[Federal Register Volume 80, Number 209 (Thursday, October 29, 2015)]
[Rules and Regulations]
[Pages 66626-66723]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2015-26790]



[[Page 66625]]

Vol. 80

Thursday,

No. 209

October 29, 2015

Part II





National Credit Union Administration





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





12 CFR Parts 700, 701, 702, 703, et al.





Risk-Based Capital; Final Rule

  Federal Register / Vol. 80 , No. 209 / Thursday, October 29, 2015 / 
Rules and Regulations  

[[Page 66626]]


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

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: Final rule.

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

SUMMARY: The NCUA Board (Board) is amending NCUA's current regulations 
regarding prompt corrective action (PCA) to require that credit unions 
taking certain risks hold capital commensurate with those risks. The 
risk-based capital provisions of this final rule apply only to 
federally insured, natural-person credit unions with assets over $100 
million.
    The overarching intent is to reduce the likelihood of a relatively 
small number of high-risk outliers exhausting their capital and causing 
systemic losses--which, by law, all federally insured credit unions 
would have to pay through the National Credit Union Share Insurance 
Fund (NCUSIF).
    This final rule restructures NCUA's PCA regulations and makes 
various revisions, including amending the agency's current risk-based 
net worth requirement by replacing it with a new risk-based capital 
ratio for federally insured, natural-person credit unions (credit 
unions).
    The risk-based capital requirement set forth in this final rule is 
more consistent with NCUA's risk-based capital measure for corporate 
credit unions and, as the law requires, more comparable to the 
regulatory risk-based capital measures used by the Federal Deposit 
Insurance Corporation (FDIC), Board of Governors of the Federal Reserve 
System, and Office of the Comptroller of Currency (Other Banking 
Agencies). The effective date is intended to coincide with the full 
phase-in of FDIC's risk-based capital measures in 2019.
    The final rule also eliminates several provisions in NCUA's current 
PCA regulations, including provisions relating to the regular reserve 
account, risk-mitigation credits, and alternative risk weights.

DATES: This final rule is effective on January 1, 2019.

FOR FURTHER INFORMATION CONTACT: Policy and Accounting: 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; John Shook, Loss/Risk 
Analyst, Division of Risk Management, Office of Examination and 
Insurance, at (703) 518-3799; Steven Farrar, Supervisory Financial 
Analyst, Division of Capital and Credit Markets, Office of Examination 
and Insurance, at (703) 518-6393; 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; Aaron Langley, 
Risk Management Officer, Division of Analytics and Surveillance; Office 
of Examination and Insurance, at (703) 518-6360; or Legal: John H. 
Brolin or Justin Anderson, Senior Staff Attorneys, Office of General 
Counsel, at (703) 518-6540; or by mail at National Credit Union 
Administration, 1775 Duke Street, Alexandria, VA 22314.

SUPPLEMENTARY INFORMATION: 
I. Background
II. Summary of the Final Rule
III. Legal Authority
IV. Section-by-Section Analysis
V. Effective Date
VI. Impact of This Final Rule
VII. Regulatory Procedures

I. Background

    NCUA's primary mission is to ensure the safety and soundness of 
federally insured credit unions. NCUA performs this function by 
examining and supervising federally chartered 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 all federally insured credit 
unions.\1\ In its role as the administrator of the NCUSIF, NCUA insures 
and regulates approximately 6,270 federally insured credit unions, 
holding total assets exceeding $1.1 trillion and representing 
approximately 99 million members.
---------------------------------------------------------------------------

    \1\ Within the nine states that allow privately insured credit 
unions, approximately 129 state-chartered credit unions are 
privately insured and are not subject to NCUA regulation or 
oversight.
---------------------------------------------------------------------------

    At its January 2014 meeting, the Board issued a proposed rule (the 
Original Proposal) \2\ to amend NCUA's PCA regulations, part 702. The 
proposed amendments were intended to implement the statutory 
requirements of the Federal Credit Union Act (FCUA) and follow 
recommendations made by the Government Accountability Office (GAO) and 
NCUA's Inspector General. The proposal was also intended to amend 
NCUA's risk-based capital regulations to be more consistent with NCUA's 
risk-based capital measure for corporate credit unions and comparable 
to the new regulatory risk-based capital regulations finalized by the 
Other Banking Agencies in 2013.\3\ In response to the Original 
Proposal, the Board received over 2,000 comments with many suggestions 
on how to improve the proposed regulation. The comments received 
addressed a wide range of issues. In general, however, the commenters 
nearly all agreed that, because the proposal assigned higher risk 
weights to some credit union asset classes, it would have placed credit 
unions at a competitive disadvantage to banks. The change most 
frequently recommended by commenters to address this concern was to 
adopt the same risk weights as the Other Banking Agencies. The Board 
generally agreed and, after reviewing all of the comments received, 
determined that it was appropriate to issue a second proposed rule.
---------------------------------------------------------------------------

    \2\ 79 FR 11183 (Feb. 27, 2014).
    \3\ The Office of the Comptroller of Currency, and the Board of 
Governors of the Federal Reserve System: 78 FR 62017 (Oct. 11, 
2013); and the Federal Deposit Insurance Corporation: 78 FR 55339 
(Sept. 10, 2013).
---------------------------------------------------------------------------

    So, at its January 2015 meeting, the Board issued a second proposed 
rule (the Second Proposal) \4\ to amend NCUA's PCA regulations, part 
702. The Second Proposal, which was based largely on the comments NCUA 
received on the Original Proposal, addressed the competitive 
disadvantage concerns raised by commenters and made the proposal more 
comparable to the Other Banking Agencies' risk-based capital 
requirements. Particular changes from the Original Proposal included: 
(1) Amending the definition of ``complex'' credit union, resulting in 
an increase in 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 member business loans); (3) assigning the same risk weights to one-
to-four family non-owner-occupied residential real estate loans and 
other types of residential real estate loans; (4) eliminating 
provisions intended to address interest rate risk (IRR); (5) 
eliminating the proposed individual minimum capital requirement; and 
(6) extending the effective date to January 1, 2019. These changes 
would have, among other things, substantially reduced the number of 
credit unions subject to the rule, and would have provided credit 
unions significantly

[[Page 66627]]

more time to prepare to implement the rule's requirements.
---------------------------------------------------------------------------

    \4\ 80 FR 4339 (Jan. 27, 2015).
---------------------------------------------------------------------------

Summary of Public Comments on the Second Proposal

    In response to the Second Proposal, the Board received over 2,100 
comments. While the total number of comment letters received was higher 
than the number received in response to the Original Proposal, the 
comment letters responding to the Second Proposal were significantly 
shorter and raised fewer distinct concerns regarding the rule's 
provisions. In addition, significantly fewer credit unions sent in 
comment letters in response to the Second Proposal. In response to the 
Original Proposal, NCUA received comment letters from more than 1,100 
different credit unions, while only 514 different credit unions sent in 
comment letters in response to the Second Proposal. In addition, more 
than 900 of the comment letters received in response to the Second 
Proposal provided no substantive input on the rule. Nearly all of these 
non-substantive letters simply stated that the commenter believed 
Congress should ``approve'' the rule, or that the commenter wanted to 
``vote no'' on the rule.
    A majority of significant comment letters received stated that the 
commenter opposed the proposal in its entirety and suggested that the 
Second Proposal be withdrawn. Most of these commenters stated they 
opposed the rule for one or more of the following reasons: A 
substantial number of commenters suggested that the strong performance 
of credit unions and the NCUSIF during and after the 2007-2009 
financial crisis demonstrated there was no need for the proposal, and 
that the Board provided no evidence that the proposal would have 
reduced material losses to the NCUSIF if it had been in place before 
the financial crisis. Other commenters maintained that the proposal was 
unnecessary given how extremely well capitalized the industry is today. 
Commenters contended further that, given NCUA's own estimates that 
fewer than 30 credit unions would be less than well capitalized under 
the proposed risk-based capital ratio if it went into effect 
immediately, NCUA's current risk-based capital regulations and other 
supervisory tools seem to be doing an adequate job. Several commenters 
claimed that most credit union failures, including the corporate credit 
unions (Corporates), and significant losses to the NCUSIF were the 
result of high concentration levels in risky loans and investments, or 
were otherwise related to a lack of internal controls that should have 
been identified through the examination process. Commenters suggested 
that, instead of updating NCUA's risk-based capital regulations, the 
Board should focus on enhanced training to improve examiner skills. A 
substantial number of commenters also claimed that the proposal would 
regulate credit unions in the same general manner as banks. They argued 
credit unions should be regulated differently than banks because they 
are structured and operate differently. Other commenters argued the 
proposed rule would place credit unions at a competitive disadvantage 
to banks, because in these commenters' opinion, the proposed rule would 
require credit unions to hold incrementally more capital than banks 
given similar levels of asset concentration. At least one commenter 
suggested that the proposal would drive the largest credit unions to 
convert to bank charters. Other commenters argued that risk-based 
capital requirements, to which banks have been subject for 
approximately 25 years, have not worked well. In addition, they argued 
that bank regulators are now moving away from risk-based capital 
structures after they failed to help banks during the 2007-2009 
recession. In support of this argument, many commenters cited a 
statement in which one FDIC Board Member, the FDIC's Vice Chairman, 
stated publicly that he believed the risk-based capital approach to 
regulation was a bad idea. A substantial number of commenters expressed 
concern that the proposal would stifle growth, innovation, 
diversification, and member services within credit unions by 
restricting credit unions' use of capital, and would impose excessive 
costs on credit unions and their members. At least one commenter 
suggested that the proposal would likely cause more risk, not less 
risk, to the system as a whole because the lower risk weightings 
assigned in some asset classes compared to others would force credit 
unions to take on excessive concentrations of lower risk-weighted 
assets. This, the commenter argued, would increase concentration risk 
compared to a diverse balance sheet.
    Other commenters expressed concern that the proposal would be 
detrimental to the interests of many credit union members because 
credit unions would have to charge their members higher interest rates 
and fees and pay lower interest on deposits to raise the additional 
capital required under the proposal. A significant number of commenters 
maintained that the benefits of the proposal did not outweigh its costs 
to the credit union industry.
    A significant number of commenters opposing the rule also argued 
that the Board failed to adequately justify the proposed changes to 
NCUA's current risk-based net worth requirement. At least one commenter 
suggested that the Board should not base its justification for the 
risk-based capital regulation on global financial trends. Other 
commenters claimed that the historical loss data and other information 
provided by NCUA in the proposed rule did not support establishing a 
higher capital standard for credit unions than banks. Some commenters 
disagreed with the Board's statutory justification for NCUA to maintain 
comparability with the capital rules of FDIC, and argued that the Board 
overemphasized the need for the regulation to be comparable to the 
other banking agency regulations. Commenters acknowledged that 
comparability is commendable where there are truly comparable 
institutions. Commenters suggested, however, that the fundamental 
structure of credit unions as not-for profit financial cooperatives is 
not comparable with the for-profit banking system. Commenters suggested 
further that member-owned credit unions generally have a different risk 
model than the profit-oriented banks, so if anything credit unions 
should have lower risk-based capital requirements than banks. Those 
commenters argued that the narrative accompanying the Second Proposal 
did not indicate sufficient research and analysis into the differences 
between banks and credit unions had been done or, if it had, that it 
was not presented in a transparent manner that adequately justified the 
structure of the proposal.
    A substantial number of commenters pointed out that, of the 1,400 
credit unions with more than $100 million in assets, only 27 would have 
a risk-based capital ratio below the 10 percent level proposed for a 
credit union to be well capitalized. Commenters contended that, based 
on these numbers, the current rule and other supervisory tools already 
at NCUA's disposal were already doing an adequate job. Other commenters 
argued that only 112 credit unions failed during the 2007-2009 
recession, costing the insurance fund less than $1 billion, which they 
suggested was remarkable considering the dollars and number of 
commercial banks that failed. Of the natural-person credit unions that 
did fail during the crisis, the commenters acknowledged that most were 
under the $100 million asset size threshold proposed. Commenters 
contended that, from 1998

[[Page 66628]]

to 2012, the NCUSIF fund losses were only $989 million; $513 million 
came from 7 credit unions in the $200 million to $500 million asset 
range, and $343 million came from credit unions under $100 million that 
would not have been covered under the Second Proposal. At least one 
commenter claimed that its analysis of the 26 credit unions with more 
than $80 million in assets just before the crisis (as of December 2007) 
that subsequently failed revealed that only seven would have had a 
lower capital classification under Second Proposal. The commenter 
suggested that six of the 21 well-capitalized credit unions under 
current rules would have been downgraded--four to adequately 
capitalized and two to undercapitalized--and that one adequately 
capitalized credit union under the current rules would have been 
classified as undercapitalized under the proposal. In other words, the 
commenter maintained, of the 26 failures, a total of three credit 
unions would have been demoted to undercapitalized if the Second 
Proposal had been in effect before the crisis. And the amount of 
capital they would have been required to obtain to become adequately 
capitalized was only $7 million, as compared to the insurance loss of 
over $700 million. The commenter claimed that the amount of capital 
that would have been necessary for all seven downgraded credit unions 
to regain their previous capital classifications (six to well-
capitalized, one to adequately-capitalized) would have totaled $43 
million.
    While most commenters did oppose finalizing the proposal, a 
substantial number of the commenters who opposed the rule acknowledged 
that the Board, in response to comments received on the Original 
Proposal, had made significant improvements to Second Proposal. 
Specific improvements mentioned included: The removal of the IRR 
provisions; the new zero percent risk weight assigned to cash held at 
the Federal Reserve; the reduction of the concentration thresholds from 
three to two tiers for residential mortgages, junior liens, and 
commercial loans; the removal of the 1.25 percent cap on allowance for 
loan and lease losses (ALLL); the lower 10 percent risk-based capital 
ratio threshold level required for credit unions to be classified as 
well capitalized; the removal of the enumerated processes to require 
that individual credit unions hold higher levels of capital under 
certain circumstances; the increase in the asset size threshold for 
defining credit unions as ``complex''; the extended implementation 
period; the lower risk-weights assigned to many categories of assets; 
and the designation of one-to-four family non-owner occupied mortgage 
loans as residential loans.
    A small number of commenters stated that they supported the Second 
Proposal. These commenters generally agreed that the credit union 
system should have risk-based capital requirements that protect the 
Share Insurance Fund and other well run credit unions by requiring that 
credit unions with more complex balance sheets hold modestly more 
capital. Several commenters supported the proposal because they felt 
that the Board had listened to commenters following the Original 
Proposal and had made substantial improvements to the Second Proposal. 
Several commenters supported the proposal for various other reasons: 
One financial services consulting firm suggested that, overall, the 
proposal presented a fair alternative to the risk-based capital 
requirements applicable to banks. At least one state supervisory 
authority suggested that, on the whole, the proposal was sound and 
substantially better than NCUA's current risk-based capital rule. One 
credit union commenter stated that it supported the proposal because 
insured credit unions, which together hold assets of $1.1 trillion, are 
backed by the full faith and credit of the United States. And if 
insured credit unions engaging in high-risk lending fail in significant 
enough numbers, then the taxpayer is left holding the bill. One 
individual stated that he supported the proposal because, in his 
opinion, it would lower the number of loans credit unions could make by 
imposing higher risk weights on loans made to higher-risk persons. 
Another individual supported the proposal because he believed it would 
lower rates for consumers who utilize credit unions. Yet another 
individual suggested that he supported the proposal because credit 
unions should be given the same scrutiny as other major lenders and not 
be given a free pass because they have good intentions as non-profits. 
The commenter suggested further that credit unions should be subject to 
tough and robust regulations such as the proposed risk-based capital 
rule.
    In addition to the comments on the Second Proposal discussed above, 
NCUA received the following general comments: At least one commenter 
agreed that NCUA's current risk-based net worth regulation is outdated 
and does not accurately reflect the level of risk in individual credit 
unions, but criticized that the statutory net worth ratio level is 
fixed at 7 percent. The commenter suggested that if the 7 percent net 
worth ratio level is inadequate, the Board should convince Congress to 
arrive at an appropriate net worth level rather than address risks 
through revisions to NCUA's risk-based capital regulations. Another 
commenter recommended that a risk-based capital requirement be 
developed to replace the statutory net worth ratio, instead of imposing 
a risk-based capital requirement in addition to the statutory net worth 
ratio requirement. The commenter argued that managing two different 
capital limits would place an unnecessary burden on credit unions and 
serve as an additional competitive disadvantage to the credit union 
charter. A significant number of commenters suggested that the proposed 
rule went too far in treating credit unions like banks, and that if 
credit unions are regulated and supervised as banks they will be forced 
to act more like banks, which would be to the detriment of their 
members. At least one state supervisory authority agreed with using a 
Basel III style capital model, but remained concerned that notable 
differences continued to exist between NCUA's proposed model and the 
one employed by FDIC and other federal bank regulators. In particular, 
the commenter suggested that the differences between the risk 
weightings for a number of the proposed asset categories represented a 
missed opportunity to reduce public confusion, and might actually 
increase confusion. The commenter explained that public users of 
government-provided Call Report data could assume that NCUA's risk-
based capital ratio is the same as other institutions' measurements of 
capital using the same terminology, but, under the Second Proposal, the 
ratios could be materially different for banks and credit unions. A 
bank trade association recommended the Board adopt the same Basel III 
model adopted by the Other Banking Agencies because without comparable 
capital requirements, credit unions will be undercapitalized relative 
to community banks, and such undercapitalization, along with credit 
unions' limited access to alternative forms of capital when needed, 
could increase the bailout risk faced by the American taxpayer. The 
commenter suggested that because credit unions are not required to pay 
federal income taxes on earnings and can retain a larger percentage of 
their earnings than community banks, they should have little or no 
difficulty in maintaining very high levels of Tier 1 capital. The 
commenter also suggested

[[Page 66629]]

that the Board impose a capital surcharge of 5 percent on credit unions 
when they exceed total consolidated assets of $10 billion because large 
credit unions, with their limited ability to react to depleted capital 
levels in times of economic uncertainty, should be subjected to 
increased scrutiny and additional capital reserves. Other commenters 
suggested that, before issuing a proposed rule, NCUA test regulatory 
approaches of the type included in the Second Proposal through the 
examination process and share the results with the industry. Some 
commenters suggested that the rule does not take into account that the 
vast majority of credit unions already have written policies to deal 
with balance sheet risk. At least one commenter suggested that the rule 
would not protect credit unions or NCUA in the event of another crisis 
that requires natural-person credit unions to pay out huge assessments. 
A few commenters recommended that the proposed risk-based capital ratio 
measure should be used as a modeling tool rather than a rigid rule, 
similar to interest rate risk monitoring tools. The commenters 
suggested that this would allow credit union risk to be calculated as a 
model by examiners using risk weights appropriate for each credit 
union's environment, and discuss with boards and management their views 
of risk for various asset classes. A model, the commenters suggested, 
would be far more flexible than a rule, and would allow for the 
pragmatic management of risk rather than through rule-based estimates 
of risk, which may or may not be accurate. Finally, one credit union 
supported making the risk-based capital framework as complicated as it 
needs to be to more accurately reflect the unique needs and structure 
of the credit union industry. The commenter suggested that the Board, 
for example, took a step in that direction in the Second Proposal when 
it created a risk-weight category for ``commercial loans'' as distinct 
from traditional member business loans for purposes of the risk-based 
capital ratio measure.

Discussion

    Commenters calling for a withdrawal of the proposed rule altogether 
are ignoring NCUA's general statutory requirement to maintain a risk-
based system comparable to the Other Banking Agencies' requirements.\5\ 
In 2013, the Other Banking Agencies issued final rules updating the 
risk-based capital regulations for insured banks.\6\ The changes to the 
Other Banking Agencies' risk-based capital regulations, the lessons 
learned from the 2007-2009 recession, and the fact that NCUA's current 
risk-based net worth requirement is ineffective and has not been 
materially updated since 2002, prompted the Board to propose revisions 
to NCUA's current risk-based net worth ratio requirement and other 
aspects of NCUA's current PCA regulations. The proposed changes were 
also prompted by specific recommendations to NCUA made by GAO in its 
January 2012 review of NCUA's system of PCA. In particular, GAO 
recommended that NCUA design a more forward-looking system to detect 
problems earlier.\7\
---------------------------------------------------------------------------

    \5\ See 12 U.S.C. 1790d(b)(1)(A)(ii), which requires that the 
NCUA's system of PCA be ``comparable'' to the PCA requirements in 
section 1831o of the Federal Deposit Insurance Act.
    \6\ 78 FR 55339 (Sept. 10, 2013) (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 FDIC's 
IFR.).
    \7\ 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 Second Proposal addressed the important role and benefits of 
capital. The proposal discussed the impact of a financial crisis and 
the benefit a higher level of capital provided to insulate certain 
financial institutions from the effects of unexpected adverse 
developments in assets and liabilities. Higher levels of capital can 
reduce the probability of a systemic crisis, allow credit unions to 
continue to serve as credit providers during times of stress without 
government intervention, and produce benefits that outweigh the 
associated costs. The proposal also emphasized that credit unions' 
senior management and boards are accountable for ensuring that 
appropriate capital levels are in place based on the credit union's 
risk exposure.
    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 2007-2009 
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.\8\ 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.\9\ 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.
---------------------------------------------------------------------------

    \8\ 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.
    \9\ 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.
---------------------------------------------------------------------------

    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.\10\ The cited figures are just 
the

[[Page 66630]]

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 2007-2009 
financial crisis is roughly $10 trillion (2014 dollars).\11\ 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.\12\
---------------------------------------------------------------------------

    \10\ 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.
    \11\ 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.
    \12\ 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 effects of unexpected adverse developments in their asset 
portfolio or their deposit liabilities.\13\ 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.\14\ 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.\15\ 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).\16\
---------------------------------------------------------------------------

    \13\ 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.
    \14\ Id.
    \15\ Id.
    \16\ 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.\17\ 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.\18\ 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 \19\ to risks 
assets ratio would be on the order of 0.1 percent.\20\ 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.
---------------------------------------------------------------------------

    \17\ 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.
    \18\ 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).
    \19\ 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.
    \20\ 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 2007-2009 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.\21\
---------------------------------------------------------------------------

    \21\ For a readable overview of the 2007-2009 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.
---------------------------------------------------------------------------

    Credit unions also experienced elevated losses and the need for 
government intervention. From 2008 through 2012, five corporate credit 
unions failed. Had NCUA not intervened in 2009 and 2010 by providing 
over $20 billion in liquidity assistance, over $100 billion in 
guarantees, and borrowing over $5 billion from the U.S. Treasury, the 
resulting losses to consumer credit unions on their uninsured funds 
invested at these institutions would have exceeded $30 billion. NCUA 
estimates as many as 2,500 consumer credit unions would have failed at 
additional cost to the Share Insurance Fund.
    In addition, during that same period, 27 consumer credit unions 
with assets greater than $50 million failed at a cost of $728 million 
to the NCUSIF.\22\ NCUA performed back-testing of the 9 complex credit 
unions (those with over $100 million in assets) that failed during this 
period to determine whether this final rule would have resulted in 
earlier identification of emerging risks and reduced losses to the 
NCUSIF. The back-testing revealed that maintaining a risk-based capital 
ratio in excess of 10 percent would have required 8 of the 9 complex 
credit unions that failed to hold additional capital.
---------------------------------------------------------------------------

    \22\ 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.
---------------------------------------------------------------------------

    The failure of the 27 consumer credit unions was 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.\23\ Although the credit union officials were 
provided with notice of the capital deficiencies, they ignored the 
supervisory concerns

[[Page 66631]]

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.
---------------------------------------------------------------------------

    \23\ 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).
---------------------------------------------------------------------------

    From 2008 to 2012, over a dozen very large consumer credit unions, 
and numerous smaller ones, also were in danger of failing and required 
extensive NCUA intervention, financial assistance, or both, along with 
increased reserve levels for the NCUSIF.\24\ NCUA estimates these 
actions saved the NCUSIF over $1 billion in losses.
---------------------------------------------------------------------------

    \24\ As most of these credit unions are still active 
institutions, or have merged into other active institutions, NCUA 
cannot provide additional details publicly.
---------------------------------------------------------------------------

    The clear implication from the impact of the 2007-2009 recession on 
the credit unions noted above 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.
    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.\25\ 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.
---------------------------------------------------------------------------

    \25\ 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 2007-
2009 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
                                    ----------------------------------------------------------------------------
     Net worth ratio in 2006Q4                                                                         Number of
                                        <6%        6-7%       7-8%      8-10%      >=10%      Total      credit
                                                                                                         unions
----------------------------------------------------------------------------------------------------------------
<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 2007-2009 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.

                      Characteristics of FICUs With Assets >$100 Million at the End of 2006 by Five Year Survival Beginning 2007Q4
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                              Median
                                                                         -------------------------------------------------------------------------------
                                                             Number of                                                                        Member
                                                           institutions                      Net worth     Loan to asset    Real estate    business loan
                                                                            Assets ($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.

[[Page 66632]]

    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.\26\ 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.
---------------------------------------------------------------------------

    \26\ 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.
BILLING CODE 7535-01-P
[GRAPHIC] [TIFF OMITTED] TR29OC15.000


[[Page 66633]]


[GRAPHIC] [TIFF OMITTED] TR29OC15.001

BILLING CODE 7535-01-C
    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, 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.\27\ 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.
---------------------------------------------------------------------------

    \27\ 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.
---------------------------------------------------------------------------

    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.

[[Page 66634]]

    This final rule replaces the current method for calculating a 
credit union's risk-based net worth ratio with a new method for 
calculating a credit union's risk-based capital ratio. Under the 
current risk-based net worth ratio measure, a lower ratio is reflective 
of financial strength. So the current measure is not intuitive, and, 
more importantly, can't be compared against the risk-based capital 
measures of other financial institutions. The new risk-based capital 
ratio, however, is more commonly applied to depository institutions 
worldwide. Generally, the new risk-based capital ratio is the 
percentage of equity and accounts available to cover losses divided by 
risk-weighted assets. Under this approach, a higher risk-based capital 
ratio is an indicator of financial strength.
    The new risk-based capital ratio adopted in this final rule is 
designed to complement the statutory net worth ratio, which is often 
referred to as the leverage ratio. The net worth ratio is a measure of 
statutorily defined capital divided by total assets. The net worth 
ratio does not assign relative risk weights among asset classes, making 
it more difficult to manipulate and provides a simple picture of a 
financial institution's ability to absorb losses, regardless of the 
source of the loss. The new risk-based capital ratio, on the other 
hand, is a measure of loss absorption ability to assets weighted based 
on the associated risk, and is intended to be more forward looking and 
reactive to changes in the risk profile of a credit union. In general, 
a risk-based capital requirement increases capital requirements at 
those institutions with asset portfolios that are, on average, higher 
risk. Conversely, risk-based capital standards generally decrease 
capital requirements at institutions with lower risk profiles. 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.
    Many commenters suggested that the Board withdraw the Second 
Proposal and retain the existing risk-based capital requirement and the 
related risk-weights, which are based largely on interest rate risk and 
liquidity risk. Ironically, most of the commenters objected to the 
Original Proposal because it included IRR and liquidity risk in the 
proposed risk weights. As discussed in the Original Proposal, since its 
implementation, the current risk-based net worth requirement has 
required less than a handful of credit unions to hold higher levels of 
capital than required by the net worth ratio. Under the current risk-
based net worth requirement, those credit unions that invest in longer-
term, low-credit risk investments experience a higher risk-based net 
worth requirement and thus have a lower buffer above the net worth 
ratio than they will have under the final rule.
    The current risk-based net worth requirement also fails to allow 
for comparison of capital adequacy on a risk-weighted level across 
financial institutions. A creditor or uninsured depositor is able to 
obtain and understand the capital measures available for all banks. 
Creditors generally know that, for banks, a higher capital ratio is an 
indication of better financial strength and a reduction in their risk 
of loss. Creditors and uninsured shareholders in credit unions, 
however, generally do not understand the application of the risk-based 
net worth requirement where a lower ratio is an indicator of financial 
strength; nor are they generally aware that the risk-based net worth 
requirement is only available by reviewing a specific page of the Call 
Report. The current lack of a comparable risk-based capital measure for 
credit unions deprives creditors and uninsured shareholders of a useful 
measure in determining the financial strength of credit unions.
    The Board also disagrees with commenters who called for a 
withdrawal of the Second Proposal because a limited number of credit 
unions may experience a decline in their capital classification, or 
because commenters claimed that back-testing the proposal would have 
resulted in only minor savings to the NCUSIF had the proposal's capital 
requirement been in place during the 2007-2009 recession. The Original 
Proposal would have imposed higher risk-weights for concentrations of 
MBLs, junior-lien real estate loans, and equity investments, which 
would have resulted in approximately 199 credit unions experiencing a 
decline in their capital classification and could have reduced losses 
to the NCUSIF to a greater degree had those requirements been in place 
prior to the 2007-2009 recession. Due to legitimate concerns raised by 
commenters regarding the impacts of the Original Proposal, however, the 
Board reduced the risk-weights for concentrations of MBLs and real 
estate loan concentrations in the Second Proposal. Thus, the potential 
impacts of the Second Proposal were lower, but still require that 
credit unions taking higher levels of risk hold higher levels of 
capital. Based on the comments received on the Original Proposal and 
the Second Proposal, the risk weights in the Second Proposal are 
calibrated to appropriately balance the impact of the proposed changes 
on credit unions while also providing meaningful improvement to the 
risk-based capital standards to which credit unions will be held in the 
future.
    The Board disagrees with commenters who suggested that the Board 
not finalize the proposal and instead focus on enhancing training to 
improve examiner skills to reduce the number of failures and losses to 
the NCUSIF. NCUA already continually seeks to enhance the training and 
skills of examiner staff within budget limitations. NCUA already 
performs analyses of all material losses to the NCUSIF, including 
material loss reviews prepared by NCUA's Inspector General on losses 
that exceed $25 million. The loss reviews include analyses of NCUA's 
and the State Supervisory Authorities' supervision of credit unions and 
include recommendations to addresses any weaknesses in related 
supervision policies and approaches. Additionally, not issuing a final 
rule would result in retention of the current risk-based net worth 
measure, which is not a comparable measure across financial 
institutions and contains risk-weights that are less closely associated 
with credit risk.
    Moreover, the Board disagrees with commenters who suggested that 
credit unions should have less stringent regulatory capital standards 
than banks. The combined statutory requirement for a minimum net worth 
ratio and the risk-based capital requirement, supported by the 
supervision process, is the backbone of protection for both the credit 
union and bank insurance funds. In addition, prudent capital standards 
serve to protect taxpayers who ultimately must fund any reliance by the 
insurance funds on the full faith and credit of the United States.
    Commenters claimed that the Second Proposal would place credit 
unions at a competitive disadvantage to banks by requiring credit 
unions to hold incrementally more capital than banks given similar 
asset-concentration levels. The net worth ratio, which is defined by 
statute, requires credit unions to hold more capital than banks are 
required to hold using the comparable Tier 1 leverage ratio for 
banks.\28\ Congress

[[Page 66635]]

required NCUA to develop PCA regulations that are comparable to those 
of banks, including the risk-based net worth requirement for complex 
credit unions. The Board ensured compliance with the law while issuing 
the Second Proposal, which would not place credit unions at a 
competitive disadvantage to banks. The vast majority of risk weights 
for credit unions would be comparable to the risk weights for banks, 
and some risk weights for credit unions would actually be lower than 
the risk weights for banks. Because the Second Proposal generally used 
the same overall risk-based capital levels as banks, the differences in 
the individual elements of the calculation can be easily identified and 
understood. For example, the proposed risk weight for secured consumer 
loans, which represent about 20 percent of total assets for complex 
credit unions, is 25 basis points less than the corresponding risk 
weight for banks. The Second Proposal also would not cap credit unions' 
allowance for loan and lease losses at 1.25 percent of risk assets, 
while the Other Banking Agencies impose such a cap in the risk-based 
capital ratio calculation for banks. In the few instances where the 
risk weights are higher for credit unions, they apply to a very low 
percentage of total assets and are directly tied to sources of higher 
losses to the NCUSIF, primarily concentrations of real estate and 
business assets.
---------------------------------------------------------------------------

    \28\ The net worth ratio and a bank's Tier 1 leverage ratio are 
both based on the total assets of the institution. Congress set the 
net worth ratio 200 basis points higher than the Tier 1 leverage 
ratio level for banks due to the nature of the 1 percent NCUSIF 
deposit, the level of investment within the corporate credit union 
system, and credit unions' limited access to capital other than 
retained earnings. U.S. Department of Treasury, Credit Unions 
(1997).
---------------------------------------------------------------------------

    The table below contains an estimate of how risk-weights generally 
compare between the risk-weights in this final rule to the risk-weights 
applied to FDIC insured institutions.

