed changes, and responses to the comments received on the 
Original Proposal, refer to the section-by-section analysis part of 
this preamble below.
    In terms of the denominator for the risk-based capital ratio 
measure, section 216(d)(2) of the FCUA requires that the Board, in 
designing a risk-based net worth requirement, ``take account of any 
material risks against which the net worth ratio required for [a 
federally] insured credit union to be adequately capitalized may not 
provide adequate protection.'' \72\ Congress specifically listed IRR 
with respect to this provision in the Senate Report accompanying CUMAA, 
which added the aforementioned requirement to the FCUA.\73\ Section 
216(d)(2) of the FCUA differs from the corresponding provision in 
section 38 of the FDI Act,\74\ which requires the Other Banking 
Agencies to implement risk-based capital requirements, because section 
216(d)(2) specifically requires that NCUA's risk-based requirement 
address ``any material risks.'' Accordingly, despite the absence of an 
IRR component in the Other Banking Agencies' risk-based capital 
requirements,\75\ the Board is still required to account for any 
material risks in the risk-based requirement unless the risk is deemed 
immaterial because of the existence of some other mechanism that the 
Board believes adequately accounts for the risk.
---------------------------------------------------------------------------

    \72\ 12 U.S.C. 1790d(d)(2) (emphasis added).
    \73\ S. Rep. No. 193, 105th Cong., 2d Sess. 13 (1998).
    \74\ 12 U.S.C. 1831o.
    \75\ 78 FR 55349, 55362 (Sept. 10, 2013) (``The risk-based 
capital ratios under these rules do not explicitly take account of 
the quality of individual asset portfolios or the range of other 
types of risk to which FDIC-supervised institutions may be exposed, 
such as interest rate, liquidity, market, or operational risks.'').
---------------------------------------------------------------------------

    NCUA's risk-based net worth requirement has included some aspect of 
IRR since its inception in 2000. Further, the Board continues to 
believe that IRR, if not adequately addressed through some regulatory, 
statutory or supervisory mechanism, can represent a material risk for 
purposes of NCUA's risk-based requirement.\76\ The Board noted its 
concerns about IRR in the preamble of the final IRR rule issued in 
January 2012 when it highlighted the need for federally insured credit 
unions to have an effective IRR management program.\77\ NCUA's 
requirement to have an effective IRR management program was 
necessitated in part by the Board's concern over the steady lengthening 
in maturity of average credit union assets, an increase that in turn 
was fueled by a steady and extended expansion into mortgage loans and 
investments. At the same time credit unions were experiencing an 
increase in the weighted average maturity of their assets, much of 
their current portfolio was established in a period of record-low 
interest rates and at contractually fixed coupon amounts. These asset 
factors, coupled with a large influx of non-maturity shares also priced 
at historically low rates, has created a unique mismatch between assets 
and liabilities and a potentially volatile sensitivity in earnings and 
capital. Accordingly, the Board continues to view IRR as a major risk 
facing credit unions.
---------------------------------------------------------------------------

    \76\ IRR has been NCUA's top supervisory priority for the last 
few years, and has appeared as an issue of significant concern in 
the Financial Stability Oversight Council's 2012 and 2013 Annual 
Reports.
    \77\ 77 FR 5155 (February 2, 2012).
---------------------------------------------------------------------------

    Based on long-term balance sheet trends at credit unions and NCUA's 
experiences dealing with problem institutions, the Board has concluded 
that NCUA's current regulations and supervisory process alone cannot 
adequately address IRR. However, the Board agrees with commenters on 
the Original Proposal who suggested that measures of IRR based 
comprehensively on assets and liabilities (including hedges) should be 
favored over measures that are based upon an asset-only approach, which 
is the approach taken in the current rule and was also the approach 
taken in the Original Proposal. Accordingly, the Board is now proposing 
to exclude consideration of IRR from the risk-based capital ratio 
measure, but in the future intends to consider alternative approaches 
for taking into account the IRR at credit unions.
    The proposed methodology for assigning risk weights in this 
proposed rule, therefore, would account only for credit risk and 
concentration risk. The Board believes that a capital-at-risk 
methodology is more appropriate for

[[Page 4356]]

measuring the risks arising from the changes in interest rates. The use 
of capital-at-risk methodologies to identify, measure and control IRR 
is a long standing practice in larger credit unions and a standard 
expectation among depository institution supervisors, including NCUA. 
Net economic value (NEV) is the most prevalent tool credit unions use 
to measure capital-at-risk. NEV measures the effect of changes in 
interest rates on a credit union's economic value. NCUA has had a 
supervisory expectation for the use of asset liability management 
modeling by large credit unions for decades. In 2013, NCUA codified the 
requirement for IRR policies and management programs under section 
741.3(b)(5).\78\ Paragraph (b)(5) currently requires federally insured 
credit unions with over $50 million in assets to develop and adopt a 
written policy on IRR management, and a program to effectively 
implement that policy, as part of their asset liability management 
responsibilities.
---------------------------------------------------------------------------

    \78\ See also 78 FR 4032, 4037 (Jan. 18, 2013).
---------------------------------------------------------------------------

    Because IRR will no longer be included in this proposal, NCUA will 
consider what alternative approaches can be taken to account for IRR at 
credit unions. Alternative approaches that could be taken include 
adding a separate IRR standard as a subcomponent of the risk-based net 
worth requirement to complement the proposed risk-based capital ratio 
measure. Conceptually, a separate IRR standard should be based on a 
comprehensive balance sheet measure, like NEV, that takes into account 
offsetting risk effects between assets and liabilities (including 
benefits from derivative transactions). The intent of such a measure 
would be to measure IRR consistently and transparently across all asset 
and liability categories, to address both rising and falling rate 
scenarios, and to supplement the supervisory process with a measure 
calibrated to address severe outliers. This approach would also 
incorporate a forward-looking, proactive measure into NCUA's capital 
standards, as recommended by GAO.\79\
---------------------------------------------------------------------------

    \79\ See U.S. Govt. Accountability Office, GAO-12-247, Earlier 
Actions Are Needed to Better Address Troubled Credit Unions, (Jan. 
2012) available at http://www.gao.gov/products/GAO-12-247.
---------------------------------------------------------------------------

    In light of the proposed elimination of IRR measures from the 
current rule, and GAO's recommendation for NCUA to incorporate a 
forward-looking measure into credit union's capital standards, the 
Board specifically requests comments on alternative approaches that 
could be taken in the future to reasonably account for IRR.
    Because the Board has decided to exclude IRR from the computation 
of the risk weights for assets in this proposal, it was necessary to 
propose significant changes to how investments are currently risk-
weighted. This proposal adopts a risk weight framework for investments 
based largely on the credit risk of the issuer or underlying 
collateral. This proposed approach would be substantially similar to 
the Other Banking Agencies' framework for investments.\80\ Because the 
same types of investments generally perform identically on a credit 
risk basis for credit unions and banks, the variations in this proposal 
from the Other Banking Agencies' investment risk weights primarily 
involve credit union-specific type investments. For example, the 
proposed risk weights assigned to investments in capital instruments 
issued by corporate credit unions and credit union service 
organizations would differ from the corresponding risk-weights assigned 
to bank investments. While this approach to assigning risk weight to 
investments would require credit unions to report additional data on 
the Call Report, the Board believes such an approach would result in 
net benefits to credit unions in terms of the improved precision of the 
capital requirements. Further, the more granular data will improve 
NCUA's offsite supervision capabilities. The section-by-section 
analysis part of the preamble contains more detailed discussions on the 
specific changes being proposed to the investment risk weights.
---------------------------------------------------------------------------

    \80\ See, e.g., 12 CFR 324.32.
---------------------------------------------------------------------------

    Concentration risk can also be a material risk. As the Basel 
Committee on Banking Supervision explained in Basel II:

    Risk concentrations are arguably the single most important cause 
of major problems in banks. Risk concentrations can arise in a 
bank's assets, liabilities, or off-balance sheet items, through the 
execution or processing of transactions (either product or service), 
or through a combination of exposures across these broad categories. 
Because lending is the primary activity of most banks, credit risk 
concentrations are often the most material risk concentrations 
within a bank. Credit risk concentrations, by their nature, are 
based on common or correlated risk factors, which, in times of 
stress, have an adverse effect on the creditworthiness of each of 
the individual counterparties making up the concentration.\81\
---------------------------------------------------------------------------

    \81\ Basel Committee on Banking Supervision, ``International 
Convergence of Capital Measurement and Capital Standards: A Revised 
Framework, Comprehensive Version'' 214 (June 2006) available at 
http://www.bis.org/publ/bcbs128.pdf (Basel II).

    The concept of higher risk weights for concentrations of real 
estate loans and MBLs exists in the current risk-based requirement. 
Eliminating the concentration dimension for risk weights would be a 
step backward and is inconsistent with the concerns raised regarding 
concentration risk by GAO and in Material Loss Reviews (MLRs) conducted 
by NCUA's OIG. The 2012 GAO report notes credit concentration risk 
contributed to 27 of 85 credit union failures that occurred between 
January 1, 2008, and June 30, 2011. Credit unions with high MBL 
concentrations are particularly susceptible to changes in business 
conditions that can affect borrower cash flow, collateral value, or 
other factors increasing the probability of default. GAO found in its 
2012 report that credit unions who failed had more MBLs as a percentage 
of total assets than peers and the industry average. GAO advised NCUA 
to revise PCA taking into account credit unions with a high percentage 
of MBLs to total assets. The report documented NCUA's agreement to 
revise PCA regulations so that capital standards adequately address 
concentration risk.\82\
---------------------------------------------------------------------------

    \82\ See U.S. Govt. Accountability Office, GAO-12-247, Earlier 
Actions are Needed to Better Address Troubled Credit Unions (2012), 
available at http://www.gao.gov/products/GAO-12-247.
---------------------------------------------------------------------------

    GAO also recommended NCUA address the real estate concentration 
risk concerns raised by NCUA's OIG, who completed several MLRs where 
failed credit unions had large real estate loan concentrations. The 
NCUSIF incurred losses of at least $25 million in each of these cases. 
The credit unions reviewed held substantial residential real estate 
loan concentrations in either first-lien mortgage loans, home equity 
lines of credit (HELOCS), or both.\83\
---------------------------------------------------------------------------

    \83\ See Office of Inspector General, National Credit Union 
Administration, OIG-10-03, Material Loss Review of Cal State 9 
Credit Union (April 14, 2010), available at http://www.ncua.gov/about/Leadership/CO/OIG/Documents/OIG201003MLRCalState9.pdf; Office 
of Inspector General, National Credit Union Administration, OIG-11-
07, Material Loss Review of Beehive Credit Union (July 7, 2011), 
available at http://www.ncua.gov/about/Leadership/CO/OIG/Documents/OIG201107MLRBeehiveCU.pdf; Office of Inspector General, National 
Credit Union Administration, OIG-10-15, Material Loss Review of 
Ensign Federal Credit Union, (September 23, 2010), available at 
http://www.ncua.gov/about/Leadership/CO/OIG/Documents/OIG201015MLREnsign.pdf.
---------------------------------------------------------------------------

    Accordingly, the Board is now proposing to include a tiered risk 
weight framework for high concentrations of residential real estate 
loans and commercial loans \84\ in NCUA's risk-based capital ratio 
measure.\85\ As a

[[Page 4357]]

credit union's concentration in these asset classes increases, 
incrementally higher levels of capital would be required. This approach 
would address concentration risk as it relates to minimum required 
capital levels through a transparent, standardized, regulatory 
requirement. Considering concentration risk solely in the examination 
process would be less consistent and transparent, and would lack a 
strong enforcement framework.
---------------------------------------------------------------------------

    \84\ The definition of commercial loans and the differences 
between commercial loans and MBLs are discussed in more detail in 
the section-by-section analysis.
    \85\ The tiered framework would provide for an incrementally 
higher capital requirement resulting in a blended rate for the 
corresponding portfolio. That is, the portion of the portfolio below 
the threshold would receive a lower risk weight, and the portion 
above the threshold would receive a higher risk weight. The higher 
risk weight would be consistent across asset categories as a 50 
percent increase from the base rate. Some comments on the Original 
Proposal suggested NCUA should have combined similar exposures 
across asset classes, such as investments and loans. For example, 
residential mortgage-backed security concentrations could have been 
included with the real estate loan thresholds due to the similarity 
of the underlying assets. However, given the more liquid nature and 
price transparency of a security, the Board believes including this 
with the risk thresholds for real estate lending is not necessary.
---------------------------------------------------------------------------

    The Board agrees with various commenters on the Original Proposal 
that the tiered risk weight system should be adjusted so as to focus on 
material outliers, thereby creating more consistency of capital 
treatment with banks. Accordingly, the Board proposes to use a single, 
higher concentration threshold to simplify the risk weight framework 
and calibrate it to be applicable only to credit unions that deviate 
significantly from the mean.\86\ This single, higher concentration 
threshold would provide sufficient flexibility for the vast majority of 
credit unions to operate at a level where the risk weights are 
substantially similar to the risk weights applied to similar bank 
assets under the Other Banking Agencies' capital regulations.\87\
---------------------------------------------------------------------------

    \86\ The concentration threshold for real estate loans is 
approximately two standard deviations from the mean. The 
concentration threshold for commercial loans is over five standard 
deviations from the mean.
    \87\ Based on NCUA's analysis of call report data, approximately 
90 percent of complex credit unions operate at levels below the 
concentration thresholds proposed for residential real estate loans. 
Over 99 percent of complex credit unions operate at levels below the 
concentration thresholds proposed for commercial loans. See also, 
e.g., 12 CFR 324.32(f) and (g) (corresponding FDIC risk weights).
---------------------------------------------------------------------------

    The concentration thresholds would not limit a credit union's 
lending activity; rather, the thresholds would merely require the 
credit union to hold capital for the elevated risk. The Board does not 
believe credit unions would be at a competitive disadvantage because 
most loans (except for loans at extremely high concentrations) would be 
assigned risk weights similar to those applicable to banks.
    Consistent with section 216(b)(1)(A)(ii) of the FCUA, which 
requires NCUA's PCA requirement be comparable to the Other Banking 
Agencies' PCA requirements, the Board largely relied on the risk 
weights assigned to various asset classes under the Basel Accords and 
the Other Banking Agencies' risk-based capital rules, as well as the 
underlying principles, for this proposal.\88\ NCUA has, however, 
tailored the risk weights in this proposal for certain assets that are 
unique to credit unions; where a demonstrable and compelling case 
exists, based on contemporary and sustained performance differences, to 
differentiate for certain asset classes between banks and credit 
unions; or where a provision of the FCUA required doing so. Thus, this 
proposal provides for even greater comparability to Other Banking 
Agencies' risk weights than the Original Proposal by adjusting asset 
classes and recalibrating risk weight, including for all loans changing 
the definition of ``current'' from less than 60 to less than 90 days 
past due.
---------------------------------------------------------------------------

    \88\ NCUA has attempted to simplify certain aspects of this 
proposed rule to take into account the cooperative character of 
credit unions while still imposing risk-based capital standards that 
are substantially similar and equivalent in rigor to the standards 
imposed on banks. See 12 U.S.C. 1790d(b)(1)(B).
---------------------------------------------------------------------------

    The following is a table showing a summary of the risk weights 
included in this proposal. See the section-by-section analysis part of 
the preamble below for more detail on the proposed changes to the asset 
classes and risk weights.

                                                            Summary of Proposed Risk Weights
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                         0%        20%       50%       75%      100%      150%      250%      300%      400%      1250%
--------------------------------------------------------------------------------------------------------------------------------------------------------
Cash/Currency/Coin..................................        X   ........  ........  ........  ........  ........  ........  ........  ........  ........
Investments:........................................
    Unconditional Claims--U.S. Govt. (Treas./GNMA)..        X   ........  ........  ........  ........  ........  ........  ........  ........  ........
    Balances Due from Federal Reserve Banks.........        X   ........  ........  ........  ........  ........  ........  ........  ........  ........
    Federally Insured Deposits in Financial                 X   ........  ........  ........  ........  ........  ........  ........  ........  ........
     Institutions...................................
    Debt Instruments issued by NCUA and FDIC........        X   ........  ........  ........  ........  ........  ........  ........  ........  ........
    CLF Stock.......................................        X   ........  ........  ........  ........  ........  ........  ........  ........  ........
    Uninsured deposits at U.S. Federally Insured                      X   ........  ........  ........  ........  ........  ........  ........  ........
     Inst...........................................
    Agency Obligations..............................                  X   ........  ........  ........  ........  ........  ........  ........  ........
    FNMA and FHLMC pass through MBS.................                  X   ........  ........  ........  ........  ........  ........  ........  ........
    Gen. Oblig. Bonds Issued by State or Political                    X   ........  ........  ........  ........  ........  ........  ........  ........
     Sub............................................
    FHLB Stock and Balances.........................                  X   ........  ........  ........  ........  ........  ........  ........  ........
    Senior Agency Residential MBS or Asset Backed                     X   ........  ........  ........  ........  ........  ........  ........  ........
     Securities (ABS) Structured....................
    Revenue Bonds Issued by State or Political Sub..                            X   ........  ........  ........  ........  ........  ........  ........
    Senior Non-Agency Residential MBS Structured....                            X   ........  ........  ........  ........  ........  ........  ........
    Corporate Membership Capital....................                                                X   ........  ........  ........  ........  ........
    Senior Non-Agency ABS Structured Securities.....                                                X   ........  ........  ........  ........  ........
    Industrial Development Bonds....................                                                X   ........  ........  ........  ........  ........
    Agency Stripped MBS (Int. Only and Prin. Only)..                                                X   ........  ........  ........  ........  ........

[[Page 4358]]

 
    Mutual Funds Part 703 Compliant.................                                              X *   ........  ........  ........  ........  ........
    Value of General Account Insurance (BOLI/CUOLI).                                              X *   ........  ........  ........  ........  ........
    Corporate Perpetual Capital.....................                                                          X   ........  ........  ........  ........
    Mortgage Servicing Assets.......................                                                                    X   ........  ........  ........
    Separate Account Life Insurance.................                                                                            X *   ........  ........
    Publicly Traded Equity Investment (non CUSO)....                                                                              X   ........  ........
    Mutual Funds Part 703 Non-Compliant.............                                                                            X *   ........  ........
    Non-Publicly Traded Equity Inv. (non CUSO)......                                                                                        X   ........
    Subordinated Tranche of Any Investment..........                                                                                               X **
Consumer Loans:
    Share-Secured...................................                  X   ........  ........  ........  ........  ........  ........  ........  ........
    Current Secured.................................                                      X   ........  ........  ........  ........  ........  ........
    Current Unsecured...............................                                                X   ........  ........  ........  ........  ........
    Non-Current.....................................                                                          X   ........  ........  ........  ........
Real Estate Loans:
    Share-Secured...................................                  X   ........  ........  ........  ........  ........  ........  ........  ........
    Current First Lien < 35% of Assets..............                            X   ........  ........  ........  ........  ........  ........  ........
    Current First Lien > 35% of Assets..............                                      X   ........  ........  ........  ........  ........  ........
    Not Current First Lien..........................                                                X   ........  ........  ........  ........  ........
    Current Junior Lien < 20% of Assets.............                                                X   ........  ........  ........  ........  ........
    Current Junior Lien > 20% of Assets.............                                                          X   ........  ........  ........  ........
    Noncurrent Junior Lien..........................                                                          X   ........  ........  ........  ........
Commercial Loans:
    Share-Secured...................................                  X   ........  ........  ........  ........  ........  ........  ........  ........
    Portion of Commercial Loans with Compensating                     X   ........  ........  ........  ........  ........  ........  ........  ........
     Balance........................................
    Commercial Loans < 50% of Assets................                                                X   ........  ........  ........  ........  ........
    Commercial Loans > 50% of Assets................                                                          X   ........  ........  ........  ........
    Non-current.....................................                                                          X   ........  ........  ........  ........
Miscellaneous:
    Loans to CUSOs..................................                                                X   ........  ........  ........  ........  ........
    Equity Investment in CUSO.......................                                                          X   ........  ........  ........  ........
    Other Balance Sheet Items not Assigned..........                                                X   ........  ........  ........  ........  ........
--------------------------------------------------------------------------------------------------------------------------------------------------------
* With the option to use the look-through options.89
** With the option to use the gross-up approach.90

     
---------------------------------------------------------------------------

    \89\ The ``look-through'' approaches are discussed in more 
detail in part of the preamble discussing Sec.  702.103(c)(4) of 
this proposal.
    \90\ The ``gross-up'' approach is discussed in more detail in 
part of the preamble discussing Sec.  702.103(c)(4) of this 
proposal.
---------------------------------------------------------------------------

    The Board notes that FDIC's capital standards are the ``minimum 
capital requirements and overall capital adequacy standards for FDIC-
supervised institutions . . . include[ing] methodologies for 
calculating minimum capital requirements . . .'' \91\
---------------------------------------------------------------------------

    \91\ See, e.g., 12 CFR 324.1(a).
---------------------------------------------------------------------------

    The FDIC may require an FDIC-supervised institution to hold an 
amount of regulatory capital greater than otherwise required under its 
capital rules if the FDIC determines that the institution's capital 
requirements under its capital rules are not commensurate with the 
institution's credit, market, operational, or other risks.\92\
---------------------------------------------------------------------------

    \92\ See, e.g., 12 CFR 324.1(d).
---------------------------------------------------------------------------

    Further, the September 10, 2013 preamble to part 324 of FDIC's 
regulations states that:

    The FDIC's general risk-based capital rules indicate that the 
capital requirements are minimum standards generally based on broad 
credit-risk considerations. The risk-based capital ratios under 
these rules do not explicitly take account of the quality of 
individual asset portfolios or the range of other types of risk to 
which FDIC-supervised institutions may be exposed, such as interest-
rate risk, liquidity, market, or operational risks . . . In light of 
these considerations, as a prudent matter, an FDIC-supervised 
institution is generally expected to operate with capital positions 
well above the minimum risk-based ratios and to hold capital 
commensurate with the level and nature of the risks to which it is 
exposed, which may entail holding capital significantly above the 
minimum requirements.\93\
---------------------------------------------------------------------------

    \93\ 78 FR 55362, Tuesday, September 10, 2013.

    As indicated above, FDIC's approach to risk weights is calibrated 
to be the minimum regulatory capital standard. Similarly, this proposal 
is calibrated to be the minimum regulatory capital standard. Therefore, 
the Board believes it is necessary to incorporate a broader regulatory 
provision requiring complex credit unions to maintain capital 
commensurate with the level and nature of all risks to which they are 
exposed, and to maintain a written strategy for assessing capital 
adequacy and maintaining an appropriate level of capital.
    Proposed new Sec.  702.101(b) is based on a similar provision in 
the Other Banking Agencies' rules.\94\ This provision would not affect 
a complex credit union's PCA classification. It would, however, support 
NCUA's assessment of complex credit unions' capital adequacy in the 
supervisory process (e.g., assigning CAMEL and risk ratings). Following 
the publication of a final risk-based capital rule, NCUA would develop 
and publish supervisory guidance for examiners and credit unions on the 
application of this provision. Please refer to the section-by-

[[Page 4359]]

section analysis part of this preamble for a more detailed discussion 
of this new provision and the related supervisory process 
considerations.
---------------------------------------------------------------------------

    \94\ See, e.g., 12 CFR 324.10(d)(1) and (2).
---------------------------------------------------------------------------

    Because of this proposed new capital adequacy provision, existing 
enforcement authority for unsafe and unsound conditions or 
practices,\95\ NCUA's authority to reclassify an insured credit union 
into a lower net worth category,\96\ and comments on the Original 
Proposal, the Board has decided to eliminate the provision in the 
Original Proposal for imposing an IMCR.
---------------------------------------------------------------------------

    \95\ See Sec.  702.1(d) of this proposed rule and the current 
rule.
    \96\ See section 1790(d)(h) of the Federal Credit Union Act, and 
Sec.  702.102(b) of this proposed rule and the current rule.
---------------------------------------------------------------------------

    Under the Original Proposal, proposed Sec.  702.105(a) would have 
introduced rules and procedures to permit the Board, on a case-by-case 
basis, to impose an IMCR that exceeds the risk-based capital 
requirement that otherwise would apply to a credit union under subpart 
A of part 702.
    Under the Original Proposal, Sec.  702.105(a) would have prescribed 
criteria to determine when a credit union's capital is, or may become, 
inadequate, making it appropriate to impose a higher capital 
requirement. It then would have prescribed standards to determine what 
heightened capital requirement to impose in such cases, based not only 
on mathematical and objective criteria, but on subjective judgment 
grounded in agency expertise.
    Under the Original Proposal, a staff-level decision to impose a 
discretionary supervisory action (DSA) under part 702,\97\ and a 
decision to impose an IMCR would have been treated as a ``material 
supervisory determination.'' \98\ As such, proposed Sec.  747.2006 
would have required NCUA to provide the affected credit union with 
reasonable notice of a proposed IMCR, and it established an independent 
process by which to challenge the proposed IMCR, culminating in Board 
review.
---------------------------------------------------------------------------

    \97\ E.g., 12 CFR 702.202(b) and (c).
    \98\ 12 U.S.C. 1790d(k).
---------------------------------------------------------------------------

    With a few notable exceptions,\99\ the comments addressing the IMCR 
were critical of the concept itself, NCUA's legal authority to impose 
an IMCR, the scope of an IMCR, the criteria and procedures for imposing 
it, the subjectivity and discretion involved, or the lack of an option 
for review by an independent third party.
---------------------------------------------------------------------------

    \99\ Several trade association commenters advocated limiting the 
scope of the IMCR to IRR and concentration risk only, otherwise 
excluding those two risks from the scope of the proposed rule.
---------------------------------------------------------------------------

    Now that the IMCR provision in this proposal has been removed, the 
commenters' concerns with the various aspects of the IMCR are no longer 
relevant. NCUA would be able to address any deficiencies in a credit 
union's capital levels relative to its risk by: (1) Reclassifying the 
credit union into a lower net worth category under Sec.  702.102(b) of 
this proposal and FCUA; \100\ (2) determining in relation to proposed 
Sec.  702.101(b) that capital levels are not commensurate with the 
level or nature of the risks to which the credit union is exposed; or 
(3) using other supervisory authorities to address unsafe or unsound 
conditions or practices as noted in Sec.  702.1(d) of this proposal and 
the current rule. As a practical matter, in using these authorities, 
NCUA may provide specific metrics for necessary reductions in risk 
levels, increases in capital levels beyond those otherwise required 
under this part, and some combination of risk reduction and increased 
capital so it is clear how the credit union can address NCUA's 
supervisory concerns. Then it would be up to the credit union to decide 
which particular option to pursue to remedy NCUA's enforcement action.
---------------------------------------------------------------------------

    \100\ 12 U.S.C. 1790d(h).
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    As discussed earlier in this preamble, the Original Proposal would 
have required that credit union meet different risk-based capital ratio 
levels for the adequately capitalized category (eight percent) and the 
well capitalized category (10.5 percent). Commenters on the Original 
Proposal questioned NCUA's legal authority to require complex credit 
unions to meet one risk-based capital ratio to be adequately 
capitalized and a different, higher risk-based capital ratio to be 
classified as well capitalized. As explained in the legal authority 
section of this preamble, the Board has the authority under the FCUA to 
take this approach.
    However, the Board supports lowering the risk-based capital ratio 
level required for a complex credit union to be classified as well 
capitalized from 10.5 percent to 10 percent. The Board agrees with 
commenters that a 10 percent risk-based capital ratio level for well 
capitalized credit unions simplifies the comparison with the Other 
Banking Agencies' rules \101\ by removing the effect of the capital 
conservation buffer.\102\ Capital ratio thresholds are largely a 
function of risk weights. As discussed in other parts of this proposal, 
the Board is now proposing to more closely align NCUA's risk weights 
with those assigned by the Other Banking Agencies,\103\ so it follows 
that the risk-based capital ratio thresholds should also align as much 
as possible. The proposed 10 percent risk-based capital ratio level for 
well capitalized credit unions, along with the eight percent risk-based 
capital ratio level for adequately capitalized credit unions, would be 
comparable to the total risk-based capital ratio requirements contained 
in the Other Banking Agencies' capital rules.\104\
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    \101\ See, e.g., 12 CFR 324.403.
    \102\ The ``capital conservation buffer'' is explained in more 
detail in the discussion on proposed Sec.  702.102(a) in the 
section-by-section analysis part of the preamble.
    \103\ See, e.g., 12 CFR 324.32.
    \104\ See, e.g., 12 CFR 324.403.
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    The Original Proposal would have applied to all credit unions with 
over $50 million in total assets. Based on NCUA's analysis of the 
comments received on the Original Proposal, the Board is now proposing 
to define a credit union as ``complex'' if it has assets of more than 
$100 million.\105\ Credit unions meeting this threshold have a 
portfolio of assets and liabilities that are complex, based upon the 
products and services in which they are engaged. Credit unions with 
$100 million in assets or less generally do not have a complex 
structure of assets and liabilities and are a small share of the 
overall assets in the credit union system, thereby limiting the 
exposure of the NCUSIF to these institutions. As discussed later in 
this document, the $100 million asset threshold is a clear demarcation 
above which all credit unions engage in complex activities, and where 
almost all such credit unions (99 percent) are involved in multiple 
complex activities, in stark contrast to credit unions with $100 
million in assets or less.
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    \105\ There is no exemption for banks from the risk-based 
capital requirements of the other banking agencies. There are 1,975 
FDIC-insured banks with assets less than $100 million as of June 
2014.
---------------------------------------------------------------------------

    The Board believes an asset threshold would be clear, logical, and 
easy to administer when compared to the more complicated formula credit 
unions are required to follow under the current rule \106\ to determine 
if they are complex. Using a more straightforward proxy for complex 
credit unions would also help account for the fact that credit unions 
have boards of directors that consist primarily of volunteers. The $100 
million dollar asset size threshold would exempt almost 80 percent of 
credit unions \107\ from any regulatory burden associated with 
complying with this rule, while covering nearly 90 percent of the 
assets in the credit union system. The threshold would also be 
consistent with the fact that the majority

[[Page 4360]]

of losses (as measured as a proportion of the total dollar cost) to the 
NCUSIF result from credit unions with assets greater than $100 million. 
For a more detailed discussion of the rationale the Board considered in 
defining complex, see the discussion associated with proposed Sec.  
702.103 in the section-by-section analysis part of the preamble.
---------------------------------------------------------------------------

    \106\ 12 CFR 702.106.
    \107\ Based upon December 31, 2013 Call Report data.
---------------------------------------------------------------------------

    The Original Proposal would have provided an 18-month 
implementation period for credit unions to adjust to the new 
requirements. The Board agrees with the comments received on the 
Original Proposal that a longer implementation period is necessary due 
to the complexity of this rule and the changes needed in the Call 
Report. Therefore, the Board is proposing to more than double the 
implementation period by extending it to January 1, 2019, to provide 
both credit unions and NCUA sufficient time to make the necessary 
adjustments, such as systems, processes, and procedures, and to reduce 
the burden on affected credit unions in meeting the new requirements.

IV. Section-by-Section Analysis

Part 702--Capital Adequacy

Revised Structure of Part 702
    Consistent with the Original Proposal, this proposed rule would 
reorganize part 702 by consolidating NCUA's PCA requirements, which are 
currently included under subsections A, B, C, and D, under proposed 
subparts A and B. Proposed subpart A would be titled ``Prompt 
Corrective Action'' and proposed subpart B would be titled 
``Alternative Prompt Corrective Action for New Credit Unions.'' \108\ 
The reorganization of the proposed rule is designed so that credit 
unions need only reference the subpart applying to their institution to 
identify the applicable minimum capital standards and PCA regulations. 
The Board believes that consolidating these sections would reduce 
confusion and save credit union staff from having to frequently flip 
back and forth through the four subparts of the current PCA rule.
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    \108\ Under both current Sec.  702.301(b) and proposed Sec.  
702.201(b), a credit union is ``new'' if it is ``a federally-insured 
credit union that both has been in operation for less than ten (10) 
years and has total assets of not more than $10 million. A credit 
union which exceeds $10 million in total assets may become `new' if 
its total assets subsequently decline below $10 million while it is 
still in operation for less than 10 years.''
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    In general, this proposed rule would restructure part 702 by 
consolidating most of the rules relating to capital and PCA that are 
applicable to credit unions that are not ``new'' credit unions under 
new subpart A. This change is intended to simplify the structure of 
part 702. The specific sections that would be included in new subpart A 
and the proposed changes to those sections are discussed in more detail 
below.
    Similarly, this proposed rule would consolidate most of NCUA's 
rules relating to alternative capital and PCA requirements for ``new'' 
credit unions under new subpart B. This change is intended to simplify 
the structure of part 702. The sections under new subpart B would 
remain largely unchanged from the requirements of current part 702 
relating to alternative capital and PCA, except for revisions to the 
sections relating to reserves and the payment of dividends. The 
specific sections included in new subpart B and the specific changes to 
the sections under new subpart B are discussed in more detail below.
    Finally, this proposed rule would retain subpart E of part 702, 
Stress Testing, but would re-designate and re-number the current 
subpart as subpart C. Other than re-designating and re-numbering the 
subpart, the language and requirements of current subpart E would 
remain unchanged.
Section 702.1 Authority, Purpose, Scope, and Other Supervisory 
Authority
    Consistent with the Original Proposal, proposed Sec.  702.1 would 
remain substantially similar to current Sec.  702.1, but would be 
amended to update terminology and internal cross references within the 
section, consistent with the changes that are being proposed in other 
sections of part 702. No substantive changes to the section are 
intended.
    The Board received a number of comments expressing concerns 
regarding the Boards authority to issue the Original Proposal. Several 
commenters stated that the Board lacks legal authority to issue a rule 
implementing the risk-based capital requirement as proposed. Other 
commenters suggested that the Board did not adequately account for the 
unique nature of credit unions in the Original Proposal. Another 
commenter suggested that the language of the FCUA does not mean that 
there should be one approach and one universal algorithm applied to all 
risk in the same fashion. Other commenters suggested that the Original 
Proposal was inconsistent with the statutory requirement for the Board 
to design a system of PCA that is comparable to that of FDIC. Other 
commenters argued that the proposed risk-based capital requirement was 
inconsistent with the FCUA because they believed it ignored the fact 
that most credit unions raise net worth only through retained earnings.
    The Board has carefully considered these comments and generally 
disagrees with commenters' reading of the FCUA. Section 216(b)(1) of 
the FCUA requires the Board to adopt by regulation a system of PCA for 
insured credit unions that is ``comparable to'' the system of PCA 
prescribed in the FDI Act, that is also ``consistent'' with the 
requirements of section 216 of the FCUA, and that takes into account 
the cooperative character of credit unions.\109\ Paragraph (d)(1) of 
the same section requires that NCUA's system of PCA include ``a risk-
based net worth requirement for insured credit unions that are complex 
. . .'' When read together, these sections grant the Board broad 
authority to design reasonable risk-based capital regulations to carry 
out the stated purpose of section 216, which is to ``resolve the 
problems of [federally] insured credit unions at the least possible 
long-term loss to the [National Credit Union Share Insurance] Fund.'' 
\110\ As explained in more detail below, the Board believes that this 
proposed rule is comparable, although not identical in detail, to the 
PCA and risk-based capital requirements for banks. In addition, as 
explained throughout the preamble to this proposed rule, this proposal 
deviates from the PCA and risk-based capital requirements applicable to 
banks as required by section 216 of the FCUA and takes into account the 
cooperative character of credit unions. Accordingly, the Board believes 
that this proposed rule would implement the risk-based net worth 
requirement consistent with section 216 of the FCUA.
---------------------------------------------------------------------------

    \109\ 12 U.S.C. 1790d(b)(1).
    \110\ Section 1790d(a)(1).
---------------------------------------------------------------------------

Section 702.2--Definitions
    Under the Original Proposal, proposed Sec.  702.2 would have 
retained many of the definitions in current Sec.  702.2 with no 
substantive changes. The Original Proposal would, however, have removed 
the paragraph number assigned to each of the definitions under current 
Sec.  702.2 and would have reorganized the section so the new and 
existing definitions were listed in alphabetic order. This reformatting 
would have made Sec.  702.2 more consistent with current Sec. Sec.  
700.2, 703.2 and 704.2 of NCUA's regulations.\111\ In addition, the 
originally proposed Sec.  702.2 would have added a number of new 
definitions, and amended some existing definitions in Sec.  702.2. 
These changes were intended to help clarify the

[[Page 4361]]

meaning of terms used in the Original Proposal.
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    \111\ 12 CFR 700.2; 12 CFR 703.2; 12 CFR 704.2.
---------------------------------------------------------------------------

    The Board received no comments on these technical changes to Sec.  
702.2 and has decided to retain the changes described above in this 
second proposal. Consistent with section 202 of the FCUA,\112\ the 
Board has incorporated the phrase `in accordance with GAAP' into many 
of the definitions to clarify that generally accepted accounting 
principles would be used determine how an item is recorded on the 
statement of financial condition from which it would be incorporated 
into the risk-based capital calculation. The following definitions, 
some of which were included in the Original Proposal, would be added, 
amended, or removed under this proposed rule:
---------------------------------------------------------------------------

    \112\ 12 U.S.C. 1782(a)(6)(C)(i).
---------------------------------------------------------------------------

    Allowances for loan and lease losses (ALLL). Under the Original 
Proposal, the term ``allowance for loan and lease loss'' would have 
been defined as reserves that have been established through charges 
against earnings to absorb future losses on loans, lease financing 
receivables, or other extensions of credit.
    The Board received no comments on the definition of ALLL in the 
Original Proposal and has decided to retain the term and definition in 
this second proposal with the following changes. As discussed in more 
detail below, the Board is now proposing to amend the definition of 
ALLL to address the importance of maintaining ALLL in accordance with 
GAAP since the integrity of the risk-based capital ratio is dependent 
upon an accurate ALLL, particularly now that this second proposal would 
allow the entire ALLL balance to be included in the risk-based capital 
ratio numerator. A credit union maintaining ALLL in accordance with 
GAAP will make timely adjustments to the ALLL including the timely 
charge off of loan losses. Accordingly, under this proposed rule, the 
term ``ALLL'' would be defined as valuation allowances that have been 
established through a charge against earnings to cover estimated credit 
losses on loans, lease financing receivables or other extensions of 
credit as determined in accordance with GAAP.
    Amortized cost. Under this proposed rule, the new term ``amortized 
cost'' would be defined as the purchase price of a security adjusted 
for amortizations of premium or accretion of discount if the security 
was purchased at other than par or face value.
    This proposed new term is being added because investments accounted 
for as held-to-maturity are reported on the balance sheet at amortized 
cost while investments accounted for as available-for-sale are reported 
on the balance sheet at fair value. As explained in more detail below, 
to ensure consistency in the measure of minimum capital for held-to-
maturity or available-for-sale investments, the risk weights will be 
applied to the amortized cost.
    Appropriate regional director. This proposed rule would amend the 
definitions section to remove the definition of the term ``appropriate 
regional director'' from the current rule. The definition is 
unnecessary and redundant because the term ``Regional Director'' is 
already defined for purposes of NCUA's regulations in Sec.  700.2.
    Appropriate state official. Under this proposed rule, the term 
``appropriate state official'' would be defined as the state 
commission, board or other supervisory authority having jurisdiction 
over the credit union. The proposal would amend the current definition 
of ``appropriate state official'' to provide additional clarity by 
adding the italicized words above (``state'' and ``the'') to the 
definition, and by removing the words ``chartered by the state which 
chartered the affected credit union,'' which the Board believes are 
unnecessary.
    Call Report. Under the Original Proposal, the term ``Call Report'' 
would have been defined as the Call Report required to be filed by all 
credit unions under Sec.  741.6(a)(2).
    The Board received no comments on the definition of ``Call Report'' 
and has decided to retain the definition unchanged in this proposal.
    Carrying value. Under this proposed rule, the new term ``carrying 
value'' would be defined, with respect to an asset, as the value of the 
asset on the statement of financial condition of the credit union, 
determined in accordance with GAAP. Under this proposed rule, for many 
assets, the carrying value would be the amount subject to the 
application of the associated risk weight.
    Central counterparty (CCP). Under this proposed rule, the new term 
``central counterparty'' would be defined as a counterparty (for 
example, a clearing house) that facilitates trades between 
counterparties in one or more financial markets by either guaranteeing 
trades or novating contracts. The Board is proposing to add this term 
to coincide with amendments it is making in the derivatives section of 
this proposal.
    Commercial loan. Under this proposed rule, the new term 
``commercial loan'' would be defined as any loan, line of credit, or 
letter of credit (including any unfunded commitments) to individuals, 
sole proprietorships, partnerships, corporations, or other business 
enterprises for commercial, industrial, and professional purposes, but 
not for investment or personal expenditure purposes. The definition 
would also provide that the term commercial loan excludes loans to 
CUSOs, first- or junior-lien residential real estate loans, and 
consumer loans.
    The Board is proposing to adopt a different approach from the 
Original Proposal, in which it applied risk weights to assets that fell 
within the statutory definition of MBLs, and is now proposing to assign 
specific risk weights to all loans meeting the new definition of 
commercial loans provided above. The proposed definition of commercial 
loans is more reflective of the risk of these loans than the previously 
defined term MBL, which would no longer be used in proposed Sec.  
702.104, and, as discussed in more detail below, is intended to better 
identify the loans made for a commercial purpose and having similar 
risk characteristics. Classification of a loan as a commercial loan 
would be based upon the purpose of the loan, the use of the proceeds of 
the loan, and the type of underlying collateral. Commercial loans may 
take the form of direct or purchased loans.
    For example, commercial loans would generally include the following 
types of loans: \113\
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    \113\ Many of the descriptions below overlap and are not 
intended to be an all-inclusive list.
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     Loans for commercial, industrial and professional purposes 
to:
    [cir] Mining, oil- and gas-producing, and quarrying companies;
    [cir] Manufacturing companies of all kinds, including those which 
process agricultural commodities;
    [cir] Construction companies;
    [cir] Transportation and communications companies and public 
utilities;
    [cir] Wholesale and retail trade enterprises and other dealers in 
commodities;
    [cir] Cooperative associates including farmers' cooperatives;
    [cir] Service enterprises such as hotels, motels, laundries, 
automotive service stations, and nursing homes and hospitals operated 
for profit;
    [cir] Insurance agents; and
    [cir] Practitioners of law, medicine and public accounting.
     Loans for the purpose of financial capital expenditures 
and current operations.
     Loans to finance agricultural production and other loans 
to farmers, including:

[[Page 4362]]

    [cir] Loans and advances made for the purpose of financing 
agricultural production, including the growing and storing of crops, 
the marketing or carrying of agricultural products by the growers 
thereof, and the breeding, raising, fattening, or marketing of 
livestock;
    [cir] Loans and advances made for the purpose of financial 
fisheries and forestries, including loans to commercial fishermen;
    [cir] Agricultural notes and other notes of farmers that the credit 
union has discounted, or purchased from, merchants and dealers, either 
with or without recourse to the seller;
    [cir] Loans and advances to farmers for purchase of farm machinery, 
equipment, and implements;
    [cir] Loans and advances to farmers for all other purposes 
associated with the maintenance or operations of the farm.
     Loan secured by multifamily residential properties with 5 
or more dwelling units in structures (including apartment buildings and 
apartment hotels) used primarily to accommodate a household on a more 
or less permanent basis and cooperative-type apartment buildings 
containing 5 or more dwelling units.\114\
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    \114\ Under this proposal, loans secured by one-to-four family 
residential property are defined as first or junior lien residential 
real estate loans.
---------------------------------------------------------------------------

     Loans secured by real estate as evidenced by mortgages or 
other liens on business and industrial properties, hotels, churches, 
hospitals, educational and charitable institutions, dormitories, clubs, 
lodges, association buildings, ``homes'' for aged persons and orphans, 
golf courses, recreational facilities, and similar properties.
     Loans to finance leases for fleets of vehicles used for 
commercial purposes.
    Commitment. Under the Original Proposal, the term ``commitment'' 
would have been defined as any legally binding arrangement that 
obligated the credit union to extend credit or to purchase assets.
    The Board received no comments on the definition of ``commitment'' 
and has decided to retain the definition in this proposal, but with a 
minor change. In this proposal, the term ``commitment'' would be 
defined as any legally binding arrangement that obligates the credit 
union to extend credit, to purchase or sell assets, or enter into a 
financial transaction. The italicized words would be added to expand 
the definition to provide additional clarity and to encompass a broader 
range of financial transactions than just extending credit or 
purchasing assets.
    Consumer loan. Under this proposed rule, the new term ``consumer 
loan'' would be defined as a loan to one or more individuals for 
household, family, or other personal expenditures, including any loans 
secured by vehicles generally manufactured for personal, family, or 
household use regardless of the purpose of the loan. The proposed 
definition would provide further that the term consumer loan excludes 
commercial loans, loans to CUSOs, first- and junior-lien residential 
real estate loans, and loans for the purchase of fleet vehicles.
    For example, under this proposed rule, consumer loans would include 
direct and indirect loans for the following purposes:
     Purchases of new and used passenger cars and other 
vehicles such as minivans, sport-utility vehicles, pickup trucks, and 
similar light trucks or heavy duty trucks generally manufactured for 
personal, family, or household use and not used as fleet vehicles or to 
carry fare-paying passengers;
     Purchases of household appliances, furniture, trailers, 
and boats;
     Repairs or improvements to the borrower's residence (that 
do not meet the definition of a loan secured by real estate);
     Education expenses, including student loans;
     Medical expenses;
     Personal taxes;
     Vacations;
     Consolidation of personal debts;
     Purchases of real estate or mobile homes to be used as the 
borrower's primary residence (that do not meet the definition of a loan 
secured by real estate); and
     Other personal expenses.
    The Board is proposing to add this new term and definition to part 
702 to distinguish loans made for a consumer purpose from real estate 
loans and commercial loans so each can be assigned to an appropriate 
risk weight category.
    Contractual compensating balance. Under this proposed rule, the new 
term ``contractual compensating balance'' would be defined as the funds 
a commercial loan borrower must maintain on deposit at the lender 
credit union as security for the loan in accordance with the loan 
agreement, subject to a proper account hold and on deposit as of the 
measurement date.
    The Board is proposing this new term because it recognizes that the 
portion of commercial loans covered by contractual compensating 
balances present a lower credit risk, and thus should be assigned a 
lower risk weight provided the credit union has a proper hold and 
maintains the compensating balance.
    Credit conversion factor (CCF). Under this proposed rule, the new 
term ``credit conversion factor'' would be defined as the percentage 
used to assign a credit exposure equivalent amount for selected off-
balance sheet accounts.
    This definition is being proposed to help clarify the process used 
to calculate the credit exposure equivalent for off-balance sheet 
items. Specific off-balance sheet items have a probability of becoming 
an actual credit exposure and shifting on to the balance sheet. The CCF 
is an estimate of this probability.
    Credit union. Under this proposed rule, the term ``credit union'' 
would be defined as a federally insured, natural-person credit union, 
whether federally or state-chartered. The proposal would amend the 
current definition of the term ``credit union'' to remove the words 
``as defined by 12 U.S.C. 1752(6)'' from the end of the definition 
because they are unnecessary, and could mistakenly be read to limit the 
definition of ``credit unions'' to state-chartered credit unions.
    Current. Under this proposed rule, the new term ``current'' would 
be defined to mean, with respect to any loan, that the loan is less 
than 90 days past due, not placed on non-accrual status, and not 
restructured.
    Commenters suggested that loans carried on non-accrual status 
should not be included with delinquent loans, and that the Original 
Proposal did not take into consideration the balances in the ALLL if 
the credit union is able, under GAAP, to reserve for individual losses. 
Other commenters suggested that the definition of ``delinquent loans'' 
should be amended to match the Other Banking Agencies' regulations, 
which count loans as delinquent only if they are 90 days or more past 
due.
    The Board is now proposing to count loans as non-current if they 
are 90 days past due (rather than 60 days past due), and, as explained 
in more detail below, to assign them to the higher risk weight category 
associated with past due loans. This change would better align this 
proposal with the definition of ``current loan'' under the Other 
Banking Agencies regulations.\115\ The change to 90 days past due would 
also be consistent with Sec.  741.3(b)(2), which specifies that a 
credit union's written lending policies must include ``loan workout 
arrangements and nonaccrual standards that include the discontinuance 
of interest accrual on loans past due by 90 days or more.''
---------------------------------------------------------------------------

    \115\ See, e.g., 12 CFR 324.32(k).
---------------------------------------------------------------------------

    In general, loans that are more than 90 days past due, or 
restructured, tend to

[[Page 4363]]

have higher incidences of default resulting in losses. The Board is 
aware that the historical and individual loan losses are reflected in 
the balance of the ALLL, and believes that removal of the 1.25 percent 
of assets limit on the ALLL addresses the concerns expressed by 
commenters that, under the Original Proposal, there was a potential for 
negative consequences for maintaining an adequate ALLL for delinquent 
loans.
    This definition would replace the term ``delinquent loans,'' which 
was used in the Original Proposal, when referring to whether a loan is 
past due, placed on non-accrual status, modified, or restructured. The 
Board believes using the term ``current'' when referring to loans will 
eliminate confusion caused by using the term ``delinquent loan'' in 
reference to regulatory reporting requirements or proper accounting 
treatment. Under this second proposed rule, loans are either current or 
non-current for purposes of determining their appropriate risk weight 
category.
    CUSO. Under the Original Proposal, the term ``CUSO'' would have 
been defined as a credit union service organization as defined in parts 
712 and 741.
    The Board received no comments on the proposed definition of 
``CUSO'' and has decided to retain the definition unchanged in this 
proposal.
    Custodian. Under this proposed rule, the new term ``custodian'' 
would be defined as a financial institution that has legal custody of 
collateral as part of a qualifying master netting agreement, clearing 
agreement or other financial agreement. The Board is proposing to add 
this new term to coincide with other changes it is proposing to make in 
the derivatives section of this proposal.
    Depository institution. Under this proposed rule, the new term 
``depository institution'' would be defined as 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. The definition provides further that the term 
depository institution includes 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, and all privately insured state-chartered credit unions.
    The term depository institution would primarily be used to address 
the risk weights assigned to deposits in depository institutions.
    Derivatives Clearing Organization (DCO). Under this proposed rule 
the term ``Derivatives Clearing Organization (DCO)'' would be defined 
as having the same definition as provided by the Commodity Futures 
Trading Commission in 17 CFR 1.3(d). The Board is proposing to add this 
new term to coincide with other changes it is proposing to make in the 
derivatives section of this proposal.
    Derivative contract. Under this proposed rule, the term 
``derivative contract'' would be defined as 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. The 
definition would provide further that the term derivative contract 
includes interest rate derivative contracts, exchange rate derivative 
contracts, equity derivative contracts, commodity derivative contracts, 
and credit derivative contracts. The definition would also provide that 
the term derivative contract also includes unsettled securities, 
commodities, and foreign exchange transactions with a contractual 
settlement or delivery lag that is longer than the lesser of the market 
standard for the particular instrument.
    The Board received no comments on the proposed definition of 
``derivatives contract.'' This proposal, however, includes a slightly 
modified definition of derivative contract to state derivative 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, and credit derivative 
contracts. Derivative contracts also include unsettled securities, 
commodities, and foreign exchange transactions with a contractual 
settlement or delivery lag that is longer than the lesser of the market 
standard for the particular instrument. The Board believes this 
modification will make this proposal more clear and accurate.
    Equity investment. Under this proposed rule, the new term ``equity 
investment'' would be defined as investments in equity securities, and 
any other ownership interests, including, for example, investments in 
partnerships and limited liability companies.
    This term would be primarily used to address the risk weights 
assigned to equity exposures. The Board recognizes that equity 
investments contain significant credit risk as they are generally in 
the first loss position and depend upon continued profitable operations 
of a business entity to retain value. The liquidity of equity 
investments can vary depending upon if the investment is publicly 
traded or closely held.
    Equity investment in CUSOs. The Original Proposal would have 
defined the term ``investment in CUSO'' as the unimpaired value of the 
credit union's aggregate CUSO investments as measured under generally 
accepted accounting principles on an unconsolidated basis.
    The Board received no comments on the definition of ``investments 
in CUSO.'' However, the Board has decided to change the term and the 
definition as follows. Under this proposed rule, the new term ``equity 
investment in CUSOs'' would be defined as the unimpaired value of the 
credit union's equity investments in a CUSO as recorded on the 
statement of financial condition in accordance with GAAP.
    The Board renamed this term and amended the definition in this 
proposal to emphasize the importance of recording equity investments in 
CUSOs in accordance with GAAP and clarify how the equity investment in 
a CUSO for the assignment of risk weights is determined. By following 
GAAP:
     For an unconsolidated CUSO, a credit union must assign the 
risk weight to the unimpaired value of the equity investment as 
presented on the statement of financial condition;
     For a consolidated CUSO, a credit union's equity 
investment is normally zero since the consolidation entries eliminate 
the intercompany transaction.
    Exchange. Under this proposed rule the new term ``exchange'' would 
be defined as a central financial clearing market where end users can 
trade derivatives. The Board is proposing to add this new term to 
coincide with other changes it is proposing to make in the derivatives 
section of this proposal.
    Excluded goodwill, and excluded other intangible assets. Under this 
proposed rule, the new term ``excluded goodwill'' would be defined as 
the outstanding balance, maintained in accordance with GAAP, of any 
goodwill originating from a supervisory merger or combination that was 
completed no more than 29 days after publication of this rule in final 
form in the Federal

[[Page 4364]]

Register. The definition would provide further that the term excluded 
goodwill and its accompanying definition will expire on January 1, 
2025.
    This proposed rule would also define the new term ``excluded other 
intangible assets'' as the outstanding balance, maintained in 
accordance with GAAP, of any other intangible assets such as core 
deposit intangibles, member relationship intangibles, or trade name 
intangible originating from a supervisory merger or combination that 
was completed no more than 29 days after publication of this rule in 
final form in the Federal Register. The definition would provide 
further that the term excluded other intangible assets and its 
accompanying definition will expire on January 1, 2025.
    The Board added these two definitions as part of a response to 
certain comments on the Original Proposal and seeks to take into 
account the impact goodwill or other intangible assets recorded from 
transactions defined as supervisory mergers or combinations has on the 
calculation of the risk-based capital ratio upon implementation. This 
proposed exclusion would apply to supervisory mergers or combinations 
that are completed prior to a date that is 30 days from the date of 
publication of this rule in final form in the Federal Register. The 
Board intends to allow this additional time (until approximately 2024) 
for supervisory mergers or combinations related goodwill and other 
intangible assets to be absorbed under the proposed risk-based capital 
ratio. Under this proposal, the amount of goodwill deducted from the 
risk-based capital ratio numerator would be reduced by the balance of 
excluded goodwill or excluded other intangible assets recorded in 
accordance with GAAP as of the measurement date. However, credit unions 
would still need to conform to GAAP in the measurement and disclosure 
of goodwill and other intangible assets. This proposed exclusion would 
end on January 1, 2025 so the last quarter-end date with this exclusion 
will be December 31, 2024. This means that any remaining goodwill or 
other intangible assets would be required to be deducted from the risk-
based capital ratio numerator after January 1, 2025.
    Exposure amount. Under this proposed rule, the new term ``exposure 
amount'' would be defined as:
     The amortized cost for investments classified as held-to-
maturity and available-for-sale, and the fair value for trading 
securities.
     The outstanding balance for Federal Reserve Bank Stock, 
Central Liquidity Facility Stock, Federal Home Loan Bank Stock, 
nonperpetual capital and perpetual contributed capital at corporate 
credit unions, and equity investments in CUSOs.
     The carrying value for non-CUSO equity investments, and 
investment funds.
     The carrying value for the credit union's holdings of 
general account permanent insurance, and separate account insurance.
     The amount calculated under Sec.  702.105 of this part for 
derivative contracts.
    This definition would be used to ensure the specific assets are 
assigned consistent risk weights based on the treatment of the specific 
assets.
    Fair value. Under this proposed rule, the new term ``fair value'' 
would be defined as having the same meaning as provided in GAAP. This 
definition is important because the proper accounting for some specific 
assets subject to risk weights are recorded on the statement of 
financial condition at fair value.
    Financial collateral. Under this proposed rule, the new term 
``financial collateral'' would be defined as collateral approved by 
both the credit union and the counterparty as part of the collateral 
agreement in recognition of credit risk mitigation for derivative 
contracts. The Board is proposing to add this new term to coincide with 
other changes it is proposing to make in the derivatives section of 
this proposal.
    First-lien residential real estate loan. Under this proposed rule, 
the new term ``first-lien residential real estate loan'' would be 
defined as a loan or line of credit primarily secured by a first-lien 
on a one-to-four family residential property where: (1) The credit 
union made a reasonable and good faith determination at or before 
consummation of the loan that the member will have a reasonable ability 
to repay the loan according to its terms; and (2) in transactions where 
the credit union holds the first-lien and junior-lien(s), and no other 
party holds an intervening lien, for purposes of this part the combined 
balance will be treated as a single first-lien residential real estate 
loan.
    Under the Original Proposal, the term ``first mortgage real estate 
loan'' would have been defined as loans and lines of credit fully 
secured by first-liens on real estate (excluding MBLs), where the 
original amortization of the mortgage exposure does not exceed 30 
years; the loan underwriting took into account all the borrower's 
obligations, including mortgage obligations, principal, interest, 
taxes, insurance (including mortgage guarantee insurance) and 
assessments; and the loan underwriting concluded the borrower is able 
to repay the exposure using the maximum interest rate that may apply in 
the first five years, the maximum contract exposure over the life of 
the mortgage, and verified income.
    A number of commenters stated that they believed the proposed 
definition of first mortgage real estate loan would conflict with rules 
promulgated by the Consumer Financial Protection Bureau (CFPB), which 
may prevent credit unions from originating mortgage loans that qualify 
as ``qualified mortgages'' under CFPB's regulations, or are otherwise 
permitted under those rules, without incurring an additional capital 
charge. One commenter suggested that the proposed definition of first 
mortgage real estate loan should be amended to read as follows: ``A 
loan on realty with the benefit of a senior security interest to all 
others.'' Other commenters stated that the definition of first mortgage 
real estate loan is overbroad and should be revised to exclude home 
equity lines of credit because the risks associated with 30-year fixed-
rate first-lien mortgages and HELOCs are vastly different and should 
not be assigned the same risk weight.
    In response to the comments received on the Original Proposal, the 
Board is now proposing to eliminate the term ``first mortgage real 
estate loan'' and the accompanying definition and instead use the new 
term ``first-lien residential real estate loan'' for purposes of this 
proposal.
    The Board believes that the credit risk for all first-lien 
residential real estate loans, in which the credit union has conducted 
a reasonable analysis of the ability of the borrower to repay, are 
sufficiently similar to justify a lower risk weight than most other 
types of loans. Accordingly, the Board is proposing to remove from the 
definition of first-lien residential real estate loans the requirement 
that such loans not have an amortization period exceeding 30 years.
    The Board also believes, however, that first-lien residential real 
estate loans with amortizations longer than 30 years contain additional 
risks and must be underwritten with great care and monitored closely. 
Accordingly, the low risk weight assigned to first-lien residential 
real estate loans should not be viewed as encouraging certain real 
estate loan features which can be harmful to the credit quality of the 
loan, including an interest-only period, negative amortization, balloon 
payments, or excess upfront points and fees.

[[Page 4365]]

    Credit unions must continue to make a good-faith effort to 
determine before the loan is made whether a borrower is likely to be 
able to repay the loan. In practice this means credit unions must 
generally ascertain, consider, and document a borrower's income, 
assets, employment status and stability, credit history and current and 
proposed monthly expenses.\116\ NCUA does not intend for this 
definition to conflict with rules promulgated by CFPB. Rather, the 
Board believes the requirement that the credit union make a reasonable 
and good-faith effort that the member has the ability to repay the 
loans is consistent with CFPB regulations and ensures the grouping of 
loans receiving this relatively low risk weight would be substantially 
similar in credit quality.
---------------------------------------------------------------------------

    \116\ See NCUA Regulatory Alert, 14-RA-01, Ability-to-Repay and 
Qualified Mortgage Requirements from the Consumer Financial 
Protection Bureau (CFPB), January 2014 for additional information.
---------------------------------------------------------------------------

    The definition of first-lien residential real estate loan would 
include first-lien residential real estate loans that are not owner 
occupied. First-lien residential real estate loans that are over 
$50,000 and not the primary residence of the borrower would continue to 
count toward the credit union's total of member business loans for the 
purpose of monitoring and compliance with the statutory limitation on 
MBLs. However, they would be included in the definition of first-lien 
residential real estate loans for the purpose of this part and would be 
risk-weighted accordingly.
    If a credit union holds both the first-and junior-liens on a 
residential real estate loan without an intervening lien holder and the 
loan otherwise meets this definition, the entire combined balance of 
the loans would be assigned the risk weight for first-lien residential 
real estate loans.
    GAAP. Under the Original Proposal, the term ``GAAP'' would have 
been defined as generally accepted accounting principles as used in the 
United States.
    The Board received no comments on the definition of ``GAAP'' and 
has decided to retain the term in this proposal with the following 
changes. Under this proposed rule, the term ``GAAP'' would be defined 
as generally accepted accounting principles in the United States as set 
forth in the Financial Accounting Standards Board's (FASB) Accounting 
Standards Codification (ASC).
    The Board is proposing to define ``GAAP'' narrowly to retain its 
conventional meaning. However, credit unions should also follow joint 
accounting issuances by the chief accountants' of the federal financial 
institution regulatory agencies (including NCUA) that provide 
implementation guidance consistent with GAAP practice. The guidance 
issued jointly by the federal financial institution regulatory 
agencies' chief accountants' does not add to or modify existing 
financial reporting requirements under GAAP but often narrows GAAP 
practice to address supervisory considerations related to financial 
institutions. The federal financial institution regulatory agencies' 
chief accountants have a practice of clearing such guidance 
implementing GAAP through the FASB and the SEC's Office of the Chief 
Accountant.
    General account permanent insurance. Under this proposed rule, the 
new term ``general account permanent insurance'' would be defined as an 
account into which all premiums, except those designated for separate 
accounts are deposited, including premiums for life insurance and fixed 
annuities and the fixed portfolio of variable annuities, whereby the 
general assets of the insurance company support the policy.
    Under this proposal, general account permanent insurance would 
include direct obligations to the insurance provider. This would mean 
that the credit risk associated with general account permanent 
insurance is to the insurance company, which generally makes these 
insurance accounts have a lower credit risk than separate account 
insurance, which is a segregated accounting and reporting account held 
separately from the insurer's general assets.
    General obligation. Under this proposed rule, the new term 
``general obligation'' would be defined as a bond or similar obligation 
that is backed by the full faith and credit of a public sector entity.
    The Board is proposing to add this definition to clarify that 
general obligation bonds or debt are generally backed by the credit and 
``taxing power'' of the issuing jurisdiction rather than the revenue 
from a given project.
    Goodwill. Under the Original Proposal, the term ``goodwill'' would 
have been defined as an intangible asset representing the future 
economic benefits arising from other assets acquired in a business 
combination (i.e., merger) that are not individually identified and 
separately recognized.
    The Board received no comments on the definition of ``goodwill'' 
and has decided to retain the definition in this proposed rule, with 
the addition that goodwill must be maintained in accordance with GAAP 
and does not include a new term ``excluded goodwill.'' Accordingly, 
under this proposal, the term ``goodwill'' would be defined as an 
intangible asset, maintained in accordance with GAAP, representing the 
future economic benefits arising from other assets acquired in a 
business combination (e.g., merger) that are not individually 
identified and separately recognized. Goodwill does not include 
excluded goodwill. These proposed changes are intended to clarify the 
definition and make it consistent with other changes being made in this 
proposal.
    Government guarantee. Under this proposed rule, the new term 
``government guarantee'' would be defined as a guarantee provided by 
the U.S. Government, FDIC, NCUA or other U.S. Government agencies, or a 
public sector entity.
    The Board recognizes that government guarantees provide enhanced 
credit protection, particularly to loans, and revised the risk weights 
for the portion of loans with a government guarantee to a lower risk 
weight.
    Government-sponsored enterprise (GSE). Under this proposed rule, 
the new term ``government-sponsored enterprise'' would be defined as an 
entity established or chartered by the U.S. Government to serve public 
purposes specified by the U.S. Congress, but whose debt obligations are 
not explicitly guaranteed by the full faith and credit of the U.S. 
Government.
    Guarantee. Under this proposed rule, the new term ``guarantee'' 
would be defined as a financial guarantee, letter of credit, insurance, 
or similar financial instrument that allows one party to transfer the 
credit risk of one or more specific exposures to another party. The 
Board is proposing to add this definition to provide clarity.
    Identified losses. Under the Original Proposal, the term 
``identified losses'' would have been defined as those items that have 
been determined by an evaluation made by a state or federal examiner, 
as measured on the date of examination, to be chargeable against 
income, capital and/or valuation allowances such as the allowance for 
loan and lease losses. That proposed definition also would have 
provided the following examples of identified losses: Assets classified 
as losses, off-balance sheet items classified as losses, any provision 
expenses that are necessary to replenish valuation allowances to an 
adequate level, liabilities not shown on the books, estimated losses in 
contingent liabilities, and differences in accounts that represent 
shortages.