------------------------------------------------------------------------
                                           Sub-category    Category as %
                                           as % of total     of total
                                              assets          assets
------------------------------------------------------------------------
                       Lower Risk Weight Than FDIC
------------------------------------------------------------------------
Secured Consumer Loans..................  ..............          21.09%
------------------------------------------------------------------------
                 More Conservative Risk Weight Than FDIC
------------------------------------------------------------------------
First-Lien Real Estate Loans >35 percent           1.19%  ..............
 of assets..............................
Junior-Lien Real Estate Loans >20                  0.11%  ..............
 percent of assets......................
Commercial Loans >50 percent of assets..           0.13%  ..............
Non-Current Junior-Lien Real Estate                0.02%  ..............
 Loans..................................
Unfunded Non-Commercial Loans...........           1.46%           2.91%
------------------------------------------------------------------------
                     Not Directly Comparable to FDIC
------------------------------------------------------------------------
CUSO Investments and Corporate Capital..  ..............           0.34%
------------------------------------------------------------------------
                     Comparable Risk Weight to FDIC
------------------------------------------------------------------------
All Other Assets........................  ..............          75.66%
------------------------------------------------------------------------

    Commenters asserted that bank regulators are moving away from risk-
based capital structures and referenced the FDIC Vice Chairman's 
related statements. The FDIC Vice Chairman, however, has favored higher 
generally accepted accounting principles (GAAP) equity ratios at banks 
of at least 10 percent of assets as an alternative to risk-based 
capital structures.\29\ The NCUA Board lacks authority to impose higher 
GAAP equity-to-asset ratios because the FCUA specifically defines the 
net worth ratio for credit unions and sets forth the minimum ratio 
levels required. Moreover, the current statutory net worth ratio 
requirement, combined with a reasonable risk-based capital ratio 
requirement to address institutions taking higher levels of risk, 
provides a well targeted level of protection to the NCUSIF.
---------------------------------------------------------------------------

    \29\ Thomas M. Hoening, American Banker, The Safe Way to Give 
Traditional Banks Regulatory Relief, (June 22, 2015), available at 
https://www.fdic.gov/news/letters/reg-relief.html.
---------------------------------------------------------------------------

    The Board disagrees with commenters who suggested that the proposal 
would stifle growth, innovation, diversification, and member services. 
The commenters' suggested revisions to the proposal revealed there is 
clear disagreement among credit unions and other interested parties 
regarding how the proposal would have impacted factors such as growth, 
innovation, diversification, and member services at credit unions. This 
final rule better reflects each individual credit union's risk profile, 
provides for more active management of risk in relation to capital, 
further ensures individual credit unions can continue to serve as 
credit providers even during times of stress, and promotes the safety 
and soundness of the credit union system.
    Commenters asserted that credit unions would need to charge higher 
interest rates, higher fees, and pay lower rates on deposits to raise 
capital because of the new risk-based capital measure. Credit unions, 
however, would have more than three years before the new risk-based 
capital requirement goes into effect. A credit union that determines it 
is in danger of having a risk-based capital ratio level below the 
required minimum level has the option of: Reducing the amount of risk-
weighted assets it holds; raising additional capital, primarily through 
earnings; or both.
    NCUA's analysis of credit union Call Report data indicates that the 
overwhelming majority of complex credit unions already have sufficient 
capital to comply with the proposed risk-based capital regulation. In 
particular, NCUA estimates that over 98 percent of complex credit 
unions would be in compliance with the regulatory capital minimums 
under the final rule if it were in effect today. The final rule is 
designed to ensure that these credit unions maintain their capacity to 
absorb losses in the future. A few credit unions, however, will likely 
want to take advantage of the three-year implementation period provided 
in this final rule to accumulate retained earnings, reduce their level 
of risk-assets, or both. As noted above, the overwhelming majority of 
credit unions have sufficient capital to comply with the revised 
capital rules, and the resulting improvements to the stability and 
resilience of the credit union

[[Page 66636]]

system outweigh any costs associated with its implementation.
    In this final rule, the Board complied with the statutory 
requirement to take into account the cooperative character of credit 
unions in that they are not-for-profit, do not issue capital stock, 
must rely on retained earnings to build net worth, and have boards of 
directors that consist primarily of volunteers. To do this, the Board 
avoided undue complexity within the rule by, among other things, not 
implementing a complex conservation buffer requirement; establishing a 
simple and straightforward proxy for the definition of a complex credit 
union; reducing the number of asset concentration thresholds; and 
requiring only complex credit unions to have a written strategy for 
maintaining an appropriate level of capital.
    Accordingly, and for the reasons discussed in more detail below, 
the Board is now adopting this final rule to revise NCUA's current 
regulations regarding PCA to require that complex credit unions taking 
certain risks hold capital commensurate with those risks.

II. Summary of the Final Rule

    This final rule replaces the method currently used by complex 
credit unions to apply risk weights to their assets with a new risk-
based capital ratio measure that is generally comparable to that 
applied to depository institutions worldwide. As discussed in more 
detail in the Legal Authority part of this preamble, the FCUA gives 
NCUA broad discretion in designing the risk-based net worth requirement 
applicable to complex credit unions. Accordingly, this final rule 
revises part 702 of NCUA's current regulations to establish a risk-
based capital ratio measure that is the percentage of a credit union's 
capital available to cover losses, divided by the credit union's 
defined risk-weighted asset base.
    This final rule adopts a broadened definition of capital to be used 
as the numerator in the new risk-based capital ratio measure. The Board 
is adopting 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 specifically available to 
cover losses and protect the NCUSIF. This broader definition of capital 
more accurately reflects the amount of capital that is actually 
available at a credit union to absorb losses.
    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.'' \30\ Section 216(d)(2) of the FCUA 
differs from the corresponding provision in section 38 of the FDI 
Act,\31\ 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, the Board is required to account for any material 
risks in the risk-based requirement unless the risk is deemed 
immaterial because of the existence of another mechanism that the Board 
believes adequately accounts for the risk.
---------------------------------------------------------------------------

    \30\ 12 U.S.C. 1790d(d)(2) (emphasis added).
    \31\ 12 U.S.C. 1831o.
---------------------------------------------------------------------------

    NCUA's risk-based net worth requirement has included some aspect of 
IRR since its inception in 2000. Further, 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. Based on long-term balance sheet trends at credit unions, 
the comments received on the Second Proposal, and NCUA's experiences 
dealing with problem institutions, however, the Board concluded that 
NCUA can adequately address IRR through its other regulations and 
supervisory processes. Accordingly, the final rule generally excludes 
IRR from NCUA's risk-based capital ratio calculation. But the Board may 
consider adopting additional regulatory or supervisory approaches for 
addressing IRR at credit unions if the need arises in the future.
    With the removal of the IRR component from the current rule, this 
final rule narrows the list of risks accounted for in the denominator 
of the new risk-based capital ratio measure. The methodology for 
assigning risk weights in this final rule primarily accounts for credit 
risk and concentration risk.
    This final rule incudes a tiered risk weight framework \32\ for 
high concentrations of residential real estate loans and commercial 
loans \33\ in NCUA's risk-based capital ratio measure. As a credit 
union's concentration in these asset classes increases, incrementally 
higher levels of capital are required. This approach addresses 
concentration risk as it relates to minimum required capital levels 
through a transparent, standardized, regulatory requirement. The 
concentration thresholds do not limit a credit union's lending 
activity; rather, the thresholds merely require the credit union to 
hold additional capital to account for the elevated concentration risk. 
The inclusion of concentration risk in the final rule does not put 
credit unions at a competitive disadvantage to banks because most real 
estate and member business loans (except for loans held in high 
concentrations) would still be assigned risk weights similar to those 
applicable to banks.
---------------------------------------------------------------------------

    \32\ 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.
    \33\ The definition of commercial loans and the differences 
between commercial loans and MBLs are discussed in more detail in 
the section-by-section analysis.
---------------------------------------------------------------------------

    Consistent with many commenters and 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 relied primarily on 
the risk weights assigned to various asset classes under the Basel 
Accords and the Other Banking Agencies' risk-based capital regulations 
for this final rule.\34\ So this final rule provides for greater 
comparability to the Other Banking Agencies' risk weights than NCUA's 
current risk-based net worth regulation. The Board, however, has 
tailored the risk weights in this final rule for certain assets that 
are unique to credit unions or where a demonstrable and compelling case 
exists, based on contemporary and sustained performance differences, to 
differentiate for certain asset classes (such as consumer loans) 
between banks and credit unions, or where a provision of the FCUA 
requires doing so.
---------------------------------------------------------------------------

    \34\ The Board has simplified certain aspects of this final 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).

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

[[Page 66637]]

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

    \35\ The ``look-through'' approaches are discussed in more 
detail in the part of this preamble discussing Sec.  
702.104(c)(3)(iii)(B).
    \36\ The ``gross-up'' approach is discussed in more detail in 
the part of this preamble discussing Sec.  702.104(c)(3)(iii)(A).
    \37\ Under Sec.  702.104(c)(3)(i) of this final rule, a credit 
union has non-significant equity exposures if the aggregate amount 
of its equity exposures does not exceed 10 percent of the sum of the 
credit union's capital elements of the risk-based capital ratio 
numerator (as defined under paragraph Sec.  702.104(b)(1)). To 
determine its aggregate amount of its equity exposures, the credit 
union must include the total amounts (as recorded on the statement 
of financial condition in accordance with GAAP) of the following (1) 
equity investments in CUSOs, (2) perpetual contributed capital at 
corporate credit unions, (3) nonperpetual capital at corporate 
credit unions, and (3) equity investments subject to a risk weight 
in excess of 100 percent.

                                                               Summary of the Risk Weights
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                   0%      20%      50%      75%      100%     150%     250%     300%     400%    1250%
--------------------------------------------------------------------------------------------------------------------------------------------------------
Cash/Currency/Coin............................................       X   .......  .......  .......  .......  .......  .......  .......  .......  .......
Investments:
    Unconditional Claims--U.S. Government.....................       X   .......  .......  .......  .......  .......  .......  .......  .......  .......
    Balances Due from Federal Reserve Banks...................       X   .......  .......  .......  .......  .......  .......  .......  .......  .......
    Federally Insured Deposits in Financial Institutions......       X   .......  .......  .......  .......  .......  .......  .......  .......  .......
    Debt Instruments issued by NCUA and FDIC..................       X   .......  .......  .......  .......  .......  .......  .......  .......  .......
    Central Liquidity Facility Stock..........................       X   .......  .......  .......  .......  .......  .......  .......  .......  .......
    Uninsured deposits at U.S. Federally Insured Institutions.  .......       X   .......  .......  .......  .......  .......  .......  .......  .......
    Agency Obligations........................................  .......       X   .......  .......  .......  .......  .......  .......  .......  .......
    FNMA and FHLMC pass through Mortgage Backed Securities      .......       X   .......  .......  .......  .......  .......  .......  .......  .......
     (MBS)....................................................
    General Obligation Bonds Issued by State or Political       .......       X   .......  .......  .......  .......  .......  .......  .......  .......
     Subdivisions.............................................
    Federal Home Loan Bank Stock and Balances.................  .......       X   .......  .......  .......  .......  .......  .......  .......  .......
    Senior Agency Residential MBS or Asset-Backed Securities    .......       X   .......  .......  .......  .......  .......  .......  .......  .......
     (ABS) Structured.........................................
    Revenue Bonds Issued by State or Political Subdivisions...  .......  .......       X   .......  .......  .......  .......  .......  .......  .......
    Senior Non-Agency Residential MBS Structured..............  .......  .......       X   .......  .......  .......  .......  .......  .......  .......
    Corporate Membership Capital..............................  .......  .......  .......  .......   X \c\   .......  .......  .......  .......  .......
    Industrial Development Bonds..............................  .......  .......  .......  .......       X   .......  .......  .......  .......  .......
    Agency Stripped MBS (Interest Only).......................  .......  .......  .......  .......       X   .......  .......  .......  .......  .......
    Part 703 Compliant Investment Funds \a\...................  .......  .......  .......  .......       X   .......  .......  .......  .......  .......
    Value of General Account Insurance (bank owned life         .......  .......  .......  .......       X   .......  .......  .......  .......  .......
     insurance, and credit union owned life insurance) \a\....
    Corporate Perpetual Capital...............................  .......  .......  .......  .......   X \c\    X \c\   .......  .......  .......  .......
    Mortgage Servicing Assets.................................  .......  .......  .......  .......  .......  .......       X   .......  .......  .......
    Separate Account Life Insurance \a\.......................  .......  .......  .......  .......  .......  .......  .......       X   .......  .......
    Publicly Traded Equity Investment (non-CUSO)..............  .......  .......  .......  .......   X \c\   .......  .......   X \c\   .......  .......
    Mutual Funds Part 703 Non-Compliant \a\...................  .......  .......  .......  .......  .......  .......  .......       X   .......  .......
    Non-Publicly Traded Equity Investments (non-CUSO).........  .......  .......  .......  .......   X \c\   .......  .......  .......   X \c\   .......
    Subordinated Tranche of Any Investment \b\................  .......  .......  .......  .......  .......  .......  .......  .......  .......       X
Consumer Loans:
    Share-Secured (shares held at the credit union)...........       X   .......  .......  .......  .......  .......  .......  .......  .......  .......
    Share-Secured (shares held at another depository            .......       X   .......  .......  .......  .......  .......  .......  .......  .......
     institution).............................................
    Current Secured...........................................  .......  .......  .......       X   .......  .......  .......  .......  .......  .......
    Current Unsecured.........................................  .......  .......  .......  .......       X   .......  .......  .......  .......  .......
    Non-Current...............................................  .......  .......  .......  .......  .......       X   .......  .......  .......  .......
Real Estate Loans:
    Share-Secured (shares held at the credit union)...........       X   .......  .......  .......  .......  .......  .......  .......  .......  .......
    Share-Secured (shares held at another depository            .......       X   .......  .......  .......  .......  .......  .......  .......  .......
     institution).............................................
    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 (shares held at the credit union)...........       X   .......  .......  .......  .......  .......  .......  .......  .......  .......
    Share-Secured (shares held at another depository            .......       X   .......  .......  .......  .......  .......  .......  .......  .......
     institution).............................................
    Portion of Commercial Loans with Compensating Balance.....  .......       X   .......  .......  .......  .......  .......  .......  .......  .......
    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 \c\    X \c\   .......  .......  .......  .......
    Other Balance Sheet Items not Assigned....................  .......  .......  .......  .......       X   .......  .......  .......  .......  .......
--------------------------------------------------------------------------------------------------------------------------------------------------------
\a\ With the option to use the look-through options.\35\
\b\ With the option to use the gross-up approach.\36\
\c\ If a credit union's total equity exposures are ``non-significant'' \37\ under Sec.   702.104(c)(3)(i), then the risk weight is 100 percent. This
  lowers the risk weight to 100 percent for CUSO equity exposures, corporate perpetual capital, and all other equity investments when they are part of a
  credit union's non-significant equity exposures.


[[Page 66638]]

    The following table provides an estimate of the risk weighting for 
aggregate assets held by complex credit union assets as of December 31, 
2014.
---------------------------------------------------------------------------

    \38\ Includes off-balance sheet items after application of the 
credit conversion factor.

----------------------------------------------------------------------------------------------------------------
                                                                  Complex credit                    Cumulative
                                                                   union assets     Percent of      percent of
                           Risk weight                             (in millions)  complex credit  complex credit
                                                                       \38\        union assets    union assets
----------------------------------------------------------------------------------------------------------------
0%..............................................................         $18,713            1.82            1.82
20%.............................................................         289,932           28.15           29.97
50%.............................................................         224,618           21.81           51.78
75%.............................................................         270,440           26.24           78.02
100%............................................................         217,159           21.08           99.01
150%............................................................           8,017            0.78           99.88
250% or greater.................................................           1,195            0.12          100.00
----------------------------------------------------------------------------------------------------------------

    The following table compares on-balance sheet risk weights in this 
final rule to the applicable risk weights assigned by other federal 
banking agencies:

------------------------------------------------------------------------
                                            NCUA  Risk-     FDIC  Risk-
                                              weight          weight
------------------------------------------------------------------------
Cash/Currency/Coin......................              0%              0%
Investments:
    Unconditional Claims--U.S.                        0%              0%
     Government.........................
    Balances Due from Federal Reserve                 0%              0%
     Banks..............................
    Federally Insured Deposits in                     0%              0%
     Financial Institutions.............
    Debt Instruments issued by NCUA and               0%              0%
     FDIC...............................
    Central Liquidity Facility Stock....              0%             n/a
    Uninsured deposits at U.S. Federally             20%             20%
     Insured Institutions...............
    Agency Obligations..................             20%             20%
    FNMA and FHLMC pass through Mortgage             20%             20%
     Backed Securities (MBS)............
    General Obligation Bonds Issued by               20%             20%
     State or Political Subdivisions....
    Federal Home Loan Bank Stock and                 20%             20%
     Balances...........................
    Senior Agency Residential MBS or                 20%             20%
     Asset-Backed Securities (ABS)
     Structured.........................
    Revenue Bonds Issued by State or                 50%             50%
     Political Subdivisions.............
    Senior Non-Agency Residential MBS                50%     Gross-up or
     Structured.........................                      Simplified
                                                             Supervisory
                                                                 Formula
    Corporate Membership Capital........            100%             n/a
    Industrial Development Bonds........            100%            100%
    Agency Stripped MBS (Interest Only).            100%            100%
    Part 703 Compliant Investment Funds.        100% \a\             n/a
    Value of General Account Insurance              100%            100%
     (bank owned life insurance, and
     credit union owned life insurance)
     \a\................................
    Corporate Perpetual Capital.........   100%/150% \c\             n/a
    Mortgage Servicing Assets...........            250%            250%
    Separate Account Life Insurance.....        300% \a\    Look-through
    Publicly Traded Equity Investment      100%/300% \c\            300%
     (non-CUSO).........................
    Mutual Funds Part 703 Non-Compliant.        300% \a\             n/a
    Non-Publicly Traded Equity             100%/400% \c\            400%
     Investments (non-CUSO).............
    Subordinated Tranche of Any               1,250% \b\     Gross-up or
     Investment.........................                      Simplified
                                                             Supervisory
                                                                 Formula
Consumer Loans:
    Share-Secured (shares held at the                 0%              0%
     credit union)......................
    Share-Secured (shares held at                    20%             20%
     another depository institution)....
    Current Secured.....................             75%            100%
    Current Unsecured...................            100%            100%
    Non-Current Consumer................            150%            150%
Real Estate Loans:
    Share-Secured (shares held at the                 0%              0%
     credit union)......................
    Share-Secured (shares held at                    20%             20%
     another depository institution)....
    Current First Lien <35% of Assets...             50%             50%
    Current First Lien >35% of Assets...             75%             50%
    Not Current First Lien..............            100%            100%
    Current Junior Lien <20% of Assets..            100%            100%
    Current Junior Lien >20% of Assets..            150%            100%
    Noncurrent Junior Lien..............            150%            100%
Commercial Loans:

[[Page 66639]]

 
    Share-Secured (shares held at the                 0%              0%
     credit union)......................
    Share-Secured (shares held at                    20%             20%
     another depository institution)....
    Portion of Commercial Loans with                 20%             n/a
     Compensating Balance...............
    Commercial Loans <50% of Assets.....            100%   100%/150% \d\
    Commercial Loans >50% of Assets.....            150%    100/150% \d\
    Non-current Commercial..............            150%            150%
Miscellaneous:
    Loans to CUSOs......................            100%            100%
    Equity Investment in CUSO...........   100%/150% \c\       100%-600%
    Other Balance Sheet Items not                   100%            100%
     Assigned...........................
------------------------------------------------------------------------
\a\ With the option to use the look-through options.
\b\ With the option to use the gross-up approach.
\c\ If a credit union's total equity exposures are ``non-significant''
  under Sec.   702.104(c)(3)(i), then the risk weight is 100 percent.
  This lowers the risk weight to 100 percent for CUSO equity exposures,
  corporate perpetual capital, and all other equity investments when
  they are part of a credit union's non-significant equity exposures.
\d\ FDIC identifies certain commercial loans as High Volatility
  Commercial Real Estate (HVCRE) and assigns a 150% risk weight.

    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 . . . .'' \39\ In other words, 
FDIC may require an FDIC-supervised institution to hold an amount of 
regulatory capital greater than otherwise required under its capital 
rules if 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.\40\
---------------------------------------------------------------------------

    \39\ See, e.g., 12 CFR 324.1(a).
    \40\ See, e.g., 12 CFR 324.1(d).
---------------------------------------------------------------------------

    As indicated above, FDIC's approach to risk weights is calibrated 
to be the minimum regulatory capital standard. Similarly, this final 
rule is calibrated to be the minimum regulatory capital standard. 
Accordingly, the final rule incorporates a broader regulatory provision 
reminding complex credit unions that, as a matter of safety and 
soundness, they are required to maintain capital commensurate with the 
level and nature of all risks to which they are exposed.\41\ In 
addition, the final rule adds a new provision requiring complex credit 
unions to maintain a written strategy for assessing capital adequacy 
and maintaining an appropriate level of capital.
---------------------------------------------------------------------------

    \41\ See, e.g., 12 U.S.C. 1786.
---------------------------------------------------------------------------

    Capital ratio thresholds are largely a function of risk weights; 
and this final rule more closely aligns NCUA's risk weights with those 
assigned by the Other Banking Agencies.\42\ Accordingly, the final rule 
adopts a 10 percent risk-based capital ratio level for well capitalized 
credit unions, and an 8 percent risk-based capital ratio level for 
adequately capitalized credit unions. To take into account the 
cooperative character of credit unions, the Board set the risk-based 
capital ratio level for well capitalized credit unions at 10 percent, 
and omitted the capital conservation buffer imposed on banks.\43\ The 
omission of the capital conservation buffer simplifies NCUA's risk-
based capital requirement relative to the Other Banking Agencies' rules 
without appreciably lowering the protections provided by NCUA's risk-
based capital regulations.\44\
---------------------------------------------------------------------------

    \42\ See, e.g., 12 CFR 324.32; and 12 CFR 324.403.
    \43\ The ``capital conservation buffer'' is explained in more 
detail in the discussion on Sec.  702.102(a) in the section-by-
section analysis part of this preamble.
    \44\ See, e.g., 12 CFR 324.403.
---------------------------------------------------------------------------

    The final rule defines a credit union as ``complex'' if it has 
assets of more than $100 million.\45\ Credit unions meeting this 
threshold have a portfolio of assets and liabilities that is complex, 
based upon the products and services in which they are engaged. As 
discussed later in this document, the $100 million asset threshold is a 
proxy measure based on detailed analysis, and a clear demarcation line 
above which all credit unions engage in complex activities and where 
almost all such credit unions (99 percent) are involved in multiple 
complex activities.
---------------------------------------------------------------------------

    \45\ There is no exemption for banks from the risk-based capital 
requirements of the other banking agencies. There are 1,872 FDIC-
insured banks with assets less than $100 million as of December 
2014.
---------------------------------------------------------------------------

    An asset size threshold is clear, logical, and easy to administer 
when compared with the more complicated formula used to determine 
whether a credit union is complex under the current rule.\46\ Using a 
more straightforward proxy for determining complexity also helps 
account for the cooperative character of credit unions, particularly, 
the fact that credit unions have boards of directors that consist 
primarily of volunteers. The $100 million asset size threshold exempts 
approximately 76 percent of credit unions \47\ from many of the 
regulatory burdens associated with complying with this rule; yet it 
will cover almost 90 percent of the assets in the credit union system. 
The threshold is consistent with the fact that the majority 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 detailed discussion associated with section 
702.103 in the Section-By-Section Analysis part of the preamble below.
---------------------------------------------------------------------------

    \46\ 12 CFR 702.106.
    \47\ Based upon December 31, 2014 Call Report data.
---------------------------------------------------------------------------

    In response to public comments received, the final rule also makes 
a number of changes to the Second Proposal. These changes include: 
Assigning a lower risk weight to non-significant equity exposures and 
certain share-secured loans; giving credit unions the option to assign 
a 100 percent risk weight to certain charitable donation accounts; 
permitting credit unions to use the gross-up approach for non-
subordinated investment tranches; assigning principal-only mortgage-
backed-security STRIPS a risk-weight based on the underlying 
collateral; extending the period during which credit unions can count 
supervisory goodwill and supervisory other intangible assets in the 
risk-based capital ratio numerator; and incorporating the text of the 
gross-up and look-through approaches into a new appendix A to the PCA 
regulation. As discussed in more detail below, for certain assets, 
these changes will lower the risk weights that would have been assigned 
under the Second Proposal, extend the period during which certain 
assets can be included in a credit union's risk-based capital ratio

[[Page 66640]]

numerator--effectively lowering certain credit unions' overall capital 
requirement for 10 years--and lower the impact of the rule for certain 
complex credit unions. The final rule also makes conforming and other 
minor changes to NCUA's regulations, which are also discussed in more 
detail below.
    To provide 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, the revisions adopted 
in this final rule will not become effective until January 1, 2019. 
This effective date is intended to coincide with the full phase-in of 
FDIC's risk-based capital measures in 2019.

III. Legal Authority

    In 1998, Congress enacted the Credit Union Membership Access Act 
(CUMAA).\48\ Section 301 of CUMAA added new section 216 to the 
FCUA,\49\ which requires the Board to maintain, by regulation, a system 
of PCA to restore the net worth of credit unions that become 
inadequately capitalized. Section 216(b)(1)(A) requires that NCUA's 
system of PCA for federally insured credit unions be ``consistent 
with'' section 216 of the FCUA, and ``comparable to'' section 38 of the 
Federal Deposit Insurance Act (FDI Act).\50\ Section 216(b)(1)(B) 
requires that the Board, in designing the PCA system, take into account 
credit unions' cooperative character: 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.\51\ In 2000, the Board first 
implemented the required system of PCA \52\ and, prior to this 
rulemaking, had made only minor adjustments to the rule's original 
requirements.\53\
---------------------------------------------------------------------------

    \48\ Public Law 105-219, 112 Stat. 913 (1998).
    \49\ 12 U.S.C. 1790d.
    \50\ 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).
    \51\ 12 U.S.C. 1790d(b)(1)(B).
    \52\ See 65 FR 8584 (Feb. 18, 2000); and 65 FR 44950 (July 20, 
2000) (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.)
    \53\ 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). 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).
---------------------------------------------------------------------------

    The stated 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].'' \54\ To carry out that purpose, 
Congress set forth a basic structure for PCA in section 216 that 
consists of three principal components: (1) A statutory framework that 
requires certain mandatory classifications of credit unions and that 
NCUA take certain mandatory and discretionary actions against credit 
unions based on their classification; (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'' that applies to credit unions that 
NCUA defines as ``complex.'' This final 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 final rule.
---------------------------------------------------------------------------

    \54\ 12 U.S.C. 1790d(a)(1).
---------------------------------------------------------------------------

    Among other things, section 216(c) of the FCUA requires that NCUA 
use a credit union's net worth ratio to determine its classification 
among the five ``net worth categories'' set forth in the FCUA.\55\ 
Section 216(o) generally defines a credit union's ``net worth'' as its 
retained earnings balance,\56\ and a credit union's ``net worth ratio'' 
\57\ as the ratio of its net worth to its total assets.\58\ 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.\59\
---------------------------------------------------------------------------

    \55\ 12 U.S.C. 1790d(c).
    \56\ 12 U.S.C. 1790d(o)(2).
    \57\ Throughout this document the terms ``net worth ratio'' and 
``leverage ratio'' are used interchangeably.
    \58\ 12 U.S.C. 1790d(o)(3).
    \59\ 12 U.S.C. 1790d(c)-(g); and 12 CFR 702.204(a) & (b).
---------------------------------------------------------------------------

    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, ``a risk-based net worth requirement \60\ for insured 
credit unions that are complex, as defined by the Board . . . .'' \61\ 
Unlike the terms ``net worth'' and ``net worth ratio,'' which are 
specifically defined in section 216(o), the term ``risk-based net 
worth'' is not defined in the FCUA.\62\ While Congress prescribed the 
net worth ratio requirement in detail in section 216, it elected not to 
define the term ``risk-based net worth,'' leaving the details of the 
risk-based net worth requirement to be filled in by the Board through 
the notice and comment rulemaking process. Section 216, when read as a 
whole, grants the Board broad authority to design reasonable PCA 
regulations, including a risk-based net worth requirement, so long as 
the regulations are comparable to the Other Banking Agencies' PCA 
requirements, are consistent with the requirements of section 216 of 
the FCUA, and take into account the cooperative character of credit 
unions.
---------------------------------------------------------------------------

    \60\ 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 unions. The 
term ``risk-based capital ratio'' is 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.
    \61\ 12 U.S.C. 1790d(d)(1).
    \62\ 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.'').
---------------------------------------------------------------------------

    Section 216(d)(1) of the FCUA directs NCUA, in determining which 
credit unions will be subject to the risk-based net worth requirement, 
to base its definition of complex ``on the portfolios of assets and 
liabilities of credit unions.'' \63\ The statute does not require, as 
some commenters have argued, that the Board adopt a definition of 
``complex'' that takes into account the portfolio of assets and 
liabilities of each credit union on an individualized basis. Rather, 
section 216(d)(1) authorizes the Board to develop a single definition 
of complex that takes into account the portfolios of assets and 
liabilities of all credit unions.
---------------------------------------------------------------------------

    \63\ 12 U.S.C. 1790d(d).
---------------------------------------------------------------------------

    In addition, section 216(d)(2) specifies that 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)] 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 and the meaning of section 216(d)(2) by providing:
---------------------------------------------------------------------------

    \64\ 12 U.S.C. 1790d(d)(2) (emphasis added).