[[Page 4366]]

    The Board received no comments on the proposed definition of 
``identified losses.'' Nevertheless, the Board is now proposing to 
amend the definition of ``identified losses'' from the Original 
Proposal to ensure that identified losses would be measured in 
accordance with GAAP. Accordingly, under this proposal, the term 
``identified losses'' would be defined as those items that have been 
determined by an evaluation made by NCUA, or in the case of a state-
chartered credit union, the appropriate state official, as measured on 
the date of examination in accordance with GAAP, to be chargeable 
against income, equity or valuation allowances such as the allowances 
for loan and lease losses. The definition would provide further that 
examples of identified losses would be assets classified as losses, 
off-balance sheet items classified as losses, any provision expenses 
that are necessary to replenish valuation allowances to an adequate 
level, liabilities not shown on the books, estimated losses in 
contingent liabilities, and differences in accounts that represent 
shortages.
    Industrial development bond. Under this proposed rule, the new term 
``industrial development bond'' would be defined as a security issued 
under the auspices of a state or other political subdivision for the 
benefit of a private party or enterprise where that party or 
enterprise, rather than the government entity, is obligated to pay the 
principal and interest on the obligation.
    This definition would be added to ensure the ultimate obligor's 
risk weight is used for risk-based capital calculations.
    Intangible assets. Under the Original Proposal, the term 
``intangible assets'' would have been defined as those assets that are 
required to be reported as intangible assets on a credit union's Call 
Report, including but not limited to purchased credit card 
relationships, goodwill, favorable leaseholds, and core deposit value.
    The Board received no comments on the definition of ``Intangible 
assets'', but is proposing to revise the definition for clarity. 
Accordingly, under this proposal, the term ``intangible assets'' would 
be defined as assets, maintained in accordance with GAAP, other than 
financial assets, that lack physical substance. This proposed change 
would not affect the substance of the definition, but will make the 
definition clearer. Additionally, the Board is proposing to add a 
definition for ``other intangibles'', which are a subset of 
``intangible assets,'' and discussed in more detail below.
    Investment fund. Under this proposed rule, the new term 
``investment fund'' would be defined as an investment with a pool of 
underlying investment assets. The proposed definition would provide 
further that the term investment fund includes an investment company 
that is registered under Sec.  8 of the Investment Company Act of 1940, 
as amended, and collective investment funds or common trust investments 
that are unregistered investment products that pool fiduciary client 
assets to invest in a diversified pool of investments.
    The Board is proposing to define the term ``investment fund'' 
broadly to capture more than SEC-registered investment companies and 
funds offered by banks. This broader definition is intended to allow 
for the use of the look-through approaches used in the Other Banking 
Agencies' capital regulations,\117\ which are discussed in more detail 
below, to separate account insurance or other pooled investments.
---------------------------------------------------------------------------

    \117\ See, e.g., 12 CFR 324.53.
---------------------------------------------------------------------------

    Junior-lien residential real estate loan. Under this proposed rule, 
the new term ``junior-lien residential real estate loan'' would be 
defined as a loan or line of credit secured by a subordinate lien on a 
one-to-four family residential property.
    Due to the observed higher delinquency and losses of junior lien 
residential real estate loans, and consistent with the risk weights 
assigned by the Other Banking Agencies,\118\ the Board proposes 
assigning higher risk weights for junior-lien residential real estate 
loans than for first-lien residential real estate loans. This 
definition would generally include all residential real estate loans 
that do not meet the definition of a first-lien residential real estate 
loans since the credit union is secured by a second or subsequent lien 
on the residential property loan.
---------------------------------------------------------------------------

    \118\ See, e.g., 12 CFR 324.32(g)(2).
---------------------------------------------------------------------------

    Loan to a CUSO. Under the Original Proposal, the term ``loans to 
CUSO'' would have been defined as the aggregate outstanding loan 
balance, available line(s) of credit from the credit union, and 
guarantees the credit union has made to or on behalf of a CUSO.
    The Board received no comments on the definition of ``Loans to 
CUSOs'' and has decided to retain the term in this proposal with the 
following changes to the term and the definition. Under this proposed 
rule the term ``loan to a CUSO'' would be defined as the outstanding 
balance of any loan from a credit union to a CUSO as recorded on the 
statement of financial condition in accordance with GAAP.
    The Board originally proposed to add this definition to capture the 
importance of recording loans to a CUSO in accordance with GAAP and to 
clarify how the assignment of risk weights would be determined. By 
following GAAP:
     For an unconsolidated CUSO, a credit union must assign the 
risk weight to the outstanding balance of the loans to the CUSO as 
presented on the statement of financial condition;
     For a consolidated CUSO, the loan to a CUSO is normally 
zero since the consolidation entries eliminate the intercompany 
transaction.
    Loan secured by real estate. Under this proposed rule, the new term 
``loan secured by real estate'' would be defined as a loan that, at 
origination, is secured wholly or substantially by a lien(s) on real 
property for which the lien(s) is central to the extension of the 
credit. The definition would provide further that a lien is ``central'' 
to the extension of credit if the borrowers would not have been 
extended credit in the same amount or on terms as favorable without the 
lien(s) on real property. The definition would also provide that, for a 
loan to be ``secured wholly or substantially by a lien(s) on real 
property,'' the estimated value of the real estate collateral at 
origination (after deducting any more senior liens held by others) must 
be greater than 50 percent of the principal amount of the loan at 
origination.
    The Board proposes using this term to ensure consistency in the 
assignment of risk weights for real estate loans. The definition would 
clarify that the terms of the loan are predicated on the existence of 
the lien on real property and that the real estate value at origination 
of the loans must be at least 50 percent of the principal amount of the 
loan to meet the definition. The Board does not intend for this to mean 
that a real estate loan with a 50 percent loan-to-value ratio is an 
appropriate credit risk but rather such a loan only meets the 
definition of secured by real estate.
    Loans transferred with limited recourse. Under the Original 
Proposal, the term ``loans transferred with limited recourse'' would 
have been defined as the total principal balance outstanding of loans 
transferred, including participations, for which the transfer qualified 
for true sale accounting treatment under GAAP, and for which the 
transferor credit union retained some limited recourse (i.e., 
insufficient recourse to preclude true sale accounting treatment). The 
proposed definition would also have clarified that the term does not 
include transfers that qualify for true sale accounting treatment but 
contain only routine

[[Page 4367]]

representation and warranty paragraphs that are standard for sale on 
the secondary market, provided the credit union is in compliance with 
all other related requirements such as capital requirements.
    Commenters suggested that the proposed definition be amended to 
represent the true risk associated with that product. Commenters stated 
that the proposed definition mirrors the Call Report field and includes 
the ``total principal balance outstanding of loans transferred . . . 
for which the transferor credit union retained some limited recourse.'' 
Although commenters stated they appreciated NCUA's efforts to align 
defined terms with existing Call Report fields, they countered that 
contingent liabilities should be taken into account only to the extent 
the credit union retains contractual and legal liability on the 
exposure. On partial recourse loans, commenters suggested that the 
credit union only retains a small fraction of the liability and is not 
exposed on the total principal balance. However, commenters stated 
that, under the Original Proposal, a credit union would be treated as 
holding the full balance as a contingent liability. Commenters 
suggested that this was a significant misrepresentation of the risk and 
created a disincentive for credit unions to utilize limited recourse 
loan sale relationships, which provide credit unions with a valuable 
option in managing liquidity risk and IRR, while still incentivizing 
the credit union to make high-quality loans. Commenters stated that the 
proposal would penalize credit unions that have utilized these programs 
prudently and effectively as part of a safe and sound asset management 
program. To remedy this problem, commenters suggested the definition of 
the term ``loans transferred with limited recourse'' and the 
corresponding Call Report field should be amended to reflect the true 
recourse exposure of the credit union.
    In response to these comments, the Board is now proposing to amend 
the calculation for determining the risk-based capital requirement for 
loans transferred with limited recourse to more accurately align the 
capital requirement with the true recourse exposure. Whereas the 
Original Proposal would have required the credit union to multiply the 
face amount, or notional value, of the loans transferred with limited 
recourse by the appropriate credit conversion factor and then apply the 
appropriate risk weight, this proposed rule would amend the calculation 
to require a credit union to multiply the off-balance sheet exposure by 
the appropriate credit conversion factor and then apply the appropriate 
risk weight. A new definition for off-balance sheet exposure is 
included in this proposal and is discussed in more detail below. In 
addition, the definition of ``loans transferred with limited recourse'' 
is revised by amending all references to ``warranty paragraphs'' to 
read ``warranty clauses'' to clarify that it is the content of the 
document and not its length that is important.
    Accordingly, under this proposed rule, the term ``Loans transferred 
with limited recourse'' would be defined as the total principal balance 
outstanding of loans transferred, including participations, for which 
the transfer qualified for true sale accounting treatment under GAAP, 
and for which the transferor credit union retained some limited 
recourse (i.e., insufficient recourse to preclude true sale accounting 
treatment). The definition would provide further that the term loans 
transferred with limited recourse excludes transfers that qualify for 
true sale accounting treatment but contain only routine representation 
and warranty clauses that are standard for sales on the secondary 
market, provided the credit union is in compliance with all other 
related requirements, such as capital requirements.
    Mortgage-backed security (MBS). Under this proposed rule, the new 
term ``mortgage-backed security'' would be defined as a security backed 
by first- or junior-lien mortgages secured by real estate upon which is 
located a dwelling, mixed residential and commercial structure, 
residential manufactured home, or commercial structure. This definition 
would be similar to the definition of MBS in part 704 of NCUA's 
regulations. The only difference is that the phrase ``first- or junior-
lien mortgages'' in the proposed part 702 definition replaces the 
phrase ``first or second mortgage'' in the definition in part 704. This 
makes the proposed part 702 definition more consistent with the 
terminology used throughout the proposal.
    Mortgage partnership finance program. Under this proposed rule, the 
new term ``mortgage partnership finance program'' would be defined as 
any Federal Home Loan Bank program through which loans are originated 
by a depository institution that are purchased or funded by the Federal 
Home Loan Banks, where the depository institutions receive fees for 
managing the credit risk of the loans and servicing them. The 
definition would provide further that the credit risk must be shared 
between the depository institutions and the Federal Home Loan Banks.
    Adding this definition is necessary because this proposal would 
apply a separate risk weight to the off-balance sheet exposure 
resulting from loans transferred under the defined program. 
Additionally, the method that would be used to calculate the risk-based 
capital requirement for loans in the defined program would be different 
from other loans transferred with limited recourse. A separate 
definition and risk weight for loans sold under this program would 
result in a risk-based capital requirement consistent with the credit 
loss history of this program.
    Mortgage servicing assets. Under the Original Proposal, the term 
``mortgage servicing asset'' would have been defined as those assets 
(net of any related valuation allowances) resulting from contracts to 
service loans secured by real estate (that have been securitized or 
owned by others) for which the benefits of servicing are expected to 
more than adequately compensate the servicer for performing the 
servicing.
    The Board received no comments on the definition of ``mortgage 
servicing asset'' and has decided to retain the proposed definition in 
this proposal with the following changes for clarity. Credit unions are 
expected to follow GAAP when reporting assets, which is intended to 
clarify that credit unions must report mortgage servicing assets net of 
any related valuation allowance because it is required by GAAP. 
Accordingly, under this proposed rule, the term ``mortgage servicing 
assets'' would be defined as those assets, maintained in accordance 
with GAAP, resulting from contracts to service loans secured by real 
estate (that have been securitized or owned by others) for which the 
benefits of servicing are expected to more than adequately compensate 
the servicer for performing the servicing.
    NCUSIF. Under the Original Proposal, the term ``NCUSIF'' means the 
National Credit Union Share Insurance Fund as defined by 12 U.S.C. 
1783. The Board received no comments on the definition of ``NCUSIF'' 
and has decided to retain the term in this proposal without 
modification.
    Net worth. Generally consistent with the current rule, under this 
proposed rule the term ``net worth'' would be defined as:
     The retained earnings balance of the credit union at 
quarter-end as determined under GAAP, subject to bullet 3 of this 
definition.
     For a low-income-designated credit union, net worth also 
includes secondary capital accounts that are uninsured and subordinate 
to all other

[[Page 4368]]

claims, including claims of creditors, shareholders, and the NCUSIF.
     For a credit union that acquires another credit union in a 
mutual combination, net worth also includes the retained earnings of 
the acquired credit union, or of an integrated set of activities and 
assets, less any bargain purchase gain recognized in either case to the 
extent the difference between the two is greater than zero. The 
acquired retained earnings must be determined at the point of 
acquisition under GAAP. A mutual combination, including a supervisory 
combination, is a transaction in which a 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.
     The term ``net worth'' also includes loans to and accounts 
in an insured credit union, established pursuant to Sec.  208 of the 
FCUA, provided such loans and accounts:
    [cir] Have a remaining maturity of more than five years;
    [cir] Are subordinate to all other claims including those of 
shareholders, creditors, and the NCUSIF;
    [cir] Are not pledged as security on a loan to, or other obligation 
of, any party;
    [cir] Are not insured by the NCUSIF;
    [cir] Have non-cumulative dividends;
    [cir] Are transferable; and
    [cir] Are available to cover operating losses realized by the 
insured credit union that exceed its available retained earnings.''
    The Original Proposal did not revise the definition of the term 
``net worth,'' and NCUA did not receive any comments on the definition. 
This proposal, however, would delete from the current definition of net 
worth the sentence ``Retained earnings consists of undivided earnings, 
regular reserve, and any other appropriations designed by management or 
regulatory authorities,'' which is included in paragraph (f)(1) of the 
current definition. That sentence lists items that are included in 
retained earnings and is not necessary. No substantive change is 
intended by this amendment.
    Paragraph (f)(3) of the current definition would also be revised to 
clarify that the term ``mutual combination'' includes a ``supervisory 
combination'' because this proposal introduces the new term supervisory 
merger to part 702, which is a specific type of mutual combination.
    Net worth ratio. Under the Original Proposal, the term ``net worth 
ratio'' means the ratio of the net worth of the credit union to the 
total assets of the credit union truncated to two decimal places. The 
Board received no comments on the definition of ``net worth ratio'' and 
has decided to retain the term in this proposal without modification.
    New credit union. To provide clarity and reduce the number of 
redundant rule sections, under this proposed rule, the term ``new 
credit union'' would be defined as having the same meaning as in Sec.  
702.201. No substantive changes to the current definition of ``new 
credit union'' are intended.
    Nonperpetual capital. Under this proposed rule, the new term 
``nonperpetual capital'' would be defined as having the same meaning as 
in 12 CFR 704.2 for consistency.
    Off-balance sheet items. Under the Original Proposal, the term 
``off-balance sheet items'' would have been defined as items such as 
commitments, contingent items, guarantees, certain repo-style 
transactions, financial standby letters of credit, and forward 
agreements that are not included on the balance sheet but are normally 
included in the financial statement footnotes.
    The Board received no comments on the definition of ``off-balance 
sheet items,'' but is proposing to change the words ``balance sheet' in 
the definition to ``statement of financial condition.'' Accordingly, 
under this proposed rule, the term ``off-balance sheet items'' would be 
defined as items such as commitments, contingent items, guarantees, 
certain repo-style transactions, financial standby letters of credit, 
and forward agreements that are not included on the statement of 
financial condition, but are normally reported in the financial 
statement footnotes.
    The Board is proposing to make this change in a number of places 
throughout the rule to make the rule more accurate and to clarify the 
definition for the reader.
    Off-balance sheet exposure. Under this proposed rule, the new term 
``off-balance sheet exposure'' would be defined as follows, depending 
on the type of exposure: (1) For loans sold under the Federal Home Loan 
Bank mortgage partnership finance (MPF) program, the outstanding loan 
balance as of the reporting date, net of any related valuation 
allowance; (2) for all other loans transferred with limited recourse or 
other seller-provided credit enhancements and that qualify for true 
sales accounting, the maximum contractual amount the credit union is 
exposed to according to the agreement, net of any related valuation 
allowance; (3) for unfunded commitments, the remaining unfunded portion 
of the contractual agreement.
    The Board added the definition of off-balance sheet exposure to 
clarify the amount of the off-balance sheet item that will be used to 
calculate a credit union's risk-based capital ratio.
    On-balance sheet. Under this proposal, the term ``on-balance 
sheet'' would be defined as a credit union's assets, liabilities, and 
equity, as disclosed on the statement of financial condition at a 
specific point in time.
    Other intangible assets. Under this proposed rule, the new term 
``other intangible assets'' would be defined as intangible assets, 
other than servicing assets and goodwill, maintained in accordance with 
GAAP. The definition would provide further that other intangible assets 
does not include excluded other intangible assets.
    Under the Original Proposal, the term ``intangible assets'' would 
have been defined as those assets that are required to be reported as 
intangible assets on a credit union's Call Report, including but not 
limited to purchased credit card relationships, goodwill, favorable 
leaseholds, and core deposit value.
    The Board received no comments on the proposed definition of 
``intangible assets,'' but has taken the opportunity in this proposed 
rule to clarify the definition. The term intangible asset is typically 
defined by GAAP and includes goodwill. However, in the context of 
deductions from the numerator of the risk-based capital ratio, goodwill 
is already a deduction. Further, servicing assets are also typically 
considered an intangible asset. However, because servicing assets can 
typically be readily sold in the marketplace, the Board believes that 
intangible assets excluded from the risk-based capital ratio numerator 
should not include servicing assets. To simplify this issue, the Board 
has defined the term ``other intangible assets'' to be those assets 
defined under GAAP as intangible assets, except goodwill and servicing 
assets. The Board notes that this is not a substantive change between 
the two proposals, but merely a clarification to make the rule easier 
to read and understand.
    Over-the-counter (OTC) interest rate derivative contract. Under 
this proposed rule, the new term ``over-the-counter (OTC) interest rate 
derivative contract'' would be defined as a derivative contract that is 
not cleared on an exchange. The Board is proposing to add this new term 
to coincide with other changes it is proposing to make in the 
derivatives section of this proposal.
    Perpetual contributed capital. Under this proposed rule, the new 
term ``perpetual contributed capital'' would be defined as having the 
same meaning as in Sec.  704.2 of this chapter.

[[Page 4369]]

    Public sector entity (PSE). Under this proposed rule, the new term 
``public sector entity'' would be defined as a state, local authority, 
or other governmental subdivision of the United States below the 
sovereign level.
    Qualifying master netting agreement. Under this proposed rule, the 
term ``qualifying master netting agreement'' would be defined as a 
written, legally enforceable agreement, provided that:
     The agreement creates a single legal obligation for all 
individual transactions covered by the agreement upon an event of 
default, including upon an event of conservatorship, receivership, 
insolvency, liquidation, or similar proceeding, of the counterparty;
     The agreement provides the credit union the right to 
accelerate, terminate, and close out on a net basis all transactions 
under the agreement and to liquidate or set off collateral promptly 
upon an event of default, including upon an event of conservatorship, 
receivership, insolvency, liquidation, or similar proceeding, of the 
counterparty, provided that, in any such case, any exercise of rights 
under the agreement will not be stayed or avoided under applicable law 
in the relevant jurisdictions, other than in receivership, 
conservatorship, resolution under the Federal Deposit Insurance Act, 
Title II of the Dodd-Frank Wall Street Reform and Consumer Protection 
Act, or under any similar insolvency law applicable to GSEs;
     The agreement does not contain a walkaway clause (that is, 
a provision that permits a non-defaulting counterparty to make a lower 
payment than it otherwise would make under the agreement, or no payment 
at all, to a defaulter or the estate of a defaulter, even if the 
defaulter or the estate is a net creditor under the agreement); and
     In order to recognize an agreement as a qualifying master 
netting agreement for purposes of this part, a credit union must 
conduct sufficient legal review, at origination and in response to any 
changes in applicable law, to conclude with a well-founded basis (and 
maintain sufficient written documentation of that legal review) that:
    [cir] The agreement meets the requirements of paragraph (2) of this 
definition; and
    [cir] In the event of a legal challenge (including one resulting 
from default or from conservatorship, receivership, insolvency, 
liquidation, or similar proceeding), the relevant court and 
administrative authorities would find the agreement to be legal, valid, 
binding, and enforceable under the law of relevant jurisdictions.
    The Board has retained this definition from the Original Proposal 
with only minor clarifying amendments.
    Recourse. Under this proposed rule, the new term ``recourse'' would 
be defined as a credit union's retention, in form or in substance, of 
any credit risk directly or indirectly associated with an asset it has 
transferred that exceeds a pro-rata share of that credit union's claim 
on the asset and disclosed in accordance with GAAP. The definition 
would provide further that if a credit union has no claim on an asset 
it has transferred, then the retention of any credit risk is recourse. 
The definition would also provide that a recourse obligation typically 
arises when a 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. 
Finally, the definition would provide that recourse may also exist 
implicitly if the credit union provides credit enhancement beyond any 
contractual obligation to support assets it has transferred.
    Residential mortgage-backed security. Under this proposed rule, the 
new term ``residential mortgage-backed security'' would be defined as a 
mortgage-backed security backed by loans secured by a first-lien on 
residential property.
    The Board proposes to define ``residential mortgage-backed 
security'' similarly to the conventional usage of that term. This 
definition was added to allow for non-subordinated mortgage-backed 
securities backed by first-lien real estate loans to receive the same 
risk weight as first-lien residential real estate loans.
    Residential property. Under this proposed rule, the new term 
``residential property'' would be defined as a house, condominium unit, 
cooperative unit, manufactured home, or the construction thereof, and 
unimproved land zoned for one-to-four family residential use. The 
definition would provide further that the term residential property 
excludes boats and motor homes, even if used as a primary residence, 
and timeshare property.
    The purpose of this new term is to broadly define the types of 
property that will be considered residential property. The definition 
is intended to allow for the inclusion of single family residential 
construction loans. The definition is intended to exclude larger scale 
speculative residential land transactions, which would be considered 
commercial loans for assigning risk weights.
    Restructured. Under this proposed rule, the new term 
``restructured'' would be defined, with respect to any loan, as a 
restructuring of the loan in which a credit union, for economic or 
legal reasons related to a borrower's financial difficulties, grants a 
concession to the borrower that it would not otherwise consider. 
According to the definition of ``current'' loan in this proposal, as 
restructured loan would not be considered a ``current'' loan. The 
definition would provide further that the term restructured excludes 
loans modified or restructured solely pursuant to the U.S. Treasury's 
Home Affordable Mortgage Program.
    The restructuring of a loan may include, but is not necessarily 
limited to: (1) The transfer from the borrower to the lending credit 
union of real estate, receivables from third parties, other assets, or 
an equity interest in the borrower, in full or partial satisfaction of 
a loan; (2) a modification of the loan terms, such as a reduction of 
the stated interest rate, principal, or accrued interest or an 
extension of the maturity date at a stated interest rate lower than the 
current market rate for new debt with similar risk; or (3) a 
combination of the above.\119\ A loan extended or renewed at a stated 
interest rate equal to the current market interest rate for new debt 
with similar risk is not a restructured loan.
---------------------------------------------------------------------------

    \119\ FASB ASC 310-40, ``Troubled Debt Restructuring by 
Creditors.''
---------------------------------------------------------------------------

    The Board proposes to add the definition of ``restructured'' 
because a loan that is restructured contains elements, as addressed 
above, which increase the credit risk of the loan and therefore is 
assigned a higher risk weight associated with non-current loans. This 
definition also enables the definition of current loan to better align 
with the Other Banking Agencies \120\ while addressing the same 
exception for loans modified or restructured pursuant to the U.S. 
Treasury's Home Affordable Mortgage Program.
---------------------------------------------------------------------------

    \120\ See 12 U.S.C. 324.32(g).
---------------------------------------------------------------------------

    Revenue obligation. Under this proposed rule, the new term 
``revenue obligation'' would be defined as a bond or similar obligation 
that is an obligation of a PSE, but which the PSE is committed to repay 
with revenues from the specific project financed rather than general 
tax funds.
    Revenue obligation bonds or debt are generally paid with revenues 
from the specific project financed rather than the general credit and 
taxing power of the issuing jurisdiction.
    Risk-based capital ratio. Under the Original Proposal, the term 
``risk-based

[[Page 4370]]

capital ratio'' would have been defined as the percentage, rounded to 
two decimal places, of the risk-based capital ratio numerator to total 
risk weighted assets, as calculated in accordance with Sec.  
702.104(a).
    A number of commenters raised concerns with the proposed changes 
that would have been made to the terminology in the current rule, 
including adding the new term ``risk-based capital ratio'' to the rule. 
Several commenters suggested that the Board would be redefining a 
statutorily defined term by using the proposed term ``risk-based 
capital ratio'' in the rule instead of the statutory term ``risk-based 
net worth ratio'' in the proposed rule.
    The Board disagrees with this comment for reasons that are 
discussed in more detail in the portion of the preamble relating to 
Sec.  702.102 below. Other than the comment above, the Board received 
no comments on the substance of the definition of ``risk-based capital 
ratio'' and has decided to retain the definition in this proposal with 
only non-substantive changes. Accordingly, under this proposed rule the 
term ``risk-based capital ratio'' would be defined as the percentage, 
rounded to two decimal places, of the risk-based capital ratio 
numerator to risk weighted assets, as calculated in accordance with 
Sec.  702.104(a).
    Risk-weighted assets. Under the Original Proposal, the term ``risk-
weighted assets'' would have been defined as the total risk-weighted 
assets as calculated in accordance with Sec.  702.104(c).
    The Board received no comments on the definition of ``risk-weighted 
assets'' and has decided to retain the definition unchanged in this 
proposal.
    Secured consumer loan. Under this proposed rule, the new term 
``secured consumer loan'' would be defined as a consumer loan 
associated with collateral or other item of value to protect against 
loss where the creditor has a perfected security interest in the 
collateral or other item of value.
    The Board recognizes that a secured consumer loan has lower credit 
risk than an unsecured consumer loan and, therefore, the Board assigns 
secured consumer loans to a lower risk weight than unsecured consumer 
loans. Secured consumer loans generally have lower delinquency rates 
and lower charge-off rates than unsecured consumer loans. Secured 
consumer loans generally include those collateralized by new and used 
vehicles, all-terrain vehicles, recreational vehicles, boats, 
motorcycles, and other items with a title and could also include a 
perfected security interest in furniture, fixtures, equipment, 
antiques, investments and collectables.
    Senior executive officer. Under the Original Proposal, the term 
``senior executive officer'' would have been defined as a senior 
executive officer as defined by Sec.  701.14(b)(2).
    The Board received no comments on the definition of ``senior 
executive officer'' and has decided to retain the definition unchanged 
in this proposal.
    Separate account insurance. Under this proposed rule, the new term 
``separate account insurance'' would be defined as an account into 
which a policyholder's cash surrender value is supported by assets 
segregated from the general assets of the carrier.
    The Board added the definition of separate account insurance. The 
credit risk associated with separate account insurance may be higher 
than for general account permanent insurance because the separate 
account insurance is a segregated accounting and reporting account held 
separately from the insurer's general assets. The investments in the 
separate account would typically not be permissible for federal credit 
unions; therefore the separate account insurance is treated as if it 
were a non-part 703 compliant investment fund.
    Shares. Under the Original Proposal, the term ``shares'' means 
deposits, shares, share certificates, share drafts, or any other 
depository account authorized by federal or state law. The Board did 
not receive any comments on this term and, therefore, has retained it 
in this proposal, without modification.
    Share-secured loan. Under this proposed rule, the new term ``share-
secured loan'' would be defined as a loan fully secured by shares on 
deposit at the credit union making the loan, and does not included the 
imposition of a statutory lien under 12 CFR 701.39.
    The Board recognizes that share-secured loans have a low credit 
risk. It added this new definition to clarify which loans can be 
classified as share secured and, therefore, assigned a 20 percent risk 
weight. A credit union should have proper internal controls to ensure 
that pledged shares are not withdrawn prior to the full payment of the 
loan they secure. This definition specifically excludes a loan upon 
which a credit union has impressed a statutory lien pursuant to Sec.  
701.39 of NCUA's regulations, where the subject loan was not originated 
as share-secured.
    STRIPS. Under this proposed rule, the new term ``STRIPS'' would be 
defined as separate traded registered interest and principal security.
    The Board proposes to define ``STRIPS'' similarly to its 
conventional usage. This definition is meant to define investments that 
are created by separating a coupon paying security into distinct 
interest-only and principal-only securities.
    Structured product. Under this proposed rule, the new term 
``structured product'' would be defined as an investment that is 
linked, via return or loss allocation, to another investment or 
reference pool.
    The Board proposes to define ``structured product'' to include 
investments that are created to behave like other investments. This 
definition is meant to ensure bonds that are indexed to equities are 
treated as equities for risk weight purposes. This definition is also 
meant to ensure that debentures that have losses that are allocated 
similarly to subordinated securities are treated as subordinated 
securities.
    Subordinated. Under this proposed rule, the new term 
``subordinated'' would mean, with respect to an investment, that the 
investment has a junior claim on the underlying collateral or assets to 
other investments in the same issuance. The definition would provide 
further that the term subordinated does not apply to securities that 
are junior only to money market fund eligible securities in the same 
issuance.
    The Board recognizes that subordinated investments can contain 
substantial and complicated credit risk elements. The definition of 
subordinated is designed to encompass all investments that take losses 
before a more senior claim takes losses. This definition would not 
include an investment that was once subordinate to a senior investment, 
but then became non-subordinate because the previously senior 
investment paid off.
    Supervisory merger or combination. Under this proposed rule, the 
new term ``supervisory merger or combination'' would be defined as a 
transaction that involved the following:
     An assisted merger or purchase and assumption where funds 
from the NCUSIF are provided to the continuing credit union;
     A merger or purchase and assumption classified by NCUA as 
an ``emergency merger'' where the acquired credit union is either 
insolvent or ``in danger of insolvency'' as defined under appendix B to 
part 701 of this chapter; or
     A merger or purchase and assumption that included NCUA's 
or the appropriate state official's

[[Page 4371]]

identification and selection of the continuing credit union.
    The Board has added this definition to clarify which merger or 
combination transactions would be subject to an extended time period 
for absorbing the directly related goodwill and other intangible assets 
that are part of the transaction.
    Swap dealer. Under this proposed rule, the new term ``swap dealer'' 
would be defined as having the same meaning as defined by the Commodity 
Futures Trading Commission in 17 CFT 1.3(ggg). The Board is proposing 
to add this new term to coincide with other changes it is proposing to 
make in the derivatives section of this proposal.
    Total assets. The Original Proposal would have retained the 
definition of ``total assets'' in current Sec.  702.2, but would have 
restructured the definition and provided additional clarifying 
language. Under proposed paragraph (1) under the definition of ``total 
assets,'' for each quarter, a credit union must elect one of the four 
measures of total assets listed in paragraph (2) of the definition to 
apply for all purposes under part 702 except Sec. Sec.  702.103 through 
702.105 (risk-based capital requirement). Proposed paragraph (2) under 
the definition of total assets would have provided that ``total 
assets'' means a credit union's total assets as measured by either: (i) 
The credit union's total assets measured by the average of quarter-end 
balances of the current and three preceding calendar quarters; (ii) the 
credit union's total assets measured by the average of month-end 
balances over the three calendar months of the applicable calendar 
quarter; (iii) the credit union's total assets measured by the average 
daily balance over the applicable calendar quarter; or (iv) the credit 
union's total assets measured by the quarter-end balance of the 
applicable calendar quarter as reported on the credit union's Call 
Report.
    The Board received no comments on the definition of ``total 
assets'' and has decided to retain the definition in this proposal with 
only minor conforming changes.
    Tranche. Under this proposed rule, the new term ``tranche'' would 
be defined as one of a number of related securities offered as part of 
the same transaction. The definition would provide further that the 
term tranche includes a structured product if it has a loss allocation 
based off of an investment or reference pool.
    The Board proposes to define ``tranche'' similarly to its 
conventional usage for securitizations. Structured products are 
included in this definition if they are allocated losses based on a 
reference investment or reference pool.
    Unsecured consumer loan. Under this proposed rule, the new term 
``unsecured consumer loan'' would be defined as a consumer loan not 
secured by collateral.
    The Board recognizes that unsecured consumer loans generally have a 
higher credit risk than secured consumer loans. Unsecured consumer 
loans have higher delinquency rates and higher charge-off rates than 
secured consumer loans. Unsecured consumer loans generally include 
credit card loans, signature loans, and co-maker and cosigner loans. 
Accordingly, the Board assigns unsecured consumer loans to a higher 
risk weight category than secured consumer loans.
    U.S. Government agency. Under the Original Proposal, the term 
``U.S. Government agency'' would have been defined as an 
instrumentality of the U.S. Government whose obligations are fully and 
explicitly guaranteed as to the timely payment of principal and 
interest by the full faith and credit of the U.S. Government.
    The Board received no comments on the definition of ``U.S. 
Government agency'' and has decided to retain the proposed definition 
unchanged in this proposal.
    Weighted-average life of investments. Under this proposed rule, the 
definition of ``weighted-average life of investments'' and the entirety 
of current Sec.  702.105 of NCUA's regulation would be removed. The use 
of weighted-average life (WAL) of investments for the assignment of 
risk weights is in the current risk-based capital measure and would 
have been modified with lower capital requirements for shorter average 
life investments in the Original Proposal. Many commenters objected to 
the use of WAL for the assignment of risk weights for investments 
because the risk weights are based primarily on interest rate and 
liquidity risks, not credit risk.
    In response to the comments, the Board now proposes to assign 
investment risk weights primarily based on credit risk with risk 
weights more comparable to the risk weights assigned by the Other 
Banking Agencies.\121\ This adjustment would require additional 
granularity in the reporting of investments on the Call Report.
---------------------------------------------------------------------------

    \121\ See, e.g., 12 CFR 324.32.
---------------------------------------------------------------------------

    The Board requests comments on the definitions included in this 
proposal.

A. Subpart A--Prompt Corrective Action

    The Original Proposal would have established new subpart A titled 
``Prompt Corrective Action.'' New subpart A would have contained the 
sections of part 702 relating to capital measures, supervisory PCA 
actions, requirements for net worth restoration plans, and reserve 
requirements for all credit unions not defined as ``new'' pursuant to 
Sec.  216(b)(2) of the FCUA.\122\ The Board received no comments on 
these changes and has decided to retain the changes in this proposal.
---------------------------------------------------------------------------

    \122\ Section 1790d(b)(2).
---------------------------------------------------------------------------

Section 702.101 Capital Measures, Capital Adequacy, Effective Date of 
Classification, and Notice to NCUA
    Under the Original Proposal, the requirements of proposed Sec.  
702.101 would have remained largely unchanged from current Sec.  
702.101. The title of proposed Sec.  702.101, however, would have been 
changed to ``Capital measures, effective date of classification, and 
notice to NCUA'' to better reflect the three major topics that would 
have been covered in the section. In addition, the Original Proposal 
would have replaced the terms ``net worth measures'' with ``capital 
measures,'' ``net worth classification'' with ``capital 
classification,'' and ``net worth category'' with ``capital category'' 
to reflect the terminology changes being made throughout the proposal, 
which were discussed above and are discussed in further detail below.
    A number of commenters raised concerns with the proposed changes 
that would have been made to the terminology in the current rule. The 
Board disagrees with these commenters for reasons that are discussed in 
more detail in the portion of the preamble relating to Sec.  702.102. 
Other than the comments discussed in more detail below, the Board 
received no other comments on proposed changes to Sec.  702.101 and has 
decided to retain the changes in this proposal.
    Capital helps to ensure that individual credit unions can continue 
to serve as credit intermediaries even during times of stress, thereby 
promoting the safety and soundness of the overall U.S. financial 
system. As a prudential matter, the NCUA has a long-established policy 
that federally insured credit unions should hold capital commensurate 
with the level and nature of the risks to which they are exposed. In 
some cases, this may entail holding capital above the minimum 
requirements, depending on the nature of the credit union's activities 
and risk profile.
    The Board notes that Other Banking Agencies' capital standards are 
the ``minimum capital requirements and

[[Page 4372]]

overall capital adequacy standards for FDIC-supervised institutions . . 
. include[ing] methodologies for calculating minimum capital 
requirements . . . .'' \123\
---------------------------------------------------------------------------

    \123\ See, e.g., 12 CFR 324.1(a).
---------------------------------------------------------------------------

    The FDIC may require an FDIC-supervised institution to hold an 
amount of regulatory capital greater than otherwise required under this 
part if the FDIC determines that the institution's capital requirements 
under this part are not commensurate with the institution's credit, 
market, operational, or other risks.\124\
---------------------------------------------------------------------------

    \124\ See, e.g., 12 CFR 324.1(d).
---------------------------------------------------------------------------

    Further, the September 10, 2013 preamble to art 324 of FDIC's 
regulations state that:

    The FDIC's general risk-based capital rules indicate that the 
capital requirements are minimum standards generally based on broad 
credit-risk considerations. The risk-based capital ratios under 
these rules do not explicitly take account of the quality of 
individual asset portfolios or the range of other types of risk to 
which FDIC-supervised institutions may be exposed, such as interest-
rate risk, liquidity, market, or operational risks . . . In light of 
these considerations, as a prudent matter, an FDIC-supervised 
institution is generally expected to operate with capital positions 
well above the minimum risk-based ratios and to hold capital 
commensurate with the level and nature of the risks to which it is 
exposed, which may entail holding capital significantly above the 
minimum requirements.\125\
---------------------------------------------------------------------------

    \125\ 78 FR 55362, Tuesday, September 10, 2013.

    As indicated above, FDIC's approach to risk weights is calibrated 
to be the minimum regulatory capital standard. This NCUA proposal would 
also be calibrated to be the minimum regulatory capital standard, 
similar to the FDIC's rule, as suggested by commenters on the Original 
Proposal. Therefore, the Board believes it is necessary to incorporate 
a broader regulatory provision requiring complex credit unions to 
maintain capital commensurate with the level and nature of all risks to 
which they are exposed, and to maintain a written strategy for 
assessing capital adequacy and maintaining an appropriate level of 
capital. Proposed new Sec.  702.101(b) is based on a similar provision 
in the Other Banking Agencies' rules and within the Board's authority 
under the FCUA.\126\ The Board notes that it has broad legal authority 
to take action to ensure the safety and soundness of credit unions and 
the NCUSIF and to carry out the powers granted to the Board.\127\ 
Requiring credit unions to maintain capital adequacy is part of 
ensuring safety and soundness, and is not a new concept.\128\ Rather, 
as discussed in more detail below, NCUA long-standing practice is to 
monitor and enforce capital adequacy through the supervisory process. 
Therefore, proposed Sec.  702.10(b) is a proper use of NCUA's broad 
legal authority to ensure safety and soundness and to carry out its 
administrative powers, is consistent with its long-standing supervisory 
practices, and furthers comparability with the Other Banking Agencies' 
risk based capital rules.
---------------------------------------------------------------------------

    \126\ See, e.g., 12 CFR 324.10(d)(1) and (2).
    \127\ 12 U.S.C. 1786 and 1789.
    \128\ See, e.g. 78 FR 55340, 55362(September 10, 2013).
---------------------------------------------------------------------------

    As the Other Banking Agencies' approach to risk assigning risk 
weights is calibrated to be the minimum regulatory capital standard, 
and this proposal is calibrated predominantly based on the Other 
Banking Agencies' rules as suggested by commenters on the Original 
Proposal, the Board has concluded it is necessary to require complex 
credit unions to maintain capital commensurate with the level and 
nature of all risks to which they are exposed, and a written strategy 
for assessing capital adequacy and maintaining an appropriate level of 
capital. This provision would complement NCUA's existing regulatory 
framework by working in tandem with other regulatory requirements, such 
as those related to liquidity, interest rate, and credit risk.
    Accordingly, proposed Sec.  702.101 would amend current Sec.  
702.101 to include a new capital adequacy provision based on a similar 
provision in FDIC's rule.\129\ The new capital adequacy provision would 
be added as proposed Sec.  702.101(b) and paragraphs (b) and (c) of 
current Sec.  702.101 would be renumbered as paragraphs (d) and (e) of 
proposed Sec.  702.101. The new capital adequacy provision would not 
affect credit unions' PCA capital category. However, the Board believes 
it would support the assessment of capital adequacy in the supervisory 
process (assigning CAMEL and risk ratings).
---------------------------------------------------------------------------

    \129\ 12 CFR 324.10 Minimum capital requirements.
---------------------------------------------------------------------------

    A complex credit union is generally expected to have internal 
processes for assessing capital adequacy that reflect a full 
understanding of its risks and to ensure that it holds capital 
corresponding to those risks to maintain overall capital adequacy.\130\ 
The nature of such capital adequacy assessments should be commensurate 
with the credit union's size, complexity, and risk-profile. Consistent 
with longstanding NCUA practice,\131\ the supervisory assessment of 
capital adequacy will take account of whether a credit union plans 
appropriately to maintain an adequate level of capital given its 
activities and risk profile, as well as risks and other factors that 
can affect its financial condition; including, for example, the level 
and severity of problem assets and its exposure to operational risk, 
IRR and significant asset concentrations. In addition to evaluating the 
appropriateness of a credit union's capital level given its overall 
risk profile, the supervisory assessment takes into account the quality 
and trends in a credit union's capital composition, whether the credit 
union is entering new activities or introducing new products. The 
assessment also considers whether a credit union is receiving special 
supervisory attention, has or is expected to have losses resulting in 
capital inadequacy, has significant exposure due to risks from 
nontraditional activities, or has significant exposure to IRR or 
operational risk. For these reasons, NCUA's supervisory assessment of 
capital adequacy may differ from conclusions that might be drawn solely 
from the calculation of a complex credit union's regulatory capital 
ratios.
---------------------------------------------------------------------------

    \130\ The Basel framework incorporates similar requirements 
under Pillar 2 of Basel II.
    \131\ NCUA Letter to Credit Unions No. 07-CU-12, December 2007, 
CAMEL Rating System and NCUA Letter to Credit Unions No. 09-CU-03, 
November 2009, Reviewing Adequacy of Earnings.
---------------------------------------------------------------------------

    An effective capital planning process involves an assessment of the 
risks to which a credit union is exposed and its processes for managing 
and mitigating those risks, an evaluation of its capital adequacy 
relative to its risks, and consideration of the potential impact on its 
earnings and capital base from current and prospective economic 
conditions. While elements of a supervisory review of capital adequacy 
would be similar across credit unions, evaluation of the level of 
sophistication of an individual credit union's capital adequacy process 
should be commensurate with the institution's size, sophistication, and 
risk profile, similar to the current supervisory practice. NCUA would 
develop and publish supervisory guidance for examiners on how to apply 
this provision.
    Some commenters stated that they manage their capital so that they 
operate with a buffer over the regulatory minimum and that examiners 
expect such a buffer. These commenters expressed concern that examiners 
will expect even higher capital levels. The Board notes that the credit 
union system is generally very well capitalized, and

[[Page 4373]]

this provision merely reflects existing supervisory standards for 
individual complex credit unions. However, NCUA plans to incorporate in 
its National Supervision Policy Manual procedural controls on the 
discretion examiners employ in relation to a complex credit union being 
deemed out of compliance with this provision.
101(b) Capital Adequacy
    For the reasons discussed above, this proposal would add new 
capital adequacy provisions to current Sec.  702.101(b). The proposed 
new capital adequacy provisions would be added as Sec.  702.101(b), and 
the proposal would redesignate paragraphs (b) and (c) of current Sec.  
702.101 as paragraphs (d) and (e) of proposed Sec.  702.101. Proposed 
Sec.  702.101(b) would provide that:
     Notwithstanding the minimum requirements in this part, a 
credit union defined as complex must maintain capital commensurate with 
the level and nature of all risks to which the institution is exposed.
     A credit union defined as complex must have a process for 
assessing its overall capital adequacy in relation to its risk profile 
and a comprehensive written strategy for maintaining an appropriate 
level of capital.
Section 702.102 Capital Classifications
    Under the Original Proposal, the title of Sec.  702.102 would have 
been changed from ``statutory net worth categories'' to ``capital 
classifications.'' The section would also have continued to list the 
five statutory capital categories that are provided in Sec.  216(c) of 
the FCUA.\132\
---------------------------------------------------------------------------

    \132\ Section 1790d(c).
---------------------------------------------------------------------------

    A number of commenters expressed concerns with the changes in 
terminology that were made in this and other sections of the 
regulation. Commenters suggested that by using the terms ``risk-based 
capital,'' ``capital categories,'' ``capital classifications,'' and 
other terms not specifically included in the FCUA, the Board was 
redefining the statutorily defined terms ``net worth'' and ``net worth 
ratio'' with terms that do not encompass the same things.
    The Board disagrees. As the Board explained in the Original 
Proposal, although Sec.  216(c) of the FCUA uses the general term ``net 
worth categories,'' the Board believes the term ``capital categories'' 
is less confusing for industry practitioners and better describes the 
two measurements, ``net worth ratio'' and ``risk-based net worth,'' 
that make up the categories listed in the statute. It is clear, from 
the distinct uses of the terms ``net worth'' and ``risk-based net 
worth'' in the FCUA that Congress intended those terms to have 
different meanings.\133\ Moreover, the new terms were defined in the 
Original Proposal in a manner consistent with both the statutory terms 
and the FCUA's requirements. The Board has considered the use of these 
new terms, as well as the comments received, and believes that the new 
terminology would not alter or otherwise be inconsistent with the 
requirements of the FCUA. Rather, the Board continues to believe that 
the use of these new terms will help to clarify the requirements of the 
regulation for credit unions and other interested parties. Therefore, 
the Board has decided to retain the changes and new terminology in this 
proposal.
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    \133\ Compare section 1790d(c)(1)(A) (providing that a credit 
union is ``well capitalized'' if it meets both the seven percent net 
worth ratio requirement and any applicable risk-based net worth 
requirement), and section 1790d(d) (requiring the Board to design a 
risk-based net worth requirement), with section 1790d(o) (defining 
the term ``net worth,'' but not defining the term risk-based net 
worth ratio).
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102(a) Capital Categories
    Under the Original Proposal, proposed Sec.  702.102(a) would have 
replaced current Sec.  702.102(a) and would have set forth new minimum 
capital measures for complex credit unions. Consistent with sections 
216(c)(1)(A) through (E) of the FCUA, the net worth ratio measures 
listed in proposed Sec. Sec.  702.102(a)(1) through (5) would have 
continued to match those listed in the statute for each capital 
category, and would have used both the net worth ratio and the proposed 
risk-based capital ratio as elements of the capital categories for 
``well capitalized,'' ``adequately capitalized,'' and 
``undercapitalized'' credit unions. The risk-based capital ratio would 
have included components that required higher capital levels to reflect 
increased risk due to IRR, concentration risk, credit risk, market 
risk, and liquidity risk.
    The Original Proposal also would have introduced a new, scaled 
risk-based capital ratio measurement approach for assigning capital 
classifications for well capitalized, adequately capitalized, and 
undercapitalized credit unions. This scaled approach would have 
recognized the relationship between higher risk-based capital ratios 
and the creditworthiness of credit unions.
    The Board received numerous general comments concerning the capital 
categories, nearly all advocating a reduction in all of the risk-based 
capital ratios for complex credit unions. Some commenters suggested the 
following risk-based ratios for complex credit unions: Eight percent or 
greater for well capitalized, 5.5 percent to 7.99 percent for 
adequately capitalized, and 5.5 percent or lower for undercapitalized. 
Other commenters suggested that, in light of the historical performance 
of credit unions through the recent financial crisis, the risk-based 
capital ratio ratios should be: 8.5 percent or greater to be well 
capitalized, six percent to 8.49 percent to be adequately capitalized, 
and six percent or less to be undercapitalized. Still other commenters 
suggested a reduction in the risk-based capital ratios for each capital 
category by a minimum of 50 basis points to avoid harming the credit 
union industry by limiting credit unions' ability to make loans, 
decreasing their earnings, and hampering current business strategies.
    After carefully considering the comments, the Board is now 
proposing to reduce the risk-based capital ratio threshold for well 
capitalized from 10.5 percent to 10 percent. All of the other risk-
based capital ratio thresholds from the Original Proposal would remain 
unchanged. As discussed below, the Board believes this structure is 
within its legal authority to implement, and that this well capitalized 
ratio threshold both achieves parity with Other Banking Agencies' 
regulations \134\ and simplifies NCUA's proposed risk-based capital 
ratio measure by not including the capital conservation buffer that is 
part of the Other Banking Agencies' risk-based capital regulations.
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    \134\ See, e.g., 12 CFR 324.403.
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102(a)(1) Well Capitalized
    Under the Original Proposal, proposed Sec.  702.102(a)(1) would 
have required a credit union to maintain a net worth ratio of seven 
percent or greater and, if it were a complex credit union, a risk-based 
capital ratio of 10.5 percent or greater to be classified as well 
capitalized. The higher proposed risk-based capital requirement for the 
well capitalized classification was designed to boost the resiliency of 
complex credit unions throughout financial cycles and align them with 
the standards used by the Other Banking Agencies.\135\ The proposed 
10.5 percent risk-based capital ratio target was comparable to the 
Other Banking Agencies' eight percent total risk-based capital ratio to 
be adequately capitalized plus the 2.5 percent capital conservation 
buffer that banks will be required to meet when the capital 
conservation buffer is fully

[[Page 4374]]

implemented in 2019.\136\ To be well capitalized, the Other Banking 
Agencies require a total risk-based capital ratio of 10 percent. 
Therefore, a bank can be well capitalized with a total risk-based 
capital ratio of 10 percent, but its inadequate capital conservation 
buffer would still limit its ability to make capital distributions and 
discretionary bonus payments. The Original Proposal included a 10.5 
percent risk-based capital ratio requirement, rather than the Other 
Banking Agencies' 10 percent,\137\ to avoid the complexity of a capital 
conservation buffer.
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    \135\ See, e.g., 12 CFR 324.10, 324.11, and 324.403.
    \136\ On September 10, 2013, FDIC published an interim final 
rule that revised its risk-based and leverage capital requirements 
for FDIC-supervised institutions. 78 FR 55339 (Sept. 10, 2013).
    \137\ See, e.g., 12 CFR 324.403.
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    The Board received a substantial number of comments regarding the 
proposed risk-based capital ratio for a credit union to be classified 
as well capitalized. As a threshold matter, a number of commenters 
questioned the Board's authority to impose any risk-based net worth 
requirement on well capitalized credit unions. Specifically, commenters 
suggested that Sec.  1790d(d) of the FCUA, which they argued provides 
the entirety of the language in the FCUA dealing with the risk-based 
component of PCA, directs NCUA to connect the risk-based net worth 
requirement to the sufficiency of a credit union's net worth only for 
the adequately capitalized classification. Commenters further 
maintained that requiring a higher risk-based capital ratio level for 
well capitalized credit unions than the level required for adequately 
capitalized credit unions contravened both Congressional intent and the 
Board's statutory authority. They argued that, not only does the FCUA 
itself prohibit the Board from imposing a higher risk-based capital 
ratio for the well capitalized threshold, but that sound public policy 
also supports applying the risk-based net worth requirement only to the 
adequately capitalized threshold. They cited the seven percent net 
worth ratio for well capitalized credit unions as support for this 
argument, stating that this net worth ratio renders a separate, higher 
risk-based capital ratio level unnecessary for well capitalized credit 
unions.
    Similarly, another commenter recommended that the Board impose the 
same risk-based capital ratio on both well capitalized and adequately 
capitalized credit unions, and the commenter encouraged the Board not 
to increase that risk-based capital ratio above eight percent. As 
support, the commenter noted that, in the preamble to the Original 
Proposal, the Board stated that the proposed risk-based capital ratio 
of eight percent would have been reasonable for an adequately 
capitalized credit union. The commenter further suggested that because 
adequately capitalized and well capitalized credit unions have higher 
net worth ratio requirements than similarly situated banks, an eight 
percent risk-based capital ratio would be sufficient and that it would 
be unreasonable to require adequately capitalized credit unions to 
maintain a 10.5 percent risk-based capital ratio.
    Other commenters suggested that the proposed 10.5 percent risk-
based capital ratio for a credit union to be classified as well 
capitalized is not appropriate because it unfairly incorporates the 
capital conservation buffer into the PCA framework for credit unions. 
These commenters noted that a bank can be classified as well 
capitalized with an eight percent total risk-based capital ratio, even 
if the bank fails to hold the 2.5 percent capital conservation buffer 
required under the Other Banking Agencies' capital regulations, 
although the commenters acknowledged that any such failure to meet the 
capital conservation buffer would limit that bank's ability to make 
capital distributions and discretionary bonus payments. These 
commenters maintained that by directly incorporating the capital 
conservation buffer into NCUA's PCA framework, the Board would 
disadvantage credit unions by making them more vulnerable to downgrades 
in their PCA capital classification level, a course of action which the 
Other Banking Agencies specifically declined to adopt. Commenters 
further stated that because the capital conservation buffer was 
designed to absorb losses in stressful periods, the Other Banking 
Agencies believed that it was appropriate for a depository institution 
to be able to use some of its capital conservation buffer without being 
considered less than well capitalized for PCA purposes. Commenters 
suggested that the Board should, at a minimum, provide credit unions 
the same flexibility. Other commenters suggested that the Other Banking 
Agencies adopted the capital conservation buffer as a means to restrict 
banks from paying dividends to shareholders and ``substantial 
discretionary bonuses'' to management, which occurred even as banks' 
financial conditions weakened during the last financial crisis. These 
commenters noted that even failed credit unions were not engaging in 
this practice and, therefore, the concern is not relevant to the credit 
union industry. Accordingly, the commenters argued that including the 
capital conservation buffer in the risk-based capital proposal and 
setting the risk-based capital ratio at 10.5 percent was arbitrary.
    Another commenter suggested that the capital conservation buffer 
for banks applies only in periods of significant credit growth, while 
NCUA's proposed risk-based capital ratio of 10.5 percent would apply at 
all times in a financial cycle. Other commenters suggested that the 
Original Proposal would have applied the capital conservation buffer 
only to the well capitalized classification, thereby subjecting 
adequately capitalized credit unions only to the eight percent total 
risk-based capital ratio used by the Other Banking Agencies. Commenters 
maintained that, for the sake of consistency and comparability among 
banks and credit unions, the Board should remove the 2.5 percent 
capital conservation buffer from the well capitalized category and 
adjust the other levels accordingly. Alternatively, they argued that 
the Board should, at a minimum, allow credit unions an equivalent five-
year implementation period to build capital reserves without 
sacrificing member services or dramatically increasing fees.
    One commenter supported the proposed 10.5 percent risk-based 
capital ratio level as the appropriate level to be considered well 
capitalized.\138\ This commenter maintained, however, that there should 
not be an associated increase in this risk-based capital requirement if 
NCUA determines to include the NCUSIF deposit in the risk-based capital 
ratio numerator.
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    \138\
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    Other commenters questioned why well capitalized credit unions 
would be subject to a risk-based capital ratio of 10.5 percent when 
banks only need a risk-based capital ratio of 10 percent.
    Finally, still other commenters suggested that credit unions 
receiving an overall capital classification of well capitalized be 
granted blanket waivers, fixed asset exemptions, longer exam cycles, 
and other incentives under any final risk-based capital rule.
    As noted in the legal authority section of this preamble, the Board 
has carefully considered these comments and generally disagrees with 
commenters' reading and interpretation of the FCUA. For the reasons 
stated in that discussion, it is within NCUA's legal authority to 
promulgate this proposal and to impose a separate, higher risk-based 
capital ratio requirement on well capitalized credit unions than the 
one imposed on adequately capitalized

[[Page 4375]]

credit unions. NCUA's interpretation of its legal authority to require 
credit unions to meet different risk-based capital ratio levels to be 
classified as either well capitalized or adequately capitalized is 
further supported by the Other Banking Agencies' PCA statute and 
regulations, which require different risk-based capital ratio levels 
for banks to be classified as well capitalized, adequately capitalized, 
undercapitalized, or significantly undercapitalized.\139\ Section 
38(c)(1)(A) of the FDI Act requires that the Other Banking Agencies' 
relevant capital measures ``include (i) a leverage limit; and (ii) a 
risk-based capital requirement.'' \140\ Therefore, by setting different 
risk-based capital ratio levels for credit unions to be adequately and 
well capitalized, NCUA's risk-based capital requirement is more 
``comparable'' to the Other Banking Agencies' risk-based capital 
requirement.
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    \139\ See 12 U.S.C. 1831o, and 12 CFR 324.403(b).
    \140\ 12 U.S.C. 1831o(c)(1)(A) (emphasis added).
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    The Board also notes there are sound policy reasons for setting a 
higher risk-based capital ratio threshold for the well capitalized 
category than the one for the adequately capitalized category. Under 
the current rule, a credit union's capital classification could rapidly 
decline directly from well capitalized to undercapitalized if it fails 
to meet the required risk-based net worth ratio level.\141\ Moreover, 
credit unions classified as well capitalized are generally considered 
financially sound, afforded greater latitude under some other 
regulatory provisions,\142\ and are not subject to most mandatory or 
discretionary supervisory actions. In contrast, credit unions that fall 
to the undercapitalized category are financially weak and are subject 
to various mandatory and discretionary supervisory actions intended to 
resolve the capital deficiency and limit risk taking until capital 
levels are restored to prudent levels. The lack of graduated thresholds 
in the current rule's construct for the risk-based net worth 
requirement does not effectively provide for earlier reflection in a 
credit union's net worth category. Under the current rule, a change in 
the credit union's risk profile, capital levels, or both that results 
in a decline in the risk-based net worth ratio does not affect its net 
worth category until it results in the credit union falling to the 
point where the situation requires mandatory or discretionary 
supervisory actions.
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    \141\ Per the FCUA, ``undercapitalized'' is the lowest PCA 
category in which a failure to meet the risk-based net worth 
requirement can result.
    \142\ See 12 CFR 745.9-2 and 12 CFR 723.7.
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    The Board believes a more effective policy is to adopt a higher 
threshold for the well capitalized category than for the adequately 
capitalized category to provide a more graduated framework where a 
credit union does not necessarily drop directly from well capitalized 
to undercapitalized. In fact, this policy objective is reflected in how 
Congress, in section 216(c) of the FCUA, and the Other Banking 
Agencies, in their risk-based capital regulations, designed the 
graduated PCA capital categories.
    For a given risk asset, the amount of capital required to be held 
for that risk asset is calculated by multiplying the dollar amount of 
the risk asset times the risk weight times the desired capital level. 
To illustrate, where the threshold for well capitalized is 10 percent, 
a credit union that has one dollar in a risk asset assigned a 50 
percent risk weight would need to hold capital of five cents ($1 
multiplied by 50 percent multiplied by 10 percent). The point of this 
illustration is that the risk weights are interdependent with the 
thresholds set for the regulatory capital categories. The Board notes 
the risk weights in this proposal are based predominantly on those used 
by the Other Banking Agencies, as suggested by commenters on the 
Original Proposal. For the total capital-to-risk assets ratio, the 
Other Banking Agencies establish a threshold of 10 percent to be well 
capitalized.\143\
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    \143\ The Other Banking Agencies' Total Risk-Based Capital ratio 
is the most analogous standard for credit unions given the proposed 
broadening of the definition of capital to include accounts that 
would not be included in the definition of Tier 1 capital, such as 
the allowance for loan and lease losses and secondary capital for 
low-income designated credit unions.
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    For NCUA's risk-based capital requirement to be comparable, it 
should also be equivalent in rigor to the Other Banking Agencies' risk-
based capital requirement.\144\ The rigor of a regulatory capital 
standard is primarily a function of how much capital an institution is 
required to hold for a given type of asset. Thus, if NCUA chose any 
threshold below 10 percent for the minimum required level of regulatory 
capital, it would either result in systematically lower incentives for 
credit unions to accumulate capital or the risk weights would need to 
be adjusted commensurately to offset the effect of the lower threshold. 
For example, if a uniform threshold for both well and adequately 
capitalized were maintained and set at only 8 percent, as some 
commenters suggested, there would be a decline in the overall rigor of 
the risk-based capital ratio. Alternatively, the risk weights for 
various assets could be increased by 20 percent to offset this effect. 
The Board believes adjusting the risk weights in this manner would 
create more difficulty in comparing asset types and risk weights across 
financial institutions, and no doubt lead to misunderstanding and 
controversy.
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    \144\ See S. Rep. No. 193, 105th Cong., 2d Sess. (1998).
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    Conversely, a uniform threshold for the well capitalized and 
adequately capitalized categories could be maintained, but raised to 
maintain the rigor of the risk-based capital standard and avoid 
adjusting the risk weights. This approach would set a higher point at 
which credit unions would fall to undercapitalized, and therefore be 
subject to mandatory and discretionary supervisory actions. The Board 
does not believe this would be optimal, as the supervisory consequences 
for credit unions with risk-based capital ratios between eight percent 
and ten percent would be worse than for institutions operating under 
the Other Banking Agencies' rules.
    Maintaining the rigor of the risk-based net worth requirement is 
also important for another key policy objective of the Board: Ensuring 
the risk-based net worth requirement is relevant and meaningful. A 
relevant and meaningful risk-based net worth requirement will result in 
capital levels better correlated to risk, and better inform credit 
union decision making.\145\ To be relevant and meaningful, the risk-
based net worth requirement must result in minimum regulatory capital 
levels on par with the net worth ratio for credit unions with elevated 
risk, and be the governing ratio (require more capital than the net 
worth ratio) for credit unions with extraordinarily high risk profiles. 
If the highest threshold for the risk-based capital ratio were set as 
low as 8 percent for well capitalized credit unions, as some commenters 
suggested, the risk-based net worth requirement would govern very few, 
if any, credit unions. If the highest risk-based capital ratio 
threshold were set at eight percent, NCUA estimates at most seven 
credit unions would have the proposed risk-based ratio be the governing 
requirement, with only one credit union currently holding insufficient 
capital to meet the requirement. Further, only credit unions with risk 
assets greater

[[Page 4376]]

than 90 percent of total assets would be bound by the risk-based 
requirement.
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    \145\ The benefits of a capital system better correlated to risk 
are discussed in the Summary section of this preamble.
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    Further, capital is a lagging indicator because it is founded 
primarily on accounting standards, which by their nature are largely 
based on past performance. The net worth ratio is even more so a 
lagging indicator because it applies capital--a lagging measure in 
itself--to total assets. Thus, the net worth ratio does not distinguish 
among risky assets or changes in a balance sheet's composition. A risk-
based capital ratio is more prospective by accounting for asset 
allocation choices and driving capital requirements before losses occur 
and capital levels decline. The more relevant the risk-based net worth 
requirement is, the more likely that credit unions will build capital 
sufficient to prevent precipitous declines in their PCA capital 
classifications that could result in greater regulatory oversight and 
even failure.
    To be relevant and meaningful, the risk-based net worth requirement 
also needs to incent credit unions to build and maintain capital as 
they increase risk to be able to absorb any corresponding unexpected 
losses. A graduated, or tiered, system of capital category thresholds 
that distinguishes between the well capitalized and adequately 
capitalized categories will incentivize credit unions to hold sound 
levels of capital without invoking supervisory action before necessary. 
While there is no requirement for a credit union to be well 
capitalized, and there are no supervisory interventions required for a 
credit union with an adequately capitalized classification, there are 
some regulatory privileges and other benefits for a credit union that 
is well capitalized. Chief among those benefits is the accumulation of 
sufficient capital to weather financial and economic stress. During the 
recent financial crisis, credit unions experienced large losses in a 
compressed timeframe, resulting in a rapid deterioration of net worth. 
Some credit unions that historically had been classified as well 
capitalized were quickly downgraded to undercapitalized. As noted in 
the summary section, credit unions that failed at a loss to the NCUSIF 
on average were very well capitalized, based on their net worth ratios, 
24 months prior to failure (average net worth ratio of 12 percent). 
Over the last 10 years, more than 80 percent of all credit union 
failures involved institutions that were well capitalized in the 24 
months immediately preceding their failure. Unlike the net worth ratio, 
which is indifferent to the composition of assets, a well-designed 
risk-based net worth requirement would reflect material shifts in the 
risk profile of assets.
    The Board believes that a risk-based capital framework that 
encourages and promotes capital accumulation benefits not only those 
credit unions that achieve the well-capitalized classification, but the 
entire credit union system. Thus, the Board remains committed to 
implementing the risk-based requirement under a graduated (multi-
tiered) capital category framework.
    As noted earlier in this preamble, the Board supports lowering the 
well capitalized risk-based capital ratio threshold from 10.5 percent 
to 10 percent. The Board agrees with the commenters who suggested that 
a 10 percent risk-based capital ratio would simplify the comparison 
with the Other Banking Agencies' rules by removing the effect of the 
capital conservation buffer. The 10 percent threshold for well 
capitalized credit unions, along with the eight percent threshold for 
adequately capitalized credit unions, would also be consistent with the 
total risk-based capital ratio requirements contained in the Other 
Banking Agencies' capital rules.
    Capital ratio thresholds are largely a function of risk weights. As 
discussed in other parts of this proposal, the Board is now proposing 
to more closely align NCUA's risk weights with those assigned by the 
Other Banking Agencies. Therefore, the Board believes that NCUA's risk-
based capital ratio threshold levels should also align with those of 
the Other Banking Agencies as closely as possible.
102(a)(2) Adequately Capitalized
    Under the Original Proposal, proposed Sec.  702.102(a)(2) would 
have required a credit union to maintain a net worth ratio of six 
percent or greater and, if it were a complex credit union, a risk-based 
capital ratio of eight percent or greater to be classified as 
adequately capitalized. This risk-based capital ratio level is 
comparable to the eight percent total risk-based capital ratio level 
required by the Other Banking Agencies for a bank to be adequately 
capitalized.
    Other than the comments discussed above and in other parts of this 
preamble, the Board received no comments on the Original Proposal's 
adequately capitalized risk-based capital ratio level. Therefore, the 
Board has decided to retain the changes, with only minor adjustments 
for clarity.
    This proposal would also add proposed Sec.  702.102(a)(2)(iii), 
which would clarify that a credit union is adequately capitalized only 
if it meets the net worth and risk-based capital criteria in proposed 
paragraphs (a)(2)(i) and (ii), and does not meet the definition of a 
well capitalized credit union.
102(a)(3) Undercapitalized
    Under the Original Proposal, proposed Sec.  702.102(a)(3) would 
have classified a credit union as undercapitalized if the credit union 
maintained a net worth ratio of four percent or greater but less than 
six percent and, if it were a complex credit union, a risk-based 
capital ratio of less than eight percent.
    Other than the comments discussed above and other parts of this 
preamble, the Board received no comments on the Original Proposal's 
undercapitalized risk-based capital ratio requirement. However, to 
provide additional clarity the Board is proposing to make additional 
minor adjustments to the paragraph in this proposal.
    Under this proposal, Sec.  702.102(a)(3) would provide that a 
credit union is undercapitalized if: (1) The credit union has a net 
worth ratio of four percent or more but less than six percent; or (2) 
the credit union, if complex, has a risk-based capital ratio of less 
than eight percent.
102(a)(4) Significantly Undercapitalized
    Under the Original Proposal, proposed Sec.  702.102(a)(4) would 
have classified a credit union as significantly undercapitalized if: 
(1) It had a net worth ratio of less than five percent and had received 
notice that its net worth restoration plan had not been approved; \146\ 
(2) the credit union had a net worth ratio of two percent or more but 
less than four percent; or (3) the credit union had a net worth ratio 
of four percent or more but less than five percent, and the credit 
union either failed to submit an acceptable net worth restoration plan 
within the time prescribed in Sec.  702.110, or materially failed to 
implement a net worth restoration plan approved by NCUA. The Original 
Proposal would have made some clarifying changes to the language in 
current Sec.  702.102(a)(4), but would not have changed the criteria 
for being classified as significantly undercapitalized under part 702.
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    \146\ To qualify for a higher net worth classification, a 
significantly undercapitalized credit union must have a net worth 
restoration plan approved by NCUA.
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    The Board received no comments on the proposed changes to this 
paragraph and has decided to retain the changes in this proposal with 
several adjustments for clarity.