    The NCUA must design the risk-based net worth requirement to 
take into account any

[[Page 66641]]

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.\65\
---------------------------------------------------------------------------

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

    As indicated by the language above, Congress intended the Board, in 
designing the risk-based net worth requirement, to address any risks 
that may not be adequately accounted for by the statutory 6 percent net 
worth ratio requirement. The legislative history is silent on why 
Congress chose to tie the provision in section 216(d)(2) to the 
statutory 6 percent net worth ratio requirement for adequately 
capitalized credit unions and not the 7 percent net worth ratio 
requirement for well capitalized credit unions.
    Section 216(c) of the FCUA provides that, if a credit union meets 
the definition of ``complex'' and it meets or exceeds the net worth 
ratio requirement to be classified as either adequately capitalized or 
well capitalized, the credit union must also satisfy the corresponding 
risk-based net worth requirement to be classified as either adequately 
capitalized or well capitalized.\66\ Accordingly, under the separate 
risk-based net worth requirement, a complex credit union must, in 
addition to meeting the statutory net worth ratio requirement, also 
meet or exceed the corresponding minimum risk-based net worth 
requirement in order to receive a capital classification of adequately 
capitalized or well capitalized, as the case may be.\67\ For example, a 
complex credit union must meet or exceed both the applicable net worth 
ratio requirement and the applicable risk-based net worth requirement 
to be classified as well capitalized. If the credit union fails to meet 
either requirement, it is classified in the lowest category for which 
it meets both the net worth ratio requirement and the risk-based net 
worth requirement.
---------------------------------------------------------------------------

    \66\ See 12 U.S.C. 1790d(c)(1)(A) & (c)(1)(B).
    \67\ 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) & (c)(1)(B)(ii).
---------------------------------------------------------------------------

    If a 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 minimum risk-based net 
worth requirement to be adequately capitalized, then the credit union's 
capital classification is ``undercapitalized'' based on the risk-based 
net worth requirement. Similarly, if a complex credit union's net worth 
ratio meets or exceeds the requirement that corresponds to the well 
capitalized category, but its risk-based net worth ratio meets only the 
requirement that corresponds with the adequately capitalized capital 
category, then that credit union's capital classification is adequately 
capitalized. In either case, the credit union is subject to the 
mandatory supervisory and discretionary supervisory actions applicable 
to its capital classification category.\68\
---------------------------------------------------------------------------

    \68\ 12 U.S.C. 1790d(c)(1)(c)(ii).
---------------------------------------------------------------------------

    In response to the Second Proposal, a significant number of 
commenters questioned the Board's legal authority to impose a risk-
based net worth requirement on both well capitalized and adequately 
capitalized credit unions. As also discussed in the Section-by-Section 
part of the preamble below, the commenters' selective reading of 
section 216 of the FCUA is a misinterpretation. NCUA is legally 
authorized to impose a risk-based net worth requirement on both well 
capitalized and adequately capitalized credit unions 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)(A)(ii) provides that a credit union must 
meet any applicable risk-based net worth requirement under section 
216(d) of this section to be classified as well capitalized. The plain 
language of sections 216(c)(1)(A)(ii) and (c)(1)(B)(ii),, read in 
conjunction with the language in section 216(d), indicates Congress' 
intent to authorize the Board to impose risk-based net worth 
requirements on both well capitalized and adequately capitalized credit 
unions.
    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).\69\ 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.''\70\ 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.\71\ 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 that may not be addressed adequately through the 
statutory 6 percent net worth ratio required for a credit union to be 
adequately capitalized.\72\
---------------------------------------------------------------------------

    \69\ 12 U.S.C. 1790d(d).
    \70\ 12 U.S.C. 1790d(d)(2) (emphasis added).
    \71\ 12 U.S.C. 1790d(c)(1)(B).
    \72\ 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.'').
---------------------------------------------------------------------------

    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 should 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, that Congress's use of the term ``adequately capitalized'' in 
section 216(d)(2) somehow limits the Board's authority to require that 
complex credit unions maintain a higher risk-based capital ratio level 
to be classified as well capitalized. Rather than prohibiting the Board 
from imposing a higher risk-based capital ratio level for credit unions 
to be classified as well capitalized, section 216(d)(2) simply requires 
that the Board design the risk-based net worth requirement to take into 
account those risks that may not adequately be addressed by the 
statute's six percent net worth ratio requirement. Thus, the plain 
language of section 216(d) does not support those commenters' 
interpretation.
    The Board's 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

[[Page 66642]]

Agencies' PCA statute and regulations.\73\ Some commenters have argued 
that Congress's use of the singular noun ``requirement'' in Section 
216(d) of the FCUA indicates its intent that there be only one risk-
based net worth ration level tied to the adequately capitalized level. 
Section 38(c)(1)(A) of the FDI Act, upon which section 216 of the FCUA 
was modeled,\74\ however, requires that the Other Banking Agencies' 
``relevant capital measures'' include ``(i) a leverage limit; and (ii) 
a risk-based capital requirement.'' \75\ 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. Moreover, the 
United States Code addresses the singular--plural question in its rules 
of statutory construction: ``In determining the meaning of any Act of 
Congress, unless the context indicates otherwise . . . words importing 
the singular include and apply to several persons, parties, or things; 
words importing the plural include the singular . . .'' \76\ Therefore, 
setting different risk-based capital ratio levels for credit unions to 
be adequately and well capitalized, is consistent with the requirements 
of section 216 of the FCUA and is ``comparable'' to the Other Banking 
Agencies' PCA regulations.
---------------------------------------------------------------------------

    \73\ See 12 U.S.C. 1831o, and, e.g., 12 CFR 324.403(b).
    \74\ 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.'').
    \75\ 12 U.S.C. 1831o(c)(1)(A) (emphasis added).
    \76\ 1 U.S.C. 1.
---------------------------------------------------------------------------

    As explained in the Second Proposal, the FCUA requires NCUA to 
establish a risk-based capital system that is comparable to that in 
place for FDIC insured banks, and to take into account the cooperative 
character of credit unions. Some commenters criticized, however, that 
the Second Proposal took into account only the comparability 
requirement, and ignored the requirement to take into consideration the 
cooperative nature of credit unions. In support of their assertion, the 
commenters suggested that, because of their unique cooperative 
structure, strong member focus, and the absence of stock options for 
executives or pressure from stockholders, credit unions eschew 
excessive risk taking. The commenters suggested further, that in the 
face of the 2007-2009 financial crisis, credit unions--unlike their 
counterparts in the for-profit banking sector--served as both a 
counter-cyclical force and a safe haven, with much stronger loan and 
deposit growth than banking institutions. Accordingly, many commenters 
suggested that the Board, to take into account the cooperative 
character of credit unions, must impose risk-based capital requirements 
that are equal to or lower than the standards applicable to banks.
    The Board disagrees with the claim that NCUA failed to take into 
account the cooperative character of credit unions in designing the 
risk-based capital requirement. In the Original Proposal, which varied 
to a greater degree from the Other Banking Agencies' capital 
regulations than the Second Proposal, the Board proposed a significant 
number of alternative provisions, many of which were specifically 
intended to take into account the cooperative character of credit 
unions. The overwhelming response from credit unions in relation to 
that proposed approach, however, was to recommend that the Board revise 
the proposal to be more like the capital requirements adopted by the 
Other Banking Agencies to avoid putting credit unions at a competitive 
disadvantage to banks. As discussed in more detail below, the Board 
generally agreed with commenters' recommendations in that regard, and 
designed the Second Proposal to be more like the Other Banking 
Agencies' capital regulations. In the preamble to the Second Proposal, 
however, the Board specifically discussed ways in which the proposal 
continued to deviate from the Other Banking Agencies' capital 
requirements to take into account the cooperative character of credit 
unions. Furthermore, while it may generally be true that ``credit 
unions eschew excessive risk taking,'' as suggested by some commenters, 
that fact alone does not support assigning lower risk weights to credit 
union assets, or requiring that credit unions meet lower risk-based 
capital ratio levels to be adequately or well capitalized. To the 
contrary, for reasons explained in more detail below, a credit union 
that eschews excessive risk taking should have no trouble maintaining a 
high risk-based capital ratio level under this final rule.
    At least one commenter also suggested that credit unions' reliance 
primarily on retained earnings to build capital and operate make their 
operational structures both unique and challenging. Thus, the commenter 
concluded that, by requiring a higher risk-based capital ratio level 
for well capitalized credit unions, the Second Proposal failed to take 
these factors into consideration, as required by section 216(b)(1)(B) 
of the FCUA. The Board disagrees. Credit unions' limited access to 
supplemental forms of capital and reliance primarily on retained 
earnings for building capital suggests, if anything, that requiring 
credit unions to maintain higher levels of capital is appropriate. In a 
financial downturn, the retained earnings of a financial institution 
are likely to decrease. Under such circumstances, an institution with 
limited access to other alternative forms of capital needs a higher 
level of capital on hand to ensure its survival. In the case of NCUA's 
capital requirements, that higher level of capital is already required 
under the statutory net worth ratio requirement, which requires credit 
unions maintain higher leverage (net worth) ratios than banks. 
Accordingly, consistent with the Second Proposal, the risk-based 
capital ratio levels adopted in this final rule for adequately and well 
capitalized credit unions are designed to be generally equivalent to 
the corresponding risk-based capital ratio levels required for banks.

IV. Section-by-Section Analysis

Part 702--Capital Adequacy

Revised Structure of Part 702
    Consistent with the Second Proposal, this final rule reorganizes 
part 702 by consolidating NCUA's PCA requirements, which are currently 
included under subsections A, B, C, and D, under new subparts A and B. 
New subpart A is titled ``Prompt Corrective Action'' and new subpart B 
is titled ``Alternative Prompt Corrective Action for New Credit 
Unions.'' The reorganization is designed so that a credit union need 
only reference the subpart that applies to its institution, rather than 
having to flip back-and-forth between multiple subparts in part 702 to 
identify the applicable minimum capital standards and PCA regulations. 
Consolidating these sections reduces confusion and will save credit 
union staff from having to frequently flip back and forth through the 
four subparts of the current PCA rule.
    In general, this final rule restructures part 702 by consolidating 
most of the sections relating to capital and PCA that are applicable to 
only credit unions that are not ``new'' under new subpart A. The 
specific sections that would be included in new subpart A and the 
changes to those sections are discussed in more detail below.

[[Page 66643]]

    Similarly, this final rule consolidates most of NCUA's rules 
relating to alternative capital and PCA requirements for ``new'' credit 
unions under new subpart B. The sections under new subpart B 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 are discussed in more detail below.
    Finally, this final rule retains subpart E of part 702, Stress 
Testing, but re-designates and re-numbers the current subpart as 
subpart C. Other than re-designating and re-numbering the subpart, the 
language and requirements of current subpart E are unchanged by this 
final rule.
Section 702.1 Authority, Purpose, Scope, and Other Supervisory 
Authority
    Consistent with the Proposal, Sec.  702.1 of the final rule remains 
substantially similar to current Sec.  702.1, but is amended to update 
terminology and internal cross references within the section, 
consistent with the changes that are being made in other sections of 
part 702. No substantive changes to the section are intended.
    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.\77\ 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.'' \78\ As explained in more detail below, 
this final 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 final rule, this rule 
deviates from the PCA and risk-based capital requirements applicable to 
banks as required by section 216 of the FCUA, and to take into account 
the cooperative character of credit unions. Accordingly, the revised 
risk-based net worth requirement and this final rule are consistent 
with section 216 of the FCUA.
---------------------------------------------------------------------------

    \77\ 12 U.S.C. 1790d(b)(1).
    \78\ 12 U.S.C. 1790d(a)(1).
---------------------------------------------------------------------------

Section 702.2--Definitions
    The Second Proposal would have removed the paragraph numbers 
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. Many of the definitions in current Sec.  
702.2 were retained, however, with no substantive changes. The 
reorganization of the section and the removal of the paragraph 
numbering made proposed Sec.  702.2 more consistent with current 
Sec. Sec.  700.2, 703.2 and 704.2 of NCUA's regulations.\79\ In 
addition, proposed Sec.  702.2 included a number of new definitions, 
and would have amended some of the definitions in current Sec.  702.2.
---------------------------------------------------------------------------

    \79\ 12 CFR 700.2; 12 CFR 703.2; and 12 CFR 704.2.
---------------------------------------------------------------------------

    Consistent with section 202 of the FCUA,\80\ the Second Proposal 
also incorporated the phrase `in accordance with GAAP' into many of the 
definitions to clarify that generally accepted accounting principles 
must 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. This proposed change was intended to help 
clarify the meaning of terms used in the Second Proposal.
---------------------------------------------------------------------------

    \80\ 12 U.S.C. 1782(a)(6)(C)(i).
---------------------------------------------------------------------------

    The Board received no comments on the proposed technical changes to 
Sec.  702.2. The Board did, however, receive one general comment on the 
definitions section: At least one commenter stated that the revisions 
to the definitions, particularly those that now rely on GAAP 
definitions, seemed fair and reasonable. At least one commenter also 
suggested that the proposed changes to the definitions were all for the 
better and made the rule much clearer. The Board agrees with the 
commenters and has decided to retain the changes described above in 
this final rule.
    The following definitions, consistent with the Second Proposal, are 
also added to, amended in, or removed from Sec.  702.2 by this final 
rule:
    Allowances for loan and lease losses (ALLL). The Second Proposal 
defined the term ``allowances for loan and lease losses'' 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.
    The Board received no comments on the proposed definition and has 
decided to retain the definition in this final rule without change.
    Amortized cost. The Second Proposal defined the term ``amortized 
cost'' 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.
    The Board received no comments on the proposed definition and has 
decided to retain the definition in this final rule without change.
    Appropriate regional director. The Second Proposal would have 
amended current Sec.  702.2 to remove the definition of the term 
``appropriate regional director'' from the current rule.
    The Board received no comments on this proposed revision and has 
decided to retain the revision in this final rule without change.
    Appropriate state official. Under the Second Proposal, the Board 
proposed revising the definition of the term ``appropriate state 
official'' by adding the italicized words (``state'' and ``the'') to 
the current definition, and by removing the words ``chartered by the 
state which chartered the affected credit union.'' The revised 
definition would have provided that the term ``appropriate state 
official'' means the state commission, board or other supervisory 
authority having jurisdiction over the credit union.

Public Comments on the Second Proposal

    One commenter suggested that, although the proposed revision to the 
definition was meant to provide clarity, it might obfuscate the role of 
state supervisors in the PCA process because several states could have 
``jurisdiction'' over a given credit union on a particular issue. In 
contemplating the possible effects of the proposed revision, the 
commenter asked a number of questions: Will NCUA consult with all state 
regulators where an affected credit union has a branch or member when 
taking discretionary supervisory action? \81\ Will a credit union have 
to obtain approval from all states that it operates in before issuing 
dividends when less than adequately capitalized? \82\ The commenter 
suggested further that while timely sharing of information across all

[[Page 66644]]

affected regulators was a laudable goal, crucial and time sensitive 
decisions regarding the reclassification or conservatorship of a credit 
union should be made by only the primary chartering authority of the 
institution in consultation with the deposit insurer. Accordingly, the 
commenter recommended that the Board should amend this definition to 
read ``the state commission, board or other supervisory authority which 
chartered the affected credit union.''
---------------------------------------------------------------------------

    \81\ 12 CFR 702.110(c).
    \82\ 12 CFR 702.114(b).
---------------------------------------------------------------------------

Discussion

    The Board generally agrees with the commenter and is adopting the 
proposed revisions to the definition of ``appropriate state official'' 
by making the following changes: At the end of the proposed the 
definition, the final rule deletes the words ``having jurisdiction over 
the'' from the proposed definition, and adds in their place the words 
``that chartered the affected.'' This change clarifies that NCUA must 
consult with only the state authority that chartered the credit union; 
not every state agency having some form of jurisdiction over the credit 
union.
    Accordingly, the final rule defines ``appropriate state official'' 
as the state commission, board or other supervisory authority that 
chartered the affected credit union.
    Call Report. The Second Proposal defined the term ``Call Report'' 
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 and has decided to 
retain the proposed definition in this final rule without change.
    Carrying value. The Second Proposal defined the term ``carrying 
value,'' 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.
    The Board received no comments on the proposed definition, but is 
clarifying in this final rule that ``carrying value'' applies to both 
assets and liabilities. Accordingly, this final rule defines ``carrying 
value'' as the value of the asset or liability on the statement of 
financial condition of the credit union, determined in accordance with 
GAAP.
    Central counterparty (CCP). The Second Proposal defined the term 
``central counterparty'' 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 received no comments on the definition and has decided to 
retain the proposed definition in this final rule without change.
    Charitable donation account. The Second Proposal did not use or 
define the term ``charitable donation account.'' Under the proposal, 
such accounts, which federal credit unions are authorized to establish 
under Sec.  721.3(b)(2) of NCUA's regulations, would have been assigned 
a risk weight based on the risk-weight of each individual asset type in 
the account.

Public Comments on the Second Proposal

    NCUA received several comments regarding the risk weights assigned 
to charitable donation accounts under the Second Proposal. Commenters 
suggested that the proposed risk weights assigned to charitable 
donation accounts would contravene the appeal for credit unions to put 
money into these investments to fund charitable activities. The 
commenters pointed out that the risk-based capital regulation from the 
Office of the Comptroller of the Currency (OCC) recognizes the 
importance of community development investments and assigns a risk 
weight of 100 percent to such assets. Commenters suggested that the 
NCUA Board should adopt a similar approach to encourage charitable 
donation accounts to support charitable goals and purposes.

Discussion

    The Board generally agrees with the commenters and, as also 
discussed in the part of the preamble associated with Sec.  702.104(c), 
has decided to assign a 100 percent risk weight to certain charitable 
donation accounts under this final rule, at the credit union's option. 
Under the Second Proposal, the assets held in a charitable donation 
account were each assigned a risk weight based on each individual asset 
type in the account. After reviewing the comments received, however, 
the Board generally agrees with commenters who suggested that 
charitable donation account equity exposures, which are held at credit 
unions, have a role analogous to community development equity 
exposures, which are held at banks, and therefore warrant assigning 
such accounts an equivalent risk weight. Community development equity 
exposures are assigned a 100 percent risk weight under the Other 
Banking Agencies' regulations. Thus, this final rule gives credit 
unions the option for risk weighting charitable donation accounts in a 
manner that is generally equivalent to the Other Banking Agencies' 100 
percent risk weight for community development investment equity 
exposures. Under this final rule, a credit union has the option of 
applying risk weights to the individual assets within a charitable 
donation account, or just applying a 100 percent risk weight to the 
whole charitable donation account. A credit union cannot, however, use 
a combination of the two methods described to assign a risk weight to 
the same charitable donation account.
    In defining ``charitable donation account,'' the Board chose to 
limit the types of accounts that would qualify for the 100 percent risk 
weight. In particular, the Board chose allow such treatment for 
accounts only if they met certain restrictions in 12 CFR 
721.3(b)(2)(i), (b)(2)(ii), and (b)(2)(v). Thus, to qualify for the 
optional 100 percent risk weight under Sec.  702.104(c)(3)(ii) of this 
final rule, an account must meet the following criteria:
     The book value of the credit union's investments in all 
charitable donation accounts (CDAs), in the aggregate, as carried on 
its statement of financial condition prepared in accordance with 
generally accepted accounting principles, must be limited to 5 percent 
of the credit union's net worth at all times for the duration of the 
accounts, as measured every quarterly Call Report cycle. This means 
that regardless of how many CDAs the credit union invests in, the 
combined book value of all such investments must not exceed 5 percent 
of its net worth. The credit union must bring its aggregate accounts 
into compliance with the maximum aggregate funding limit within 30 days 
of any breach of this limit.
     The assets of a charitable donation account must be held 
in a segregated custodial account or special purpose entity and must be 
specifically identified as a charitable donation account.
     The credit union is required to distribute to one or more 
qualified charities, no less frequently than every 5 years, and upon 
termination of a charitable donation account regardless of the length 
of its term, a minimum of 51 percent of the account's total return on 
assets over the period of up to 5 years. Other than upon termination, 
the credit union may choose how frequently charitable donation account 
distributions to charity will be made during each period of up to 5 
years. For example, the credit union may choose to make periodic 
distributions over a period of up to 5 years, or only a single 
distribution as required at the end of that period. The credit union 
may choose to donate in excess of the minimum distribution frequency 
and amount;

[[Page 66645]]

    The three criteria above are included in the definition of 
charitable donation account to ensure that such accounts, if assigned a 
100 percent risk weight, will be used primarily for charitable purposes 
and not present a material risk to a credit union regardless of the 
types of assets held in the accounts. The definition includes a 5 
percent of net worth limit on charitable donation accounts to reflect 
an amount that allows a credit union to generate income for the charity 
while ensuring any risks associated with such accounts do not pose 
safety and soundness issues. In determining the 5 percent of net worth 
limit, the Board considered the investment types a credit union could 
purchase in a charitable donation account, which can include 
investments with significant credit risk. The Board determined that a 5 
percent of net worth limit was reasonable given NCUA's charitable 
donation account regulations and necessary to ensure that the accounts 
were small enough to not pose a safety and soundness issue to the 
NCUSIF if assigned a 100 percent risk weight.
    The definition also specifies that charitable donation accounts 
must be held in segregated custodial accounts or special purpose 
entities, and must be specifically identified as charitable donation 
accounts, to ensure holdings can be measured for exposure and monitored 
for performance and distribution. The Board determined the segregation 
of accounts is necessary to ensure a credit union and NCUA could 
measure compliance with the net worth and distribution criteria, 
consistent with safety and soundness and the account's purpose.
    Finally, the definition specifies that distributions must be made 
in a particular manner to ensure such accounts are used primarily for 
charitable giving. By specifying the distribution manner, the 
definition of charitable donation account ensures that the account will 
primarily be used for charitable giving. This distinction is generally 
consistent with the Other Banking Agencies' regulations, which assign a 
100 percent risk-weight to community development investment equity 
exposures.
    Without each of the three criteria discussed above, a charitable 
donation account would primarily be an investment vehicle for a credit 
union and could present a material risk to the credit union and the 
NCUSIF. Accordingly, this final rule defines ``charitable donation 
account'' as an account that satisfies all of the conditions in 12 CFR 
721.3(b)(2)(i), (b)(2)(ii), and (b)(2)(v).
    Commercial loan. The Second Proposal defined the new term 
``commercial loan'' 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 have also provided that the term commercial loan excludes loans 
to CUSOs, first- or junior-lien residential real estate loans, and 
consumer loans.

Public Comments on the Second Proposal

    The Board received many comments regarding the proposed new term 
``commercial loan'' and its definition. Several commenters agreed with 
creating a category of ``commercial loans'' as distinct from 
traditional member business loans for purposes of the risk-based 
capital ratio requirement. At least one commenter stated that, while 
differentiating between ``commercial loans'' for risk-based capital 
purposes and ``member-business loans'' as defined for lending purposes 
is appropriate, the subtle differences in these definitions may cause 
confusion. Similarly, another commenter suggested that even though it 
would require changes to the call report and how credit union classify 
these loans, the Board was right to use the broader definition of 
commercial loans in the proposal because there is no difference in the 
credit risk of member business loans and commercial loans.
    Conversely, other commenters suggested that replacing the term 
``member business loan,'' which credit unions and NCUA's regulations 
already use, with the new term ``commercial loan'' for purposes of the 
risk-based capital regulation would cause unnecessary confusion. Other 
commenters suggested that the proposed definition of ``commercial 
loan'' should be revised to be consistent with the definition of 
``member business loan'' in part 723 of NCUA's regulations because they 
believed the differences between the two definitions were immaterial to 
a credit union's capital requirement, but would add unnecessary 
administrative burden to the Call Report.
    In addition, a trade association commenter pointed out that the 
proposed definition of a ``commercial loan'' specifies that it is a 
loan ``to individuals, sole proprietorships, partnerships, 
corporations, or other business enterprises,'' and explicitly excludes 
loans to CUSOs, first- or junior-lien residential real estate loans, 
and consumer loans. The commenter pointed out, however, that the 
preamble to the Second Proposal seemed to indicate that whether or not 
a loan is ``commercial'' will be based exclusively on the purpose of 
the loan, use of the proceeds, and type of collateral. The Commenter 
suggested that if a loan can be considered commercial regardless of the 
type of borrower, the Board should consider removing the list of 
potential borrowers and simply retaining the exclusions of specific 
loan types. The commenter suggested further that the proposal specified 
that a commercial loan is a loan made for ``commercial, industrial, and 
professional purposes, but not for investment or personal expenditure 
purposes.'' But, under part 723 of NCUA's regulations, MBLs are made 
for commercial, corporate, other business investment property or 
venture, or agricultural purposes.\83\ The commenter recommending 
clarifying the alignment of these two definitions in the final rule, 
and that if the only intended differences in treatment arise from the 
definitions of loans to CUSOs, first- or junior-lien residential real 
estate loans, and consumer loans, then the Board should consider 
adopting the member business loan language and retaining those explicit 
exclusions. At least one commenter also pointed out that current Sec.  
723.1(d) and (e) of NCUA's member business lending regulations 
reference treatment of purchased member and non-member loans and loan 
participations for risk-weight purposes under part 702, and encouraged 
the Board to review those sections for consistency with the proposed 
definition of commercial loan. Another commenter requested that the 
Board clarify whether the definition of ``commercial loans'' includes 
loans to non-profits. One state supervisory authority commenter 
requested clarification on whether the definition, which lists a number 
of specific asset types, would include agricultural loans.
---------------------------------------------------------------------------

    \83\ 12 CFR 723.1(a).
---------------------------------------------------------------------------

Discussion

    As stated in the Second Proposal, the new term ``commercial loan'' 
and its proposed definition more accurately capture the risks these 
loans present than the term MBL, and better identifies loans that are 
made for a commercial purpose and have similar risk characteristics. 
While there could be some initial confusion associated with the use of 
this new term, the Board notes that such confusion can be addressed 
during the implementation period and in guidance before the final rule 
becomes effective in 2019.

[[Page 66646]]

Guidance contained in the Call Report for the proper reporting of 
commercial loans will also provide information to credit unions to 
ensure proper reporting of both ``commercial'' loans for the purpose of 
assigning risk weights and the reporting of MBLs for the purpose of 
monitoring compliance with the statutory limit.
    The Board agrees, however, with commenters who suggested that the 
purpose of a loan determine its classification as a ``commercial'' 
loan. The risks associated with a commercial loan are related to its 
purpose. Moreover, the proposed list of entities that could have 
received the loans encompassed all possibilities, including non-profit 
organizations. Thus the removal of the list of parties who could 
receive the loans would be inconsequential. Accordingly, the Board is 
amending the definition of ``commercial loan'' to remove the words ``to 
individuals, sole proprietorships, partnerships, corporations, or other 
business enterprises.''
    The Board maintains, however, that the listing of commercial 
purposes in the proposed definition was adequate and plainly included 
agricultural loans if they are granted for a commercial or industrial 
purpose. Similarly, it is clear that a loan purchased by a credit 
union, which was made for a commercial purpose, was also included 
within the proposed definition of a commercial loan, whether it is a 
loan to member or non-member. Thus no additional changes to the 
definition are necessary.
    Accordingly, this final rule defines ``commercial loan'' as any 
loan, line of credit, or letter of credit (including any unfunded 
commitments) for commercial, industrial, and professional purposes, but 
not for investment or personal expenditure purposes. The definition 
provides further that the term commercial loan excludes loans to CUSOs, 
first- or junior-lien residential real estate loans, and consumer 
loans.
    Commitment. The Second Proposal defined the term ``commitment'' 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 Board received no comments on the proposed definition, but has 
decided to clarify in this final rule that a ``commitment'' can also 
refer to funding transactions. Accordingly, this final rule would 
define ``commitment'' as any legally binding arrangement that obligates 
the credit union to extend credit, purchase or sell assets, enter into 
a borrowing agreement, or enter into a financial transaction.
    Consumer loan. The Second Proposal defined the term ``consumer 
loan'' 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 
have provided 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.

Public Comments on the Second Proposal

    The proposed definition of ``consumer loan'' referenced loans ``to 
one or more individuals . . . including any loans secured by vehicles 
generally manufactured for personal, family, or household use 
regardless of the purpose of the loan.'' At least one commenter 
requested that the Board clarify whether the same loan would still be 
considered a consumer loan if made to an incorporated entity. If the 
definition is not dependent on the type of borrower, the commenter 
suggested that the words ``one or more individuals'' were not 
necessary. The commenter also requested that the Board clarify the 
definition of a loan ``for the purchase of fleet vehicles,'' and, to 
maximize ease of compliance, recommended the Board incorporate the 
definition of ``fleet'' contained in a 2012 NCUA legal opinion directly 
into the definition.\84\
---------------------------------------------------------------------------

    \84\ NCUA, Definition of Fleet, Legal Opinion Letter 12-0764 
(Sept. 13, 2012), available at http://www.ncua.gov/Legal/Pages/OL2012-12-0764.aspx.
---------------------------------------------------------------------------

Discussion

    The Board agrees with the commenter who suggested that a consumer 
loan should be defined by the purpose of the loan and not depend on the 
type of entity receiving the loan, be it an individual, corporation, or 
some other business. The material risks associated with holding a 
prudently underwritten consumer loan are related to its purpose, not on 
the type of borrower. Accordingly, this final rule amends the proposed 
definition of consumer loan to remove the words ``to one or more 
individuals'' from the definition.
    The Board also generally agrees with the commenter who suggested 
the final rule should further clarify the reference to ``fleet 
vehicles'' in the proposed definition of consumer loans. As pointed out 
by the commenter, NCUA's General Counsel issued a legal opinion letter 
in 2012 that interprets the term ``fleet'' for purposes of Sec.  
723.7(e) of NCUA's regulations.\85\ The letter provides that a fleet 
means ``five or more vehicles that are centrally controlled and used 
for a business purpose, including for the purpose of transporting 
persons or property for commission or hire.'' The meaning of the term 
``fleet,'' as used in the proposed definition of consumer loan, should 
be consistent with the use of the term in Sec.  723.7(e). While the 
Second Proposal did not propose adopting the definition of ``fleet'' 
provided in the 2012 legal opinion letter, the term should have the 
same meaning. The term does not need to be defined in this final rule. 
Future changes in market realities surrounding the use of the term 
``fleet'' make adopting a fixed definition of the term impractical. The 
Board agrees, however, that revising the proposed use of the term 
``fleet'' in the definition of consumer loan to be more consistent with 
the use of the term fleet in Sec.  723.7(e) will help avoid confusion 
regarding the term's meaning. Accordingly, the final rule revises the 
last clause in the second sentence of the definition of the term 
``consumer loan'' to provide, ``and loans for the purchase of one for 
more vehicles to be part of a fleet of vehicles.''
---------------------------------------------------------------------------

    \85\ NCUA, Definition of Fleet, Legal Opinion Letter 12-0764 
(Sept. 13, 2012), available at http://www.ncua.gov/Legal/Pages/OL2012-12-0764.aspx.
---------------------------------------------------------------------------

    NCUA will provide separate examiner guidance on the application of 
the definition of consumer loans to ensure consistent interpretation of 
the definition in the future. NCUA's Call Report instructions will also 
contain appropriate guidance for the proper reporting of consumer 
loans. For the reasons discussed above, this final rule defines the 
term ``consumer loan'' as a loan for household, family, or other 
personal expenditures, including any loans that, at origination, are 
wholly or substantially secured by vehicles generally manufactured for 
personal, family, or household use regardless of the purpose of the 
loan. The definition provides 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 one or 
more vehicles to be part of a fleet of vehicles.
    Contractual compensating balance. The Second Proposal defined the 
term ``contractual compensating balance'' 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.

[[Page 66647]]

    The Board received no comments on the definition and has decided to 
retain the proposed definition in this final rule without change.
    Credit conversion factor (CCF). The Second Proposal defined the 
term ``credit conversion factor'' as the percentage used to assign a 
credit exposure equivalent amount for selected off-balance sheet 
accounts.
    The Board received no comments on this definition and has decided 
to retain the proposed definition in this final rule without change.
    Credit union. The Second Proposal defined the term ``credit union'' 
as a federally insured, natural-person credit union, whether federally 
or state-chartered. The proposal would have amended 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 were unnecessary, and could mistakenly be read to limit the 
definition of ``credit unions'' to state-chartered credit unions.
    The Board received no comments on the proposed revisions to the 
definition of ``credit union'' and has decided to retain the proposed 
definition in this final rule without change.
    Current. The Second Proposal defined the term ``current,'' with 
respect to any loan, as less than 90 days past due, not placed on non-
accrual status, and not restructured.

Public Comments on the Second Proposal

    The Board received only a small number of comments on the proposed 
definition of the term ``current.'' Most commenters who mentioned it 
supported the proposed definition of ``current.'' One credit union 
commenter, however, suggested that the Board should define ``current'' 
as loans that are 60 days past due, which was the period provided in 
the Original Proposal, because expanding the delinquency loans to 90 
days has more risk and greater exposer to potential loss. Another 
commenter recommended that the definition of ``current'' be revised so 
it does not automatically exclude all restructured loans. Another 
commenter argued that while it is understandable to require a higher 
risk-weighting for non-current loans, lumping restructured loans into 
this same category and treatment would be punitive. The commenter 
suggested that the definition of ``restructured loans'' be amended to 
specifically address loans that the commenter referred to as ``troubled 
debt relief assets,'' which are loans that have been modified because 
of financial hardship in the face of some type of credit impairment. 
According to the commenter, the Financial Accounting Standards Board 
already requires excess reserves be held for these assets based on the 
difference between the net present value of the loans under the 
original terms versus the modified terms. The commenter contended that 
credit unions currently hold reserves of over 10 percent against loans 
that are performing and have very low incidents of future default. 
Therefore, the commenter concluded, treating a ``troubled debt relief 
asset'' as a non-current loan would not reflect the fact that a 
modification has been made to a loan and it is performing. The 
commenter suggested that such restructurings aid the future performance 
of such loans.

Discussion

    The Board believes that the proposed definition of ``current'' is 
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,'' and aligns 
well with the definition of ``current loan'' under the Other Banking 
Agencies' regulations.\86\ In general, loans that are more than 90 days 
past due, or restructured, tend to have higher incidences of default 
resulting in losses. The proposed definition is consistent with the 
definition used under the Other Banking Agencies' risk-based capital 
rules and is not dependent upon, nor contradictory to, related 
accounting pronouncements. Additional guidance will be provided to 
credit unions in the future regarding reporting troubled debt 
restructuring (TDR) loans through supervisory guidance and in the 
instructions on the Call Report. Accordingly, the Board has decided to 
retain the proposed definition in this final rule without change.
---------------------------------------------------------------------------

    \86\ See, e.g., 12 CFR 324.32(k).
---------------------------------------------------------------------------

    CUSO. The Second Proposal defined the term ``CUSO'' as a credit 
union service organization as defined in parts 712 and 741.
    The Board received no comments on this definition and has decided 
to retain the proposed definition in this final rule without change.
    Custodian. The Second Proposal defined the term ``custodian'' 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 received no comments on this definition and has decided 
to retain the proposed definition in this final rule without change.
    Depository institution. The Second Proposal defined the term 
``depository institution'' 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 provided 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 Board received no comments on this definition and has decided 
to retain the proposed definition in this final rule without change.
    Derivatives Clearing Organization (DCO). The Second Proposal 
defined the term ``Derivatives Clearing Organization (DCO)'' as having 
the same definition as provided by the Commodity Futures Trading 
Commission in 17 CFR 1.3(d).
    The Board received no comments on this definition and has decided 
to retain the proposed definition in this final rule without change.
    Derivative contract. The Second Proposal defined the term 
``derivative contract'' 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 provided 
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 also provided 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 or five business days.
    The Board received no comments on this definition and has decided 
to retain the proposed definition in this final rule without change.
    Equity investment. The Second Proposal defined the term ``equity

[[Page 66648]]

investment'' as investments in equity securities, and any other 
ownership interests, including, for example, investments in 
partnerships and limited liability companies.
    The Board received no comments on this definition and has decided 
to retain the proposed definition in this final rule without change.
    Equity investment in CUSOs. The Second Proposal defined the term 
``equity investment in CUSOs'' 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 received no comments on this definition and has decided 
to retain the proposed definition in this final rule without change.
    Exchange. The Second Proposal defined the term ``exchange'' as a 
central financial clearing market where end users can trade 
derivatives.
    The Board received no comments on this definition, but has decided 
to clarify in this final rule that derivatives are engaged in through 
agreements and not traded like securities. Accordingly, this final rule 
would define ``exchange'' as a central financial clearing market where 
end users can enter into derivative transactions.
    Excluded goodwill, and excluded other intangible assets. The Second 
Proposal defined the term ``excluded goodwill'' 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 Register. The definition provided further that the term 
excluded goodwill and its accompanying definition would expire on 
January 1, 2025.
    The Second Proposal would have also defined the 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 provided further 
that the term excluded other intangible assets and its accompanying 
definition would expire on January 1, 2025.

Public Comments on the Second Proposal

    The Board received many comments regarding the proposed treatment 
of goodwill and other intangible assets under NCUA's risk-based capital 
requirement. A significant number of commenters requested that the 
terms ``excluded goodwill'' and ``excluded intangible assets'' and 
their proposed treatment be retained permanently (or, if not retained 
permanently, commenters requested that the time period during which 
they are allowed be extended). The specific comments received and a 
more detailed description of the Board's response are provided below in 
the part of the preamble associated with Sec.  702.104(b)(2).

Discussion

    The Board generally agrees with commenters who suggested the time 
periods allowed for these proposed exclusions be extended. The Board 
added these two definitions to take into account the impact goodwill or 
other intangible assets recorded from transactions defined as 
supervisory mergers or combinations have on the calculation of the 
risk-based capital ratio upon implementation. The proposed exclusions 
would have applied to supervisory mergers or combinations that were 
completed prior to the date of publication of this final rule in the 
Federal Register. The proposed exclusion would have ended on January 1, 
2025. For the reasons discussed below in the part of the preamble 
associated with Sec.  702.104(b)(2), the Board has decided to revise 
the proposed definitions of ``excluded goodwill'' and ``excluded other 
intangible assets'' to extend the period during which credit unions can 
count these assets in the risk-based capital ratio numerator to January 
1, 2029. In addition, the Board is extending the period, after the 
publication of this final rule in the Federal Register, during which 
credit unions can obtain ``excluded goodwill'' and ``excluded other 
intangible assets'' to 60 days to allow credit unions additional time 
to adjust to the changes made by this final rule.
    Accordingly, this final rule defines ``excluded goodwill'' as the 
outstanding balance, maintained in accordance with GAAP, of any 
goodwill originating from a supervisory merger or combination that was 
completed on or before a date to be set upon publication, which will be 
60 days after publication of this final rule in the Federal Register. 
The definition provides further that the term and definition expire on 
January 1, 2029.
    Similarly, this final rule also defines ``excluded other intangible 
assets'' as 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 on or 
before a date to be set upon publication, which will be 60 days after 
publication of this final rule in the Federal Register. The definition 
provides further that the term and definition expire on January 1, 
2029.
    Exposure amount. The Second Proposal defined the term ``exposure 
amount'' 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.
    The Board received no comments on this definition and has decided 
to retain the proposed definition in this final rule without change.
    Fair value. The Second Proposal defined the term ``fair value'' as 
having the same meaning as provided in GAAP.
    The Board received no comments on this definition and has decided 
to retain the proposed definition in this final rule without change.
    Financial collateral. The Second Proposal defined the term 
``financial collateral'' 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 received no comments on this definition and has decided 
to retain the proposed definition in this final rule without change.
    First-lien residential real estate loan. The Second Proposal 
defined the term ``first-lien residential real estate loan'' 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-

[[Page 66649]]

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.
    The Board received no comments on this definition and has decided 
to retain the proposed definition in this final rule without change.
    GAAP. The Second Proposal defined the term ``GAAP'' 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 received no comments on this definition and has decided 
to retain the proposed definition in this final rule without change.
    General account permanent insurance. The Second Proposal defined 
the term ``general account permanent insurance'' 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 the proposed 
definition, general account permanent insurance would have included 
direct obligations to the insurance provider. This would have meant 
that the credit risk associated with general account permanent 
insurance was to the insurance company, which generally makes such 
insurance accounts have a lower credit risk than separate account 
insurance. A separate account insurance is a segregated accounting and 
reporting account held separately from the insurer's general assets.
    The Board received no comments on this definition and has decided 
to retain the proposed definition in this final rule without change.
    General obligation. The Second Proposal defined the term ``general 
obligation'' as a bond or similar obligation that is backed by the full 
faith and credit of a public sector entity.
    The Board received no comments on this definition and has decided 
to retain the proposed definition in this final rule without change.
    Goodwill. The Second Proposal defined the term ``goodwill'' 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. The Proposed definition provided 
further that goodwill does not include excluded goodwill.
    The Board received no comments on this definition and has decided 
to retain the proposed definition in this final rule without change.
    Government guarantee. The Second Proposal defined the term 
``government guarantee'' as a guarantee provided by the U.S. 
Government, FDIC, NCUA or other U.S. Government agencies, or a public 
sector entity.

Public Comments on the Second Proposal

    One state supervisory authority commenter requested clarification 
on the definition of ``government guarantee,'' and whether the 
definition includes any type of guarantee from a state government, 
state government agency, or municipality.

Discussion

    The Board definition of ``government guarantee'' does include 
guarantees from a state government, state government agency, or 
municipality. The definition expressly includes a guarantee provided by 
a ``public sector entity,'' which the second proposal defines 
separately in Sec.  702.2 as a state, local authority, or other 
governmental subdivision of the United States below the sovereign 
level. The proposed definition of ``public sector entity'' would 
include state governments, state government agencies, and 
municipalities. Accordingly, the Board has decided to retain the 
proposed definition of ``government guarantee'' in this final rule 
without change.
    Government-sponsored enterprise (GSE). The Second Proposal defined 
the term ``government-sponsored enterprise'' 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.
    The Board received no comments on this definition and has decided 
to retain the proposed definition in this final rule without change.
    Guarantee. The Second proposal defined the term ``guarantee'' 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 received no comments on this definition and has decided 
to retain the proposed definition in this final rule without change.
    Identified losses. The Second Proposal defined the term 
``identified losses'' 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 provided 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.

Public Comments on the Second Proposal

    At least one commenter requested that the Board specify in the 
definition of ``identified losses'' that such losses are only 
chargeable against losses.

Discussion

    The commenter's suggested revision to the proposed definition is 
not consistent with generally accepted accounting principles. The 
definition of ``identified losses'' specifies that it be recorded in 
accordance with GAAP to appropriately address this matter and any 
further limiting conditions could run afoul of GAAP reporting. 
Accordingly, the Board has decided to retain the proposed definition in 
this final rule without change.
    Industrial development bond. The Second Proposal defined the term 
``industrial development bond'' 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.
    The Board received no comments on this definition and has decided 
to retain the proposed definition in this final rule without change.
    Intangible assets. The Second Proposal defined the term 
``intangible assets'' as assets, maintained in accordance with GAAP, 
other than financial assets, that lack physical substance.
    The Board received no comments on this definition and has decided 
to retain the proposed definition in this final rule without change.
    Investment fund. The Second Proposal defined the term ``investment 
fund'' as an investment with a pool of underlying investment assets. 
The proposed definition provided further that the term investment fund 
includes an investment company that is

[[Page 66650]]

registered under section 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 received no comments on this definition and has decided 
to retain the proposed definition in this final rule without change.
    Junior-lien residential real estate loan. The Second Proposal 
defined the term ``junior-lien residential real estate loan'' as a loan 
or line of credit secured by a subordinate lien on a one-to-four family 
residential property. The proposed definition generally included all 
residential real estate loans that did not meet the definition of a 
first-lien residential real estate loan because the credit union is 
secured by a second or subsequent lien on the residential property 
loan.
    The Board received no comments on this definition and has decided 
to retain the proposed definition in this final rule without change.
    Limited Recourse. The Second Proposal did not define the term 
``limited recourse.''

Public Comments on the Second Proposal

    At least one commenter suggested that the Board define ``limited 
recourse'' as provided under GAAP and clarify that the definition 
excludes normal reps and warranties in a loan sale transaction.

Discussion

    There is no need to define ``limited recourse'' because the Second 
Proposal and this final rule define the term ``loans transferred with 
limited recourse.'' That definition provides sufficient information 
regarding the rule's use of the term ``limited recourse,'' and 
adequately addresses the normal representations and warranties 
associated with limited recourse. Accordingly, the Board has decided 
not to separately define the term ``limited recourse'' in this final 
rule.
    Loan to a CUSO. The Second Proposal defined the term ``loan to a 
CUSO'' 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 received no comments on this definition and has decided 
to retain the proposed definition in this final rule without change. 
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 risk 
weight of a loan to a CUSO is normally zero since the consolidation 
entries eliminate the intercompany transaction.
    Loan secured by real estate. The Second Proposal defined the term 
``loan secured by real estate'' 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 
provided 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 also provided 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 received no comments on this definition and has decided 
to retain the proposed definition in this final rule without change.
    Loans transferred with limited recourse. The Second Proposal 
defined the term ``Loans transferred with limited recourse'' 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 provided 
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.
    The Board received no comments on this definition and has decided 
to retain the proposed definition in this final rule without change.
    Mortgage-backed security (MBS). The Second Proposal defined the 
term ``mortgage-backed security'' 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.
    The Board received no comments on this definition and has decided 
to retain the proposed definition in this final rule without change.
    Mortgage partnership finance program. The Second Proposal defined 
the term ``mortgage partnership finance program'' 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.

Public Comments on the Second Proposal

    The Board received several comments on the proposed definition of 
``mortgage partnership finance program.'' One commenter explained that 
the Federal Home Loan Banks have programs through which they acquire 
conventional and government-issued residential mortgage loans from 
certain of their members, called Participating Financial Institutions 
(PFIs). The commenter explained that the Mortgage Partnership Finance 
(MPF) Program is offered today by most Federal Home Loan Banks, but 
that the Federal Home Loan Banks of Cincinnati and Indianapolis each 
independently operate a similar member product called the Mortgage 
Purchase Program (MPP). According to the commenter, both the MPP and 
MPF Programs operate pursuant to Federal Housing Finance Agency 
regulation and the majority of PFIs that sell mortgage loans under 
these programs are small to mid-sized community banks, thrifts, and 
credit unions. Several commenters suggested that NCUA's proposed 
definition of ``Mortgage Partnership Finance Program,'' could be 
reasonably construed to only apply to MPF Program loans that a credit 
union services. If the intent of the rule is to treat all MPF program 
loans the same, regardless of whether the credit union retains or sells 
the servicing, then the commenters recommended the Board clarify the 
definition by deleting the words ``and servicing them'' from the 
definition of ``Mortgage Partnership Finance Program.''
    Commenters also suggested that, although the MPP and the MPF 
Programs are similar in many respects, there is an important difference 
regarding recourse risk. According to the commenters, the MPF Program 
achieves credit enhancement by creating a contingent liability for PFIs 
while the MPP achieves credit enhancement by creating a contingent 
asset for the PFI. Because credit unions retain recourse risk on MPF 
loans but not on MPP loans, the commenters recommended

[[Page 66651]]

that the Board amend the proposed definition of ``Mortgage Partnership 
Finance Program'' to clarify that the term expressly excludes MPP 
loans. In particular, the commenters recommended that the Board add the 
words ``in a manner other than by establishing a contingent asset for 
the benefit of or payable to the depository institution'' at the end of 
the definition of Member Partnership Finance Program.

Discussion

    The Board generally agrees with the commenters who suggested 
removing the words ``and servicing them'' from the proposed definition 
of ``mortgage partnership finance program.'' The Board's intent is to 
treat all MPF program loans the same under the final rule regardless of 
whether the credit union retains or sells the servicing. Accordingly, 
this final rule revises the definition of mortgage partnership finance 
program to remove the words ``and servicing them.''
    The Board also agrees with commenters who suggested there is an 
important difference between the MPP and the MPF Programs regarding 
recourse risk. MPF loans are not the same as MPP loans with regard to 
risk because credit unions retain recourse risk through a credit 
enhancement obligation to the Federal Home Loan Bank for credit losses 
on MPF loans. Loans sold under the MPP program are risk-weighted based 
on the contractual recourse obligation, if any. Thus the commenters' 
suggested change to the definition of MPF Programs is necessary.
    Accordingly, this final rule defines ``mortgage partnership finance 
program'' 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 institution receives 
fees for managing the credit risk of the loans. The definition provides 
further that the credit risk must be shared between the depository 
institution and the Federal Home Loan Banks.
    Mortgage servicing assets. The Second Proposal defined the term 
``mortgage servicing asset'' 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.
    The Board received no comments on this definition and has decided 
to retain the proposed definition in this final rule without change.
    NCUSIF. The Second Proposal defined the term ``NCUSIF'' as the 
National Credit Union Share Insurance Fund as defined by 12 U.S.C. 
1783.
    The Board received no comments on this definition and has decided 
to retain the proposed definition in this final rule without change.
    Net worth. Generally consistent with the current rule, the Second 
Proposal defined the term ``net worth'' 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 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 section 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 Board received no comments on this definition and has decided 
to retain the proposed definition in this final rule without change.
    Net worth ratio. The Second Proposal defined the term ``net worth 
ratio'' as the ratio of the net worth of the credit union to the total 
assets of the credit union rounded to two decimal places.
    The Board received no comments on this definition and has decided 
to retain the proposed definition in this final rule without change.
    New credit union. The Second Proposal would have revised the 
definition of ``new credit union'' by removing the definition provided 
in current Sec.  702.2 and providing that the term has the same meaning 
as in Sec.  702.201.
    The Board received no comments on this definition and has decided 
to retain the proposed definition in this final rule without change.
    Nonperpetual capital. The Second Proposal defined the term 
``nonperpetual capital'' as having the same meaning as in 12 CFR 704.2.
    The Board received no comments on this definition and has decided 
to retain the proposed definition in this final rule without change.
    Off-balance sheet items. The Second Proposal defined the term 
``off-balance sheet items'' 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 received no comments on this definition and has decided 
to retain the proposed definition in this final rule without change.
    Off-balance sheet exposure. The Second Proposal defined the term 
``off-balance sheet exposure'' as: (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 received no comments on this definition and has decided 
to retain the proposed definition in this final rule without change.
    On-balance sheet. The Second Proposal defined the term ``on-balance 
sheet'' as a credit union's assets, liabilities, and equity, as 
disclosed on the statement of financial condition at a specific point 
in time.
    The Board received no comments on this definition and has decided 
to retain

[[Page 66652]]

the proposed definition in this final rule without change.
    Other intangible assets. The Second Proposal defined the term 
``other intangible assets'' as intangible assets, other than servicing 
assets and goodwill, maintained in accordance with GAAP. The definition 
provided further that other intangible assets does not include excluded 
other intangible assets.
    The Board received no comments on this definition and has decided 
to retain the proposed definition in this final rule without change.
    Over-the-counter (OTC) interest rate derivative contract. The 
Second Proposal defined the term ``over-the-counter (OTC) interest rate 
derivative contract'' as a derivative contract that is not cleared on 
an exchange.
    The Board received no comments on this definition and has decided 
to retain the proposed definition in this final rule without change.
    Part 703 compliant investment fund. The Second proposal used the 
term ``part 703 compliant investment fund,'' but did not specifically 
define the term in Sec.  702.2. The discussion in the preamble to the 
proposal, however, used the term to mean an investment fund that is 
restricted to holding only investments that are permissible under 12 
CFR 703.14(c).

Public Comments on the Second Proposal

    The Board received many comments on the risk weights assigned to 
``part 703 compliant investment funds.'' Some of the comments received 
seemed to indicate that credit unions and other interested parties were 
unclear regarding the rule's use of the term. The specific comments 
received regarding investment funds and part 703 compliance are 
discussed in more detail below in the part of preamble associated with 
Sec.  702.104(c).

Discussion

    The Board has decided to define the term ``part 703 compliant 
investment funds'' in Sec.  702.2 to clarify the meaning of the term 
and avoid possible confusion in the future. Accordingly, this final 
rule defines ``part 703 compliant investment fund'' as an investment 
fund that is restricted to holding only investments that are 
permissible under 12 CFR 703.14(c).
    Perpetual contributed capital. The Second Proposal defined the term 
``perpetual contributed capital'' as having the same meaning as in 12 
CFR 704.2.
    The Board received no comments on this definition and has decided 
to retain the proposed definition in this final rule without change.
    Public sector entity (PSE). The Second Proposal defined the term 
``public sector entity'' as a state, local authority, or other 
governmental subdivision of the United States below the sovereign 
level.
    The Board received no comments on this definition and has decided 
to retain the proposed definition in this final rule without change.
    Qualifying master netting agreement. The Second Proposal defined 
the term ``qualifying master netting agreement'' 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 received no comments on this definition and has decided 
to retain the proposed definition in this final rule without change.
    Recourse. The second Proposal defined the term ``recourse'' 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 provided 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 also provided 
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 
provided that recourse may also exist implicitly if the credit union 
provides credit enhancement beyond any contractual obligation to 
support assets it has transferred.
    The Board received no comments on this definition and has decided 
to retain the proposed definition in this final rule without change.
    Residential mortgage-backed security. The Second Proposal defined 
the term ``residential mortgage-backed security'' as a mortgage-backed 
security backed by loans secured by a first-lien on residential 
property.
    The Board received no comments on this definition and has decided 
to retain the proposed definition in this final rule without change.
    Residential property. The Second Proposal defined the term 
``residential property'' 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 
provided further that the term residential property excludes boats and 
motor homes, even if used as a primary residence, and timeshare 
property.
    The Board received no comments on this definition and has decided 
to retain the proposed definition in this final rule without change.
    Restructured. The Second Proposal defined the term 
``restructured,'' with respect to any loan, as a restructuring of the 
loan in which a credit union, for economic or legal reasons related to 
a

[[Page 66653]]

borrower's financial difficulties, grants a concession to the borrower 
that it would not otherwise consider. The definition provided further 
that the term restructured excludes loans modified or restructured 
solely pursuant to the U.S. Treasury's Home Affordable Mortgage 
Program.

Public Comments on the Second Proposal

    At least one commenter argued that the definition of the term 
``restructured,'' as it applied to loans, and the accompanying footnote 
in the preamble to the Second Proposal were troublesome.\87\ The 
commenter believed that the footnote accompanying the preamble 
discussion on the definition of ``restructured'' suggested that a loan 
that was restructured was what FASB calls a TDR. The commenter was 
confused further by the following statement in the preamble: ``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.'' \88\ According to the commenter, however, such a 
loan would be treated as a restructured loan for accounting purposes by 
FASB and under the TDR guidance. To avoid confusion, the commenter 
recommended that the Board amend the definition of ``restructured'' to 
be consistent with the standards and guidance set by FASB.
---------------------------------------------------------------------------

    \87\ See 80 FR 4339, 4369 (Jan. 27, 2015) (Footnote 119, 
referred to by the commenter, relates to Financial Accounting 
Standards Board ASC 310-40, ``Troubled Debt Restructuring by 
Creditors.'').
    \88\ Id. at 4369.
---------------------------------------------------------------------------

Discussion

    The proposed definition of ``restructured'' was based on the 
classification of restructured loans for the purpose of assigning 
appropriate risk weights. The proposed definition is consistent with 
the definition used under the Other Banking Agencies' risk-based 
capital rules and is not dependent upon nor contradictory to related 
accounting pronouncements. Additional guidance will be provided to 
credit unions in the future regarding risk-weighting restructured loans 
through supervisory guidance and in the instructions on the Call 
Report. Accordingly, the Board has decided to retain the proposed 
definition of ``restructured'' in this final rule without change.
    Revenue obligation. The Second Proposal defined the term ``revenue 
obligation'' as a bond or similar obligation that is an obligation of a 
public sector entity, but which the public sector entity is committed 
to repay with revenues from the specific project financed rather than 
general tax funds. Generally, such bonds or debts are paid with 
revenues from the specific project financed rather than the general 
credit and taxing power of the issuing jurisdiction.
    The Board received no comments on this definition and has decided 
to retain the proposed definition in this final rule without change.
    Risk-based capital ratio. The Second Proposal defined the term 
``risk-based capital ratio'' 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).
    The Board received no comments on this definition and has decided 
to retain the proposed definition in this final rule without change.
    Risk-weighted assets. The Second Proposal defined the term ``risk-
weighted assets'' as the total risk-weighted assets as calculated in 
accordance with Sec.  702.104(c).
    The Board received no comments on this definition and has decided 
to retain the proposed definition in this final rule without change.
    Secured consumer loan. The Second Proposal defined the term 
``secured consumer loan'' 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 received no comments on this definition and has decided 
to retain the proposed definition in this final rule without change.
    Senior executive officer. The Second Proposal defined the term 
``senior executive officer'' as a senior executive officer as defined 
by 12 CFR 701.14(b)(2).
    The Board received no comments on this definition and has decided 
to retain the proposed definition in this final rule without change.
    Separate account insurance. The Second Proposal defined the term 
``separate account insurance'' 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 received no comments on this definition and has decided 
to retain the proposed definition in this final rule without change.
    Shares. The Second Proposal defined the term ``shares'' as 
deposits, shares, share certificates, share drafts, or any other 
depository account authorized by federal or state law.
    The Board received no comments on this definition and has decided 
to retain the proposed definition in this final rule without change.
    Share-secured loan. The Second Proposal defined the term ``share-
secured loan'' as 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 12 CFR 701.39.
    The Board received no comments on this definition and has decided 
to retain the proposed definition in this final rule with the following 
conforming changes. This final rule amends the definition of share-
secured loans to be consistent with the new zero percent risk weight 
assigned to share-secured loans, where the shares securing the loan are 
on hold with the credit union, which is discussed in more detail below. 
Accordingly, this final rule defines the term ``share-secured loan'' as 
a loan fully secured by shares, and does not include the imposition of 
a statutory lien under Sec.  701.39 of this chapter.
    STRIPS. The Second Proposal defined the term ``STRIPS'' as separate 
traded registered interest and principal security.
    The Board received no comments on this definition and has decided 
to retain the proposed definition in this final rule without change.
    Structured product. The Second Proposal defined the term 
``structured product'' as an investment that is linked, via return or 
loss allocation, to another investment or reference pool.
    The Board received no comments on this definition and has decided 
to retain the proposed definition in this final rule without change.
    Subordinated. The Second Proposal defined the term ``subordinated'' 
to 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 provided further that 
the term subordinated does not apply to securities that are junior only 
to money market fund eligible securities in the same issuance.

Public Comments on the Second Proposal

    At least one commenter recommended the Board more clearly define 
the term ``subordinated'' with respect to a ``tranche.'' As discussed 
in the part of the preamble associated with Sec.  702.104(c)(2), 
commenters also expressed some confusion regarding NCUA's use of the 
term ``non-subordinated'' in the Second Proposal. Additionally, 
commenters expressed their desire to have the risk-weight assigned to a 
non-subordinated tranche

[[Page 66654]]

be based on the underlying collateral in the tranche.

Discussion

    The Second Proposal defined the terms ``subordinated'' and 
``tranche.'' These definitions, when read together, make it clear that 
a subordinated tranche is an investment that has a junior claim to 
other securities within the same transaction.
    The Board agrees, however, that clarifying the definition of 
``subordinated'' to clarify the meaning of the term non-subordinated in 
Sec.  702.2 will help clarify the meaning of the term for credit unions 
and other interested parties, and clarify that under this final rule 
all tranches of investments, regardless of standing, can be risk-
weighted using the gross-up approach. As discussed in more detail 
below, commenters suggested that credit unions be given the option of 
using the gross-up approach to risk-weight non-subordinated tranches of 
investments. A non-subordinated instrument is the most senior tranche 
in a security with a senior/subordinated structure. The Board has 
decided to further clarify the definition of ``subordinated'' for 
credit unions using the gross-up approach for both subordinated and 
non-subordinated investment tranches. This change will benefit credit 
unions purchasing non-subordinated tranches of securities 
collateralized with lower credit risk assets.
    Accordingly, this final rule defines the term ``subordinated'' as 
meaning, 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 also provides that an 
investment that does not have a junior claim to other investments in 
the same issuance on the underlying collateral or assets is non-
subordinated. Finally, the definition provides that a security that is 
junior only to money-market-eligible securities in the same issuance is 
also non-subordinated.
    Supervisory merger or combination. The Second Proposal defined the 
term ``supervisory merger or combination'' 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 identification and selection of the 
continuing credit union.
    The Board received no comments on this definition and has decided 
to retain the proposed definition in this final rule without change.
    Swap dealer. The Second Proposal defined the term ``swap dealer'' 
as having the same meaning as defined by the Commodity Futures Trading 
Commission in 17 CFR 1.3(ggg).
    The Board received no comments on this definition and has decided 
to retain the proposed definition in this final rule without change.
    Total assets. The Second Proposal retained the definition of 
``total assets'' in current Sec.  702.2, but would have restructured 
the definition and provided additional clarifying language. The 
proposal amended the definition to provide that ``total assets'' means 
a credit union's total assets as measured \89\ by either:
---------------------------------------------------------------------------

    \89\ 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).
---------------------------------------------------------------------------

     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;
     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;
     Average daily balance. The credit union's total assets 
measured by the average daily balance over the applicable calendar 
quarter; or
     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.

Public Comments on the Second Proposal

    One commenter suggested that the proposed definition of ``total 
assets'' would create inconsistency as to how risk-based capital 
results are reported and would hinder comparability among credit 
unions. The commenter recommended that the Board amend the definition 
to require that total assets be measured by the average of quarter-end 
balances of the current and three preceding calendar quarters.

Discussion

    With the exception of a few non-substantive amendments, the 
proposed definition of ``total assets'' is the same as the definition 
in current Sec.  702.2. In fact, the revision suggested by the 
commenter above would reduce the number of options available to a 
credit union in determining which total assets to apply in calculating 
its net worth ratio. Such a narrowing of the definition is not 
appropriate. Accordingly, the Board has decided to retain the proposed 
revisions to the definition in this final rule without change.
    Tranche. The Second Proposal defined the term ``tranche'' as one of 
a number of related securities offered as part of the same transaction. 
The definition provided 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 received no comments on this definition and has decided 
to retain the proposed definition in this final rule without change.
    Unfunded commitment. Neither the current rule nor the Second 
Proposal define the term ``unfunded commitment.''

Public Comments on the Second Proposal

    At least one commenter recommended that the Board define the term 
``unfunded commitment'' in the final rule because the commenter 
believed the proposed definition was unclear as to whether a credit 
union real estate loan pipeline or outstanding auto loan convenience 
check would be classified as an unfunded commitment.

Discussion

    The proposal provides in Sec.  702.2 that ``off-balance sheet 
exposure'' means, for unfunded commitments, the remaining unfunded 
portion of the contractual agreement. The definition of off-balance-
sheet exposure defines unfunded commitment, so adding an additional 
separate definition for unfunded commitment would be redundant. 
Additional guidance, however, will be included in future supervisory 
guidance and in the instructions on the Call Report. Accordingly, the 
Board has decided not to define the term ``unfunded commitment'' in 
this final rule.
    Unsecured consumer loan. The Second Proposal defined the term 
``unsecured consumer loan'' as a consumer loan not secured by 
collateral.
    The Board received no comments on this definition and has decided 
to retain the proposed definition in this final rule without change.
    U.S. Government agency. The Second Proposal defined the term ``U.S. 
Government agency'' as an

[[Page 66655]]

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 this definition and has decided 
to retain the proposed definition in this final rule with only minor 
clarifying amendments. In particular, the Board clarified in the 
definition that NCUA is a U.S. Government agency, to confirm that 
NCUA's obligations receive a zero percent risk weight. Accordingly, the 
final rule defines ``U.S. Government agency'' 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 definition provides 
further that the term ``U.S. Government agency'' includes NCUA.
    Weighted-average life of investments. Under the Second Proposal, 
the definition of ``weighted-average life of investments'' and the 
provisions in current Sec.  702.105 of NCUA's regulation would have 
been removed completely.
    Other than the comments supporting the removal of IRR from NCUA's 
risk-based capital requirement, the Board received no comments 
regarding the removal of this definition and has decided to retain the 
proposed amendment in this final rule without change.

A. Subpart A--Prompt Corrective Action

    The Second Proposal would have established a 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 
section 216(b)(2) of the FCUA.\90\ The Board received no comments on 
these revisions and has decided to retain the proposed amendments in 
this final rule.
---------------------------------------------------------------------------

    \90\ 12 U.S.C. 1790d(b)(2).
---------------------------------------------------------------------------

Section 702.101 Capital Measures, Capital Adequacy, Effective Date of 
Classification, and Notice to NCUA
    The Second Proposal retained the requirements of Sec.  702.101 
leaving it largely unchanged from current Sec.  702.101, with a few 
notable exceptions that are discussed in more detail below. The title 
of proposed Sec.  702.101 would have been changed to ``Capital 
Measures, capital adequacy, 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, proposed Sec.  702.101 
would have amended current Sec.  702.101 to include a new capital 
adequacy provision that was based on a similar provision in FDIC's 
capital regulations.\91\ The new capital adequacy provision was added 
as proposed Sec.  702.101(b). Paragraphs (b) and (c) of current Sec.  
702.101 would have been renumbered as paragraphs (d) and (e). The new 
capital adequacy provision would not have affected credit unions' PCA 
capital category, but could have supported the assessment of capital 
adequacy in the supervisory process (assigning CAMEL and risk ratings).
---------------------------------------------------------------------------

    \91\ 12 CFR 324.10.
---------------------------------------------------------------------------

Public Comments on the Second Proposal

    A substantial number of commenters objected to the proposed 
addition of capital adequacy provisions to Sec.  702.101. Many 
commenters stated that they were concerned about the subjective nature 
of the capital adequacy provision. Commenters contended that if a 
credit union meets the net worth and risk-based capital requirements, 
NCUA should not have the ability to require the credit union to hold 
additional capital. Other commenters argued that the proposed capital 
adequacy provisions could be problematic because they would grant 
examiners considerable latitude to determine whether a credit union 
needs more capital even if it is well capitalized according to standard 
net worth and risk-based capital ratio requirements. Commenters argued 
that credit unions and the NCUSIF have functioned well without these 
provisions and NCUA has not provided sufficient justification to 
support their imposition now. Still other commenters noted that credit 
unions already provide for capital adequacy through budgeting, ALM 
planning, liquidity, interest rate risk, and risk management, and 
speculated that the proposed capital adequacy provision would subject 
credit unions' capital plans to be judged in an arbitrary and 
subjective manner by hundreds of different NCUA examiners. The 
commenters argued that such an approach would provide examiners with 
too much authority to change the ``playing field,'' especially when 
there is no independent entity to which a credit union can appeal. At 
least one commenter suggested that the Board already has this authority 
so adding to the existing authority would be unnecessary and redundant.
    One commenter, however, acknowledged that codifying the additional 
capital adequacy requirements in Sec.  702.101(b) was reasonable. But 
the commenter suggested that the standards surrounding the provision's 
use should be made clear because NCUA already examines credit unions to 
determine whether they have sufficient net worth relative to risk, and 
whether credit unions have adequate policies, practices, and procedures 
regarding net worth and capital accounts.\92\ The commenter noted 
further, the proposed rule indicates that it ``may provide specific 
metrics for necessary reductions in risk levels, increases in capital 
levels beyond those otherwise required under part 702, and some 
combination of risk reduction and increased capital.'' \93\ The 
commenter recommended that the Board clarify how it envisions Sec.  
702.101(b) augmenting NCUA's current supervisory process and any 
enforcement authority the agency holds in conjunction with that 
process. Another commenter suggested that credit unions with lower risk 
profiles and/or higher capital levels should be subjected to less 
rigorous examinations of risk management. The commenter also suggested 
that credit unions with higher risk levels against a given set of 
reasonable thresholds, or those with lower capital levels, should have 
their examination of risk elevated to the risk management specialists 
within NCUA. The commenter suggested that removing field examiners with 
little specific knowledge from the examination findings and 
recommendation process would provide a more consistent exam, and 
recommended that NCUA produce a set of known, published and reasonable 
filters to define outlier credit unions, including a cross-risk look at 
risks due to concentration, low capital or earnings levels, interest 
rate exposure, credit quality, etc.
---------------------------------------------------------------------------

    \92\ See LTCU 00-CU-08 (Nov. 2000); see also NCUA Examiner's 
Guide, Ch. 16. available at http://www.ncua.gov/Legal/GuidesEtc/ExaminerGuide/chapter16.pdf.
    \93\ 80 FR 4340, 4359 (Jan. 27, 2015).
---------------------------------------------------------------------------

    At least one commenter questioned the Board's legal authority to 
adopt a provision that would require individual credit unions to hold 
capital above that required under the other provisions of the 
regulation. The commenter acknowledged that the FCUA establishes a 
risk-based net worth requirement for complex credit unions, but 
suggested it does not grant NCUA the authority to impose individualized 
capital requirements on a credit union-by-credit union basis. Another

[[Page 66656]]

commenter suggested if Congress had intended the capital thresholds 
required under PCA to be minimum requirements, it would have described 
the classification as minimally capitalized. The commenter maintained 
that each credit union's long-term desired capital ratio will depend on 
the credit union's own assessment of the risks it faces, and its 
tolerance for risk. The commenter recommended the Board delete the 
capital adequacy provisions, because credit unions' capital plans 
should not be the subject of examination and supervision, and the goals 
a credit union establishes for its own capital sufficiency should not 
become targets or standards for review in an examination.
    One commenter requested clarification on how NCUA would coordinate 
the requirements of this new provision with state regulators for 
capital planning purposes.