[[Page 4377]]

    Under this proposal, Sec.  702.102(a)(4) would provide that a 
credit union is significantly undercapitalized if:
     The credit union has a net worth ratio of two percent or 
more but less than four percent; or
     The credit union has a net worth ratio of four percent or 
more but less than five percent, and either--
    [cir] Fails to submit an acceptable net worth restoration plan 
within the time prescribed in Sec.  702.111;
    [cir] Materially fails to implement a net worth restoration plan 
approved by the Board; or
    [cir] Receives notice that a submitted net worth restoration plan 
has not been approved.
102(a)(5) Critically Undercapitalized
    Under the Original Proposal, proposed Sec.  702.102(a)(5) would 
have classified a credit union as critically undercapitalized if it had 
a net worth ratio of less than two percent. The Original Proposal would 
have made some minor technical amendments to the language in current 
702.102(a)(5), but would not have changed the criteria for being 
classified as critically undercapitalized under part 702.
    The Board received no comments on the proposed changes to this 
paragraph and, therefore, it has decided to retain the changes in this 
proposal.
102(b) Reclassification Based on Supervisory Criteria Other Than Net 
Worth
    The Original Proposal would have retained current Sec.  702.102(b), 
with only a few amendments to update terminology and make minor edits 
for clarity. No substantive changes were intended.
    The Board received no comments or suggested changes to this 
paragraph and has decided to retain the changes in this proposal.
102(c) Non-Delegation
    Proposed Sec.  702.102(c) would have been unchanged from current 
Sec.  702.102(c).
    The Board received no comments or suggested changes to this 
paragraph and has decided to make no changes in this proposal.
102(d) Consultation With State Officials
    Proposed Sec.  702.102(d) would have retained current Sec.  
702.102(d) with only a few small amendments for consistency with other 
sections of NCUA's regulations. No substantive changes were intended.
    The Board received no comments or suggested changes to this 
paragraph and has decided to retain the changes in this proposal.
Section 702.103 Applicability of the Risk-Based Capital Ratio Measure
    Under the Original Proposal, proposed Sec.  702.103 would have 
changed the title of current Sec.  702.103 from ``Applicability of 
risk-based net worth requirement'' to ``Applicability of risk-based 
capital ratio measure.'' Proposed Sec.  702.103 would have provided 
that, for purposes of Sec.  702.102, a credit union is defined as 
``complex,'' and a risk-based capital ratio requirement is applicable, 
only if the credit union's quarter-end total assets exceed $50 million, 
as reflected in its most recent Call Report.
    Under the current rule, credit unions are ``complex'' and subject 
to the risk-based net worth requirement only if they have quarter-end 
total assets over $50 million and they have a risk based net worth 
requirement exceeding six percent. The Original Proposal would have 
eliminated current Sec.  702.103(b) and defined all credit unions with 
over $50 million in assets as ``complex.''
    The Board received a significant number of comments on the proposed 
definition of complex credit unions. Many commenters pointed out that 
NCUA already has a complexity index based on deposit account types, 
member services, loan and investment types, and portfolio composition, 
and given the availability of such a measure, which takes into account 
``the portfolio of assets and liabilities'' of credit unions. 
Commenters stated that it seemed odd that the Board would define 
complex based solely on credit unions' asset size given the fact that 
the NCUA already has a complexity index.
    Commenters suggested that section 1790d(d)(1) of the FCUA directs 
the Board to establish a risk-based net worth system for ``complex'' 
credit unions, but does not give the Board complete discretion on how 
the system must be structured and applied to credit unions. Commenters 
argued that defining ``complex'' using only an asset size threshold 
fails to comply with the requirement in section 1790d(d)(1) that the 
Board take into account the ``portfolios of assets and liabilities of 
credit unions'' when defining complex credit unions.
    Commenters also suggested that a single-dimension definition of 
``complex'' credit union does not account for actual operational 
complexity. Other commenters suggested that the proposed definition of 
``complex'' was arbitrary and is too simplistic a measure because it 
did not take into account a credit union's comprehensive book of 
assets, including all loans, investments, and liabilities, as well as 
whether a credit union's operations are sufficiently diverse to warrant 
a ``complex'' designation.
    Other commenters stated that determining whether a credit union is 
complex should be influenced by whether they do real estate lending, 
member business lending, have risky investments, and many other factors 
contributing to the composition of a credit union's balance sheet and 
overall operation. Commenters claimed that many larger credit unions 
have limited service offerings or narrow portfolio composition and are 
not complex institutions. Commenters suggested that NCUA's own 
complexity index shows that using asset size alone does not result in 
an accurate measure of complexity for credit unions.
    One commenter suggested that all federally insured credit unions 
with assets above $250 million and that have an NCUA complexity index 
value of 17 or higher be required to meet risk-based capital 
requirements. Another commenter suggested that, consistent with NCUA's 
final liquidity rule, credit unions with over $250 million in assets 
have a great degree of interconnectedness with other market entities, 
and when they experience unexpected or severe liquidity constraints 
they are more likely to adversely affect the credit union system, 
public perception, and the NCUSIF. The commenter suggested that setting 
the size threshold at $250 million will encourage mid-size credit union 
growth.
    Other commenters believed the Board has defined complex in NCUA's 
derivatives regulation and for examinations as $250 million in assets.
    Other commenters suggested the Board raise that threshold to $500 
million given the burden they believe would be imposed by the rule and 
the potential for unintended consequences. The commenters further 
suggested it would be wise to phase-in the application of the rule 
slowly by starting with credit unions with assets of $500 million or 
more to ensure smooth implementation of the rule without threatening 
the viability of smaller institutions.
    Other commenters questioned whether the Board cares about the 
safety and soundness of credit unions with $50 million in assets or 
less. Several of those commenters suggested the risk-based capital 
requirements should apply to all credit unions regardless of size 
because if they are not subject to the capital regulation they will be 
unprepared when they reach $50 million size threshold.
    Some commenters suggested that the situation is further compounded 
by the number of credit unions that have

[[Page 4378]]

received a low-income designation. They envisioned a difficult 
transition for low-income credit unions going from no caps on 
commercial lending and commercial loan participations, to tiered risk 
weights that could become problematic in terms of regulatory 
compliance.
    A small number of commenters suggested the Board should adjust for 
inflation any asset-size threshold used in the definition of complex.
    Another commenter suggested that any credit union that is 
identified as ``complex'' by NCUA should be able to present evidence to 
the agency as to why it is not complex and should not be subject to 
risk-based capital requirements. The commenter suggested the process 
for contesting an agency designation of ``complex'' should also be 
detailed in the rule.
    Other commenters suggested the rule should acknowledge the 
differences between credit unions of different asset sizes and assign 
different risk weights for credit unions of different asset sizes.
    The Board has carefully considered the comments received and 
generally agrees that a higher asset size threshold is appropriate. 
Based on comments received on the Original Proposal, the Board is now 
proposing to use $100 million in assets as a proxy for determining 
whether a credit union is complex. Under this proposal, the title of 
current Sec.  702.103 would continue to be changed from ``Applicability 
of risk-based net worth requirement'' to ``Applicability of risk-based 
capital ratio measure.''
    However, after diligently considering the comments on the Original 
Proposal and further analyzing the ``portfolios of assets and 
liabilities of credit unions,'' the Board now believes that $100 
million in assets would be a more appropriate threshold level for 
defining ``complex'' credit unions. Accordingly, consistent with 
requirements of Sec.  216(d)(1) of the FCUA, this proposed Sec.  
702.103 would now provide that, for purposes of Sec.  702.102, a credit 
union is defined as ``complex,'' and a risk-based capital ratio 
requirement is applicable, only if the credit union's quarter-end total 
assets exceed $100 million, as reflected in its most recent Call 
Report. The Board would periodically evaluate this threshold as part of 
NCUA's annual review of one-third of its regulations.
    Under the current rule, credit unions are ``complex'' and subject 
to the risk-based net worth requirement only if they have quarter-end 
total assets over $50 million and they have a risk-based net worth 
ratio over six percent. In effect, this means that all credit unions 
with over $50 million in assets are subject to the current risk-based 
net worth requirement unless their level of risk assets is relatively 
low.
    Consistent with requirements of section 216(d)(1) of the FCUA, the 
Board is proposing to eliminate the additional complexity measure in 
current Sec.  702.103(b) and declines to propose a complexity measure 
in addition to the $100 million asset sized threshold for defining 
``complex'' credit unions. Accordingly, this proposal would eliminate 
current Sec.  702.103(b) and define all credit unions with over $100 
million in assets as ``complex.'' For reasons described more fully 
below, the Board believes that defining the term ``complex'' credit 
union using a single asset size threshold of $100 million as a proxy 
for a credit union's complexity would be accurate and reduce the 
complexity of the rule, would provide regulatory relief for smaller 
institutions, and would eliminate the complexity and potential 
unintended consequences of having a checklist of activities that would 
determine whether or not a credit union is subject to the risk-based 
capital requirement.
    Under this proposal, the term ``complex'' is defined only for 
purposes of the risk-based capital ratio measure. The Board believes 
there are a number of products and services, which under GAAP are 
reflected as the credit unions portfolio of assets and liabilities, in 
which credit unions are engaged \147\ that are inherently complex based 
on the nature of their risk and the expertise and operational demands 
necessary to manage and administer such activities effectively. The 
Board believes that credit unions offering such products and services 
have complex portfolios of assets and liabilities for purposes of 
NCUA's risk-based net worth requirement. In particular, the Board 
believes that the following products and services engaged in by credit 
unions are good indicators of complexity:
---------------------------------------------------------------------------

    \147\ Products and services comprise a portfolio of assets and 
liabilities through the accounts and fixed assets that must be 
maintained to operate, the resources of staff and funds necessary to 
operate the credit union, and the liabilities that may arise from 
contractual obligations, among other things. Altogether, these 
products and services are accounted for on the balance sheet through 
the assets and liabilities according to GAAP.
---------------------------------------------------------------------------

     Member business loans,
     Participation loans,
     Interest-only loans,
     Indirect loans,
     Real estate loans,
     Non-federally guaranteed student loans,
     Investments with maturities of greater than five years 
(where the investments are greater than one percent of total assets),
     Non-agency mortgage-backed securities,
     Non-mortgage-related securities with embedded options,
     Collateralized mortgage obligations/real estate mortgage 
investment conduits,
     Commercial mortgage-related securities,
     Borrowings,
     Repurchase transactions,
     Derivatives, or
     Internet banking.
    Based on a review of Call Report data as of June 30, 2014, all 
credit unions with more than $100 million in assets were engaged in the 
products and services listed above, with 99 percent having more than 
one complex activity, and 87 percent having four or more. On the other 
hand, less than two-thirds of credit unions below $100 million in 
assets are involved in even a single complex activity, and only 15 
percent have four or more. Moreover, credit unions with total assets 
less than $100 million are a small share (approximately 10 percent) of 
the overall assets in the credit union system--which limits the 
exposure of the Share Insurance Fund to these institutions. 
Accordingly, the Board believes $100 million in assets is a clear 
demarcation above which complex activities are always present, and 
where credit unions are almost always engaged in one or more complex 
activities, in contrast to credit unions $100 million or less in 
assets.
    As discussed earlier, and consistent with section 216(d)(1) of the 
FCUA, the Board believes $100 million in assets is an accurate proxy 
for complexity based on credit unions' portfolios of assets and 
liabilities. It is logical, clear, and easy to administer. This 
proposed approach would also benefit credit union boards of directors, 
which consist primarily of volunteers. Based on December 31, 2013 Call 
Report data, this proposed approach would exempt almost 80 percent of 
credit unions from the regulatory burden associated with complying with 
the risk-based net worth requirement, while still covering 90 percent 
of the assets in the credit union system. It is also consistent with 
the fact that the majority of losses (68 percent as measured as a 
proportion of the total dollar cost \148\) to the NCUSIF over the last 
10 years have come from credit unions with assets greater than $100 
million.\149\ Accordingly, this proposal

[[Page 4379]]

would eliminate current Sec.  702.103(b) and amend current Sec.  
702.103 to define all credit unions with over $100 million in assets as 
``complex.''
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    \148\ Based on NCUA's loss and failure data.
    \149\ NCUA performed back testing analysis of Call Report and 
failure data to determine whether this proposed regulation would 
have resulted in earlier identification of emerging risks and 
possibly reduced losses to the NCUSIF. We evaluated the impact of 
this proposal on more recent failures of credit unions with total 
assets over $100 million. This testing revealed that maintaining a 
risk-based capital ratio in excess of 10 percent would have 
triggered eight out of nine such failing credit unions to hold 
additional capital, which could have prevented failure or reduced 
losses to the NCUSIF.
---------------------------------------------------------------------------

    In addition, the Board is requesting comment on an alternative 
measurement for the definition of ``complex.'' This alternative 
approach would define ``complex'' as engaging in a threshold number of 
products and services, such as those listed above, which the Board 
believes make up a complex portfolio of assets and liabilities. For 
example, this alternative approach could define a credit union as 
complex if it engaged in one or more of the products and services 
listed above. In addition to general comments on this approach, the 
Board is requesting comments on the following aspects of this 
alternative measurement for the definition of ``complex'':
    1. What specific products and services should the Board include in 
the list of products and services used to determine whether a credit 
union's portfolio of assets and liabilities is ``complex,'' and why?
    2. What number of complex products and services should a credit 
union be allowed to engage in before being designated as ``complex,'' 
and why?
Section 702.104 Risk-Based Capital Ratio
    Under the Original Proposal, the Board proposed changing the title 
of current Sec.  702.104 from ``Risk portfolio defined'' to ``Risk-
based capital ratio measures.'' In addition, the Board originally 
proposed entirely replacing the requirements for calculating the risk-
based net worth requirement for ``complex'' credit unions under current 
Sec.  702.104 with a new risk-based capital ratio measure.\150\ The 
proposed section would have required all ``complex'' credit unions to 
calculate their risk-based capital ratio as directed in the section. 
The proposed risk-based capital ratio was designed to enhance sound 
capital management and help ensure that credit unions maintain adequate 
levels of loss-absorbing capital going forward, strengthening the 
stability of the credit union system and ensuring credit unions serve 
as a source of credit in times of stress.
---------------------------------------------------------------------------

    \150\ 12 U.S.C. 1790d(d).
---------------------------------------------------------------------------

    NCUA received a number of general comments on the proposed Sec.  
702.104. Commenters argued that the proposed risk-based capital 
calculation did not match the real risk in the system. Other commenters 
suggested the proposed risk-based capital calculation was an 
oversimplification of risk.
    Some commenters stated that they generally supported the proposed 
calculation for the risk-based capital ratio. Other commenters stated 
that the proposed changes would make the risk-based capital ratio 
calculations more reflective of comparable calculations required by 
FDIC, provide clarity and understandability to a complex calculation, 
and make the resulting analysis more valuable and useable.
    Other commenters suggested that the funding source of the credit 
union's assets should also be factored into the risk-based capital 
ratio measure, and that credit unions that fund assets solely with 
member deposits should be given a credit compared to credit unions that 
fund assets with borrowing and/or broker deposits. These commenters 
stated that the proposal would regulate only one side of the balance 
sheet--the assets--while not allowing credit unions the flexibility to 
deal with this new capital requirement through supplementary capital or 
the matching of term liabilities to specific assets. Similarly, other 
commenters suggested that the proposal did not effectively consider a 
credit union's liabilities as a source of funds matched against its 
assets. The commenters suggested that the cost at which some credit 
unions can borrow funds to then loan out or invest is very low and 
carry a healthy spread, but they believed the proposal would have 
penalized credit unions on the asset side of the balance sheets 
irrespective of their management of matching sources and uses of funds. 
Other commenters suggested that applying higher risk weights on long-
term assets to deal with IRR is misleading without considering 
liabilities.
    Commenters stated that NCUA assigns a CAMEL rating based on a 
number of factors, including management effectiveness, and that an 
institution with a more effective management team can adequately manage 
an increased level of risk. Commenters suggested that by not taking 
risk management techniques and qualities into account in the proposed 
rule when determining the required risk-based capital ratios, credit 
unions with strong management effectiveness would be essentially 
limited in how well they could utilize the skills that reside on their 
team.
    One commenter suggested that credit unions should be given a credit 
for checking and savings non-maturity deposits. Another commenter 
suggested that the Original Proposal appeared to concentrate on risks 
faced by credit unions in a low interest rate environment, but that the 
rule should be amended to be flexible enough to also work in high 
interest rate environments that may occur in the future.
    As discussed in more detail below, the Board believes most of the 
comments outlined above would be addressed by removing the IRR 
components from the risk weights in this proposal. Accordingly, 
consistent with the Original Proposal, the Board is now proposing to 
change the title of current Sec.  702.104 from ``Risk portfolio 
defined'' to ``Risk-based capital ratio.'' In addition, the Board is 
now proposing, with some minor changes from the Original Proposal, to 
entirely replace the requirements for calculating the risk-based net 
worth ratio for ``complex'' credit unions under current Sec.  702.104 
with a new risk-based capital ratio measure.\151\
---------------------------------------------------------------------------

    \151\ 12 U.S.C. 1790d(d).
---------------------------------------------------------------------------

    Proposed Sec.  702.104 would continue to require all ``complex'' 
credit unions to calculate the risk-based capital ratio as directed in 
the section. The Board believes the proposed risk-based capital ratio 
would enhance sound capital management and help ensure that credit 
unions maintain adequate levels of loss-absorbing capital going 
forward, strengthen the stability of the credit union system, provide a 
more leading indicator of deteriorating strength than the net worth 
ratio, and ensure credit unions serve as a source of credit in times of 
stress.
104(a) Calculation of Capital for the Risk-Based Capital Ratio
    Under the Original Proposal, proposed Sec.  702.104(a) would have 
provided that to determine its risk-based capital ratio, a complex 
credit union must calculate the percentage, rounded to two decimal 
places, of its risk-based capital ratio numerator as described in Sec.  
702.104(b) to its total risk-weighted assets denominator as described 
in Sec.  702.104(c). The proposed method of calculating risk-based 
capital would have been generally consistent with the methods used in 
other sectors of the financial services industry. As with the current 
risk-based net worth requirement, the proposed risk-based capital ratio 
calculation would have been calculated primarily using information 
credit unions already report on the Call Report form required under 
Sec.  741.6(a)(2) of NCUA's regulations.
    The Board received a number of comments regarding the Original

[[Page 4380]]

Proposal's reliance primarily on information credit unions already 
report on the Call Report form. A number of commenters stated that the 
Call Report is sufficient and should not be amended or expanded. 
Commenters generally appreciated the Board's awareness of the 
regulatory burdens on credit unions relating to reporting requirements.
    Other commenters suggested the Call Report information currently 
collected should be modified to properly capture risks associated with 
assets and liabilities in more detail. One commenter suggested that by 
supporting and ensuring strong risk-based capital calculations through 
enhanced Call Report data, the Board could help to improve 
communications between credit unions and examiners during the 
examination process, which could result in more efficient examinations 
and would help alleviate regulatory burdens on credit unions.
    Other commenters suggested that adopting investment risk weights 
consistent with the Other Banking Agencies' regulations would require 
additional reporting in the Call Reports, but stated additional 
reporting would be a small issue for some credit unions and a non-event 
for others.
    One commenter suggested that the Board's goal should be to produce 
the best risk-based capital proposal regardless of the current 
reporting structure and the proposal should be rewritten and the effort 
begun anew without the instructions to minimize changes to the current 
call report form. Another commenter suggested that the call report 
should be amended to include a separate line item labeled, ``deposits 
in Federal Reserve Banks,'' and that such a change would not be 
burdensome, either for credit unions or NCUA.
    Several commenters stated that the revised Call Report would make 
the reporting process more costly and complicated for credit unions due 
to the amount of new information that credit unions would be required 
to provide under the Original Proposal because gathering new data would 
require changes by data processors, additional staff time and staff 
training, all of which costs money.
    Conversely, one commenter suggested that the vast majority of 
credit unions that would be affected by the Original Proposal either 
use systems developed by, or outsourced their investment accounting and 
reporting to, firms who already provide the required information to 
banks, and it would require little relative effort to modify the 
reports provided to credit unions to be able to report this information 
in the Call Reports. Another commenter stated that the Board should 
overhaul the current call reporting platform to better align credit 
union Call Report data with the Call Report data collected by the other 
U.S. regulated depository institutions to build a consistent framework 
for both the assignment of appropriate risk weights, as well as the 
comparability of capital adequacy across institutions. Still another 
credit union commenter stated that it captures credit scores and 
current loan-to-value (LTV) ratios and would gladly report additional 
loan information to NCUA in its Call Report rather than be subject to 
the proposed risk-based capital standards.
    The Board has decided to retain the original changes to Sec.  
702.104(a) in this proposal with only minor, non-substantive edits. 
However, the Board is aware that changes to the Call Report could 
create a reporting burden on credit unions. The Board agrees with 
commenters who encouraged Call Report data enhancement which would 
improve the assignment of appropriate risk weights using more granular 
data. While this approach would require more call report data, it would 
also result in improved precision of capital requirements, and more 
granular data that would also enhance NCUA's offsite supervision 
capabilities. As NCUA has done in the past (most recently in October 
2012), the agency will provide credit unions with prior notification of 
significant reporting changes to the Call Report,\152\ and credit 
unions will have an opportunity to comment via the related Paperwork 
Reduction Act filing through the U.S. Office of Management and Budget 
(OMB). The assignment and discussion of specific risk weights for 
assets that would be identified within the Call Report is contained in 
Sec.  702.104(c).
---------------------------------------------------------------------------

    \152\ NCUA Letter to Credit Unions No. 12-CU-12, October 2012, 
Changes Planned for Upcoming Call Reports.
---------------------------------------------------------------------------

104(b) Risk-Based Capital Ratio Numerator
    Under the Original Proposal, proposed Sec.  702.104(b) would have 
provided that the risk-based capital ratio numerator is the sum of 
certain specific capital elements listed in Sec.  702.104(b)(1), minus 
certain regulatory adjustments listed in Sec.  702.104(b)(2). The 
proposed numerator for the risk-based capital ratio would have 
continued to consist primarily of the components of a credit union's 
net worth. In order to capture all of the material risks while keeping 
the calculation from becoming overly complicated, the Original Proposal 
would have added some additional equity and loss allowance items and 
other specified balance sheet items would be subtracted. The goal of 
the proposed risk-based capital ratio numerator was to achieve a 
measure that reflects a more accurate amount of equity and reserves 
available to cover losses.
    A number of commenters suggested that the Board should focus more 
on the numerator of the risk-based capital ratio in the rule by 
allowing credit unions to hedge IRR by obtaining ``credits'' for low-
risk assets such as certificates of deposit. Other commenters made 
similar statements suggesting that credit unions should be given a 
credit when they build their own insurance through certificates of 
deposit or long-term borrowing because such investments are considered 
additional insurance that are being used to hedge IRR.
    The Board determined these comments are related to the IRR 
components of the risk weights in the Original Proposal and, as 
previously stated, this proposal would not include IRR components in 
the risk weights assigned to investments. The Board also determined 
quantifying ``credits'' for specific types of shares and liabilities 
would be extraordinarily complicated and require a large amount of 
additional data, and be inconsistent with how the Other Banking 
Agencies approach risk-based capital requirements.
    The Original Proposal maintained the structure of the computation 
of the risk-based capital ratio numerator with some revisions, which 
are addressed under the discussion on each of the individual elements 
below. Accordingly, the Board is now proposing to retain Sec.  
702.104(b) of the Original Proposal without change.
104(b)(1) Capital Elements of the Risk-Based Capital Ratio Numerator
    Section 702.104(b)(1) of the Original Proposal would have listed 
the capital elements of the risk-based capital ratio numerator as 
follows: undivided earnings (including any regular reserve); 
appropriation for non-conforming investments; other reserves; equity 
acquired in merger; net income; ALLL, limited to 1.25 percent of risk 
assets; secondary capital accounts included in net worth (as defined in 
Sec.  702.2); and Sec.  208 assistance included in net worth (as 
defined in Sec.  702.2). Consistent with the Original Proposal, Sec.  
702.104(b)(1) of this proposal would list the elements of the risk-
based capital ratio numerator.
    The Board received a significant number of comments suggesting 
various changes or additions to the list of capital elements included 
in the Original

[[Page 4381]]

Proposal, which are discussed in more detail below.
    The Board generally disagrees with the comments received and has, 
with the exception of the ALLL, decided to retain the language from the 
Original Proposal without change. As explained above, the FCUA gives 
NCUA broad discretion in designing the risk-based net worth 
requirement. Thus, this proposal incorporates a broadened definition of 
capital for purposes of calculating the proposed new risk-based capital 
ratio that would serve as the risk-based net worth requirement. The 
Board proposes to do this to provide for a more comparable measure of 
capital across all financial institutions and better account for 
related elements of the financial statement that are available (or not) 
to cover losses and protect the NCUSIF. This broader definition of 
capital would contribute over 50 basis points, on average, to affected 
credit unions' risk-based capital ratio.
Undivided Earnings
    The Original Proposal would have included undivided earnings 
(including any regular reserve) in the risk-based capital ratio 
numerator.
    The Board received no comments on the inclusion of this capital 
element in the risk-based capital ratio numerator. Accordingly, the 
Board has decided to retain this aspect of the Original Proposal with a 
minor change. The reference to regular reserve would be removed, as the 
regular reserve account is a part of undivided earnings and this 
proposal seeks to eliminate the provisions of the rule relating to 
maintenance of the regular reserve account.
Appropriation for Nonconforming Investments
    The Original Proposal would have included the appropriation for 
nonconforming investments in the risk-based capital ratio numerator.
    The Board received no comments on the inclusion of this capital 
element in the risk-based capital ratio numerator. Accordingly, the 
Board has decided to retain this aspect of the Original Proposal 
without change.
Other Reserves
    The Original Proposal would have included other reserves in the 
risk-based capital ratio numerator.
    The Board received no comments on the inclusion of this capital 
element in the risk-based capital ratio numerator. Accordingly, the 
Board has decided to retain this aspect of the Original Proposal 
without change.
Equity Acquired in Merger
    Under the Original Proposal, the proposed risk-based capital ratio 
numerator would have included the equity acquired in merger component 
of the balance sheet. This equity item would have been used in place of 
the total adjusted retained earnings acquired through business 
combinations amount that credit unions report on the PCA net worth 
calculation worksheet in the Call Report. The equity acquired in merger 
is the GAAP equity recorded in a business combination and can vary from 
the amount of total adjusted retained earnings acquired through 
business combinations, which is not a GAAP accounting item. The use of 
equity acquired in a merger, as measured using GAAP, would have more 
accurately reflected the overall value of the business combination 
transaction.
    The Board received no comments on the inclusion of this capital 
element in the risk-based capital ratio numerator. Accordingly, the 
Board has decided to retain this aspect of the Original Proposal 
without change.
Net Income
    The Original Proposal would have included net income in the risk-
based capital ratio numerator.
    The Board received no comments on the inclusion of this capital 
element in the risk-based capital ratio numerator. Accordingly, the 
Board has decided to retain this aspect of the Original Proposal 
without change.
ALLL
    The Original Proposal would have included the ALLL in the risk-
based capital ratio numerator. The Board noted in the Original Proposal 
that the ALLL would have been included in the risk-based capital ratio 
numerator because it is available to cover expected levels of loan 
losses at a credit union. The Original Proposal, however, would have 
limited the amount of the ALLL that a credit union could include in the 
risk-based capital ratio numerator to 1.25 percent of total risk-
weighted assets. In the preamble to the Original Proposal, the Board 
stated that this approach would have been consistent with the Basel III 
framework and the Other Banking Agencies' capital regulations,\153\ and 
it also would have induced credit unions to grant quality loans and 
record loan losses in a timely manner.
---------------------------------------------------------------------------

    \153\ See, e.g., 12 CFR 324.20(d).
---------------------------------------------------------------------------

    The Board received a number of comments regarding the proposed 
inclusion of the ALLL in the risk-based capital ratio numerator. A 
substantial number of commenters stated that the ALLL is a dedicated 
item on the balance sheet and should not be limited or restricted in 
any way. Commenters suggested that GAAP will not allow the ALLL to be 
an excessive amount, so the reasoning for limiting the ALLL in the 
Original Proposal was unclear, even if the Other Banking Agencies' 
rules treat it that way. Commenters suggested that, rather than 
implementing a 1.25 percent cap to capture risks in credit unions that 
are holding excess ALLL, the Board should address the risks that the 
cap was intended to address one-on-one with ``overly conservative'' 
credit unions. Commenters suggested that risk reserved for within the 
ALLL for credit risk should not be duplicated under the risk-based 
capital ratio measure. Other commenters stated that limiting the ALLL 
would have minimal practical effect on the way credit unions underwrite 
loans or record losses, but it could create a disincentive for credit 
unions to hold higher reserves.
    Some commenters suggested that for banks, the 1.25 percent 
limitation prevents the use of the ALLL as a means to control taxable 
revenue by maintaining excessive reserves, but that credit unions have 
no incentive to manipulate the reserve in such a manner so the Board 
should include the full ALLL balance in the risk-based capital ratio 
numerator.
    Other comments stated that the allocation of 1.5 percent of loans 
in the current rule more appropriately captures the insulating 
contribution that the ALLL provides to capital, particularly during 
times of economic stress.
    Still other commenters stated that credit unions with portfolios of 
agricultural and business loans, which are allowed by GAAP to reserve 
for each loan individually in the ALLL rather than just using 
historical data, would be adversely affected by the original proposal 
because credit unions would have a lot less incentive to include 
economic downturns as part of their calculations under the rule.
    A small number of commenters suggested that the ALLL in excess of 
1.25 percent of risk assets should be recognized as a reduction of 
risk-based loans at 100 percent consistent with the treatment by the 
Other Banking Agencies.
    Conversely, some other commenters stated that both the inclusion of 
the ALLL in the risk-based capital ratio numerator and the 1.25 percent 
limit were appropriate based on the current environment.

[[Page 4382]]

    However, another commenter suggested that by excluding the amount 
of the ALLL above 1.25 percent, the Original Proposal would have 
implicitly encouraged credit unions to cap their ALLL at 1.25 percent, 
ignoring the responsibility to develop the ALLL based on portfolio 
risk.
    In response to the comments received, the Board is now proposing to 
remove the 1.25 percent of risk asset limit on the amount of the ALLL 
that can be included in the risk-based capital ratio numerator. Under 
this proposal, all of the ALLL, maintained in accordance with GAAP, 
would be included in the risk-based capital ratio numerator. The 
proposed removal of the limit on the ALLL would result in this reserve 
fully counting as capital. The Board believes this is appropriate given 
that credit unions will have already expensed through the income 
statement the expected credit losses on the loan portfolio. In times of 
financial stress, while risk may be increasing (such as rising non-
current loans), an uncapped inclusion of the ALLL in the risk-based 
capital ratio numerator would allow a properly funded ALLL to somewhat 
offset the impact of the financial stressors on the risk-based capital 
ratio.
    The Board also believes that this proposed change is appropriate 
given the high quality of credit union capital. The quality of credit 
union capital should eliminate concerns that the ALLL could account for 
too much of the capital required to be held against total risk-weighted 
assets.
    Further, the Board agrees with commenters that NCUA's supervision 
process could address any concerns with uncapping inclusion of the 
ALLL, such as artificially slow charge-offs to manipulate capital 
requirements. Removal of the limitation in the amount of the ALLL 
included in risk-based capital ratio would also address the treatment 
of excess ALLL that was excluded from the calculation.
    A significant number of commenters also stated that if the 
Financial Accounting Standards Board (FASB) changes the accounting 
standards that cause more than inconsequential increases to the normal 
levels of ALLL, the Board should increase the limit of ALLL to be 
included in the risk-based capital ratio numerator comparable to the 
additional levels of normal ALLL. Other commenters suggested that the 
Board eliminate the ALLL cap of 1.25 percent of risk-weighted assets 
given the high risk weight associated with non-current loans. Further, 
commenters suggested elimination of the ALLL cap based on the FASB's 
proposed accounting for credit losses, which, if finalized, could 
result in an increase of credit unions' ALLL by more than 50 percent. 
Another commenter suggested that language be added to the rule that 
states that the ALLL credit will be increased if FASB proposal is 
implemented. Other commenters suggested that reducing the ALLL 
allocation would be inconsistent with the expected accounting 
conventions for future allowance methodologies.
    The Board notes that eliminating the cap on ALLL inclusion in the 
risk-based capital ratio numerator would address concerns with FASB's 
proposed related changes to GAAP.\154\ However, FASB has implied its 
intent in the upcoming Current Expected Credit Loss Model to change 
current GAAP and require entities to establish a day one credit loss 
allowance on Purchased Credit Impaired (PCI) assets.
---------------------------------------------------------------------------

    \154\ FASB Financial Instruments-Credit Losses Subtopic 825-15 
(exposure drafted dated December 20, 2012).
---------------------------------------------------------------------------

    As the entire credit loss allowance would be included in a credit 
union's risk-based capital ratio numerator under the proposed rule, the 
Board is requesting specific comment on how a final rule should 
mitigate strategies by credit unions to ``purchase'' a credit loss 
allowance by acquiring PCI assets in an acquisition or merger, and 
thus, artificially increase their risk-based capital ratio numerator.
Secondary Capital Accounts
    The Original Proposal would have included secondary capital 
accounts included in net worth (as defined in Sec.  702.2) in the risk-
based capital ratio numerator.
    The Board received no comments on the inclusion of this capital 
element in the risk-based capital ratio numerator. Accordingly, the 
Board has decided to retain this aspect of the Original Proposal in 
this proposal without change.
Section 208 Assistance
    The Original Proposal would have included Sec.  208 assistance 
included in net worth (as defined in Sec.  702.2) in the risk-based 
capital ratio numerator.
    The Board received no comments on the inclusion of this capital 
element in the risk-based capital ratio numerator. Accordingly, the 
Board has decided to retain this aspect of the Original Proposal in 
this proposal without change.
Call Report Equity Items Not Included in the Risk-Based Capital Ratio 
Numerator
    Under the Original Proposal, the proposed risk-based capital ratio 
numerator would not have included the following Call Report equity 
items: accumulated unrealized gains (losses) on available for sale 
securities; accumulated unrealized losses for other than temporary 
impairment (OTTI) on debt securities; accumulated unrealized net gains 
(losses) on cash flow hedges; and other comprehensive income. In 
designing the proposed rule, the Board recognized that the items listed 
above reflected a credit union's actual loss absorption capacity at a 
specific point in time, but included gains or losses that may or may 
not be realized. The Board also recognized that including these items 
in the risk-based ratio numerator could lead to volatility in the risk-
based capital ratio measure, difficulty in capital planning and asset-
management, and other unintended consequences.\155\ Accordingly, the 
Board chose to exclude these items from the risk-based capital ratio 
numerator in the Original Proposal.
---------------------------------------------------------------------------

    \155\ The Other Banking Agencies' regulatory capital rules (12 
CFR 324.22) allow institutions to make an opt-out election for 
similar accounts. See, e.g., 78 FR 55339 (Sept. 10, 2013).
---------------------------------------------------------------------------

    The Board received a number of comments on the exclusion of 
accumulated unrealized gains and losses from the risk-based capital 
ratio numerator in the proposed rule. Commenters suggested that to 
offset the effect of unrealized gains or losses, credit unions should 
be allowed to net the gain or loss against the investment that created 
it, which would mean valuing the investment at book. Commenters stated 
that this would make adjustments to the unrealized gains or losses have 
no net effect on the calculation. Commenters stated further that under 
the Original Proposal an unrealized gain would increase the value of 
the investment in the denominator and an unrealized loss would decrease 
the value of the investment in the denominator, creating volatility. 
Commenters also suggested that with an unrealized loss there is no 
deduction from net worth and the asset is still decreased in the 
risked-based asset calculation; thus, a large unrealized loss could 
hide a risk that the net worth would have to be reduced if the credit 
union was liquidated. Other commenters agreed that including unrealized 
gains and losses could lead to volatility in the risk-based capital 
measure, difficulty in capital planning and asset-management, and other 
unintended consequences as the unrealized gain or loss expands and 
contracts.
    Still other commenters suggested that while the Original Proposal 
would have

[[Page 4383]]

appropriately left unrealized gains and losses on available-for-sale 
securities out of the risk-based capital ratio numerator, and explains 
NCUA's sound reasoning behind that position, the proposed high risk 
weights applied to investments would almost completely offset this for 
many credit unions. These commenters suggested the high risk weights 
applied to investments would reduce some credit unions' risk-based 
capital ratios as if they had already sold their entire portfolio at 
the loss in market values they would expect in an unrealized, 
instantaneous, ``up 300 basis points'' rate-shock scenario.
    As noted earlier, this proposal removes the IRR components 
contained in the risk weights, so related concerns raised by commenters 
on the investment risk weights should now be moot.
    Due to the changes this proposal would make to the assignment of 
risk weights for investments, and in response to the comments in 
agreement with the concerns about volatility in the risk-based capital 
ratio that can occur with investments, the Board has decided to retain 
this aspect of the Original Proposal without change. The proposed 
application of excluding accumulated unrealized gains (losses) on 
available-for-sale securities; accumulated unrealized losses for OTTI 
on debt securities; accumulated unrealized net gains (losses) on cash 
flow hedges, and other comprehensive income also would eliminate the 
added complication of an opt-in or opt-out approach.
Other Supplemental Forms of Capital
    Under the Original Proposal, forms of supplemental capital, other 
than secondary capital accounts included in net worth (as defined in 
Sec.  702.2), would not have been included in the risk-based capital 
ratio numerator. For natural-person credit unions, the only form of 
supplemental capital the FCUA includes in the definition of ``net 
worth'' is secondary capital that it authorizes for low-income credit 
unions.\156\ The Board did not propose including other supplemental 
forms of capital in the risk-based capital ratio numerator.
---------------------------------------------------------------------------

    \156\ 12 U.S.C. 1757(6), 1790d(o)(2)(C) (defining ``net 
worth''), and proposed Sec.  702.2 (defining ``net worth'').
---------------------------------------------------------------------------

    As a result, the Board received a substantial number of comments 
expressing concern about the omission of supplemental capital from the 
risk-based capital ratio numerator.
    A number of commenters suggested that the Original Proposal would 
have regulated only the asset side of the balance sheet, representing 
the risk-based capital ratio denominator, while depriving credit unions 
of the flexibility to use supplemental capital to address the newly 
introduced capital requirement through the risk-based capital ratio 
numerator. Other commenters stated that, in order for any credit unions 
but low-income credit unions to use supplemental capital to meet the 
risk-based net worth requirement, Congress would have to amend the FCUA 
to give NCUA the authority to permit that use of supplemental capital. 
In that regard, commenters contended that the Board should have raised 
the supplemental capital issue with Congress before issuing the 
proposed rule.
    Without being able to include supplemental capital in the risk-
based capital ratio numerator, some commenters stated that credit 
unions would be forced to address capital concerns by increasing 
profitability (through higher fees and loan rates, etc.), shrinking 
assets, or both; none of which they suggested would be in a credit 
union's best interest.
    A small number of commenters suggested that credit unions would not 
need supplemental capital to be effective if the Board were to devise a 
risk-based capital regulation that enabled credit unions to grow in a 
manner consistent with safety and soundness.
    Other commenters protested that since the Board had altered the 
definition of capital in the Original Proposal, it therefore should 
also extend the risk-based capital ratio numerator to include 
supplemental capital. In making the same argument, others noted that 
the risk-based capital ratio numerator as proposed already included 
items that are not part of ``net worth'' as defined by the FCUA.
    Commenters generally acknowledged that counting supplemental 
capital as part of a credit union's net worth requirement (for all but 
low-income credit unions) would require an authorizing amendment to the 
FCUA, but they maintain that, in contrast, nothing in the Act prohibits 
the Board from including supplemental capital in the risk-based capital 
ratio numerator. More expansively, some commenters interpreted the 
absence of an express prohibition in the Act barring the use of 
supplemental capital by any credit union for any purpose as implicit 
support for allowing it to be used for risk-based purposes only. Under 
either interpretation, commenters urged the Board to make supplemental 
capital a component of the risk-based capital ratio numerator 
consistent with the proposed definition of capital as ``equity, as 
measured by GAAP, available to a credit union to cover losses.'' \157\
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    \157\ See 79 FR 11183, 11211 (Feb. 27, 2014) (Proposing to 
define ``capital'' as ``the equity, as measured by GAAP, available 
to a credit union to cover losses.'').
---------------------------------------------------------------------------

    In contrast to the lack of authority for federally chartered credit 
unions, other than low-income credit unions, to currently accept 
secondary capital, several commenters suggested that the laws of some 
states authorize their federally insured state chartered credit unions 
to raise other supplemental forms of capital. Therefore, the commenters 
suggested the rule should permit those federally insured state 
chartered credit unions that are authorized to raise other forms of 
capital under state law to also count that capital in the risk-based 
capital ratio numerator.
    Commenters suggested that the FCUA already authorizes federally 
chartered credit unions to issue certificates of indebtedness, which 
function as loans from the holder to the credit union with interest 
paid to the holder, as well as to offer subordinated debt instruments 
to members and non-members. They urged the Board to allow FCUs to count 
those certificates of indebtedness, and those instruments that meet 
GAAP capital requirements, in the risk-based capital ratio numerator.
    Having considered the comments on supplemental capital, the Board 
declines to permit credit unions (other than low-income credit unions) 
to include other supplemental forms of capital in the risk-based 
capital ratio numerator as part of this proposal, pending potential 
Congressional action and more specific comments as described 
below.\158\
---------------------------------------------------------------------------

    \158\ 702.104(b)(2)
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    Members of Congress have introduced legislation in the past that 
would authorize all federally insured credit unions to accept 
supplemental capital.\159\ Individual Board members have publicly 
supported such legislation in the past. At this time the Board prefers 
to await the outcome of previously proposed legislation that, if passed 
by Congress, would expressly authorize supplemental capital as a 
component of net worth,\160\ and permit

[[Page 4384]]

the Board to decide whether or how to include such capital in the net 
worth ratio and the risk-based net worth requirement. Individual Board 
members have publicly supported such legislation in the past.
---------------------------------------------------------------------------

    \159\ See, e.g., HR 719, 113th Cong. (2013) (HR 719 would have 
amended the FCUA to allow the Board to authorize certain forms of 
supplemental capital that could be counted toward a credit union's 
``net worth,'' as that term is defined in section 1790d(o)(2)).
    \160\ The Capital Access for Small Businesses and Jobs Act, HR 
719, was introduced in the House of Representatives and referred to 
the House Financial Services Committee during the 113th Congress.
---------------------------------------------------------------------------

    Such authority would also raise a host of other complicated issues 
that would need to be addressed through additional changes to NCUA's 
regulations, including providing consumer protections, amending NCUSIF 
payout priorities, and imposing prudent limitations on the ability of 
non-low-income credit union to offer and include supplemental capital.
    Although the FCUA does authorize federally chartered credit unions 
to issue certificates of indebtedness and subordinated debt instruments 
to members and non-members, the ability to include them in the risk-
based capital ratio numerator depends on whether such supplemental 
forms of capital are structured to satisfy prudential capital and 
consumer protection requirements--issues not addressed in this 
rulemaking.
    The Board does, however, specifically request comment on the 
following questions regarding additional supplemental forms of capital.
    1. Should additional supplemental forms of capital be included in 
the risk-based capital ratio numerator and how would including such 
capital protect the NCUSIF from losses?
    2. If yes, to be included in the risk-based capital ratio 
numerator, what specific criteria should such additional forms of 
capital reasonably be required to meet to be consistent with GAAP and 
the FCUA, and why?
    3. If certain forms of certificates of indebtedness were included 
in the risk-based capital ratio numerator, what specific criteria 
should such certificates reasonably be required to meet to be 
consistent with GAAP and the FCUA, and why?
    4. In addition to amending NCUA's risk-based capital regulations, 
what additional changes to NCUA's regulations would be required to 
count additional supplemental forms of capital in NCUA's risk-based 
capital ratio numerator?
    5. For state-chartered credit unions, what specific examples of 
supplemental capital currently allowed under state law do commenters 
believe should be included in the risk-based capital ratio numerator, 
and why should they be included?
    6. What investor suitability, consumer protection, and disclosure 
requirements should be put in place related to additional forms of 
supplemental capital?
104(b)(2) Risk-based Capital Ratio Numerator Deductions
    Under the Original Proposal, proposed Sec.  702.104(b)(2) would 
have provided that the elements deducted from the sum of the capital 
elements of the risk-based capital ratio numerator are: (1) The NCUSIF 
Capitalization Deposit; (2) goodwill; (3) other intangible assets; and 
(4) identified losses not reflected in the risk-based capital ratio 
numerator.
    The Board received a significant number of comments, which are 
outlined in detail below, regarding the capital elements that would 
have been deducted from the risk-based capital ratio numerator. 
However, for the reasons explained in more detail below, the Board has 
decided to retain most of these aspects of the Original Proposal with a 
few changes that are discussed in more detail below.
    NCUSIF capitalization deposit. The Original Proposal would have 
addressed concerns about the NCUSIF capitalization deposit being 
reflected on the NCUSIF's balance sheet both as equity to pay losses 
and as an asset of the insured credit unions. Under the Original 
Proposal, the NCUSIF capitalization deposit would have been subtracted 
from both the numerator and denominator of the risk-based capital 
ratio.\161\ This treatment of the risk-based capital ratio would not 
have altered the NCUSIF capitalization deposit's accounting treatment 
for credit unions.
---------------------------------------------------------------------------

    \161\ See U.S. Govt. Accountability Office, GAO-04-849, 
Available Information Indicates No Compelling Need for Secondary 
Capital (2004), available at http://www.gao.gov/assets/250/243642.pdf.
---------------------------------------------------------------------------

    The Board received a number of comments expressing concerns about 
the Original Proposal's treatment of the NCUSIF capitalization deposit. 
A majority of commenters disagreed with or questioned the treatment of 
the NCUSIF deposit. Commenters suggested that the NCUSIF deposit should 
not be deducted from the risk-based capital ratio numerator or 
denominator.
    Commenters stated that if the risk-based capital ratio numerator is 
intended to reflect ``equity available to cover losses in the event of 
liquidation,'' then the NCUSIF deposit should be included because it is 
one of the most reliable assets available to credit unions to cover 
losses. Commenters suggested that the only condition under which it 
would not be available is during a system-wide catastrophe, in which 
case most other credit union assets, other than cash, would similarly 
be subject to substantial losses. Those commenters argued there is no 
reason to believe the NCUSIF capitalization deposit would not be 
available to cover losses or that it should be excluded from the 
numerator of the risk-based capital ratio.
    Other commenters suggested that NCUA has control of these funds so 
credit unions should be able to count the deposit toward their capital 
requirement (i.e., the deposit should be included in the risk-based 
capital ratio numerator and be counted only as a zero-risk item in the 
risk-based capital ratio denominator).
    Other commenters stated that although banks expense their deposit 
insurance, credit unions treat the deposit as an asset. Commenters 
stated that while it is true that the bank's deposit insurance premiums 
have reduced the bank's capital, a credit union's capital has been 
reduced in real terms by the lost income the credit union would have 
earned had it placed the funds in an earning asset rather than in a 
non-interest-bearing deposit to NCUSIF.
    Another commenter stated that it appeared that the Board was 
attempting to make the risk-based capital ratio numerator comparable to 
banks, which expense their insurance premiums paid by eliminating the 
NCUSIF capitalization, but that banks pay and expense their premiums 
for each period due and cannot get those funds back. The commenter 
stated further that federally insured credit unions, on the other hand, 
not only pay an upfront deposit of one percent of insured shares and 
record that as an asset, but also pay for and immediately expense 
periodic assessments from NCUA needed to bolster the NCUSIF. In 
addition, the commenter stated that federally insured credit unions can 
have their deposits returned if, for example, they convert to a bank, 
elect private insurance (in the nine states where private insurance is 
permitted), or complete a voluntary liquidation, and the NCUSIF 
capitalization deposit is an asset as recognized by GAAP, is tangible, 
and easily measured.
    Some commenters suggested that this accounting difference is 
already captured as part of the higher leverage ratio for credit unions 
as compared to banks. They believe Congress established a capital level 
for credit unions two percentage points higher than the capital level 
for banks because one percent of a credit union's capital is dedicated 
to the NCUSIF and another one percent of the typical credit union's 
capital is dedicated to its corporate credit union. Those commenters 
stated that if the Board excludes the NCUSIF deposit it will create an 
uneven playing field between banks and credit unions

[[Page 4385]]

that will disadvantage credit unions by adjusting for the deposit 
twice.
    Commenters generally suggested that this new approach could bring 
the accounting treatment of the NCUSIF deposit into question; that if 
the deposit is not available to cover a credit union's risks during 
liquidation then that leads to the question of whether or not the 
deposit is an asset. Going further, other commenters suggested the 
Board reconsider this aspect of the Original Proposal, as it implies 
that the deposit is worthless and should be expensed versus the current 
method of capitalizing the deposit.
    Conversely, another commenter stated that after experiencing the 
corporate credit union meltdown, it has become evident that NCUA has 
the superior claim on the deposit and that the credit union really 
cannot claim to own it. Still another commenter stated that perhaps the 
NCUSIF deposit should have been expensed all along, but writing it down 
now comes at a time when generating earnings is already a big 
challenge.
    One commenter suggested that the NCUSIF deposit should be treated 
as an investment like Federal Home Loan Bank stock, which would mean 
assigning a risk weight to account for the possibility of the NCUSIF 
having to use the credit union's funds beyond normal premiums and 
losing some of the credit union's equity in the NCUSIF. The commenter 
suggested that leaving the NCUSIF deposit on the balance sheet, 
assigning it a risk weight, and removing the deduction from net worth 
is the best option for accurately measuring the ability of each credit 
union to weather losses. Other commenters suggested that the deposit 
should be assigned a risk weight of 100 percent or lower.
    It was suggested that the NCUSIF deposit should not be excluded 
from the calculation of risk-based capital ratios at all, but that 
excluding it from the denominator penalizes more than excluding it from 
the risk-based capital ratio numerator.
    Yet other commenters disagreed, suggesting that the NCUSIF deposit 
be excluded from the calculation of risk-based capital altogether.
    One commenter suggested that the deposit be treated like any other 
illiquid asset instead of contra-equity.
    The Board has carefully considered the comments received and 
continues to believe exclusion of the NCUSIF deposit from both the 
risk-based capital ratio numerator and denominator is the appropriate 
way to handle its risk-based capital treatment. Accordingly, for all 
the reasons discussed below, the Board has decided to retain this 
aspect of the Original Proposal without change.
    The 1997 U.S. Treasury Report on Credit Unions supports NCUA's 
current position of excluding the NCUSIF deposit from the risk-based 
capital ratio calculation. The Treasury report concluded that the 
NCUSIF deposit is double counted because it is an asset on credit union 
balance sheets and equity in the NCUSIF.\162\ The Treasury noted that, 
in lieu of expensing the NCUSIF deposit, holding additional capital is 
necessary to offset risk of loss from required credit union 
replenishment. According to comments within the 1997 Treasury Report, 
Congress established a higher statutory leverage ratio for credit 
unions in part to offset the risk of loss from required credit union 
replenishment.\163\
---------------------------------------------------------------------------

    \162\ Department of U.S. Treasury Report titled; Credit Unions, 
1997, Page 58: ``The one percent deposit does present a double-
counting problem. And it would be feasible for credit unions to 
expense the deposit now, when they are healthy and have strong 
earnings. However, expensing the deposit would add nothing to the 
Share Insurance Fund's reserves, and--as we will explain--better 
ways of protecting the Fund are available. Accordingly, we do not 
recommend changing the accounting treatment of the 1 percent 
deposit.''
    \163\ Id. at page 4-5 and 55-59
---------------------------------------------------------------------------

    The Board believes the NCUSIF deposit deduction needs to be 
addressed in the risk-based capital ratio, not just the leverage ratio, 
to correct for the double-counting concern in those credit unions where 
the risk-based capital ratio is the governing requirement.
    The NCUSIF deposit is not available for a credit union to cover 
losses from risk exposures on its own individual balance sheet in the 
event of insolvency.\164\ The purpose of the NCUSIF deposit is to cover 
losses in the credit union system. The Board is required to assess 
premiums necessary to restore and maintain the NCUSIF equity ratio at 
1.2 percent. Premiums were necessary from 2009 through 2011 as a result 
of losses. A series of NCUA Letters to Credit Unions issued during 2009 
discuss the necessary write-down of the one percent NCUSIF deposit and 
required NCUSIF premium expenses needed to restore the NCUSIF equity 
ratio.\165\
---------------------------------------------------------------------------

    \164\ 12 U.S.C. 1782(c)(1)(B)(iii).
    \165\ NCUA Letter 09-CU-20, Premium Assessments; NCUA Letter 
09CU-14, Corporate Stabilization Fund Implementation; NCUA Letter 
09-CU-02, Letter Corporate Credit Union System Strategy.
---------------------------------------------------------------------------

    The NCUSIF deposit is refundable in the event of voluntary credit 
union charter cancellation or conversion. However, this aspect does not 
change the unavailability of the NCUSIF deposit to cover individual 
losses while the credit union is an active going concern, or its at 
risk stature in the event of major losses to the NCUSIF. NCUA refunds 
the NCUSIF deposit only in the event a solvent credit union voluntarily 
liquidates, or converts to a bank charter or private insurance.
    Consistent with its exclusion from the risk-based capital ratio 
numerator, the NCUSIF deposit would also be deducted from the 
denominator under proposed Sec.  702.104(c)(1), which would properly 
adjust the risk-based capital ratio calculation and reduce the impact 
of the adjustment.
    Neither the Original Proposal nor this second proposal would adjust 
for the NCUSIF deposit twice or put credit unions at a disadvantage in 
relation to banks because banks have expensed premiums to build the 
Deposit Insurance Fund.
    The Board does not agree with commenters who suggested that the 
NCUSIF deposit should be treated as an investment similar to FHLB 
stock. The NCUSIF deposit and FHLB stock have several fundamental 
differences. The deposit in the NCUSIF results in double counting of 
capital within the credit union system. Investments in FHLB stock do 
not. A financial institution does not need to change its charter for a 
FHLB stock redemption as a credit union must do for a NCUSIF deposit 
refund. Further, unlike FHLB stock, the NCUSIF deposit is not an 
income-producing asset. The NCUSIF deposit has not paid a dividend 
since 2006. The NCUSIF cannot pay another dividend while the Corporate 
Stabilization Fund loan from the Treasury is still outstanding.
    The Board is not requiring credit unions to expense the NCUSIF 
deposit, and does not believe the risk-based capital treatment will 
lead to a change in how this asset is accounted for under GAAP. The 
Board agrees with the U.S. Treasury position as stated in its 1997 
Report on Credit Unions. Treasury stated expensing the NCUSIF deposit 
would not strengthen the NCUSIF. The financial structure of the NCUSIF 
is reasonable and works well for credit unions.
    The assignment of a risk weight for the NCUSIF has the potential to 
create additional criticisms, as a low risk weight may not capture the 
true nature of the account and a high risk weight could produce 
unnecessary concern about risk of the NCUSIF. The NCUSIF is treated 
similarly to other intangible assets, (e.g. goodwill and core deposits 
intangible assets), as they are not available assets upon liquidation.

[[Page 4386]]

Goodwill and Other Intangible Assets
    Under the Original Proposal, goodwill and other intangible assets 
would have been deducted from both the risk-based capital ratio 
numerator and denominator in order to achieve a risk-based capital 
ratio numerator reflecting equity available to cover losses in the 
event of liquidation.
    Goodwill and other intangible assets contain a high level of 
uncertainty regarding a credit union's ability to realize value from 
these assets, especially under adverse financial conditions.
    The Board received a number of comments regarding the treatment of 
goodwill under the proposal. Commenters suggested that credit unions 
should not be required to subtract goodwill even though doing so is 
consistent with Basel III and the Other Banking Agencies' capital 
regulations. One commenter suggested that the proposed rule and the 
treatment of goodwill should follow GAAP. Another commenter suggested 
that goodwill is an asset and should be counted as such.
    Other commenters suggested that goodwill should be excluded from 
the risk-based capital calculation because goodwill is not immediately 
available to absorb losses in accordance with the intended purpose of 
regulatory capital, but that the Board should also consider what impact 
such a change could have on merger incentives in the industry. Another 
commenter suggested that goodwill not be immediately deducted from the 
numerator of the risk-based capital ratio, but instead be phased out 
over a 10-year period, or longer on a case-by-case basis.
    Commenters generally suggested that the exclusion of goodwill 
disincentives merger activity, which would prevent healthy industry 
consolidation and the combining of unhealthy credit unions with 
stronger ones in the future.
    Other commenters suggested that not including intangibles resulting 
from a merger in the risk-based capital ratio numerator causes a 
reduction in the risk-based capital ratio for non-goodwill intangibles, 
which are not included in the numerator and are deducted from the 
numerator when amortized.
    Other commenters stated they agree with the proposed treatment of 
goodwill, but that the Board should only deduct those items initially 
included, and only to the extent of current (net) assets.
    The Board also received a few comments on the treatment of other 
intangible assets under the proposed rule. Commenters suggested the 
Board should rethink the treatment of the core deposit intangible and 
let GAAP determine how core deposit intangible is to be written off in 
fairness to the surviving credit union and to encourage future mergers 
of both healthy and distressed institutions whether credit unions or 
banks.
    The Board has considered the comments and, as explained above, has 
decided to retain the definition of goodwill and to clarify the 
definition of other intangibles. However, the Board recognizes that 
requiring the exclusion of goodwill and other intangibles associated 
with supervisory mergers and combinations that occurred prior to this 
proposal would directly reduce the credit union's risk-based capital 
ratio. The Board is now proposing to amend the Original Proposal in a 
manner that would allow credit unions to include certain goodwill and 
other intangibles in the risk-based capital ratio numerator. In 
particular, this second proposed rule would exclude from the definition 
of goodwill which must be deducted from the risk-based capital ratio 
numerator, any goodwill acquired by a credit union in a supervisory 
merger or consolidation that occurred before the publication of this 
rule in final form.
    The Board notes, however, that this proposed change would not 
change financial reporting requirements for credit unions to use GAAP 
to determine how certain intangibles are valued over time.
    Under this proposal, credit unions would still need to account for 
goodwill in accordance with GAAP and the amount of excluded goodwill 
and other intangibles is based on the outstanding balance of the 
goodwill directly related to supervisory mergers.
    The Board is proposing to allow the excluded goodwill until 
December 31, 2024. The Board believes this date would allow most, if 
not all, credit unions to adjust to this change as they continue to 
value goodwill and other intangibles in accordance with GAAP. Also, the 
Board notes that this provision would only apply to goodwill and other 
intangibles acquired through supervisory mergers or consolidations, as 
that term is defined above, and is not available for goodwill and other 
intangibles acquired from mergers or consolidations that do not meet 
this definition. This change would allow affected credit unions time to 
revise business practices to ensure goodwill and other intangibles 
directly related to supervisory mergers do not adversely impact their 
risk-based capital calculation.
    In response to commenters who sought to include goodwill and other 
intangibles in the risk-based capital ratio numerator, the Board 
reiterates that there is a high level of uncertainty regarding the 
ability of credit unions to realize the value of these items, 
particularly in times of adverse conditions. In addition, the Board 
notes that its proposed approach to other intangibles generally mirrors 
the treatment by the Other Banking Agencies.\166\ However, the longer 
implementation period included in this proposal would serve to mitigate 
some of the commenters' concerns regarding existing goodwill and other 
intangibles because it would provide affected credit unions with 
approximately a 10-year period to write down the goodwill or otherwise 
adjust their balance sheet.
---------------------------------------------------------------------------

    \166\ See, e.g., 12 CFR 324.22.
---------------------------------------------------------------------------

    While the Board is proposing to include a provision to address 
goodwill and other intangibles acquired through supervisory mergers and 
consolidations completed prior to this rule, the Board is now proposing 
to retain the requirement that all other goodwill and other intangibles 
be excluded from the risk-based capital ratio numerator as they are not 
available to cover losses. Credit unions will need to consider the 
impact future combinations will have on both the net worth and risk-
based capital ratios. For mergers involving financial assistance from 
the NCUSIF, this means a credit union with higher capital may be able 
to outbid a competing credit union. A credit union will need to 
consider the impact on its capital when determining the components of a 
merger proposal, which may result in higher costs to the NCUSIF. 
However, stronger capital and a risk-based capital measure that is less 
lagging should reduce the number and cost of failures, resulting in a 
net positive benefit to the NCUSIF and the industry.
    Finally, in order to improve clarity about which particular 
intangible assets are deducted from the risk-based capital ratio 
numerator, the Board is proposing to revise the definition of other 
intangible assets. Specifically, the Board is proposing to exclude 
servicing assets from the amount of intangible assets deducted from the 
risk-based capital ratio numerator since they have the potential for 
value in the event of liquidation.
Identified Losses Not Reflected in the Risk-Based Capital Ratio 
Numerator
    The Original Proposal would have included a provision to allow for 
identified losses, not reflected as

[[Page 4387]]

adjustments in the risk-based capital ratio numerator, to be deducted. 
The inclusion of identified losses would have allowed for the 
calculation of an accurate risk-based capital ratio.
    The Board received no comments on this aspect of the proposal. 
Accordingly, the Board has decided to retain this aspect of the 
Original Proposal without change. However, the definition for 
identified losses was modified, for reasons articulated above, to make 
it clear any such items would be measured in accordance with GAAP.
104(c) Risk-weighted Assets
    In developing the proposed risk weights included in the Original 
Proposal, the Board reviewed the Basel accords and the U.S. and various 
international banking systems' existing risk weights.\167\ The Board 
considered the comments contained in MLRs prepared by the NCUA's OIG 
and comments by GAO in their respective reviews of the financial 
services industry's implementation of PCA.\168\ As previously 
mentioned, the FCUA requires the risk-based measure to include all 
material risks. Accordingly, in assigning the originally proposed risk 
weights, the Board considered credit risk, concentration risk, market 
risk, IRR, operational risk, and liquidity risk.
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    \167\ The Basel Committee on Banking Supervision (BCBS) 
published Basel III in December 2010 and revised it in June 2011, 
available at http://www.bis.org/publ/bcbs189.htm.
    \168\ Section 988 of the Dodd-Frank Wall Street Reform and 
Consumer Protection Act obligates NCUA's OIG to conduct MLRs of 
credit unions that incurred a loss of $25 million or more to the 
NCUSIF. In addition, section 988 requires NCUA's OIG to review all 
losses under the $25 million threshold to assess whether an in-depth 
review is warranted due to unusual circumstances. The MLRs are 
available at http://www.ncua.gov/about/Leadership/CO/OIG/Pages/MaterialLossReviews.aspx; see also GAO/GGD-98-153 (July 1998); GAO-
07-253 (Feb. 2007), GAO-11-612 (June 2011), GAO-12-247 (Jan. 2012), 
and GAO-13-71 (Jan. 2013).
---------------------------------------------------------------------------

    The Board received a number of comments expressing general concerns 
about the proposed risk weights. A significant number of commenters 
suggested that the Original Proposal did not contain sufficient 
statistical analysis of credit union losses or failures, quantified and 
summarized data on historical NCUSIF loss experiences, and comparisons 
of the loss or failure rates at banks to rationalize the proposed asset 
risk weights. One commenter suggested that the risk weights reflect 
``socio-economic reasons'' instead of ``reasoned judgment about actual 
risks.''
    A number of commenters argued that the absence of rigorous 
quantitative analysis accompanying the proposal's risk weights raises 
many questions and makes it exceedingly difficult to respond fully to 
the agency's proposal. Other commenters contended that the proposal 
provides no explanation of how the risk-based ratings were derived and 
how they would directly correlate to risks the proposal attempts to 
mitigate. Commenters suggested that the Board's proposed increases to 
various risk weights were excessively blunt given the small number of 
failures and the MLR narratives cited in the proposed rule. Other 
commenters suggested that some of the risk weights appear to be 
excessive, arbitrary, and/or appear to cover all types of risk by 
adopting excessive risk weight amounts.
    A number of commenters suggested that the proposed risk weights 
would encourage credit unions to increase levels of poorer credit 
quality consumer loans at the expense of higher levels of even the 
strongest, most secure MBLs, real estate loans, and longer-term 
investments. A significant number of commenters expressed concerns that 
the Original Proposal would have been inconsistent in the treatment of 
the real risks associated with some on-balance sheet assets when the 
risk weights of various assets were compared to one another; e.g., the 
risk weights for delinquent first mortgage loans, buildings, prepaid 
expenses, foreclosed properties, investments in CUSOs, and any 
investment with a weighted-average life of more than 5 years.
    Other commenters suggested that the Board reconsider the 
limitations of any single metric at assessing risk and match the 
consequences of a low risk-based capital ratio to the limitations and 
potential inaccuracy of that metric.
    One commenter suggested that, based on the proposal, the implied 
balance sheet structure of most credit unions would be as follows: (1) 
Commercial lending would be limited to roughly 15 percent of assets, 
because of the heavier risk weight at higher thresholds; (2) real 
estate lending would be limited to approximately 35 percent of assets 
regardless of the repricing structure of the loans; (3) home equity 
loans/second lien mortgage loans would be limited to 10 percent of 
assets; and (4) the remainder of a credit union's balance sheet would 
be limited to consumer loans and very short-term investments because of 
the risk weights.
    A number of commenters suggested that asset quality (e.g., number 
of delinquencies, classified loans, and charge-offs) should also be 
taken into account in setting the risk weights to avoid penalizing 
credit unions that are doing their jobs well. Other commenters 
suggested that the calculation should provide relief to well-run credit 
unions that manage their risk appropriately.
    A number of commenters suggested that the Original Proposal was 
biased toward lending and against investments, but that many credit 
unions have no other option but to purchase investments to improve 
their interest income to boost their overall earnings. Other commenters 
stated that the proposal created a bias in favor of consumer loans and 
short-term assets, which, along with the investment portfolio risk 
weights, would have forced credit unions down the yield curve to short-
duration assets and impeded their ability to build capital. A number of 
commenters suggested that the risk weight categories and asset 
categories were over generalized.
    A small number of commenters suggested that the rule would be 
better balanced if credit to the risk weights could be established with 
a rolling average to reward credit unions effectively managing their 
loan risks.
    The Board generally agrees with comments related to the need for 
more consistency of risk weights across asset classes, and that IRR and 
credit risk should not be commingled in the risk weights. Therefore, 
the Board has decided to make corresponding changes to the risk weights 
in this proposal. In this second proposal, the Board would address 
credit risk and concentration risk to be comparable to the Other 
Banking Agencies.\169\ The Board believes the other types of risks that 
would have been addressed in the Original Proposal are either currently 
addressed through supervision or will be addressed through alternative 
approaches in the future. In response to the comments received, 
particularly those related to investments and residential real estate 
loans, the Board believes deviating from the current rule's and 
Original Proposal's method for assigning risk weights would be more 
consistent with the associated credit risk and the risk weights 
assigned by the Other Banking Agencies.
---------------------------------------------------------------------------