Discussion

    The Board has carefully considered the comments above, and 
disagrees with commenters who suggested that the capital adequacy 
provisions are unnecessary. As stated in the preamble to the Second 
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, 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.
    Proposed Sec.  702.101(b) was based on a similar provision in the 
Other Banking Agencies' rules \94\ and is within the Board's legal 
authority under the FCUA. The FCUA grants NCUA broad 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.\95\ Requiring 
credit unions to maintain capital adequacy is part of ensuring safety 
and soundness, and is not a new concept.\96\ NCUA's long-standing 
practice has been to monitor and enforce capital adequacy through the 
supervisory process. Proposed Sec.  702.101(b) would, with the 
exception of the written capital adequacy plan discussed in more detail 
below, merely codify the existing statutory requirement. The proposed 
new capital adequacy provision would not affect credit unions' PCA 
capital category, but would support the assessment of capital adequacy 
in the supervisory process (assigning CAMEL and risk ratings).
---------------------------------------------------------------------------

    \94\ See, e.g., 12 CFR 324.10(d)(1) & (2).
    \95\ 12 U.S.C. 1786; and 1789.
    \96\ See, e.g. 78 FR 55340, 55362 (Sept. 10, 2013).
---------------------------------------------------------------------------

    Section 206 of the FCUA provides the Board with broad authority to 
intervene and require credit unions to take actions to correct unsafe 
or unsound practices, including requiring individual credit unions to 
hold capital above that required under NCUA's PCA regulation.\97\ And 
section 209 of the FCUA specifically authorizes the Board to prescribe 
such rules and regulations as it may deem necessary or appropriate to 
carry out the provisions of subchapter II of the FCUA, which includes 
section 206. Accordingly, NCUA clearly has the legal authority to 
include proposed Sec.  702.101(b) in this final rule.
---------------------------------------------------------------------------

    \97\ 12 U.S.C. 1786.
---------------------------------------------------------------------------

    Accordingly, the Board has decided to retain the proposed capital 
adequacy provisions in this final rule without change.

101(b) Capital Adequacy

    For the reasons discussed above, the new capital adequacy 
provisions are added as Sec.  702.101(b) of this final rule, and 
paragraphs (b) and (c) of current Sec.  702.101 are designated as 
paragraphs (d) and (e) of Sec.  702.101 of this final rule.
101(b)(1)
    The Second Proposal would have revised Sec.  702.101(b)(1) to 
provide: 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.
    For the reasons discussed above, the Board has decided to retain 
the proposed capital adequacy provision in proposed Sec.  702.101(b)(1) 
in this final rule without change.
101(b)(2)
    Proposed Sec.  702.101(b)(2) provided: 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.

Public Comments on the Second Proposal

    A significant number of commenters specifically objected to the 
proposed new provision added as Sec.  702.101(b)(2) that would require 
complex credit unions to have a comprehensive written strategy for 
maintaining an appropriate level of capital. One commenter pointed out 
that, while the Board has taken steps to closely align this proposal 
with banking agency requirements in other areas, it has chosen to 
deviate from that standard to add a written reporting requirement for 
credit unions under this provision.\98\ The commenter suggested that 
given that the specific requirements of the proposed capital adequacy 
plan are not delineated in this proposed rule, but will be subsequently 
outlined in supervisory guidance, commenters are unable to determine 
the extent of the burden this requirement might entail. The commenter 
noted that all credit unions with assets of $50 million or more are 
already required to have a written policy on interest rate risk 
management and a program to implement it effectively,\99\ as well as a 
written liquidity policy and contingency funding plan.\100\ In 
addition, the commenter noted that the largest credit unions are 
already required by regulation to maintain a written capital policy and 
capital plan that is approved annually by NCUA.\101\ The commenter 
recommended the Board explain why it felt compelled to add a written 
requirement to this provision for credit unions, and make every effort 
to streamline it and other similar requirements to minimize the 
associated regulatory burden.
---------------------------------------------------------------------------

    \98\ There is no mandated written element to the corresponding 
FDIC provision. 12 CFR 324.1(d); 12 CFR 324.100(d).
    \99\ 12 CFR 741.3.
    \100\ 12 CFR 741.12.
    \101\ 12 CFR 702.501 through 702.506.
---------------------------------------------------------------------------

    One commenter recommended that if the Board adopts a written 
capital strategy requirement for all complex credit unions, it utilize 
that written strategy to ensure that credit unions are addressing any 
heightened risks from loan concentrations. The commenter suggested such 
an approach should obviate the need for elevated risk weights in 
connection with real estate and commercial loans by allowing NCUA to 
address concentration risk in a more targeted way. The commenter 
suggested further that such an approach would satisfy recommendations 
from NCUA's Office of Inspector General (OIG) and GAO that NCUA 
consider concentration risk as it pertains to capital adequacy, without 
creating a competitive disadvantage for all complex credit unions in 
relation to their banking counterparts. The commenter also recommended 
that the Board incorporate any written capital strategy required within 
the credit

[[Page 66657]]

union's strategic plan, or another existing report in order to minimize 
duplication of effort across various reporting requirements. In 
addition, the commenter suggested that an exemption from the 
requirement be provided to institutions that are already subject to 
capital planning and stress testing requirements, as the analysis 
contemplated by this part would already be addressed by those existing 
requirements. Other commenters contended that the written capital plan 
requirement is not necessary for the vast majority of complex credit 
unions based on their management, risk profiles, and current levels of 
capital. And if NCUA examiners have concerns regarding the credit 
unions they supervise, those commenters argued, those situations should 
be addressed on an individual basis and not through rulemaking that 
would apply universal requirements to all complex credit unions, 
regardless of how well managed they may be.
    At least one commenter stated that while NCUA should be able to 
access the adequacy of a credit union's capital adequacy plan, 
safeguards should be put in place to prevent over-zealous examiners 
from implementing individualized minimum capital requirements during 
the exam process. Another commenter suggested that the concept of a 
written strategy was not bad, but that the final rule should provide 
additional clarity about what exactly would be required under the 
provision. Yet another commenter asked: What are the components of the 
``comprehensive written strategy'' contemplated under this provision? 
What are the possible consequences of an examiner determining that a 
credit union's comprehensive written strategy does not meet the 
requirements? The commenter requested that the Board provide more 
description in this area and elaborate on its expectations of credit 
unions.

Discussion

    The Board disagrees with commenters who suggested the requirement 
that complex credit unions maintain a written capital strategy be 
removed from the final rule. The supervisory evaluation of a complex 
credit union's capital adequacy, including the requirement to maintain 
a written capital strategy, is focused on the credit union's own 
process and strategy for assessing and maintaining its overall capital 
adequacy in relation to its risk profile. The supervisory evaluation 
may include various factors--such as whether the credit union is 
engaged in merger activity, entering into new activities, introducing 
new products, operating in a challenging economic environment, engaged 
in nontraditional activities, or exposed to other risks like interest 
rate risk or operational risks. The assessment evaluates the 
comprehensiveness and effectiveness of the capital planning in light of 
its activities. An effective capital planning process involves an 
assessment of the risk to which a credit union is exposed and its 
process for managing and mitigating those risks, an evaluation of 
capital relative to those risks, and consideration of the potential 
impact on earnings and capital from current and prospective economic 
conditions. Under the proposal, the evaluation of an individual credit 
union's risk management strategy and process will be commensurate with 
the credit union's size, sophistication, and risk profile--which is 
similar to the current supervisory process for credit unions.
    For credit unions subject to Capital Planning and Stress Testing 
under subpart E of part 702 of NCUA's regulations, compliance with 
Sec.  702.504 will result in compliance with Sec.  702.101(b). Thus, 
those credit unions subject to the stress testing regulation will not 
be expected to write redundant capital plans to fulfill the 
requirements of this final rule.
    For other complex credit unions that will be expected to write 
capital plans, supervisory guidance will be issued to help those credit 
unions evaluate their compliance with Sec.  702.101(b). The supervisory 
guidance will also be designed to provide consistency in the 
examination process.
    Accordingly, the Board has decided to retain the proposed capital 
adequacy provision in proposed Sec.  702.101(b)(1) in this final rule 
without change.

Section 702.102 Capital Classifications

    Under the Second Proposal, the title of Sec.  702.102 would have 
been changed from ``statutory net worth categories'' to ``capital 
classifications.'' The section would have continued to list the five 
statutory capital categories that are provided in Sec.  216(c) of the 
FCUA.\102\
---------------------------------------------------------------------------

    \102\ 12 U.S.C. 1790d(c).
---------------------------------------------------------------------------

    The Board received no comments on these revisions and has decided 
to retain the proposed amendments in this final rule without change.
102(a) Capital Categories
    The Second Proposal would have revised current Sec.  702.102(a) to 
include new minimum risk-based capital ratio levels for complex credit 
unions. Consistent with section 216(c)(1)(A) through (E) of the FCUA, 
the minimum net worth ratio levels listed in proposed Sec. Sec.  
702.102(a)(1) through (5) would have continued to match the ratio 
levels listed in the statute for each capital category, and would have 
included 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 
new minimum risk-based capital ratio levels included components that 
required higher capital ratio levels to reflect increased risk due to 
concentration risk and credit risk.
    The Original Proposal also introduced a new, scaled approach to 
assigning minimum risk-based capital ratio levels to the capital 
classifications for well capitalized, adequately capitalized, and 
undercapitalized credit unions. This scaled approach recognized the 
relationship between higher risk-based capital ratios and the 
creditworthiness of credit unions.

Public Comments on the Second Proposal

    The Board received numerous general comments concerning the capital 
categories. Most of those commenters simply stated that they opposed 
the proposed two-tiered risk-based capital requirement, believed that 
the Board generally lacked the legal authority to impose the risk-based 
capital requirement as proposed, or both. Others specifically suggested 
that the language in section 216(d) of the FCUA prohibits NCUA from 
adopting different risk-based capital ratio threshold levels for well 
capitalized and adequately capitalized credit unions. At least one 
commenter suggested that section 216(d)(2) expressly ties NCUA's 
statutory authority to its assessment of whether the 6 percent net 
worth ratio threshold provides ``adequate protection'' because the term 
``adequately capitalized'' used in the section refers to the 
``adequately capitalized'' net worth category defined in section 
216(c)(1)(B)(i) of the FCUA. The commenter suggested further that the 
FCUA limits NCUA, in developing the risk-based net worth requirement, 
to considering only ``whether the 6 percent requirement provides 
adequate protection'' against the risks faced by credit unions because 
section 216(d)(2) speaks only to whether an institution is ``adequately 
capitalized,'' not ``well capitalized.'' Accordingly, the commenter 
concludes that NCUA lacks the authority to implement a separate risk-
based net worth threshold level for the ``well capitalized'' net worth 
category. The commenter argued further that the legislative history of 
the FCUA suggests that section 216(d) bars NCUA

[[Page 66658]]

from implementing a separate RBC ratio for ``well capitalized'' credit 
unions because an earlier version of CUMAA passed by the House of 
Representatives provided in relevant part:

    [NCUA is authorized to] establish reasonable net worth 
requirements, including risk-based net worth requirements in the 
case of complex credit unions, for various categories of credit 
unions and prescribe the manner in which net worth is calculated 
(for purposes of such requirements) with regard to various types of 
investments, including investments in corporate credit unions, 
taking into account the unique nature and role of credit 
unions.\103\
---------------------------------------------------------------------------

    \103\ H.R. Rep. 105-472, 1998 WL 141880, at *9 (1998).

    The language quoted above was never included in the Senate version 
of the CUMAA legislation, which was ultimately enacted, nor was it ever 
included in the FCUA. The commenter suggested that this legislative 
change demonstrates Congress' express consideration and rejection of 
NCUA's proposed approach of adopting separate RBC thresholds for ``well 
capitalized'' and ``adequately capitalized'' credit unions.
    Another commenter suggested that any credit union, with a 7 percent 
or higher net worth ratio, that fails to exceed its required risk-based 
capital ratio level be given consideration in any prompt corrective 
action required under the risk-based capital regulation. In such a 
case, the commenter recommended the Board limit the remedy to a capital 
restoration plan that allows the credit union a reasonable and 
appropriate period of time to improve its risk-based capital ratio--
even as they maintain their statutory net worth ratio above 7 percent.

Discussion

    NCUA has the authority to impose the proposed risk-based capital 
requirement on complex credit unions. For the reasons discussed in both 
the Second Proposal and above in the legal authority part of this 
preamble, requiring credit unions to meet different minimum risk-based 
capital ratio levels to be adequately and well capitalized is 
consistent with the plain language of section 216 of the FCUA, is 
``comparable'' to the Other Banking Agencies' PCA regulations, and 
takes into account the cooperative character of credit unions. 
Moreover, the Agency is not persuaded by the language quoted above from 
a prior House bill,\104\ which Congress ultimately choose not to 
include in CUMAA. Contrary to the commenter's suggestion, Congress' 
choice of language in section 216(d) instead of the language in a prior 
House version of CUMAA does not demonstrate that Congress expressly 
considered and rejected NCUA's proposed approach of adopting separate 
RBC thresholds for well capitalized and adequately capitalized credit 
unions.
---------------------------------------------------------------------------

    \104\ H.R. Rep. 105-472, 1998 WL 141880, at *9 (1998).
---------------------------------------------------------------------------

    Furthermore, requiring complex credit unions to meet a higher risk-
based capital ratio threshold to be classified as well capitalized 
allows for a graduated scale, which can measure either a decline or 
improvement in a credit union's risk-based capital level in relation to 
the minimum capital requirements. Such a system provides for earlier 
identification and resolution of credit unions experiencing gradual 
declines in the level of capital held on a risk-based measure. Under 
the current rule, a credit union failing the risk-based net worth 
requirement is immediately subject to the mandatory supervision action 
for undercapitalized credit unions and may not have been fully aware of 
their declining capital buffer. The use of a two-tiered risk-based 
capital measure also allows stakeholders and creditors, such as 
uninured shareholders, to reasonably compare financial institution 
capital measures to the minimum regulatory requirements on a risk-based 
level.
    The Agency also questions the legality of the suggestion to amend 
the final rule to require only a capital restoration plan in cases 
where a credit union fails to meet or exceed the minimum risk-based 
capital requirement, but meets or exceeds the 7 percent net worth ratio 
requirement. Such an approach was not proposed and appears to conflict 
with the mandatory restrictions on undercapitalized credit unions under 
section 216(g) of the FCUA.
    Accordingly, the Board has decided to retain the proposed capital 
categories in this final rule without change.

102(a)(1) Well Capitalized

    Proposed Sec.  702.102(a)(1) required a credit union to maintain a 
net worth ratio of 7 percent or greater and, if it were a complex 
credit union, a risk-based capital ratio of 10 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.\105\
---------------------------------------------------------------------------

    \105\ See, e.g., 12 CFR 324.10; 324.11; and 324.403.
---------------------------------------------------------------------------

Public Comments on the Second Proposal

    A substantial number of commenters speculated that the proposed 
risk-based capital ratio level for well capitalized credit unions would 
place credit unions at a competitive disadvantage to banks unless all 
credit unions are given the ability to meet the 10 percent requirement 
with supplemental (Tier 2) capital, as banks are allowed to do under 
their rules. The commenters recommended the Board either delay the 
final release of the risk-based capital rule until it has developed a 
supplemental capital rule or eliminate the 10 percent risk-based 
capital ratio requirement and establish a single-tier requirement of 8 
percent that aligns with the banking industry's Tier 1 capital 
requirement.
    A few commenters suggested that, in removing the effect of the 
capital conservation buffer from the Original Proposal, the Board 
should have lowered the risk-based capital ratio requirement to 8 
percent, not the 10 percent in the Second Proposal. After examining the 
makeup of capital at credit unions and banks, the commenter suggested 
that Tier 1 capital is most similar because both credit union and bank 
Tier 1 capital is comprised of either equity or retained earnings, and 
both bank and credit union Tier 1 capital represent the strongest form 
of capital on a financial institution's balance sheet. Under NCUA's 
Second Proposal, credit unions could count their ALLL towards their 
risk-based capital requirement, which is similar to banks; however, 
banks have the added benefit of counting supplemental capital as Tier 2 
capital. Since NCUA has not yet authorized all credit unions to use 
secondary capital as part of their capital base for risk-based capital 
purposes, the commenter claimed the most logical point of comparability 
between banks and credit unions is Tier 1 capital. The commenter 
recommended that the Board set the risk-based capital ratio level at 8 
percent, which aligns with the banking industry's Tier 1 risk-based 
capital ratio level for well capitalized banks, to ensure that credit 
unions' and banks' risk-based capital requirements are comparable. The 
commenter recommended further that such an approach would eliminate the 
capital benefit from the ALLL to ensure comparability to the banks' 
Tier 1 risk-based capital ratio requirement.
    One bank trade association commenter, however, suggested that the 
Board adopt the same Basel III model that was adopted by prudential 
banking regulators. The commenter argued the

[[Page 66659]]

NCUA's proposed model would not be the same because under the Second 
Proposal, credit unions were not subjected to a capital conservation 
buffer, which banks are. The commenter suggested that, because of this 
difference, the proposed risk-based capital ratio level required for a 
credit union to be classified as well capitalized was 50 basis points 
lower than the analogous requirement applicable to banks under the 
Other Banking Agencies' regulations. The commenter suggested further 
that credit unions, with their ability to avoid the payment of U.S. 
income taxes and retain all their earnings, should not be subject to 
lower capital requirements than banks while managing the same risk 
profile as community banks that are subject to taxation.
    Other commenters simply stated they believed the proposal did not 
sufficiently justify assigning a risk-based capital ratio requirement 
for well capitalized credit unions that is 3 percent higher than the 
statutory 7 percent net worth ratio level required for a credit union 
to be classified as well capitalized.
    One commenter speculated that the proposed risk-based capital ratio 
of 10 percent would limit the ability of credit unions to allocate 
resources as they see fit, directly impacting what credit unions can do 
for their members because credit unions need flexibility to be 
successful. The commenter pointed out that credit union management is 
held accountable by fiduciary responsibility of the Board of Directors, 
while some are overseen by both Certified Public Accountants' opinion 
audits and ongoing NCUA examination, and are therefore in the best 
position to determine the appropriate balance to best serve the needs 
of their members.

Discussion

    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.\106\ Moreover, credit unions 
classified as well capitalized are generally considered financially 
sound, afforded greater latitude under some other regulatory 
provisions,\107\ and, with the exception of a small earnings retention 
requirement, are not subject to 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 early reflection through a credit union's net worth 
category, as suggested in the GAO and OIG reports. Under the current 
rule, a change in the credit union's risk profile, capital levels, or 
both, that results in a decline in the credit union's 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 mandates that 
harsh supervisory actions be taken.
---------------------------------------------------------------------------

    \106\ Per the FCUA, ``undercapitalized'' is the lowest PCA 
category in which a failure to meet the risk-based net worth 
requirement can result.
    \107\ See 12 CFR 745.9-2; and 12 CFR 723.7.
---------------------------------------------------------------------------

    The Board reasons that the more effective approach and better 
policy option 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 risk weights 
included in the Second Proposal were based predominantly on those used 
by the Other Banking Agencies, as suggested by credit unions and other 
interested parties who submitted comment letters in response to 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.\108\
---------------------------------------------------------------------------

    \108\ 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.
---------------------------------------------------------------------------

    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.\109\ 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. While NCUA's proposed risk weights for 
various assets could be increased by 20 percent to offset this effect, 
adjusting the risk weights in this manner would create more difficulty 
in comparing asset types and risk weights across financial 
institutions, and lead to misunderstanding.
---------------------------------------------------------------------------

    \109\ See S. Rep. No. 193, 105th Cong., 2d Sess. Sec.  301 
(1998) (`` `Comparable' here means parallel in substance though not 
necessarily identical in detail) and equivalent in rigor.'').
---------------------------------------------------------------------------

    Conversely, the uniform threshold level 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 (such as any risk-
based capital ratio under 10 percent), and therefore be subject to 
mandatory and discretionary supervisory actions. The Board concluded 
this approach would not be optimal, as the supervisory consequences for 
credit unions with risk-based capital ratios between eight percent and 
10 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

[[Page 66660]]

to risk, and better inform credit union decision making.\110\ 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 8 percent, 
NCUA estimates at most seven credit unions would have the proposed 
risk-based capital ratio be the governing requirement, with only one 
credit union currently holding insufficient capital to meet the 
requirement.
---------------------------------------------------------------------------

    \110\ The benefits of a capital system better correlated to risk 
are discussed in the Summary of the Final Rule part of this 
preamble.
---------------------------------------------------------------------------

    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 encourage 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 
2007-2009 financial crisis, some 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 Second Proposal, 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 12.1 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 should reflect material shifts in the 
risk profile of assets.
    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.
    The Board agrees with the commenters who suggested that a 10 
percent risk-based capital ratio threshold 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 8 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 final rule, the Board is now more 
closely aligning NCUA's risk weights with those assigned by the Other 
Banking Agencies. Therefore, for consistency, the Board reasons that 
NCUA's risk-based capital ratio threshold levels should likewise align 
with those of the Other Banking Agencies as closely as possible.
    The Board plans to address additional forms of supplemental capital 
in a separate proposed rule, with the intent to finalize a new 
supplemental capital rule before the effective date of this risk-based 
capital final rule. Therefore there is no need to delay release of this 
final rule. The Board notes the second risk-based capital proposal 
invited general comment on supplemental capital much in the way an 
advanced notice of proposed rulemaking would do. A notice of proposed 
rulemaking on supplemental capital with specific criteria and 
requirements is necessary under the Administrative Procedure Act before 
the Board could issue a final rule. Issuing a new, more specific and 
detailed proposed rule on supplemental capital will give interested 
parties full opportunity to comment on it.
    Accordingly, the Board has decided to retain proposed Sec.  
702.102(a)(1) in this final rule without change.

102(a)(2) Adequately Capitalized

    Under the Second Proposal, Sec.  702.102(a)(2) required a credit 
union to maintain a net worth ratio of 6 percent or greater and, if it 
were a complex credit union, a risk-based capital ratio of 8 percent or 
greater to be classified as adequately capitalized. This risk-based 
capital ratio level is comparable to the 8 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 proposed adequately 
capitalized risk-based capital ratio level. Therefore, the Board has 
decided to retain proposed Sec.  702.102(a)(2) in this final rule 
without change.

102(a)(3) Undercapitalized

    Under the Second Proposal, Sec.  702.102(a)(3) would have 
classified a credit union as undercapitalized if: (1) The credit union 
has a net worth ratio of 4 percent or more but less than 6 percent; or 
(2) the credit union, if complex, has a risk-based capital ratio of 
less than 8 percent.
    Other than the comments discussed above and other parts of this 
preamble, the Board received no comments on the proposed 
undercapitalized risk-based capital ratio requirement. Therefore, the 
Board has decided to retain proposed Sec.  702.102(a)(3) without 
change.

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:
     The credit union has a net worth ratio of 2 percent or 
more but less than 4 percent; or

[[Page 66661]]

     The credit union has a net worth ratio of 4 percent or 
more but less than 5 percent, and either--
    o Fails to submit an acceptable net worth restoration plan within 
the time prescribed in Sec.  702.111;
    o Materially fails to implement a net worth restoration plan 
approved by the Board; or
    o Receives notice that a submitted net worth restoration plan has 
not been approved.
    The Board received no comments on the revisions to this paragraph 
and has decided to retain the proposed amendments in this final rule 
without change.

102(a)(5) Critically Undercapitalized

    Under the Second Proposal, Sec.  702.102(a)(5) classified a credit 
union as critically undercapitalized if it had a net worth ratio of 
less than 2 percent. The Second Proposal would have also made some 
minor technical amendments to the language in current Sec.  
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 revisions to this paragraph 
and has decided to retain the proposed amendments in this final rule 
without change.

102(b) Reclassification Based on Supervisory Criteria Other Than Net 
Worth

    The Second 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 on the revisions to this paragraph 
and has decided to retain the proposed amendments in this final rule 
without change.

102(c) Non-Delegation

    Proposed Sec.  702.102(c) would have been unchanged from current 
Sec.  702.102(c).
    The Board received no comments on this paragraph and has decided to 
retain the paragraph in this final rule without change.

102(d) Consultation With State Officials

    Proposed Sec.  702.102(d) would have retained current Sec.  
702.102(d) with only non-substantive amendments for consistency with 
other sections of NCUA's regulations. No substantive changes were 
intended.
    The Board received no comments on this paragraph and has decided to 
retain the proposed amendments in this final rule without change.
Section 702.103 Applicability of the Risk-Based Capital Ratio Measure
    The Second Proposal 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 the risk-based capital ratio 
measure is applicable only if the credit union's quarter-end total 
assets exceed $100 million, as reflected in its most recent Call 
Report.

Public Comments on the Second Proposal

    The Board received a large number of comments on proposed Sec.  
702.103. Several commenters argued that the FCUA requires the Board to 
define ``complex'' credit unions based on the ``portfolios of assets 
and liabilities of credit unions,'' and that the proposed use of an 
asset size threshold to define ``complex'' credit unions would not 
comply with the statutory requirement.
    A substantial number of commenters also stated that they opposed 
the proposed definition of ``complex'' credit union because they 
believed asset size should not be a primary qualifier of a credit 
union's complexity.
    At least one trade association commenter, however, acknowledged 
that an asset threshold proxy, while less precise than individual 
balance sheet analysis, would allow for a streamlined application of 
the rule and would minimize opportunities for arbitrage. The commenter 
suggested that if the definition of ``complex'' were tied to specific 
activities, credit unions could be incentivized, on the margin, to 
simply avoid those activities in order to avoid the risk-based capital 
requirements. And such conduct could have unintended consequences and 
create new unanticipated risks to capital adequacy. Similarly, at least 
one credit union commenter stated that using an asset size threshold to 
define complex credit unions would give credit unions a bright line 
test and eliminate the difficulty of having to anticipate what products 
and services should be classified as complex. Another credit union 
commenter suggested that a rule that identified specific types of 
lending activity that made an institution complex might mask undue 
concentration risk.
    A substantial number of commenters suggested that asset size, if 
used in the final rule, should be raised to some amount above $100 
million. Specific threshold amounts suggested by commenters ranged from 
$250 million to $10 billion. Several commenters speculated that 
refining the complexity analysis and raising the asset size threshold 
would not considerably increase the risk to the Share Insurance Fund 
because by the time the final rule is implemented in 2019, an even 
greater percentage of system assets would be covered. Other commenters 
maintained that the final rule should only apply to credit unions that 
meet the same asset size threshold used by the Other Banking Agencies 
to define small banks. One commenter suggested that the Board should 
align the definitions of ``complex'' credit union across all of NCUA's 
regulations so they are the same, and, at a minimum, the Board should 
increase the threshold to $250 million to be consistent with the 
definition in the derivatives regulation.
    Some commenters contended that the proposed list of assets and 
liabilities identified as complex were much too broad. One commenter 
suggested that Congress limited the application of risk-based capital 
to complex credit unions \111\ and directed NCUA to design the risk-
based capital standard to protect against material risks that may not 
be adequately captured by the net worth ratio requirement \112\ because 
Congress intended that credit unions be designated as ``complex'' based 
on only their involvement in high-risk activities that the net worth 
ratio requirement may not account for. The commenter noted further that 
the list of complex assets and liabilities used by the Board to set the 
asset size threshold at $100 million included several standard 
activities that are already contemplated by the statutory net worth 
ratio requirement. The commenter believed, for example, that real 
estate loans, investments with maturities greater than five years, and 
internet banking are staple activities of financial services 
institutions in today's marketplace and should not be considered 
complex; and that other activities only become complex when undertaken 
in significant volumes--for example, a credit union that lends a member 
$60,000 to purchase new equipment for his bakery is engaged in member 
business lending, but that credit union should not be designated as 
complex by virtue of that single loan. The commenter contended that the 
size of the portfolio and its significance to the credit union's 
overall business strategy drives complexity; so the commenter concluded 
that member

[[Page 66662]]

business, indirect, interest-only, and participation loans should only 
indicate complexity where the activity exceeds a certain percentage of 
total assets, and borrowings should only denote complexity where they 
constitute a significant element of the credit union's funding 
strategy. Other commenters suggested that a credit union be defined as 
``complex'' only if it engages in three or more of the following assets 
or liabilities: Member business loans, participation loans, interest-
only loans, indirect loans, non-federally guaranteed student loans, 
borrowings, and derivatives. Still other commenters suggested that the 
definition of ``complex'' be based on the following activities: 
Participation loans, interest-only loans, indirect loans, real estate 
loans, non-agency mortgage backed securities, non-mortgage related 
securities with embedded options, collateralized mortgage obligations/
real estate mortgage investment conduits, commercial mortgage-related 
securities, and derivatives.
---------------------------------------------------------------------------

    \111\ 12 U.S.C. 1790d(d)(1).
    \112\ 12 U.S.C. 1790d(d)(2).
---------------------------------------------------------------------------

    In addition, commenters argued that because they do not adequately 
represent complexity, the Board should not use the following assets or 
liabilities: Real estate loans, obligations fully guaranteed by the 
U.S. Government, investments with maturities of greater than five 
years, non-agency mortgage-backed securities, non-mortgage-related 
securities with embedded options, collateralized mortgage obligations/
real estate mortgage investment conduits, commercial mortgage-related 
securities, and internet banking. In addition, one commenter argued 
that internet banking, a service that credit unions provide, is neither 
an asset nor a liability so the FCUA bars NCUA from considering 
internet banking when considering complexity.
    One commenter recommended that the asset size threshold should be 
set where all or most credit unions are engaged in four or more of the 
activities the Board identifies as complex. The commenter claimed that 
the FCUA, which requires NCUA to specify which credit unions are 
``complex'' based on the portfolios of assets and liabilities of credit 
unions,\113\ prohibits a credit union from being classified based on a 
single complex activity.
---------------------------------------------------------------------------

    \113\ 12 U.S.C. 1790(d)(1).
---------------------------------------------------------------------------

    Another commenter suggested that using an asset size threshold 
alone to define complexity was appropriate and that the presence of 
more complex lending products should not necessarily define a complex 
credit union because financial institutions in general become more 
complex with size and by moving into more complex/sophisticated 
financial transactions such as mortgage-backed securities, derivatives, 
loan sales or purchases, mortgage pipelines and servicing assets. The 
commenter suggested that these types of financial transactions are not 
ordinary in smaller asset size institutions because they generally 
require more scale and overhead of a larger institution to manage and 
understand.
    Other commenters recommended that the Board define complexity using 
a credit union's product offerings, in a manner similar to that used in 
the current rule. The commenters suggested that the most analogous 
approach would be a ratio of risk-weighted assets to total assets 
greater than 67 percent as measure by the proposal's risk weights. At 
least one of those commenters, however, acknowledged that the 67 
percent threshold might not be a meaningful measure of risk, but that 
using different thresholds yielded similar results.
    At least one commenter suggested that all federally insured credit 
unions with assets of $500 million or less should be excluded from the 
definition of ``complex,'' and that only those credit unions with $500 
million or more in assets and that have an NCUA Complexity Index 
(discussed in the Supplementary Information to the Original Proposal) 
value of 17 or higher should be required to meet NCUA's risk-based 
capital requirement. Similarly, another commenter suggested that all 
federally insured credit unions with assets of $500 million or less 
should be excluded from the definition of ``complex,'' and that only 
those credit unions with $500 million or more in assets and that have 
an NCUA Complexity Index value of 20 or higher should be required to 
meet NCUA's risk-based capital requirement. Yet another commenter 
suggested that all federally insured credit unions with assets of $1 
billion or less should be excluded from the definition of ``complex,'' 
and that only those credit unions with assets above $1 billion and that 
have an NCUA Complexity Index value of 20 or higher should be required 
to meet NCUA's risk-based capital requirement.
    Additional suggestions provided by commenters for defining credit 
unions as ``complex'' included:
     Defining ``complex'' with attributes such as deposit 
account features, member services, loan and investment products, and 
portfolio makeup.
     Defining ``complex'' based on whether a credit union 
engages in a combination of activities including, participation loans, 
non-agency mortgage-backed securities, repurchase transactions, and 
derivatives.
     Defining ``complex'' as credit unions with over $100 
million or more in assets and that provide member business loans and 
invest in derivatives.
     Defining ``complex'' as credit unions with $500 million or 
more in assets and/or that are engaged in over 50 percent of all of the 
categories, especially the investment section, noted in the preamble to 
the Second Proposal.
     Defining ``complex'' as credit unions with $500 million or 
more in assets, and that invest in non-agency mortgage-backed 
securities and non-mortgage related securities with embedded options.
    As an alternative, one trade organization commenter suggested that 
with credit unions exiting an extreme financial crisis where many of 
these institutions failed due to lack of high-quality capital and 
elevated risk profiles, the Board should be focusing its attention on 
raising the minimum regulatory capital levels for all credit unions.
    Other credit union commenters argued that the risk-based capital 
requirements should apply to all credit unions because recent data on 
credit union failures contradict claims that there is less risk in 
credit unions with less than $100 million in assets. Granted, the 
commenters suggested, in rural areas and in a few other special 
circumstances, small credit unions play a crucial role, and in such 
cases NCUA should offer waivers. A small credit union commenter 
suggested that many credit unions with $100 million or less in assets 
have the same, and often times more, risk on their balance sheets and 
in their operations than credit unions with over $100 million in 
assets. The commenter believed that smaller credit unions engage in 
complex activities for the following reasons: (1) If they do not offer 
products and services that the bigger credit unions do, their members 
will leave and the credit unions will (eventually) be forced to merge 
(not an outcome they wanted); (2) they need products that increase 
their income and capital (e.g., business loans, participation loans, 
and indirect lending); (3) they recognize they do not have the 
expertise they should have but it is expensive and hard to attract 
expertise based on their compensation structure. Another credit union 
commenter claimed that smaller credit unions have failed at a higher 
rate and have had a higher incidence of catastrophic failure due to a 
lack of comprehensive internal management and process controls that can 
lead to fraud. The commenter maintained that a

[[Page 66663]]

credit union charter is a privilege and not a right and that all credit 
unions should be subject to the same risk-based capital requirements 
and examination standards.
    One commenter suggested that it is very likely that a small credit 
union could pose a much larger risk to the NCUSIF than a larger credit 
union, and that using asset size as a threshold for complexity suggests 
that capital is not as critical for smaller institutions. The commenter 
suggested further that ``complexity'' should be defined based on the 
quality of the management of the risks undertaken by the institution, 
which is ideally measured by the ``M'' in the CAMEL rating. The 
commenter recommended that identifying the credit unions to which the 
risk-based capital requirement applies is best done through the 
supervision process so that those credit unions posing a higher risk to 
the NCUSIF have higher standards and expectations by which to abide. 
The commenter suggested that this solution would reduce the ``broad-
brush'' effect of the current proposal, applying more stringent 
standards to those institutions that may benefit from regulatory risk 
management and thus provide greater protection to the NCUSIF.
    A significant number of commenters requested that the asset size 
threshold, if used, be indexed so that it does not apply to smaller and 
smaller credit unions through time due to inflation. And at least one 
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 thus, should not be subject to risk-based 
capital requirements. The commenter suggested further that the process 
for contesting an agency designation of ``complex'' should be detailed 
in the final rule.

Discussion

    The proposed use of an asset size threshold to define ``complex'' 
does comply with section 216 of the FCUA. As discussed in the Legal 
Authority part of this preamble, section 216(d)(1) directs NCUA, in 
determining which credit unions will be subject to the risk-based net 
worth requirement, to base its definition of complex ``on the 
portfolios of assets and liabilities of credit unions.'' \114\ The 
statute does not require, as some commenters have argued, that the 
Board adopt a definition of ``complex'' that takes into account the 
portfolio of assets and liabilities of each credit union on an 
individualized basis. Rather, section 216(d)(1) authorizes the Board to 
develop a single definition of ``complex'' that takes into account the 
portfolios of assets and liabilities of all credit unions. Consistent 
with section 216(d)(1), the proposed definition of a ``complex'' credit 
union included an asset size threshold that, as explained in more 
detail below, was designed by taking into account the portfolios of 
assets and liabilities of all credit unions.
---------------------------------------------------------------------------

    \114\ 12 U.S.C. 1790d(d).
---------------------------------------------------------------------------

    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 6 percent. In effect, this means that all credit unions with 
over $50 million in assets compute the risk-based net worth requirement 
to determine if they meet the complex definition.
    For reasons described more fully below, the Board maintains 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 is 
accurate, reduces the complexity of the rule, provides regulatory 
relief for smaller institutions, and eliminates the 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 the Second Proposal, the term ``complex'' was defined only 
for purposes of the risk-based capital ratio measure. For the purpose 
of defining a complex credit union, assets include tangible and 
intangible items that are economic resources (products and services) 
that are expected to produce economic benefit (income), and liabilities 
are obligations (expenses) the credit union has to outside parties. The 
Board recognizes there are products and services--which under GAAP are 
reflected as the credit unions' portfolio of assets and liabilities 
\115\--in which credit unions are engaged 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. 
Thus, credit unions offering such products and services have complex 
portfolios of assets and liabilities for purposes of NCUA's risk-based 
net worth requirement.
---------------------------------------------------------------------------

    \115\ 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.
---------------------------------------------------------------------------

    Consistent with the Second Proposal, the following products and 
services, if engaged in by a credit union, are accurate indicators of 
complexity:

 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
 Internet Banking

    NCUA's review of Call Report data as of June 30, 2014 and March 31, 
2015, showed that all credit unions with more than $100 million in 
assets were engaged in offering at least one of the products and 
services listed above; 99 percent engaged in two or more complex 
activities, and 87 percent engaged in four or more. On the other hand, 
less than two-thirds of credit unions below $100 million in assets were 
involved in even a single complex activity, and only 15 percent had 
four or more. Moreover, credit unions with total assets of less than 
$100 million are only 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, a $100 
million asset size threshold is a clear demarcation above which complex 
activities are always present, and where credit unions are almost 
always engaged in multiple complex activities. Additionally, the 
percentage of credit unions engaged in multiple activities using asset 
size thresholds above $100 million does not produce a significant 
demarcation between credit unions when compared to the differences 
observed at the $100 million threshold.
    Conversely, using a credit union's percentage of risk assets to 
total assets as the factor for determining whether the credit union is 
complex would require all credit unions to understand, monitor, and 
apply a complex measure their risk asset to asset ratio each quarter. 
This would be an additional and unnecessary burden for credit unions 
below the $100 million asset size threshold.

[[Page 66664]]

    As discussed earlier, $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. Based on 
December 31, 2014 Call Report data, this approach exempts approximately 
76 percent of credit unions from the regulatory burden associated with 
complying with the risk-based net worth requirement and capital 
adequacy plan, 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) \116\ to the NCUSIF spanning the last 12 years have come 
from credit unions with assets greater than $100 million.\117\
---------------------------------------------------------------------------

    \116\ Based on an analysis of loss and failure data collected by 
NCUA.
    \117\ NCUA performed backtesting analysis of Call Report and 
failure data to determine whether this final regulation would have 
resulted in earlier identification of emerging risks and possibly 
reduced losses to the NCUSIF. The impact of the final rule on more 
recent failures of credit unions with total assets over $100 million 
was also evaluated. The 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.
---------------------------------------------------------------------------

    Accordingly, consistent with requirements of Sec.  216(d)(1) of the 
FCUA, the final rule eliminates current Sec.  702.103(b) and defines 
all credit unions with over $100 million in assets as ``complex.''

Section 702.104 Risk-Based Capital Ratio

    Under the Second Proposal, the Board proposed changing the title of 
current Sec.  702.104 from ``Risk portfolio defined'' to ``Risk-based 
capital ratio.'' In addition, the Board 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.\118\ The proposed section would have 
required all ``complex'' credit unions to calculate their risk-based 
capital ratio as directed under 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.
---------------------------------------------------------------------------

    \118\ 12 U.S.C. 1790d(d).
---------------------------------------------------------------------------

Public Comments on the Second Proposal

    NCUA received many general comments on the proposed Sec.  702.104. 
Many commenters simply stated that they opposed the new risk-based 
capital ratio measure altogether, and preferred maintaining the current 
risk-based net worth measure. Others objected to specific aspects of 
the calculation, which are discussed in more detail below.

Discussion

    As discussed above and in more detail below, the proposed changes 
are necessary 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. The proposed risk-based capital ratio employed the 
method for computing the risk-based capital measures used by the Other 
Federal Banking Agencies: A higher ratio reflects the existence of a 
higher level of funds available to cover losses in relation to risk-
weighted assets. Because the risk weights in the final rule are 
generally comparable to those used by banks, the risk-based capital 
ratio will allow an interested party to compare risk-based capital 
measures across institutions to obtain a relative measure of their 
financial strength. Additionally, the current risk-based net worth 
requirement assigns high risk weights to low-credit-risk assets to 
account for interest rate risk--such as investments in Treasury 
securities with maturities in excess of five years--which results in a 
higher risk-based capital requirement for credit unions holding these 
types of low-credit-risk investments. Thus, the Board concluded it is 
no longer appropriate to retain NCUA's current risk-based net worth 
measure.
    Consistent with the Second Proposal, this final rule changes the 
title of current Sec.  702.104 from ``Risk portfolio defined'' to 
``Risk-based capital ratio.'' In addition, this final rule entirely 
replaces 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.\119\
---------------------------------------------------------------------------

    \119\ 12 U.S.C. 1790d(d).
---------------------------------------------------------------------------

104(a) Calculation of Capital for the Risk-Based Capital Ratio

    Under the Second Proposal, Sec.  702.104(a) 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 as described in Sec.  702.104(c). The 
proposed method of calculating risk-based capital was generally 
consistent with the methods used in other sectors of the financial 
services industry.
    Other than the comments discussed elsewhere in the preamble, the 
Board received no comments on the proposed revisions to this paragraph 
and has decided to retain the amendments in this final rule without 
change.

104(b) Risk-Based Capital Ratio Numerator

    Under the Second Proposal, Sec.  702.104(b) provided that the risk-
based capital ratio numerator is the sum of certain specific capital 
elements listed in Sec.  702.104(b)(1), minus regulatory adjustments 
listed in Sec.  702.104(b)(2).
    Other than the comments discussed elsewhere in the preamble, the 
Board received no comments on the proposed revisions to this paragraph 
and has decided to retain the amendments in this final rule without 
change.

104(b)(1) Capital Elements of the Risk-Based Capital Ratio Numerator

    Under the Second Proposal, Sec.  702.104(b)(1) 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; secondary capital accounts included in net worth (as 
defined in Sec.  702.2); and section 208 assistance included in net 
worth (as defined in Sec.  702.2). Consistent with the Second Proposal, 
Sec.  702.104(b)(1) listed the elements of the risk-based capital ratio 
numerator.

Public Comments on the Second Proposal

    The Board received a significant number of comments suggesting 
various amendments or additions to the capital elements included in the 
Second Proposal, which are discussed in more detail below.

Discussion

    The Board generally disagrees with the comments concerning capital 
elements and has, for the reasons discussed in more detail below, 
decided to retain the language in proposed Sec.  702.104(b)(1) in this 
final rule. The Board proposed Sec.  702.104(b)(1) to provide for a 
more comparable measure of capital across all financial institutions 
and better account for

[[Page 66665]]

related elements of the financial statement that are available (or not) 
to cover losses and protect the NCUSIF. As explained above, the FCUA 
gives NCUA broad discretion in designing the risk-based net worth 
requirement. Accordingly, this final rule incorporates the proposed 
broadened definition of capital for purposes of calculating the new 
risk-based capital ratio.

Undivided Earnings

    The Second Proposal included undivided earnings 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 Second Proposal in this final rule without change.

Appropriation for Nonconforming Investments

    The Second Proposal 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 Second Proposal in this final rule without 
change.

Other Reserves

    The Original Proposal 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 Second Proposal in this final rule without change.

Equity Acquired in Merger

    Under the Second Proposal, the risk-based capital ratio numerator 
included the equity acquired in merger component of the balance sheet. 
This equity item was used in place of the total adjusted retained 
earnings acquired through business combinations amount that credit 
unions currently report on the PCA net worth calculation worksheet in 
the Call Report. 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, more accurately reflects 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 Second Proposal in this 
final rule without change.

Net Income

    The Second Proposal 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 Second 
Proposal in this final rule without change.

ALLL

    The Second Proposal included the total amount of the ALLL, 
maintained in accordance with GAAP, in the risk-based capital ratio 
numerator. Credit unions already expense 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.

Public Comments on the Second Proposal

    The vast majority of commenters who mentioned the treatment of ALLL 
stated that they agreed with its proposed treatment in the Second 
Proposal. A few commenters, however, did argue that the ALLL should be 
limited to 1.25 percent of risk assets in determining the risk-based 
capital ratio numerator. These commenters suggested that if the loan 
loss reserves are established for identified losses, then they do not 
possess the essential characteristic of capital--the ability to absorb 
unidentified losses--and should not be included in the capital base. 
The commenters suggested further that because it is not always possible 
to clearly distinguish between identified and unidentified losses, the 
Other Banking Agencies capped the amount of ALLL being counted as 
capital at 1.25 percent of risk assets. These commenters argued further 
that limiting ALLL to 1.25 percent of risk assets would not create a 
disincentive for complex credit unions to fully fund the ALLL above the 
1.25 percent ceiling because complex credit unions are bound by 
generally accepted accounting principles to fully fund their ALLL, so 
not doing so would constitute an unsafe and unsound practice. Finally, 
these commenters argued that removing the 1.25 percent cap on ALLL 
would overstate the amount of capital that complex credit unions have 
available to absorb unexpected losses, and would make the comparison 
between bank and credit union risk-based capital ratios more difficult.

Discussion

    The Board disagrees with the commenters who suggested that the ALL 
should be limited to 1.25 percent of risk assets. All of the ALLL, 
maintained in accordance with GAAP, should be included in the risk-
based capital ratio numerator because 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 will allow a 
properly funded ALLL to somewhat offset the impact of the financial 
stressors on the risk-based capital ratio. Further, NCUA's supervision 
process can address any concerns with inclusion of the ALLL, such as 
ensuring proper funding. Accordingly, the Board has decided to retain 
this aspect of the Second Proposal in this final rule without change.

Secondary Capital Accounts

    The Second Proposal included secondary capital accounts included in 
net worth (as defined in Sec.  702.2) in the risk-based capital ratio 
numerator.
    While there was overwhelming support for allowing credit unions to 
count secondary capital accounts in the risk-based capital ratio 
numerator (including support for access for additional forms of 
supplemental capital), the Board received no comments opposing its 
inclusion. Accordingly, the Board has decided to retain this aspect of 
the Second Proposal in this final rule without change.
    The Board plans to address comments supporting additional forms of 
supplemental capital in a separate proposed rule, with the intent to 
finalize a new supplemental capital rule before the effective date of 
this risk-based capital final rule.

Section 208 Assistance

    The Second Proposal included section 208 assistance that is 
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 Second Proposal in this 
final rule without change.

[[Page 66666]]

Call Report Equity Items Not Included in the Risk-Based Capital Ratio 
Numerator

    Under the Second Proposal, the risk-based capital ratio numerator 
did not include 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.\120\
---------------------------------------------------------------------------

    \120\ The Other Banking Agencies' regulatory capital rules allow 
institutions to make an opt-out election for similar accounts. See, 
e.g., 12 CFR 324.22; and 78 FR 55339 (Sept. 10, 2013).
---------------------------------------------------------------------------

    The Board received no comments on the exclusion of these elements 
in the risk-based capital ratio numerator. Accordingly, the Board has 
decided to retain this aspect of the Second Proposal in this final rule 
without change.

Other Supplemental Forms of Capital

    Under the Second Proposal, supplemental forms of capital, other 
than those discussed above, were not included in the risk-based capital 
ratio numerator. The Board, however, did specifically request comment 
on specific detailed questions regarding whether revisions should be 
made to NCUA's regulations through a separate rulemaking to allow 
additional supplemental forms of capital to be included in the risk-
based capital ratio.

Public Comments on the Second Proposal

    A majority of the commenters who mentioned supplemental capital 
stated that it was imperative the Board consider allowing credit unions 
ready access to additional supplemental forms of capital. Commenters 
suggested it was particularly important as risk-based capital goes into 
effect, as credit unions are at a disadvantage in the financial market 
because of lack of access to additional capital outside of retained 
earnings. Commenters suggested that if supplemental capital were to 
count toward regulatory capital, it would benefit the credit union by 
allowing it to expand products and services without diluting its 
regulatory capital, and it would protect the NCUSIF by incentivizing 
credit unions to attract private capital that could absorb losses 
before causing a loss to the Insurance Fund.
    Some commenters suggested further that the Board include (as a 
placeholder in this final rule) supplemental forms of capital, as 
defined by the Board and approved by NCUA or the appropriate state 
supervisory authority, in the risk-based capital numerator. Those 
commenters suggested the specific criteria could then be developed 
between finalizing the rule and its effective date in 2019.
    Other commenters acknowledged that because Congress did not speak 
directly to the calculation of risk-based capital, the Board need not 
be limited by section 216(0)(2) of the FCUA in defining what elements, 
including supplemental capital, constitute the ratio. Several 
commenters, however, suggested that not allowing all credit unions to 
use additional supplemental forms of capital to meet their risk-based 
capital requirements would create a more stringent capital requirement 
for credit unions, which would place credit unions at a competitive 
disadvantage to banks. One commenter argued the Board failed to meet 
the requirement to establish a capital framework that is comparable to 
the Other Banking Agencies because credit unions will be disadvantaged 
to banks.
    Other commenters recommended that the Board delay the publication 
of the final risk-based capital rule so that it can coincide with the 
publication of a final supplemental capital rule.

Discussion

    Consistent with the Second Proposal, this final rule would not 
include additional supplemental forms of capital in the risk-based 
capital ratio numerator at this time.
    The authorization of additional supplemental forms of capital for 
federal credit unions, and the inclusion of such forms of capital and 
the various forms of capital authorized for federally insured state-
chartered credit unions in the risk-based capital ratio numerator, is 
beyond the scope of this rulemaking. Delaying the issuance of this 
final rule until a separate supplemental capital proposal could be 
issued and then finalized, as several commenters suggested, would only 
reduce the amount of time credit unions have to prepare to comply with 
this final rule.
    The Board, however, appreciates the comments requesting access to 
additional supplemental forms of capital for credit unions. Board 
Chairman Debbie Matz has formed a working group at NCUA to consult with 
stakeholders and develop a separate proposed rule regarding 
supplemental forms of capital that could be included in the numerator 
of the risk-based capital ratio. The working group has reviewed the 
comments received on this issue, studied the alternative forms of 
capital used internationally and within the cooperative system, and 
obtained additional insight from industry practitioners who were highly 
interested or experienced with alternative forms of capital.
    In the near future, the working group plans to present its 
recommendations to the Board for revisions that could be made to NCUA's 
regulations through a separate rulemaking to allow additional 
supplemental forms of capital to be included in the risk-based capital 
ratio. The Board's intent is to finalize a new supplemental capital 
rule before the effective date of this risk-based capital final rule.
    The Board also continues to support amending the FCUA to provide 
all credit unions access to additional supplemental forms of capital 
that, subject to certain reasonable restrictions and consumer 
protections, could be counted toward a credit union's net worth ratio 
requirement and its risk-based capital requirement.

104(b)(2) Risk-Based Capital Ratio Numerator Deductions

    Under the Second Proposal, 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 Second Proposal in this 
final rule without change.
    NCUSIF capitalization deposit. Under the Second Proposal, the 
NCUSIF capitalization deposit was subtracted from both the numerator 
and denominator of the risk-based capital ratio.\121\ This treatment of 
the risk-based capital ratio would not have altered the

[[Page 66667]]

NCUSIF capitalization deposit's accounting treatment for credit unions.
---------------------------------------------------------------------------

    \121\ See U.S. Govt. Accountability Office, Available 
Information Indicates No Compelling Need for Secondary Capital, GAO-
04-849 (2004), available at http://www.gao.gov/assets/250/243642.pdf.
---------------------------------------------------------------------------

Public Comments on the Second Proposal

    The Board received many comments expressing concerns about the 
Second Proposal's treatment of the NCUSIF capitalization deposit. A 
minority of commenters suggested that they agreed with the proposed 
treatment of the NCUSIF deposit. A majority of commenters who mentioned 
the NCUSIF deposit, however, noted that credit unions treat their 
NCUSIF capitalization deposit as an asset on their books. Those 
commenters suggested that while banks expense their deposit insurance 
and can never reclaim it, a credit union's deposit will be returned if 
it decides to liquidate, convert to another charter, or convert to 
private insurance. The commenters recommended that the Board 
acknowledge the difference in treatment of insurance deposits between 
the two systems and assign a capital value to the NCUSIF capitalization 
deposit for credit unions. Another commenter suggested that, compared 
to banks, credit unions on average have 1 percent less capital than the 
net worth ratio suggests because credit unions carry the NCUSIF 
capitalization deposit as an asset: Pre-paid NCUSIF premiums, which the 
commenter argued should be amortized. The commenter speculated that if 
credit unions amortized their NCUSIF premium at eight basis points per 
year, it would have about the same effect as stabilization premiums and 
credit unions would, over 12 years, write off the deposit. The 
commenter suggested further that the deposit adds to the risk in 
economic downturns because it poses the danger of increased pressure on 
earnings and capital during a financial crisis. Another commenter 
argued that GAAP recognizes the NCUSIF capitalization deposit as an 
asset so it does not make sense to treat the deposit as an intangible 
asset given that it is easily measured and can be returned or refunded. 
Finally, some commenters recommended that the NCUSIF capitalization 
deposit be treated as a credit union asset with a risk weighting of 100 
percent or lower.

Discussion

    As stated in the Second Proposal, the 1997 U.S. Treasury Report on 
Credit Unions supports NCUA's position of excluding the NCUSIF 
capitalization deposit from the risk-based capital ratio calculation. 
The Treasury report concluded that the NCUSIF capitalization deposit is 
double counted because it is an asset on credit union balance sheets 
and equity in the NCUSIF.\122\ The Treasury noted that, in lieu of 
expensing the NCUSIF capitalization deposit, holding additional capital 
is necessary to offset the 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.\123\
---------------------------------------------------------------------------

    \122\ U.S. Dep't of Treasury, Credit Unions 58 (1997) (``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 [. . 
.] better ways of protecting the Fund are available. Accordingly, we 
do not recommend changing the accounting treatment of the 1 percent 
deposit.'').
    \123\ Id. at 4-5 & 55-59.
---------------------------------------------------------------------------

    The NCUSIF capitalization 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 capitalization 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.\124\ The purpose of the NCUSIF 
capitalization 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 1 percent NCUSIF capitalization deposit and required 
NCUSIF premium expenses needed to restore the NCUSIF equity ratio.\125\
---------------------------------------------------------------------------

    \124\ 12 U.S.C. 1782(c)(1)(B)(iii).
    \125\ NCUA, Premium Assessments, Letter to Credit Unions 09-CU-
20 (Oct. 2009); NCUA, Corporate Stabilization Fund Implementation, 
Letter to Credit Unions 09-CU-14 (June 2009); NCUA, Corporate Credit 
Union System Strategy, Letter to Credit Unions 09-CU-02 (Jan. 2009).
---------------------------------------------------------------------------

    The NCUSIF capitalization 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 
capitalization 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 capitalization 
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 capitalization deposit was also deducted from the 
denominator under proposed Sec.  702.104(c)(1), which properly adjusted 
the risk-based capital ratio calculation and reduced the impact of the 
adjustment.
    Neither the Second Proposal nor this final rule adjusts for the 
NCUSIF capitalization deposit twice or puts 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 capitalization deposit should be treated as an investment 
similar to Federal Home Loan Bank (FHLB) stock. The NCUSIF 
capitalization 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 
capitalization deposit refund. Further, unlike FHLB stock, the NCUSIF 
capitalization deposit is not an income-producing asset. The deposit 
has not paid a dividend since 2006. And it 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 
capitalization deposit, and does not believe the risk-based capital 
treatment will lead to a change in how this asset is accounted under 
GAAP. The Board agrees with the U.S. Treasury position as stated in its 
1997 Report on Credit Unions. Treasury stated that expensing the NCUSIF 
capitalization deposit would not strengthen the NCUSIF. The financial 
structure of the NCUSIF is reasonable and works well for credit unions.
    The assignment of an appropriate risk weight for the NCUSIF 
capitalization deposit, based on its credit risk, 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 deposit. The NCUSIF 
capitalization deposit is treated similarly to other intangible assets, 
(e.g. goodwill and core deposits intangible assets), as they are not 
available assets upon liquidation.
    Accordingly, for all the reasons discussed above, the Board has 
decided to retain this aspect of the Second Proposal in this final rule 
without change.

[[Page 66668]]

Goodwill and Other Intangible Assets

    Under the Second Proposal, goodwill and other intangible assets 
were 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, however, recognized that requiring the exclusion of 
goodwill and other intangibles associated with supervisory mergers and 
combinations of credit unions that occurred prior to this proposal 
could directly reduce a credit union's risk-based capital ratio. 
Accordingly, the Board also proposed allowing credit unions to include 
certain goodwill and other intangibles in the risk-based capital ratio 
numerator. In particular, the Second Proposal would have excluded from 
the definition of goodwill, which must be deducted from the risk-based 
capital ratio numerator, any goodwill or other intangible assets 
acquired by a credit union in a supervisory merger or consolidation 
that occurred before the publication of this rule in final form.
    The Second Proposal would not have changed the financial reporting 
requirements for credit unions, which requires they use GAAP to 
determine how certain intangibles are valued over time. Under the 
proposal, credit unions would have still been required to account for 
goodwill in accordance with GAAP, and the amount of excluded goodwill 
and other intangible assets would have been based on the outstanding 
balance of the goodwill directly related to supervisory mergers.
    The Board proposed allowing the excluded goodwill and other 
intangible assets to be counted until December 31, 2024, to allow 
affected credit unions to adjust to this change as they continue to 
value goodwill and other intangibles in accordance with GAAP. The 
proposed exclusions would have applied only to goodwill and other 
intangible assets acquired through supervisory mergers or 
consolidations and would not have been available for goodwill and other 
intangible assets acquired from mergers or consolidations that did not 
meet this definition. This change would have provided affected credit 
unions time to revise their business practices to ensure goodwill and 
other intangible assets directly related to supervisory mergers would 
not adversely impact their risk-based capital ratio.

Public Comments on the Second Proposal

    At least one commenter stated that they agreed with the proposed 
treatment of goodwill and other intangible assets. A significant number 
of commenters, however, suggested that the Board include all goodwill 
and other intangible assets in the risk-based capital ratio numerator 
so long as these intangible assets meet GAAP requirements (subjected to 
annual goodwill impairment testing). Commenters reasoned that the 
exclusion of non-supervisory goodwill from the numerator would 
discourage some well managed and well capitalized credit unions from 
participating in mergers, and many mergers serve to benefit the members 
of both the surviving and non-surviving credit union. Similarly, 
commenters reasoned that mergers can also have a favorable influence on 
safety and soundness--producing institutions that in combination have 
stronger financials and are able to weather more extreme economic 
swings.
    At least one commenter suggested that, as an alternative to 
including all goodwill and intangible assets in the risk-based capital 
ratio numerator, the Board might limit the retention of non-supervisory 
goodwill and other intangible assets in the numerator of the risk-based 
capital ratio for those credit unions that are well capitalized on the 
basis of the net worth ratio. The commenter suggested further that, at 
a minimum, non-supervisory goodwill that meets annual impairment 
testing should be retained in the numerator over a 10-year phase-out 
period, and all previous supervisory goodwill should be grandfathered 
without time limit, subject to regular impairment testing. The 
commenter suggested three reasons for taking such an approach: First, 
those credit unions that engaged in such transactions almost certainly 
reduced insurance losses to the Share Insurance Fund, and should not be 
penalized after the fact. Second, they did so with an understanding of 
current rules at that time. Many of these transactions would likely not 
have occurred had the proposed treatment of goodwill been known; so no 
longer counting this goodwill at some point in the future would be 
changing the rules midstream. Third, the amount of previous supervisory 
goodwill is a known, fixed, and relatively small quantity. Only 20 
credit unions with more than $100 million in assets have goodwill 
amounting to more than 5 percent of net worth, and the average goodwill 
to net worth ratio at these credit unions is 12.8 percent. Supervisory 
goodwill likely represents no more than three quarters of that goodwill 
(approximately 10 percent of net worth). Considering future growth, the 
commenter suggested that supervisory goodwill will decline in 
proportion to net worth and assets going forward, and grandfathering it 
would protect those credit unions that in the past reduced NCUSIF 
resolution costs from a cliff reduction in their RBC ratios in the 
future.
    Other commenters suggested that excluding goodwill from the risk-
based capital ratio numerator would harm credit unions by: (1) 
Penalizing credit unions who have recently gone through a merger, and 
(2) dis-incentivizing merger activity, which could prevent healthy 
industry consolidation and the combining of unhealthy credit unions 
with stronger ones in the future. Some commenters suggested that if a 
well-situated credit union relies on goodwill as a component of a 
merger, and is no longer able to justify such as a business decision 
because of a lack of allowance for goodwill, NCUA is then forced to 
step in, which would negatively impact the NCUSIF and could require the 
payment of additional premiums by all credit unions. Use of goodwill 
allows a well-situated credit union to absorb a struggling credit union 
without negatively impacting the NCUSIF, which the commenter suggested 
should be incentivized. Thus, the commenter recommended that goodwill 
arising from both previous and future mergers should continue to be 
counted without a time limitation, so long as it meets GAAP 
requirements.
    Several commenters suggested that the rule grandfather credit 
unions that have included goodwill on their books, and not impose the 
10-year limit, since it has been used by the credit union in the past 
and was sanctioned by NCUA. Another commenter suggested that if mergers 
were part of a strategic plan accomplished before the risk-based 
capital rule is finalized, then any goodwill acquired through those 
mergers should be grandfathered.
    Some commenters contended that goodwill acquired through a 
supervisory merger should not be treated differently than goodwill 
acquired through a strategic merger. Goodwill acquired through both 
types of mergers have value according to GAAP. One commenter argued 
that separating goodwill and other intangibles derived through a merger 
of healthy credit unions versus those assisted by a regulator does not 
make sense for the following reasons: (1) Some mergers that involve 
troubled credit unions may have had informal assistance from state or 
federal regulators, but may not meet the

[[Page 66669]]

definition outlined in the proposal as supervisory-assisted. This will 
create inconsistency in the application of the rule. (2) The treatment 
is inconsistent and provides potentially more risk to the NCUSIF as the 
risk-based capital ratio may not reflect the actual risk of future 
impairment of those assets. (3) The proposal favors troubled credit 
union mergers while discouraging healthy credit union consolidation due 
to the negative impact on the risk-based capital ratio. (4) Using a 10-
year life for supervisory-assisted transactions provides only temporary 
relief for those credit unions impacted and it overstates the risk-
based capital ratios until the phase-out period is over.
    One commenter argued that the proposed treatment of goodwill would 
place credit unions that acquired failing or insolvent credit unions 
(under supervisory/emergency merger conditions)--including those where 
NCUA, the NCUSIF, and the credit union industry realized benefits from 
the acquisition activities--at a competitive disadvantage. The 
commenter suggested that the proposed 10-year deferral of goodwill is 
an equitable solution for those credit unions that acquired failed 
credit unions and received some level of funded assistance from the 
NCUSIF, as the amount of goodwill carried on their books would 
typically be less than goodwill carried by those credit unions that did 
not receive assistance. The commenter explained that this is due to the 
fact that the funded amount of assistance from the NCUSIF upon receipt 
by the continuing credit union is recorded as a reduction to the 
goodwill determined at the time the failed credit union was acquired. 
The commenter argued that other credit unions, however, that acquired 
failed credit unions relying on the current risk-based net worth 
regulations, but did not receive funded assistance from the NCUSIF 
would be penalized under the proposed 10-year deferral of goodwill. The 
commenter speculated that these credit unions would be forced to forgo 
many opportunities in lieu of having to meet changed regulator risk-
based capital targets, while their competitors (for the next 10 years) 
would have the opportunity to focus on survival, service, product 
innovation, community reinvestment and growth. Accordingly, the 
commenter recommended the Board grant a one-time permanent exemption of 
goodwill to credit unions that made significant, capital-impacting 
decisions under the current risk-based net worth regulations.

Discussion

    There is a high level of uncertainty regarding the ability of 
credit unions to realize the value of goodwill and other intangibles, 
particularly in times of adverse conditions. Thus, the proposed 
approach to other intangibles generally mirrors the treatment by the 
Other Banking Agencies.\126\
---------------------------------------------------------------------------

    \126\ See, e.g., 12 CFR 324.22.
---------------------------------------------------------------------------

    However, as discussed in the definitions part of this rule above, 
the longer implementation period included in this final rule will serve 
to mitigate some of the commenters' concerns regarding existing 
goodwill and other intangibles because it provides affected credit 
unions more than 13 years to write down the goodwill or otherwise 
adjust their balance sheet.
    While the final rule includes a provision to address goodwill and 
other intangibles acquired through supervisory mergers and 
consolidations that were completed 60 days following this rule's 
publication, the final rule retains 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.
    Consistent with the comments, the Board recognizes that only 15 
credit unions report total goodwill and intangible assets of more than 
1 percent of assets, and notes that the valuation under GAAP of these 
existing assets will be immaterial by the end of the extended sunset 
date.
    In future combinations, a credit union will need to consider the 
impacts a combination will have on both its net worth ratio and its 
risk-based capital ratio. 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.
    Accordingly, for all the reasons discussed above, the Board has 
decided to retain this aspect of the Second Proposal in this final rule 
without change.

Identified Losses Not Reflected in the Risk-Based Capital Ratio 
Numerator

    The Second Proposal allowed for identified losses, not reflected as 
adjustments in the risk-based capital ratio numerator, to be deducted. 
The inclusion of identified losses 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 Second 
Proposal in this final rule without change.