    \169\ See, e.g., 12 CFR 324.32.
---------------------------------------------------------------------------

    This proposal would substantially change how the risk weights for 
investments would be assigned. Instead of assigning the investment risk 
weights based on weighted average life, the investment risk weights 
would be assigned based primarily on the credit quality of the 
underlying collateral or repayment ability of the issuer. This 
adjustment addresses the inconsistencies between the risk weights for 
loans and investments.
    For example, under this proposal most first-lien residential real 
estate

[[Page 4388]]

loans receive a 50 percent risk weight and an investment backed by 
similar assets would receive a 50 percent risk weight. Under this 
proposal, a credit union managing assets well by avoiding 
concentrations, non-current loans and risky investments would realize 
lower total risk-assets and thus a higher risk-based capital ratio. 
Further details on the changes to individual assets are addressed in 
the discussion on proposed Sec.  702.104(c)(2) below.
    Regarding support for the risk weights themselves, the Board notes 
that given the requirement in section 216(b)(1)(A)(ii) to maintain 
comparability with the Other Banking Agencies' PCA requirements, NCUA 
generally relied on risk weights assigned to various asset classes 
within the Basel Accords and established by the Other Banking Agencies' 
risk-based capital regulations to develop this proposal. Based on the 
comments received, the Board believes it has more precisely defined the 
risk weights. NCUA has tailored risk weights in this proposal for 
assets unique to credit unions, or where a demonstrable and compelling 
case existed based on contemporary and sustained performance 
differences as shown in Call Report data to differentiate for certain 
asset classes between banks and credit unions, or where a provision of 
the FCUA necessitated doing so. Thus, when compared to the Original 
Proposal, this second proposal would adjust asset classes and 
recalibrate risk weights, and is more comparable to the risk weights in 
the Other Banking Agencies' capital regulations.\170\
---------------------------------------------------------------------------

    \170\ See, e.g., 12 CFR 324.32.
---------------------------------------------------------------------------

104(c)(1) General
    Under the Original Proposal, proposed Sec.  702.104(c)(1) would 
have provided that total risk weighted assets include risk-weighted on-
balance sheet assets as described in Sec.  702.104(c)(2), plus the 
risk-weighted off-balance sheet assets in Sec.  702.104(c)(3), plus the 
risk-weighted derivative contracts in Sec.  702.104(c)(4), minus the 
risk-based capital ratio numerator deductions in Sec.  702.104(b)(2). 
The proposal would have required a complex credit union to calculate 
its risk-weighted asset amount for its on- and off-balance sheet 
exposures. In the proposal, risk-weighted asset amounts would have 
generally been determined by assigning an on-balance sheet asset to 
broad risk weight categories according to the asset type, collateral, 
and level of concentration. Similarly, risk-weighted assets amounts for 
off-balance sheet items would have been calculated using a two-step 
process: (1) Multiplying the notational principal or face value of the 
off-balance sheet item by a credit conversion factor (CCF) to determine 
a credit equivalent amount, and (2) assigning the credit equivalent 
amount to the relevant risk weighted category. A credit union would 
determine its total risk weighted assets by calculating (1) its risk 
weighted assets, minus (2) goodwill and other intangibles, and minus 
(3) the NCUSIF deposit.
    The Board received no comments on the language in this paragraph 
and has decided to retain this aspect of the Original Proposal with the 
following two changes.
    First, the Board proposes to add the following language to this 
subsection to address the assignment of a risk weight should a 
particular on- or off-balance sheet item meet more than one defined 
risk weight category: ``If a particular asset, derivative contract, or 
off-balance sheet item has features or characteristics that suggest it 
could potentially fit into more than one risk weight category, then a 
credit union shall assign the asset, derivative contract, or off-
balance sheet item to the risk weight category that most accurately and 
appropriately reflects its associated credit risk.'' A thorough 
evaluation of the true credit risk associated with such an item would 
be the determining factor for the appropriate risk weight.
    Second, the Board proposes to make minor conforming amendments to 
the language to further clarify the requirements.
    Accordingly, under this proposal Sec.  702.104(c)(1) would provide 
that risk-weighted assets includes risk-weighted on-balance sheet 
assets as described in Sec. Sec.  702.104(c)(2) and (c)(3), plus the 
risk-weighted off-balance sheet assets in Sec.  702.104(c)(4), plus the 
risk-weighted derivatives in Sec.  702.104(c)(5), less the risk-based 
capital ratio numerator deductions in Sec.  702.104(b)(2). In addition, 
the section would provide further that if a particular asset, 
derivative contract, or off balance sheet item has features or 
characteristics that suggest it could potentially fit into more than 
one risk weight category, then a credit union shall assign the asset, 
derivative contract, or off-balance sheet item to the risk weight 
category that most accurately and appropriately reflects its associated 
credit risk. The Board is proposing to add this language to account for 
the evolution of financial products that could lead to such products 
meeting the definition of more than one risk asset category. If 
necessary, NCUA would publish guidance to address these products, if 
and when developed.
104(c)(2) Risk Weights for On-Balance Sheet Assets
    Under the Original Proposal, proposed Sec.  702.104(c)(2) would 
have defined the risk categories and risk weights to be assigned to 
each specifically defined on-balance sheet asset. All on-balance sheet 
assets would be assigned to one of the 10 categories and risk weights.
    The Board received a significant number of comments on the proposed 
risk-weight categories and the risk weights assigned to particular 
assets and has decided to make a number of changes to this subsection, 
which are discussed in more detail below.
Material Risks
    In accordance with section 216(d)(2) of the FCUA, which requires 
NCUA's risk-based capital requirement ``to take account of any material 
risks against which the [6 percent] net worth ratio required for an 
insured credit union to be adequately capitalized may not provide 
adequate protection,'' \171\ the risk weights under the Original 
Proposal would have included elements to address credit, concentration, 
market risk, interest rate, and liquidity risk. In doing so, proposed 
Sec.  702.104(c) of the Original Proposal would have addressed 
concentration risk by assigning higher risk weights to larger 
percentages of assets in MBLs and real estate loans in Sec.  
702.104(c). The concentration threshold amounts were generally based on 
the average percentage of assets held in the asset types.
---------------------------------------------------------------------------

    \171\ 12 U.S.C. 1790d(d)(2).
---------------------------------------------------------------------------

    The Board has addressed comments received on the Original Proposal 
related to specific assets in the preamble parts corresponding to the 
various types of assets covered by this proposal below. However, the 
Board received a number of general comments on total risk-weighted 
assets.
    A number of commenters stated that NCUA did not adequately support 
the proposed risk weights nor show a significant correlation between 
losses and the current risk-based capital structure. Some commenters 
argued that the proposed risk weights were arbitrary and unsupported. 
Other commenters noted that the proposed risk weights did not take into 
account the quality of assets, the ability of credit unions to manage 
capital, liabilities on credit unions' balance sheets, or the actual 
loss experience of credit unions. A few commenters believed the 
proposal would create a bias against long-term lending and investments 
in favor of short-term assets. One commenter stated

[[Page 4389]]

that all risk weights should be capped at 100 percent. One commenter 
stated that the proposal would essentially structure the balance sheet 
for most credit unions so that commercial lending would be limited to 
15 percent of assets, real estate lending would be limited to 35 
percent of assets, HELOCs and second-lien mortgages would be limited to 
10 percent of assets, and the remainder of the balance sheet would be 
limited to short-term investments and consumer loans.
    After diligently considering all of the comments, and as discussed 
in more detail in the applicable sections, the Board is now proposing 
to make significant revisions to the current rule and the Original 
Proposal, which are discussed in more detail below, to address many of 
the concerns raised by commenters.
    Cash and investment risk weights. In general, the Original Proposal 
would have retained the approach used in the current rule for measuring 
risk weights for most cash items and investments. Consistent with the 
current rule, the risk weights for specific investments generally would 
have been based upon the weighted-average life of investments (WAL). 
The WAL is generally calculated based on the average time until a 
dollar of principal is repaid.\172\ Under the current rule, a higher 
risk weight is generally assigned to an investment with a longer WAL.
---------------------------------------------------------------------------

    \172\ There are a few exceptions, most notably calculating WAL 
until the next adjustment date for variable-rate obligations.
---------------------------------------------------------------------------

    Under the Original Proposal, the proposed risk weights for cash and 
investments would have been assigned as follows:

        Original Proposal--Risk Weights for Cash and Investments
------------------------------------------------------------------------
                                                               Proposed
                            Item                             risk weight
                                                               percent
------------------------------------------------------------------------
Cash on hand...............................................            0
NCUA and FDIC issued Guaranteed Notes......................            0
Direct, unconditional U.S. Government obligations..........            0
Cash on deposit............................................           20
Cash equivalents...........................................           20
Total investments with WAL <= 1-year.......................           20
Total investments with WAL > 1-year and <= 3-years.........           50
Total investments with WAL > 3-year and <= 5-years.........           75
Corporate credit union nonperpetual capital................          100
Total investments with WAL > 5-year and <= 10-years........          150
Total investments with WAL > 10-years......................          200
Corporate credit union perpetual capital...................          200
------------------------------------------------------------------------

    The Original Proposal would have also lowered the risk weight for 
direct and unconditional U.S. Government obligations (FDIC-issued 
Guaranteed Notes, and other U.S. Government obligations) from the WAL 
measure to zero percent risk weight, and maintained the current zero 
percent risk weight for NCUA-guaranteed assets. Finally, the Original 
Proposal would have removed nonperpetual and perpetual capital in 
corporate credit unions from the >1-3 year WAL category under the 
current rule and assigned those assets their own specific risk weights 
based on factors other than the WAL.
    The Board received a large number of comments on the risk weights 
for investments. Generally, commenters disagreed with the proposed risk 
weights. Specifically, many commenters felt that the risk weights were 
not the appropriate place to address IRR and that many of the risk 
weights could act to limit credit unions' investments in a way that 
would be detrimental to the individual credit unions and the credit 
union industry. In addition, many commenters cited inconsistencies 
between the risk weights for certain investments and the risk weights 
for the underlying assets, arguing that this may have the unintended 
consequence of encouraging credit unions to obtain riskier assets with 
lower risk weights rather than relatively safe investments that have 
much higher risk weights.
    Commenters who sought lower risk weights for investment varied in 
exactly how to lower risk weights. Some commenters argued that no 
investment should have a risk weight over 100 percent. Other commenters 
requested a reduced number of risk weight tiers, stating that it is 
more appropriate to have a 20 percent risk weight on investments with 
WALs up to five years and a risk weight of 100 percent for investments 
that have a WAL greater than 5 years. Commenters suggested that overall 
the proposed risk weight structure penalizes credit unions for 
investing and unfairly discriminates against longer-term investments. 
Several commenters also sought an ``other'' category for investments 
that would allow credit unions to demonstrate why certain investments 
do not warrant the risk weight associated with their WAL. Still other 
commenters asked that the Board adopt the weights for investments that 
are included in FDIC's interim final rule.
    In addition to requesting lower overall risk weights, many of the 
commenters addressing this topic also requested all agency and GSE 
securities receive a lower risk weight. Most commenters felt that 
securities offered by a federal agency or GSE and overnight Fed Fund 
deposits should have the same zero percent risk weight that is applied 
to NCUA- and FDIC-issued guaranteed notes and direct, unconditional 
U.S. Government obligations. These commenters argued that securities 
offered by agencies other than NCUA and FDIC and overnight Fed Fund 
deposits pose little to no risk to the investing credit unions and have 
an implicit or, in some cases, explicit guarantee of the U.S. 
Government. Further, commenters contend that without a lower risk 
weight on agency securities and overnight Fed Fund deposits, credit 
unions are actually incentivized to avoid these low-risk investments in 
favor of investments that carry greater credit risk, but offer the 
potential for a higher return as both types of investments carry the 
same risk weight. Commenters provided the

[[Page 4390]]

following example to illustrate this point: A credit union can invest 
in a private-label, asset-backed security with a 5.5-year WAL, or a 
security backed by the guarantee of a GSE with the same WAL, and both 
investments would have carried a 150 percent risk weight.
    Some commenters also asked for clarification on the risk weight for 
long-term CDs purchased from FDIC-insured institutions and investments 
in Federal Home Loan Banks.
    Further, a majority of the commenters addressing this section of 
the proposed rule argued that risk-based capital is not the appropriate 
medium to address IRR. Commenters stated that NCUA's attempt to 
regulate IRR through the risk-based capital requirement appeared 
arbitrary and was inconsistent with treatment provided to banks by the 
Other Banking Agencies. One commenter stated that, if NCUA uses the 
risk-based capital requirement to regulate IRR, it should note that 
shocks of 300 basis points are rare and have not been seen since the 
early 1980's. Further, commenters stated that basing risk weights on 
the WAL does not take into account credit risk, the funding source for 
the investments, whether the investment is fixed- or variable-rate, 
actual maturity of the investment, optionality, or the benefit of 
longer-term investments--all of which, commenters argue, provide a 
better evaluation of the risk associated with an investment than the 
WAL.
    Some commenters also noted that the proposed risk weights for 
investments would lead to inconsistent treatments among various assets. 
Specifically, commenters argued that the risk weights on some long-term 
investments that pose a low degree of risk are weighted higher than 
other, riskier assets. To support these arguments, commenters cited 
examples that included: A member business loan with a seven-year 
balloon would carry a lower risk weight than a seven-year bullet agency 
security; a current credit card loan would have a lower risk weight 
than a 5.5-year security guaranteed by a GSE; and an indirect auto loan 
with a 130 percent loan-to-value would have a lower risk weight than a 
5.5-year GSE guaranteed security. Other commenters questioned why the 
risk weight for a mortgage-backed security is higher than the 
underlying 30-year mortgage that backs the security.
    Several commenters questioned how the proposal affects the 
authority in Sec.  701.19, which allows a federal credit union to 
purchase investments to fund employee benefit plans without being 
subject to NCUA's investment rules. Generally, commenters requested 
lower risk weights for investments held to fund employee benefit plans 
and life insurance contracts held by the credit union on its executive-
level employees. Commenters contend that credit unions may be less 
likely to offer and fund employee benefit plans because of the risk 
weights. Further, one commenter stated that the proposal does not take 
into account the purpose of the investments and their applicability to 
benefit plan funding, potentially creating risks from both a fiduciary 
standpoint and the loyalty of executives and employees. Several 
commenters also requested that the Board include specific risk weights 
for annuities and mutual funds used to fund employee benefit programs 
based on the underlying accounts and investment strategies. One 
commenter suggested that mutual funds be weighted based on the 
underlying investment strategy. This commenter suggested the following 
breakdown: State and federal government funds--20 percent; Municipal 
bond strategies--50 percent; Asset-backed, mortgage-backed, and bank 
loan funds--100 percent; Other funds--150 percent; Bonds--WAL; Equity 
securities--200 percent. Another commenter stated that life insurance 
contracts owned by the credit union should be rated at 20 percent for 
AAA- and AA-rated insurers.
    The Board generally agrees with commenters' concerns regarding the 
differences between the current risk-based requirements, the Original 
Proposal's investment risk weights, and the risk weights assigned by 
the Other Banking Agencies. As discussed in the summary part of the 
preamble above, the Board believes that measures of IRR should be based 
on a credit union's entire balance sheet to take into account the 
offsetting risk effects of assets and liabilities (including any 
benefits from derivative transactions). The Board also generally agrees 
with commenters that the use of asset-duration risk weights in the 
risk-based capital scheme is overly simplistic and does not fully take 
into account potential risk mitigation benefits, such as liabilities 
and derivatives.
    The Board agrees that the approach taken in the Original Proposal 
should be revised. Accordingly, the Board is now proposing to change 
the risk weights in the investment area to more closely align them with 
the risk weights in the Other Banking Agencies' regulations,\173\ and 
to handle IRR outliers through alternative approaches and possibly a 
separate subsequent rulemaking.
---------------------------------------------------------------------------

    \173\ See, e.g., 12 CFR 324.32.
---------------------------------------------------------------------------

    In particular, the Board is now proposing to eliminate the process 
of assigning risk weights for investments based on WAL of investments 
in favor of a credit-risk centered approach for investments. As 
discussed earlier in the document, the credit risk approach to 
assigning risk weights under this proposal is based on applying lower 
risk weights to safer investment types and higher risk weights to 
riskier investment types.\174\ The proposed investment risk weights 
would be similar to the risk weights assigned to investments under the 
Other Banking Agencies' regulations,\175\ which are based on the 
credit-risk elements of the issuer and the position of the particular 
type of investment. The proposed changes to the risk weights assigned 
to investments are outlined in the following table:
---------------------------------------------------------------------------

    \174\ When the Board evaluates the risk of an investment type, 
it is based on criteria such as volatility, historical performance 
of the investments, and standard market conventions.
    \175\ See, e.g., 12 CFR 324.32.

          This Proposal--Risk weights for Cash and Investments
------------------------------------------------------------------------
                                                               Proposed
                            Item                             risk weight
                                                              (percent)
------------------------------------------------------------------------
 The balance of cash, currency and coin, including             0
 vault, automatic teller machine, and teller cash..........
 The exposure amount of:
    [cir] An obligation of the U.S. Government, its central
     bank, or a U.S. Government agency that is directly and
     unconditionally guaranteed, excluding detached
     security coupons, ex-coupon securities, and principal
     and interest only mortgage-backed STRIPS..............
    [cir] Federal Reserve Bank stock and Central Liquidity
     Facility stock........................................
 Insured balances due from FDIC-insured              ...........
 depositories or federally insured credit unions...........

[[Page 4391]]

 
 The uninsured balances due from FDIC-insured                 20
 depositories, federally insured credit unions, and all
 balances due from privately-insured credit unions.........
 The exposure amount of:
    [cir] A non-subordinated obligation of the U.S.
     Government, its central bank, or a U.S. Government
     agency that is conditionally guaranteed, excluding
     principal and interest only mortgage-backed STRIPS....
    [cir] A non-subordinated obligation of a GSE other than
     an equity exposure or preferred stock, excluding
     principal and interest only GSE obligation STRIPS.....
    [cir] Securities issued by PSEs in the United States
     that represent general obligation securities..........
    [cir] Investment funds whose portfolios are permitted
     to hold only part 703 permissible investments that
     qualify for the zero or 20 percent risk categories....
    [cir] Federal Home Loan stock..........................
 Balances due from Federal Home Loan Banks.........
 The exposure amount of:                                      50
    [cir] Securities issued by PSEs in the U.S. that
     represent non-subordinated revenue obligation
     securities............................................
    [cir] Other non-subordinated, non-U.S. Government
     agency or non-GSE guaranteed, residential mortgage-
     backed securities, excluding principal and interest
     only STRIPS...........................................
 The exposure amount of:                                     100
    [cir] Industrial development bonds.....................
    [cir] All stripped mortgage-backed securities (interest
     only and principal only STRIPS).......................
    [cir] Part 703 compliant investment funds, with the
     option to use the look-through approaches.............
    [cir] Corporate debentures and commercial paper........
    [cir] Nonperpetual capital at corporate credit unions..
    [cir] General account permanent insurance..............
    [cir] GSE equity exposure and preferred stock..........
 All other assets listed on the statement of
 financial condition not specifically assigned a different
 risk weight...............................................
 The exposure amount of perpetual contributed                150
 capital at corporate credit unions........................
 The exposure amount of:                                     300
    [cir] Publicly traded equity investment, other than a
     CUSO investment.......................................
    [cir] Investment funds that are not in compliance with
     part 703 of this Chapter, with the option to use the
     look-through approaches...............................
    [cir] Separate account insurance, with the option to
     use the look-through approaches.......................
 The exposure amount of non-publicly traded equity           400
 investments, other than equity investments in CUSOs.......
 The exposure amount of any subordinated tranche of        1,250
 any investment, with the option to use the gross-up
 approach..................................................
------------------------------------------------------------------------

    The Board disagrees with commenters who suggested that all 
investments should be assigned a risk weight of 100 percent or less. 
Assigning a maximum of 100 percent risk weight to all investments would 
not sufficiently capture the risk of equity or leveraged investments, 
and would unjustifiably differ from the risk weights used by the Other 
Banking Agencies. Based on the extensive analyses performed by the 
Basel Committee \176\ and the Other Banking Agencies in the development 
of their regulations, the Board believes the Other Banking Agencies' 
risk weights sufficiently reflect the credit risk in their respective 
categories. As the same type of investment will perform on a credit 
risk basis identically for credit unions and banks, in general, 
variations in this proposal from the approach taken by the Other 
Banking Agencies' regulations \177\ are due to differences in credit 
union investments, the investment authorities of credit unions, or are 
intended to offer credit unions a simplified but equivalent approach 
for applying risk weights.
---------------------------------------------------------------------------

    \176\ Basel Committee on Banking Supervision, ``International 
Convergence of Capital Measurement and Capital Standards: A Revised 
Framework, Comprehensive Version'' 214 (June 2006) available at 
http://www.bis.org/publ/bcbs128.pdf (Basel II) and Basel Committee 
on Banking Supervision, ``An Explanatory Note on the Basel II IRB 
Risk Weight Functions'' (July 2005).
    \177\ See, e.g., 12 CFR 324.32.
---------------------------------------------------------------------------

    Another area where commenters expressed concern was with the risk 
weights assigned to U.S. Government agency and GSE securities under the 
Original Proposal. The Board believes it has addressed these concerns 
in this second proposed rule by removing the IRR component from the 
risk weights for investments. The Board also believes this concern 
would be addressed for these and other investment types by assigning 
risk weights on long-term assets only based on the credit risk, and not 
IRR. For example, an 11-year WAL non-subordinated mortgage-backed 
security issued by a GSE would have been assigned a 200 percent risk 
weight under the Original Proposal, while a 2-year WAL of the same 
security type would have been assigned a 50 percent risk weight. 
Conversely, under this second proposed rule, both securities would be 
assigned a 20 percent risk weight, which is based only on the credit 
risk of the investment type.
    The Board has also assigned risk weights to types of investments, 
such as corporate bonds, asset-backed securities and corporate 
equities, which are generally not available to federal credit unions. 
These risk weights were assigned to account for the fact that federally 
insured state chartered credit unions sometimes have investment 
authorities that allow then to invest in assets not available to FCUs. 
In addition, Sec.  701.19 permits federal credit unions to purchase 
investments to fund employee benefits that are not otherwise available 
to federal credit unions under NCUA's investment regulations. For these 
types of assets, the Board has assigned risk weights that it believes 
reflect the risk of the assets that could be used to fund employee 
benefit plans.
    The Board disagrees with commenters who suggested lower risk 
ratings should be applied to such assets because they were purchased 
for employee benefit plans. However, the Board does seek comment on 
whether lower risk weights should be applied to investments that fund 
employee benefit plans in which all of the risk of loss is held by the

[[Page 4392]]

beneficiary. For example, how should NCUA assign a risk weight to an 
equity investment on a credit union's statement of financial condition 
that represents a holding in a credit union executive's 457(b) plan?
    The Board chose not to assign risk weights based on credit ratings, 
as at least one commenter requested. Consistent with the Dodd-Frank 
Wall Street Reform and Consumer Protection Act of 2010, which required 
agencies to remove all references to credit ratings, NCUA does not use 
credit ratings to determine risk weights for part 702.\178\
---------------------------------------------------------------------------

    \178\ Public Law 111-203, Title IX, Subtitle C, section 939A, 
124 Stat. 1376, 1887 (July 21, 2010).
---------------------------------------------------------------------------

    Loans generally. NCUA received a substantial number of comments 
regarding the risk weights assigned to loans in general. A number of 
commenters stated that the proposed risk weights for various types of 
loans were overly broad, arbitrary, punitive, and did not take into 
account the individual underwriting terms, pricing and risk management 
of individual credit unions. Other commenters suggested that the 
proposed risk weights for loans failed to consider loan-to-value 
ratios, fixed- versus variable-rate loans, repricing opportunities, 
maturity length, and other risk mitigation strategies. Still other 
commenters stated that the quality of the loan portfolio is the most 
determinant of risk to capital. A number of commenters stated that all 
loans are not the same like the rule is treating them. Other commenters 
objected to laddering quantitative risk-based metrics for loans because 
doing so ignores credit union's strategic and business plans, taking 
growth management away from the board of directors.
    However, the Board cannot uniformly use these criteria to measure 
minimum capital requirements for credit unions because of the 
indeterminate reporting that would be necessary and the myriad of 
variables available to establish a sound lending program. This second 
proposed rule is consistent with the regulatory capital models under 
the Basel framework, which are portfolio invariant.\179\ Being 
``portfolio invariant'' means that the capital charge for a particular 
loan category is consistent among all credit union portfolios based on 
the loan characteristics, rather than the individual credit union's 
portfolio performance or characteristics. Taking into account each 
credit union's individual characteristics would be too complicated for 
both credit unions and NCUA for minimum regulatory capital 
requirements.
---------------------------------------------------------------------------

    \179\ Basel Committee on Banking and Supervision, An Explanatory 
Note on the Basel II IRB Risk Weight Functions, July 2005, available 
at http://www.bis.org/bcbs/irbriskweight.htm. ``The model should be 
portfolio invariant, i.e. the capital required for any given loan 
should only depend on the risk of that loan and must not depend on 
the portfolio it is added to. This characteristic has been deemed 
vital in order to make the new IRB framework applicable to a wider 
range of countries and institutions.''
---------------------------------------------------------------------------

    A number of commenters stated that assigning risk weights to loans 
based on the risk of the underlying loans makes more sense than on the 
size of the portfolio. Other commenters suggested that if IRR is 
included in investment risk weights, it should also be included in loan 
risk weights.
    As noted in the summary section, the Board believes the revised 
loan concentration risk thresholds and corresponding risk weights under 
this proposal would address only credit risk exposures, and to a 
limited extent concentration risk exposures. While certain loans 
contain a substantial amount of IRR, the Board does plan to consider 
alternative approaches to address IRR separately from this rulemaking.
    Several commenters suggested that the Board remove the higher-risk 
components for delinquent loans because the ALLL balance is already 
factored into the formula. Conversely, other commenters stated that 
they appreciated that the Original Proposal assigned delinquent and 
non-delinquent loans different risk weights.
    At least one commenter suggested that troubled debt restructuring 
loans be risk-weighted at 50 percent.
    This proposal would maintain a separate, higher risk weight for 
loans that are not current, but would also, as discussed in detail 
above, eliminate the 1.25 percent cap on the ALLL in the risk-based 
capital ratio numerator. The Board believes the proposed higher risk 
weight that would be assigned to non-current loans is warranted because 
such loans have a higher probability of default when compared to 
current loans. Non-current loans are more likely to default because 
repayment is already impaired making them one step closer to default 
compared to current loans. Additionally, a higher risk weight for non-
current loans is consistent with the risk weights assigned by the Other 
Banking Agencies.\180\
---------------------------------------------------------------------------

    \180\ See, e.g., 12 CFR 324.32(k).
---------------------------------------------------------------------------

    A small number of commenters suggested that share-secured loans 
should have a risk weight between zero and 25 percent since they are 
fully secured. Also, some commenters noted that secured consumer loans 
generally pose less risk than unsecured consumer loans. The Board 
generally agrees that share-secured loans pose less risk to credit 
unions than other types of secured loans. Accordingly, under this 
second proposal share-secured loans would be assigned a 20 percent risk 
weight. The board does not believe a risk weight of zero percent is 
warranted because of the small amount of operational and transaction 
risk present in share-secured loans. A risk weight of 20 percent for 
share-secured loans is proposed because it recognizes the low amount of 
risk and is consistent with the 20 percent risk weight for contractual 
compensating balances on commercial loans that are also secured by 
shares on deposit.
    The Board also agrees unsecured consumer loans generally pose more 
risk than secured consumer loans, and is therefore proposing to assign 
a lower risk weight of 75 percent to secured consumer loans and a 
higher risk weight of 100 percent to unsecured consumer loans. The 100 
percent risk weight for unsecured consumer loans would be comparable to 
the Other Banking Agencies' risk weight for consumer loans.\181\ 
Because secured consumer loans pose less risk to a credit union than 
unsecured consumer loans, the Board is proposing to assign secured 
consumer loans a lower risk weight of 75 percent compared to the 100 
percent risk weight for unsecured consumer loans.
---------------------------------------------------------------------------

    \181\ See, e.g., 12 CFR 324.32(l)(5).
---------------------------------------------------------------------------

    A small number of commenters suggested that loans held for sale 
should have a 25 percent risk weight. Other commenters suggested that 
loans held for sale should have a 50 percent risk weight.
    After considering the comments received, the Board continues to 
believe that loans held for sale carry identical risks to the 
originating credit union as other loans held in the credit union's 
portfolio until transfer to the purchaser is final. Until the 
originating credit union transfers the loan to the purchaser, the 
originating credit union bears the risk of the loan defaulting. If the 
loan defaults prior to the finalization of the transfer, the 
originating credit union must account for any loss from the defaulting 
loan, similar to other loans held on the credit union's books. Because 
they carry the same risks, loans held for sale would be assigned a risk 
weight based on the loan's type.
    Commercial Loans. The Original Proposal would have increased the 
risk weights for member business loans (MBLs) from the current rule to 
address the historical correlation between high concentrations of MBLs 
and higher risk to the credit union. As noted in the

[[Page 4393]]

Original Proposal, many of the largest losses the NCUSIF has 
experienced over its history have occurred in credit unions with high 
concentrations of MBLs.\182\ In addition, the failures of many small 
banks between 2008 and 2011 were largely driven by high concentrations 
of commercial loans.\183\
---------------------------------------------------------------------------

    \182\ GAO found in its 2012 report that credit unions who failed 
had more MBLs as a percentage of total assets than peers and the 
industry average. See. U.S. Govt. Accountability Office, GAO-12-247, 
Earlier Actions Are Needed to Better Address Troubled Credit Unions 
17 (Jan. 2012) available at http://www.gao.gov/products/GAO-12-247.
    \183\ U.S. Government Accountability Office, GAO-13-704T, Causes 
and Consequences of Recent Community Bank Failures 4 (June 12, 2013) 
available at http://www.gao.gov/assets/660/655193.pdf.
---------------------------------------------------------------------------

    For purposes of the Original Proposal, ``member business loans 
outstanding'' would have consisted of loans outstanding that qualified 
as MBLs under NCUA's definition,\184\ or under a state's NCUA-approved 
definition.\185\ If a loan qualified as a MBL when it is originated, it 
would have remained so until it had been repaid in full, sold, or 
otherwise disposed of.
---------------------------------------------------------------------------

    \184\ See 12 CFR 723.1.
    \185\ See 12 CFR 723.20.
---------------------------------------------------------------------------

    Consistent with the current rule, the Original Proposal would have 
applied risk weights to MBLs as a percentage of total assets. As a 
credit union's concentration in particular asset classes increased, 
incrementally higher levels of capital would have been required.\186\ 
The following table shows a comparison of the current rule and the 
Original Proposal:
---------------------------------------------------------------------------

    \186\ Under the current rule, the Original Proposal and this 
second proposal, concentration risk is accounted for in commercial 
and real estate loans because historically this is where credit 
unions have experienced concentration risk problems.
    \187\ The current MBL risk weights were converted to a 
comparable risk weight by dividing the current risk weight by eight 
percent, with eight percent representing the level of risk weighted 
capital needed to be adequately capitalized. In the current rule 
total MBLs less than the threshold 15 percent of assets receive a 
six percent risk weight, which is equivalent to a 75 percent risk 
weight under this proposal (six percent divided by eight percent). 
The next threshold in the current regulation for total MBLs from 15 
percent to 25 percent of assets received an eight percent risk 
weight, which is equivalent to a 100 percent risk weight under this 
proposal (eight percent divided by eight percent) and the highest 
concentrations of MBLs received a 14 percent risk weight, which is 
equivalent to a 175 percent risk weight under the proposal (14 
percent divided by eight percent).
    \188\ This is consistent with the Other Banking Agencies' 
capital rules (e.g., 12 CFR 324.32), which maintain a 100 percent 
risk weight for commercial real estate (CRE) and includes a 150 
percent risk weigh for loans defined as high-volatility commercial 
real estate (HVCRE). See, e.g., 78 FR 55339 (Sept. 10, 2013).

                      Comparison--MBL Components of the Current Rule and Original Proposal
----------------------------------------------------------------------------------------------------------------
                                                                 Current rule MBL risk
                                                                     weights\187\--
                          Total MBLs                               (converted for 8%      Original proposal MBL
                                                                 adequately capitalized        risk weights
                                                                         level)
----------------------------------------------------------------------------------------------------------------
0 to 15% of Assets............................................                      75%                100%\188\
>15 to 25% of Assets..........................................                     100%                     150%
Amount over 25%...............................................                     175%                     200%
----------------------------------------------------------------------------------------------------------------

    Under the Original Proposal, MBLs that were at least 75 percent 
guaranteed by the federal government, typically by the Small Business 
Administration (SBA) or U.S. Department of Agriculture, would have 
received a risk weight of 20 percent regardless of the percent of the 
credit union assets they represented.\189\
---------------------------------------------------------------------------

    \189\ Under the current rule the entire balance of MBLs 
outstanding, including any amount partially guaranteed by a U.S. 
Government agency, is included in the risk weight for MBLs (i.e., 
the equivalent risk-weight under the current rule for an MBL that is 
75 percent government guaranteed is the same as the risk weight for 
any other MBL. Thus, this proposed rule would be more favorable 
because it would assign a low risk weight of 20% to the portion of 
the commercial loan with a U.S. Government guarantee. This is in 
addition to the lower risk weight that would be assigned to non-
owner occupied one-to-four-family residential real estate loans that 
would not be risk-weighted as commercial loans under this proposal.
---------------------------------------------------------------------------

    A substantial number of commenters addressed MBLs and generally 
disagreed with the proposed risk weights in the Original Proposal, 
noting that the risk weight assigned to commercial loans under the 
Other Banking Agencies' capital regulations would have been lower for 
such loans when held in higher concentrations.
    There were, however, a few commenters that agreed that higher risk 
weights should be applied to MBLs held in higher concentrations.
    Many commenters objected to the Board's methodology for assigning 
risk weights to MBLs based on concentration. Other commenters disagreed 
with NCUA's methodology of assigning risk weights based on 
concentrations of MBLs compared to total assets. These commenters 
argued that risk weights based on concentration levels do not take into 
account all pertinent information to accurately determine risk. Some 
commenters believed that risk weights should be assigned based on the 
type of loan, specifically separating loans by business purpose 
(commercial, agricultural, or construction and development). Some of 
these commenters suggested the Board should address concentration risk 
through supervision rather than through a rulemaking.
    Some commenters questioned the interplay between exemptions from 
the statutory cap on MBLs and higher risk weights for credit unions 
that exceed the cap. These commenters pointed out that many credit 
unions have been given an exemption from the statutory MBL 
concentration limit. Some of these commenters stated that the proposed 
risk weights would nullify the exemptions included in the Federal 
Credit Union Act and may lead some credit unions to discontinue 
business lending, particularly in the area of agriculture. To that end, 
commenters requested a variety of solutions. Some commenters believed 
credit unions exempt from the statutory MBL cap should be given more 
time to comply with the MBL risk weights, while other commenters argued 
there should be a separate set of risk weights for exempt credit 
unions. Finally, some commenters requested that the Board allow credit 
unions exempt from the statutory MBL cap to continue following the risk 
weights in the current rule.
    Higher capital requirements for concentrations of MBLs exist in the 
current rule and the Board believes completely eliminating them would 
be a step backwards in matching risks with minimum risk-based capital 
requirements. Credit unions with high commercial loan concentrations 
are particularly susceptible to changes in business conditions that can 
affect borrower cash flow, collateral value, and other factors 
increasing the probability of default.
    NCUA does currently review credit concentrations during 
examinations as commenters recommended. However, as discussed in the 
summary section, the

[[Page 4394]]

FCUA requires that NCUA's risk-based net worth requirement account for 
material risks that the six percent net worth ratio may not provide 
adequate protection, which would include credit concentration 
risks.\190\
---------------------------------------------------------------------------

    \190\ See 12 U.S.C. 1790d(d)(2).
---------------------------------------------------------------------------

    Basel II states, ``risk concentrations are arguably the single most 
important cause of major problems in banks.'' \191\ In addition, GAO 
specifically recommended that the Board continue to address 
concentration risk in the risk-based capital requirement. GAO found in 
its 2012 report that credit unions that failed had more MBLs as a 
percentage of total assets than peers and the industry average.\192\ 
GAO advised the Board to revise NCUA's PCA requirements to take into 
account credit unions with a high percentage of MBLs to total assets. 
In addition, NCUA's OIG recommended in MLRs that the Board increase the 
risk weights assigned to MBLs, citing numerous and excessive NCUSIF 
losses related to MBLs, including a number of large credit unions with 
high concentrations of MBLs.\193\
---------------------------------------------------------------------------

    \191\ International Convergence of Capital Measurement and 
Capital Standards--June 2006. Basel Committee on Banking 
Supervision.
    \192\ See U.S. Govt. Accountability Office, GAO-12-247, Earlier 
Actions Are Needed to Better Address Troubled Credit Unions (Jan. 
2012) available at http://www.gao.gov/products/GAO-12-247.
    \193\ OIG Capping Report on Material Loss Reviews, Report # OIG-
10-20, November 23, 2010. Also see Material Loss Review of Telesis 
Community Credit Union, Report # OIG-13-05, March 15, 2013.
---------------------------------------------------------------------------

    However, after consideration of the comments, the Board is 
proposing to modify the approach to MBLs taken in the Original Proposal 
assigning risk weights to ``commercial loans'' rather than ``MBLs.'' 
Under this second proposal the risk weights assigned to commercial 
loans would generally be consistent with those assigned by Other 
Banking Agencies and with the objectives of the Basel Committee on 
Banking Supervision.\194\ This proposal reduces the number of 
commercial loan concentration thresholds from two to one, with a single 
concentration threshold at 50 percent of total assets. Applicable 
commercial loans less than the 50 percent threshold would be assigned a 
100 percent risk weight, and commercial loans over the threshold would 
be assigned a 150 percent risk weight. Commercial loans that are not 
current would be assigned a 150 percent risk weight. This change to a 
single, higher concentration risk threshold would simplify the risk 
weight framework and calibrate it to only pick up outliers. The 
concentration threshold for commercial loans is well over two standard 
deviations from the mean. Based on December 2013 Call Report data, all 
but 12 credit unions with total assets of $100 million or greater 
operate at a level in which the risk weights assigned to commercial 
loans would be similar to the risk weight assigned by the Other Banking 
Agencies.\195\
---------------------------------------------------------------------------

    \194\ This is comparable with the other Federal Banking 
Regulatory Agencies' capital rules (e.g., 12 CFR 324.32), which 
maintain a 100 percent risk-weight for commercial real estate (CRE) 
and includes a 150 percent risk-weight for loans defined as high 
volatility commercial real estate (HVCRE). See, e.g., 78 FR 55339 
(Sept. 10, 2013). Basel Committee on Banking Supervision, 
International Convergence of Capital Measurement and Capital 
Standards, June 2006, ``In view of the experience in numerous 
countries that commercial property lending has been a recurring 
cause of troubled assets in the banking industry over the past few 
decades, Committee holds to the view that mortgages on commercial 
real estate do not, in principle, justify other than a 100% risk 
weight of the loans secured.'' Available at http://www.bis.org/publ/bcbs128.htm.
    \195\ See, e.g., 12 CFR 324.32(f).
---------------------------------------------------------------------------

    Further, the 50 percent threshold and the risk weights of 100 
percent and 150 percent result in nearly identical capital 
requirements, as compared to the current rule, for high concentrations 
of commercial loans. This creates parity to the Other Banking Agencies' 
rules\196\ for virtually all credit unions, and allows credit unions 
exempt from the MBL cap (with very high concentration levels) to 
continue to operate under effectively the same capital requirements of 
the current rule. Further, none of the credit unions that would be 
subject to the concentration threshold have material variations in the 
type of their MBLs. So such an approach would add significant 
complexity to the rule with no benefit.
---------------------------------------------------------------------------

    \196\ Id.

----------------------------------------------------------------------------------------------------------------
                                                     Commercial loan concentration (percent of total assets)
                                                ----------------------------------------------------------------
                                                     15%          20%          50%          75%          100%
----------------------------------------------------------------------------------------------------------------
Effective Capital Rate:\197\
    Current Rule...............................         6.0%         6.5%        10.4%        11.6%        12.2%
    This Proposal..............................        10.0%        10.0%        10.0%        11.7%        12.5%
----------------------------------------------------------------------------------------------------------------

    The Board also disagrees that concentration thresholds for 
commercial loans should vary based on the business purpose or 
underlying collateral. Utilizing specific commercial loan type or 
collateral loss history is not a reliable or consistent method for 
assigning risk weights in a regulatory model. Nor is it consistent with 
the Basel framework or the Other Banking Agencies' capital models. All 
commercial asset classes experience performance fluctuations with 
variations in business cycles. Some sectors that have experienced 
minimal losses are now pre-disposed to heightened credit risk. Both 
NCUA and FDIC have recently addressed these types of exposures in 
respective Letters to Credit Unions and Financial Institution 
Letters.\198\
---------------------------------------------------------------------------

    \197\ The effective capital rate represents the blended 
percentage of capital necessary for a given level of commercial loan 
concentration. For this proposal's figures, the calculation uses 10% 
as the level of risk-based capital to be well capitalized under this 
proposal.
    \198\ NCUA Letter to Credit Unions, 14-CU-06, Taxi Medallion 
Lending, April 2014. Financial Institution Letter, Prudent 
Management of Agricultural Credits Through Economic Cycles, FIL-39-
2014, July 16, 2014.
---------------------------------------------------------------------------

    A large number of commenters addressing MBLs argued that the risk 
weights for credit unions should be lower than the risk weights 
employed by FDIC for banks. Commenters noted that the proposed risk 
weight of 100 percent for total MBLs of zero to 15 percent of total 
assets was the same as the risk weight for commercial loans under 
FDIC's interim final regulation. Commenters argued, however, that 
credit unions have historically had a lower loss rate on MBLs than 
community banks had for commercial loans. These commenters argued that 
since credit unions have a lower historical loss rate than banks, the 
risk weights assigned to MBLs should also be lower. Other commenters 
noted that NCUA's MBL regulation is more conservative than commercial 
lending regulations for banks, and, therefore, at a minimum the Board 
should adopt a 100 percent risk weight, regardless of concentration, to 
mirror the commercial loan risk weights for banks.
    The Board does not believe the contemporary variances between bank 
and credit union losses on commercial loans are substantial enough to 
warrant assigning lower risk weights to

[[Page 4395]]

commercial loans held by credit unions. Credit unions' commercial loan 
loss experience is comparable to community banks after adjusting for 
asset size. The recent loss experience for credit unions and banks is 
very similar.

------------------------------------------------------------------------
                                            3 Year average loss history
                                         -------------------------------
                                           Credit unions  Banks $100M to
                                             >$100M in        $10B in
                                              assets          assets
------------------------------------------------------------------------
Commercial & Industrial.................            0.75            0.78
------------------------------------------------------------------------

    Further, credit unions' long-term historical MBL losses are 
somewhat understated because the NCUA's Call Report did not collect 
separate MBL data until 1992. Thus, significant MBL losses experienced 
in the late 1980s and early 1990s are not included in the long-term 
historical credit union MBL loss data.\199\
---------------------------------------------------------------------------

    \199\ NCUSIF losses from MBLs are a recurring historical trend. 
The U.S. Treasury Report on Credit Union Member Business Lending 
discusses 16 credit union failures from 1987 to 1991 that cost the 
NCUSIF over $100 million. Department of the Treasury, Credit Union 
Member Business Lending (Washington DC January 2001).
---------------------------------------------------------------------------

    Some commenters also questioned the disparity between NCUA's 
treatment of unfunded commitments and the treatment in Basel III. For 
this second proposal, the Board has adjusted the treatment for unfunded 
MBL commitments to be more comparable to the Other Banking Agencies' 
rules.\200\
---------------------------------------------------------------------------

    \200\ See, e.g., 12 CFR 324.33.
---------------------------------------------------------------------------

    Under this proposal, the definition of ``commercial loans,'' as 
discussed in the definition section of this preamble, would: (1) 
include all commercial purpose loans regardless of dollar amount; (2) 
exclude one-to-four-family non-owner occupied first-lien real estate 
loans, which would be considered residential real estate loans for the 
purpose of assigning risk weights in this proposal; (3) exclude any 
loans secured by a vehicle generally manufactured for personal use; (4) 
assign to the portion of a commercial loan that is insured or 
guaranteed by the U.S. Government, U.S. Government agency, or a public 
sector entity a lower risk weight of 20 percent and not count such 
loans toward the 50 percent of assets concentration threshold; and (5) 
assign to any amount of a contractual compensating balance associated 
with a commercial loan and on deposit in the credit union a 20 percent 
risk weight and not count such amounts toward the 50 percent of assets 
concentration threshold. The revised definition of commercial loan 
would better capture the loans made for a commercial purpose that have 
similar risk characteristics. The portion of a commercial loan that is 
insured or guaranteed by the U.S. Government, U.S. Government agency, 
or a public sector entity would be assigned a lower risk weight of 20 
percent and would not count toward the 50 percent of asset threshold. 
This provision is comparable to the Other Banking Agencies.\201\ The 
amount of a contractual compensating balance associated with a 
commercial loan and on deposit in the credit union would receive a 20 
percent risk weight and not count toward the 50 percent of assets 
concentration threshold since the credit union has the ability to apply 
the compensating balance against the amount owed, lowering the 
potential loss exposure. This provision would be unique to credit 
unions but appropriately reduces the risk weight due to the existence 
of the compensating balances. The Board believes these changes would 
encourage the use of government guarantees and compensating balances 
and provide credit unions with additional methods to serve commercial 
borrowers while reducing their minimum capital requirement without 
increasing risk to the NCUSIF for commercial loan losses.
---------------------------------------------------------------------------

    \201\ See, 12 U.S.C. 324.32(a).
---------------------------------------------------------------------------

    Residential real estate loans. The current standard approach to 
assigning risk weights in part 702 of NCUA's regulations establishes 
higher capital requirements for only ``long term'' real estate loans, 
and excludes loans that re-price, refinance, or mature within five 
years or less. By excluding loans that re-price, refinance, or mature 
within five years or less from higher capital requirements, as a 
result, the current rule does not adequately account for credit unions 
that have high real estate loan concentrations.
    Additionally, junior-lien real estate loans, which have a 
significantly higher loss history, are assigned the same risk weight as 
first-lien mortgage real estate loans under the current rule. As a 
result, the current real estate loan risk weights incentivize credit 
unions to structure their mortgage products to minimize their capital 
requirements, which can impact the marketability of such loans. As 
discussed in more detail below, the Original Proposal would have made a 
number of changes to the current rule to address these concerns.
    Consistent with the current rule, the Original Proposal would have 
continued to exclude from the real estate risk weights those real 
estate loans reported as MBLs. The Original Proposal would have 
recognized the lower loss history for current, prudently written first-
lien real estate-secured loans by assigning a lower risk weight of 50 
percent to the first 25 percent of assets.\202\ To account for 
concentration risk, the proposal would have raised the risk weight for 
first-lien real estate loans between 25 and 35 percent of assets from 
50 percent to 75 percent. First-lien real estate loans over 35 percent 
of assets would have been assigned a 100 percent risk weight. The 
threshold of 25 percent was based on the average percentage of first-
lien real estate loans to total assets, which, as of June 30, 2013, was 
24.9 percent for complex credit unions, as defined under the current 
rule.
---------------------------------------------------------------------------

    \202\ This is comparable with the Other Banking Agencies' 
capital rules (e.g., 12 CFR 324.32), which maintained the 50 percent 
risk weight for one-to-four-family real estate loans that are 
prudently underwritten, not 90 days or more past due, and not 
restructured or modified, and a 100 percent risk weight for such 
loans otherwise. See, e.g., 78 FR 55339 (Sept. 10, 2013).
---------------------------------------------------------------------------

    Under the Original Proposal, if a credit union held the first- and 
junior-liens on a property, and no other party held an intervening 
lien, the credit union could have treated the combined exposure as a 
single loan secured by a first lien for the purpose of assigning the 
risk weight. First-lien real estate loans assigned to the 50 percent 
risk weight category could not have been restructured or modified 
loans. First-lien real estate loans modified or restructured on a 
permanent or trial basis solely under the U.S. Treasury's Home 
Affordability Mortgage Program (HAMP) would not have been considered 
restructured or modified.
    First-lien real estate loans guaranteed by the federal government 
through the Federal Housing Administration (FHA) or the Department of 
Veterans Affairs (VA) generally would have been risk-weighted at 20 
percent. While a U.S. Government guarantee against default mitigates 
credit risk, normally the loans

[[Page 4396]]

are not fully guaranteed and routinely subject the credit union to 
meeting loan underwriting and servicing requirements.
    Under the Original Proposal, real estate-secured loans that did not 
meet the definition of a ``first mortgage real estate loan'' would have 
been defined as ``other real estate loans'' and assigned a higher risk 
weight. First-lien real estate loans delinquent for 60 days or more, or 
carried on non-accrual status, would have been included in the category 
of other real estate loans for the purpose of assigning the risk 
weight. Other real estate loans would have been assigned a risk weight 
of 100 percent for the first 10 percent of assets. To account for 
concentration risk, the risk weight for other real estate loans would 
increase to 125 percent for loans between 10 and 20 percent of assets, 
and other real estate loans over 20 percent of assets would have been 
risk-weighted at 150 percent.
    The threshold of 10 percent was based on the average percentage of 
other real estate loans to total assets, which, as of June 30, 2013, 
was 6.85 percent for complex credit unions.
    Under the Original Proposal, the aggregate minimum capital 
requirement for first- and junior-lien real estate loans would have 
been slightly less than the current minimum requirement.\203\ The 
originally proposed risk weights for real estate loans, however, would 
have resulted in a higher variance in the minimum capital requirement 
for individual affected credit unions because the risk weights better 
differentiated between the risks associated with lien position and 
concentration.
---------------------------------------------------------------------------

    \203\ Credit unions predominantly offering first lien real 
estate loans would have had lower capital requirements than the 
current rule. Credit unions predominantly offering junior-lien real 
estate loans would have had higher capital requirements than the 
current rule. Analysis of December 31, 2013, Call Report data 
indicates that the originally proposed risk weights produce an 
aggregate minimum capital requirement, at the well capitalized 
level, of 97 percent of the current minimum risk-based net worth 
ratio required for real estate loans when applied to affected credit 
unions.
---------------------------------------------------------------------------

    NCUA received a significant number of comments on the proposed risk 
weights for real estate loans. Most commenters generally disagreed with 
the proposed risk weights, stating that they were too high. Commenters 
suggested that, given lower historical loss rates on residential 
mortgage loans at credit unions compared to community banks and the 
fact that credit unions with higher concentrations of these loans tend 
to experience lower loss rates than their peers, the risk weights and 
concentration thresholds for real estate loans should be far lower than 
the Original Proposal indicated and lower than what banks must meet. 
Commenters generally acknowledged that the proposed 50 percent risk 
weight (i.e., excluding the higher weights for concentration risk) for 
first mortgage loans was equal to the bank risk weight, but argued that 
credit union losses on these loans historically have been lower than 
community bank loss totals. One commenter claimed that credit unions' 
losses on first mortgage loans were in fact equal to 60 percent of 
community bank loss totals over the long term, since the start of the 
Great Recession, and at peak value losses. Based on this historical 
performance, the commenter suggested that if the appropriate bank risk 
weights for residential first mortgages is indeed 50 percent, the 
history-based risk weights for credit unions ought to be closer to 30 
percent (i.e., 60 percent of 50 percent).
    The Board does not believe the contemporary variances between bank 
and credit union losses on real estate loans are substantial enough to 
warrant assigning lower risk weights. Based on the credit union Call 
Reports and FDIC Quarterly Banking reports for the years ended December 
31, 2011, 2012, and 2013, credit union real estate loan loss experience 
is comparable to community banks. Credit unions with over $100 million 
in assets have an average overall real estate loan loss ratio of 0.58 
percent over the past three years. Banks with assets up to $10 billion 
have an average real estate loan loss ratio of 0.65 percent over the 
same time period. Credit union first mortgage loan losses average 0.34 
percent over the last three years compared to 0.49 percent for banks. 
Credit union home equity loan losses average 0.96 percent over the last 
three years compared to 0.73 percent for banks.
    Another commenter suggested that NCUA's tiered risk weight approach 
for real estate-secured loans for both the current risk-based net worth 
ratio framework and the proposed risk-based capital ratio framework is 
arbitrary and unsupported by the administrative record, and that NCUA 
has not offered specific analyses or other evidence to support either 
framework's implied assumption that there is a correlative relationship 
between the size of a credit union's portfolio of real estate secured 
loans and the risk that portfolio presents to the NCUSIF.
    Other commenters believed the proposed risk weights would 
discriminate against homeownership because home loans bring a positive 
reputation value that the rule cannot factor, and that any additional 
capital requirement for providing home loans to the common family is 
destructive. Commenters also suggested that the proposed risk weights 
would limit credit unions' ability to help low-income members and 
members with troubled real estate and impact credit unions' ability to 
provide members with a low cost source of funds for financing their 
primary residence by discouraging credit unions from making real estate 
loans over 25 percent or 35 percent of their total assets.
    A small number of commenters suggested that the rule allow some 
type of waiver when it is apparent that a credit union can make sound 
real estate loans. Another commenter suggested that the rule exclude 
some parts of a credit union's first-lien mortgage portfolio.
    Some commenters suggested that although significant losses did 
occur during the recent economic downturn, first-lien residential 
mortgage loans have historically been a low credit risk and an 
important part of credit unions' presence and mission in their 
communities. One commenter stated that major progress has been made in 
underwriting first mortgage loans following the recent recession, that 
high-risk mortgage products are no longer common, and the CFPB and 
Dodd-Frank Act regulations have eliminated the likelihood of a repeat 
of the circumstances that caused extensive losses for first-lien 
residential mortgage loans during the recession. Therefore, the 
commenters suggested the Board should eliminate the higher risk weights 
for a concentration of first-lien residential mortgage loans.
    A small number of commenters acknowledged that there is a great 
deal of differentiation across mortgage products that make it difficult 
to determine the best framework to identify those higher-risk mortgages 
without imposing an untenable reporting requirement. Given the delicate 
balance between regulatory burden and meaningful reporting, many 
commenters suggested the Board should maintain the proposed definition 
for non-delinquent first mortgage real estate loans and risk weight 
them all at 50 percent, regardless of concentration level. Commenters 
argued that such a change would provide parity with the banking system 
and obviate the need for more onerous reporting. Commenters argued the 
Board should adopt a similar approach for other real estate-secured 
loans by eliminating the concentration thresholds and, consistent with 
the Other Banking Agencies' rules, risk-weight them all at 100 percent.

[[Page 4397]]

    A number of other commenters suggested various specific risk weight 
schemes for real estate loans, but did not explain why their suggested 
risk weights would more accurately account for risk than those 
originally proposed by the Board.
    Higher capital requirements for concentrations of real estate loans 
exists in the current rule, and the Board believes completely 
eliminating them would be a step backwards in matching risks with 
minimum risk-based capital requirements. Credit unions with high real 
estate loan concentrations are particularly susceptible to changes in 
the economy and housing market because a significant portion of their 
assets are focused in one industry.
    NCUA does currently review credit concentrations during 
examinations as commenters recommended. However, as discussed in the 
summary section, the FCUA requires that NCUA's risk-based capital 
requirement account for material risks that the 6 percent net worth 
ratio may not provide adequate protection, including credit and 
concentration risks.\204\
---------------------------------------------------------------------------

    \204\ See 12 U.S.C. 1790d(d)(2).
---------------------------------------------------------------------------

    Credit concentration risk can be a material risk under certain 
circumstances. The Board generally agrees that CFPB's new ability-to-
repay regulations should improve credit quality. However, the extent to 
which this will alter loss experience rates remains to be seen.
    NCUA has also been advised by its OIG and GAO to address real 
estate credit concentration risk. NCUA's OIG completed several MLRs 
where failed credit unions had large real estate loan concentrations. 
The NCUSIF incurred losses of at least $25 million in each of these 
cases. The credit unions reviewed held substantial residential real 
estate loan concentrations in either first-lien mortgages, home equity 
lines of credit, or both.\205\ In addition, in 2012 GAO recommended 
that NCUA address the credit concentration risk concerns the NCUA OIG 
raised.\206\ The 2012 GAO report notes credit concentration risk 
contributed to 27 of 85 credit union failures that occurred between 
January 1, 2008, and June 30, 2011. The report indicated that the Board 
should revise PCA so that minimum net worth levels emphasize credit 
concentration risk. Accordingly, the Board believes eliminating the 
concentration dimension for risk weights entirely would be inconsistent 
with the concerns raised on concentration risk by GAO and the MLRs 
conducted by NCUA's OIG.
---------------------------------------------------------------------------

    \205\ See OIG-10-03, Material Loss Review of Cal State 9 Credit 
Union (April 14, 2010), OIG-11-07, Material Loss Review OF Beehive 
Credit Union (July 7, 2011), OIG-10-15, Material Loss Review OF 
Ensign Federal Credit Union, (September 23, 2010), available at 
http://www.ncua.gov/about/Leadership/CO/OIG/Pages/MaterialLossReviews.aspx
    \206\ See U.S. Govt. Accountability Office, GAO-12-247, Earlier 
Actions are Needed to Better Address Troubled Credit Unions (2012), 
available at http://www.gao.gov/products/GAO-12-247.
---------------------------------------------------------------------------

    However, after consideration of the comments, the Board proposes to 
modify the real estate loan risk weights presented in the Original 
Proposal. Under this second proposal the risk weights assigned to 
residential real estate loans would generally be consistent with those 
assigned by Other Banking Agencies.\207\ This proposal would reduce the 
number of first- and junior-lien residential real estate loan 
concentration thresholds from two to one, with single concentration 
thresholds at 35 percent and 20 percent of total assets respectively.
---------------------------------------------------------------------------

    \207\ See, e.g., 12 CFR 324.32(g).