104(c) Risk-Weighted Assets

    In developing the proposed risk weights included in the Second 
Proposal, the Board reviewed the Basel accords and the U.S. and various 
international banking systems' existing risk weights.\127\ The Board 
considered the comments contained in Material Loss Reviews (MLRs) 
prepared by NCUA's OIG and comments by GAO in their respective reviews 
of the financial services industry's implementation of PCA.\128\ The 
Second Proposal was designed to address credit risk and concentration 
risk in a manner comparable to the Other Banking Agencies' capital 
regulations.\129\ As a result, the Second Proposal would have 
substantially changed how the risk weights for nearly all credit union 
assets are assigned. For example, instead of assigning an investment a 
risk weight based on its weighted average life, the Second Proposal 
assigned risk weights to investments based primarily on the credit 
quality of the underlying collateral or repayment ability of the 
issuer. These and other adjustments were intended to address, where 
possible depending on the particular requirements of section 216 of the 
FCUA, inconsistencies between the risk weights assigned to assets under 
the Other Banking Agencies' capital regulations and NCUA's current PCA 
regulations.
---------------------------------------------------------------------------

    \127\ 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.
    \128\ 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).
    \129\ See, e.g., 12 CFR 324.32.
---------------------------------------------------------------------------

Public Comments on the Second Proposal

    The Board received many general comments regarding the proposed 
risk

[[Page 66670]]

weights. At least one commenter suggested the proposal significantly 
improved the various risk weightings and that most of the proposed risk 
weightings seemed appropriate. Most commenters who mentioned the risk 
weights also acknowledged that the Board had made significant 
improvements to the risk-weight categories from the original risk-based 
capital proposal, and many of the adjustments and more detailed asset 
categories included in the Second Proposal were significant 
improvements.
    A substantial number of the commenters, however, argued that the 
proposed risk weights remained too high in key areas, given credit 
unions' level of risk, and suggested they should be lower than what the 
federal bank regulators require for assets such as mortgage loans, 
member business loans, servicing and certain investments. These 
commenters suggested that lower risk weightings for credit union assets 
are appropriate given their different incentives to manage risk as 
compared to banks, and lower loss history based on their comparison to 
the banking industry.
    A significant number of commenters complained that the proposed 
risk-weighting scheme was overly complex. At least one commenter 
suggested that credit unions have assets on their books at fair value; 
the change to fair value is accounted for in either the profit and loss 
statement or in other comprehensive income. The commenter recommended 
that the Board clarify the application of the risk weight for these 
assets when a component of their book value has already impacted 
capital through earnings or other comprehensive income. Other 
commenters recommended that the risk weights and concentration 
percentages take into account the standard credit risk factors such as 
loan-to-value ratio, credit score, origination channel, etc. One 
commenter suggested that credit risk is a function of underwriting, the 
economy, loan portfolio diversity, institutional structure, business 
strategy, profitability demands, time horizons, performance-monitoring 
capacity, funding stability and other factors. But, the commenter 
argued, the proposal ignores these local, individual factors in favor 
of a one-size-fits-all risk weighting.
    Interest rate risk. The Board also received many comments regarding 
the proposed removal of IRR from the risk-weight calculation. A 
majority of the commenters who mentioned IRR stated that they agreed 
with the proposed removal of interest rate risk from the rule. 
Moreover, they suggested a separate IRR standard was not needed to 
reasonably account for IRR at credit unions because NCUA's current 
framework of policies and regulations sufficiently address the risk. 
One credit union commenter did recommend, however, that NCUA expand the 
data it gathers in the 5300 Call Reports and use that information to 
facilitate both RBC compliance and interest rate risk management. The 
commenter suggested Call Reports also be used to monitor investment 
losses for credit unions that invest in complex securities, which would 
show the direction a credit union is trending and provide regulators 
with an objective basis for determining which credit unions need 
capital buffers that exceed regulatory minimums.
    Concentration risk. The Board received a substantial number of 
comments regarding the Second Proposal's retention of concentration 
risk measures in the risk weightings of certain categories of assets. A 
majority of the commenters who mentioned it suggested that 
concentration risk is best addressed through the examination process as 
it is for banks, and thus, should be dropped from the risk weights in 
the final rule. At least one commenter argued that the proposed 
concentration threshold requirements violate the FCUA, which requires 
the Board to ``prescribe a system of prompt corrective action'' that is 
``comparable to section 1831o'' of the Federal Deposit Insurance Act.
    One commenter noted that while NCUA did cite to specific credit 
union failures that involved high concentrations of certain assets, the 
Material Loss Reviews associated with those failures revealed that 
fraud or board mismanagement played a pivotal, if not a determining, 
role in the failure of the credit unions. Other commenters claimed 
that, based on 2007 and 2014 data, there was no meaningful difference 
in the performance of credit unions with higher or lower levels of 
concentration in mortgages or home equity loans. The proposal would 
require credit unions to hold more capital than banks at certain levels 
of asset concentration, which commenters argued would not create a 
``comparable'' capital framework and would put credit unions at a 
competitive disadvantage. The commenters contended this is particularly 
true for mortgages and home equity loans where the capital requirements 
materially increase even at relatively lower levels of concentration 
(35 percent and 20 percent of assets, respectively).
    One commenter claimed the Board did not provided any evidence the 
proposed concentration risk thresholds aligned with increased capital 
at risk, and insisted that the historical loss data provided by NCUA 
did not support establishing a higher capital standard for credit 
unions than banks. The commenter argued that the data in the Second 
Proposal showing the differences in asset concentrations between those 
credit unions that failed and those that survived was insufficient. And 
for real estate loans, the commenter claimed the data was inconclusive 
because credit unions that failed had 58 percent of their assets in 
real estate whereas those credit unions that survived had 49 percent. 
While there was a higher concentration of real estate assets for those 
that failed, the commenter suggested the difference of 9 percent was 
not a firm basis on which to assert higher concentrations of real 
estate loans were a significant contributing factor to the credit 
union's failure such that it warrants higher capital levels for all 
complex credit unions. Similarly, the commenter argued that the data 
for commercial loans would not support a concentration risk threshold 
of 50 percent, and alleged that the Board examined the current level of 
real estate exposure across the industry and set the capital 
requirements such that roughly the top 10 percent of the industry would 
see their capital requirements increase. Further, the commenter argued 
that the methodology was unsupported by the evidence, that there was no 
empirical evidence to support that either (a) two standard deviations 
is the right basis for determining this threshold, or (b) the resultant 
risk thresholds correlated directly to higher degrees of risk such that 
additional capital should be held by these institutions. The commenter 
insisted that, based on the comparability requirement in the FCUA, the 
Board should eliminate the concentration risk thresholds for these 
asset classes and set the risk weights equal to those applied to the 
banking industry (50 percent for mortgages and 100 percent for both 
home equity loans and commercial loans).
    Another commenter noted that the examples given by the Board in 
support of adopting concentration risk elements did not acknowledge the 
fact that mortgage and home equity line of credit (HELOC) underwriting 
standards have tightened, and claimed that credit unions have generally 
divested away from residential real estate, and that the proposal fails 
to anticipate where the credit union asset mix will likely migrate in 
the future. Based on this claim, the commenter speculated that

[[Page 66671]]

the proposed concentration limits may not prudently attain the desired 
goal of portfolio invariance and may, in fact, threaten the long-term 
viability of many credit unions. The commenter recommended that the 
Board adopt one of the following alternative approaches: (1) Do away 
with the concentration risk element altogether; (2) use current 
demarcation points as a trigger for expanded reporting in the Call 
Report, thereby allowing NCUA to assess if there is in fact additional 
risk; or (3) increase the current threshold levels that call for 
increased weighting--for example, by moving the mortgage threshold to 
50 percent to match the commercial loan threshold, and increasing the 
residential junior lien threshold from 20 percent to 25 percent.
    One commenter argued that the proposed approach of including 
concentration risk thresholds in the risk weights was fundamentally 
flawed because it considered the relative size of the portfolio and not 
the benefit of diversification. Another commenter speculated that 
without more specific information to capture diversification within a 
lending portfolio,\130\ the proposal would have limited value in 
providing early warning of truly unsafe concentrations. Instead, the 
commenter recommended NCUA address outlier credit unions through the 
timely application of supervisory tools or, if necessary, by applying 
the capital adequacy planning requirements of section 702.101(b) to 
credit unions flagged as outliers. The commenter suggested that using 
capital adequacy plans to address concentration risk would control for 
asset concentrations that pose safety and soundness risk without 
placing the wider credit union system at a competitive disadvantage to 
banks. The commenter speculated further that, given the shifting 
landscape of the financial services market and the credit union 
industry, building risk parameters around the current shape of the 
market may not align with future risks.
---------------------------------------------------------------------------

    \130\ For example, diversification based on geography, industry, 
credit profile, or product type.
---------------------------------------------------------------------------

    Yet another commenter suggested that if concentration risk is 
maintained in the final rule, the concentration threshold level for all 
secured loan categories should be 50 percent, and only unsecured loans 
should have a concentration threshold level below 50 percent.
    Finally, one commenter argued that there is no need for the rule to 
address concentration risk, claiming that concentration risk would 
address itself since the dollar amount applied against the risk weight 
increases as concentration increases.

Discussion

    After carefully considering the comments received, the Board 
generally agrees with commenters who suggested that IRR concerns can be 
addressed through NCUA guidance, supervision, and other regulations. 
NCUA's guidance, supervision, and other regulations are designed to 
address how IRR is managed and reported in a manner that is appropriate 
to the size, complexity, risk profile, and scope of each credit union's 
operations. The Board has determined not to include IRR in the risk-
based net worth requirement \131\ given the other mechanisms available 
to NCUA to address such risk. NCUA will continue to monitor credit 
unions' exposure to IRR through the supervision process and plans to 
provide additional supervisory guidance in the future.
---------------------------------------------------------------------------

    \131\ See 12 U.S.C. 1790d(d)(2) (``The Board shall design the 
risk-based net worth requirement to take account of any material 
risks against with the net worth ratio required for an insured 
credit union to be adequately capitalized may not provide adequate 
protection.'').
---------------------------------------------------------------------------

    The Board, however, disagrees with commenters who suggested further 
reductions in the scope of the use of risk weights to address 
concentration risk. Under the Second Proposal, the Board substantially 
reduced the risk-based capital requirements related to concentration 
risk by using one concentration threshold, set at a higher level, for 
assets that NCUA determined are vulnerable to concentration risk. As 
stated in the preamble to the Second Proposal, the concept of 
addressing concentration risk with the assignment of risk weights is 
consistent with the risk-based net worth requirement under current part 
702. Higher risk weights are assigned to real estate loans and MBLs 
held in higher concentrations under the current rule. Elimination or 
additional reductions in the concentration risk dimension of the risk-
based net worth requirement would be inconsistent with concerns 
regarding concentration risk raised by GAO and in MLRs conducted by 
NCUA's OIG.\132\ The preamble also noted that the Basel Committee on 
Banking Supervision has stated that ``risk concentrations are arguably 
the single most important cause of major problems in banks.'' \133\
---------------------------------------------------------------------------

    \132\ 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; 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.
    \133\ 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.
---------------------------------------------------------------------------

    It is not appropriate to rely solely on the supervisory process to 
address concentration risk because the holding of additional capital 
for concentration risk should occur prior to the development of the 
concentration risk, and is difficult to achieve after a concern with 
concentration risk is identified during the supervisory process.
    The concentration risk thresholds were adjusted in the Second 
Proposal to focus on material levels of concentration risk and for more 
consistency with the current effective impact of the concentration risk 
on capital requirements for commercial loans. As a result of the risk-
weight adjustments, very few credit unions would be subject to the 
marginally higher risk weights due to concentration risk. Credit unions 
subject to the concentration risk weights will not be placed at a 
competitive disadvantage, because all banks are required to maintain 
capital commensurate with the level and nature of all risks, including 
concentration risk, to which they are exposed.\134\
---------------------------------------------------------------------------

    \134\ See 12 CFR 324.10(d).
---------------------------------------------------------------------------

    Regarding support for the risk weights themselves, given the 
statutory requirement to maintain comparability with the Other Banking 
Agencies' PCA requirements,\135\ NCUA relied primarily on the 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. The Board, however, did tailor 
the proposed risk weights for assets unique to credit unions, where 
contemporary and sustained performance differences existed (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.
---------------------------------------------------------------------------

    \135\ See 12 U.S.C. 1790d(b)(1)(A)(ii).
---------------------------------------------------------------------------

    The Board generally agrees with commenters who suggested that 
credit risk factors such as loan-to-value ratio (LTV), credit score, 
origination and other individual factors are meaningful

[[Page 66672]]

and should be evaluated. However, reporting loan data on LTVs and 
credit scores to NCUA would be administratively burdensome. For 
example, establishing regulations on how the LTV would be measured 
would be complex when considering such items as how to take into 
account private mortgage insurance as the financial strength of 
mortgage insurers varies, or the LTV of a restructured loan. NCUA also 
lacks credit union industry data on loan performance based on LTV 
ratios that could be used to establish a framework for LTV-based risk 
weights. And risk weights based on LTVs for real estate loans would not 
be comparable to the risk weight framework used by the other banking 
agencies.
    Accordingly, the Board has decided to maintain the proposed 
approach to risk-weighting assets in this final rule.

104(c)(1) General

    Under the Second Proposal, Sec.  702.104(c)(1) provided that risk-
weighted assets include 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). The section 
provided 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 proposed 
adding 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.
    The Board received no comments on the language in this paragraph of 
the proposal. Accordingly, the Board has decided to retain the language 
in this proposed paragraph in this final rule without change.

104(c)(2) Risk Weights for On-Balance Sheet Assets

    Under the Second Proposal, Sec.  702.104(c)(2) defined the risk 
categories and risk weights to be assigned to each defined on-balance 
sheet asset. All on-balance sheet assets were assigned to one of 10 
risk-weight categories.
    The Board received a significant number of comments, which are 
discussed in more detail below, on the proposed risk-weight categories 
and the risk weights assigned to particular assets.

Cash and Investment Risk Weights

    Under the Second Proposal, the Board proposed eliminating the 
process of assigning risk weights for investments based on the weighted 
average life of investments in favor of a credit-risk centered approach 
for investments. The credit risk approach to assigning risk weights 
under the Second Proposal was based on applying lower risk weights to 
safer investment types and higher risk weights to riskier investment 
types.\136\ The proposed investment risk weights are similar to the 
risk weights assigned to investments under the Other Banking Agencies' 
regulations,\137\ which are based on the credit-risk elements of the 
issuer, the underlying collateral, and the payout position of the 
particular type of investment. The proposed changes to the risk weights 
assigned to investments are outlined in the following table:
---------------------------------------------------------------------------

    \136\ 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.
    \137\ See, e.g., 12 CFR 324.32.

         Second Proposal: Risk Weights for Cash and Investments
------------------------------------------------------------------------
                                                             Proposed
                          Item                               (percent)
                                                            risk weight
------------------------------------------------------------------------
 The balance of cash, currency and coin,                       0
 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........
 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.......

[[Page 66673]]

 
 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 equity investments in
 CUSOs..................................................
 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                  400
 equity investments, other than equity investments in
 CUSOs..................................................
 The exposure amount of any subordinated tranche     \138\ 1,250
 of any investment, with the option to use the gross-up
 approach...............................................
------------------------------------------------------------------------

Public Comments on the Second Proposal

    The Board received many general comments regarding the proposed 
investment risk weights. At least one commenter maintained that the 
proposal would unfairly penalize credit unions by using investment risk 
weights to compensate for interest rate risk, which the commenter 
argued would create a bias towards lending and against investments. 
Other commenters, however, suggested that, in general, the revised risk 
weights for investments were reasonable, including the zero risk 
weighting for investments issued by the U.S. Government, including NCUA 
and FDIC. Some commenters suggested the 20 percent weight for 
government-sponsored enterprises (GSEs) seemed reasonable given that 
they are quasi-government entities.
---------------------------------------------------------------------------

    \138\ The 1,250 percent risk-weight amount is based on holding 
capital dollar-for-dollar at the 8 percent adequately capitalized 
level for the risk-based capital ratio (8 percent adequately 
capitalized level *1,250 percent = 100 percent).
---------------------------------------------------------------------------

    The Board also received other comments regarding the risk weights 
assigned to the following particular investments:
    Deposits in banks or credit unions. One commenter contended that 
the proposed risk weightings for investments were mute on weights for 
deposits in banks or credit unions. The commenter believed such 
deposits should have some level of risk weighting, at least for any 
uninsured amounts on deposit at banks and credit unions, because they 
can be a part of a smaller credit union's investment portfolio.
    Part 703 compliant investment funds. At least one commenter 
objected to a default risk weight of 100 percent for part 703 compliant 
investment funds, and 300 percent for non-part 703 compliant funds. The 
commenter believed the 200 percent increase in a default risk weight 
would be punitive and would create a disadvantage for state-chartered 
credit unions. The commenter suggested there are several non-
conforming, state-authorized investments that are not based in equities 
or other ``volatile and risky investments'' and that do not warrant a 
300 percent risk weight. The commenter argued further that, by using 
part 703 as a threshold, the Board was assigning a significantly lower 
baseline assumption of risk on the basis of the regulator that approved 
the investment, which would single out state-chartered institutions and 
force them to undertake look-through calculations on their investments 
when federal charters may be able to rely on the default risk weight. 
The commenter recommended that the default thresholds be tied to the 
underlying holdings and investment strategy of the fund.
    At least one commenter recommended that investment funds that hold 
only investments that qualify for a zero or 20 percent risk weight 
should receive a 20 percent risk weight regardless of whether the 
underlying investments are part 703 compliant.
    One commenter complained that the proposed risk-weight categories 
for non-loan investments were too general, lumping together assets with 
widely varying risks, especially when considering risks beyond those 
tied to interest rate fluctuations. The commenter suggested that 
additional risk-weighting tools within categories were needed to 
properly take account of issuer- and security-specific issues for both 
debt and equity securities and non-part 703 compliant funds. The 
commenter speculated further that the proposed approach would 
discourage responsible employee benefit pre-funding by penalizing those 
investments, and provide incentives for excessively aggressive equity 
investing in pursuit of higher returns to offset the especially high 
reserve requirements. The commenter recommended that the baseline risk 
weights should be presumptive only, so that if a credit union can 
present good reasons why a lower risk weight should be assigned to its 
investments within a certain category, those lower weights should be 
applied going forward. Another commenter suggested that, while the 
proposed 100 percent risk weight assigned to all private issuer 
corporate debt is not a punitive level, there ought to be some ability 
for a credit union to demonstrate that the corporate debt it holds 
qualifies for a lower weighting, closer to the 20 percent for state and 
local debt, or the 50 percent for revenue bonds, which are limited for 
repayment to the revenue generated by a specific facility and thus 
often are in reality private issuer obligations. The commenter believed 
that a flat 100 percent weighting for all corporate debt takes no 
account of actual issuer-specific repayment risk, and could serve to 
distort reasonable investment decisions by credit unions looking to 
include such issues in their employee benefit pre-funding portfolios. 
The commenter recommended some issue/issuer-specific risk assessment be 
allowed to more rationally, precisely equal risk and risk weights.
    Non-significant equity exposures. Several commenters suggested that 
banks are permitted to apply a 100 percent risk weight to certain 
equity exposures deemed non-significant. The commenters suggested 
further that non-significant exposures mean an equity exposure that 
does not exceed 10 percent of the bank's total capital. The commenters 
recommended that NCUA adopt a similar treatment if the publicly traded 
equities and equity allocation within an investment fund are less than 
10 percent of a credit union's total capital; then a risk weight of 100 
percent shall be applied to the equity exposure. The commenters 
suggested this would reduce the complexity of the look-through approach 
and simplify the overall risk-weighting process for non-significant 
equity exposure.

[[Page 66674]]

    Community development investments. Several commenters suggested 
that OCC's risk-based capital regulation recognizes the importance of 
community development investments and assigns a risk weight of 100 
percent rather than the standard 300 percent factor. The commenters 
suggested further that the public policy embraced by OCC with this 
allowance is to encourage investments to support charitable goals and 
purposes. Commenters recommended that NCUA embrace a similar policy and 
assign a risk weight of 100 percent for any equity or corporate bond 
exposure in a community development investment. The commenters 
suggested that such treatment would support broader participation by 
credit unions with community development investments and enhance the 
goodwill and reputation of the credit union industry as it builds an 
investment resource to support charitable contributions.
    Employee benefit plan investments. Some commenters argued that the 
300 percent risk weighting assigned to publicly traded equity 
investments should be much lower so that credit unions are not unduly 
limited in their investments for employee benefit funding. One 
commenter recommended that the Board continue to apply standard risk 
weights to benefit plan investments. The commenter contended that a 
457(b) executive plan is un-funded and does not vest until the employee 
retires or terminates employment, and the assets underlying such plans 
generally must remain the property of the credit union until vested and 
are subject to the claims of general creditors. The commenter 
speculated further that, if the credit union is put into 
conservatorship, the investments never transfer to the employee. So, 
the commenter maintained, it is appropriate for the Board to risk 
weight such investments as part of the overall balance. The commenter 
expressed concern that it could be very difficult for NCUA to determine 
with certainty whether, and to what extent, the credit union held a 
risk of loss in connection with the investments because employee 
benefit plans can be tailored to fit the needs of each individual 
credit union and executive.
    One commenter claimed risk weighting all publicly traded equities 
at 300 percent would be punitive and unjustified by real-world 
experience with a long list of blue-chip, dividend-paying, financially 
secure stocks regularly included in credit union client Sec.  701.19 
portfolios. The commenter suggested that, as with corporate debt, some 
tools must be offered to allow a credit union to obtain relief from the 
extremely high risk assessment for specific equity issues which are 
more secure than consumer loans in default, to which the proposal 
assigns a 150 percent risk weight. The commenter suggested further that 
relevant factors which could support a lowering of the risk weighting 
for specific equity investments include the issuer's debt rating, 
market capitalization and financial condition, history of dividend 
payments, and absence of financial defaults. The commenter speculated 
that imposing a blanket 300 percent risk weight on all public equity 
would create two negative, counterproductive incentives: First, it 
would discourage any public equity investments, driving down expected 
overall portfolio return and requiring investment of a larger amount of 
credit union funds to achieve a needed annual return tied to projected 
future benefit costs. Second, for those credit unions which do 
nevertheless include an equity component in their Sec.  701.19 
portfolios, there would be pressure to overcome the high reserve ratio 
by investing in higher-return, higher-risk equities, instead of more 
stable dividend-paying stocks. The commenter also maintained that the 
300 percent risk weight assigned to pre-funded, non-part 703 compliant 
mutual funds, while subject to reduction under various look-through 
methods, was unjustifiably high in comparison to the other weights 
assigned to performing and even non-performing loans.
    Publicly traded equity investments. One commenter recommended that 
all publicly traded equity investments be treated as either available 
for sale or trading. The commenter suggested that these two methods of 
accounting require the investment to be recorded at market value, which 
should be easily determined since they are publicly traded. Thus, the 
commenter argued, the 300 percent risk weight assigned under the Second 
Proposal would be excessive, especially given the amount of class B 
Visa shares held by a significant number of credit unions, and with the 
employee benefit funding allowed by Sec.  701.19 of NCUA's regulations.
    Non-agency ABS structured securities. One commenter suggested that 
collateral utilized to secure investments included in the non-agency 
ABS structured securities category could include automobile loans. 
Because the Second Proposal requires a risk weighting of 75 percent for 
all current secured consumer loans--and since the risk profile of the 
underlying collateral does not differ between secured automobile loans 
and non-agency ABS structured securities backed by secured auto loans--
the commenter recommended the risk weightings for both instruments be 
set at 75 percent.
    Subordinate tranche of any investment. At least one commenter 
complained that the Second Proposal would assign a risk weighting of 
1,250 percent, or require the use of the gross-up approach to determine 
the overall weighting of this category of investment. The commenter 
argued that the 1,250 percent risk weighting was punitive in nature and 
could not be justified from a safety and soundness standpoint because 
it may appear to represent more than 100 percent of the monies at risk 
in any one investment.
    At least one commenter also objected that, by not including the 
``simplified supervisory formula approach'' \139\ in the Second 
Proposal, the Board deprived credit unions of a measurement tool that 
is allowed by the Other Banking Agencies and the Basel Committee on 
Banking Supervision. The commenter argued that this could represent a 
competitive disadvantage to credit unions who are evaluating certain 
investments for inclusion in their strategies. Given the significance 
of the weighting and the exclusion of the evaluation method, the 
commenter recommended the 1,250 percent weighting should be eliminated 
and the Simplified Supervisory Formula Approach be utilized to 
determine the weighting of investment categories.
---------------------------------------------------------------------------

    \139\ See, e.g., 12 CFR 324.43.
---------------------------------------------------------------------------

    One commenter suggested that the Board assign the subordinate 
tranche of any investments the same risk weight that applies to 
commercial loans.
    Corporate debt. Several commenters maintained that applying high 
risk weights to investments in the corporate system would penalize 
credit unions that invest within the industry. Commenters also 
suggested that the risk weights assigned to corporate paid-in capital 
should recognize how the stricter regulatory standards for corporate 
credit unions adopted in 2010 not only mitigate risks to natural-person 
credit unions, but also protect the NCUSIF from potential losses. 
Accordingly, some commenters recommended that a lower risk weight of 
125 percent be assigned to corporate paid-in capital under the final 
rule.
    One commenter suggested that it would be more reasonable to 
generally structure risk weights for corporate debt into tiers similar 
to that of municipal bonds because the proposed structure would make it 
costly to diversify and gain yield because the risk weights assigned 
would negate the added yield

[[Page 66675]]

of these bonds. The commenter insisted that, in order to preserve a 
credit union's ability to diversify and avoid concentration risk in 
agency or government bonds, more reasonable risk weights should be 
assigned to different forms of corporate debt. The commenter suggested 
one alternative option for structuring risk weights for corporate debt 
would be to create a four-tiered risk classification that would include 
investment grade and non-investment grade bonds. The commenter noted 
that the current definition is silent on whether bonds can be non-
investment grade. The commenter suggested further that the investment 
grades could be broken down into high, medium and low investment grade 
plus non-investment grade for four tiers. According to the commenter, 
the high grade would be equivalent to an AAA rating, the medium grade 
would be equivalent to an A rating, the low grade would be equivalent 
to a BBB rating, and the non-investment grade would be non-investment 
grade. The commenter recommended these ratings be part of the credit 
union's internal ratings system for bonds, which would allow for lower 
risk weights for high-grade bonds at 50 percent, medium-grade bonds at 
75 percent, and low-grade bonds at 100 percent.

Discussion

    The Board disagrees with commenters who suggested that the proposal 
would unfairly penalize credit unions by using investment risk weights 
to compensate for IRR. The Board intentionally removed the weighted 
average life calculation from the assignment of risk weights to remove 
the IRR components from the Second Proposal. As stated above, the risk 
weights assigned to investments were based on credit risk, consistent 
with the risk weights assigned to investments by the Other Banking 
Agencies.
    The Board disagrees with the commenters who claimed the proposed 
risk weights assigned to investments were mute on the weights for 
deposits in banks and credit unions. The Second Proposal assigned a 
risk weight of zero percent to insured balances from FDIC-insured 
depositories or federally insured credit unions. Uninsured balances, 
and all balances due from privately insured credit unions, were risk-
weighted at 20 percent. Deposits in a bank that are guaranteed by a 
state received the same 20 percent risk weight as an investment in a 
PSE.
    The Board disagrees with the commenters who suggested that a 300 
percent risk weight for non-part 703 compliant investment funds would 
be punitive compared to the 100 percent risk weight for part 703 
compliant investment funds. The Board chose to create standard risk 
weights for investment funds to allow credit unions a simple 
alternative to calculating the risk weights for such assets using the 
look-through approaches. Part 703 compliant investment funds were 
assigned a 100 percent risk weight under the Second Proposal unless 
they qualified for a lower risk weight because they were limited to 
holding lower risk-weighted assets. The Board determined that part 703 
compliant investment funds should qualify for a maximum 100 percent 
risk weight under Sec.  702.104(c)(2) because the underlying 
investments permitted under part 703 of NCUA's regulations were almost 
exclusively assigned a risk weight of 100 percent or less under the 
proposal. Non-part 703 investment funds, on the other hand, are 
potentially more risky, so assigning them a risk weight equivalent to 
the risk weight assigned to publicly traded equity investments is 
appropriate. Under the Second Proposal, credit unions were also given 
the option to calculate the risk weight for any investment fund using 
one of the look-through approaches, which allow a credit union to risk 
weight such a fund based on its underlying assets.
    The Board disagrees with commenters who claimed the proposed risk 
weights were too general because they lumped together assets with 
widely varying risk, and those who suggested including additional risk-
weight measures, such as taking into account the specific loan-to-value 
ratio or FICO scores of the underlying assets. As with loans, the risk 
weights assigned to investments were generally determined based on the 
underlying collateral or type of loan, and the relative credit risk. 
The Board chose not to apply separate risk weights to investments based 
on additional risk-weighting tools due to the complexity involved and 
the backward-looking nature of an analysis based on past performance. 
Adding risk-weighting factors within investment type categories would 
have been inconsistent with the approach taken by the Other Banking 
Agencies.
    The Board also disagrees with commenters who suggested that credit 
unions should be able use lower risk weights if they are able to 
demonstrate that an investment should qualify for a lower-risk weight. 
Alternative and individualized risk weight mechanisms would be 
difficult and costly to implement consistently, and would be 
inconsistent with the Other Banking Agencies' regulations.
    Several commenters recommended that the Board apply a 100 percent 
risk weight to non-significant equity exposures, which would be similar 
to the approach taken by the Other Banking Agencies. As discussed in 
more detail below in the part of the preamble associated with Sec.  
702.104(c)(3)(i), the Board generally agrees with commenters on this 
point and has amended this final rule to assign a 100 percent risk 
weight to non-significant equity exposures. This change is consistent 
with the Board's objective of assigning risk weights to assets that are 
similar to the Other Banking Agencies' regulations where the level of 
risk exposure does not create safety and soundness concerns.
    The Board disagrees with commenters who suggested that lower risk 
weights should be applied to certain types of investments, such as 
corporate bonds and publicly traded equities, which are generally not 
available to federal credit unions, simply because they were purchased 
for employee benefit plans. In particular, several commenters argued 
that the 300 percent risk weight assigned to publicly traded equity 
investments should be much lower so that credit unions are not limited 
in their investments for employee benefits. The proposed risk weights 
were intended to be applied based on risk, not on use. And, consistent 
with commenters' suggestions on the Original Proposal, the Board 
assigned risk weights in a manner similar to the Other Banking 
Agencies' regulations unless the FCUA or a unique circumstance 
warranted a different risk weight be adopted. The 300 percent risk 
weight for non-part 703 compliant investment funds is appropriate when 
they are used to fund employee benefits because there are few limits on 
the investments in these types of funds. A credit union may, however, 
use one of the look-through approaches if the underlying assets have a 
risk weight of less than 300 percent. Accordingly, for these types of 
assets, the proposed risk weight reasonably reflects the risks 
associated with the types of assets available to fund employee benefit 
plans.
    The Board disagrees with the commenter who suggested that a 300 
percent risk-weight was excessive for publicly traded equity 
investments because they are treated as available for sale or trading 
and recorded at market value. The value at which an equity is recorded 
does not reflect the risk of loss and does not preclude an equity from 
losing a substantial amount of its value in the future. The lack of a 
maturity date, loss position, and unknown

[[Page 66676]]

dividends make an equity riskier than many other types of assets.
    The Board generally agrees with the commenter who suggested that a 
senior asset-backed security should have the same risk weight as a 
similar loan. Such an approach is consistent with the Other Banking 
Agencies' regulations and focuses on the risk of the underlying 
collateral. By applying the gross-up approach to a non-subordinated 
tranche of an investment, a credit union can risk weight a non-
subordinated tranche of an investment with the same risk weight as if 
they had owned the loans directly. Accordingly, this final rule adds 
non-subordinated tranches of any investments to the 100 risk-weight 
category and gives credit unions the option to use the gross-up 
approach.
    The Board disagrees with commenters who suggested that the proposed 
1,250 percent risk weight was punitive for subordinated tranches of 
investments. Under the proposal, credit unions were given the option to 
use the gross-up approach to lower the risk weight of a subordinated 
tranche of an investment if it did not contain an excessively large 
amount of leverage. The 1,250 percent risk weight is a reasonable risk 
weight for subordinated tranches if the credit union is unable, or 
unwilling to use the gross-up approach. The risk weight is appropriate 
given the leveraged risk in subordinated tranches, and is consistent 
with the Other Banking Agencies' regulations.\140\ As noted in the 
Second Proposal, the simplified supervisory formula approach for 
subordinated tranches permitted under the Other Banking Agencies' 
capital regulations was not included in the Second Proposal because of 
its complexity and limited applicability.
---------------------------------------------------------------------------

    \140\ NCUA estimates a de minimis number of investments would be 
subject to the 1,250 risk weight.
---------------------------------------------------------------------------

    The Board also disagrees with commenters who suggested that 
subordinated tranches of investments should receive the same risk 
weight as commercial loans. Applying subordinated tranches of 
investments the same risk weights as commercial loans would likely fail 
to account for highly leveraged transactions, and would be inconsistent 
with the Other Banking Agencies' regulations. The Board also notes 
that, using the gross-up approach, low-risk subordinated tranches of 
certain investments could receive risk weights equal to or less than 
the risk weights assigned to commercial loans.
    The Board disagrees with commenters who suggested that assigning 
high risk weights to investments in the corporate credit union system 
would penalize credit unions that invest within the industry. The 
proposed risk weights assigned to nonperpetual capital and perpetual 
contributed capital at corporate credit unions are 100 percent and 150 
percent, respectively. The proposed risk weights were not intended to 
be a penalty or disincentive for holding any particular assets. Rather, 
the intent was to assign appropriate risk weights that adequately 
account for the risk associated with each particular asset. The risk 
weights for corporate capital investments did take into consideration 
the stricter regulations commenters cited when seeking lower risk 
weights. And as a result, this final rule assigns reasonable risk 
weights to corporate-capital investments given the stricter regulatory 
requirements applicable to corporate credit unions as compared to the 
higher risk weights associated with non-publicly traded equity 
investments under the Other Banking Agencies' regulations.
    The Board disagrees with the commenter who suggested that the final 
rule should assign different risk-weight tiers in corporate debt, 
similar to municipal bonds. Under the Second Proposal, the risk weight 
assigned to a corporate debt was consistent with the risk weight 
assigned to an industrial development bond, which is a type of 
municipal bond. An industrial development bond is 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. Typically the ultimate 
obligation of repayment of the industrial development bond is on a 
corporation. The 100 percent risk weight for corporate bonds is 
consistent with the risk weights assigned to industrial development 
bonds, a tier within municipal bonds, where the ultimate obligation of 
repayment is a corporate entity. The proposed risk weight for corporate 
debt is generally consistent with the Other Banking Agencies' 
regulations. The Board decided not to apply tiers within investment 
types due to the complexity and the inability to apply a standard and 
objective approach.
    Consistent with the Dodd-Frank Wall Street Reform and Consumer 
Protection Act of 2010, which required agencies to remove all 
references to credit ratings, this final rule does not use credit 
ratings to determine risk weights for part 702.\141\
---------------------------------------------------------------------------

    \141\ Public Law 111-203, Title IX, Subtitle C, section 939A, 
124 Stat. 1376, 1887 (July 21, 2010).
---------------------------------------------------------------------------

Commercial Loans

    The Second Proposal assigned risk weights to commercial loans in a 
manner generally consistent with the Other Banking Agencies' capital 
regulations and the objectives of the Basel Committee on Banking 
Supervision.\142\ The proposal set a single concentration threshold at 
50 percent of total assets. Commercial loans that were less than the 50 
percent threshold were assigned a 100 percent risk weight, and 
commercial loans over the threshold were assigned a 150 percent risk 
weight. Commercial loans that were not current were assigned a 150 
percent risk weight.
---------------------------------------------------------------------------

    \142\ This is comparable with the other Federal Banking 
Regulatory Agencies' capital rules. See e.g., 12 CFR 324.32 (Assigns 
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)); 78 FR 55339 (Sept. 10, 
2013); and 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 percent risk weight of the loans 
secured.'') available at http://www.bis.org/publ/bcbs128.htm.
    \143\ The effective capital rate represents the blended 
percentage of capital necessary for a given level of commercial loan 
concentration. The calculation uses 10 percent as the level of risk-
based capital to be well capitalized.