                             Residential Real Estate Loans Concentration Thresholds
----------------------------------------------------------------------------------------------------------------
                                          50%                 75%                100%                150%
----------------------------------------------------------------------------------------------------------------
First-Lien......................  Current <35% of     Current >=35% of
                                   Assets.             Assets.
Junior-Lien.....................  ..................  ..................  Current <20% of     Current >=20% of
                                                                           Assets.             Assets
----------------------------------------------------------------------------------------------------------------

    First- and junior-lien residential real estate loans that are not 
current would be assigned 100 percent and 150 percent risk weights 
respectively. This change to a single, higher concentration risk 
threshold would simplify the risk weight framework and calibrate it to 
only pick up outliers. The concentration thresholds are roughly two 
standard deviations from the mean for both first and junior-liens. This 
means that roughly 90 percent of credit unions with more than $100 
million in assets operate at levels below the concentration thresholds 
proposed for residential real estate loans, and only two credit unions 
operate above both thresholds (based on December 2013 Call Report 
data). Thus, most credit unions would operate at a level in which the 
risk weights assigned to residential real estate loans would be the 
same as the risk weights of the Other Banking Agencies.\208\
---------------------------------------------------------------------------

    \208\ See, e.g., 12 CFR 324.32(g).
---------------------------------------------------------------------------

    The Board believes the single higher concentration threshold would 
simplify the risk weight framework and better calibrate it to apply 
only to credit unions with outlying levels of concentration risk. The 
revised approach taken in this second proposal would be more comparable 
with the approaches taken by the Other Banking Agencies' rules \209\ 
and Basel III, while also maintaining higher minimum capital 
requirements for large concentrations of real estate loans as 
recommended by GAO and OIG. The Board believes the proposed risk 
weights would also be consistent with credit union loss history and 
recent NCUSIF losses reviewed by OIG.
---------------------------------------------------------------------------

    \209\ Id.
---------------------------------------------------------------------------

    The Board does not agree that the proposed risk weights would slow 
residential real estate loan origination, stifle homeownership, or 
limit credit unions' ability to assist low-income members because the 
revised risk weights provide credit unions with continued flexibility 
to assist members in a sustainable manner while maintaining sufficient 
minimum capital.
    Commenters stated that credit unions should not be penalized for 
having high-quality, performing first mortgage loan portfolios, 
suggesting that risk weights should be lowered on first mortgage real 
estate portfolios that demonstrate strong performance through lower 
charge-off ratios. Numerous commenters suggested that the risk weights 
should take underwriting into account that offsets the risk of these 
loans (e.g., a portfolio made up of borrowers with high credit scores 
is less risky than one that is made of low-credit-score borrowers).
    A small number of commenters suggested the mortgage risk weights 
could be better balanced by providing credit unions with some type of 
earned credit based on managed risk performance.
    Another commenter suggested that low-income credit unions that are 
Community Development Financial Institutions have loan portfolios that 
are primarily made up of non-prime and sub-prime loans, which have a 
greater propensity for delinquency. The commenter suggested that such 
institutions should not be penalized for

[[Page 4398]]

serving historically disenfranchised and marginalized populations.
    The Board agrees with commenters that credit scores, loan 
underwriting, portfolio seasoning, and portfolio performance are good 
measures to evaluate a residential real estate lending program. 
However, broadly applicable regulatory capital models are portfolio 
invariant. This means the capital charge for a particular loan category 
is consistent among all credit union portfolios based on the loan 
characteristics, rather than the individual credit union's portfolio 
performance or characteristics. Taking into account each credit union's 
individual characteristics would be too complicated for many credit 
unions and NCUA for minimum capital requirements.\210\ Further, such an 
approach would not be comparable to the risk weight framework used by 
the other banking agencies.
---------------------------------------------------------------------------

    \210\ Basel Committee on Banking and Supervision, An Explanatory 
Note on the Basel II IRB Risk Weight Functions, July 2005, available 
at http://www.bis.org/bcbs/irbriskweight.htm: ``The model should be 
portfolio invariant, i.e. the capital required for any given loan 
should only depend on the risk of that loan and must not depend on 
the portfolio it is added to. This characteristic has been deemed 
vital in order to make the new IRB framework applicable to a wider 
range of countries and institutions.''
---------------------------------------------------------------------------

    NCUA will continue to take into account loan underwriting 
practices, portfolio performance and loan seasoning as part of the 
examination and supervision process. This method of review is 
consistent with the Basel three-pillar framework: minimum capital 
requirements, supervisory review, and market discipline.\211\ Credit 
unions should use criteria from their own internal risk models and loan 
underwriting in developing their internal risk management systems.
---------------------------------------------------------------------------

    \211\ Basel Committee on Banking Supervision, International 
Convergence of Capital Measurement and Capital Standards, June 2006, 
available at http://www.bis.org/publ/bcbs128.htm. ``The Committee 
notes that, in their comments on the proposals, banks and other 
interested parties have welcomed the concept and rationale of the 
three pillars (minimum capital requirements, supervisory review, and 
market discipline) approach on which the revised Framework is 
based.''
---------------------------------------------------------------------------

    The Board also agrees LTV ratios are an informative measure to 
assess risk. However, it is not a practical measure to assess minimum 
capital requirements because of volatility in values and the 
corresponding reporting burden for credit unions tracking LTVs and 
keeping them current. There also is no historical data across 
institutions upon which to base varying risk weights according to LTVs 
and other underwriting criteria (like credit scores). Examiners take 
LTVs into consideration during the examination process. Supervisory 
experience has demonstrated LTV verification requires on-site review 
and application of credit analytics to validate the most current 
information. On-site review also minimizes reporting requirements on 
credit unions.
    Commenters questioned why real estate loans were risk-weighted 
differently than GSE and other mortgage-backed securities. Under the 
Original Proposal, a 30-year first mortgage loan would have been 
assigned a 50 percent risk weight while a federal agency mortgage-
backed security that has an average life of six years would have been 
assigned a 150 percent risk weight. Numerous commenters remarked that 
the differences between these two risk weights seemed inappropriate 
because the two assets have similar interest-rate risk, and that the 
security has less credit risk and is more marketable. Commenters stated 
that one way credit unions can lower the risk of holding first mortgage 
loans on their balance sheets is to securitize them, making them more 
readily available to serve as collateral to borrow against or to sell 
as a security. Commenters also suggested that the higher risk weight 
that would apply to securitized mortgages would discourage credit 
unions from using this strategy.
    The Board agrees with the commenters' concerns regarding 
consistency of risk weights across assets classes. As noted above, by 
removing consideration of IRR from the risk weights for purposes of 
this second proposal, analogous risk across loans and investments would 
be more consistently risk-weighted.
    Commenters suggested that the rule should distinguish between 
variable-rate first mortgage loans and fixed-rate first mortgage loans, 
with lower risk weights associated with the variable-rate loans and 
shorter-term fixed-rate loans in order to capture the lower IRR 
associated with such loans as compared to 30-year fixed-rate first 
mortgage loans. Other commenters suggested that the capital requirement 
for adjustable-rate mortgages and shorter-maturity fixed-rate mortgage 
loans should be lowered to take into consideration the reduced risk 
associated with these adjustable and shorter-term mortgage loan 
products. Commenters also suggested that the IRR may in fact be lower 
for junior-lien loans because many are home equity lines of credit with 
variable rates. The Board notes, as discussed above, removal of 
consideration of IRR from the risk weights for purposes of this second 
proposal resolves these commenters' concerns.
    Commenters questioned the risk weight for junior-lien mortgage 
loans, suggesting such loans represent no more risk than first mortgage 
loans if underwritten at appropriate loan-to-value ratios. Some of 
these commenters stated that many credit unions have established loan-
to-value and combined loan-to-value limits for junior-lien real estate 
loans of 75-80 percent (or less) as a means of managing risk. 
Commenters suggested that consideration should also be given to the 
equity position and not just the lien position when setting risk 
weights.
    A small number of commenters stated that no clear explanation or 
rationale was offered for why junior-lien mortgage loans have higher 
risk weights than first mortgage loans.
    Conversely, other commenters stated that while they have many 
concerns about the risk weights, they agree that the proposed risk 
weights for home equity/second mortgages seem appropriate based on 
losses at comparable banks and credit unions.
    The Board continues to believe junior-lien residential real estate 
loans warrant a higher risk weight based on loss history. Call Report 
data indicates credit unions over $100 million in asset size reported 
three times the rate of loan losses (0.96 percent) on other real estate 
loans \212\ when compared to first mortgage real estate loans (0.34 
percent) during the past three years. In addition, the base risk weight 
for junior-lien residential real estate loans in this proposal is 
comparable to the Other Banking Agencies.\213\
---------------------------------------------------------------------------

    \212\ Junior-lien real estate loans are currently reported on 
the Call Report as part of ``other real estate loans.''
    \213\ See, e.g., 12 CFR 324.32(g)(2).
---------------------------------------------------------------------------

    After carefully considering the comments, the Board is now 
proposing to modify the definitions and risk weights for loans secured 
by residential real estate. Three substantive changes are discussed in 
more detail below.
    First, one-to-four family non-owner-occupied residential real 
estate loans would now be included in the definition of either first- 
or junior-lien residential real estate loan.\214\ The Board believes 
this change is consistent with the credit risk inherent in these loans 
and corresponding risk weights assigned by the Other Banking 
Agencies.\215\
---------------------------------------------------------------------------

    \214\ Under the Original Proposal, one-to-four-family non-owner 
occupied residential real estate loans greater than $50,000 would 
have been defined as member business loans.
    \215\ See, e.g., 12 CFR 324.32(g).
---------------------------------------------------------------------------

    Second, for a loan to be included in the definition of a first-lien 
residential

[[Page 4399]]

real estate loan, a reasonable and good faith determination must have 
been made to determine that the borrower had the ability to repay the 
loan according to its terms. The Board believes this change is 
consistent with existing legal requirements for residential real estate 
secured loans and prudential underwriting expectations in the Other 
Banking Agencies' risk weight definitions, and would provide some 
standard of quality to justify residential real estate loans receiving 
a lower risk weight. Under this second proposal a credit union would 
not be required to underwrite ``qualified mortgages'' to receive a 
lower risk weight. However, a first-lien residential real estate loan 
would receive the proposed 50 percent risk weight only if the credit 
union underwrites them in accordance with CFPB's ability-to-repay 
requirements under Sec.  1026.43 of this title.\216\
---------------------------------------------------------------------------

    \216\ The Ability-to-Repay requirements include eight loan 
underwriting factors a credit union will need to consider and 
verify. These include the following: (1) current or reasonably 
expected income or assets; (2) current employment status; (3) the 
monthly payment on the covered transaction; (4) the monthly payment 
on any simultaneous loan; (5) the monthly payment for mortgage-
related obligations; (6) current debt obligations; (7) the monthly 
debt-to-income ratio or residual income; and (8) credit history. 
See, e.g., 78 FR 6407 at 6585 (Jan. 30, 2013).
---------------------------------------------------------------------------

    Finally, this second proposal would provide a risk weight of 20 
percent for the portion of real estate loans with a government 
guarantee and exclude this amount from the calculation of the 
concentration threshold. The Board believes this change would better 
reflect the risk and encourage credit unions to take advantage of 
available programs designed to reduce their risk of loss.
    Current consumer loans. Consumer loans (unsecured credit card 
loans, lines of credit, automobile loans, and leases) are generally 
highly desired credit union assets and a key element of providing basic 
financial services.\217\ For most current consumer loans, the Original 
Proposal would have assigned a risk weight of 75 percent.\218\ Non-
federally guaranteed student loans, which contain higher risks (e.g., 
default risk and extension risk), would have been risk-weighted at 100 
percent under the Original Proposal. Federally guaranteed student loans 
would have received a zero percent risk weight.\219\
---------------------------------------------------------------------------

    \217\ Per Call Report data for years ending December 31, 2012 
and 2013, consumer loans were greater than 40 percent of loans in 
credit unions with total assets greater than $100 million.
    \218\ The Other Banking Agencies' capital rules maintained the 
100 percent risk weight for current consumer loans. See, e.g., 12 
CFR 324.32 and 78 FR 55339 (Sept. 10, 2013).
    \219\ Up until 2010, guaranteed student loans were available 
through private lending institutions under the Federal Family 
Education Loan Program (FFELP). These loans were funded by the 
federal government and administered by approved private lending 
organizations. In effect, these loans were underwritten and 
guaranteed by the federal government, ensuring that the private 
lender would assume no risk should the borrower ultimately default. 
Loans issued under this program prior to June 30, 2012 will remain 
on the books of credit unions for many years.
---------------------------------------------------------------------------

    The Board received a number of comments regarding the risk weights 
for consumer loans. A number of commenters recommended the Board lower 
the risk weights for performing collateralized consumer loans, and that 
data on such loans is reflected on the Call Report and could easily be 
incorporated into the risk weights.
    Several commenters asked why a secured auto loan was assigned the 
same risk weight as an unsecured credit card loan under the Original 
Proposal when credit card loans have a delinquency rate more than four 
times that of auto loans.
    Other commenters stated the rule should take into account the type 
of consumer loan (unsecured versus secured, loss history, and term of 
the loan) and generation source (direct versus indirect) because 
different loan types and generation sources have different performance 
experiences historically and should be evaluated as part of the 
rulemaking.
    Another commenter stated that the proposal would have made no 
distinction between indirect loans and loans originated in-house, which 
would have encouraged ``buy rate'' indirect lending (i.e., markups by 
dealer), which is bad for consumers.
    Other commenters suggested different risk weights should be applied 
to consumer loans based on credit score ranges.
    A small number of commenters suggested that consumer loans have 
significantly less IRR than first-mortgage loans, but are assigned a 75 
percent risk weight while first-mortgage loans are assigned a 50 
percent risk weight, suggesting that only credit risk was considered in 
setting the risk weight for consumer loans.
    A small number of commenters suggested that consumer loans should 
be assigned a 20 percent risk weight because credit loss risk is 
covered in the ALLL.
    A number of other commenters suggested that the proposed risk 
weights for consumer loans seemed appropriate based on losses at 
comparable banks and credit unions.
    The Board generally agrees with commenters who suggested that 
secured and unsecured consumer loans have different levels of risk 
exposure. To address the different risks between these two loan types, 
this second proposal would assign separate risk weights for secured and 
unsecured consumer loans. To differentiate between these two loan 
types, this proposed rule would include new definitions for secured 
consumer loans and unsecured consumer loans. Loans meeting the 
definition of a current secured consumer loan would receive a risk 
weight of 75 percent, and those meeting the definition of a current 
unsecured consumer loan would be assigned a 100 percent risk weight. 
This would account for the higher risk associated with unsecured loans 
given their lack of collateral.
    The Board also generally agrees that credit scores, staff 
qualifications, loan underwriting, portfolio seasoning, and portfolio 
performance are good measures to evaluate a lending program. However, 
the Board cannot uniformly use these criteria to measure minimum 
capital requirements for all credit unions because of the indeterminate 
reporting requirements that would be necessary and the myriad variables 
used to establish sound lending programs.
    The Board disagrees that credit loss risk would be entirely covered 
in the ALLL. The ALLL is intended to cover expected losses as of the 
balance sheet date. The ALLL is not intended to cover unexpected 
losses. While a credit union's funding of the ALLL through provision 
expenses decreases retained earnings, the proposed new risk-based 
capital ratio calculation would add back in the balance of the ALLL 
without limit.
    Non-current consumer loans. The current risk-based capital measure 
does not contain a higher risk weight for non-current consumer loans. 
Increasing levels of non-current loans are an indicator of increased 
risk. To reflect the impaired credit quality of past-due loans, the 
Original Proposal would have required credit unions to assign a 150 
percent risk weight to loans (other than real estate loans) 60 days or 
more past due or in nonaccrual status. The higher risk weight on past-
due exposures ensures sufficient regulatory capital for the increased 
probability of unexpected losses on these exposures. The higher risk 
weights were intended to capture the risk associated with the impaired 
credit quality of these exposures, and were consistent with the risk 
weights used by Basel III and the Other Banking Agencies.\220\
---------------------------------------------------------------------------

    \220\ See, e.g., 12 CFR 324.32(k).
---------------------------------------------------------------------------

    A small number of commenters questioned why delinquent consumer 
loans were assigned a 150 percent risk weight under the Original 
Proposal

[[Page 4400]]

when such loans are assigned only a 100 percent risk weight under the 
Other Banking Agencies' capital rules. However, in fact, a 150 percent 
risk weight is consistent with the risk weight for past-due consumer 
loans under the Other Banking Agencies' regulations \221\ and would 
result in a risk-based capital measure that is more responsive to 
changes in the credit performance of the loan portfolio. Thus, this 
proposal would retain the 150 percent risk weight for consumer loans 
that are not current.
---------------------------------------------------------------------------

    \221\ See, e.g., 12 CFR 324.32(k).
---------------------------------------------------------------------------

Loans to CUSOs and CUSO Investments.
    Under the Original Proposal, investments in CUSOs were assigned a 
risk weight of 250 percent and loans to CUSOs were assigned a risk 
weight of 100 percent. A majority of the commenters addressed these 
risk weights and, nearly unanimously, opposed them. There were, 
however, a few commenters who generally agreed with the proposed risk 
weights.
    In brief, commenters generally maintained that the originally 
proposed risk weight for investments in CUSOs was too high. Some 
commenters argued that the Original Proposal was arbitrary and 
unsupported by analytical data. Others stated that the risk weights did 
not take into account the requirements of the CUSO regulation or the 
nature and business of individual CUSOs. Finally, some commenters 
believed the Original Proposal would have a chilling effect on CUSOs 
and could lead credit unions to seek out more expensive third-party 
vendors.
    Some commenters questioned why the Original Proposal included 
different risk weights for investments and loans. Other commenters 
argued that there should be only one risk weight and that it should not 
exceed 100 percent. Several commenters suggested risk weights below 100 
percent, stating that higher risk weights would diminish the 
cooperative nature of credit unions. A few commenters advocated 
eliminating risk weights for CUSOs altogether, claiming that assigning 
risk weights to these assets would be detrimental to credit unions 
forming and utilizing CUSOs.
    Other commenters stated that NCUA should address risk in CUSOs 
through supervision of the credit union investors, rather than 
assigning risk weights to investments and loans.
    One commenter expressed concern about investments in CUSOs being 
included in the risk-based capital ratio calculation on an 
unconsolidated basis, combined with including a CUSO's mortgage 
servicing assets (MSAs) on a consolidated basis. This commenter stated 
that if mortgage servicing assets represent a significant portion of 
the equity of a CUSO on an unconsolidated basis, then the credit 
union's MSAs would effectively be weighted at 500 percent.
    Several commenters argued that the risk weights for CUSO loans and 
investments should be lower because the actual degree of risk from 
CUSOs is relatively low. A few commenters noted that credit unions have 
less than 0.2 percent of total assets invested in CUSOs, which, they 
argued, is an immaterial risk to the credit union industry.
    Other commenters stated that the requirements in the recently 
finalized CUSO rule effectively reduce risk from CUSOs, thereby 
eliminating the need for higher risk weights.
    Several commenters expressed concern that the 250 percent risk 
weight on investments in CUSOs would restrict or reduce the benefits 
from using CUSOs. Some of these commenters argued that credit unions 
would be forced to contract with higher-priced third-party vendors for 
services because third-party vendors do not carry a capital risk 
weight.
    Several commenters also questioned the mechanics of the two risk 
weights that would have applied to CUSOs. One commenter stated that the 
risk weight for loans did not take into account collateral for the loan 
or the quality of any such collateral.
    Another commenter stated that there was no reason for a risk weight 
if the amount of an investment in a CUSO was fully offset by net income 
or cost savings generated by the CUSO. Other commenters suggested that 
NCUA not apply a risk weight to both the cash investment made in the 
CUSO and the CUSO's appreciated value.
    Several commenters stated that the Original Proposal would have 
double counted exposure for majority-owned CUSOs. They reasoned that 
because risk-based capital is based on a credit union's consolidated 
balance sheet, adding a schedule that shows unconsolidated results is 
essentially double counting.
    Several commenters addressed a comparison made in the Original 
Proposal between CUSOs and an unsecured equity investment by a bank in 
a non-publicly traded entity. These commenters argued that this 
comparison is not analogous and NCUA should abandon this approach. 
These commenters stated further that the regulations applying to credit 
union investments in CUSOs and the collaborative platform between CUSOs 
and credit unions makes this relationship sufficiently different, such 
that it should not be treated the same as a bank's unsecured equity 
investment in a non-publicly traded entity.
    Finally, several commenters requested that risk weights for CUSOs 
take into account certain aspects of the specific CUSO. Many of these 
commenters stated that they supported risk weights that were based on 
the CUSO's business function. Others stated that risk weights should 
take into account the CUSO's historical profitability, if it is 
generating income for its investors, the complexity of the CUSO's 
operations, or how long it has been in operation. Several commenters 
argued that a ``one-sized-fits-all'' approach is not sufficient to 
accurately risk weight investments in CUSOs.
    After diligent consideration of the comments discussed above, the 
Board has decided to rely on GAAP accounting standards to determine the 
reporting basis upon which any CUSO equity investments and loans are 
assigned risk weights. For CUSOs subject to consolidation under GAAP, 
the amount of CUSO equity investments and loans are eliminated from the 
consolidated financial statements because the loans and investments are 
intercompany transactions. The related CUSO assets that are not 
eliminated are added to the consolidated financial statement and 
receive risk-based capital treatment as part of the credit union's 
statement of financial condition. For CUSOs not subject to 
consolidation, the recorded value of the credit union's equity 
investment would be assigned a 150 percent risk weight, and the balance 
of any outstanding loan would be assigned a 100 percent risk weight.
    NCUA recognizes the uniqueness of CUSOs and the support they 
provide. However, an equity investment in a CUSO is an unsecured, at-
risk equity investment (first loss position), which is analogous to an 
investment in a non-publicly traded entity. There is no price 
transparency and extremely limited marketability associated with CUSO 
equity exposures. In addition, unlike the Other Banking Agencies, NCUA 
has no enforcement authority over third-party vendors, including CUSOs.
    The Board recognizes there are statutory limits on how much a 
federal credit union can loan to and invest in CUSOs. However, the 
limitations are not as stringent for some state charters, and only 
binding for federal credit unions at the time the loan or investment is 
made (that is, the position can grow in proportion to assets over 
time). In setting capital standards (e.g., Basel and FDIC), the risk of 
loss is central to

[[Page 4401]]

determining the risk weight--not the size of the exposure.
    In addition, while a CUSO must predominantly serve credit unions or 
their members (more than 50 percent) to be a CUSO, it can be owned and 
controlled primarily by persons and organizations other than credit 
unions. Therefore, it may not only serve non-credit unions, it can be 
majority-controlled by a party or parties with interests not 
necessarily aligned with the credit union's interests.\222\
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    \222\ Further, not all CUSOs are closely held. They can have 
wider ownership distributed among many credit unions, none of which 
may have significant control. If a particular credit union has 
significant control, it will likely have to consolidate under GAAP 
and then there will be no risk weight associated with the loan or 
investment for the controlling credit union since it will be netted 
out on a consolidated basis.
---------------------------------------------------------------------------

    Also, given the equity investment in a CUSO is in a first loss 
position, is an unsecured equity investment in a non-publicly traded 
entity, the significant history of losses to the NCUSIF related to 
CUSOs, and the fact NCUA lacks vendor authority, the risk weight should 
be higher than 100 percent.
    Loans to CUSOs, on the other hand, have a higher payout priority in 
the event of bankruptcy of a CUSO and therefore warrant a lower risk 
weight of 100 percent, which corresponds to the base risk weight for 
commercial loans.
    The Board notes it may be possible to make more meaningful risk 
distinctions between the risk various types of CUSOs pose once the CUSO 
registry is in place and sufficient trend information has been 
collected.
    Under the Original Proposal, the risk weights were derived from a 
review of FDIC's capital treatment of bank service organizations. 
FDIC's rule looks across all equity exposures.\223\ If the total is 
``non-significant'' (less than 10 percent of the institution's total 
capital), the entire amount receives a risk weight of 100 percent. 
Otherwise, all the exposures are matched against a complicated risk 
weight framework that runs from a minimum of 250 percent to 600 percent 
risk weight, with some subsidiary equity having to be deducted from 
capital. The equity investment in a CUSO would be treated the same as 
an equity investment in a non-publicly traded entity (limited 
marketability and valuation transparency), which would receive a 400 
percent risk weight unless the cumulative level of all equity exposures 
held by the institution were ``non-significant.''
---------------------------------------------------------------------------

    \223\ See, e.g., 12 CFR 324.52.
---------------------------------------------------------------------------

    The Board recognizes the complexity of FDIC's approach and 
continues to believe that a simplified risk weight approach is more 
appropriate given the limited amount of credit union assets in CUSOs 
and the value CUSOs provide to credit unions in achieving economies of 
scale.
Mortgage Servicing Assets (MSAs).
    The Original Proposal would have assigned a 250 percent risk weight 
to MSAs to address the complexity and volatility of these assets. In 
the preamble to the Original Proposal, the Board noted that MSAs 
typically lose value when interest rates fall and borrowers refinance 
or prepay their mortgage loans, leading to earnings volatility and 
erosion of capital.
    A large number of commenters addressed this provision and generally 
disagreed with the 250 percent risk weight. Most commenters addressing 
this topic maintained that the risk weight was too high and would have 
been punitive to credit unions. Further, some of these commenters noted 
that MSAs are an important hedge for credit unions and that MSAs are 
very liquid assets with an active secondary market.
    A few commenters provided suggestions on how to amend this 
provision of the rule. Most suggested lowering the risk weight to 100 
percent. Others, however, suggested a phase-in approach of the 250 
percent risk weight or assigning a risk weight above 100 percent when a 
credit union reaches a certain concentration level of MSAs.
    One commenter suggested that assigning the same risk weight to all 
MSAs, as if they are all equivalent, is not an accurate representation 
of the actual risk involved. One other commenter stated that the rule 
should include a mechanism for differentiating between loans sold with 
and without recourse.
    Another commenter stated, ``For many credit unions, maintaining the 
personal member relationship throughout the life of a transaction is of 
strategic importance. If the practical effect of a regulation is to 
force the sale of a mortgage or the servicing rights, the supervisory 
necessity of such a regulation must be unquestionably clear.''
    Finally, a few commenters predicted that a 250 percent risk weight 
on MSAs could discourage loan participations and limit the options 
available to manage balance sheet risk. One commenter further suggested 
that risk weights for loan participations should be lowered not to 
exceed the weight of the underlying loan participated.
    After considering these comments, the Board continues to believe 
that the 250 percent risk weight is appropriate in light of the 
relatively greater risks inherent in these assets, and to maintain 
comparability with the risk weight assigned to these assets by the 
Other Banking Agencies.\224\ Specifically, MSA valuations are highly 
sensitive to unexpected shifts in interest rates and prepayment speeds. 
MSAs are also sensitive to the costs associated with servicing. These 
risks contribute to the high level of uncertainty regarding the ability 
of credit unions to realize value from these assets, especially under 
adverse financial conditions, and support assigning a 250 percent risk 
weight to MSAs.
---------------------------------------------------------------------------

    \224\ See, e.g., 12 CFR 324.32(l)(4)(i).
---------------------------------------------------------------------------

    While the Board acknowledges that MSAs may provide some hedge 
against falling rates under certain circumstances, it further believes 
that MSAs' effectiveness as a hedge, relative to particular credit 
unions' balance sheets, is subject to too many variables to conclude 
that MSAs warrant a lower risk weight. More importantly, since IRR has 
been removed from the risk weights of this proposal, this argument is 
no longer directly applicable.
    Furthermore, NCUA does not agree with commenters who suggested that 
the proposed 250 percent risk weight assigned to this relatively small 
asset class would significantly disincentivize credit unions from 
granting loans, engaging in loan participations, and retaining 
servicing of their member loans. NCUA notes that banks have been 
subject to at least as stringent (if not more so) of a risk weight for 
MSAs for some time and continue to sell loans and retain MSAs.
    The Board believes the proposed January 1, 2019 effective date for 
this rule would provide credit unions sufficient time to adjust to this 
second proposal and would provide credit unions with a phase-in period 
comparable to that given to banks following a similar change to the 
Other Banking Agencies' capital regulations.\225\
---------------------------------------------------------------------------

    \225\ See, e.g., 12 CFR 324.1(f).
---------------------------------------------------------------------------

    Other on-balance sheet assets. The current risk-based measure for 
all other balance sheet assets not otherwise assigned a specific risk 
weight is 100 percent of the risk-based target. Under the Original 
Proposal, these same assets would have received a 100 percent risk 
weight.\226\
---------------------------------------------------------------------------

    \226\ This is comparable to the Other Banking Agencies' capital 
rules (e.g., 12 CFR 324.32), which maintained the 100 percent risk 
weight for assets not assigned to a risk weight category. See, e.g., 
78 FR 55339 (Sept. 10, 2013).

[[Page 4402]]



    Original Proposal--Risk Weights for Other On-Balance Sheet Assets
------------------------------------------------------------------------
                                                               Proposed
                      Other asset type                       risk weight
                                                              (percent)
------------------------------------------------------------------------
Loans Held for Sale........................................          100
Foreclosed and Repossessed Assets..........................          100
Land and Building..........................................          100
Other Fixed Assets.........................................          100
Accrued Interest on Loans..................................          100
Accrued Interest on Investments............................          100
All Other Assets not otherwise specifically assigned a risk          100
 weight....................................................
------------------------------------------------------------------------

    The Board received a number of comments regarding the proposed risk 
weights for other on-balance sheet assets.
    A small number of commenters suggested that under Basel III loans 
held for sale are risk-weighted at zero as long as they are sold within 
120 days because such assets are more of a receivable than a loan.
    Commenters suggested that a 100 percent risk weight for land and 
building was excessive and that speculative land should be risk 
weighted at 50 percent and a financial institution building should be 
risk-weighted at 25 percent, less depreciation. Other commenters stated 
that all credit unions must invest in fixed assets (such as buildings, 
furniture and equipment) and that the current 5 percent cap on fixed 
assets helps to manage risk and credit unions seeking to exceed the 5 
percent cap must obtain prior NCUA approval. Commenters suggested that 
consideration should be given to assigning a lower risk weight to 
investments in fixed assets when the 5 percent cap is maintained. Other 
commenters suggested that assigning a 100 percent risk weight on land, 
building and fixed assets would discourage investments in growing 
branch networks or modernizing equipment.
    A small number of commenters suggested that accounts receivable, 
prepaid income items, accrued interest, and other small items that have 
no credit risk or IRR should be assigned a zero percent risk weight. 
These commenters suggested that a 100 percent risk weight assigned to 
accrued interest on loans and accrued interest on investments is 
excessive.
    As with the Original Proposal, in this second proposal, where the 
rule does not assign a specific risk weight to an asset or exposure 
type, the applicable risk weight would be 100 percent. For example, 
premises, fixed assets, and other real estate owned would receive a 
risk weight of 100 percent.
    The Board determined the 100 percent risk weight would be 
appropriate for this class of assets since the difference between the 
book balance of some particular fixed assets and the value of the 
assets in the event of liquidation can be substantial. For example, in 
an area that has experienced a decline in the value of real estate, the 
book value of a fairly recently constructed credit union headquarters 
could be well below the fair value. Differentiating between the risks 
of types of assets not otherwise identified is not currently possible 
due to lack of data, would add complexity to the rule, and require even 
more Call Report data.
    The 100 percent risk weight would also be appropriate when 
considering that most assets in this group are predominately non-
earning assets which can hinder a credit union's ability to increase 
capital.
    Further, the proposed risk weights match the risk weights in the 
Other Banking Agencies' capital regulations.\227\
---------------------------------------------------------------------------

    \227\ See, e.g., 12 CFR 324.32(l).
---------------------------------------------------------------------------

    This proposal would include loans held for sale within the pool of 
loans subject to assignment of risk weights by loan type to avoid the 
added complexity of determining the age of the loans held for sale.
104(c)(2)(i) Category 1--Zero Percent Risk Weight
    Proposed Sec.  702.104(c)(2)(i) would provide that a credit union 
must assign a zero percent risk weight to the following on-balance 
sheet assets:
     The balance of cash, currency and coin, including vault, 
automatic teller machine, and teller cash.
     The exposure amount of:
    [cir] An obligation of the U.S. Government, its central bank, or a 
U.S. Government agency that is directly and unconditionally guaranteed, 
excluding detached security coupons, ex-coupon securities, and 
principal and interest only mortgage-backed STRIPS.
    [cir] Federal Reserve Bank stock and Central Liquidity Facility 
stock.
     Insured balances due from FDIC-insured depositories or 
federally insured credit unions.
    Consistent with the Original Proposal, this second proposal would 
continue to assign a zero percent risk weight for cash, which includes 
the balance of cash, currency and coin, including vault, automatic 
teller machine, and other teller cash.
    This proposal would change the assignment of risk weights for cash 
on deposit, assigning a zero percent risk weight to insured cash on 
deposit and a 20 percent risk weight for all uninsured \228\ cash on 
deposit as outlined in the proposed changes to the revised risk 
weights. Cash items in process of collection (currently included in 
cash on deposit) would not be specifically measured or assigned a risk 
weight. This change would be comparable with the risk weights 
applicable to banks.\229\ The Board believes having two risk weights 
for cash on deposit is appropriate because of the different risk 
profiles between insured and uninsured deposits.
---------------------------------------------------------------------------

    \228\ Privately insured balances are included with uninsured 
deposits and assigned a risk weight of 20 percent as outlined in the 
proposed rule language.
    \229\ See 12 CFR 324.32(a)(1)(i)(B) and (d)(1).
---------------------------------------------------------------------------

    This proposal would apply a risk weight of zero percent to the 
exposure amounts of an obligation of the U.S. Government, its central 
bank, or a U.S. Government agency that is directly and unconditionally 
guaranteed--excluding detached security coupons, ex-coupon securities, 
and principal and interest only mortgage-backed STRIPS. This zero 
percent risk weight would also exclude indirect ownership and 
securities collateralized with zero percent risk weight assets.
    This proposal would apply a risk weight of zero percent to these 
types of exposures because they have no or very limited credit risk.
    However, exposures that are through a trust, or similar vehicle, 
would not receive a zero percent risk weight. In addition, conditional 
guarantees that can be revoked if a condition(s) is not met would not 
receive a zero percent risk weight.
    For example, the following types of investment exposures would be 
assigned a zero percent risk weight: \230\
---------------------------------------------------------------------------

    \230\ The list provided is not meant to be comprehensive. Any 
exposure in a principal- or interest-only mortgage-backed strip 
would not be assigned a zero percent risk weight.
---------------------------------------------------------------------------

     U.S. Treasury Securities
     GNMA securities (not including principal and interest only 
STRIPS)
     SBA pools (not including principal and interest only 
STRIPS)
     SBA loan participations
     FDIC-guaranteed securities
     NCUA-guaranteed securities
    This proposal would also apply a zero percent risk weight to 
Federal Reserve Bank stock and Central Liquidity Facility stock. Under 
the applicable statutes, these two types of ``stocks'' do not carry a 
risk of loss of principal \231\

[[Page 4403]]

and, therefore, the Board believes they warrant a zero percent risk 
weight.
---------------------------------------------------------------------------

    \231\ See 12 U.S.C. 287 and 12 U.S.C. 1795f(a).
---------------------------------------------------------------------------

    This proposed rule would materially increase the amount of zero 
risk-weighted investments compared to the current rule. The proposed 
zero percent risk weight category is consistent with risk weights 
applicable to banks.\232\ The Board believes it is appropriate to 
assign a zero percent risk weight to additional investments under this 
proposal because IRR would no longer be included in the proposed risk 
weights.
---------------------------------------------------------------------------

    \232\ See, e.g., 12 CFR 324(a)(i).
---------------------------------------------------------------------------

    The Board requests comments on whether any items currently listed 
in this category should be assigned a higher risk weight and why. In 
addition, the Board requests comments on whether additional items 
should be assigned a zero percent risk weight and why.
104(c)(2)(ii) Category 2--20 Percent Risk Weight
    Proposed Sec.  702.104(c)(2)(ii) would provide that a credit union 
must assign a 20 percent risk weight to the following on-balance sheet 
assets:
     The uninsured balances due from FDIC-insured depositories, 
federally insured credit unions, and all balances due from privately 
insured credit unions.
     The exposure amount of:
    [cir] A non-subordinated obligation of the U.S. Government, its 
central bank, or a U.S. Government agency that is conditionally 
guaranteed, excluding principal and interest only mortgage-backed 
STRIPS.
    [cir] A non-subordinated obligation of a GSE other than an equity 
exposure or preferred stock, excluding principal and interest only GSE 
obligation STRIPS.
    [cir] Securities issued by public sector entities in the United 
States that represent general obligation securities.
    [cir] Investment funds whose portfolios are permitted to hold only 
part 703 permissible investments that qualify for the zero or 20 
percent risk categories.
    [cir] Federal Home Loan Bank stock.
     The balances due from Federal Home Loan Banks.
     The balance of share-secured loans.
     The portions of outstanding loans with a government 
guarantee.
     The portions of commercial loans secured with contractual 
compensating balances.
    This proposal would apply a 20 percent risk weight to uninsured 
balances due from FDIC-insured depositories and federally insured 
credit unions, and all balances due from privately insured credit 
unions. The proposed 20 percent risk weight is consistent with the risk 
weights applicable to banks.\233\ The Board believes it is an 
appropriate risk weight due to the low risk of loss with these types of 
exposures.
---------------------------------------------------------------------------

    \233\ See, e.g., 12 CFR 324.32(d)(1).
---------------------------------------------------------------------------

    This proposal would also apply a risk weight of 20 percent to non-
subordinated obligations of the U.S. Government, its central bank, or a 
U.S. Government agency that is conditionally guaranteed, excluding 
principal- and interest-only mortgage-backed STRIPS. This 20 percent 
risk weight is also applied to indirect and unconditionally guaranteed 
exposures to the U.S. Government, its central bank, or a U.S. 
Government agency. Additionally, a risk weight of 20 percent would be 
applied to non-subordinated exposures of a GSE, other than an equity 
exposure or preferred stock, excluding principal- and interest-only GSE 
obligation STRIPS.
    The following are exposures that would be assigned a 20 percent 
risk weight:
     Farm Credit System
     Federal Home Loan Bank System
     Federal Home Loan Mortgage Corporation
     Federal National Mortgage Association
     Financing Corporation
     Resolution Funding Corporation
     Tennessee Valley Authority
     United States Postal Service
    The above list is not meant to be comprehensive and includes 
mortgage-backed securities issued and guaranteed by U.S. Government 
agencies and GSEs, excluding principal- and interest-only mortgage-
backed STRIPS that are assigned a 100 percent risk weight. The above 
risk weights are generally consistent with the risk weights applicable 
to banks,\234\ as several commenters requested. Many commenters also 
requested that U.S. Government agency and GSE exposures be measured 
based on their risk, and not WAL, which is addressed by the risk 
weights above. The Board believes it is appropriate to assign these 
investments a 20 percent risk weight due to the fact that GSEs 
generally do not have the full faith and credit of the U.S. Government 
guaranteeing payment of their obligations. It is common, however, for 
GSEs to have an assigned federal regulator and an ability to borrow 
from the U.S. Treasury.
---------------------------------------------------------------------------

    \234\ See, e.g., 12 CFR 324.32(a)(1)(ii) and (c).
---------------------------------------------------------------------------

    This proposal would also apply a 20 percent risk weight to 
securities issued by public sector entities in the United States that 
represent a general obligation. General obligation securities are 
backed by the full faith and credit of a public sector entity, which 
warrants the low risk weight. This risk weight is consistent with risk 
weights applicable to banks.\235\ The Board believes it is an 
appropriate risk weight due to the low risk and full faith and credit 
of the public sector entities.
---------------------------------------------------------------------------

    \235\ See, e.g., 12 CFR 324.32(e).
---------------------------------------------------------------------------

    Indirect unconditionally guaranteed exposures to the U.S. 
Government, its Central Bank, or a U.S. Government agency would receive 
a 20 percent risk weight. An example is U.S. Treasury securities in a 
trust that are sold to an investor. The U.S. Treasury security would be 
an indirect obligation since the obligation is to the trust and not the 
credit union. Being indirect adds a layer of risk, which would increase 
the level of risk from risk-free to low, which warrants the 20 percent 
risk weight. This risk weight is also consistent with Other Banking 
Agencies' corresponding risk weight.\236\
---------------------------------------------------------------------------

    \236\ See, e.g., 12 CFR 324.53.
---------------------------------------------------------------------------

    Another example of an indirect unconditional guarantee would be a 
U.S. Treasury security in an investment fund. The obligation is to the 
investment fund, and not the owner of the fund. This is why an 
investment fund, or individual asset in an investment fund, cannot have 
a risk weight of less than 20 percent. This proposal would apply a 20 
percent risk weight to investment funds with portfolios permitted to 
hold only part 703 permissible investments that qualify for the zero to 
20 percent risk categories. This restriction must be stated in the fund 
documentation (e.g. prospectus), and must be binding (e.g. intent alone 
is not sufficient).
    Based on June 2014 Call Report data, approximately 93 percent of 
investments held by complex credit unions would receive a risk weight 
of 20 percent or less, with the majority of investments receiving a 20 
percent risk weight.\237\
---------------------------------------------------------------------------

    \237\ This analysis assumes immaterial exposures to subordinated 
tranches and interest-only and principal-only STRIPS.
---------------------------------------------------------------------------

    As discussed earlier, the Board agrees with commenters who 
suggested that share-secured loans present a lower risk than other loan 
types and has added a new category in this proposal for share-secured 
loans under the 20 percent risk weight, as well as for portions of 
compensating balances on commercial loans.
    The Board requests comments on whether any items currently listed 
in this category should be assigned a higher or lower risk weight and 
why. In addition, the Board requests comments

[[Page 4404]]

on whether additional items should be assigned a 20 percent risk weight 
and why.
104(c)(2)(iii) Category 3--50 Percent Risk Weight
    Proposed Sec.  702.104(c)(2)(iii) would provide that a credit union 
must assign a 50 percent risk weight to the following on-balance sheet 
assets:
     The outstanding balance (net of government guarantees), 
including loans held for sale, of current first-lien residential real 
estate loans less than or equal to 35 percent of assets.
     The exposure amount of:
    [cir] Securities issued by PSEs in the U.S. that represent non-
subordinated revenue obligation securities.
    [cir] Other non-subordinated, non-U.S. Government agency or non-GSE 
guaranteed, residential mortgage-backed security, excluding principal- 
and interest-only STRIPS.
    As discussed earlier, this proposal would include the use of a 
single concentration threshold for current first-lien residential real 
estate loans. All current first-lien residential real estate loans less 
than or equal to 35 percent of assets would receive a 50 percent risk 
weight.
    The proposal would also apply a risk weight of 50 percent to the 
exposure amount of securities issued by PSE in the U.S. that represent 
non-subordinated revenue obligation securities (revenue bonds). These 
securities are backed by the revenue assigned when the security is 
issued. An example is a revenue security backed by tolls on the toll 
road for which the funding was used. This risk weight is comparable to 
the Other Banking Agencies' capital regulations,\238\ which some 
commenters recommended. This risk weight also reflects the greater risk 
that non-subordinated revenue obligations have compared to securities 
issued by a PSE that represent general obligation securities.
---------------------------------------------------------------------------

    \238\ See, e.g., 12 CFR 324.32(e)(1)(ii).
---------------------------------------------------------------------------

    The proposal would also apply a risk weight of 50 percent to other 
non-subordinated, non-agency and non-GSE guaranteed, residential 
mortgage-backed securities (RMBS), excluding principal-and interest-
only STRIPS. The underlying loans in the security must be first-lien 
residential real estate loans, in order to qualify. Furthermore, the 
security must be in the most senior position in the securitization if 
losses are applied to the securitization. The senior position is not 
based on allocation of principal, only losses. This risk weight would 
be consistent with the 50 percent risk weight that would be assigned to 
first-lien residential real estate loans under this proposal and FDIC's 
capital regulation.\239\ Many commenters wanted risk weights more 
aligned with the collateral risk weight, which this risk weight does. 
Furthermore, this risk weight would be comparable with the FDIC's 
approach for calculating the risk weight for RMBSs \240\ as some other 
commenters requested.
---------------------------------------------------------------------------

    \239\ See, e.g., 12 CFR 324.32(g)(1).
    \240\ 12 CFR 324.43(e).
---------------------------------------------------------------------------

    The Board requests comments on whether certain items currently 
listed in this category should be assigned a higher or lower risk 
weight and why. In addition, the Board requests comments on whether 
additional items should be assigned a 50 percent risk weight and why.
104(c)(2)(iv) Category 4--75 Percent Risk Weight
    Proposed Sec.  702.104(c)(2)(iv) would provide that a credit union 
must assign a 75 percent risk weight to the outstanding balance (net of 
government guarantees), including loans held for sale, of the following 
on-balance sheet assets:
     Current first-lien residential real estate loans greater 
than 35 percent of assets.
     Current secured consumer loans.
    This proposal would apply to the amount of first-lien residential 
real estate loans above the single concentration threshold of 35 
percent of assets, which is a reduction in the amount of capital 
required due to exceeding the concentration thresholds when compared to 
the Original Proposal.
    This proposed rule would apply separate risk weights for current 
consumer loans based on whether they are secured or unsecured. Current 
secured consumer loans would receive a 75 percent risk weight because 
they generally have a lower credit risk than unsecured consumer loans 
due to the collateral available for secured loans.
    The Board requests comments on whether any items currently listed 
in this category should be assigned a higher or lower risk weight and 
why. In addition, the Board requests comments on whether additional 
items should be assigned a 75 percent risk weight and why.
104(c)(2)(v) Category 5--100 Percent Risk Weight
    Proposed Sec.  702.104(c)(2)(v) would provide that a credit union 
must assign a 100 percent risk weight to the following on-balance sheet 
assets:
     The outstanding balance (net of government guarantees), 
including loans held for sale, of:
    [cir] First-lien residential real estate loans that are not 
current.
    [cir] Current junior-lien residential real estate loans less than 
or equal to 20 percent of assets.
    [cir] Current unsecured consumer loans.
    [cir] Current commercial loans, less contractual compensating 
balances that comprise less than 50 percent of assets.
    [cir] Loans to CUSOs.
     The exposure amount of:
    [cir] Industrial development bonds.
    [cir] All stripped mortgage-backed securities (interest only and 
principal only STRIPS).
    [cir] Part 703 compliant investment funds, with the option to use 
the look-through approaches in Sec.  702.104(c)(3)(ii) of this section.
    [cir] Corporate debentures and commercial paper.
    [cir] Nonperpetual capital at corporate credit unions.
    [cir] General account permanent insurance.
    [cir] GSE equity exposure or preferred stock.
     All other assets listed on the statement of financial 
condition not specifically assigned a different risk weight under this 
subpart.
    Unless otherwise noted below, the investment risk weights are also 
consistent with the risk weights applicable to banks,\241\ which some 
commenters requested. The Board believes the 100 percent risk weight 
for these investments would be appropriate due to their risk of loss.
---------------------------------------------------------------------------

    \241\ See, e.g., 12 CFR 324.32 and 324.42.
---------------------------------------------------------------------------

    Industrial development bonds (IDB) are issued under the auspices of 
a state or political subdivision but are an obligation of a private 
party or enterprise and are therefore akin to a corporate exposure. An 
example of an IDB is a security issued by an airport authority for a 
terminal of an airliner. The security would be issued by the airport 
authority and be an obligation of the airliner.
    Stripped mortgage-backed securities (interest-only and principal-
only STRIPS) represent either the payments of principal or interest 
from an underlying pool of mortgages. The Board believes the increased 
risk associated with these two structures warrants a higher risk weight 
compared to non-principal-only and non-interest-only STRIPS with 
similar collateral. The Board chose to include principal-only STRIPS in 
the 100 percent risk weight category due to the explicit prohibition of 
this structure in part 703. The Board

[[Page 4405]]

requests comments on whether risk weights for principal-only STRIPS 
should be more comparable to the Other Banking Agencies and assign a 
risk weight for STRIPS based on the underlying guarantor or collateral.
    The proposal would assign a risk weight of 100 percent to part 703 
compliant investment funds, with the option to use the look-through 
approaches in the proposal. For an investment fund to be assigned a 100 
percent risk weight, compliance with part 703 of NCUA's regulations 
must be stated in the investment fund's documentation (such as the 
prospectus) and must be binding (intent alone is insufficient).
    The credit union also has the ability to choose an alternate 
approach for investment funds. The risk weight for investment funds 
deviates slightly from the approach applicable to banks. The Board has 
added a standard risk weight of 100 percent for part 703 compliant 
funds, in addition to adopting the approach applicable to banks,\242\ 
as an additional option for credit unions. However, the Board believes 
the approach for investment funds is consistent with recommendations 
received from commenters who suggested the risk weights be based on the 
underlying accounts and investment strategies.
---------------------------------------------------------------------------

    \242\ See, e.g., 12 CFR 324.53.
---------------------------------------------------------------------------

    The proposal would assign a risk weight of 100 percent to the 
balance of nonperpetual capital at corporate credit unions. 
Nonperpetual capital is subordinate to deposits in a corporate credit 
union, which warrants a higher risk weight than deposits.
    The proposal would apply the 100 percent risk weight to general 
account permanent insurance. This type of insurance is typically 
associated with the funding of employee benefits. General account 
permanent insurance with returns indexed to equity returns should have 
the same risk weight as publically traded equity investments, unless it 
has a positive return floor. The 100 percent risk weight is reflective 
of the moderate risk associated with this asset.
    Some commenters argued for lower risk weights for investments 
funding employee benefits. However, the Board disagrees with those 
commenters and, consistent with the general approach taken in assigning 
risk weights under this proposal, believes that the risk weight 
assigned to investments funding employee benefits should be based on 
the credit risk and not the purpose of the asset. The Board notes this 
is comparable to the approach taken by the Other Banking Agencies.\243\
---------------------------------------------------------------------------

    \243\ See, e.g., 12 CFR 324.32.
---------------------------------------------------------------------------

    Under this proposal, first-lien residential real estate loans that 
are not current would be assigned a 100 percent risk weight reflecting 
the increased credit risk and consistent with the risk weights for 
similar loans held by banks under the Other Banking Agencies' 
regulations.\244\ The Board believes the proposed higher risk weight 
that would be assigned to non-current loans is warranted because such 
loans have a higher probability of default when compared to current 
loans. Non-current loans are more likely to default because repayment 
is already impaired making them one step closer to default compared to 
current loans. Additionally, a higher risk weight for non-current loans 
is consistent with the risk weights assigned by the Other Banking 
Agencies.
---------------------------------------------------------------------------

    \244\ See, e.g., 12 CFR 324.32(g)(2).
---------------------------------------------------------------------------

    Under this proposal, current junior-lien residential real estate 
loans under the single concentration threshold would be assigned a 100 
percent risk weight, which would be consistent with the risk weight for 
similar residential real estate loans assigned by the Other Banking 
Agencies.\245\
---------------------------------------------------------------------------

    \245\ See, e.g., 12 CFR 324.32(g)(2).
---------------------------------------------------------------------------

    The 125 percent risk category that was included in the Original 
Proposal would be eliminated. The 125 percent risk category applied to 
the portion of other real estate loans that made up between 10 to 20 
percent of a credit union's total assets. The reduction in the number 
of concentration thresholds applicable to junior-lien real estate loans 
resulted in the elimination of the 125 percent risk weight.
    Under this proposal, secured and unsecured consumer loans would be 
separated into different risk-weight categories, with current unsecured 
consumer loans assigned a 100 percent risk weight. The higher risk 
weight for current unsecured consumer loans would reflect the elevated 
risk from this loan type compared to current secured consumer loans. 
Generally, unsecured loans reflect higher levels of delinquency and 
charge-offs, as reported on the quarterly Call Report, and, therefore, 
expose the credit union to higher risk than secured loans.
    The Board notes that under this proposal, student loans would be 
incorporated into the definition of consumer loans and risk-weighted 
accordingly.
    The approach for assigning the risk weight for commercial loans 
would be comparable to the Other Banking Agencies' rules.\246\ As 
discussed previously, the changes to the definition of commercial loans 
would align the risk weights with actual credit risk exposure instead 
of assigning risk weights based on the $50,000 exemption as it relates 
to the statutory MBL cap \247\ (which commenters pointed out). The 
change would result in improved and more easily reconcilable call 
reporting, and enhance NCUA's ability to account for all loans that 
support commercial ventures.\248\
---------------------------------------------------------------------------

    \246\ See, e.g., 12 CFR 324.32(f) (standard commercial loans) 
and 324.32(j) (high volatility commercial real estate loans).
    \247\ See. 12 CFR 723.1(b).
    \248\ Other than auto secured loans, business purpose loans 
below $50,000 would still receive a 100 percent risk weight as an 
unsecured consumer loan or fall into the ``all other assets'' 
category.
---------------------------------------------------------------------------

    Consistent with the Original Proposal, this proposed rule would 
assign a 100 percent risk weight to the outstanding balance of 
unconsolidated loans to CUSOs.
    This proposal would assign a 100 percent risk weight to all other 
balance sheet assets not specifically assigned a different risk weight 
under this subpart, but reported on the statement of financial 
condition. This 100 percent risk weight is consistent with the risk 
weight applicable to banks \249\ and the Board believes this risk 
weight is appropriate for assets not specifically assigned a risk 
weight.
---------------------------------------------------------------------------

    \249\ See, e.g., 12 CFR 324.32(l)(5).
---------------------------------------------------------------------------

104(c)(2)(vi) Category 6--150 Percent Risk Weight
    Proposed Sec.  702.104(c)(2)(vi) would provide that a credit union 
must assign a 150 percent risk weight to the following on-balance sheet 
assets:
     The outstanding balance, net of government guarantees and 
including loans held for sale, of:
    [cir] Current junior-lien residential real estate loans that 
comprise more than 20 percent of assets.
    [cir] Junior-lien residential real estate loans that are not 
current.
    [cir] Consumer loans that are not current.
    [cir] Current commercial loans (net of contractual compensating 
balances), which comprise more than 50 percent of assets.
    [cir] Commercial loans (net of contractual compensating balances), 
which are not current.
     The exposure amount of:
    [cir] Perpetual contributed capital at corporate credit unions.
    [cir] Equity investments in CUSOs.
    Under the Original Proposal, the risk weight for perpetual 
contributed capital at corporate credit unions would have

[[Page 4406]]

been 200 percent. This proposal would lower the risk weight for 
perpetual contributed capital at corporate credit unions to 150 
percent. Perpetual contributed capital at corporate credit unions would 
receive a higher risk weight than nonperpetual capital at corporate 
credit unions because perpetual contributed capital is available to 
absorb losses before nonperpetual capital. The Board believes the 150 
percent risk weight is appropriate due to heightened risk of loss 
compared to the 100 percent risk-weighted nonperpetual capital.
    Under this proposal, current junior-lien residential real estate 
loans that exceed 20 percent of assets would be assigned a 150 percent 
risk weight. Additionally, any junior-lien residential real estate 
loans that are not current, as defined in the proposal, would receive 
the 150 percent risk weight reflecting the higher credit risk of such 
loan than current junior-lien real estate loans up to 20 percent of 
assets, which would receive a 100 percent risk weight.
    The Board also proposes that consumer loans that are non-current be 
assigned a 150 percent risk weight, as in the Original Proposal. The 
Board believes the proposed higher risk weight that would be assigned 
to non-current loans is warranted because such loans have a higher 
probability of default when compared to current loans. Non-current 
loans are more likely to default because repayment is already impaired 
making them one step closer to default compared to current loans. This 
rule would more clearly define those loans that are assigned a 150 
percent risk weight through new definitions for consumer loan and 
current loan. The 150 percent risk weight for non-current consumer 
loans is also consistent with the risk weight for non-current consumer 
loans assigned by the Other Banking Agencies.\250\
---------------------------------------------------------------------------

    \250\ See, e.g., 12 CFR 324.32(k)(1).
---------------------------------------------------------------------------

    This proposal would maintain higher risk weights for high 
concentrations of commercial loans as GAO and OIG recommend. A high 
concentration is defined as commercial loans over 50 percent of assets, 
which would receive the 150 percent risk weight. The amount of 
commercial loans subject to the 150 percent concentration risk weight 
would be determined as follows:
[GRAPHIC] [TIFF OMITTED] TP27JA15.007

    As discussed earlier, due to the higher credit risk of non-current 
commercial loans, they would receive a 150 percent risk weight.
    The Board requests comments on whether any items currently listed 
in this category should be assigned a higher or lower risk weight and 
why. In addition, the Board requests comments on whether additional 
items should be assigned a 150 percent risk weight and why.
104(c)(2)(vii) Category 7--250 Percent Risk Weight
    Proposed Sec.  702.104(c)(2)(vii) would provide that a credit union 
must assign a 250 percent risk weight to the carrying value of mortgage 
servicing assets (MSAs) held on-balance sheet.
    As discussed above, MSA valuations are highly sensitive to 
unexpected shifts in interest rates and prepayment speeds. As noted 
above, MSAs are also sensitive to the costs associated with servicing. 
These risks contribute to the high level of uncertainty regarding the 
ability of credit unions to realize value from such assets, especially 
under adverse financial conditions, and support this proposed rule's 
treatment for MSAs. Given there is no differentiation between the risk 
as it relates to MSAs for credit unions versus banks, the Board 
believes this treatment would generally maintain comparability with the 
Other Banking Agencies' capital regulations.\251\
---------------------------------------------------------------------------

    \251\ See, e.g., 12 CFR 324.32(l)(4)(i).
---------------------------------------------------------------------------

    The Board requests comments on whether any items currently listed 
in this category should be assigned a higher or lower risk weight and 
why. In addition, the Board requests comments on whether additional 
items should be assigned a 250 percent risk weight and why.
104(c)(2)(viii) Category 8--300 Percent Risk Weight
    Proposed Sec.  702.104(c)(2)(viii) would provide that a credit 
union must assign a 300 percent risk weight to the exposure amount of 
the following on-balance sheet assets:
     Publicly traded equity investments, other than a CUSO 
investment.
     Investment funds that are not in compliance with 12 CFR 
part 703, with the option to use the look-through approaches in Sec.  
702.104(c)(3)(ii) of this section.
     Separate account insurance, with the option to use the 
look-through approaches in Sec.  702.104(c)(3)(ii).
    The 300 percent risk weight category would be a new category 
relative to current rule and the Original Proposal. This second 
proposal would apply a 300 percent risk weight to the exposure amount 
of publicly traded equity

[[Page 4407]]

investments, other than a CUSO investment. This proposal would also 
apply a 300 percent risk weight to investment funds that do not comply 
with part 703, and to separate account insurance, with the option to 
use the look-through approaches for both. The 300 percent risk weight 
is due to the heightened level of uncertainty and potential risks 
within these assets as discussed below.
    Publicly traded equities have no contractual returns, no maturity 
date, and are generally considered more volatile than fixed-income 
investments. Furthermore, publically traded equities have a greater 
risk of loss since they are in a first loss position versus the debt of 
a company. Non-part 703 compliant investment funds and separate account 
insurance may contain equities, or other volatile and risky 
investments, which warrants the 300 percent risk weight. The risk 
exposure of both of these investments comes from the underlying assets 
supporting the investment fund or separate account insurance. Thus, 
credit unions would have the option of applying one of the look-through 
approaches discussed in more detail below for investment funds and 
separate account insurance risk weights to lower risk weights for 
investment funds and separate account insurance, if a credit union 
chooses to use one of the alternative approaches.
    This proposal would allow the 300 percent risk weight to apply to 
all publicly traded equity exposures, both directly and indirectly. The 
300 percent risk weight for publicly traded equities is generally 
consistent with the risk weight applicable to banks \252\ and the Board 
believes this risk weight is appropriate due the elevated risk of loss 
with publicly traded equities. This would include direct exposure via 
purchasing an equity investment or having exposure to publicly traded 
equities through some other structure. An example of public equity 
exposure through other structures would be general account permanent 
insurance where the returns are indexed off of the Standard and Poor's 
500 Index. A minimum positive return floor is sufficient to exclude 
general account permanent insurance from the 300 percent risk weight. 
Structured products can also be structured to have returns based off 
the return of an index or one or more publicly traded equities.
---------------------------------------------------------------------------

    \252\ See, e.g., 12 CFR 324.52(b)(5).
---------------------------------------------------------------------------

    The risk weights for investment funds and separate account 
insurance deviate slightly from the Other Banking Agencies' capital 
regulations.\253\ This proposal adds a standard risk weight of 300 
percent for non-part 703 compliant funds, in addition to the approach 
applicable to banks,\254\ as an additional option for credit unions. 
The approach for investment funds and separate account insurance is 
consistent with several commenters who requested risk weights be based 
on the underlying accounts and investment strategies.
---------------------------------------------------------------------------

    \253\ See, e.g., 12 CFR 324.53.
    \254\ See, e.g., 12 CFR 324.53.
---------------------------------------------------------------------------

    The Board believes the 300 percent risk weight that would be 
assigned to non-part 703 compliant investment funds and separate 
account insurance is appropriate due to the potential risk the 
underlying assets may have. The risk weight of 300 percent for these 
exposures is due to the wide availability of equity-based investment 
funds and equity-based separate account insurance in the market. The 
Board notes that credit unions may get a lower risk weight if they use 
a look-through approach for investment funds and separate account 
insurance.
    The Board requests comments on whether any items currently listed 
in this category should be assigned a higher or lower risk weight and 
why. In addition, the Board requests comments on whether additional 
items should be assigned a 300 percent risk weight and why.
104(c)(2)(ix) Category 9--400 Percent Risk Weight
    Proposed Sec.  702.104(c)(2)(ix) would provide that a credit union 
must assign a 400 percent risk weight to the exposure amount of non-
publicly traded equity investments that are held on-balance sheet, 
other than equity investments in CUSOs.
    This 400 percent risk weight is due to the greater relative risk 
versus publicly traded equity investments, which have a 300 percent 
risk weight. The greater risk is due to non-publicly traded equity 
investments not having the reporting requirements and active market 
that a publicly traded equity has. The 400 percent risk weight for non-
publicly traded equity investments is consistent with the risk weight 
applicable to banks \255\ and the Board believes this risk weight is 
appropriate due to the increased risk of non-publicly traded equities 
versus publicly traded equities.
---------------------------------------------------------------------------

    \255\ See, e.g., 12 CFR 324.52(b)(6).
---------------------------------------------------------------------------

    The 400 percent risk weight category is a new category when 
compared to the current rule and the Original Proposal. This risk 
weight is unlikely to have an effect on most credit unions due to 
federal and state restrictions on credit union purchases of these types 
of investments. The Board, however, believes it is a necessary category 
to have in the unlikely event a credit union would own a non-publically 
traded non-CUSO investment. The proposed addition of this category 
would also be comparable to the Other Banking Agencies' capital 
regulations.\256\
---------------------------------------------------------------------------

    \256\ Id.
---------------------------------------------------------------------------

    The Board requests comments on whether any items currently listed 
in this category should be assigned a higher or lower risk weight and 
why. In addition, the Board requests comments on whether additional 
items should be assigned a 400 percent risk weight and why.
104(c)(2)(x) Category 10--1,250 Percent Risk Weight
    Under the Original Proposal, proposed Sec.  702.104(c)(2)(x) would 
have required a credit union to assign a 1,250 percent risk weight to 
an asset-backed investment for which the credit union is unable to 
demonstrate, as required under Sec.  702.104(d), a comprehensive 
understanding of the features of the asset-backed investment that would 
materially affect its performance. A 1,250 percent risk weight is 
equivalent to holding capital equal to 100 percent of the investment's 
balance sheet value.\257\
---------------------------------------------------------------------------

    \257\ The eight percent adequately capitalized level times 1,250 
percent = 100 percent.
---------------------------------------------------------------------------

    During the recent financial crisis, it became apparent that many 
federally insured financial institutions relied exclusively on ratings 
issued by Nationally Recognized Statistical Organizations (NRSOs) and 
did not perform internal credit analysis of asset-backed investments.
    Complex credit unions must be able to demonstrate a comprehensive 
understanding of any investment, particularly an understanding of the 
features of an asset-backed investment that would materially affect its 
performance. Upon purchase, and on an ongoing basis, the credit union 
must evaluate, review, and update as appropriate the analysis performed 
on an asset-backed investment. In the event a credit union is unable to 
demonstrate a comprehensive understanding of an asset-backed 
investment, the Original Proposal would have provided for assigning a 
risk weight of 1,250 percent to that investment.
    The Board received a significant number of comments on the 
assignment of the 1,250 percent risk weight to certain investments and 
the proposed due diligence requirements in Sec.  702.104(d). Commenters 
generally agreed that credit unions should have a

[[Page 4408]]

comprehensive understanding of any investments they purchase. Several 
commenters objected to assigning a 1,250 percent risk weight to 
investments credit unions do not understand.
    One commenter stated that the proposal gave the Board broad 
discretion to require dollar-for-dollar capital on asset-backed 
investments that NCUA determines the credit union is unable to 
demonstrate a comprehensive understanding. The commenter stated that 
while such an investment may represent a significant safety and 
soundness concern, an elevated capital requirement is not an 
appropriate means of addressing that risk. The commenter suggested that 
if a credit union does not understand an investment on its books, the 
regulator should rectify the situation through the supervisory process. 
The commenter stated further that, although this provision was adopted 
in the bank rule, use of these types of products is more limited in the 
credit union industry and risks can and should be addressed through 
examinations.
    Other commenters suggested that the Board minimize the regulatory 
burdens of this provision by limiting the proposed reporting 
requirements to investments identified during the supervisory process 
as a potential concern.
    A number of commenters expressed concern that NCUA would not apply 
the requirements in a fair and consistent manner across credit unions. 
A small number of commenters suggested that the Board should be 
required to perform an on-site evaluation and reach a joint 
determination with the state regulator before recommending a 1,250 
percent risk weight on a state-chartered institution.
    Commenters suggested that the rule should clarify the 
administrative level within NCUA at which this determination will be 
made because such a finding could have a dramatic impact on a credit 
union's PCA classification and major implications for that credit 
union's balance sheet and management structure. Other commenters 
suggested that the rule should specify that a 1,250 percent risk weight 
constitutes a material supervisory determination that is subject to 
appeal.
    A number of commenters stated that the term ``asset-backed 
investment'' is not defined, which they stated could lead to wide 
interpretation both of the 1,250 percent risk weight as well as 
potential examiner expectations of the initial and ongoing depth of the 
review, analysis, and documentation of asset-backed investments. 
Commenters suggested that such depth of review is appropriate for some 
types of investments, but not others. For example, commenters contended 
that a government agency-guaranteed mortgage-backed security does not 
warrant the type of analysis and documentation outlined in the Original 
Proposal because the lack of inherent credit risk in the government 
agency security should reduce the concern of a large credit loss on the 
investment and therefore should reduce the depth of review and 
analysis.
    Other commenters suggested if the Board determines it can provide a 
clear definition of ``asset-backed investments,'' it should do so in a 
new proposed rule that also outlines reasonable expectations and 
provides a method for fair and consistent application of the due 
diligence requirements.
    One commenter agreed that complex asset backed investments (private 
label) with inherent credit risk exposure should have additional due 
diligence requirements, but argued a 250 percent risk weight would be 
more appropriate. Another commenter suggested that the rule should make 
it clear that the due diligence requirement does not apply to any asset 
backed investments guaranteed by the U.S. Government or any U.S. 
Government agency.
    Based on a diligent review of these comments the Board has 
significantly revised this section and now proposes to require a 1,250 
percent risk weight only for subordinated tranches of any investments. 
Specifically, the Board is proposing to change application of a 1,250 
percent risk weight from ``asset-backed investments,'' to 
``subordinated tranche'' investments.
    Commenters requested clarity on the interpretation on what 
investments would be considered asset-backed investments. The Board 
believes subordinated tranche is a clearer term, has provided a 
corresponding definition, and thus will eliminate the ambiguity cited 
by commenters.
    The Board also believes this proposed change will more accurately 
apply risk weights based on risk while providing clarity and 
consistency.
    However, NCUA still expects credit unions to perform appropriate 
credit analysis on non-subordinated tranches of mortgage- and asset-
backed securities. NCUA will address deficiencies in the credit 
analysis of non-subordinated tranches through the supervision process.
    The Board is also proposing changes to address concerns raised by 
commenters with respect to securities issued by the U.S. Government and 
NCUA's ability to use its discretion to apply a 1,250 percent risk 
weight.
    First, the Board is proposing to specifically exclude senior 
tranches and most securities issued by the U.S. Government, any U.S. 
Government agency, or GSEs. The Board believes this change would 
address a major concern expressed by commenters.
    The Board is also proposing to remove the discretion for NCUA to 
impose a 1,250 percent risk weight by allowing credit unions to choose 
the standard 1,250 percent risk weight or allowing credit unions the 
option to use the gross-up approach, which is explained in more detail 
below. The Board believes that removing NCUA discretion to impose a 
1,250 risk weight also addresses a major concern by commenters. As 
previously noted, deficiencies in credit analysis will be addressed in 
supervision.
    The Board believes a 1,250 percent risk weight is appropriate for 
subordinated tranches based on the leveraged nature of the credit risk 
in these investments. In addition, this approach is consistent with the 
approach applicable to banks,\258\ which some commenters requested.
---------------------------------------------------------------------------

    \258\ See, e.g., 12 CFR 324.43(e) and 324.44; Note, the Board is 
not offering the option for the Simplified Supervisory Formula 
Approach permitted under the Other Banking Agencies' capital 
regulations due to its complexity and limited applicability.
---------------------------------------------------------------------------

    The Board intends for the 1,250 percent risk weight to apply to 
subordinated tranches of MBS, asset-backed securities, revenue bonds, 
and areas where there is subordinated credit risk in a structured 
product. Subordinated MBS and asset-backed securities are the most 
common form of subordinated tranches, and include any MBS or asset-
backed securities that take credit losses before a more senior class. 
Senior mezzanine tranches \259\ would be considered subordinated unless 
the more senior tranches have paid off. A subordinated tranche can 
become a non-subordinated tranche if the more senior tranches pay off.
---------------------------------------------------------------------------

    \259\ Senior mezzanine tranches are subordinated to more senior 
tranches at issuance.
---------------------------------------------------------------------------

    Subordinated revenue bonds would typically involve a bond similar 
to an asset-backed security that is issued as a revenue bond. An 
example is a subordinated revenue bond issued by a state corporation 
that facilitates the granting of student loans. The performance of 
these types of subordinated bonds is based on the revenue provided by 
the underlying loans, as in the case of an asset-backed security.

[[Page 4409]]

    Structured products that take credit losses based on a reference 
pool would be considered subordinated tranches. An example would be the 
loss sharing bonds that are issued by Fannie Mae and Freddie Mac. These 
structured securities are Fannie Mae or Freddie Mac debentures that pay 
less than par to investors if the reference pool takes a certain amount 
of losses. In this case the majority of the credit risk comes from the 
principal payout formula, not the issuer.
    As discussed above, subordinated tranches are leveraged. This 
leverage allocates a disproportionate amount of losses to subordinated 
tranches in relation to the pool of collateral, or reference pool. By 
applying a 1,250 percent risk weight, the Board is ensuring that the 
risk of highly leveraged subordinated tranches would be captured.
    The Board is also proposing to provide credit unions with the 
ability to use the gross-up approach to apply a lower risk weight to 
less leveraged subordinated tranches, which may result in a lower risk 
weight. The gross-up approach is discussed in more detail below.
    Accordingly, under this proposal, Sec.  702.104(c)(2)(x) would 
provide that a credit union must assign a 1,250 percent risk weight to 
the exposure amount of any subordinated tranche of any investment held 
on balance sheet, with the option to use the gross-up approach in Sec.  
702.104(c)(3)(i).\260\
---------------------------------------------------------------------------

    \260\ Based on June 30, 2014, Call Report data, NCUA estimates 
that 93.3 percent of all investments for credit unions with more 
than $100 million in assets would receive a risk weight of 20 
percent or less; and, 96.1 percent of all investments would receive 
a risk weight of 100 percent or less.
---------------------------------------------------------------------------

    The Board is not retaining the due diligence requirement that would 
have been contained in Sec.  702.104(d) of the Original Proposal. 
Proposed Sec.  702.104(d) would have contained a list of due diligence 
requirements credit unions would have been required to implement to 
demonstrate a comprehensive understanding of the features of an asset-
backed investment and a requirement that if a credit union is unable to 
demonstrate a comprehensive understanding of the features of an asset-
backed investment exposure that would materially affect the performance 
of the exposure, the credit union must assign a 1,250 percent risk 
weight to the asset-backed investment exposure. The Original Proposal 
would have also required that the credit union's analysis be 
commensurate with the complexity of the asset-backed investment and the 
materiality of the position in relation to regulatory capital according 
to this part. As noted above, the Board is deleting this section from 
this proposal in conjunction with the changes it is making to the 
requirements to apply a 1,250 percent risk weight.
    While it remains a best practice for credit unions to understand 
the features that would affect the performance of all investments, not 
just asset-based investments, any weakness with investment purchase 
analysis and documentation can be addressed through the supervision 
process.
    The Board requests comments on this provision of the proposal.
104(c)(3) Alternative Risk Weights for Certain On-Balance Sheet Assets
    Proposed Sec.  702.104(c)(3) would provide that instead of using 
the risk weights assigned in Sec.  702.104(c)(2), a credit union may 
determine the risk weight of investment funds and subordinated tranches 
of any investment using the approaches which are discussed in more 
detail below. The Board believes these alternative approaches would 
provide a credit union with the ability to risk weight based on the 
underlying exposure of the subordinated tranche or investment fund 
without exposing the NCUSIF to additional risk. This approach may also 
allow for lower risk weights compared to the standard risk weights 
proposed.
104(c)(3)(i) Gross-up Approach
    Proposed Sec.  702.104(c)(3)(i) would provide that a credit union 
may use the gross-up approach under 12 CFR 324.43(e) to determine the 
risk weight of the carrying value of any subordinated tranche of any 
investment. As noted above, the Board is allowing for the use of the 
gross-up approach, included in the Other Banking Agencies' capital 
rules, when applying risk weights to subordinated tranches of any 
investment. The Board believes this approach is appropriate in applying 
risk weights, if the credit union chooses to use it, since it captures 
the total exposure the subordinate tranche is supporting.
    However, the credit union can only use one methodology to calculate 
the risk weight for subordinate tranches, either the gross-up approach 
or a 1,250 percent risk weight.
    The basic logic behind the gross-up approach is that the risk 
weight should reflect the entire amount of exposure the subordinated 
tranche is supporting. Said another way, the credit union must hold 
capital for the subordinated tranche, as well as all the senior 
tranches for which the subordinated tranche provides credit support.
    When calculating the risk weight using the gross-up approach, the 
credit union must have the following information:
     Exposure amount of the subordinated tranche;
     Current outstanding par value of the credit union's 
subordinated tranche;
     Current outstanding par value of the total amount of the 
entire tranche where the credit union has exposure;
     Current outstanding par value of the more senior positions 
in the securitization that are supported by the tranche the credit 
union owns the subordinated tranche; and
     The weighted average risk weight applicable to the assets 
underlying the securitization.
    The following is an example of the application of the gross-up 
approach: \261\
---------------------------------------------------------------------------

    \261\ More simple terminology than the FDIC rule language is 
used to make this example easier to follow.

    A credit union owns $4 million (exposure amount and outstanding 
par value) of a subordinated tranche of a private label mortgage-
backed security backed by first-lien residential mortgages. The 
total outstanding par value of the subordinated tranche that the 
credit union owns part of is $10 million. The current outstanding 
par value for the tranches that are senior to and supported by the 
credit union's tranche is $90 million.

----------------------------------------------------------------------------------------------------------------
                                                                           Calculation               Result
----------------------------------------------------------------------------------------------------------------
A......................................  Current outstanding par    $4,000,000/$10,000,000...                40%
                                          value of the credit
                                          union's subordinated
                                          tranche divided by the
                                          current outstanding par
                                          value of the entire
                                          tranche where the credit
                                          union has exposure.
B......................................  Current outstanding par    .........................        $90,000,000
                                          value of the senior
                                          positions in the
                                          securitization that are
                                          supporting the tranche
                                          the credit union owns.

[[Page 4410]]

 
C......................................  Pro-rata share of the      40% times $90,000,000....        $36,000,000
                                          more senior positions
                                          outstanding in the
                                          securitization that is
                                          supported by the credit
                                          union's subordinated
                                          tranche: (A) multiplied
                                          by (B).
D......................................  Current exposure amount    .........................         $4,000,000
                                          for the credit union's
                                          subordinated tranche.
E......................................  Enter the sum of (C) and   $36,000,000 + $4,000,000.        $40,000,000
                                          (D).
F......................................  The higher of the          50% primary risk weight                  50%
                                          weighted average risk      for 1st lien residential
                                          weight applicable to the   real estate loan.
                                          assets underlying the
                                          securitization or 20%.
G......................................  Risk-weighted asset        $40,000,000 times 50%....        $20,000,000
                                          amount of the credit
                                          union's purchased
                                          subordinated tranche:
                                          (E) multiplied by (F).
----------------------------------------------------------------------------------------------------------------

    In this example, under the gross-up approach, the credit union 
would be required to risk weight the subordinated tranche at 
$20,000,000. Conversely, under the 1,250 percent risk weight approach, 
the credit union would be required to risk weight the subordinated 
tranche at $50 million (1250 percent times $4 million). The Board 
believes this example shows the benefit to credit unions of the 
proposed inclusion of the gross-up approach.
    In the case of master trust \262\ type structures and structured 
products,\263\ credits unions should calculate the pro-rata share of 
the more senior positions using the prospectus and current servicing/
reference pool reports.
---------------------------------------------------------------------------

    \262\ Master trust subordinated tranches do not support any 
particular senior tranche in the trust. The subordinated tranche 
supports an amount of senior tranches as defined in the prospectus 
and the current servicing reports.
    \263\ Structured products may allocate losses based on other 
securities or a reference pool. The credit union should calculate 
the pro-rata senior tranche based on the amount the subordinated 
tranche would support if it were an actual tranched security.
---------------------------------------------------------------------------

104(c)(3)(i) Look-Through Approaches
    Proposed Sec.  702.104(c)(3)(ii) would provide that a credit union 
may use one of the look-through approaches under 12 CFR 324.53 to 
determine the risk weight of the fair value of mutual funds that are 
not in compliance with part 703 of this chapter, the recorded value of 
separate account insurance; or part 703 compliant mutual funds. The 
Board is proposing this approach to allow credit unions to use the 
look-through approach in the Other Banking Agencies' regulations for 
investment funds. This proposed provision responds to commenters who 
requested this authority.
    Specifically, for purposes of applying risk weights to investment 
funds, the Board is proposing to give credit unions the option of using 
the three look-through approaches that FDIC allows its regulated 
institutions to use under 12 CFR 324.53 of its regulations, instead of 
using the standard risk weights of 20, 100 and 300 percent that would 
be assigned under proposed Sec.  702.104(c)(2). The Board believes that 
including these alternative approaches makes NCUA's risk-based capital 
requirement more comparable to the Other Banking Agencies' regulations 
and grants credit unions additional flexibility.
    The first of the three full look-through approaches under 12 CFR 
324.53 would require a credit union to look at the underlying assets 
owned by the investment fund and apply an appropriate risk weight. The 
other two approaches under 12 CFR 324.53 would require a credit union 
to use the information provided in the investment fund's prospectus. 
The minimum risk weight for any investment fund asset would be 20 
percent, regardless of which approach was used.
    The Board notes that regardless of the look-through approach 
selected, the credit union must include any derivative contract that is 
part of the investment fund, unless the derivative contract is used for 
hedging rather than speculative purposes and does not constitute a 
material portion of the fund's exposure.\264\
---------------------------------------------------------------------------

    \264\ At this time FCUs are not permitted to engage in 
derivative contract activity for the purpose of speculation. 
However, federally insured, state-chartered credit unions may be 
permitted to use derivative contracts for speculative purposes under 
applicable state law, and thus the Board is including this statement 
to address those scenarios.
---------------------------------------------------------------------------

    The following examples outline each of the three look-through 
approaches:
    Full look-through approach. The full look-through approach would 
allow credit unions to weight the underlying assets in the investment 
fund as if they were owned separately, with a minimum risk weight of 20 
percent for all underlying assets. Credit unions would be required to 
use the most recently available holdings reports when utilizing the 
full look-through approach. An example of the application of the full 
look-through approach is as follow:
---------------------------------------------------------------------------

    \265\ Fund holdings (percent of fund) multiplied by the credit 
union investment.
    \266\ Minimum 20 percent risk weight for assets in an investment 
fund, even if the individual risk weight is zero percent.
    \267\ Use 1,250 percent risk weight or gross-up calculation.
    \268\ The weighted average risk weight was calculated by 
dividing the amount of risk assets ($5,600,000) by the credit union 
exposure ($10,000,000).

                                      Credit Union Investment--$10,000,000
----------------------------------------------------------------------------------------------------------------
                                         Fund      Credit union
          Fund investment:            holding (%     exposure          Risk weight:         Dollar risk weight:
                                      of fund):       \265\:
----------------------------------------------------------------------------------------------------------------
U.S. Treasury Notes:...............           50      $5,000,000  20% \266\.............  $1,000,000.
FNMA PACs:.........................           30       3,000,000  20%...................  $600,000.
PSE Revenue Bonds:.................         17.5       1,750,000  50%...................  $875,000.
Subordinated MBS \267\.............          2.5         250,000  1,250%................  $3,125,000.
                                    ----------------------------------------------------------------------------

[[Page 4411]]

 
    Totals.........................  ...........      10,000,000  56% \268\.............  $5,600,000 (amount of
                                                                  (weighted average risk   risk assets).
                                                                   weight).
----------------------------------------------------------------------------------------------------------------

    Using the above example, the investment fund would have a weighted 
average risk weight of 56 percent, which would be lower than the 100 
percent standard risk weight for part 703 compliant investment funds or 
the standard 300 percent risk weight for investment funds not compliant 
with part 703.
    Simple modified look-through approach. The simple modified look-
through approach would allow credit unions to risk weight their 
holdings in an investment fund by the highest risk weight of any asset 
permitted by the investment fund's prospectus. Credit unions should use 
the most recently available prospectus to determine investment 
permissibility for an investment fund. An example of the application of 
the simple modified look-through approach is as follow:

                  Credit Union Investment--$10,000,000
------------------------------------------------------------------------
                                          Fund limits (%    Risk weight
        Permissible investments:             of fund):      (percent):
------------------------------------------------------------------------
U.S. Treasury Notes:....................             100        \269\ 20
Agency MBS (non IO or PO):..............              50              20
PSE GEO Bonds:..........................              20              20
PSE Revenue Bonds:......................              20              50
Non-Government/Subordinated/IO/PO MBS...              30              50
Subordinated MBS........................              10     \270\ 1,250
------------------------------------------------------------------------

    Using the above example, the investment fund would have a risk 
weight of 1,250 percent using the simple modified look-through approach 
because the investment fund can hold 1,250 percent risk-weighted 
subordinated MBS. In this case, the credit union would most likely use 
a 100 percent standard risk weight for the part 703 compliant 
investment fund or the standard 300 percent risk weight for investment 
funds not in compliance with part 703.
---------------------------------------------------------------------------

    \269\ Minimum 20 percent risk weight for assets in an investment 
fund, even if the individual risk weight is zero percent.
    \270\ Use 1,250 percent risk weight unless the prospectus limits 
gross-up risk weight.
---------------------------------------------------------------------------

    Alternative modified look-through approach. The alternative 
modified look-through approach would allow credit unions to risk weight 
their holdings in an investment fund by applying the risk weights to 
the limits in the prospectus. In the case where the aggregate limits in 
the prospectus exceed 100 percent, the credit union must assume the 
fund will invest in the highest risk-weighted assets first. An example 
of the application of the simple modified look-through approach is as 
follows:

                                      Credit Union Investment--$10,000,000
----------------------------------------------------------------------------------------------------------------
                                    Fund limits (%
     Permissible investments:          of fund):         Risk weight:       CU Exposure:    Dollar risk weight:
----------------------------------------------------------------------------------------------------------------
U.S. Treasury Notes:..............             100  20% \271\............              $0
Agency MBS (non IO or PO):........              50  20%..................       2,000,000  400,000.
PSE GEO Bonds:....................              20  20%..................       2,000,000  400,000.
PSE Revenue Bonds:................              20  50%..................       2,000,000  1,000,000.
Non-Government/...................              30  50%..................       3,000,000  1,500,000.
Subordinated/IO/PO MBS............
Subordinated MBS..................              10  1,250% \272\.........       1,000,000  12,500,000.
                                   -----------------------------------------------------------------------------
    Total.........................  ..............  158% \273\ (weighted      $10,000,000  15,800,000 (Amount of
                                                     average risk weight).                  Risk Assets).
----------------------------------------------------------------------------------------------------------------

    Using the example above, the investment fund would have a weighted 
average risk weight of 158 percent using the alternative modified look-
through approach. In this case, the credit union would most likely use 
a 100 percent standard risk weight for part 703 compliant investment 
funds or the alternative modified look-through approach for risk 
weights for investment funds that are not compliant with part 703.
---------------------------------------------------------------------------

    \271\ Minimum 20 percent risk weight for assets in an investment 
fund, even if the individual risk weight is zero percent.
    \272\ Use 1,250 percent risk weight unless the prospectus limits 
gross-up risk weights.
    \273\ The weighted average risk weight was calculated by 
dividing the amount of risk assets ($15,800,000) by the credit union 
exposure ($10,000,000).
---------------------------------------------------------------------------

104(c)(4) Risk Weights for Off-Balance Sheet Activities
    Under the Original Proposal, proposed Sec.  702.104(b)(3), which 
has been re-numbered as Sec.  702.104(b)(4) under this proposal, would 
have

[[Page 4412]]

provided that the risk-weighted amounts for all off-balance sheet items 
are determined by multiplying the notional principal, or face value, by 
the appropriate conversion factor and the assigned risk weight as 
follows:
     A 75 percent conversion factor with a 100 percent risk 
weight for unfunded commitments for MBLs.
     A 75 percent conversion factor with a 100 percent risk 
weight for MBLs transferred with limited recourse.
     A 75 percent conversion factor with a 50 percent risk 
weight for first mortgage real estate loans transferred with limited 
recourse.
     A 75 percent conversion factor with a 100 percent risk 
weight for other real estate loans transferred with limited recourse.
     A 75 percent conversion factor with a 100 percent risk 
weight for non-federally guaranteed student loans transferred with 
limited recourse.
     A 75 percent conversion factor with a 75 percent risk 
weight for all other loans transferred with limited recourse.
     A 10 percent conversion factor with a 75 percent risk 
weight for total unfunded commitments for non-business loans.
    Under the Original Proposal, a credit union would have calculated 
the exposure amount of an off-balance sheet component, which is 
typically the contractual amount multiplied by the applicable credit 
conversion factor (CCF). This treatment would have applied to specific 
off-balance sheet items, including loans transferred with limited 
recourse, unfunded commitments for business loans, and other unfunded 
commitments. The Original Proposal would have improved risk sensitivity 
and implemented capital requirements for certain exposures through a 
simple methodology.
    The Board received a number of comments on the proposed risk 
weights for off-balance sheet activities. Commenters suggested that the 
off-balance sheet computations seemed excessive and added unnecessary 
risk assets.
    One commenter disagreed with the 75 percent conversion factor with 
a 100 percent risk weight for unfunded commitments for MBLs, if that 
meant that a $10,000 line of credit that is funded to $6,000 would 
require a risk-based capital funding of $10,000 times 0.75, which would 
equal $7,500 for a $4,000 unfunded commitment.
    A number of commenters suggested that under the proposed rule, 
credit unions would have been penalized for having unfunded commitments 
on non-business loans and business loans. Other commenters suggested 
that unfunded commitments on non-business loans and business loans 
should be assigned lower risk weights because the proposed risk weights 
would encourage credit unions to terminate or decrease lines of credit 
to consumers or small business owners to improve their risk-based 
capital classification. Another commenter agreed with including off-
balance sheet activities in the assets denominator.
    Others stated the 75 percent conversion factor for unfunded 
business loans did not give appropriate consideration to the liability 
side of off-balance sheet items to offset some of this risk or other 
risks needs to be considered for lowering the assets denominator. 
Another commenter appreciated the proposed approach to capture off-
balance sheet items.
    Still others stated that the reporting of off-balance sheet loans 
sold with limited recourse creates a negative impact on a credit 
union's balance sheet. One other commenter suggested that the rule 
should include a mechanism for differentiating between loans sold with 
and without recourse.
    A number of commenters stated that some credit unions that sell 
conforming first mortgages through the Federal Home Loan Banks' (FHLB) 
mortgage partnership finance (MPF) program retain a limited contractual 
portion of the credit risk. Those commenters suggested that the 
proposed risk weight is much too high for these loans because credit 
unions must generate their net earnings on such transactions at 
origination. Those commenters stated further that to generate 
sufficient income under the proposed risk weights, credit unions would 
have to charge rates on the MPF loans that would be very high and would 
not be competitive with bank rates for the same types of mortgages. 
Other commenters suggested that MPF loans sold to FHLBs should be 
assigned a conversion factor of 50 percent or less (along with the 
proposed 50 percent risk weight) because of their low risk exposure and 
to allow credit unions to compete in the mortgage market. Those 
commenters observed that the MPF program is a unique secondary market 
outlet for conforming fixed rate residential mortgages, in which 
participating FHLB members provide a credit enhancement (CE) based on 
the characteristics of mortgages being originated and sold under the 
Program. Those commenters stated further that the CE is a fixed dollar 
exposure for a specific pool of loans or Master Commitment, and one 
piece of the credit support that absorbs losses in a specific loan pool 
which exceed homeowners' equity, primary mortgage insurance and an 
FHLB-provided first loss account (FLA). Those commenters explained that 
in exchange for providing the CE, members receive ongoing credit 
enhancement fee income over the life of the loans. Those commenters 
stated that this approach rewards FHLB-member credit unions for quality 
underwriting and provides a superior execution because it removes 
inefficiencies associated with charging guarantee fees based on the 
possible future performance of loans because, instead of assessing 
charges to cover projected losses, actual losses are covered by private 
capital provided by the FHLB and its members, resulting in strong 
historic performance of the MPF loans. In addition, those commenters 
suggested that due to the FLA covering the majority of the credit risk 
on MPF loans, participating member credit unions do not retain any 
interest rate or concentration risk on the sold loans. Those commenters 
recommended that, based on the historic performance of MPF loans and 
the very small amount of sustained credit losses, the capital charge 
under the Original Proposal was too high and a lower conversion factor 
should be used that recognizes the FLA and the strong historic 
performance of MPF loans.
    After considering the comments, the Board continues to believe that 
the risks associated with recourse loans and unfunded commitments are 
analogous to those associated with similar on-balance sheet loans. For 
this reason, these items will continue to be included in the risk-based 
capital ratio calculation. The Board generally agrees, however, that 
some specific changes should be made to more accurately measure the 
risks this subsection of the proposal is intended to account.
    In particular, the Board generally agrees that a credit union's 
risk-based capital ratio calculation relating to off-balance sheet 
items should be limited to the amount of the credit union's contractual 
exposure. Accordingly, the Board has amended this proposal to require 
that the credit equivalent amount that is applied to the appropriate 
risk weight category for all off-balance sheet items be determined by 
multiplying the off-balance sheet exposure, which is newly defined in 
this rule, by the appropriate credit conversion factor.
    This proposal would retain the 10 percent credit conversion factor 
for non-commercial unused lines of credit. Commenters suggested that to 
improve their risk-based capital ratio credit unions would have looked 
to either terminate or decrease their lines of credit to consumers. 
Open lines of

[[Page 4413]]

credit to consumers, even those that are unconditionally cancellable, 
can quickly result in a credit union shifting assets from low risk 
weight investments to higher risk weight loans. Credit unions can be 
hesitant to cancel or reduce consumer lines of credit due to the 
potential for negative reputation risk. Credit unions need to monitor 
the amount and type of outstanding unused lines of credit. The Board 
believes the proposed 10 percent credit conversion factor for unused 
consumer lines of credit would encourage credit unions to manage open 
consumer lines of credit through active monitoring and review of trends 
and exposures, and is consistent with the calculation of off-balance 
sheet exposure measures contained in Basel III.\274\
---------------------------------------------------------------------------

    \274\ Basel III was published in December 2010 and revised in 
June 2011. The text is available at http://www.bis.org/publ/bcbs189.htm.
---------------------------------------------------------------------------

    The Board generally agrees with commenters' who stated that the 
credit conversion factor for unfunded commercial loans, in the Original 
Proposal, was too high and could have created a competitive 
disadvantage for credit unions in relation to banks. Accordingly, the 
Board is proposing to reduce the credit conversion factor for 
commercial loans from 75 percent to 50 percent. This change would be 
consistent with the credit conversion factor applied to longer-term 
commitments not unconditionally cancelable under the Other Banking 
Agencies' regulations.\275\
---------------------------------------------------------------------------

    \275\ See, e.g., 12 CFR 324.33.
---------------------------------------------------------------------------

    The Board also generally agrees with commenters that, based on the 
structure of the CE provided through the FHLBs' MPF or similar 
programs, loans sold under these programs should be categorized and 
risk-weighted separately from other types of loans transferred with 
limited recourse. In an effort to better match the minimum capital 
requirements for loans sold as part of the MPF or similar programs, the 
proposed credit conversion factor, which converts the off-balance sheet 
exposure to a credit equivalent amount, would be set at 20 percent and 
applied a 50 percent risk weight (the same risk weight applied to 
first-lien residential real estate loans), resulting in an effective 
minimum capital requirement of one percent of the outstanding 
balance.\276\ Applying the CCF against the outstanding loan balance 
would reduce the risk-based capital requirement as loans in the MPF 
pool pay down. The Board believes this proposed methodology and CCF 
would result in a risk-based capital requirement consistent with 
historic credit losses in this program. The Board believes such 
treatment is appropriate because a credit union incurring higher than 
normal levels of losses from loans in the MPF or similar programs would 
have to record a reserve for losses that would reduce the credit 
union's retained earnings.
---------------------------------------------------------------------------

    \276\ This proposed approach is based on historical loss 
information regarding the MPF program that was provided to NCUA by 
the Federal Home Loan Banks.
---------------------------------------------------------------------------

    In addition, under this proposed rule, credit unions would be able 
to deduct any associated established valuation allowance when 
determining the off-balance sheet exposure amount that is multiplied by 
the CCF to obtain the credit equivalent amount.
    The Board recognizes commenters' concerns that the conversion 
factors and risk weights applicable to loans transferred with limited 
recourse could result in a competitive disadvantage. Therefore, the 
Board has changed its approach with respect to loans transferred with 
limited recourse to amend the conversion factors to better match those 
used by the Other Banking Agencies. Under this proposed rule, the Board 
has further clarified that the conversion factors and risk weights only 
apply to the maximum amount of the loan exposure, rather than the whole 
loan \277\ as in the Original Proposal. The maximum amount of exposure 
is the portion of the loan that a credit union could be required to 
take back under the recourse provision of a loan sales contract.
---------------------------------------------------------------------------

    \277\ As noted earlier, FHLBs' MPF loans are handled separately.
---------------------------------------------------------------------------

    As shown in the charts and proposed rule text below, the Board has 
amended many of the conversion factors and applicable risk weights in 
an effort to lower the burden on credit unions while still retaining 
the necessary safety and soundness components of this section of the 
rule.
    First, the Board has lowered the conversion factor for unfunded 
commitments for commercial loans to achieve parity with the Other 
Banking Agencies' approach.\278\ Further, the conversion factors for 
loans transferred with limited recourse would be consistent with the 
conversion factors assigned for banks under the Other Banking Agencies' 
rules.
---------------------------------------------------------------------------

    \278\ See, e.g., 12 CFR 324.33.
---------------------------------------------------------------------------

    However, under this proposal the conversion factor is applied only 
to the credit union's off-balance sheet exposure. The Board is also 
proposing to apply a lower credit conversion factor to loans sold under 
the FHLBs' MPF to more accurately account for historical losses in this 
program and to reduce the risk-based capital requirement as each loan 
pays down.
    The following tables summarize the risk weights and conversion 
factors included in this proposal:

Loans Sold With Recourse

                            Original Proposal
------------------------------------------------------------------------
                                       Conversion factor
                                        (applied to the
                                        outstanding loan    Risk weight
                                            balance)         (percent)
                                           (percent)
------------------------------------------------------------------------
MBLs sold with recourse..............                 75             100
First mortgage real estate loans sold                 75              50
 with recourse.......................
Other real estate loans sold with                     75             100
 recourse............................
Non-federally guaranteed student                      75             100
 loans sold with recourse............
All other loans sold with recourse...                 75             75.
------------------------------------------------------------------------


[[Page 4414]]


                              This Proposal
------------------------------------------------------------------------
                                       Conversion factor
                                        (applied to the
  Loan type transferred with limited   off-balance sheet    Risk weight
               recourse                     exposure)        (percent)
                                           (percent)
------------------------------------------------------------------------
Outstanding balance of loans sold                     20              50
 under the FHLB's mortgage
 partnership finance or similar
 program.............................
Commercial loans.....................                100             100
First-lien residential real estate                   100              50
 loans...............................
Junior-lien residential real estate                  100             100
 loans...............................
Secured consumer loans...............                100              75
Unsecured consumer loans.............                100             100
------------------------------------------------------------------------

Unfunded Commitments

                            Original Proposal
------------------------------------------------------------------------
                                       Conversion factor    Risk weight
                                           (percent)         (percent)
------------------------------------------------------------------------
Total unfunded commitments for non-                   10              75
 business loans......................
Unused MBL commitments...............                 75             100
------------------------------------------------------------------------


                              This Proposal
------------------------------------------------------------------------
                                       Conversion factor    Risk weight
   Loan Type of Unfunded Commitment        (percent)         (percent)
------------------------------------------------------------------------
Commercial loans.....................                 50             100
First-lien residential real estate                    10              50
 loans...............................
Junior-lien residential real estate                   10             100
 loans...............................
Secured consumer loans...............                 10              75
Unsecured consumer loans.............                 10             100
------------------------------------------------------------------------

    For the reasons discussed above, the Board has revised this section 
of the proposed rule and lowered many of the conversion factors and 
applicable risk weights. Accordingly, proposed Sec.  702.104(b)(4) 
would provide that the risk-weighted amounts for all off-balance sheet 
items are determined by multiplying the off-balance sheet exposure 
amount by the appropriate credit conversion factor and the assigned 
risk weight as follows:
     For the outstanding balance of loans transferred to a 
Federal Home Loan Bank under the MPF program, a 20 percent CCF and a 50 
percent risk weight.
     For other loans transferred with limited recourse, a 100 
percent CCF applied to the off-balance sheet exposure and:
    [cir] For commercial loans, a 100 percent risk weight.
    [cir] For first-lien residential real estate loans, a 50 percent 
risk weight.
    [cir] For junior-lien residential real estate loans, a 100 percent 
risk weight.
    [cir] For all secured consumer loans, a 75 percent risk weight.
    [cir] For all unsecured consumer loans, a 100 percent risk weight.
     For unfunded commitments:
    [cir] For commercial loans, a 50 percent CCF with a 100 percent 
risk weight.
    [cir] For first-lien residential real estate loans, a 10 percent 
CCF with a 50 percent risk weight.
    [cir] For junior-lien residential real estate loans, a 10 percent 
CCF with a 100 percent risk weight.
    [cir] For all secured consumer loans, a 10 percent CCF with a 75 
percent risk weight.
    [cir] For all unsecured consumer loans, a 10 percent CCF with a 100 
percent risk weight.
    The Board requests comments on this provision of the proposal.
104(c)(5) Derivatives
    This section of the Original Proposal addressed the risk weights 
for derivative contracts. Based on NCUA's recently finalized 
derivatives rule, the Board is proposing to make minor changes and 
additions to the treatment of derivative contracts. Further, the Board 
is proposing to move derivative contracts to its own section of the 
rule for clarity and ease of reading. The full discussion of derivative 
contracts is included below in Sec.  702.105.
Current Sec.  702.105 Weighted-Average Life of Investments
    As discussed above, proposed new Sec.  702.105 below would replace 
current Sec.  702.105 regarding weighted-average life of investments. 
The definition of weighted-average life of investments and the term 
``weighted-average life of investments'' would be removed from this 
proposed rule altogether.
Section 702.105 Derivatives
    This proposal separates derivatives into its own section, Sec.  
702.105, and includes a cross reference in the general risk weight 
category that indicates that all derivatives must be risk-weighted in 
accordance with Sec.  702.105. This new proposed section includes all 
of the language from Sec.  702.104(c)(4) of the Original Proposal, with 
only a few minor amendments. In addition, this proposed section 
addresses cleared transactions, provides further authority for 
recognizing the credit risk mitigation benefits of collateral, and 
addresses derivatives transactions by federally insured state chartered 
credit unions that are impermissible under NCUA's rules.
    Derivatives rule. The Board finalized NCUA's derivatives rule at 
its January

[[Page 4415]]

2014 open meeting. In brief, that final rule allows FCUs to use 
specific types of derivatives for the purpose of mitigating IRR. The 
final rule also addressed ``clearing,'' which was not addressed in the 
proposed derivatives rule. Specifically, the final derivatives rule 
permits FCUs to clear derivatives transactions, provided the FCU 
follows applicable Commodity and Futures Trading Commission (CFTC) 
regulations. The Board notes, however, that NCUA's derivatives rule 
only applied to FCUs. As discussed in the preamble to the final rule, 
federally insured, state-chartered credit unions engaging in 
derivatives are required to follow applicable state regulations.
    Proposed risk based capital treatment of derivatives. Based on its 
recently finalized derivatives rule, the Board is now proposing to 
adopt an approach to assign risk weights to derivatives that is 
generally consistent with the approach adopted by FDIC in its recently 
issued interim final rule regarding regulatory capital.\279\ Under 
FDIC's interim rule, derivatives transactions covered under clearing 
arrangements are treated differently than non-cleared transactions. The 
Board addresses clearing separately below.
---------------------------------------------------------------------------

    \279\ See 78 FR 55339 (Sept. 10, 2013).
---------------------------------------------------------------------------

    The Board is proposing to focus only on interest rate related 
derivatives in the proposed rule and to refer credit unions to FDIC's 
rules for all non-interest-rate-related derivatives. The Board is 
making this distinction because federal credit unions are restricted to 
interest rate-related contracts under the final derivatives rule 
approved in January 2014; however, federally insured, state-chartered 
credit unions may have broader authorization to use non-interest-rate 
contracts if approved by the respective state banking authorities. As 
of September 30th, 2014, NCUA is not aware of any non-interest rate 
derivative contracts being used by federally insured, state-chartered 
credit unions (as per the Call Report data) for derivative contracts.
    OTC derivatives transaction risk weight. The Original Proposal only 
assigned risk weights to OTC derivatives transactions. While the Board 
received few comments on the general language in this section, the 
Board is now proposing to make two amendments. First, the Board is 
proposing to state that the current credit exposure is the greater of 
the fair value or zero rather than the mark to fair value or zero. This 
change is non-substantive and only intended as a clarifying correction.
    Second, the Board is proposing to delete two subsections from the 
Original Proposal's section on potential future credit exposure, 
Sec. Sec.  702.104(d)(4)(B)(2) and (3) of the Original Proposal. 
Section 702.104(d)(4)(B)(2) stated that for a derivatives contract that 
is structured such that on specified dates any outstanding exposure is 
settled and the terms are reset so that the fair value of the contract 
is zero, the remaining maturity equals the time until the next reset 
date. Section 702.104(d)(4)(B)(3) stated that for an interest rate 
derivative contract with a remaining maturity of greater than one year 
that meets these criteria, the minimum conversion factor is 0.005. In 
place of these two sections, the Board is now proposing to add the 
following:

    A credit union must use an OTC interest rate derivative 
contract's effective notional principal amount (that is, the 
apparent or stated notional principal amount multiplied by any 
multiplier in the OTC interest rate derivative contract) rather than 
the apparent or stated notional principal amount in calculating 
potential future exposure (PFE).

    The Board is making these changes to improve how credit unions will 
calculate the PFE given the high probability of only having interest 
rate-related contracts. The Board believes these proposed changes make 
the rule clearer and more closely align this section with other changes 
it is proposing throughout this rule.
    Including the changes discussed above, the following is a 
description of the process a credit union would undertake under this 
proposal to determine the risk weight for OTC derivative contracts. The 
Board is proposing to require that to determine the risk-weighted asset 
amount for a derivatives contract; under this proposal, a credit union 
would first determine its exposure amount for the contract. It would 
then recognize the credit mitigation of financial collateral, if 
qualified, and then apply to that amount a risk weight based on the 
counterparty or recognized collateral or exchange (Derivatives Clearing 
Organization or DCO). For a single interest rate derivatives contract 
that is not subject to a qualifying master netting agreement, the 
proposed rule would require the exposure amount to be the sum of (1) 
the credit union's current credit exposure (CCE), which is the greater 
of fair value or zero, and (2) PFE, which is calculated by multiplying 
the notional principal amount of the derivatives contract by the 
appropriate conversion factor, in accordance with the table below. Non-
interest rate derivative contract conversion factors can be referenced 
in 12 CFR 324.34 of the FDIC rule.

     Proposed Conversion Factor Matrix for Interest Rate Derivatives
                                Contracts
------------------------------------------------------------------------
                                                             IRR hedge
                   Remaining maturity                       derivatives
------------------------------------------------------------------------
One year or less........................................           0.00
Greater than one year and less than or equal to five               0.005
 years..................................................
Greater than five years.................................           0.015
------------------------------------------------------------------------

    For multiple interest rate derivatives contracts subject to a 
qualifying master netting agreement, a credit union would calculate the 
exposure amount by adding the net CCE and the adjusted sum of the PFE 
amounts for all derivatives contracts subject to that qualifying master 
netting agreement.
    The net CCE is the greater of zero and the net sum of all positive 
and negative fair values of the individual derivatives contracts 
subject to the qualifying master netting agreement. The adjusted sum of 
the PFE amounts would be calculated as described in proposed Sec.  
702.105(a)(2)(ii)(B).
    Under this proposal, to recognize the netting benefit of multiple 
derivatives contracts, the contracts would have to be subject to the 
same qualifying master netting agreement. For example, a credit union 
with multiple derivatives contracts with a single counterparty could 
net the counterparty exposure if the transactions fall under the same 
International Swaps and Derivatives Association, Inc. (ISDA) Master 
Agreement and Schedule.
    If a derivatives contract is collateralized by financial 
collateral, a credit union would first determine the exposure amount of 
the derivatives contract as described in Sec. Sec.  702.105(a)(i) or 
(ii). Next, to recognize the credit risk mitigation benefits of the 
financial collateral, the credit union would use the approach for 
collateralized transactions as described in Sec.  702.105(c) of the 
proposed rule, which is discussed in more detail below.
    Cleared derivatives risk weight. As discussed above, under the 
Original Proposal, the Board did not include a discussion of cleared 
derivatives contracts, but generally tried to mirror the Other Banking 
Agencies' approach to derivatives, which treats derivatives 
transactions covered under clearing arrangements differently than non-
cleared transactions. NCUA's Original Proposal, however, proposed a 
single regulatory capital approach regardless of the credit union's 
derivatives transaction clearing status, because most credit unions 
would qualify for an exemption or exception from clearing

[[Page 4416]]

under CFTC's regulations. The exemption and exception applicable to 
credit unions is discussed below.
    As noted above, the Board received only a few comments on the 
proposed derivatives section of the Original Proposal. However, the 
majority of the comments the Board did receive requested that NCUA's 
rules align with the rules for banks. Specifically, commenters pointed 
out that the derivatives industry is migrating toward clearing and that 
clearing provides a valuable risk- reducing component to a derivatives 
transaction.
    Other commenters requested examples of calculations and 
clarification on the process by which a credit union can recognize the 
risk mitigation benefits of collateral and how derivatives in federally 
insured, state-chartered credit unions would be treated under the 
Original Proposal.
    After carefully considering the comments and its recent final 
derivatives rule, the Board agrees that NCUA's risk-based capital 
regulations should more closely align with the Other Banking Agencies' 
capital regulations. To that end, the Board is now proposing to include 
provisions to address clearing, a more robust collateral process, and 
the treatment of derivatives outside of NCUA's rule. The Board notes 
that this is consistent with its statement in the Original Proposal 
that it would amend any final rule regarding NCUA's risk-based capital 
requirements to take into account changes made in the final derivatives 
rule.
    As noted above, the Board is now proposing to include a separate 
risk weight for cleared derivatives transactions. The approach in this 
section mirrors the approach taken by the Other Banking Agencies and 
will allow credit unions to account for the lower degree of risk for 
cleared transactions.
    In NCUA's final derivatives rule, the Board discussed recent CFTC 
final rules \280\ on cleared derivatives and included a section 
allowing FCUs to elect to clear under CFTC rules. The Board noted that 
CFTC's final rules provide credit unions with an exception and an 
exemption from clearing. The CTFC exception and exemption are the End-
User Exception, which applies to financial institutions with total 
assets of $10 billion or less and the Cooperative Exemption, which 
applies to entities with assets greater than $10 billion where the 
entity is a cooperative.\281\ CFTC's definition scope includes credit 
unions. Therefore, all credit unions have the right, as cooperatives, 
to elect to either clear swaps or engage in a traditional bilateral 
agreement. The Board notes that the clearing structure only applies to 
swaps.
---------------------------------------------------------------------------

    \280\ 78 FR 52285 (Aug. 22, 2013); see also 17 CFR 50.51.
    \281\ Id.
---------------------------------------------------------------------------

    For cleared derivatives transactions, each party to the swap 
submits the transaction to a DCO \282\ for clearing. This reduces 
counterparty risk for the original swap participants in that they each 
bear the same risk attributable to facing the intermediary DCO as their 
counterparty. In addition, DCOs exist for the primary purpose of 
managing credit exposure from the swaps being cleared and therefore 
DCOs are effective at standardizing transactions and mitigating 
counterparty risk through the use of exchange-based risk management 
frameworks. Finally, swap clearing requires both counterparties to post 
collateral (i.e., initial margin) with the clearinghouse when they 
enter into a swap. The clearinghouse can use the posted collateral to 
cover defaults in the swap. As the valuation of the swap changes, the 
clearinghouse determines the fair market value of the swap and may 
collect additional collateral (i.e., variation margin) from the 
counterparties in response to fluctuations in market values. The 
clearinghouse can apply this collateral to cover defaults in payments 
under the swap.
---------------------------------------------------------------------------

    \282\ DCO has the meaning as defined by the Commodity Futures 
Trading Commission in 17 CFR 1.3(d)
---------------------------------------------------------------------------

    Proposed Sec.  702.105 would adopt an approach to assign risk 
weights to derivatives that is generally consistent with the approach 
adopted by the Other Banking Agencies.\283\ Under this proposed rule, a 
credit union would be required to calculate a trade exposure amount, 
determine the risk mitigation of any financial collateral, and multiply 
that amount by the applicable risk weight. The Board notes that this 
approach allows credit unions to take into account the lower degree of 
risk associated with cleared derivatives transactions and the benefit 
of collateral associated with these transactions. In addition, this 
approach also accounts for the risk of loss associated with collateral 
posted by a credit union.
---------------------------------------------------------------------------

    \283\ See 78 FR 55339 (Sept. 10, 2013).
---------------------------------------------------------------------------

    Trade exposure amount. The trade exposure amount, in this proposal, 
would equal the amount of the derivative, calculated as if it were an 
OTC transaction under subsection (b) of this section, added to the fair 
value of the collateral posted by the credit union and held by a DCO, 
clearing member or custodian. This calculation would take into account 
the exposure amount of the derivatives transaction and the exposure 
associated with any collateral posted by the credit union. The Board 
notes that this is the same approach employed by the Other Banking 
Agencies.\284\
---------------------------------------------------------------------------

    \284\ See, e.g., 12 CFR 324.35.
---------------------------------------------------------------------------

    Cleared transaction risk weights. Under this proposal, after a 
credit union determines its trade exposure amount, it would be required 
to apply a risk weight that is based on agreements preventing risk of 
loss of the collateral posted by the counterparty to the transaction. 
The proposed rule would require credit unions to apply a two percent 
risk weight if the collateral posted by a counterparty is subject to an 
agreement that prevents any losses caused by the default, insolvency, 
liquidation, or receivership of the clearing member or any of its 
clients. To qualify for this risk weight, a credit union would also 
have conducted a sufficient legal review and determined that the 
agreement to prevent risk of loss is legal, valid, binding, and 
enforceable. If a credit union does not meet either or both of these 
requirements, the credit union would have to apply a four percent risk 
weight to the transaction.
    The differing risk weights for cleared transactions take into 
account the risk that collateral will not be there because of a default 
or other event, which further exposes the credit union to loss. 
However, cleared transactions pose very low probability that collateral 
will not be available in the event of a default, which is reflected in 
the low overall risk weights. Again, the Board notes that this is the 
same approach employed by the Other Banking Agencies.\285\
---------------------------------------------------------------------------

    \285\ See, e.g., 12 CFR 324.35.
---------------------------------------------------------------------------

    Collateralized transactions. Under the Original Proposal, NCUA 
proposed to permit a credit union to recognize risk-mitigating effects 
of financial collateral in OTC transactions. The collateralized portion 
of the exposure would receive the risk weight applicable to the 
collateral. In all cases, (1) The collateral must be subject to a 
collateral agreement (for example, an ISDA Credit Support Annex) for at 
least the life of the exposure; (2) the credit union must revalue the 
collateral at least every three months; and (3) the collateral and the 
exposure must be denominated in U.S. dollars.
    Generally, the risk weight assigned to the collateralized portion 
of the exposure would be no less than 20 percent. However, the 
collateralized portion of an exposure may be assigned a risk weight of 
less than 20 percent for the following exposures. Derivatives

[[Page 4417]]

contracts that are marked to fair value on a daily basis and subject to 
a daily margin maintenance agreement could receive: (1) A zero percent 
risk weight to the extent that contracts are collateralized by cash on 
deposit; or (2) a 10 percent risk weight to the extent that the 
contracts are collateralized by an exposure that qualifies for a zero 
percent risk weight under Sec.  702.104(c)(2)(i) of this proposed rule. 
In addition, a credit union could assign a zero percent risk weight to 
the collateralized portion of an exposure where the financial 
collateral is cash on deposit. It also could do so if the financial 
collateral is an exposure that qualifies for a zero percent risk weight 
under Sec.  702.104(c)(2)(i) of this proposed rule, and the credit 
union has discounted the fair value of the collateral by 20 percent. 
The credit union would be required to use the same approach for similar 
exposures or transactions.
    Risk management guidance for recognizing collateral. The Board is 
proposing to include a new subsection in this section to address 
recognizing the risk mitigation of collateral. In the Original 
Proposal, this section was included in the discussion on assigning risk 
weights to OTC derivatives transactions. The Board recognizes, however, 
that derivative contracts are collateralized for risk mitigation 
purposes whether OTC or cleared. Collateralizing derivatives 
transactions is now industry practice and widely accepted to reduce and 
mitigate the credit risk and default impact of a counterparty to a 
transaction not being able to meet its obligations of the contract. A 
collateral agreement between two counterparties or exchange will 
stipulate the type of collateral that may be used, otherwise known as 
``eligible collateral.'' As such, this proposed subsection will be 
applicable to both types of transactions.
    Under this proposal, before a credit union recognizes collateral 
for credit risk mitigation purposes, it should: (1) Conduct sufficient 
legal review to ensure, at the inception of the collateralized 
transaction and on an ongoing basis, that all documentation used in the 
transaction is binding on all parties and legally enforceable in all 
relevant jurisdictions; (2) consider the correlation between risk of 
the underlying direct exposure and collateral in the transaction; and 
(3) fully take into account the time and cost needed to realize the 
liquidation proceeds and the potential for a decline in collateral 
value over this time period.
    A credit union should also ensure that the legal mechanism under 
which the collateral is pledged or transferred ensures that the credit 
union has the right to liquidate or take legal possession of the 
collateral in a timely manner in the event of the default, insolvency, 
or bankruptcy (or other defined credit event) of the counterparty and, 
where applicable, the custodian holding the collateral.
    Finally, a credit union should ensure that it: (1) Has taken all 
steps necessary to fulfill any legal requirements to secure its 
interest in the collateral so that it has, and maintains, an 
enforceable security interest; (2) has set up clear and robust 
procedures to ensure satisfaction of any legal conditions required for 
declaring the borrower's default and prompt liquidation of the 
collateral in the event of default; (3) has established procedures and 
practices for conservatively estimating, on a regular ongoing basis, 
the fair value of the collateral, taking into account factors that 
could affect that value (for example, the liquidity of the market for 
the collateral and deterioration of the collateral); and (4) has in 
place systems for promptly requesting and receiving additional 
collateral for transactions with terms requiring maintenance of 
collateral values at specified thresholds.
    When collateral other than cash is used to satisfy a margin 
requirement, then a haircut is applied to incorporate the credit risk 
associated with collateral, such as securities. The Board is proposing 
to include this concept in the revised rule so that credit unions can 
accurately recognize the risk mitigation benefit of collateral. The 
Board notes that this is the same approach taken by the Other Banking 
Agencies.
    The table below illustrates an example of the calculations for Risk 
Weighted Asset Amounts for both OTC and clearing derivatives 
agreements. For this example both the OTC and clearing are considered 
to be a multiple contracts under a Qualified Master Netting Agreement. 
Credit unions can use this as a guide in confirming the calculations 
involved to produce a risk-weighted asset for derivatives. (See the 
number references below for each line number of the table example.)
    1. The Agreement Type indicates the transaction legal agreement 
between the credit union and the counterparty.
    2. The examples provide, but are not limited to the basis 
calculations required for various collateral and agreement approaches.
    3. Variation Margin (amount as basis for margin calls which are 
satisfied with collateral) collateral used for these examples.
    4. The Risk Weight of Collateral is applied when utilizing the 
Simple Approach in the recognition of credit risk of collateralized 
derivative contracts.
    5. To recognize the risk-mitigating effects of financial 
collateral, a credit union may use the ``Simple Approach'' or the 
``Collateral Haircut Approach''.
    6. The Collateral Haircut is determined by using Table 2 to Sec.  
702.105 in the rule text: ``Standard Supervisor Market Price Volatility 
Haircuts.''
    7. Counterparty risk weights are determined in Sec.  702.104 for 
OTC and Sec.  702.105 for clearing.
    8-16. Are calculations based on the approach and types of 
agreement, collateral, fair values and notional amounts of the credit 
union derivatives transactions.

[[Page 4418]]

[GRAPHIC] [TIFF OMITTED] TP27JA15.006

    Federally insured, state-chartered credit unions' derivative 
transactions. As noted above, the Original Proposal did not 
specifically address derivatives transactions entered into by federally 
insured, state-chartered credit unions under state law that are 
impermissible under NCUA's regulations for FCUs. In this proposal, the 
Board is proposing to include language that would require federally 
insured, state-chartered credit unions to calculate risk weights in 
accordance with FDIC's rules for derivatives transactions that are not 
permissible under NCUA's derivatives rule.
    The Board has also considered the following two approaches to 
addressing derivatives held by FISCUs that are not permissible under 
NCUA's rules, and invites stakeholders to comment on each:
     Additional risk weights. The Board has considered 
including an additional risk weight that would address any derivative 
entered into by a federally insured, state-chartered credit union that 
would be impermissible for an FCU to enter into. The Board notes that 
this risk weight would have to account for the added risk of additional 
types of transactions that are not permitted under its rules.
     Adopting FDIC's rules verbatim. Finally, the Board has 
considered incorporating FDIC's risk weights and rules for derivatives 
verbatim and creating a separate appendix for derivatives transactions. 
Incorporating FDIC's rules verbatim would add a high degree of 
complexity to a final risk-based capital rule and would likely address 
transactions into which federally insured, state chartered credit 
unions, while permitted to engage in, would likely not enter into.
    The Board is interested in the comments of stakeholders on the pros 
and cons of each of these approaches, as well as any other approaches 
that may adequately address derivatives transactions by federally 
insured, state-chartered credit unions.
Current Section 702.106 Standard Calculation of Risk-based Net Worth 
Requirement
    Consistent with the Original Proposal, this proposed rule would 
eliminate current Sec.  702.106 regarding the standard RBNW 
requirement. The current rule is structured so that credit unions have 
a standard measure and optional alternatives for measuring a credit 
union's RBNW. The proposed rule, on the other hand, would contain only 
a single measurement for calculating a credit union's risk-based 
capital ratio. Accordingly, current Sec.  702.106 would no longer be 
necessary and would be removed by this proposed rule.
Current Section 702.107 Alternative Component for Standard Calculation
    Consistent with the Original Proposal, this proposed rule would 
eliminate current Sec.  702.107 regarding the use of

[[Page 4419]]

alternative risk weight measures. The Board believes the current 
alternative risk weight measures add unnecessary complexity to the 
rule. The current alternative risk weights focus almost exclusively on 
IRR, which has resulted in some credit unions with higher risk 
operations reducing their regulatory minimum capital requirement to a 
level inconsistent with the risk of the credit union's business model. 
The proposed risk weights would provide for lower risk-based capital 
requirements for those credit unions making good quality loans, 
investing prudently, and avoiding excessive concentrations of assets.
Current Section 702.108 Risk Mitigation Credit
    The Original Proposal would have eliminated current Sec.  702.108 
regarding the risk mitigation credit. The risk mitigation credit 
provides a system for reducing a credit union's risk-based capital 
requirement if it can demonstrate significant mitigation of credit risk 
or IRR. Credit unions have rarely taken advantage of risk mitigation 
credits; only one credit union has ever received a risk mitigation 
credit.
    The Board did receive a few comments regarding the elimination of 
the provision for risk mitigation credit in the current rule. 
Commenters suggested that there should continue to be a risk mitigation 
credit and that the agency has well-developed procedures for credit 
unions under current Sec.  701.108, as well as for examiners under its 
``Guidelines for Evaluation of an Application for a PCA Risk Mitigation 
Credit.'' Commenters suggested that this authority could provide an 
important incentive for credit unions to manage certain risks more 
proactively--and receive an added benefit of seeing their risk-based 
capital requirements at least somewhat reduced as a result. Other 
commenters suggested that by not allowing for some method of 
recognizing credit unions' ability to manage risks, the Board runs the 
risk of de-incentivizing credit unions to invest in the resources 
necessary to manage and mitigate risks, which could encourage a 
dangerous mind-set among credit unions to hold additional capital in 
place of a well-managed risk mitigation program.
    Consistent with the Original Proposal, this proposed rule would 
eliminate current Sec.  702.108 regarding the risk mitigation credit. 
The review of a credit union's application for a risk mitigation credit 
requires a substantial commitment of NCUA and credit union resources. 
In practice, it is very difficult to determine the validity of the 
credit union's mitigation efforts and how much mitigation credit to 
allow. The Board appreciates the issues raised by commenters, but 
continues to believe that maintaining the risk mitigation credit option 
is unjustified given the burden it imposes on NCUA and credit unions, 
its limited use in the past, and its improbable use in the future.
Mandatory and Discretionary Supervisory Actions
    Section 216(a)(2) of the FCUA directs the Board to take ``prompt 
corrective action to resolve the problems of insured credit unions.'' 
\286\ To facilitate this purpose, the FCUA defined five regulatory 
capital categories that include capital thresholds for a defined net 
worth ratio and risk-based capital measure for ``complex'' credit 
unions. These five PCA categories are: Well capitalized, adequately 
capitalized, undercapitalized, significantly undercapitalized, and 
critically undercapitalized. Credit unions that fail to meet these 
capital measures are subject to increasingly strict limits on their 
activities.\287\
---------------------------------------------------------------------------

    \286\ 12 U.S.C. 1790d(a)(2).
    \287\ Credit unions defined as ``new credit unions'' under 
section 1790(d)(2) of the FCUA are subject to an alternative PCA 
system.
---------------------------------------------------------------------------

    This proposal would generally maintain the existing mandatory and 
discretionary supervisory actions (PCA actions) currently contained in 
Sec. Sec.  702.201 through 702.204,\288\ with certain additions that 
are discussed in more detail below. The PCA actions assist the Board in 
accomplishing the statutory purpose of section 219 \289\ of the FCUA 
and provide a transparent guide to the supervisory actions that a 
credit union can expect as capital measures decline.
---------------------------------------------------------------------------

    \288\ The requirements would be moved to proposed Sec. Sec.  
702.106 through 702.109.
    \289\ 12 U.S.C. 1790d(a).
---------------------------------------------------------------------------

Section 702.106 Prompt Corrective Action for Adequately Capitalized 
Credit Unions
    Generally consistent with the Original Proposal, this proposed rule 
would renumber current Sec.  702.201 as proposed Sec.  702.106, and 
would make only minor conforming amendments to the text of the section. 
Consistent with the proposed elimination of the regular reserve 
requirement in current Sec.  702.401(b), proposed Sec.  702.106(a) 
would be amended to remove the requirement that adequately capitalized 
credit unions transfer the earnings retention amount from undivided 
earnings to their regular reserve account.
Section 702.107 Prompt Corrective Action for Undercapitalized Credit 
Unions
    Generally consistent with the Original Proposal, this proposed rule 
would renumber current Sec.  702.202 as proposed Sec.  702.107, and 
would make only minor conforming amendments to the text of the section. 
Consistent with the proposed elimination of the regular reserve 
requirement in current Sec.  702.401(b), proposed Sec.  702.107(a)(1) 
would be amended to remove the requirement that undercapitalized credit 
unions transfer the earnings retention amount from undivided earnings 
to their regular reserve account.
Section 702.108 Prompt Corrective Action for Significantly 
Undercapitalized Credit Unions
    Generally consistent with the Original Proposal, this proposed rule 
would renumber current Sec.  702.203 as proposed Sec.  702.108, and 
would make only minor conforming amendments to the text of the section. 
Consistent with the proposed elimination of the regular reserve 
requirement in current Sec.  702.401(b), proposed Sec.  702.108(a)(1) 
would be amended to remove the requirement that significantly 
undercapitalized credit unions transfer the earnings retention amount 
from undivided earnings to their regular reserve account.
Section 702.109 Prompt Corrective Action for Critically 
Undercapitalized Credit Unions
    Generally consistent with the Original Proposal, this proposed rule 
would renumber current Sec.  702.204 as proposed Sec.  702.109, and 
would make only minor conforming amendments to the text of the section. 
Consistent with the proposed elimination of the regular reserve 
requirement in current Sec.  702.401(b), proposed Sec.  702.109(a)(1) 
would be amended to remove the requirement that critically 
undercapitalized credit unions transfer the earnings retention amount 
from undivided earnings to their regular reserve account.
Section 702.110 Consultation with State Official on Proposed Prompt 
Corrective Action
    Generally consistent with the Original Proposal, this proposed rule 
would renumber current Sec.  702.205 as proposed Sec.  702.110, and 
would make only minor conforming amendments to the text of the section.

[[Page 4420]]

Section 702.111 Net Worth Restoration Plans (NWRPs)
    Generally consistent with the Original Proposal, this proposed rule 
would renumber current Sec.  702.206 as proposed Sec.  702.111, and 
would make only minor conforming amendments to the text of most of the 
subsections, with a few exceptions discussed in more detail below.
111(c) Contents of NWRP
    Consistent with the Original Proposal, proposed Sec.  
702.111(c)(1)(i) would provide that the contents of an NWRP must 
specify a quarterly timetable of steps the credit union will take to 
increase its net worth ratio and risk-based capital ratio, if 
applicable, so that it becomes adequately capitalized by the end of the 
term of the NWRP, and will remain so for four consecutive calendar 
quarters. The italicized words above ``and risk-based capital ratio, if 
applicable'' would be added to clarify that an NWRP prepared by a 
complex credit union must specify the steps the credit union will take 
to increase its risk-based capital ratio. This proposal would remove 
the sentence ``If complex, the credit union is subject to a risk-based 
net worth requirement that may require a net worth ratio higher than 
six percent to be adequately capitalized.'' This statement would be 
removed as repetitive and unnecessary because proposed Sec.  
702.102(a)(2)(i) already states clearly that a complex credit union 
must also attain a net worth ratio of higher than six percent to be 
adequately capitalized. No substantive changes to the requirements of 
this paragraph are intended by these revisions.
    In addition, consistent with the proposed elimination of the 
regular reserve requirement in current Sec.  702.401(b), proposed Sec.  
702.111(c)(1)(ii) would be amended by removing the requirement that 
credit unions transfer the earnings retention amount from undivided 
earnings to their regular reserve account.
111(g)(4) Submission of Multiple Unapproved NWRPs
    Consistent with the Original Proposal, proposed Sec.  702.111(g)(4) 
would provide that the submission of more than two NWRPs that are not 
approved is considered an unsafe and unsound condition and may subject 
the credit union to administrative enforcement actions under section 
206 of the FCUA.\290\ NCUA regional directors have expressed concerns 
that some credit unions have in the past submitted multiple NWRPs that 
could not be approved due to non-compliance with the requirements of 
the current rule, resulting in delayed implementation of actions to 
improve the credit union's net worth. The proposed amendments are 
intended to clarify that submitting multiple NWRPs that are rejected by 
NCUA, or the applicable state official, because of the inability of the 
credit union to produce an acceptable NWRP is an unsafe and unsound 
practice and may subject the credit union to further actions as 
permitted under the FCUA.
---------------------------------------------------------------------------

    \290\ 12 U.S.C. 1786 and 1790d.
---------------------------------------------------------------------------

111(j) Termination of NWRP
    Consistent with the Original Proposal, proposed Sec.  702.111(j) 
would provide that, for purposes of part 702, an NWRP terminates once 
the credit union has been classified as adequately capitalized or well 
capitalized and for four consecutive quarters. The proposed paragraph 
would also provide as an example that if a credit union with an active 
NWRP attains the classification as adequately capitalized on December 
31, 2015, this would be quarter one and the fourth consecutive quarter 
would end September 30, 2016. The proposed paragraph is intended to 
provide clarification for credit unions on the timing of an NWRP's 
termination.
Section 702.112 Reserves
    Generally consistent with the Original Proposal, this proposed rule 
would renumber current Sec.  702.401 as proposed Sec.  702.112. 
Consistent with the text of current Sec.  702.401(a), this proposal 
also would require that each credit union shall establish and maintain 
such reserves as may be required by the FCUA, by state law, by 
regulation, or, in special cases, by the Board or appropriate state 
official.
Regular Reserve Account
    As mentioned above, this proposed rule would eliminate current 
Sec.  702.401(b) regarding the regular reserve account from the 
earnings retention process. The process and substance of requesting 
permission for charges to the regular reserve would be eliminated upon 
the effective date of a final rule. Upon the effective date of a final 
rule, a federal credit union would close out the regular reserve 
balance into undivided earnings. A state-chartered, federally insured 
credit union may, however, still be required to maintain a regular 
reserve account by its respective state supervisory authority.
    In the past, the Board initially included the regular reserve in 
part 702 for purposes of continuity from past regulatory expectations 
that involved this account to ease credit unions' transition to the 
then-new PCA rules. The regular reserve account is not necessary to 
satisfying the statutory ``earnings retention requirement'' and is not 
required under GAAP. CUMAA requires credit unions that are not well 
capitalized to ``annually set aside as net worth an amount equal to not 
less than 0.4 percent of its total assets.'' \291\ The earnings 
retention requirement in current Sec.  702.201(a) requires a credit 
union that is not well capitalized to increase the ``dollar amount of 
its net worth either in the current quarter, or on average over the 
current and three preceding quarters by an amount equivalent to at 
least 1/10th percent of total assets.'' Under the same section of the 
current rule, the credit union must then ``quarterly transfer that 
amount'' from undivided earnings to the regular reserve account. 
Increasing net worth alone satisfies the statutory earnings retention 
requirement. The additional step of transferring earnings from the 
undivided earnings account to the regular reserve account is not 
necessary to meet the PCA statutory requirement.
---------------------------------------------------------------------------

    \291\ 12 U.S.C. 1790(e)(1).
---------------------------------------------------------------------------

    The regular reserve was initially incorporated into the earnings 
retention process because of familiarity. Prior to PCA, credit unions 
used the regular reserve account under the former reserving process 
prescribed by the now-repealed section 116 of the FCUA.\292\ However, 
NCUA examiner experience indicates that, since PCA was first 
implemented, the regular reserve account in part 702 has been a source 
of unnecessary confusion. Some credit unions have continued to make 
transfers as if the repealed section 116 were still in force. Other 
credit unions have confused the purpose of the regular reserve in the 
current PCA process. Thus, some credit unions have made earnings 
transfers that are not required and others have done so without first 
increasing net worth.
---------------------------------------------------------------------------

    \292\ 12 U.S.C. 1762.
---------------------------------------------------------------------------

    For these reasons, the Board considers the regular reserve account 
requirement to be obsolete and is proposing to eliminate it upon the 
effective date of a final rule. The proposed rule would also eliminate 
the cross references to the regular reserve requirement as discussed in 
more detail in each corresponding part of the section-by-section 
analysis.
Section 702.113 Full and Fair Disclosure of Financial Condition
    Generally consistent with the Original Proposal, this proposed rule 
would renumber current Sec.  702.402 as proposed Sec.  702.113, and 
would make only minor conforming amendments to the text of

[[Page 4421]]

the section with the exception of the changes to proposed Sec.  
702.113(d) that are discussed in more detail below.
113(d) Charges for Loan and Lease Losses
    Consistent with the proposed elimination of the regular reserve 
requirement which is discussed above, proposed Sec.  702.113(d) would 
remove paragraph (d)(4) of the current rule, which provides that the 
maintenance of an ALLL shall not affect the requirement to transfer 
earnings to a credit union's regular reserve when required under 
subparts B or C of part 702.
    In addition, the proposed rule would remove paragraph (d)(3) of the 
current rule, which provides that adjustments to the valuation ALLL 
will be recorded in the expense account ``Provision for Loan and Lease 
Losses.'' This is to clarify that the ALLL is to be maintained in 
accordance with GAAP, as discussed above.
    The remaining provisions in paragraph (d) of the current rule would 
be amended as follows:
(d)(1)
    Proposed Sec.  702.113(d)(1) would amend current Sec.  
702.401(d)(1) to provide that charges for loan and lease losses shall 
be made timely and in accordance with GAAP. The proposal would add the 
italicized words ``and lease'' and ``timely and'' to the language in 
the current rule to clarify that the requirement also applies to lease 
losses and to require that credit unions make charges for loan and 
lease losses in a timely manner. As with the section above, this 
section was changed to clarify that charges for potential lease losses 
are to be recorded in accordance with GAAP through the same allowance 
account as loan losses. In addition, timely recording is critical to 
maintain full and fair disclosure as required under this section.
(d)(2)
    Proposed Sec.  702.113(d)(2) would amend current Sec.  
702.401(d)(2) to eliminate the detailed requirement and simply provide 
that the ALLL must be maintained in accordance with GAAP. This is 
necessary to provide full and fair disclosure to a credit union member, 
NCUA, or, at the discretion of a credit union's board of directors, to 
creditors to fairly inform them of the credit union's financial 
condition and operations.
(d)(3)
    Proposed Sec.  702.113(d)(3) would retain the language in current 
Sec.  702.401(d)(5) with no changes.
Section 702.114 Payment of Dividends
    Generally consistent with the Original Proposal, this proposed rule 
would renumber current Sec.  702.402 as proposed Sec.  702.114 and make 
a number of amendments to the text of paragraphs (a) and (b).
    The Board received several comments to the Original Proposal 
regarding the proposed restrictions on the payments of dividends. 
Commenters generally stated that the rule should not prohibit states 
from authorizing FISCUs to declare dividends. Other commenters 
suggested that NCUA should not be able to restrict dividend payments.
    The Board disagrees with commenters and continues to believe that 
reasonable restrictions on dividend payments for credit unions that are 
less than adequately capitalized are necessary to protect the NCUSIF. 
The restrictions in Sec.  702.402 of the current rule are prudent 
restrictions that were brought forward into the Original Proposal and 
now into this proposal. The changes would simply clarify what funds are 
available for dividends under GAAP. Accordingly, the Board is proposing 
the following amendments to the current rule.
    Since the implementation of PCA for credit unions, FASB has issued 
accounting standards that impact the accounting for credit union equity 
items. Most specifically in December 2007, the FASB issued Accounting 
Standards Codification (ASC) Topic 805, Business Combinations.\293\ 
Under ASC 805, all business combinations were to be accounted for by 
applying the acquisition method starting in late 2008.
---------------------------------------------------------------------------

    \293\ Pre-codification reference: Statement of Financial 
Accounting Standards No. 141(R), Business Combinations.
---------------------------------------------------------------------------

    In June of 2010, Interagency Supervisory Guidance on Bargain 
Purchases and FDIC- and NCUA-Assisted Acquisitions was released and 
principally focused on bargain purchase gains and business combinations 
in general. The supervisory guidance addressed the special 
considerations to regulatory capital reporting for credit unions 
involved in combinations and specifically that acquired equity 
generated as a result of a business combination for credit unions is 
part of GAAP equity, but not part of net worth. Consistent with the 
statutory definition of net worth, a credit union includes an amount 
equal to the acquired credit unions retained earnings as measured in 
accordance with GAAP. This special consideration can result in a credit 
union reporting a negative balance in undivided earnings while 
reporting a much larger positive balance of acquired equity which 
produces a total positive GAAP equity position and different positive 
total net worth. The changes to this section seek to address this 
issue.
114(a) Restriction on Dividends
    Current Sec.  702.402(a) permits credit unions with a depleted 
undivided earnings balance to pay dividends out of the regular reserve 
account without regulatory approval, as long as the credit union will 
remain at least adequately capitalized. Under this proposal, Sec.  
702.114(a), however, only credit unions that have substantial net 
worth, but no undivided earnings, would be allowed to pay dividends 
without regulatory approval. Due to the removal of the regular reserve 
account, as discussed above, and to conform with GAAP, this proposal 
would amend the language to further clarify that dividends may be paid 
when there is sufficient net worth. Net worth may incorporate accounts 
in addition to undivided earnings. Accordingly, Sec.  702.114(a) of 
this proposal would provide that dividends shall be available only from 
net worth, net of any special reserves established under Sec.  702.112, 
if any.
114(b) Payment of Dividends and Interest Refunds
    This proposed rule would eliminate the language in current Sec.  
702.403(b) and Sec.  702.114(b) and (c) of the Original Proposal 
entirely and replace it with a new provision. Under this proposal, 
Sec.  702.114(b) would provide that the board of directors must not pay 
a dividend or interest refund that will cause the credit union's 
capital classification to fall below adequately capitalized under 
subpart A of part 702 unless the appropriate regional director and, if 
state-chartered, the appropriate state official, have given prior 
written approval (in an NWRP or otherwise). Paragraph (b) would provide 
further that the request for written approval must include the plan for 
eliminating any negative retained earnings balance.
    Historically, credit unions with a net worth ratio below adequately 
capitalized were restricted from making a dividend payment without 
regional director approval and, if state-chartered, approval of the 
appropriate state official. This proposed rule would not remove the 
existing regulatory requirement for credit unions to obtain prior 
approval from the regional director and, if state-chartered, the 
appropriate state official, to pay a dividend if the credit union's net 
worth classification is, or if the dividend payment will cause the 
credit union's net worth

[[Page 4422]]

classification to fall below, adequately capitalized.
    However, as addressed above, special circumstances can result in a 
credit union reporting a negative balance in retained earnings while 
reporting a much larger positive balance of acquired equity which 
produces a total positive GAAP equity position and a different amount 
of positive total net worth. The Board believes it is prudent for 
credit unions with negative retained earnings to develop a plan to 
eliminate that negative balance to ensure long-term viability and 
sustainability. As such, this proposal would require a credit union 
that must request written approval to pay dividends because the payment 
would cause its net worth classification to fall below adequately 
capitalized to also include a plan for eliminating the negative 
retained earnings balance as part of the written request. This will 
ensure credit unions that are classified below adequately capitalized 
and have negative retained earnings have in place a plan to increase 
retained earnings and thereby increase net worth.

B. Subpart B--Alternative Prompt Corrective Action for New Credit 
Unions

    Consistent with the Original Proposal, this proposed rule would add 
new subpart B, which would contain most of the capital adequacy rules 
that apply to ``new'' credit unions. Section 216(b)(2) of the FCUA 
requires NCUA to prepare regulations that apply to new credit 
unions.\294\
---------------------------------------------------------------------------

    \294\ 12 U.S.C. 1790d(b)(2).
---------------------------------------------------------------------------

    The current net worth measures, net worth classification, and text 
of the PCA requirements applicable to new credit unions would be 
renumbered. They would remain mostly unchanged under the proposed rule, 
except for minor conforming changes and the following substantive 
amendments:
    (1) Clarification of the language in current Sec.  702.301(b) 
regarding the ability of credit unions to become ``new'' again due to a 
decrease in asset size after having exceed the $10 million threshold.
    (2) Elimination of the regular reserve account requirement in 
current Sec.  702.401(b) and all cross references to the requirement;
    (3) Addition of new Sec.  701.206(f)(3) clarifying that the 
submission of more than two revised business plans would be considered 
and unsafe and unsound condition; and
    (4) Amendment of the language of current Sec.  702.402 regarding 
the full and fair disclosure of financial condition.
    (5) Amendment of the requirements of current Sec.  702.403 
regarding the payment of dividends.
Section 702.201 Scope
    Consistent with the Original Proposal, this proposed rule would 
renumber current Sec.  702.301 as proposed Sec.  702.201. The proposed 
rule would also clarify that a credit union may not regain a 
designation of ``new'' after reporting total assets in excess of $10 
million.
    Section 216(b)(2)(B)(iii) of the FCUA defines a ``new'' credit 
union as one that has been in operation for 10 years or less, or has 
$10 million or less in total assets.\295\ Section 216(b)(2)(B)(v) of 
the FCUA further requires that rules for new credit unions prevent 
evasion of the purpose of Sec.  216, which provides new credit unions a 
period of time to accumulate net worth.\296\ NCUA recently conducted a 
postmortem review of a credit union failure that caused a loss to the 
NCUSIF. The review revealed that the credit union intentionally reduced 
its total assets below $10 million to regain the designation as a 
``new'' credit union under current part 702 and the associated lower 
net worth requirement. Shifting back and forth between the minimum 
capital requirement for ``new'' and all other credit unions resulted in 
slowed capital accumulation, which contributed to the loss incurred by 
the NCUSIF. Accordingly, consistent with the current rule, proposed 
Sec.  702.201(b) would amend the definition of ``new'' credit union in 
current Sec.  702.301(b) to provide that a ``new'' credit union for 
purposes of subpart B is a credit union that both has been in operation 
for less than 10 years and has total assets of not more than $10 
million. In addition, consistent with section 216(b)(2) of the FCUA, 
proposed paragraph (b) would further provide that once a credit union 
reports total assets of more than $10 million on a Call Report, the 
credit union is no longer new, even if its assets subsequently decline 
below $10 million.
---------------------------------------------------------------------------

    \295\ 12 U.S.C. 1790d(b)(2)(B)(iii).
    \296\ 12 U.S.C. 1790d(b)(2)(B)(v).
---------------------------------------------------------------------------

    In general, credit unions attaining an asset size of $10 million 
begin to offer a greater range of services and loans, which increase 
the credit union's sophistication and risk to the NCUSIF. In the event 
a new credit union reports total assets of over $10 million and then 
subsequently declines to under $10 million, the additional PCA 
regulatory requirements under the proposed rule would not be 
substantially increased. Both new credit unions and non-new credit 
unions with net worth ratios of less than 6 percent, but over 2 
percent, are required under either Sec.  702.206 or Sec.  702.111 of 
the proposal to operate under substantially similar plans to restore 
their net worth. For example, a new credit union with a net worth ratio 
of 5 percent is required to operate under a revised business plan, and 
a non-new credit union with a net worth ratio of 5 percent is required 
to operate under a NWRP. Accordingly, the Board believes any burden 
associated with the proposed change to the requirements of part 702 
would be minimal.
Section 702.202 Net Worth Categories for New Credit Unions
    Consistent with the Original Proposal, this proposed rule would 
renumber current Sec.  702.302 as proposed Sec.  702.202, and would 
make only minor technical edits and conforming amendments to the text 
of the section.
Section 702.203 Prompt Corrective Action for Adequately Capitalized New 
Credit Unions
    Consistent with the Original Proposal, this proposed rule would 
renumber current Sec.  702.303 as proposed Sec.  702.203, and would 
make only minor conforming amendments to the text of the section. 
Consistent with the proposed elimination of the regular reserve 
requirement in current Sec.  702.401(b), proposed Sec.  702.203 would 
also be amended to remove the requirement that adequately capitalized 
credit unions transfer the earnings retention amount from undivided 
earnings to their regular reserve account.
Section 702.204 Prompt Corrective Action for Moderately Capitalized, 
Marginally Capitalized or Minimally Capitalized New Credit Unions
    Consistent with the Original Proposal, this proposed rule would 
renumber current Sec.  702.304 as proposed Sec.  702.204, and would 
make only minor conforming amendments to the text of the section. 
Consistent with the proposed elimination of the regular reserve 
requirement in current Sec.  702.401(b), which is discussed in more 
detail below, proposed Sec.  702.204(a)(1) would be amended to remove 
the requirement that such credit unions transfer the earnings retention 
amount from undivided earnings to their regular reserve account.
Section 702.205 Prompt Corrective Action for Uncapitalized New Credit 
Unions
    Consistent with the Original Proposal, this proposed rule would 
renumber current Sec.  702.305 as proposed Sec.  702.205,

[[Page 4423]]

and would make only minor conforming amendments to the text of the 
section.
Section 702.206 Revised Business Plans (RBP) for New Credit Unions
    Consistent with the Original Proposal, this proposed rule would 
renumber current Sec.  702.306 as proposed Sec.  702.206, would make 
mostly minor conforming amendments to the text of the section, and 
would add new Sec.  702.206(g)(3). Consistent with the proposed 
elimination of the regular reserve requirement in current Sec.  
702.401(b), which is discussed in more detail below, proposed Sec.  
702.206(b)(3) would be amended to remove the requirement that new 
credit unions transfer the earnings retention amount from undivided 
earnings to their regular reserve account.
206(g)(3) Submission of Multiple Unapproved Revised Business Plans
    Consistent with the Original Proposal, proposed Sec.  702.206(g)(3) 
would provide that the submission of more than two RBPs that were not 
approved is considered an unsafe and unsound condition and may subject 
the credit union to administrative enforcement actions under section 
206 of the FCUA.\297\ NCUA regional directors have expressed concerns 
that some credit unions have in the past submitted multiple RBPs that 
could not be approved due to non-compliance with the requirements of 
the current rule, resulting in delayed implementation of actions to 
improve the credit union's net worth. The proposed amendment is 
intended clarify that submitting multiple RBPs that are rejected by 
NCUA, or the state official, because of the failure of the credit union 
to produce an acceptable RBP is an unsafe and unsound practice and may 
subject the credit union to further actions as permitted under the 
FCUA.
---------------------------------------------------------------------------

    \297\ 12 U.S.C. 1786 and 1790d.
---------------------------------------------------------------------------

Section 702.207 Incentives for New Credit Unions
    Consistent with the Original Proposal, this proposed rule would 
renumber current Sec.  702.307 as proposed Sec.  702.207, and would 
make only minor conforming amendments to the text of the section.
Section 702.208 Reserves
    Consistent with the Original Proposal, this proposed rule would add 
new Sec.  702.208 regarding reserves for new credit unions to the rule 
and, consistent with the text of the current reserve requirement in 
Sec.  702.401(a), would require that each new credit union establish 
and maintain such reserves as may be required by the FCUA, by state 
law, by regulation, or in special cases, by the Board or appropriate 
state official.
    As explained under Sec.  702.112, the proposed rule would eliminate 
the regular reserve account under current Sec.  702.402(b) from the 
earnings retention requirement. Additionally, the process and substance 
of requesting permission for charges to the regular reserve would be 
eliminated upon the effective date of a final rule. Upon the effective 
date of a final rule, a federal credit union would close out the 
regular reserve balance into undivided earnings. A federally insured, 
state-chartered credit union would still be required to maintain a 
regular reserve account as per state law or its state supervisory 
authority.
Section 702.209 Full and Fair Disclosure of Financial Condition
    Generally consistent with the Original Proposal, this proposed rule 
would renumber current Sec.  702.402 as Sec.  702.209 and would make 
only minor conforming amendments to the text of this section with the 
exception of the changes to paragraph (d) that are discussed in more 
detail below.
209(d) Charges for Loan and Lease Losses
    Consistent with the proposed elimination of the regular reserve 
requirement in current Sec.  702.401(b), proposed Sec.  702.209(d) 
would remove paragraph (d)(4) of the current rule, which provides that 
the maintenance of an ALLL shall not affect the requirement to transfer 
earnings to a credit union's regular reserve when required under 
subparts B or C of part 702. In addition, this proposed rule would 
remove paragraph (d)(3) of the current rule, which provides that 
adjustments to the valuation ALLL will be recorded in the expense 
account ``Provision for Loan and Lease Losses.'' As discussed in Sec.  
702.113, the changes in the section emphasize the need to record the 
ALLL in accordance with GAAP.
    The remaining provisions in paragraph (d) of the current rule would 
be amended as follows:
(d)(1)
    Proposed Sec.  702.209(d)(1) would amend current Sec.  
702.401(d)(1) to provide that charges for loan and lease losses shall 
be made timely and in accordance with GAAP. The proposal would add the 
italicized words ``and lease'' and ``timely and'' to the language in 
the current rule to clarify that the requirement also applies to lease 
losses and to require that credit unions make charges for loan and 
lease losses in a timely manner. As with the section above, this 
section was changed to clarify that charges for potential lease losses 
should be recorded in accordance with GAAP through the same allowance 
account as loan losses. In addition, timely recording is critical to 
maintain full and fair disclosure as required under this section.
(d)(2)
    Proposed Sec.  702.209(d)(2) would amend current Sec.  
702.401(d)(2) to eliminate the detailed requirement and simply provide 
that the ALLL must be maintained in accordance with GAAP.
    This is necessary to provide full and fair disclosure to a credit 
union member, NCUA, or, at the discretion of a credit union's board of 
directors, to creditors to fairly inform them of the credit union's 
financial condition and operations.
(d)(3)
    Proposed Sec.  702.209(d)(3) would retain the language in current 
Sec.  702.401(d)(5) with no changes.
Section 702.210 Payment of Dividends
    Generally consistent with the Original Proposal, this proposed rule 
would reorganize the rules regarding the payment of dividends contained 
in the current Sec.  702.403, which also apply to new credit unions, to 
new Sec.  702.210 of the proposed rule. The proposed rule also would 
make a number of amendments to the text of paragraphs (a) and (b) of 
the current rule. Each of these changes is discussed in more detail 
below.
210(a) Restriction on Dividends
    Current Sec.  702.402(a) permits small credit unions with a 
depleted undivided earnings balance to pay dividends out of the regular 
reserve account without regulatory approval, as long as the credit 
union will remain at least adequately capitalized. Proposed Sec.  
702.210(a), however, would provide that, for small credit unions, 
dividends shall be available only from net worth, net of any special 
reserves established under Sec.  702.208, if any.
210(b) Payment of dividends if retained earnings depleted
    This proposed rule would eliminate the language in current Sec.  
702.403(b) and Sec.  702.210(b) and (c) of the Original Proposal 
entirely and replace it with a new provision. Under this proposal, 
Sec.  702.210 would provide that the board of directors must not pay a 
dividend or interest refund that will cause the credit union's capital 
classification to fall below adequately capitalized under

[[Page 4424]]

subpart B of part 702 unless the appropriate regional director and, if 
state-chartered, the appropriate state official, have given prior 
written approval (in an RBP or otherwise). Paragraph (b) would provide 
further that the request for written approval must include the plan for 
eliminating any negative retained earnings balance.
    As noted earlier in the section of this preamble associated with 
Sec.  702.114(b), the changes in this section would retain the 
restrictions on payment of dividends included in the current rule. 
However, this proposal would require a credit union that must request 
written approval to pay dividends because the payment would cause its 
net worth classification to fall below adequately capitalized to also 
include a plan for eliminating the negative retained earnings balance 
as part of the written request. This will ensure credit unions that are 
classified below adequately capitalized and have negative retained 
earnings to have in place a plan to increase retained earnings and 
thereby increase net worth.

C. Other Conforming Changes to the Regulations

    In addition to the amendments discussed above, and consistent with 
the Original Proposal, this proposed rule would make minor conforming 
amendments to Sec. Sec.  700.2, 701.21, 701.23, 701.34, 703.14, 713.6, 
723.7, 747.2001, 747.2002, and 747.2003. The conforming amendments 
would primarily involve updating terminology and cross citations to 
proposed part 702 and proposed Sec.  747.2006. No substantive changes 
are intended by these amendments.

V. Effective Date

How much time would credit unions have to implement these new 
requirements?

    The Original Proposal included an effective date of 18 months from 
the date of publication of a final rule. An overwhelming majority of 
commenters addressed this provision and nearly all disagreed with an 
18-month effective date. They argued that 18 months would be 
insufficient to allow credit unions to make adjustments to internal 
systems, balance sheets, and operations in advance of the effective 
date.
    Some commenters cited the phased-in implementation period that the 
Other Banking Agencies' rules provided in their final rules on risk-
based capital for banks, and requested that the Board consider the 
same. Other commenters suggested implementation time frames from three 
years to nine years, with some suggesting each credit union have its 
own implementation period based on the complexity of its operations. 
The majority position, however, was that the effective date be three 
years from the date of publication of a final rule.
    The Board agrees with the comments that a longer implementation 
period is necessary. Therefore, the Board is proposing an 
implementation date of January 1, 2019 to provide both credit unions 
and NCUA sufficient time to make the necessary adjustments, such as 
systems, processes, and procedures, and to reduce the burden on 
affected credit unions in meeting the new requirements.
    In response to commenters who asked the Board to phase in the 
implementation, the Board has concluded that phasing in the new capital 
rules for credit unions would add additional complexity with minimal 
benefit, and therefore has provided for an extended implementation 
period. The Board believes this increase would provide credit unions 
with sufficient time to make the necessary adjustments to systems and 
operations before the effective date of this final rule. In addition, 
as noted above, an extended effective date would generally coincide 
with the full phase-in of FDIC's.

VI. Impact of the Proposed Regulation

    A substantial number of commenters on the Original Proposal 
suggested NCUA underestimated the adverse effect the proposal would 
have had on credit unions. A number of commenters stated that they 
believed that more credit unions than the Board indicated in the 
proposal would be impacted because their net worth would fall to just 
barely over well capitalized or adequately capitalized levels. The 
Board has considered the concerns that were raised by commenters and 
has made substantial modifications in this proposal, as summarized 
above, to refine the scope and improve the targeting of the proposed 
risk-based capital requirements. These changes would reduce the number 
of affected credit unions substantially.
    This proposal would apply to credit unions with $100 million or 
greater in total assets. As of December 31, 2013, there were 1,455 
credit unions (21.5 percent of all credit unions) with assets of $100 
million or greater. This proposal would therefore exempt almost 80 
percent of all credit unions.\298\ The Board notes that the risk-based 
capital requirements in this proposed rule would apply only to credit 
unions with assets of $100 million or more, compared to the Other 
Banking Agencies' rules that apply to banks of all sizes.\299\
---------------------------------------------------------------------------

    \298\ The Original Proposal applied to credit unions with total 
assets of more than $50 million. At the time, 2,237 credit unions 
had total assets greater than $50 million. Thus, the original 
proposal would have exempted over two-thirds of all credit unions. 
For those credit unions that would have been subject to the Original 
Proposal, over 90 percent would have remained well capitalized.
    \299\ There are 1,975 FDIC-insured banks with assets less than 
$100 million as of June 2014.
---------------------------------------------------------------------------

    Based on December 2013 Call Report data, NCUA estimates over 98 
percent of credit unions with over $100 million in assets already have 
sufficient capital to remain well capitalized under this proposal.\300\ 
NCUA estimates this proposal (based on December 2013 data) would cause 
fewer than 20 credit unions (with total assets of $10.9 billion) to 
experience a decline in their capital classification from well 
capitalized to adequately capitalized.\301\ NCUA estimates that these 
credit unions would need to retain an additional $53.6 million in 
eligible capital in total to be well capitalized, assuming no 
adjustments to asset distributions.\302\
---------------------------------------------------------------------------

    \300\ Of the 1,455 impacted credit unions, only 27, or 1.86%, 
would have less than the 10 percent risk-based capital requirement 
to be well capitalized. Of these, eight have net worth ratios less 
than seven percent and therefore are already categorized as less 
than well capitalized.
    \301\ One credit union declines to undercapitalized in the 
estimate. However, given the proposal's provision to phase in 
supervisory goodwill over a longer period, which the estimation 
methodology could not separate out from total goodwill, this credit 
union's capital category would not actually decline.
    \302\ NCUA estimated the original proposal (based on June 2013 
data) would cause 189 credit unions to experience a decline in their 
PCA classification from well capitalized to adequately capitalized, 
and 10 well capitalized credit unions to experience a decline to 
undercapitalized. Assuming no other adjustments to the balance sheet 
structure, NCUA estimated that the 10 credit unions that would 
experience a decline to undercapitalized would have needed to retain 
an additional $63 million (total) in risk-based capital to become 
adequately capitalized; the 189 credit unions would have needed to 
add roughly $700 million in capital to be restored to well 
capitalized.
---------------------------------------------------------------------------

    Based on December 2013 Call Report data, NCUA estimates that if the 
risk-based capital requirements in the current proposal were applied 
today, the proposed risk weights would result in a ratio of total risk-
weighted assets (in the aggregate) to total assets of 57.4 percent. 
Further, the aggregate average risk-based capital ratio would be 18.2 
percent with an average risk-based capital ratio of 19.3 percent.\303\ 
As

[[Page 4425]]

shown in the two tables below, almost all complex credit unions would 
operate well above the proposed 10 percent requirement for 
classification as well capitalized.
---------------------------------------------------------------------------

    \303\ Based on June 2013 Call Report data, NCUA estimated that 
if risk-based capital requirements in the original Proposal were 
applied at that time, the aggregate risk-based capital ratio for 
credit unions subject to the proposed risk-based capital measure 
would be 14.6 percent and the average risk-based capital ratio would 
be 15.7 percent. By way of comparison, the bank aggregate total 
risk-weighted assets to total assets is 67.8 percent, with an 
average total risk-based capital ratio of 18.4 percent.

                                Distribution of Proposed Risk Based Capital Ratio
----------------------------------------------------------------------------------------------------------------
     Proposed RBC Ratio          <10%       10-13%      13-16%      16-20%      20-30%      30-50%       >50%
----------------------------------------------------------------------------------------------------------------
# of CUs....................         27         169         365         408         382          86          18
----------------------------------------------------------------------------------------------------------------


                      Distribution of Net Worth Ratio and Proposed Risk Based Capital Ratio
----------------------------------------------------------------------------------------------------------------
                                                                                                   Greater than
                                  Less than well       Well            Well            Well            well
            # of CUs                capitalized   capitalized to   capitalized +   capitalized +   capitalized +
                                                     well + 2%     2% to + 3.5%    3.5% to + 5%         5%
----------------------------------------------------------------------------------------------------------------
Net Worth Ratio.................              16             339             430             332             338
Proposed RBC Ratio..............              27              99             118             181           1,030
----------------------------------------------------------------------------------------------------------------

    Various commenters suggested that as many as 1,000 credit unions 
would have been required to raise anywhere from $2 billion to $7 
billion in additional capital under the original proposal to retain the 
same ``buffers'' that exist today to be considered well capitalized. 
Commenters stated that credit unions cannot easily manage their capital 
to the exact dollar level that equates to NCUA's proposed standards, 
and that the management of credit unions typically strives to maintain 
sufficient space or buffers between their actual net worth ratios and 
the minimum required levels to be well capitalized because the 
consequences of missing the net worth standards would be very serious. 
Commenters stated that to regain their buffer, credit unions would only 
have three choices: (1) Rebalance their assets, recognizing an 
opportunity cost when they forego higher earnings which would diminish 
their ability to grow; (2) ration services, stifling asset and 
membership growth; or (3) ask members to pay more, resulting in fewer 
member benefits and increased competition from banks.
    The Board believes sound capital levels are vital to the long-term 
health of all financial institutions. Further, provided it is not 
otherwise unsafe or unsound, it is a business decision on the part of a 
credit union to maintain capital levels above those required by 
regulation. Balancing proper capital accumulation with product offering 
and pricing strategies helps ensure credit unions are able to provide 
affordable member services over time. Credit unions are already 
expected to incorporate into their business models and strategic plans 
provisions for maintaining prudent levels of capital.
    This proposal is intended to ensure minimum regulatory capital 
levels are better correlated to risk. Regulatory capital levels 
correlated to risk help reduce the incentive for credit unions to hold 
levels of capital significantly higher than required, unless it is the 
credit union's choice to do so to meet member service and strategic 
objectives. The Board does recognize that unduly high minimum 
regulatory capital requirements could lead to less than optimal 
outcomes.
    Some commenters suggested that for some credit unions the Original 
Proposal would have increased the amount of capital required to be 
well-capitalized above the current level of seven percent of total 
assets depending on the ratio of risk assets to total assets. The 
commenter claimed that on net, across all potentially affected credit 
unions (those with more than $40 million in assets), the total amount 
of capital necessary to be well capitalized would increase by $7.6 
billion, or in other words, that the proposal would have increased the 
net worth ratio required to be well capitalized, on average, from seven 
percent to 7.76 percent. It is not the Board's intent to systematically 
increase capital requirements for all credit unions. Rather, the 
Board's goals are to ensure capital is commensurate with risk, thereby 
aligning incentives for managing risk with required capital levels, and 
to increase regulatory tools for addressing outliers. The Board 
believes this proposal will be effective in achieving these goals.
    As shown in the table below, this proposal is estimated to raise 
minimum required capital levels above the current net worth ratio 
requirement for only 59 complex credit unions (four percent of the 
credit unions subject to the proposal). The proposed risk-based capital 
rule achieves a reasonable balance between requiring credit unions 
posing an elevated risk of failure to hold more capital while not over 
burdening lower-risk credit unions.
---------------------------------------------------------------------------

    \304\ This computation calculates the amount of capital required 
by multiplying the proposed risk weighted assets by 10 percent (the 
level to be well capitalized), and then dividing this result by 
total assets. This provides a measure comparable to the net worth 
ratio. Since the risk-based capital provisions provide for a broader 
definition of capital included in the risk-based capital ratio 
numerator, which on average benefits credit unions by approximately 
50 basis points, the appropriate comparison point for the leverage 
equivalent is 7.5 percent, not the 7 percent level for well 
capitalized for the net worth ratio.

                           Distribution of Risk-Based Leverage Equivalent Ratio \304\
----------------------------------------------------------------------------------------------------------------
Proposed RBC ratio--leverage
         equivalent              < 6%       6-7.5%     7.5-8.5%    8.5-9.5%     9.5-11%      > 11%      Average
----------------------------------------------------------------------------------------------------------------
# of CUs....................        878         518          42          11           6           0       5.74%
----------------------------------------------------------------------------------------------------------------


[[Page 4426]]

    Unlike the Original Proposal, which was more closely tied to 
existing Call Report data, there are greater limitations in estimating 
the impact of this second proposal. Some of the key differences between 
the Original Proposal and the current proposal include: Assigning a 
risk weight to loans secured by non-owner-occupied residential property 
(First-Lien, 1-4 Family) of 50 percent rather than 100 percent; 
assigning a risk weight to insured and Federal Reserve deposits of zero 
percent; and assigning a risk weight to all loans with government 
guarantees or portions of commercial loans with compensating balances 
on deposit of 20 percent. These differences, among others, would 
benefit credit unions, as the lower risk-weights would result in lower 
capital requirements than those measured under the Original Proposal. 
Thus, NCUA reasonably believes, based on its estimates using the Call 
Report data currently available, that this second proposal would have a 
lower impact than the Original Proposal. Further, these estimates are 
believed to be conservative, with the expected benefit to credit unions 
likely being larger than projected, potentially resulting in even fewer 
adversely impacted credit unions than estimated.
    As noted earlier, concentration risk is a material risk that NCUA 
addresses in this proposed rule. Based on December 31, 2013 Call Report 
data, if this proposal were applied today, NCUA estimates that this 
additional capital requirement for concentration risk would have the 
following impact:

----------------------------------------------------------------------------------------------------------------
                                                                Number of credit unions
                                                                   with total assets       Percentage of 1,455
                    Concentration threshold                        greater than $100        credit unions with
                                                                  million as of 12/31/     total assets greater
                                                                          2013              than $100 million
----------------------------------------------------------------------------------------------------------------
First Lien Residential Real Estate (> 35% of Total Assets)....                      149                    10.2%
Junior Lien Residential Real Estate (> 20% of Total Assets)...                       67                     4.6%
Commercial Loans (Used MBLs as a proxy) \305\ > 50% of Total                         12                     0.8%
 Assets)......................................................
----------------------------------------------------------------------------------------------------------------

VII. Regulatory Procedures
---------------------------------------------------------------------------

    \305\ Using MBL data as the current Call Report does not capture 
commercial loan data as defined in this proposal.
---------------------------------------------------------------------------

Regulatory Flexibility Act

    The Regulatory Flexibility Act (RFA) generally requires that, in 
connection with a notice of proposed rulemaking, an agency prepare and 
make available for public comment an initial regulatory flexibility 
analysis that describes the impact of a proposed rule on small 
entities. A regulatory flexibility analysis is not required, however, 
if the agency certifies that the rule will not have a significant 
economic impact on a substantial number of small entities (defined for 
purposes of the RFA to include credit unions with assets less than $50 
million) and publishes its certification and a short, explanatory 
statement in the Federal Register together with the rule.
    The proposed amendments to part 702 would primarily affect complex 
credit unions, which are those with $100 million or more in assets. As 
a result, small credit unions with assets less than $50 million are 
much less affected by the proposed rule. NCUA recognizes, however, that 
even small credit unions will be affected by the proposed amendments to 
some minor extent in that credit unions may need to collect additional 
data for the NCUA Call Report.
    In particular, the proposed rule, if finalized as-is, would likely 
impose some one-time minimal costs on credit unions mostly related to 
training and updates to internal data systems. NCUA estimates that for 
any small credit union that does have to change its current practices 
to deal with the expanded reporting required, it would take, on 
average, less than an additional three hours per quarter per credit 
union. For many small credit unions, it would take even less time 
because they would not need to collect as much data because of the 
simplicity of their operations and products and services offered. The 
costs associated with this would also be minimal. The Call Report 
changes prompted by this proposed rule are the kind that would easily 
be handled as part of the normal and routine maintenance of a credit 
union's data reporting system. Accordingly, the costs and other effects 
of this proposal on small credit unions are minor, and NCUA certifies 
that this proposal will not have a significant economic impact on a 
substantial number of small credit unions.

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 increases an existing burden.\306\ For purposes of the PRA, 
a paperwork burden may take the form of a reporting, disclosure or 
recordkeeping requirement, each referred to as an information 
collection. The proposed changes to part 702 impose new information 
collection requirements.
---------------------------------------------------------------------------

    \306\ 44 U.S.C. 3507(d); 5 CFR part 1320.
---------------------------------------------------------------------------

    NCUA has determined that the proposed changes to part 702 will have 
costs associated with updating internal policies, and updating data 
collection and reporting systems for preparing Call Reports. Based on 
December 2013 Call Report data, NCUA estimates that all 6,554 credit 
unions would have to amend their procedures and systems for preparing 
Call Reports. NCUA will address the costs and provide notice of these 
changes in other collections, such as the NCUA Call Report and Profile 
as part of its regular amendments separate from this proposed rule.
    Finally, NCUA estimates that approximately 21.5 percent, or 1,455 
credit unions, will be defined as ``complex'' under the proposed rule 
and would have additional data collection requirements related to the 
new risk-based capital requirements.
Title of Information Collection: Risk-Based Capital policy implications 
for complex credit unions
Affected Public: Complex Credit Unions
Estimated Number of Respondents: 1,455
Estimated Burden Per Respondent: One-time policy review and revision, 
40 hours
Estimated Cost Per Respondent: $1,276
Title of Information Collection: Risk-Based Capital policy implications 
for non-complex credit unions
Affected Public: Non-Complex Credit Unions
Estimated Number of Respondents: 5,099
Estimated Burden Per Respondent: One-time policy review and revision, 
20 hours
Estimated Cost Per Respondent: $638
    Total Estimated One-Time:
    One-time burden for policy review and revision, (20 hours times 
5,099 credit unions (non-complex), or 40 hours times 1,455 credit 
unions (complex)). The total one-time cost for non-complex credit 
unions totals 101,980 hours or $3,252,142, an average

[[Page 4427]]

of $638 per credit union. The total one-time cost for complex credit 
unions totals 58,200 hours or $1,855,998, an average of $1,276 per 
credit union.
    Submission of comments. 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 NCUA, 
including whether the information will have a practical use;
    Evaluating the accuracy of 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.

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 principles of the executive order to 
adhere to fundamental federalism principles. This proposed rule will 
apply to all federally insured natural-person credit unions, including 
federally insured, state-chartered natural-person credit unions. 
Accordingly, it may have, to some degree, a direct effect on the 
states, on the relationship between the national government and the 
states, or on the distribution of power and responsibilities among the 
various levels of government. The Board believes this impact is minor, 
and it is an unavoidable consequence of carrying out the statutory 
mandate to adopt a system of PCA to apply to all federally insured, 
natural person credit unions. Throughout the rulemaking process, NCUA 
has consulted with representatives of state regulators regarding the 
impact of PCA on state-chartered credit unions. Comments and 
suggestions of those state regulators are reflected in this proposed 
rule.

Assessment of Federal Regulations and Policies on Families

    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 700

    Credit unions.

12 CFR Part 701

    Credit, Credit unions, Insurance, Reporting and recordkeeping 
requirements.

12 CFR Part 702

    Credit unions, Reporting and recordkeeping requirements.

12 CFR Part 703

    Credit unions, Investments, Reporting and recordkeeping 
requirements.

12 CFR Part 713

    Bonds, Credit unions, Insurance.

12 CFR Part 723

    Credit unions, Loan programs-business, Reporting and recordkeeping 
requirements.

12 CFR Part 747

    Administrative practice and procedure, Bank deposit insurance, 
Claims, Credit unions, Crime, Equal access to justice, Investigations, 
Lawyers, Penalties.

    By the National Credit Union Administration Board on January 15, 
2015.
Gerard Poliquin,
Secretary of the Board.
    For the reasons discussed above, the Board proposes to amend 12 CFR 
parts 700, 701, 702, 703, 713, 723, and 747 as follows:

PART 700--DEFINITIONS

0
1. The authority citation for part 700 continues to read as follows:

    Authority: 12 U.S.C. 1752, 1757(6), 1766.


Sec.  700.2  [Amended]

0
2. Amend the definition of ``net worth'' in Sec.  700.2 by removing 
``Sec.  702.2(f)'' and adding in its place ``Sec.  702.2''.

PART 701--ORGANIZATION AND OPERATION OF FEDERAL CREDIT UNIONS

0
3. The authority citation for part 701 continues to read as follows:

    Authority: 12 U.S.C. 1752(5), 1755, 1756, 1757, 1758, 1759, 
1761a, 1761b, 1766, 1767, 1782, 1784, 1786, 1787, 1789. Section 
701.6 is also authorized by 15 U.S.C. 3717. Section 701.31 is also 
authorized by 15 U.S.C. 1601 et seq.; 42 U.S.C. 1981 and 3601-3610. 
Section 701.35 is also authorized by 42 U.S.C. 4311-4312.


Sec.  701.21  [Amended]

0
4. Amend Sec.  701.21(h)(4)(iv) by removing ``Sec.  702.2(f)'' and 
adding in its place ``Sec.  702.2''.


Sec.  701.23  [Amended]

0
5. Amend Sec.  701.23(b)(2) introductory text by removing the words 
``net worth'' and adding in their place the word ``capital'', and 
removing the words ``or, if subject to a risk-based net worth (RBNW) 
requirement under part 702 of this chapter, has remained ``well 
capitalized'' for the six (6) immediately preceding quarters after 
applying the applicable RBNW requirement''.


Sec.  701.34  [Amended]

0
5. Amend Sec.  701.34 as follows:
0
a. In paragraph (b)(12) remove the words ``Sec. Sec.  702.204(b)(11), 
702.304(b) and 702.305(b)'' and add in their place the words ``part 
702''.
0
b. In paragraph (d)(1)(i) remove the words ``net worth'' and add in 
their place the word ``capital''.

Appendix to Sec.  701.34 [Amended]

0
6. In the appendix to Sec.  701.34, amend the paragraph beginning ``8. 
Prompt Corrective Action'' by removing the words ``net worth 
classifications (see 12 CFR 702.204(b)(11), 702.304(b) and 702.305(b), 
as the case may be)'' and adding in their place the words ``capital 
classifications (see 12 CFR part 702)''.

PART 702--CAPITAL ADEQUACY

0
7. The authority citation for part 702 continues to read as follows:

    Authority:  12 U.S.C. 1766(a), 1790d.
0
8. Revise Sec.  702.1 to read as follows:


Sec.  702.1  Authority, purpose, scope, and other supervisory 
authority.

    (a) Authority. Subparts A and B of this part and subpart L of part 
747 of this chapter are issued by the National Credit Union 
Administration (NCUA) pursuant to sections 120 and 216 of the Federal 
Credit Union Act (FCUA), 12 U.S.C. 1776 and 1790d (section 1790d), as 
revised by section 301 of the Credit Union Membership Access Act, 
Public Law 105-219, 112 Stat. 913 (1998).
    (b) Purpose. The express purpose of prompt corrective action under 
section 1790d is to resolve the problems of federally insured credit 
unions at the least possible long-term loss to the National Credit 
Union Share Insurance Fund. Subparts A and B of this part carry out the 
purpose of prompt corrective action by establishing a framework of 
minimum capital

[[Page 4428]]

requirements, and mandatory and discretionary supervisory actions 
applicable according to a credit union's capital classification, 
designed primarily to restore and improve the capital adequacy of 
federally insured credit unions.
    (c) Scope. Subparts A and B of this part implement the provisions 
of section 1790d as they apply to federally insured credit unions, 
whether federally- or state-chartered; to such credit unions defined as 
``new'' pursuant to section 1790d(b)(2); and to such credit unions 
defined as ``complex'' pursuant to section 1790d(d). Certain of these 
provisions also apply to officers and directors of federally insured 
credit unions. Subpart C applies capital planning and stress testing to 
credit unions with $10 billion or more in total assets. This part does 
not apply to corporate credit unions. Unless otherwise provided, 
procedures for issuing, reviewing and enforcing orders and directives 
issued under this part are set forth in subpart L of part 747 of this 
chapter.
    (d) Other supervisory authority. Neither section 1790d nor this 
part in any way limits the authority of the NCUA Board or appropriate 
state official under any other provision of law to take additional 
supervisory actions to address unsafe or unsound practices or 
conditions, or violations of applicable law or regulations. Action 
taken under this part may be taken independently of, in conjunction 
with, or in addition to any other enforcement action available to the 
NCUA Board or appropriate state official, including issuance of cease 
and desist orders, orders of prohibition, suspension and removal, or 
assessment of civil money penalties, or any other actions authorized by 
law.
0
9. Revise Sec.  702.2 to read as follows:


Sec.  702.2  Definitions.

    Unless otherwise provided in this part, the terms used in this part 
have the same meanings as set forth in FCUA sections 101 and 216, 12 
U.S.C. 1752, 1790d. The following definitions apply to this part:
    Allowances for loan and lease losses (ALLL) means valuation 
allowances that have been established through a charge against earnings 
to cover estimated credit losses on loans, lease financing receivables 
or other extensions of credit as determined in accordance with GAAP.
    Amortized cost means the purchase price of a security adjusted for 
amortizations of premium or accretion of discount if the security was 
purchased at other than par or face value.
    Appropriate state official means the state commission, board or 
other supervisory authority having jurisdiction over the credit union.
    Call Report means the Call Report required to be filed by all 
credit unions under Sec.  741.6(a)(2) of this chapter.
    Carrying value means, with respect to an asset, the value of the 
asset on the statement of financial condition of the credit union, 
determined in accordance with GAAP.
    Central counterparty (CCP) means a counterparty (for example, a 
clearing house) that facilitates trades between counterparties in one 
or more financial markets by either guaranteeing trades or novating 
contracts.
    Commercial loan means any loan, line of credit, or letter of credit 
(including any unfunded commitments) to individuals, sole 
proprietorships, partnerships, corporations, or other business 
enterprises for commercial, industrial, and professional purposes, but 
not for investment or personal expenditure purposes. Commercial loan 
excludes loans to CUSOs, first- or junior-lien residential real estate 
loans, and consumer loans.
    Commitment means any legally binding arrangement that obligates the 
credit union to extend credit, to purchase or sell assets, or enter 
into a financial transaction.
    Consumer loan means a loan to one or more individuals for 
household, family, or other personal expenditures, including any loans 
secured by vehicles generally manufactured for personal, family, or 
household use regardless of the purpose of the loan. Consumer loan 
excludes commercial loans, loans to CUSOs, first- and junior-lien 
residential real estate loans, and loans for the purchase of fleet 
vehicles.
    Contractual compensating balance means the funds a commercial loan 
borrower must maintain on deposit at the lender credit union as 
security for the loan in accordance with the loan agreement, subject to 
a proper account hold and on deposit as of the measurement date.
    Credit conversion factor (CCF) means the percentage used to assign 
a credit exposure equivalent amount for selected off-balance sheet 
accounts.
    Credit union means a federally insured, natural person credit 
union, whether federally- or state-chartered.
    Current means, with respect to any loan, that the loan is less than 
90 days past due, not placed on non-accrual status, and not 
restructured.
    CUSO means a credit union service organization as defined in part 
712 and 741 of this chapter.
    Custodian means a financial institution that has legal custody of 
collateral as part of a qualifying master netting agreement, clearing 
agreement, or other financial agreement.
    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. Depository institution includes 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, and all privately insured state chartered 
credit unions.
    Derivatives Clearing Organization (DCO) means the same as defined 
by the Commodity Futures Trading Commission in 17 CFR 1.3(d).
    Derivative contract 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, and credit derivative contracts. Derivative contracts also 
include unsettled securities, commodities, and foreign exchange 
transactions with a contractual settlement or delivery lag that is 
longer than the lesser of the market standard for the particular 
instrument.
    Equity investment means investments in equity securities and any 
other ownership interests, including, for example, investments in 
partnerships and limited liability companies.
    Equity investment in CUSOs means the unimpaired value of the credit 
union's equity investments in a CUSO as recorded on the statement of 
financial condition in accordance with GAAP.
    Exchange means a central financial clearing market where end users 
can trade derivatives.
    Excluded goodwill means the outstanding balance, maintained in 
accordance with GAAP, of any goodwill originating from a supervisory 
merger or combination that was completed no more than 29 days after 
publication of this rule in final form in the Federal Register. This 
term and definition will expire on January 1, 2025.

[[Page 4429]]

    Excluded other intangible assets means the outstanding balance, 
maintained in accordance with GAAP, of any other intangible assets such 
as core deposit intangible, member relationship intangible, or trade 
name intangible originating from a supervisory merger or combination 
that was completed no more than 29 days after publication of this rule 
in final form in the Federal Register. This term and definition will 
expire on January 1, 2025.
    Exposure amount means:
    (1) The amortized cost for investments classified as held-to-
maturity and available-for-sale, and the fair value for trading 
securities.
    (2) The outstanding balance for Federal Reserve Bank Stock, Central 
Liquidity Facility Stock, Federal Home Loan Bank Stock, nonperpetual 
capital and perpetual contributed capital at corporate credit unions, 
and equity investments in CUSOs.
    (3) The carrying value for non-CUSO equity investments, and 
investment funds.
    (4) The carrying value for the credit union's holdings of general 
account permanent insurance, and separate account insurance.
    (5) The amount calculated under Sec.  702.105 of this part for 
derivative contracts.
    Fair value has the same meaning as provided in GAAP.
    Financial collateral means collateral approved by both the credit 
union and the counterparty as part of the collateral agreement in 
recognition of credit risk mitigation for derivative contracts.
    First-lien residential real estate loan means a loan or line of 
credit primarily secured by a first-lien on a one-to-four family 
residential property where:
    (1) The credit union made a reasonable and good faith determination 
at or before consummation of the loan that the member will have a 
reasonable ability to repay the loan according to its terms; and
    (2) In transactions where the credit union holds the first-lien and 
junior lien(s), and no other party holds an intervening lien, for 
purposes of this part the combined balance will be treated as a single 
first-lien residential real estate loan.
    GAAP means generally accepted accounting principles in the United 
States as set forth in the Financial Accounting Standards Board's 
(FASB) Accounting Standards Codification (ASC).
    General account permanent insurance means an account into which all 
premiums, except those designated for separate accounts are deposited, 
including premiums for life insurance and fixed annuities and the fixed 
portfolio of variable annuities, whereby the general assets of the 
insurance company support the policy.
    General obligation means a bond or similar obligation that is 
backed by the full faith and credit of a public sector entity.
    Goodwill means an intangible asset, maintained in accordance with 
GAAP, representing the future economic benefits arising from other 
assets acquired in a business combination (e.g., merger) that are not 
individually identified and separately recognized. Goodwill does not 
include excluded goodwill.
    Government guarantee means a guarantee provided by the U.S. 
Government, FDIC, NCUA or other U.S. Government agency, or a public 
sector entity.
    Government-sponsored enterprise (GSE) means an entity established 
or chartered by the U.S. Government to serve public purposes specified 
by the U.S. Congress, but whose debt obligations are not explicitly 
guaranteed by the full faith and credit of the U.S. Government.
    Guarantee means a financial guarantee, letter of credit, insurance, 
or similar financial instrument that allows one party to transfer the 
credit risk of one or more specific exposures to another party.
    Identified losses means those items that have been determined by an 
evaluation made by NCUA, or in the case of a state chartered credit 
union the appropriate state official, as measured on the date of 
examination in accordance with GAAP, to be chargeable against income, 
equity or valuation allowances such as the allowances for loan and 
lease losses. Examples of identified losses would be assets classified 
as losses, off-balance sheet items classified as losses, any provision 
expenses that are necessary to replenish valuation allowances to an 
adequate level, liabilities not shown on the books, estimated losses in 
contingent liabilities, and differences in accounts that represent 
shortages.
    Industrial development bond means a security issued under the 
auspices of a state or other political subdivision for the benefit of a 
private party or enterprise where that party or enterprise, rather than 
the government entity, is obligated to pay the principal and interest 
on the obligation.
    Intangible assets mean assets, maintained in accordance with GAAP, 
other than financial assets, that lack physical substance.
    Investment fund means an investment with a pool of underlying 
investment assets. Investment fund includes an investment company that 
is registered under section 8 of the Investment Company Act of 1940, 
and collective investment funds or common trust investments that are 
unregistered investment products that pool fiduciary client assets to 
invest in a diversified pool of investments.
    Junior-lien residential real estate loan means a loan or line of 
credit secured by a subordinate lien on a one-to-four family 
residential property.
    Loan to a CUSO means the outstanding balance of any loan from a 
credit union to a CUSO as recorded on the statement of financial 
condition in accordance with GAAP.
    Loan secured by real estate means a loan that, at origination, is 
secured wholly or substantially by a lien(s) on real property for which 
the lien(s) is central to the extension of the credit. A lien is 
``central'' to the extension of credit if the borrowers would not have 
been extended credit in the same amount or on terms as favorable 
without the liens on real property. For a loan to be ``secured wholly 
or substantially by a lien(s) on real property,'' the estimated value 
of the real estate collateral at origination (after deducting any more 
senior liens held by others) must be greater than 50 percent of the 
principal amount of the loan at origination.
    Loans transferred with limited recourse means the total principal 
balance outstanding of loans transferred, including participations, for 
which the transfer qualified for true sale accounting treatment under 
GAAP, and for which the transferor credit union retained some limited 
recourse (i.e., insufficient recourse to preclude true sale accounting 
treatment). Loans transferred with limited recourse excludes transfers 
that qualify for true sale accounting treatment but contain only 
routine representation and warranty clauses that are standard for sales 
on the secondary market, provided the credit union is in compliance 
with all other related requirements, such as capital requirements.
    Mortgage-backed security (MBS) means a security backed by first- or 
junior-lien mortgages secured by real estate upon which is located a 
dwelling, mixed residential and commercial structure, residential 
manufactured home, or commercial structure.
    Mortgage partnership finance program means a Federal Home Loan Bank 
program through which loans are originated by a depository institution 
that are purchased or funded by the Federal Home Loan Banks, where the

[[Page 4430]]

depository institutions receive fees for managing the credit risk of 
the loans and servicing them. The credit risk must be shared between 
the depository institutions and the Federal Home Loan Banks.
    Mortgage servicing assets mean those assets, maintained in 
accordance with GAAP, resulting from contracts to service loans secured 
by real estate (that have been securitized or owned by others) for 
which the benefits of servicing are expected to more than adequately 
compensate the servicer for performing the servicing.
    NCUSIF means the National Credit Union Share Insurance Fund as 
defined by 12 U.S.C. 1783.
    Net worth means:
    (1) The retained earnings balance of the credit union at quarter-
end as determined under GAAP, subject to paragraph (3) of this 
definition.
    (2) For a low income-designated credit union, net worth also 
includes secondary capital accounts that are uninsured and subordinate 
to all other claims, including claims of creditors, shareholders, and 
the NCUSIF.
    (3) For a credit union that acquires another credit union in a 
mutual combination, net worth also includes the retained earnings of 
the acquired credit union, or of an integrated set of activities and 
assets, less any bargain purchase gain recognized in either case to the 
extent the difference between the two is greater than zero. The 
acquired retained earnings must be determined at the point of 
acquisition under GAAP. A mutual combination, including a supervisory 
combination, is a transaction in which a 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.
    (4) The term ``net worth'' also includes loans to and accounts in 
an insured credit union, established pursuant to section 208 of the Act 
[12 U.S.C. 1788], provided such loans and accounts:
    (i) Have a remaining maturity of more than 5 years;
    (ii) Are subordinate to all other claims including those of 
shareholders, creditors, and the NCUSIF;
    (iii) Are not pledged as security on a loan to, or other obligation 
of, any party;
    (iv) Are not insured by the NCUSIF;
    (v) Have non-cumulative dividends;
    (vi) Are transferable; and
    (vii) Are available to cover operating losses realized by the 
insured credit union that exceed its available retained earnings.
    Net worth ratio means the ratio of the net worth of the credit 
union to the total assets of the credit union rounded to two decimal 
places.
    New credit union has the same meaning as in Sec.  702.201.
    Nonperpetual capital has the same meaning as in Sec.  704.2 of this 
chapter.
    Off-balance sheet items means items such as commitments, contingent 
items, guarantees, certain repo-style transactions, financial standby 
letters of credit, and forward agreements that are not included on the 
statement of financial condition, but are normally reported in the 
financial statement footnotes.
    Off-balance sheet exposure means:
    (1) For loans transferred under the Federal Home Loan Bank mortgage 
partnership finance program, the outstanding loan balance as of the 
reporting date, net of any related valuation allowance.
    (2) For all other loans transferred with limited recourse or other 
seller-provided credit enhancements and that qualify for true sales 
accounting, the maximum contractual amount the credit union is exposed 
to according to the agreement, net of any related valuation allowance.
    (3) For unfunded commitments, the remaining unfunded portion of the 
contractual agreement.
    On-balance sheet means a credit union's assets, liabilities, and 
equity, as disclosed on the statement of financial condition at a 
specific point in time.
    Other intangible assets means intangible assets, other than 
servicing assets and goodwill, maintained in accordance with GAAP. 
Other intangible assets does not include excluded other intangible 
assets.
    Over-the-counter (OTC) interest rate derivative contract means a 
derivative contract that is not cleared on an exchange.
    Perpetual contributed capital has the same meaning as in Sec.  
704.2 of this chapter.
    Public sector entity (PSE) means a state, local authority, or other 
governmental subdivision of the United States below the sovereign 
level.
    Qualifying master netting agreement means a written, legally 
enforceable agreement, provided that:
    (1) The agreement creates a single legal obligation for all 
individual transactions covered by the agreement upon an event of 
default, including upon an event of conservatorship, receivership, 
insolvency, liquidation, or similar proceeding, of the counterparty;
    (2) The agreement provides the credit union the right to 
accelerate, terminate, and close out on a net basis all transactions 
under the agreement and to liquidate or set off collateral promptly 
upon an event of default, including upon an event of conservatorship, 
receivership, insolvency, liquidation, or similar proceeding, of the 
counterparty, provided that, in any such case, any exercise of rights 
under the agreement will not be stayed or avoided under applicable law 
in the relevant jurisdictions, other than in receivership, 
conservatorship, resolution under the Federal Deposit Insurance Act, 
Title II of the Dodd-Frank Wall Street Reform and Consumer Protection 
Act, or under any similar insolvency law applicable to GSEs;
    (3) The agreement does not contain a walkaway clause (that is, a 
provision that permits a non-defaulting counterparty to make a lower 
payment than it otherwise would make under the agreement, or no payment 
at all, to a defaulter or the estate of a defaulter, even if the 
defaulter or the estate is a net creditor under the agreement); and
    (4) In order to recognize an agreement as a qualifying master 
netting agreement for purposes of this part, a credit union must 
conduct sufficient legal review, at origination and in response to any 
changes in applicable law, to conclude with a well-founded basis (and 
maintain sufficient written documentation of that legal review) that:
    (i) The agreement meets the requirements of paragraph (2) of this 
definition; and
    (ii) In the event of a legal challenge (including one resulting 
from default or from conservatorship, receivership, insolvency, 
liquidation, or similar proceeding), the relevant court and 
administrative authorities would find the agreement to be legal, valid, 
binding, and enforceable under the law of relevant jurisdictions.
    Recourse means a credit union's retention, in form or in substance, 
of any credit risk directly or indirectly associated with an asset it 
has transferred that exceeds a pro rata share of that credit union's 
claim on the asset and disclosed in accordance with GAAP. If a credit 
union has no claim on an asset it has transferred, then the retention 
of any credit risk is recourse. A recourse obligation typically arises 
when a 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 the credit union provides credit enhancement 
beyond any contractual obligation to support assets it has transferred.

[[Page 4431]]

    Residential mortgage-backed security means a mortgage-backed 
security backed by loans secured by a first-lien on residential 
property.
    Residential property means a house, condominium unit, cooperative 
unit, manufactured home, or the construction thereof, and unimproved 
land zoned for one-to-four family residential use. Residential property 
excludes boats or motor homes, even if used as a primary residence, or 
timeshare property.
    Restructured means, with respect to any loan, a restructuring of 
the loan in which a credit union, for economic or legal reasons related 
to a borrower's financial difficulties, grants a concession to the 
borrower that it would not otherwise consider. Restructured excludes 
loans modified or restructured solely pursuant to the U.S. Treasury's 
Home Affordable Mortgage Program.
    Revenue obligation means a bond or similar obligation that is an 
obligation of a PSE, but which the PSE is committed to repay with 
revenues from the specific project financed rather than general tax 
funds.
    Risk-based capital ratio means the percentage, rounded to two 
decimal places, of the risk-based capital ratio numerator to risk-
weighted assets, as calculated in accordance with Sec.  702.104(a).
    Risk-weighted assets means the total risk-weighted assets as 
calculated in accordance with Sec.  702.104(c).
    Secured consumer loan means a consumer loan associated with 
collateral or other item of value to protect against loss where the 
creditor has a perfected security interest in the collateral or other 
item of value.
    Senior executive officer means a senior executive officer as 
defined by Sec.  701.14(b)(2) of this chapter.
    Separate account insurance means an account into which a 
policyholder's cash surrender value is supported by assets segregated 
from the general assets of the carrier.
    Shares means deposits, shares, share certificates, share drafts, or 
any other depository account authorized by federal or state law.
    Share-secured loan means a loan fully secured by shares on deposit 
at the credit union making the loan, and does not include the 
imposition of a statutory lien under Sec.  701.39 of this chapter.
    STRIPS means a separately traded registered interest and principal 
security.
    Structured product means an investment that is linked, via return 
or loss allocation, to another investment or reference pool.
    Subordinated means, with respect to an investment, that the 
investment has a junior claim on the underlying collateral or assets to 
other investments in the same issuance. Subordinated does not apply to 
securities that are junior only to money market fund eligible 
securities in the same issuance.
    Supervisory merger or combination means a transaction that involved 
the following:
    (1) An assisted merger or purchase and assumption where funds from 
the NCUSIF were provided to the continuing credit union;
    (2) A merger or purchase and assumption classified by NCUA as an 
``emergency merger'' where the acquired credit union is either 
insolvent or ``in danger of insolvency'' as defined under appendix B to 
part 701 of this chapter; or
    (3) A merger or purchase and assumption that included NCUA's or the 
appropriate state official's identification and selection of the 
continuing credit union.
    Swap dealer has the meaning as defined by the Commodity Futures 
Trading Commission in 17 CFT 1.3(ggg).
    Total assets means a credit union's total assets as measured \1\ by 
either:
---------------------------------------------------------------------------

    \1\ For each quarter, a credit union must elect one of the 
measures of total assets listed in paragraph (2) of this definition 
to apply for all purposes under this part except Sec. Sec.  702.103 
through 702.106 (risk-based capital requirement).
---------------------------------------------------------------------------

    (1) Average quarterly balance. The credit union's total assets 
measured by the average of quarter-end balances of the current and 
three preceding calendar quarters;
    (2) Average monthly balance. The credit union's total assets 
measured by the average of month-end balances over the three calendar 
months of the applicable calendar quarter;
    (3) Average daily balance. The credit union's total assets measured 
by the average daily balance over the applicable calendar quarter; or
    (4) Quarter-end balance. The credit union's total assets measured 
by the quarter-end balance of the applicable calendar quarter as 
reported on the credit union's Call Report.
    Tranche means one of a number of related securities offered as part 
of the same transaction. Tranche includes a structured product if it 
has a loss allocation based off of an investment or reference pool.
    Unsecured consumer loan means a consumer loan not secured by 
collateral.
    U.S. Government agency means an instrumentality of the U.S. 
Government whose obligations are fully and explicitly guaranteed as to 
the timely payment of principal and interest by the full faith and 
credit of the U.S. Government.
0
10. Revise subpart A to read as follows:
Subpart A--Prompt Corrective Action
Sec.
702.101 Capital measures, capital adequacy, effective date of 
classification, and notice to NCUA.
702.102 Capital classifications.
702.103 Applicability of the risk-based capital ratio measure.
702.104 Risk-based capital ratio.
702.105 Derivative contracts.
702.106 Prompt corrective action for adequately capitalized credit 
unions.
702.107 Prompt corrective action for undercapitalized credit unions.
702.108 Prompt corrective action for significantly undercapitalized 
credit unions.
702.109 Prompt corrective action for critically undercapitalized 
credit unions.
702.110 Consultation with state officials on proposed prompt 
corrective action.
702.111 Net worth restoration plans (NWRP).
702.112 Reserves.
702.113 Full and fair disclosure of financial condition.
702.114 Payment of dividends.

Subpart A--Prompt Corrective Action


Sec.  702.101  Capital measures, capital adequacy, effective date of 
classification, and notice to NCUA.

    (a) Capital measures. For purposes of this part, a credit union 
must determine its capital classification at the end of each calendar 
quarter using the following measures:
    (1) The net worth ratio; and
    (2) If determined to be applicable under Sec.  702.103, the risk-
based capital ratio.
    (b) Capital adequacy. (1) Notwithstanding the minimum requirements 
in this part, a credit union defined as complex must maintain capital 
commensurate with the level and nature of all risks to which the 
institution is exposed.
    (2) A credit union defined as complex must have a process for 
assessing its overall capital adequacy in relation to its risk profile 
and a comprehensive written strategy for maintaining an appropriate 
level of capital.
    (c) Effective date of capital classification. For purposes of this 
part, the effective date of a federally insured credit union's capital 
classification shall be the most recent to occur of:
    (1) Quarter-end effective date. The last day of the calendar month 
following the end of the calendar quarter;
    (2) Corrected capital classification. The date the credit union 
received subsequent written notice from NCUA or, if state-chartered, 
from the appropriate state official, of a decline in capital 
classification due to correction

[[Page 4432]]

of an error or misstatement in the credit union's most recent Call 
Report; or
    (3) Reclassification to lower category. The date the credit union 
received written notice from NCUA or, if state-chartered, the 
appropriate state official, of reclassification on safety and soundness 
grounds as provided under Sec. Sec.  702.102(b) or 702. 202(d).
    (d) Notice to NCUA by filing Call Report. (1) Other than by filing 
a Call Report, a federally insured credit union need not notify the 
NCUA Board of a change in its capital measures that places the credit 
union in a lower capital category;
    (2) Failure to timely file a Call Report as required under this 
section in no way alters the effective date of a change in capital 
classification under paragraph (b) of this section, or the affected 
credit union's corresponding legal obligations under this part.


Sec.  702.102  Capital classification.

    (a) Capital categories. Except for credit unions defined as ``new'' 
under subpart B of this part, a credit union shall be deemed to be 
classified (Table 1 of this section)--
    (1) Well capitalized if:
    (i) Net worth ratio. The credit union has a net worth ratio of 7.0 
percent or greater; and
    (ii) Risk-based capital ratio. The credit union, if complex, has a 
risk-based capital ratio of 10 percent or greater.
    (2) Adequately capitalized if:
    (i) Net worth ratio. The credit union has a net worth ratio of 6.0 
percent or greater; and
    (ii) Risk-based capital ratio. The credit union, if complex, has a 
risk-based capital ratio of 8.0 percent or greater; and
    (iii) Does not meet the definition of a well capitalized credit 
union.
    (3) Undercapitalized if:
    (i) Net worth ratio. The credit union has a net worth ratio of 4.0 
percent or more but less than 6.0 percent; or
    (ii) Risk-based capital ratio. The credit union, if complex, has a 
risk-based capital ratio of less than 8.0 percent.
    (4) Significantly undercapitalized if:
    (i) The credit union has a net worth ratio of 2.0 percent or more 
but less than 4.0 percent; or
    (ii) The credit union has a net worth ratio of 4.0 percent or more 
but less than 5.0 percent, and either--
    (A) Fails to submit an acceptable net worth restoration plan within 
the time prescribed in Sec.  702.110;
    (B) Materially fails to implement a net worth restoration plan 
approved by the NCUA Board; or
    (C) Receives notice that a submitted net worth restoration plan has 
not been approved.
    (5) Critically undercapitalized if it has a net worth ratio of less 
than 2.0 percent.

                                  Table 1 to Sec.   702.102--Capital Categories
----------------------------------------------------------------------------------------------------------------
                                                                      Risk-based capital
   A credit union's capital                                               ratio also          And subject to
    classification is . . .      Net worth ratio                         applicable if    following condition(s)
                                                                            complex                . . .
----------------------------------------------------------------------------------------------------------------
Well Capitalized..............  7% or greater....  And..............  10.0% or greater..
Adequately Capitalized........  6% or greater....  And..............  8% or greater.....  And does not meet the
                                                                                           criteria to be
                                                                                           classified as well
                                                                                           capitalized.
Undercapitalized..............  4% to 5.99%......  Or...............  Less than 8%......
Significantly Undercapitalized  2% to 3.99%......  .................  N/A...............  Or if
                                                                                           ``undercapitalized at
                                                                                           < 5% net worth and
                                                                                           (a) fails to timely
                                                                                           submit, (b) fails to
                                                                                           materially implement,
                                                                                           or (c) receives
                                                                                           notice of the
                                                                                           rejection of a net
                                                                                           worth restoration
                                                                                           plan.
Critically Undercapitalized...  Less than 2%.....  .................  N/A...............
----------------------------------------------------------------------------------------------------------------

    (b) Reclassification based on supervisory criteria other than net 
worth. The NCUA Board may reclassify a well capitalized credit union as 
adequately capitalized and may require an adequately capitalized or 
undercapitalized credit union to comply with certain mandatory or 
discretionary supervisory actions as if it were classified in the next 
lower capital category (each of such actions hereinafter referred to 
generally as ``reclassification'') in the following circumstances:
    (1) Unsafe or unsound condition. The NCUA Board has determined, 
after providing the credit union with notice and opportunity for 
hearing pursuant to Sec.  747.2003 of this chapter, that the credit 
union is in an unsafe or unsound condition; or
    (2) Unsafe or unsound practice. The NCUA Board has determined, 
after providing the credit union with notice and opportunity for 
hearing pursuant to Sec.  747.2003 of this chapter, that the credit 
union has not corrected a material unsafe or unsound practice of which 
it was, or should have been, aware.
    (c) Non-delegation. The NCUA Board may not delegate its authority 
to reclassify a credit union under paragraph (b) of this section.
    (d) Consultation with state officials. The NCUA Board shall consult 
and seek to work cooperatively with the appropriate state official 
before reclassifying a federally insured state-chartered credit union 
under paragraph (b) of this section, and shall promptly notify the 
appropriate state official of its decision to reclassify.


Sec.  702.103  Applicability of the risk-based capital ratio measure.

    For purposes of Sec.  702.102, a credit union is defined as 
``complex'' and the risk-based capital ratio measure is applicable only 
if the credit union's quarter-end total assets exceed one hundred 
million dollars ($100,000,000), as reflected in its most recent Call 
Report.


Sec.  702.104  Risk-based capital ratio.

    A complex credit union must calculate its risk-based capital ratio 
in accordance with this section.
    (a) Calculation of the risk-based capital ratio. To determine its 
risk-based capital ratio, a complex credit union must calculate the 
percentage, rounded to two decimal places, of its risk-based capital 
ratio numerator as described in paragraph (b) of this section, to its 
total risk-weighted assets as described in paragraph (c) of this 
section.
    (b) Risk-based capital ratio numerator. The risk-based capital 
ratio numerator is the sum of the specific capital elements in 
paragraph (b)(1) of this section, minus the regulatory adjustments in 
paragraph (b)(2) of this section.

[[Page 4433]]

    (1) Capital elements of the risk-based capital ratio numerator. The 
capital elements of the risk-based capital numerator are:
    (i) Undivided earnings;
    (ii) Appropriation for non-conforming investments;
    (iii) Other reserves;
    (iv) Equity acquired in merger;
    (v) Net income
    (vi) ALLL, maintained in accordance with GAAP;
    (vii) Secondary capital accounts included in net worth (as defined 
in Sec.  702.2); and
    (viii) Section 208 assistance included in net worth (as defined in 
Sec.  702.2).
    (2) Risk-based capital ratio numerator deductions. The elements 
deducted from the sum of the capital elements of the risk-based capital 
ratio numerator are:
    (i) NCUSIF Capitalization Deposit;
    (ii) Goodwill;
    (iii) Other intangible assets; and
    (iv) Identified losses not reflected in the risk-based capital 
ratio numerator.
    (c) Risk-weighted assets. (1) General. Risk-weighted assets 
includes risk- weighted on-balance sheet assets as described in 
paragraphs (c)(2) and (3) of this section, plus the risk-weighted off-
balance sheet assets in paragraph (c)(4) of this section, plus the 
risk-weighted derivatives in paragraph (c)(5) of this section, less the 
risk-based capital ratio numerator deductions in paragraph (b)(2) of 
this section. If a particular asset, derivative contract, or off 
balance sheet item has features or characteristics that suggest it 
could potentially fit into more than one risk weight category, then a 
credit union shall assign the asset, derivative contract, or off 
balance sheet item to the risk weight category that most accurately and 
appropriately reflects its associated credit risk.
    (2) Risk weights for on-balance sheet assets. The risk categories 
and weights for assets of a complex credit union are as follows:
    (i) Category 1--zero percent risk weight. A credit union must 
assign a zero percent risk weight to:
    (A) The balance of cash, currency and coin, including vault, 
automatic teller machine, and teller cash.
    (B) The exposure amount of:
    (1) An obligation of the U.S. Government, its central bank, or a 
U.S. Government agency that is directly and unconditionally guaranteed, 
excluding detached security coupons, ex-coupon securities, and 
principal- and interest-only mortgage-backed STRIPS.
    (2) Federal Reserve Bank stock and Central Liquidity Facility 
stock.
    (C) Insured balances due from FDIC-insured depositories or 
federally insured credit unions.
    (ii) Category 2--20 percent risk weight. A credit union must assign 
a 20 percent risk weight to:
    (A) The uninsured balances due from FDIC-insured depositories, 
federally insured credit unions, and all balances due from privately-
insured credit unions.
    (B) The exposure amount of:
    (1) A non-subordinated obligation of the U.S. Government, its 
central bank, or a U.S. Government agency that is conditionally 
guaranteed, excluding principal- and interest-only mortgage-backed 
STRIPS.
    (2) A non-subordinated obligation of a GSE other than an equity 
exposure or preferred stock, excluding principal- and interest-only GSE 
obligation STRIPS.
    (3) Securities issued by PSEs in the U.S. that represent general 
obligation securities.
    (4) Investment funds whose portfolios are permitted to hold only 
part 703 permissible investments that qualify for the zero or 20 
percent risk categories.
    (5) Federal Home Loan Bank stock.
    (C) The balances due from Federal Home Loan Banks.
    (D) The balance of share-secured loans.
    (E) The portions of outstanding loans with a government guarantee.
    (F) The portions of commercial loans secured with contractual 
compensating balances.
    (iii) Category 3--50 percent risk weight. A credit union must 
assign a 50 percent risk weight to:
    (A) The outstanding balance (net of government guarantees), 
including loans held for sale, of current first-lien residential real 
estate loans less than or equal to 35 percent of assets.
    (B) The exposure amount of:
    (1) Securities issued by PSEs in the U.S. that represent non-
subordinated revenue obligation securities.
    (2) Other non-subordinated, non-U.S. Government agency or non-GSE 
guaranteed, residential mortgage-backed security, excluding principal- 
and interest-only STRIPS.
    (iv) Category 4--75 percent risk weight. A credit union must assign 
a 75 percent risk weight to the outstanding balance (net of government 
guarantees), including loans held for sale, of:
    (A) Current first-lien residential real estate loans greater than 
35 percent of assets.
    (B) Current secured consumer loans.
    (v) Category 5--100 percent risk weight. A credit union must assign 
a 100 percent risk weight to:
    (A) The outstanding balance (net of government guarantees), 
including loans held for sale, of:
    (1) First-lien residential real estate loans that are not current.
    (2) Current junior-lien residential real estate loans less than or 
equal to 20 percent of assets.
    (3) Current unsecured consumer loans.
    (4) Current commercial loans, less contractual compensating 
balances that comprise less than 50 percent of assets.
    (5) Loans to CUSOs.
    (B) The exposure amount of:
    (1) Industrial development bonds.
    (2) All stripped mortgage-backed securities (principal- and 
interest-only STRIPS).
    (3) Part 703 compliant investment funds, with the option to use the 
look-through approaches in paragraph (c)(3)(ii) of this section.
    (4) Corporate debentures and commercial paper.
    (5) Nonperpetual capital at corporate credit unions.
    (6) General account permanent insurance.
    (7) GSE equity exposure or preferred stock.
    (C) All other assets listed on the statement of financial condition 
not specifically assigned a different risk weight under this subpart.
    (vi) Category 6--150 percent risk weight. A credit union must 
assign a 150 percent risk weight to:
    (A) The outstanding balance, net of government guarantees and 
including loans held for sale, of:
    (1) Current junior-lien residential real estate loans that comprise 
more than 20 percent of assets.
    (2) Junior-lien residential real estate loans that are not current.
    (3) Consumer loans that are not current.
    (4) Current commercial loans (net of contractual compensating 
balances), which comprise more than 50 percent of assets.
    (5) Commercial loans (net of contractual compensating balances), 
which are not current.
    (B) The exposure amount of:
    (1) Perpetual contributed capital at corporate credit unions.
    (2) Equity investments in CUSOs.
    (vii) Category 7--250 percent risk weight. A credit union must 
assign a 250 percent risk weight to the carrying value of mortgage 
servicing assets.
    (viii) Category 8--300 percent risk weight. A credit union must 
assign a 300 percent risk weight to the exposure amount of:
    (A) Publicly traded equity investment, other than a CUSO 
investment.
    (B) Investment funds that are not in compliance with part 703 of 
this Chapter, with the option to use the look-

[[Page 4434]]

through approaches in paragraph (c)(3)(ii) of this section.
    (C) Separate account insurance, with the option to use the look-
through approaches in paragraph (c)(3)(ii) of this section.
    (ix) Category 9--400 percent risk weight. A credit union must 
assign a 400 percent risk weight to the exposure amount of non-publicly 
traded equity investments, other than equity investments in CUSOs.
    (x) Category 10--1,250 percent risk weight. A credit union must 
assign a 1,250 percent risk weight to the exposure amount of any 
subordinated tranche of any investment, with the option to use the 
gross-up approach in paragraph (c)(3)(i) of this section.
    (3) Alternative risk weights for certain on-balance sheet assets. 
Instead of using the risk weights assigned in paragraph (c)(2) of this 
section, a credit union may determine the risk weight of investment 
funds and subordinated tranches of any investment as follows:
    (i) Gross-up approach. A credit union may use the gross-up approach 
under Sec.  324.43(e) of this title to determine the risk weight of the 
carrying value of any subordinated tranche of any investment.
    (ii) Look-through approaches. A credit union may use one of the 
look-through approaches under Sec.  324.53 of this title to determine 
the risk weight of the exposure amount of investment funds that are not 
in compliance with part 703 of this chapter, the holdings of separate 
account insurance; or part 703 compliant investment funds.
    (4) Risk weights for off-balance sheet activities. The risk 
weighted amounts for all off-balance sheet items are determined by 
multiplying the off-balance sheet exposure amount by the appropriate 
CCF and the assigned risk weight as follows:
    (i) For the outstanding balance of loans transferred to a Federal 
Home Loan Bank under the mortgage partnership finance program, a 20 
percent CCF and a 50 percent risk weight.
    (ii) For other loans transferred with limited recourse, a 100 
percent CCF applied to the off-balance sheet exposure and:
    (A) For commercial loans, a 100 percent risk weight.
    (B) For first-lien residential real estate loans, a 50 percent risk 
weight.
    (C) For junior-lien residential real estate loans, a 100 percent 
risk weight.
    (D) For all secured consumer loans, a 75 percent risk weight.
    (E) For all unsecured consumer loans, a 100 percent risk weight.
    (iii) For unfunded commitments:
    (A) For commercial loans, a 50 percent CCF with a 100 percent risk 
weight.
    (B) For first-lien residential real estate loans, a 10 percent CCF 
with a 50 percent risk weight.
    (C) For junior-lien residential real estate loans, a 10 percent CCF 
with a 100 percent risk weight.
    (D) For all secured consumer loans, a 10 percent CCF with a 75 
percent risk weight.
    (E) For all unsecured consumer loans, a 10 percent CCF with a 100 
percent risk weight.
    (5) Derivative contracts. A complex credit union must assign a 
risk-weighted amount to any derivative contracts as determined under 
Sec.  702.105 of this part.


Sec.  702.105  Derivative contracts.

    (a) OTC interest rate derivative contracts.
    (1) Exposure amount--(i) Single OTC interest rate derivative 
contract. Except as modified by paragraph (a)(2) of this section, the 
exposure amount for a single OTC interest rate derivative contract that 
is not subject to a qualifying master netting agreement is equal to the 
sum of the credit union's current credit exposure and potential future 
credit exposure (PFE) on the OTC interest rate derivative contract.
    (A) Current credit exposure. The current credit exposure for a 
single OTC interest rate derivative contract is the greater of the fair 
value of the OTC interest rate derivative contract or zero.
    (B) PFE. (1) The PFE for a single OTC interest rate derivative 
contract, including an OTC interest rate derivative contract with a 
negative fair value, is calculated by multiplying the notional 
principal amount of the OTC interest rate derivative contract by the 
appropriate conversion factor in Table 1 of this section.
    (2) A credit union must use an OTC interest rate derivative 
contract's effective notional principal amount (that is, the apparent 
or stated notional principal amount multiplied by any multiplier in the 
OTC interest rate derivative contract) rather than the apparent or 
stated notional principal amount in calculating PFE.
---------------------------------------------------------------------------

    \2\ Non-interest rate derivative contracts are addressed in 
paragraph (d) of this section.

  Table 1 to Sec.   702.105--Conversion Factor Matrix for Interest Rate
                        Derivative Contracts \2\
------------------------------------------------------------------------
                                                            Conversion
                   Remaining maturity                         factor
------------------------------------------------------------------------
One year or less........................................            0.00
Greater than one year and less than or equal to five               0.005
 years..................................................
Greater than five years.................................           0.015
------------------------------------------------------------------------

    (ii) Multiple OTC interest rate derivative contracts subject to a 
qualifying master netting agreement. Except as modified by paragraph 
(a)(2) of this section, the exposure amount for multiple OTC interest 
rate derivative contracts subject to a qualifying master netting 
agreement is equal to the sum of the net current credit exposure and 
the adjusted sum of the PFE amounts for all OTC interest rate 
derivative contracts subject to the qualifying master netting 
agreement.
    (A) Net current credit exposure. The net current credit exposure is 
the greater of the net sum of all positive and negative fair value of 
the individual OTC interest rate derivative contracts subject to the 
qualifying master netting agreement or zero.
    (B) Adjusted sum of the PFE amounts (Anet). The adjusted sum of the 
PFE amounts is calculated as Anet = (0.4 x Agross) + (0.6 x NGR x 
Agross), where:
    (1) Agross equals the gross PFE (that is, the sum of the PFE 
amounts as determined under paragraph (a)(1)(i)(B) of this section for 
each individual derivative contract subject to the qualifying master 
netting agreement); and
    (2) Net-to-gross Ratio (NGR) equals the ratio of the net current 
credit exposure to the gross current credit exposure. In calculating 
the NGR, the gross current credit exposure equals the sum of the 
positive current credit exposures (as determined under paragraph 
(a)(1)(i) of this section) of all individual derivative contracts 
subject to the qualifying master netting agreement.
    (3) Recognition of credit risk mitigation of collateralized OTC 
derivative contracts. A credit union may recognize credit risk 
mitigation benefits of financial collateral that secures an OTC 
derivative contract or multiple OTC derivative contracts subject to a 
qualifying master netting agreement (netting set) by following the 
requirements of paragraph (c) of this section.
    (b) Cleared transactions for interest rate derivatives--(1) General 
requirements. A credit union must use

[[Page 4435]]

the methodologies described in paragraph (b) of this section to 
calculate risk-weighted assets for a cleared transaction.
    (2) Risk-weighted assets for cleared transactions. (i) To determine 
the risk weighted asset amount for a cleared transaction, a credit 
union must multiply the trade exposure amount for the cleared 
transaction, calculated in accordance with paragraph (b)(3) of this 
section, by the risk weight appropriate for the cleared transaction, 
determined in accordance with paragraph (b)(4) of this section.
    (ii) A credit union's total risk-weighted assets for cleared 
transactions is the sum of the risk-weighted asset amounts for all its 
cleared transactions.
    (3) Trade exposure amount. For a cleared transaction the trade 
exposure amount equals:
    (i) The exposure amount for the derivative contract or netting set 
of derivative contracts, calculated using the methodology used to 
calculate exposure amount for OTC interest rate derivative contracts 
under paragraph (a) of this section; plus
    (ii) The fair value of the collateral posted by the credit union 
and held by the, clearing member, or custodian.
    (4) Cleared transaction risk weights. A credit union must apply a 
risk weight of:
    (i) Two percent if the collateral posted by the credit union to the 
DCO or clearing member is subject to an arrangement that prevents any 
losses to the credit union due to the joint default or a concurrent 
insolvency, liquidation, or receivership proceeding of the clearing 
member and any other clearing member clients of the clearing member; 
and the clearing member credit union has conducted sufficient legal 
review to conclude with a well-founded basis (and maintains sufficient 
written documentation of that legal review) that in the event of a 
legal challenge (including one resulting from an event of default or 
from liquidation, insolvency, or receivership proceedings) the relevant 
court and administrative authorities would find the arrangements to be 
legal, valid, binding and enforceable under the law of the relevant 
jurisdictions; or
    (ii) Four percent if the requirements of paragraph (b)(4)(i) are 
not met.
    (5) Recognition of credit risk mitigation of collateralized OTC 
derivative contracts. A credit union may recognize the credit risk 
mitigation benefits of financial collateral that secures a cleared 
derivative contract by following the requirements of paragraph (c) of 
this section.
    (c) Recognition of credit risk mitigation of collateralized 
interest rate derivative contracts. (1) A credit union may recognize 
the credit risk mitigation benefits of financial collateral that 
secures an OTC interest rate derivative contract or multiple interest 
rate derivative contracts subject to a qualifying master netting 
agreement (netting set) or clearing arrangement by using the simple 
approach in paragraph (c)(3) of this section.
    (2) As an alternative to the simple approach, a credit union may 
recognize the credit risk mitigation benefits of financial collateral 
that secures such a contract or netting set if the financial collateral 
is marked-to-fair value on a daily basis and subject to a daily margin 
maintenance requirement by applying a risk weight to the exposure as if 
it were uncollateralized and adjusting the exposure amount calculated 
under paragraph (a) or (b) of this section using the collateral 
approach in paragraph (c)(3) of this section. The credit union must 
substitute the exposure amount calculated under paragraphs (b) or (c) 
of this section in the equation in paragraph (c)(3) of this section.
    (3) Collateralized transactions. (i) General. A credit union may 
use the approach in paragraph (c)(3)(ii) of this section to recognize 
the risk-mitigating effects of financial collateral.
    (ii) Simple collateralized derivatives approach. To qualify for the 
simple approach, the financial collateral must meet the following 
requirements:
    (A) The collateral must be subject to a collateral agreement for at 
least the life of the exposure;
    (B) The collateral must be revalued at least every six months; and
    (C) The collateral and the exposure must be denominated in the same 
currency.
    (iii) Risk weight substitution. (A) A credit union may apply a risk 
weight to the portion of an exposure that is secured by the fair value 
of financial collateral (that meets the requirements for the simple 
collateralized approach of this section) based on the risk weight 
assigned to the collateral as established under Sec.  702.104(c).
    (B) A credit union must apply a risk weight to the unsecured 
portion of the exposure based on the risk weight applicable to the 
exposure under this subpart.
    (iv) Exceptions to the 20 percent risk weight floor and other 
requirements. Notwithstanding the simple collateralized derivatives 
approach in paragraph (c)(3)(ii) of this section:
    (A) A credit union may assign a zero percent risk weight to an 
exposure to a derivatives contract that is marked-to-market on a daily 
basis and subject to a daily margin maintenance requirement, to the 
extent the contract is collateralized by cash on deposit.
    (B) A credit union may assign a 10 percent risk weight to an 
exposure to an derivatives contract that is marked-to-market daily and 
subject to a daily margin maintenance requirement, to the extent that 
the contract is collateralized by an exposure that qualifies for a zero 
percent risk weight under Sec.  702.104(c)(2)(i).
    (v) A credit union may assign a zero percent risk weight to the 
collateralized portion of an exposure where:
    (A) The financial collateral is cash on deposit; or
    (B) The financial collateral is an exposure that qualifies for a 
zero percent risk weight under Sec.  702.104(c)(2)(i), and the credit 
union has discounted the fair value of the collateral by 20 percent.
    (4) Collateral haircut approach. (i) A credit union may recognize 
the credit risk mitigation benefits of financial collateral that 
secures a collateralized derivative contract by using the standard 
supervisory haircuts in paragraph (c)(3) of this section.
    (ii) The collateral haircut approach applies to both OTC and 
cleared interest rate derivatives contracts discussed in this section.
    (iii) A credit union must determine the exposure amount for a 
collateralized derivative contracts by setting the exposure amount 
equal to the max{0,[(exposure amount--value of collateral)+(sum of 
current fair value of collateral instruments * market price volatility 
haircut of the collateral instruments)]{time} , where:
    (A) The value of the exposure equals the exposure amount for OTC 
interest rate derivative contracts (or netting set) calculated under 
paragraphs (a)(1)(i) and (ii) of this section.
    (B) The value of the exposure equals the exposure amount for 
cleared interest rate derivative contracts (or netting set) calculated 
under paragraph (b)(3) of this section.
    (C) The value of the collateral is the sum of cash and all 
instruments under the transaction (or netting set).
    (D) The sum of current fair value of collateral instruments as of 
the measurement date.
    (E) A credit union must use the standard supervisory haircuts for 
market price volatility in Table 2 to Sec.  702.105 of this section.

[[Page 4436]]



 Table 2 to Sec.   702.105--Standard Supervisory Market Price Volatility
                                Haircuts
               [based on a 10 business-day holding period]
------------------------------------------------------------------------
                                           Haircut (in percent) assigned
                                                     based on:
                                         -------------------------------
            Residual maturity               Collateral risk weight  (in
                                                     percent)
                                         -------------------------------
                                               Zero          20 or 50
------------------------------------------------------------------------
Less than or equal to 1 year............             0.5             1.0
Greater than 1 year and less than or                 2.0             3.0
 equal to 5 years.......................
Greater than 5 years....................             4.0             6.0
------------------------------------------------------------------------
Cash collateral held....................               Zero
Other exposure types....................               25.0
------------------------------------------------------------------------

    (d) All other derivative contracts and transactions. Credit unions 
must follow the requirements of the applicable provisions of Part 324, 
Title 12, Chapter 3, when assigning risk weights to exposure amounts 
for derivatives contracts not addressed in paragraphs (a) or (b) of 
this section.


Sec.  702.106  Prompt corrective action for adequately capitalized 
credit unions.

    (a) Earnings retention. Beginning on the effective date of 
classification as adequately capitalized or lower, a federally insured 
credit union must increase the dollar amount of its net worth quarterly 
either in the current quarter, or on average over the current and three 
preceding quarters, by an amount equivalent to at least 1/10th percent 
(0.1%) of its total assets (or more by choice), until it is well 
capitalized.
    (b) Decrease in retention. Upon written application received no 
later than 14 days before the quarter end, the NCUA Board, on a case-
by-case basis, may permit a credit union to increase the dollar amount 
of its net worth by an amount that is less than the amount required 
under paragraph (a) of this section, to the extent the NCUA Board 
determines that such lesser amount:
    (1) Is necessary to avoid a significant redemption of shares; and
    (2) Would further the purpose of this part.
    (c) Decrease by FISCU. The NCUA Board shall consult and seek to 
work cooperatively with the appropriate state official before 
permitting a federally insured state-chartered credit union to decrease 
its earnings retention under paragraph (b) of this section.
    (d) Periodic review. A decision under paragraph (b) of this section 
to permit a credit union to decrease its earnings retention is subject 
to quarterly review and revocation except when the credit union is 
operating under an approved net worth restoration plan that provides 
for decreasing its earnings retention as provided under paragraph (b) 
of this section.


Sec.  702.107  Prompt corrective action for undercapitalized credit 
unions.

    (a) Mandatory supervisory actions by credit union. A credit union 
which is undercapitalized must--
    (1) Earnings retention. Increase net worth in accordance with Sec.  
702.106;
    (2) Submit net worth restoration plan. Submit a net worth 
restoration plan pursuant to Sec.  702.111, provided however, that a 
credit union in this category having a net worth ratio of less than 
five percent (5%) which fails to timely submit such a plan, or which 
materially fails to implement an approved plan, is classified 
significantly undercapitalized pursuant to Sec.  702.102(a)(4)(i);
    (3) Restrict increase in assets. Beginning the effective date of 
classification as undercapitalized or lower, not permit the credit 
union's assets to increase beyond its total assets for the preceding 
quarter unless--
    (i) Plan approved. The NCUA Board has approved a net worth 
restoration plan which provides for an increase in total assets and--
    (A) The assets of the credit union are increasing consistent with 
the approved plan; and
    (B) The credit union is implementing steps to increase the net 
worth ratio consistent with the approved plan;
    (ii) Plan not approved. The NCUA Board has not approved a net worth 
restoration plan and total assets of the credit union are increasing 
because of increases since quarter-end in balances of:
    (A) Total accounts receivable and accrued income on loans and 
investments; or
    (B) Total cash and cash equivalents; or
    (C) Total loans outstanding, not to exceed the sum of total assets 
plus the quarter-end balance of unused commitments to lend and unused 
lines of credit provided however that a credit union which increases a 
balance as permitted under paragraphs (a)(3)(ii)(A), (B) or (C) of this 
section cannot offer rates on shares in excess of prevailing rates on 
shares in its relevant market area, and cannot open new branches;
    (4) Restrict member business loans. Beginning the effective date of 
classification as undercapitalized or lower, not increase the total 
dollar amount of member business loans (defined as loans outstanding 
and unused commitments to lend) as of the preceding quarter-end unless 
it is granted an exception under 12 U.S.C. 1757a(b).
    (b) Second tier discretionary supervisory actions by NCUA. Subject 
to the applicable procedures for issuing, reviewing and enforcing 
directives set forth in subpart L of part 747 of this chapter, the NCUA 
Board may, by directive, take one or more of the following actions with 
respect to an undercapitalized credit union having a net worth ratio of 
less than five percent (5%), or a director, officer or employee of such 
a credit union, if it determines that those actions are necessary to 
carry out the purpose of this part:
    (1) Requiring prior approval for acquisitions, branching, new lines 
of business. Prohibit a credit union from, directly or indirectly, 
acquiring any interest in any business entity or financial institution, 
establishing or acquiring any additional branch office, or engaging in 
any new line of business, unless the NCUA Board has approved the credit 
union's net worth restoration plan, the credit union is implementing 
its plan, and the NCUA Board determines that the proposed action is 
consistent with and will further the objectives of that plan;
    (2) Restricting transactions with and ownership of a CUSO. Restrict 
the credit union's transactions with a CUSO, or

[[Page 4437]]

require the credit union to reduce or divest its ownership interest in 
a CUSO;
    (3) Restricting dividends paid. Restrict the dividend rates the 
credit union pays on shares to the prevailing rates paid on comparable 
accounts and maturities in the relevant market area, as determined by 
the NCUA Board, except that dividend rates already declared on shares 
acquired before imposing a restriction under this paragraph may not be 
retroactively restricted;
    (4) Prohibiting or reducing asset growth. Prohibit any growth in 
the credit union's assets or in a category of assets, or require the 
credit union to reduce its assets or a category of assets;
    (5) Alter, reduce or terminate activity. Require the credit union 
or its CUSO to alter, reduce, or terminate any activity which poses 
excessive risk to the credit union;
    (6) Prohibiting nonmember deposits. Prohibit the credit union from 
accepting all or certain nonmember deposits;
    (7) Dismissing director or senior executive officer. Require the 
credit union to dismiss from office any director or senior executive 
officer, provided however, that a dismissal under this clause shall not 
be construed to be a formal administrative action for removal under 12 
U.S.C. 1786(g);
    (8) Employing qualified senior executive officer. Require the 
credit union to employ qualified senior executive officers (who, if the 
NCUA Board so specifies, shall be subject to its approval); and
    (9) Other action to carry out prompt corrective action. Restrict or 
require such other action by the credit union as the NCUA Board 
determines will carry out the purpose of this part better than any of 
the actions prescribed in paragraphs (b)(1) through (8) of this 
section.
    (c) First tier application of discretionary supervisory actions. An 
undercapitalized credit union having a net worth ratio of five percent 
(5%) or more, or which is classified undercapitalized by reason of 
failing to maintain a risk-based capital ratio equal to or greater than 
8 percent under Sec.  702.104, is subject to the discretionary 
supervisory actions in paragraph (b) of this section if it fails to 
comply with any mandatory supervisory action in paragraph (a) of this 
section or fails to timely implement an approved net worth restoration 
plan under Sec.  702.111, including meeting its prescribed steps to 
increase its net worth ratio.


Sec.  702.108  Prompt corrective action for significantly 
undercapitalized credit unions.

    (a) Mandatory supervisory actions by credit union. A credit union 
which is significantly undercapitalized must--
    (1) Earnings retention. Increase net worth in accordance with Sec.  
702.106;
    (2) Submit net worth restoration plan. Submit a net worth 
restoration plan pursuant to Sec.  702.111;
    (3) Restrict increase in assets. Not permit the credit union's 
total assets to increase except as provided in Sec.  702.107(a)(3); and
    (4) Restrict member business loans. Not increase the total dollar 
amount of member business loans (defined as loans outstanding and 
unused commitments to lend) as provided in Sec.  702.107(a)(4).
    (b) Discretionary supervisory actions by NCUA. Subject to the 
applicable procedures for issuing, reviewing and enforcing directives 
set forth in subpart L of part 747 of this chapter, the NCUA Board may, 
by directive, take one or more of the following actions with respect to 
any significantly undercapitalized credit union, or a director, officer 
or employee of such credit union, if it determines that those actions 
are necessary to carry out the purpose of this part:
    (1) Requiring prior approval for acquisitions, branching, new lines 
of business. Prohibit a credit union from, directly or indirectly, 
acquiring any interest in any business entity or financial institution, 
establishing or acquiring any additional branch office, or engaging in 
any new line of business, except as provided in Sec.  702.107(b)(1);
    (2) Restricting transactions with and ownership of CUSO. Restrict 
the credit union's transactions with a CUSO, or require the credit 
union to divest or reduce its ownership interest in a CUSO;
    (3) Restricting dividends paid. Restrict the dividend rates that 
the credit union pays on shares as provided in Sec.  702.107(b)(3);
    (4) Prohibiting or reducing asset growth. Prohibit any growth in 
the credit union's assets or in a category of assets, or require the 
credit union to reduce assets or a category of assets;
    (5) Alter, reduce or terminate activity. Require the credit union 
or its CUSO(s) to alter, reduce, or terminate any activity which poses 
excessive risk to the credit union;
    (6) Prohibiting nonmember deposits. Prohibit the credit union from 
accepting all or certain nonmember deposits;
    (7) New election of directors. Order a new election of the credit 
union's board of directors;
    (8) Dismissing director or senior executive officer. Require the 
credit union to dismiss from office any director or senior executive 
officer, provided however, that a dismissal under this clause shall not 
be construed to be a formal administrative action for removal under 12 
U.S.C. 1786(g);
    (9) Employing qualified senior executive officer. Require the 
credit union to employ qualified senior executive officers (who, if the 
NCUA Board so specifies, shall be subject to its approval);
    (10) Restricting senior executive officers' compensation. Except 
with the prior written approval of the NCUA Board, limit compensation 
to any senior executive officer to that officer's average rate of 
compensation (excluding bonuses and profit sharing) during the four (4) 
calendar quarters preceding the effective date of classification of the 
credit union as significantly undercapitalized, and prohibit payment of 
a bonus or profit share to such officer;
    (11) Other actions to carry out prompt corrective action. Restrict 
or require such other action by the credit union as the NCUA Board 
determines will carry out the purpose of this part better than any of 
the actions prescribed in paragraphs (b)(1) through (10) of this 
section; and
    (12) Requiring merger. Require the credit union to merge with 
another financial institution if one or more grounds exist for placing 
the credit union into conservatorship pursuant to 12 U.S.C. 
1786(h)(1)(F), or into liquidation pursuant to 12 U.S.C. 
1787(a)(3)(A)(i).
    (c) Discretionary conservatorship or liquidation if no prospect of 
becoming adequately capitalized. Notwithstanding any other actions 
required or permitted to be taken under this section, when a credit 
union becomes significantly undercapitalized (including by 
reclassification under Sec.  702.102(b)), the NCUA Board may place the 
credit union into conservatorship pursuant to 12 U.S.C. 1786(h)(1)(F), 
or into liquidation pursuant to 12 U.S.C. 1787(a)(3)(A)(i), provided 
that the credit union has no reasonable prospect of becoming adequately 
capitalized.


Sec.  702.109  Prompt corrective action for critically undercapitalized 
credit unions.

    (a) Mandatory supervisory actions by credit union. A credit union 
which is critically undercapitalized must--
    (1) Earnings retention. Increase net worth in accordance with Sec.  
702.106;
    (2) Submit net worth restoration plan. Submit a net worth 
restoration plan pursuant to Sec.  702.111;

[[Page 4438]]

    (3) Restrict increase in assets. Not permit the credit union's 
total assets to increase except as provided in Sec.  702.107(a)(3); and
    (4) Restrict member business loans. Not increase the total dollar 
amount of member business loans (defined as loans outstanding and 
unused commitments to lend) as provided in Sec.  702.107(a)(4).
    (b) Discretionary supervisory actions by NCUA. Subject to the 
applicable procedures for issuing, reviewing and enforcing directives 
set forth in subpart L of part 747 of this chapter, the NCUA Board may, 
by directive, take one or more of the following actions with respect to 
any critically undercapitalized credit union, or a director, officer or 
employee of such credit union, if it determines that those actions are 
necessary to carry out the purpose of this part:
    (1) Requiring prior approval for acquisitions, branching, new lines 
of business. Prohibit a credit union from, directly or indirectly, 
acquiring any interest in any business entity or financial institution, 
establishing or acquiring any additional branch office, or engaging in 
any new line of business, except as provided by Sec.  702.107(b)(1);
    (2) Restricting transactions with and ownership of CUSO. Restrict 
the credit union's transactions with a CUSO, or require the credit 
union to divest or reduce its ownership interest in a CUSO;
    (3) Restricting dividends paid. Restrict the dividend rates that 
the credit union pays on shares as provided in Sec.  702.107(b)(3);
    (4) Prohibiting or reducing asset growth. Prohibit any growth in 
the credit union's assets or in a category of assets, or require the 
credit union to reduce assets or a category of assets;
    (5) Alter, reduce or terminate activity. Require the credit union 
or its CUSO(s) to alter, reduce, or terminate any activity which poses 
excessive risk to the credit union;
    (6) Prohibiting nonmember deposits. Prohibit the credit union from 
accepting all or certain nonmember deposits;
    (7) New election of directors. Order a new election of the credit 
union's board of directors;
    (8) Dismissing director or senior executive officer. Require the 
credit union to dismiss from office any director or senior executive 
officer, provided however, that a dismissal under this clause shall not 
be construed to be a formal administrative action for removal under 12 
U.S.C. 1786(g);
    (9) Employing qualified senior executive officer. Require the 
credit union to employ qualified senior executive officers (who, if the 
NCUA Board so specifies, shall be subject to its approval);
    (10) Restricting senior executive officers' compensation. Reduce 
or, with the prior written approval of the NCUA Board, limit 
compensation to any senior executive officer to that officer's average 
rate of compensation (excluding bonuses and profit sharing) during the 
four (4) calendar quarters preceding the effective date of 
classification of the credit union as critically undercapitalized, and 
prohibit payment of a bonus or profit share to such officer;
    (11) Restrictions on payments on uninsured secondary capital. 
Beginning 60 days after the effective date of classification of a 
credit union as critically undercapitalized, prohibit payments of 
principal, dividends or interest on the credit union's uninsured 
secondary capital accounts established after August 7, 2000, except 
that unpaid dividends or interest shall continue to accrue under the 
terms of the account to the extent permitted by law;
    (12) Requiring prior approval. Require a critically 
undercapitalized credit union to obtain the NCUA Board's prior written 
approval before doing any of the following:
    (i) Entering into any material transaction not within the scope of 
an approved net worth restoration plan (or approved revised business 
plan under subpart C of this part);
    (ii) Extending credit for transactions deemed highly leveraged by 
the NCUA Board or, if state-chartered, by the appropriate state 
official;
    (iii) Amending the credit union's charter or bylaws, except to the 
extent necessary to comply with any law, regulation, or order;
    (iv) Making any material change in accounting methods; and
    (v) Paying dividends or interest on new share accounts at a rate 
exceeding the prevailing rates of interest on insured deposits in its 
relevant market area;
    (13) Other action to carry out prompt corrective action. Restrict 
or require such other action by the credit union as the NCUA Board 
determines will carry out the purpose of this part better than any of 
the actions prescribed in paragraphs (b)(1) through (12) of this 
section; and
    (14) Requiring merger. Require the credit union to merge with 
another financial institution if one or more grounds exist for placing 
the credit union into conservatorship pursuant to 12 U.S.C. 
1786(h)(1)(F), or into liquidation pursuant to 12 U.S.C. 
1787(a)(3)(A)(i).
    (c) Mandatory conservatorship, liquidation or action in lieu 
thereof--(1) Action within 90 days. Notwithstanding any other actions 
required or permitted to be taken under this section (and regardless of 
a credit union's prospect of becoming adequately capitalized), the NCUA 
Board must, within 90 calendar days after the effective date of 
classification of a credit union as critically undercapitalized--
    (i) Conservatorship. Place the credit union into conservatorship 
pursuant to 12 U.S.C. 1786(h)(1)(G); or
    (ii) Liquidation. Liquidate the credit union pursuant to 12 U.S.C. 
1787(a)(3)(A)(ii); or
    (iii) Other corrective action. Take other corrective action, in 
lieu of conservatorship or liquidation, to better achieve the purpose 
of this part, provided that the NCUA Board documents why such action in 
lieu of conservatorship or liquidation would do so, provided however, 
that other corrective action may consist, in whole or in part, of 
complying with the quarterly timetable of steps and meeting the 
quarterly net worth targets prescribed in an approved net worth 
restoration plan.
    (2) Renewal of other corrective action. A determination by the NCUA 
Board to take other corrective action in lieu of conservatorship or 
liquidation under paragraph (c)(1)(iii) of this section shall expire 
after an effective period ending no later than 180 calendar days after 
the determination is made, and the credit union shall be immediately 
placed into conservatorship or liquidation under paragraphs (c)(1)(i) 
and (ii) of this section, unless the NCUA Board makes a new 
determination under paragraph (c)(1)(iii) of this section before the 
end of the effective period of the prior determination;
    (3) Mandatory liquidation after 18 months--(i) Generally. 
Notwithstanding paragraphs (c)(1) and (2) of this section, the NCUA 
Board must place a credit union into liquidation if it remains 
critically undercapitalized for a full calendar quarter, on a monthly 
average basis, following a period of 18 months from the effective date 
the credit union was first classified critically undercapitalized.
    (ii) Exception. Notwithstanding paragraph (c)(3)(i) of this 
section, the NCUA Board may continue to take other corrective action in 
lieu of liquidation if it certifies that the credit union--
    (A) Has been in substantial compliance with an approved net worth 
restoration plan requiring consistent improvement in net worth since 
the date the net worth restoration plan was approved;

[[Page 4439]]

    (B) Has positive net income or has an upward trend in earnings that 
the NCUA Board projects as sustainable; and
    (C) Is viable and not expected to fail.
    (iii) Review of exception. The NCUA Board shall, at least 
quarterly, review the certification of an exception to liquidation 
under paragraph (c)(3)(ii) of this section and shall either--
    (A) Recertify the credit union if it continues to satisfy the 
criteria of paragraph (c)(3)(ii) of this section; or
    (B) Promptly place the credit union into liquidation, pursuant to 
12 U.S.C. 1787(a)(3)(A)(ii), if it fails to satisfy the criteria of 
paragraph (c)(3)(ii) of this section.
    (4) Nondelegation. The NCUA Board may not delegate its authority 
under paragraph (c) of this section, unless the credit union has less 
than $5,000,000 in total assets. A credit union shall have a right of 
direct appeal to the NCUA Board of any decision made by delegated 
authority under this section within ten (10) calendar days of the date 
of that decision.
    (d) Mandatory liquidation of insolvent federal credit union. In 
lieu of paragraph (c) of this section, a critically undercapitalized 
federal credit union that has a net worth ratio of less than zero 
percent (0%) may be placed into liquidation on grounds of insolvency 
pursuant to 12 U.S.C. 1787(a)(1)(A).


Sec.  702.110  Consultation with state officials on proposed prompt 
corrective action.

    (a) Consultation on proposed conservatorship or liquidation. Before 
placing a federally insured state-chartered credit union into 
conservatorship (pursuant to 12 U.S.C. 1786(h)(1)(F) or (G)) or 
liquidation (pursuant to 12 U.S.C. 1787(a)(3)) as permitted or required 
under subparts A or B of this part to facilitate prompt corrective 
action--
    (1) The NCUA Board shall seek the views of the appropriate state 
official (as defined in Sec.  702.2), and give him or her an 
opportunity to take the proposed action;
    (2) The NCUA Board shall, upon timely request of the appropriate 
state official, promptly provide him or her with a written statement of 
the reasons for the proposed conservatorship or liquidation, and 
reasonable time to respond to that statement; and
    (3) If the appropriate state official makes a timely written 
response that disagrees with the proposed conservatorship or 
liquidation and gives reasons for that disagreement, the NCUA Board 
shall not place the credit union into conservatorship or liquidation 
unless it first considers the views of the appropriate state official 
and determines that--
    (i) The NCUSIF faces a significant risk of loss if the credit union 
is not placed into conservatorship or liquidation; and
    (ii) Conservatorship or liquidation is necessary either to reduce 
the risk of loss, or to reduce the expected loss, to the NCUSIF with 
respect to the credit union.
    (b) Nondelegation. The NCUA Board may not delegate any 
determination under paragraph (a)(3) of this section.
    (c) Consultation on proposed discretionary action. The NCUA Board 
shall consult and seek to work cooperatively with the appropriate state 
official before taking any discretionary supervisory action under 
Sec. Sec.  702.107(b), 702.108(b), 702.109(b), 702.204(b) and 
702.205(b) with respect to a federally insured state-chartered credit 
union; shall provide prompt notice of its decision to the appropriate 
state official; and shall allow the appropriate state official to take 
the proposed action independently or jointly with NCUA.


Sec.  702.111  Net worth restoration plans (NWRP).

    (a) Schedule for filing--(1) Generally. A credit union shall file a 
written net worth restoration plan (NWRP) with the appropriate Regional 
Director and, if state-chartered, the appropriate state official, 
within 45 calendar days of the effective date of classification as 
either undercapitalized, significantly undercapitalized or critically 
undercapitalized, unless the NCUA Board notifies the credit union in 
writing that its NWRP is to be filed within a different period.
    (2) Exception. An otherwise adequately capitalized credit union 
that is reclassified undercapitalized on safety and soundness grounds 
under Sec.  702.102(b) is not required to submit a NWRP solely due to 
the reclassification, unless the NCUA Board notifies the credit union 
that it must submit an NWRP.
    (3) Filing of additional plan. Notwithstanding paragraph (a)(1) of 
this section, a credit union that has already submitted and is 
operating under a NWRP approved under this section is not required to 
submit an additional NWRP due to a change in net worth category 
(including by reclassification under Sec.  702.102(b)), unless the NCUA 
Board notifies the credit union that it must submit a new NWRP. A 
credit union that is notified to submit a new or revised NWRP shall 
file the NWRP in writing with the appropriate Regional Director within 
30 calendar days of receiving such notice, unless the NCUA Board 
notifies the credit union in writing that the NWRP is to be filed 
within a different period.
    (4) Failure to timely file plan. When a credit union fails to 
timely file an NWRP pursuant to this paragraph, the NCUA Board shall 
promptly notify the credit union that it has failed to file an NWRP and 
that it has 15 calendar days from receipt of that notice within which 
to file an NWRP.
    (b) Assistance to small credit unions. Upon timely request by a 
credit union having total assets of less than $10 million (regardless 
how long it has been in operation), the NCUA Board shall provide 
assistance in preparing an NWRP required to be filed under paragraph 
(a) of this section.
    (c) Contents of NWRP. An NWRP must--
    (1) Specify--
    (i) A quarterly timetable of steps the credit union will take to 
increase its net worth ratio, and risk-based capital ratio if 
applicable, so that it becomes adequately capitalized by the end of the 
term of the NWRP, and to remain so for four (4) consecutive calendar 
quarters;
    (ii) The projected amount of net worth increases in each quarter of 
the term of the NWRP as required under Sec.  702.106(a), or as 
permitted under Sec.  702.106(b);
    (iii) How the credit union will comply with the mandatory and any 
discretionary supervisory actions imposed on it by the NCUA Board under 
this subpart;
    (iv) The types and levels of activities in which the credit union 
will engage; and
    (v) If reclassified to a lower category under Sec.  702.102(b), the 
steps the credit union will take to correct the unsafe or unsound 
practice(s) or condition(s);
    (2) Include pro forma financial statements, including any off-
balance sheet items, covering a minimum of the next two years; and
    (3) Contain such other information as the NCUA Board has required.
    (d) Criteria for approval of NWRP. The NCUA Board shall not accept 
a NWRP plan unless it--
    (1) Complies with paragraph (c) of this section;
    (2) Is based on realistic assumptions, and is likely to succeed in 
restoring the credit union's net worth; and
    (3) Would not unreasonably increase the credit union's exposure to 
risk (including credit risk, interest-rate risk, and other types of 
risk).
    (e) Consideration of regulatory capital. To minimize possible long-
term losses to the NCUSIF while the credit union takes steps to become 
adequately capitalized, the NCUA Board shall, in evaluating an NWRP 
under this section,

[[Page 4440]]

consider the type and amount of any form of regulatory capital which 
may become established by NCUA regulation, or authorized by state law 
and recognized by NCUA, which the credit union holds, but which is not 
included in its net worth.
    (f) Review of NWRP--(1) Notice of decision. Within 45 calendar days 
after receiving an NWRP under this part, the NCUA Board shall notify 
the credit union in writing whether the NWRP has been approved, and 
shall provide reasons for its decision in the event of disapproval.
    (2) Delayed decision. If no decision is made within the time 
prescribed in paragraph (f)(1) of this section, the NWRP is deemed 
approved.
    (3) Consultation with state officials. In the case of an NWRP 
submitted by a federally insured state-chartered credit union (whether 
an original, new, additional, revised or amended NWRP), the NCUA Board 
shall, when evaluating the NWRP, seek and consider the views of the 
appropriate state official, and provide prompt notice of its decision 
to the appropriate state official.
    (g) NWRP not approved--(1) Submission of revised NWRP. If an NWRP 
is rejected by the NCUA Board, the credit union shall submit a revised 
NWRP within 30 calendar days of receiving notice of disapproval, unless 
it is notified in writing by the NCUA Board that the revised NWRP is to 
be filed within a different period.
    (2) Notice of decision on revised NWRP. Within 30 calendar days 
after receiving a revised NWRP under paragraph (g)(1) of this section, 
the NCUA Board shall notify the credit union in writing whether the 
revised NWRP is approved. The Board may extend the time within which 
notice of its decision shall be provided.
    (3) Disapproval of reclassified credit union's NWRP. A credit union 
which has been classified significantly undercapitalized shall remain 
so classified pending NCUA Board approval of a new or revised NWRP.
    (4) Submission of multiple unapproved NWRPs. The submission of more 
than two NWRPs that are not approved is considered an unsafe and 
unsound condition and may subject the credit union to administrative 
enforcement actions under section 206 of the FCUA, 12 U.S.C. 1786 and 
1790d.
    (h) Amendment of NWRP. A credit union that is operating under an 
approved NWRP may, after prior written notice to, and approval by the 
NCUA Board, amend its NWRP to reflect a change in circumstance. Pending 
approval of an amended NWRP, the credit union shall implement the NWRP 
as originally approved.
    (i) Publication. An NWRP need not be published to be enforceable 
because publication would be contrary to the public interest.
    (j) Termination of NWRP. For purposes of this part, an NWRP 
terminates once the credit union is classified as adequately 
capitalized and remains so for four consecutive quarters. For example, 
if a credit union with an active NWRP attains the classification as 
adequately classified on December 31, 2015 this would be quarter one 
and the fourth consecutive quarter would end September 30, 2016.


Sec.  702.112  Reserves.

    Each credit union shall establish and maintain such reserves as may 
be required by the FCUA, by state law, by regulation, or in special 
cases by the NCUA Board or appropriate state official.


Sec.  702.113  Full and fair disclosure of financial condition.

    (a) Full and fair disclosure defined. ``Full and fair disclosure'' 
is the level of disclosure which a prudent person would provide to a 
member of a credit union, to NCUA, or, at the discretion of the board 
of directors, to creditors to fairly inform them of the financial 
condition and the results of operations of the credit union.
    (b) Full and fair disclosure implemented. The financial statements 
of a credit union shall provide for full and fair disclosure of all 
assets, liabilities, and members' equity, including such valuation 
(allowance) accounts as may be necessary to present fairly the 
financial condition; and all income and expenses necessary to present 
fairly the statement of income for the reporting period.
    (c) Declaration of officials. The Statement of Financial Condition, 
when presented to members, to creditors or to NCUA, shall contain a 
dual declaration by the treasurer and the chief executive officer, or 
in the latter's absence, by any other officer designated by the board 
of directors of the reporting credit union to make such declaration, 
that the report and related financial statements are true and correct 
to the best of their knowledge and belief and present fairly the 
financial condition and the statement of income for the period covered.
    (d) Charges for loan and lease losses. Full and fair disclosure 
demands that a credit union properly address charges for loan losses as 
follows:
    (1) Charges for loan and lease losses shall be made timely and in 
accordance with GAAP;
    (2) The ALLL must be maintained in accordance with GAAP; and
    (3) At a minimum, adjustments to the ALLL shall be made prior to 
the distribution or posting of any dividend to the accounts of members.


Sec.  702.114  Payment of dividends.

    (a) Restriction on dividends. Dividends shall be available only 
from net worth, net of any special reserves established under Sec.  
702.112, if any.
    (b) Payment of dividends and interest refunds. The board of 
directors must not pay a dividend or interest refund that will cause 
the credit union's capital classification to fall below adequately 
capitalized under this subpart unless the appropriate Regional Director 
and, if state-chartered, the appropriate state official, have given 
prior written approval (in an NWRP or otherwise). The request for 
written approval must include the plan for eliminating any negative 
retained earnings balance.
0
11. Revise subpart B to read as follows:

Subpart B--Alternative Prompt Corrective Action for New Credit Unions
Sec.
702.201 Scope and definition.
702.202 Net worth categories for new credit unions.
702.203 Prompt corrective action for adequately capitalized new 
credit unions.
702.204 Prompt corrective action for moderately capitalized, 
marginally capitalized, or minimally capitalized new credit unions.
702.205 Prompt corrective action for uncapitalized new credit 
unions.
702.206 Revised business plans (RBP) for new credit unions.
702.207 Incentives for new credit unions.
702.208 Reserves.
702.209 Full and fair disclosure of financial condition.
702.210 Payment of dividends.

Subpart B--Alternative Prompt Corrective Action for New Credit 
Unions


Sec.  702.201  Scope and definition.

    (a) Scope. This subpart B applies in lieu of subpart A of this part 
exclusively to credit unions defined in paragraph (b) of this section 
as ``new'' pursuant to section 216(b)(2) of the FCUA, 12 U.S.C. 
1790d(b)(2).
    (b) New credit union defined. A ``new'' credit union for purposes 
of this subpart is a credit union that both has been in operation for 
less than ten (10) years and has total assets of not more than $10 
million. Once a credit union

[[Page 4441]]

reports total assets of more than $10 million on a Call Report, the 
credit union is no longer new, even if its assets subsequently decline 
below $10 million.
    (c) Effect of spin-offs. A credit union formed as the result of a 
``spin-off'' of a group from the field of membership of an existing 
credit union is deemed to be in operation since the effective date of 
the spin-off. A credit union whose total assets decline below $10 
million because a group within its field of membership has been spun-
off is deemed ``new'' if it has been in operation less than 10 years.
    (d) Actions to evade prompt corrective action. If the NCUA Board 
determines that a credit union was formed, or was reduced in asset size 
as a result of a spin-off, or was merged, primarily to qualify as 
``new'' under this subpart, the credit union shall be deemed subject to 
prompt corrective action under subpart A of this part.


Sec.  702.202  Net worth categories for new credit unions.

    (a) Net worth measures. For purposes of this part, a new credit 
union must determine its capital classification quarterly according to 
its net worth ratio.
    (b) Effective date of net worth classification of new credit union. 
For purposes of subpart B of this part, the effective date of a new 
credit union's classification within a capital category in paragraph 
(c) of this section shall be determined as provided in Sec.  
702.101(c); and written notice of a decline in net worth classification 
in paragraph (c) of this section shall be given as required by Sec.  
702.101(c).
    (c) Net worth categories. A credit union defined as ``new'' under 
this section shall be classified--
    (1) Well capitalized if it has a net worth ratio of seven percent 
(7%) or greater;
    (2) Adequately capitalized if it has a net worth ratio of six 
percent (6%) or more but less than seven percent (7%);
    (3) Moderately capitalized if it has a net worth ratio of three and 
one-half percent (3.5%) or more but less than six percent (6%);
    (4) Marginally capitalized if it has a net worth ratio of two 
percent (2%) or more but less than three and one-half percent (3.5%);
    (5) Minimally capitalized if it has a net worth ratio of zero 
percent (0%) or greater but less than two percent (2%); and
    (6) Uncapitalized if it has a net worth ratio of less than zero 
percent (0%).

   Table 1 to Sec.   702.202--Capital Categories for New Credit Unions
------------------------------------------------------------------------
       A new credit union's capital
             classification is               If it's net worth ratio is
------------------------------------------------------------------------
Well Capitalized..........................  7% or above.
Adequately Capitalized....................  6 to 7%.
Moderately Capitalized....................  3.5% to 5.99%.
Marginally Capitalized....................  2% to 3.49%.
Minimally Capitalized.....................  0% to 1.99%.
Uncapitalized.............................  Less than 0%.
------------------------------------------------------------------------

    (d) Reclassification based on supervisory criteria other than net 
worth. Subject to Sec.  702.102(b), the NCUA Board may reclassify a 
well capitalized, adequately capitalized or moderately capitalized new 
credit union to the next lower capital category (each of such actions 
is hereinafter referred to generally as ``reclassification'') in either 
of the circumstances prescribed in Sec.  702.102(b).
    (e) Consultation with state officials. The NCUA Board shall consult 
and seek to work cooperatively with the appropriate state official 
before reclassifying a federally insured state-chartered credit union 
under paragraph (d) of this section, and shall promptly notify the 
appropriate state official of its decision to reclassify.


Sec.  702.203  Prompt corrective action for adequately capitalized new 
credit unions.

    Beginning on the effective date of classification, an adequately 
capitalized new credit union must increase the dollar amount of its net 
worth by the amount reflected in its approved initial or revised 
business plan in accordance with Sec.  702.204(a)(2), or in the absence 
of such a plan, in accordance with Sec.  702.106 until it is well 
capitalized.


Sec.  702.204  Prompt corrective action for moderately capitalized, 
marginally capitalized, or minimally capitalized new credit unions.

    (a) Mandatory supervisory actions by new credit union. Beginning on 
the date of classification as moderately capitalized, marginally 
capitalized or minimally capitalized (including by reclassification 
under Sec.  702.202(d)), a new credit union must--
    (1) Earnings retention. Increase the dollar amount of its net worth 
by the amount reflected in its approved initial or revised business 
plan;
    (2) Submit revised business plan. Submit a revised business plan 
within the time provided by Sec.  702.206 if the credit union either:
    (i) Has not increased its net worth ratio consistent with its then-
present approved business plan;
    (ii) Has no then-present approved business plan; or
    (iii) Has failed to comply with paragraph (a)(3) of this section; 
and
    (3) Restrict member business loans. Not increase the total dollar 
amount of member business loans (defined as loans outstanding and 
unused commitments to lend) as of the preceding quarter-end unless it 
is granted an exception under 12 U.S.C. 1757a(b).
    (b) Discretionary supervisory actions by NCUA. Subject to the 
applicable procedures set forth in subpart L of part 747 of this 
chapter for issuing, reviewing and enforcing directives, the NCUA Board 
may, by directive, take one or more of the actions prescribed in Sec.  
702.109(b) if the credit union's net worth ratio has not increased 
consistent with its then-present business plan, or the credit union has 
failed to undertake any mandatory supervisory action prescribed in 
paragraph (a) of this section.
    (c) Discretionary conservatorship or liquidation. Notwithstanding 
any other actions required or permitted to be taken under this section, 
the NCUA Board may place a new credit union which is moderately 
capitalized, marginally capitalized or minimally capitalized (including 
by reclassification under Sec.  702.202(d)) into conservatorship 
pursuant to 12 U.S.C. 1786(h)(1)(F), or into liquidation pursuant to 12 
U.S.C. 1787(a)(3)(A)(i), provided that the credit union has no 
reasonable prospect of becoming adequately capitalized.


Sec.  702.205  Prompt corrective action for uncapitalized new credit 
unions.

    (a) Mandatory supervisory actions by new credit union. Beginning on 
the effective date of classification as uncapitalized, a new credit 
union must--
    (1) Earnings retention. Increase the dollar amount of its net worth 
by the amount reflected in the credit union's approved initial or 
revised business plan;
    (2) Submit revised business plan. Submit a revised business plan 
within the time provided by Sec.  702.206, providing for alternative 
means of funding the credit union's earnings deficit, if the credit 
union either:
    (i) Has not increased its net worth ratio consistent with its then-
present approved business plan;
    (ii) Has no then-present approved business plan; or
    (iii) Has failed to comply with paragraph (a)(3) of this section; 
and
    (3) Restrict member business loans. Not increase the total dollar 
amount of member business loans as provided in Sec.  702.204(a)(3).

[[Page 4442]]

    (b) Discretionary supervisory actions by NCUA. Subject to the 
procedures set forth in subpart L of part 747 of this chapter for 
issuing, reviewing and enforcing directives, the NCUA Board may, by 
directive, take one or more of the actions prescribed in Sec.  
702.109(b) if the credit union's net worth ratio has not increased 
consistent with its then-present business plan, or the credit union has 
failed to undertake any mandatory supervisory action prescribed in 
paragraph (a) of this section.
    (c) Mandatory liquidation or conservatorship. Notwithstanding any 
other actions required or permitted to be taken under this section, the 
NCUA Board--
    (1) Plan not submitted. May place into liquidation pursuant to 12 
U.S.C. 1787(a)(3)(A)(ii), or conservatorship pursuant to 12 U.S.C. 
1786(h)(1)(F), an uncapitalized new credit union which fails to submit 
a revised business plan within the time provided under paragraph (a)(2) 
of this section; or
    (2) Plan rejected, approved, implemented. Except as provided in 
paragraph (c)(3) of this section, must place into liquidation pursuant 
to 12 U.S.C. 1787(a)(3)(A)(ii), or conservatorship pursuant to 12 
U.S.C. 1786(h)(1)(F), an uncapitalized new credit union that remains 
uncapitalized one hundred twenty (120) calendar days after the later 
of:
    (i) The effective date of classification as uncapitalized; or
    (ii) The last day of the calendar month following expiration of the 
time period provided in the credit union's initial business plan 
(approved at the time its charter was granted) to remain uncapitalized, 
regardless whether a revised business plan was rejected, approved or 
implemented.
    (3) Exception. The NCUA Board may decline to place a new credit 
union into liquidation or conservatorship as provided in paragraph 
(c)(2) of this section if the credit union documents to the NCUA Board 
why it is viable and has a reasonable prospect of becoming adequately 
capitalized.
    (d) Mandatory liquidation of uncapitalized federal credit union. In 
lieu of paragraph (c) of this section, an uncapitalized federal credit 
union may be placed into liquidation on grounds of insolvency pursuant 
to 12 U.S.C. 1787(a)(1)(A).


Sec.  702.206  Revised business plans (RBP) for new credit unions.

    (a) Schedule for filing --(1) Generally. Except as provided in 
paragraph (a)(2) of this section, a new credit union classified 
moderately capitalized or lower must file a written revised business 
plan (RBP) with the appropriate Regional Director and, if state-
chartered, with the appropriate state official, within 30 calendar days 
of either:
    (i) The last of the calendar month following the end of the 
calendar quarter that the credit union's net worth ratio has not 
increased consistent with the-present approved business plan;
    (ii) The effective date of classification as less than adequately 
capitalized if the credit union has no then-present approved business 
plan; or
    (iii) The effective date of classification as less than adequately 
capitalized if the credit union has increased the total amount of 
member business loans in violation of Sec.  702.204(a)(3).
    (2) Exception. The NCUA Board may notify the credit union in 
writing that its RBP is to be filed within a different period or that 
it is not necessary to file an RBP.
    (3) Failure to timely file plan. When a new credit union fails to 
file an RBP as provided under paragraphs (a)(1) or (2) of this section, 
the NCUA Board shall promptly notify the credit union that it has 
failed to file an RBP and that it has 15 calendar days from receipt of 
that notice within which to do so.
    (b) Contents of revised business plan. A new credit union's RBP 
must, at a minimum--
    (1) Address changes, since the new credit union's current business 
plan was approved, in any of the business plan elements required for 
charter approval under chapter 1, section IV.D. of appendix B to part 
701 of this chapter, or for state-chartered credit unions under 
applicable state law;
    (2) Establish a timetable of quarterly targets for net worth during 
each year in which the RBP is in effect so that the credit union 
becomes adequately capitalized by the time it no longer qualifies as 
``new'' per Sec.  702.201;
    (3) Specify the projected amount of earnings of net worth increases 
as provided under Sec.  702.204(a)(1) or Sec.  702.205(a)(1);
    (4) Explain how the new credit union will comply with the mandatory 
and discretionary supervisory actions imposed on it by the NCUA Board 
under this subpart;
    (5) Specify the types and levels of activities in which the new 
credit union will engage;
    (6) In the case of a new credit union reclassified to a lower 
category under Sec.  702.202(d), specify the steps the credit union 
will take to correct the unsafe or unsound condition or practice; and
    (7) Include such other information as the NCUA Board may require.
    (c) Criteria for approval. The NCUA Board shall not approve a new 
credit union's RBP unless it--
    (1) Addresses the items enumerated in paragraph (b) of this 
section;
    (2) Is based on realistic assumptions, and is likely to succeed in 
building the credit union's net worth; and
    (3) Would not unreasonably increase the credit union's exposure to 
risk (including credit risk, interest-rate risk, and other types of 
risk).
    (d) Consideration of regulatory capital. To minimize possible long-
term losses to the NCUSIF while the credit union takes steps to become 
adequately capitalized, the NCUA Board shall, in evaluating an RBP 
under this section, consider the type and amount of any form of 
regulatory capital which may become established by NCUA regulation, or 
authorized by state law and recognized by NCUA, which the credit union 
holds, but which is not included in its net worth.
    (e) Review of revised business plan --(1) Notice of decision. 
Within 30 calendar days after receiving an RBP under this section, the 
NCUA Board shall notify the credit union in writing whether its RBP is 
approved, and shall provide reasons for its decision in the event of 
disapproval. The NCUA Board may extend the time within which notice of 
its decision shall be provided.
    (2) Delayed decision. If no decision is made within the time 
prescribed in paragraph (e)(1) of this section, the RBP is deemed 
approved.
    (3) Consultation with state officials. When evaluating an RBP 
submitted by a federally insured state-chartered new credit union 
(whether an original, new or additional RBP), the NCUA Board shall seek 
and consider the views of the appropriate state official, and provide 
prompt notice of its decision to the appropriate state official.
    (f) Plan not approved --(1) Submission of new revised plan. If an 
RBP is rejected by the NCUA Board, the new credit union shall submit a 
new RBP within 30 calendar days of receiving notice of disapproval of 
its initial RBP, unless it is notified in writing by the NCUA Board 
that the new RBP is to be filed within a different period.
    (2) Notice of decision on revised plan. Within 30 calendar days 
after receiving an RBP under paragraph (f)(1) of this section, the NCUA 
Board shall notify the credit union in writing whether the new RBP is 
approved. The Board may extend the time within which notice of its 
decision shall be provided.
    (3) Submission of multiple unapproved RBPs. The submission of more 
than two RBPs that are not

[[Page 4443]]

approved is considered an unsafe and unsound condition and may subject 
the credit union to administrative enforcement action pursuant to 
section 206 of the FCUA, 12 U.S.C. 1786 and 1790d.
    (g) Amendment of plan. A credit union that has filed an approved 
RBP may, after prior written notice to and approval by the NCUA Board, 
amend it to reflect a change in circumstance. Pending approval of an 
amended RBP, the new credit union shall implement its existing RBP as 
originally approved.
    (h) Publication. An RBP need not be published to be enforceable 
because publication would be contrary to the public interest.


Sec.  702.207  Incentives for new credit unions.

    (a) Assistance in revising business plans. Upon timely request by a 
credit union having total assets of less than $10 million (regardless 
how long it has been in operation), the NCUA Board shall provide 
assistance in preparing a revised business plan required to be filed 
under Sec.  702.206.
    (b) Assistance. Management training and other assistance to new 
credit unions will be provided in accordance with policies approved by 
the NCUA Board.
    (c) Small credit union program. A new credit union is eligible to 
join and receive comprehensive benefits and assistance under NCUA's 
Small Credit Union Program.


Sec.  702.208  Reserves.

    Each new credit union shall establish and maintain such reserves as 
may be required by the FCUA, by state law, by regulation, or in special 
cases by the NCUA Board or appropriate state official.


Sec.  702.209  Full and fair disclosure of financial condition.

    (a) Full and fair disclosure defined. ``Full and fair disclosure'' 
is the level of disclosure which a prudent person would provide to a 
member of a new credit union, to NCUA, or, at the discretion of the 
board of directors, to creditors to fairly inform them of the financial 
condition and the results of operations of the credit union.
    (b) Full and fair disclosure implemented. The financial statements 
of a new credit union shall provide for full and fair disclosure of all 
assets, liabilities, and members' equity, including such valuation 
(allowance) accounts as may be necessary to present fairly the 
financial condition; and all income and expenses necessary to present 
fairly the statement of income for the reporting period.
    (c) Declaration of officials. The Statement of Financial Condition, 
when presented to members, to creditors or to NCUA, shall contain a 
dual declaration by the treasurer and the chief executive officer, or 
in the latter's absence, by any other officer designated by the board 
of directors of the reporting credit union to make such declaration, 
that the report and related financial statements are true and correct 
to the best of their knowledge and belief and present fairly the 
financial condition and the statement of income for the period covered.
    (d) Charges for loan and lease losses. Full and fair disclosure 
demands that a new credit union properly address charges for loan 
losses as follows:
    (1) Charges for loan and lease losses shall be made timely in 
accordance with generally accepted accounting principles (GAAP);
    (2) The ALLL must be maintained in accordance with GAAP; and
    (3) At a minimum, adjustments to the ALLL shall be made prior to 
the distribution or posting of any dividend to the accounts of members.


Sec.  702.210  Payment of dividends.

    (a) Restriction on dividends. Dividends shall be available only 
from net worth, net of any special reserves established under Sec.  
702.208, if any.
    (b) Payment of dividends and interest refunds. The board of 
directors may not pay a dividend or interest refund that will cause the 
credit union's capital classification to fall below adequately 
capitalized under subpart A of this Part unless the appropriate 
regional director and, if state-chartered, the appropriate state 
official, have given prior written approval (in an RBP or otherwise). 
The request for written approval must include the plan for eliminating 
any negative retained earnings balance.

Subpart C--[Removed]

0
12. Remove subpart C.

Subpart E [Redesignated as Subpart C]

0
13. Redesignate subpart E as subpart C and redesignate Sec. Sec.  
702.501 through 702.506 as Sec. Sec.  702.301 through 702.306 
respectively.


Sec.  702.304  Capital planning.

0
14. Amend the newly redesignated Sec.  702.304(b)(4) by replacing the 
citation ``Sec.  702.506(c)'' with ``Sec.  702.306(c)''.


Sec.  702.305  NCUA action on capital plans.

0
15. Amend the newly redesignated Sec.  702.305(b)(4) by replacing the 
citation ``Sec.  702.504'' with ``Sec.  702.304''.


Sec.  702.306  Annual supervisory stress testing.

0
16. Amend the newly redesignated Sec.  702.306(c) by replacing the 
citation ``Sec.  702.504'' with ``Sec.  702.304''.

PART 703--INVESTMENT AND DEPOSIT ACTIVITIES

0
17. The authority citation for part 703 continues to read as follows:

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


Sec.  703.14  [Amended]

0
18. Amend Sec.  703.14 as follows:
0
a. In paragraph (i) remove the words ``net worth classification'' and 
add in their place the words ``capital classification'', and remove the 
words ``or, if subject to a risk-based net worth (RBNW) requirement 
under part 702 of this chapter, has remained `well capitalized' for the 
six (6) immediately preceding quarters after applying the applicable 
RBNW requirement,''.
0
b. In paragraph (j)(4) remove the words ``net worth classification'' 
and add in their place the words ``capital classification'', and remove 
the words ``or, if subject to a risk-based net worth (RBNW) requirement 
under part 702 of this chapter, has remained `well capitalized' for the 
six (6) immediately preceding quarters after applying the applicable 
RBNW requirement,''.

PART 713--FIDELITY BOND AND INSURANCE COVERAGE FOR FEDERAL CREDIT 
UNIONS

0
19. The authority citation for part 713 continues to read as follows:

    Authority: 12 U.S.C. 1761a, 1761b, 1766(a), 1766(h), 
1789(a)(11).
0
20. Amend Sec.  713.6 as follows:
0
a. In paragraph (a)(1), revise the table; and
0
b. In paragraph (c) remove the words ``net worth'' each place they 
appear and add in their place the word ``capital'', and remove the 
words ``or, if subject to a risk-based net worth (RBNW) requirement 
under part 702 of this chapter, has remained `well capitalized' for the 
six (6) immediately preceding quarters after applying the applicable 
RBNW requirement,''.
    The revision reads as follows:


Sec.  713.6  What is the permissible deductible?

    (a)(1) * * *

[[Page 4444]]



------------------------------------------------------------------------
              Assets                         Maximum deductible
------------------------------------------------------------------------
$0 to $100,000....................  No deductible allowed.
$100,001 to $250,000..............  $1,000
$250,000 to $1,000,000............  $2,000
Over $1,000,000...................  $2,000 plus 1/1000 of total assets
                                     up to a maximum of $200,000; for
                                     credit unions that have received a
                                     composite CAMEL rating of ``1'' or
                                     ``2'' for the last two (2) full
                                     examinations and maintained a
                                     capital classification of ``well
                                     capitalized'' under part 702 of
                                     this chapter for the six (6)
                                     immediately preceding quarters the
                                     maximum deductible is $1,000,000.
------------------------------------------------------------------------

* * * * *

PART 723--MEMBER BUSINESS LOANS

0
21. The authority citation for part 723 continues to read as follows:

    Authority: 12 U.S.C. 1756, 1757, 1757A, 1766, 1785, 1789.


Sec.  723.7  [Amended]

0
22. In Sec.  723.7 amend paragraph (c)(1) by removing the words ``as 
defined by Sec.  702.102(a)(1)'' and adding in their place the words 
``under part 702''.

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

0
23. The authority citation for part 747 continues to read as follows:

    Authority: 12 U.S.C. 1766, 1782, 1784, 1785, 1786, 1787, 1790a, 
1790d; 42 U.S.C. 4012a; Pub. L. 101-410; Pub. L. 104-134; Pub. L. 
109-351; 120 Stat. 1966.


Sec.  747.2001  [Amended]

0
24. In Sec.  747.2001, amend paragraph (a) by removing the citation 
``702.302(d)'' and adding in its place the citation ``702.202(d)''.


Sec.  747.2002  [Amended]

0
25. In Sec.  747.2002, amend paragraph (a)(1) by removing the words 
``Sec. Sec.  702.202(b), 702.203(b) and 702.204(b)'' and adding in 
their place the words ``Sec. Sec.  702.107 (b), 702.108(b) or 
702.109(b)'', and by removing the words ``Sec. Sec.  702.304(b), or 
702.305(b)'' and adding in their place the words ``Sec. Sec.  
702.204(b) or 702.205(b)''.


Sec.  747.2003  [Amended]

0
26. In Sec.  747.2003, amend paragraph (a) by removing the citation 
``702.302(d)'' and adding in its place the citation ``702.202(d)''.

[FR Doc. 2015-00947 Filed 1-26-15; 8:45 am]
BILLING CODE 7535-01-P