----------------------------------------------------------------------------------------------------------------
                                              Commercial loan concentration (percent of total assets)
                                 -------------------------------------------------------------------------------
                                        15%             20%             50%             75%            100%
----------------------------------------------------------------------------------------------------------------
Effective Capital Rate: \143\
    Current Rule................             6.0             6.5            10.4            11.6            12.2
    This Proposal...............            10.0            10.0            10.0            11.7            12.5
----------------------------------------------------------------------------------------------------------------


[[Page 66677]]

Public Comments on the Second Proposal

    A substantial number of commenters recommended that the risk 
weights for commercial loans be adjusted downward to levels no more 
than those in place for banks. Those commenters claimed credit unions 
do not have higher levels of risk associated with holding commercial 
loans than banks do. Commenters acknowledged that lower risk weights 
for higher concentrations of commercial loans would imply lower risk 
weights for lower concentrations of these loans compared to bank risk 
weights, but they insisted this disparity would be appropriate given 
lower loss rates at credit unions. One commenter recommended assigning 
a lower risk weight, of perhaps 50-75 percent, to secured commercial 
loans. The commenter explained that in locations where there is a 
market for certain types of commercial vehicles, a lower risk weight 
makes more sense. Another commenter recommended the following risk 
weights for commercial loans be assigned as an alternative: Credit card 
and other unsecured loans that are less than 50 percent of assets 
should be assigned a 100 percent risk weight, and such loans that are 
over 50 percent of assets should be assigned a 150 percent risk weight; 
new vehicle loans that are less than 50 percent of assets should be 
assigned a 50 percent risk weight, and such loans that are greater than 
50 percent of assets should be assigned a 75 percent risk weight; used 
vehicle loans that are less than 50 percent of assets should be 
assigned a 75 percent risk weight, and such loans that are greater than 
50 percent of assets should be assigned a 112 percent risk weight; 
first-lien residential real estate loans and lines of credit that are 
less than 50 percent of assets should be assigned a 75 percent risk 
weight, and such loans that are greater than 50 percent of assets 
should be assigned a 112 percent risk weight; all other real estate 
loans and lines of credit that are less than 50 percent of assets 
should be assigned a 100 percent risk weight, and such loans that are 
greater than 50 percent of assets should be assigned a 150 percent risk 
weight.
    At least one commenter speculated that the vast majority of credit 
union member business loans have real estate as collateral, while 
commercial bank loans are typically collateralized with receivables, 
etc. The commenter noted that under the banking agencies' rules, 
commercial loans made by banks are assigned a 100 percent risk weight. 
The commenter argued, however, that NCUA's risk weight for member 
business loans should be lowered from 100 percent to 75 percent to 
account for the fact that credit union member business loans are safer 
than commercial loans made by banks.
    Some commenters complained that the proposal did not account for 
the different types of commercial loans made by credit unions. 
Commenters also speculated that credit unions chartered for the purpose 
of making MBLs would be unfairly penalized under the proposal.

Discussion

    The Board disagrees that concentration thresholds for commercial 
loans should vary based on the business purpose or underlying 
collateral. The Agency did not pursue the alternative commercial risk 
weights suggested by commenters because such alternatives would be 
extremely difficult to implement consistently across all credit unions. 
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 regulations. All commercial asset 
classes experience performance fluctuations with variations in business 
cycles. Some sectors that had historically 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.\144\
---------------------------------------------------------------------------

    \144\ NCUA, Taxi Medallion Lending, Letter to Credit Unions 14-
CU-06 (April 2014); FDIC, Prudent Management of Agricultural Credits 
Through Economic Cycles, Financial Institution Letter FIL-39-2014 
(July 16, 2014).
---------------------------------------------------------------------------

    Contemporary variances between bank and credit union losses on 
commercial loans are not substantial enough to warrant assigning lower 
risk weights to commercial loans held by credit unions. As stated in 
the Second Proposal, and as further clarified below using data to match 
the asset breakouts within the FDIC Quarterly Banking Profile, 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.
---------------------------------------------------------------------------

    \145\ See Yearend FDIC Quarterly Banking Profiles 11 (2012, 
2013, & 2014).
    \146\ See NCUA Financial Performance Report using year end data 
for credit unions with assets greater than $100 million.

                                           3 Year Average Loss History
                                               [2012, 2013, 2014]
----------------------------------------------------------------------------------------------------------------
                                                    Credit unions >$100M    Banks $100M to     Banks $1B to $10B
                                                          in assets         $10B in assets         in assets
----------------------------------------------------------------------------------------------------------------
Commercial & Industrial \145\.....................  ....................               0.61                0.42
Member Business Loans \146\.......................                 0.52
----------------------------------------------------------------------------------------------------------------

    Further, credit unions' long-term historical MBL losses are 
somewhat understated because 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.\147\
---------------------------------------------------------------------------

    \147\ 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. See Department of the Treasury, Credit 
Union Member Business Lending (Washington, DC January 2001).
---------------------------------------------------------------------------

Residential Real Estate Loans

    The Second Proposal assigned risk weights to residential real 
estate loans that are generally consistent with those assigned by the 
Other Banking Agencies.\148\ The proposal set the first- and junior-
lien residential real estate loan concentration thresholds at 35 
percent and 20 percent of total assets respectively. Current first-lien 
residential real estate loans that were less than 35 percent of assets 
were assigned a 50 percent risk weight, and

[[Page 66678]]

those equal to or greater than 35 percent of assets were assigned a 75 
percent risk weight. Current junior-lien residential real estate loans 
that were less than 20 percent of assets were assigned a 100 percent 
risk weight, and those equal to or greater than 20 percent of assets 
were assigned a 150 percent risk weight.
---------------------------------------------------------------------------

    \148\ See, e.g., 12 CFR 324.32(g).

                 Proposed Residential Real Estate Loan Concentration Thresholds and Risk Weights
----------------------------------------------------------------------------------------------------------------
                                          50%                 75%                100%                150%
----------------------------------------------------------------------------------------------------------------
First-Lien......................  Current <35% of     Current >=35% of
                                   Assets.             Assets.
Junior-Lien.....................  ..................  ..................  Current <20% of     Current >=20% of
                                                                           Assets.             Assets.
----------------------------------------------------------------------------------------------------------------

    In addition, under the Second Proposal, first- and junior-lien 
residential real estate loans that are not current were assigned 100 
percent and 150 percent risk weights, respectively.

Public Comments on the Second Proposal

    A majority of the commenters who mentioned these loans recommended 
that the concentration risk component be removed entirely from the risk 
weights for first- and junior-lien residential real estate loans. One 
commenter expressed concern that the high risk weights assigned to 
certain first-lien residential real estate loans and certain junior-
lien residential real estate loans could negatively impact mortgage 
lending in the communities served by credit unions. The commenter 
argued that the proposal did not appear to address the underlying 
attributes of the mortgages nor the degree in which they may be match 
funded, which could thereby restrict lending and curtail profitability 
and capital growth at well managed, risk-averse credit unions. 
Accordingly, the commenter recommended that the Board reconsider and 
revise the risk weights for mortgage loans held on balance sheet to be 
more consistent with the requirements of the Other Federal Banking 
Agencies. Similarly, a substantial number of credit union commenters 
suggested that the risk weights for mortgage loans be adjusted downward 
to levels no more than those in place for banks because they claimed 
credit unions do not have higher levels of risk associated with holding 
these assets. Another commenter argued that the risk weights assigned 
to real estate loans were arbitrary because: (1) The vast majority of 
MBLs are collateralized with real estate at a loan-to-value ratio of 75 
percent or less; (2) the vast majority of home equity loans are first 
mortgages with a loan-to-value ratio of 80 percent or less; and (3) 
some increased risk is associated with junior lien mortgages, but it is 
not extensive or widespread. Yet another commenter suggested that the 
final rule assign risk weights to these assets by including a study of 
loss history and the market where a credit union operates.
    Several commenters recommended further that consideration be given 
to incorporating loan-to-value ratios, credit scores, salability of the 
loan to secondary mortgage market participants, and the size of loans 
in the proposed risk weighting. One commenter suggested that both 
junior- and first-lien residential real estate loans amortize over 
time, lessening their credit risk profile, and in the case of junior 
liens, over time they can become first liens, at which point the risk 
weightings become too conservative. The commenter maintained that this 
reduction in risk was not accounted for under the Second Proposal.
    One commenter suggested that the Board consider lower risk 
weightings for loans with private mortgage insurance or government 
guarantees.
    One commenter suggested that one-to-four-family non-owner occupied 
real-estate-backed loans should be treated as a separate category and 
not count toward the premium of 75 percent risk weight when real estate 
loans comprise over 35 percent of assets. From a concentration risk 
standpoint, commercial loans are already limited by a statutory cap 
under the FCUA at 12.25 percent for the majority of credit unions.
    Some commenters argued that the proposal would exacerbate the 
burden and costs credit unions are already facing under the Dodd-Frank 
Act regulations by requiring higher levels of capital for those credit 
unions that hold first-lien residential real estate loans in excess of 
35 percent of total assets. Those commenters speculated that the 
increased capital cost based upon concentration risk will put credit 
unions at a competitive disadvantage to other financial institutions 
that do not have higher risk weightings for holding higher 
concentrations of loans.
    Similarly, some commenters argued that the proposal would 
exacerbate the burden and costs credit unions are already facing under 
the Dodd-Frank Act regulations by requiring higher levels of capital 
for those credit unions that hold junior-lien residential real estate 
loans in excess of 20 percent of total assets. Those commenters 
maintained that the increased capital cost based upon concentration 
risk puts credit unions at a competitive disadvantage to other 
financial institutions that do not have higher risk weightings for 
holding higher concentrations of loans.

Discussion

    The Board has considered the comments received, but, as stated in 
the proposal, the contemporary variances between bank and credit union 
losses on real estate loans are not substantial enough to warrant 
assigning lower risk weights. As stated in the Second Proposal and as 
further clarified below using data to match the asset breakouts within 
the FDIC Quarterly Banking Profile, credit unions' real estate loss 
experience is comparable to community banks after adjusting for asset 
size.
---------------------------------------------------------------------------

    \149\ See yearend FDIC Quarterly Banking Profiles for 2012, 
2013, and 2014, page 11 and NCUA Financial Performance Report (FPR) 
using year end data for credit unions with assets greater than $100 
million.

                                        3 Year Average Loss History \149\
                                               [2012, 2013, 2014]
----------------------------------------------------------------------------------------------------------------
                                                          Credit unions       Banks $100M to   Banks $1B to $10B
                                                         >$100M in assets     $10B in assets       in assets
----------------------------------------------------------------------------------------------------------------
All real estate loans................................                 0.33               0.36               0.38

[[Page 66679]]

 
Other 1-4 family residential loans...................  ...................               0.30               0.37
First mortgage loans.................................                 0.24  .................  .................
Home equity loans....................................  ...................               0.52               0.51
Other real estate loans..............................                 0.63  .................  .................
----------------------------------------------------------------------------------------------------------------

    Higher capital requirements for concentrations of real estate loans 
exist in the current rule, and 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.
    NCUA currently reviews credit concentrations during examinations as 
commenters recommended. As discussed in the summary section, however, 
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.\150\
---------------------------------------------------------------------------

    \150\ 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 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.\151\ In addition, in 2012, GAO recommended that NCUA 
address the credit concentration risk concerns raised by the NCUA 
OIG.\152\ 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 also indicated that the 
Board should revise NCUA's PCA regulation so that the minimum net worth 
levels required under the rule emphasize credit concentration risk. So 
eliminating the concentration dimension for risk weights entirely would 
be inconsistent with the concerns raised by GAO and the MLRs conducted 
by NCUA's OIG.
---------------------------------------------------------------------------

    \151\ See NCUA, Material Loss Review of Cal State 9 Credit 
Union, OIG-10-03 (April 14, 2010); NCUA, Material Loss Review OF 
Beehive Credit Union, OIG-11-07 (July 7, 2011); and NCUA, Material 
Loss Review OF Ensign Federal Credit Union, OIG-10-15 (September 23, 
2010), available at http://www.ncua.gov/about/Leadership/CO/OIG/Pages/MaterialLossReviews.aspx.
    \152\ See U.S. Govt. Accountability Office, Earlier Actions are 
Needed to Better Address Troubled Credit Unions, GAO-12-247 (2012), 
available at http://www.gao.gov/products/GAO-12-247.
---------------------------------------------------------------------------

    The proposed risk weights would not 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.
    The Board agrees with commenters that credit scores, loan 
underwriting, portfolio seasoning, and portfolio performance are 
appropriate measures to evaluate a specific credit union's 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 an 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 unwieldy for NCUA to enforce 
minimum capital requirements.\153\ Further, such an approach would not 
be comparable to the risk weight framework used by the Other Banking 
Agencies.
---------------------------------------------------------------------------

    \153\ 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.\154\ Credit 
unions should use criteria from their own internal risk models and loan 
underwriting in developing their internal risk management systems.
---------------------------------------------------------------------------

    \154\ 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 likewise 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. There is no 
historical data across institutions upon which to base varying risk 
weights according to LTVs and other underwriting criteria (such as 
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.
    Junior-lien residential real estate loans continue to warrant a 
higher risk weight based on loss history. Call Report data indicate 
credit unions over $100 million in asset size reported nearly three 
times the rate of loan losses (0.63 percent) on other real estate loans 
\155\ when compared to first mortgage real estate loans (0.24 percent) 
during the past three years. The final base risk weight for junior-lien 
residential real estate loans is comparable to the risk weight assigned 
by the Other Banking Agencies.\156\
---------------------------------------------------------------------------

    \155\ Junior-lien real estate loans are currently reported on 
the Call Report as part of ``other real estate loans.''
    \156\ See, e.g., 12 CFR 324.32(g)(2).

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

[[Page 66680]]

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.\157\ 
Under the Second Proposal, a current secured consumer loan received a 
risk weight of 75 percent, and a current unsecured consumer loan was 
assigned a 100 percent risk weight.
---------------------------------------------------------------------------

    \157\ Per Call Report data for years ending December 31, 2012, 
2013, and 2014, consumer loans were greater than 40 percent of loans 
in credit unions with total assets greater than $100 million.
---------------------------------------------------------------------------

Public Comments on the Second Proposal

    One commenter claimed the risk weightings assigned to secured and 
unsecured consumer loans at credit unions would be more restrictive 
than the comparable risk weightings applicable to community banks. To 
remain competitive, the commenter recommended that the proposed risk 
weights should be changed to be more in line with Basel III instead of 
being more restrictive. Other commenters argued that based on the 
historical performance of credit unions in managing consumer loan risk, 
the Board should assign a 50 percent risk weight to secured consumer 
loans and a 75 percent risk weight to unsecured consumer loans. These 
commenters speculated that if the risk weights proposed for consumer 
loans were adopted, some credit unions would have to reduce the 
services they are currently able to provide to members.

Discussion

    The Board disagrees with the commenter who claimed the proposed 
risk weight assigned to consumer loans that are current is more 
restrictive than the corresponding risk weight assigned to such loans 
for community banks. The risk weight for secured consumer loans in the 
Second Proposal and in this final rule is 75 percent, which is less 
than the 100 percent risk weight assigned to such loans held at 
community banks under the Other Banking Agencies' regulations. The risk 
weight for unsecured consumer loans that are current is identical to 
the corresponding risk weight for such loans held at community banks.
    Comparisons of historical losses on consumer loans between credit 
unions and banks is difficult due to differences in Call Report data, 
but generally the difference in historical performance measured by loss 
history is not significant. Accordingly, the Board has decided to 
maintain the consumer loan risk weights contained in the Second 
Proposal.

Non-Current Consumer Loans

    The risk-based net worth measure in NCUA's current PCA regulation 
does not assign a higher risk weight to non-current consumer loans. 
Increasing levels of non-current loans, however, are an indicator of 
increased risk. To reflect the impaired credit quality of past-due 
loans, the Second Proposal required credit unions to assign a 150 
percent risk weight to loans (other than real estate loans) that are 90 
days or more past due, in nonaccrual status, or restructured.

Public Comments on the Second Proposal

    One commenter suggested that consumer loans that are not current 
(90 days past due), could be assigned a 100 percent risk weight, 
instead of a 150 percent risk weight, given the historically low 
default rate of these loan types, strong underwriting and possible 
further protection by underlying collateral. At least one commenter 
maintained that with ALLL calculations already in place to account for 
higher charge offs, the proposed risk weight for non-current loans 
would be unnecessarily high and would ultimately hurt credit union 
members. Other commenters speculated that the proposed risk weights 
would force credit unions to pull back lending to low-income 
communities for fear of carrying delinquent (non-current) loans at 
elevated risk weightings.

Discussion

    The proposed risk weight of 150 percent is warranted because non-
current consumer loans have a higher probability of default when 
compared to current consumer loans. Non-current consumer loans are more 
likely to default because repayment is already impaired, making them 
one step closer to default compared to current consumer loans. As 
stated in the Second Proposal, the Board assigned a higher risk weight 
on past-due exposures to ensure sufficient regulatory capital for the 
increased probability of unexpected losses on these exposures, which 
results in a risk-based capital measure that is more responsive to 
changes in the credit performance of the loan portfolio. The higher 
risk weight will capture the risk associated with the impaired credit 
quality of these exposures. Moreover, the 150 percent risk weight is 
consistent with the risk weights used under Basel III and the Other 
Banking Agencies.\158\
---------------------------------------------------------------------------

    \158\ See, e.g., 12 CFR 324.32(k).
---------------------------------------------------------------------------

    The Board disagrees with commenters who speculated that the 
proposed risk weights would limit credit unions' ability to assist low-
income members. The removal of the ALLL cap will reduce the impact of 
non-current loans to the risk-based capital ratio.
    Accordingly, this final rule retains the 150 percent risk weight 
for consumer loans that are not current.

Loans to CUSOs, and CUSO Investments

    Under the Second Proposal, investments in CUSOs were assigned a 
risk weight of 150 percent and loans to CUSOs were assigned a risk 
weight of 100 percent.

Public Comments on the Second Proposal

    Commenters generally maintained that the proposed risk weight for 
investments in CUSOs was too high. A majority of the commenters who 
mentioned it suggested that the risk weight for CUSO investments was 
too high and should be the same as for CUSO loans, or less. A 
substantial number of commenters argued that given the unique position 
of CUSOs as cooperative cost-saving structures in the credit union 
system, the Board should use its statutorily granted discretion to draw 
distinctions between CUSOs and private equity investments held by 
banks. Commenters maintained that not only must CUSOs provide NCUA with 
open access to their books and records, but CUSOs will be required to 
register directly with NCUA and, if complex, report audited financial 
statements and customer information.\159\ Commenters reasoned that this 
heightened supervisory oversight compared to general investment 
exposures, combined with the limits on credit union investment powers, 
makes a 100 percent risk weight more appropriate. The commenters 
suggested further that, given the limits on credit union investment 
powers, the vast majority of credit unions with unconsolidated equity 
investments in CUSOs would fall within the ``non-significant'' 
exception under the banking regulations for investments aggregating 
less than 10 percent of total assets, and would receive a 100 percent 
risk weight. Therefore, the commenters reasoned, adjusting the CUSO 
investment weighting to 100 percent would better reflect the role of 
CUSOs in the credit union industry while still aligning in practice 
with treatment of similar exposures in banks.
---------------------------------------------------------------------------

    \159\ 12 CFR part 712; and 12 CFR 741.222.
---------------------------------------------------------------------------

    Other commenters stated that they supported the proposed treatment 
of

[[Page 66681]]

consolidated CUSO investments and loans in which no separate risk 
weighting would apply. One commenter suggested that, if GAAP is 
followed for the valuation of CUSOs, the proper valuation of the asset 
should allow for the lowering of the risk weight from the proposed 150 
percent risk weight. Several commenters contended that the 150 percent 
risk weight assigned to unconsolidated CUSO investments, which applies 
to the accumulated and undistributed earnings of these CUSOs under 
GAAP, is inappropriate because it would require credit unions to set 
aside additional capital, beyond what they initially invested, to cover 
retained earnings to support future growth of these CUSOs. These 
commenters recommended that the Board reduce the risk weight to 100 
percent, or, if not lowered, to risk weight only the initial investment 
by the credit union and not the appreciation of that investment over 
time.
    One commenter argued that the risk weight assigned to 
unconsolidated investments in CUSOs would be counter-productive. The 
commenter claimed that the Board presented only anecdotal and 
unsubstantiated references to what it considers ``substantial CUSO 
losses'' over the last decade as justification for CUSO regulations and 
assigning a 150 percent risk weight to CUSO investments. The commenter 
contended that no detailed statistics have been provided to justify 
these losses as substantial, and the commenter would challenge any such 
claim because they were not able to substantiate any losses of a 
significant nature through credit union investment in CUSOs over the 
past 10 years. The commenter recommended the Board investigate the 
industry benefits of CUSOs and the relatively immaterial level of CUSO 
investment impact on the NCUSIF before finalizing the current proposed 
risk weights for CUSO investments.
    Other commenters suggested that assigning a 150 percent risk weight 
to multi-credit union owned CUSOs, which are important collaborative 
tools for credit unions, is not reflective of the actual systemic risk 
CUSOs pose. The commenters explained that, overall, based on 2014 data, 
federally insured credit unions in total have less than 22 basis points 
of their assets invested in CUSOs, including fully consolidated CUSO 
investments. Therefore, the commenters asserted, CUSO investments are 
not a systemic risk to the NCUSIF.
    One commenter pointed out that the proposal stated that the risks 
associated with CUSOs are similar to the risks associated with third-
party vendors. However, the commenter could not find any references in 
the proposal that would account for the risks posed by non-CUSO third-
party vendors. The commenter claimed that only CUSOs were singled out 
for their supposed risk, and argued that was not adequate justification 
for the risk weight assigned to CUSO investments.
    Some commenters argued that the proposal cited FDIC's capital 
regulation in saying that risk weights should be set based on the risk 
of loss and not the size of exposure. Those commenters suggested, 
however, that FDIC agrees that non-significant investment exposures in 
unconsolidated equity of a privately held company should be risk 
weighted at 100 percent. The commenters recommended the Board look 
deeper into the FDIC definition of ``non-significant'' and how it 
translates to unconsolidated CUSO investments. In the commenters' 
opinion, the statutory and regulatory structure of CUSO investments 
make such investments non-significant using the FDIC definition, and 
thereby should be assigned only a 100 percent risk weight.
    One commenter suggested that investments in CUSOs should carry a 
100 percent risk weighting based on the following risk-mitigating 
factors: (1) GAAP requires credit unions to evaluate the asset for 
potential impairment; (2) the majority of CUSOs are limited liability 
corporations (LLCs) and the credit union would be protected under the 
LLC structure; and (3) the stated purpose of NCUA's CUSO rule is to 
reduce risk exposure to credit unions. Another commenter suggested that 
investments in and loans to CUSOs should be equally risk weighted. The 
commenter recommended assigning a 75 percent risk weight due to the 
expertise that is brought to the business strategy within the relevant 
business model that they are operating within and to encourage the use 
of the cooperative business model. Other commenters suggested that 
CUSOs should be risk weighted based on type: Operational CUSOs should 
receive a 50 percent risk weight, fee-generating CUSOs should receive a 
zero percent risk weight, and start-up CUSOs should receive a 100 
percent risk weight.
    Several commenters suggested that instead of assuming that all 
CUSOs are inherently risky, the proposal should be primarily concerned 
with the riskiness of the services provided by a CUSO and how dependent 
a credit union is on CUSO investments. One commenter suggested that in 
order to minimize the impacts of the proposal, CUSOs would be required 
to give excess earnings back to the credit unions to reduce their CUSO 
exposure. This would result in reduced services for the credit union.

Discussion

    The Board has carefully considered the comments received. As 
discussed in more detail below in the part of this preamble associated 
with Sec.  702.104(c)(3)(i), under this final rule a credit union's 
investments in CUSOs will receive a 100 percent risk weight if the 
credit union has non-significant equity exposures.\160\
---------------------------------------------------------------------------

    \160\ A credit union has ``non-significant equity exposures'' if 
the aggregate amount of its equity exposures does not exceed 10 
percent of the sum of the credit union's capital elements of the 
risk-based capital ratio numerator.
---------------------------------------------------------------------------

    The Board relied 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 100 percent risk weight if its equity 
exposures are non-significant or a 150 percent risk weight if its 
equity exposures are significant, 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 to many credit unions. However, an equity investment in a CUSO 
is an unsecured, at-risk equity investment in a 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. The position can grow in proportion to assets over time. In 
setting capital standards (such as Basel and FDIC), the risk of loss--
not the size of the

[[Page 66682]]

exposure--is central to determining the risk weight. 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.\161\
---------------------------------------------------------------------------

    \161\ 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.
---------------------------------------------------------------------------

    The Second Proposal noted that the risk weight should be higher 
than 100 percent given that an 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. 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. It may be possible, however, to make more meaningful risk 
distinctions in the future between the risk various types of CUSOs pose 
once NCUA's CUSO registry is in place and sufficient trend information 
has been collected.
    Under the Second 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.\162\ 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. Under the Other Banking Agencies' regulations, an equity 
investment in a CUSO would be treated the same as an equity investment 
in a non-publicly traded entity (with 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.
---------------------------------------------------------------------------

    \162\ See, e.g., 12 CFR 324.52.
---------------------------------------------------------------------------

    The Board recognizes the complexity of FDIC's approach and believes 
that a simplified lower-risk-weight approach is appropriate when the 
entire amount of equity exposures within the credit union are not 
significant.
    Accordingly, this final rule retains the proposed 100 percent risk 
weight assigned to loans to CUSOs, and retains the 150 percent risk 
weight assigned to investments in CUSOs if the equity exposure is 
significant. As discussed in more detail below, however, this final 
rule reduces the risk weight assigned to investments in CUSOs to 100 
percent for complex credit unions with non-significant equity 
exposures.

Mortgage Servicing Assets (MSAs)

    The Second Proposal would have assigned a 250 percent risk weight 
to MSAs to address the complexity and volatility of these assets.

Public Comments on the Second Proposal

    A significant number of commenters maintained that the 250 percent 
risk-weight assigned to MSAs would reduce the ability of credit unions 
to grant mortgage loans, engage in loan participations, and retain 
servicing of their member loans, and that it would likely also prevent 
credit unions from using mortgage servicing rights as a hedge against 
future rate changes. Accordingly, they argued the proposed risk 
weighting for MSAs, which would be the same as for banks, would be too 
high and should be significantly lower. One commenter suggested that, 
because much of the risk associated with holding MSAs relates to the 
volatility of their market value with changes in interest rates, credit 
unions that book MSAs at, or close to, their current market value are 
at a greater risk of loss in a falling interest rate scenario. One 
commenter suggested further that those institutions that book MSAs more 
conservatively have a built-in book-to-market value cushion to absorb 
normal downward fluctuations in market value and are in a better 
position to recapture their investment over a shorter period of time. 
The commenter stated that in a rising-rate environment, the value of 
MSAs and the corresponding cushion grow and the risk declines. 
Consequently, the commenter contended, a flat 250 percent in all 
circumstances would be punitive for those credit unions that 
conservatively book MSAs, particularly in a low-interest-rate or low-
refinance environment. The commenter maintained that it is important to 
note that the operational risks associated with MSAs are not avoided by 
holding originated mortgage loans in portfolio, yet the risk weights of 
portfolio mortgage loans varies from 50 percent to 75 percent, despite 
the fact that such assets are burdened with a multitude of other risks 
not inherent in MSAs.
    One commenter observed that for sound asset, liability, and 
liquidity management purposes, some credit unions sell nearly all of 
their mortgage loan production into the secondary market and retain a 
sizable portion of the servicing rights for member service and risk 
mitigation purposes, the latter in terms of the stability of earnings 
from the aggregate of mortgage-related activities over time. The 
commenter maintained that these credit unions' MSA-portfolio market 
values are evaluated independently each quarter, with the market value 
consistently representing more than the stated book values, 
representing sizable off-balance sheet assets. The commenter 
recommended that the risk weight for MSAs be based on a reasonable 
formula related to the ratio of book value to market value and in any 
case not exceed a 75 percent risk weight.
    Several commenters argued that MSAs are salable and, consistent 
with GAAP, they are evaluated for potential impairment. Accordingly, 
they argued MSAs should be assigned a risk weight of 100 percent. One 
commenter suggested that the risk weight for MSAs should be no more 
than 150 percent. Another commenter suggested that MSAs should be 
assigned the same risk weight that is assigned to mortgage loans held 
in portfolio and that are under 35 percent of assets. At least one 
commenter recommended that, if a 250 percent risk weight is adopted for 
MSAs, a lower risk weight of 100 percent should be assigned to MSAs on 
loans sold without recourse, but that are serviced by the credit union.
    Other commenters suggested that if a credit union is following 
GAAP, it must record mortgage servicing as an asset that then requires 
a valuation be done every year, and if as an asset it does not meet the 
actual valuation reflected it must be written down to the audited 
value.
    One commenter argued that weighting MSAs at 250 percent would 
penalize those credit unions who lowered their interest rate risk on 
their balance sheet by selling their longer-term, fixed-rate real 
estate loans. Another commenter suggested that the 250 percent risk 
weight would pressure credit unions to sell the servicing rights on 
mortgages they originate, effectively forcing credit unions to end a 
significant member relationship many credit unions have with their 
members, in order to manage interest rate risk.

[[Page 66683]]

    One commenter claimed that MSAs only have two significant risks 
associated with them: (1) Prepayment penalties, and (2) operational/
reputational risk. Both risks, the commenter suggested, are relatively 
easily mitigated because prepayment risk can be mitigated by 
maintaining a viable origination pipeline, and operational/reputational 
risk can be mitigated by maintaining a good system of internal 
controls. Moreover, the commenter argued MSAs provide a significant, 
reliable source of fee revenue for many credit unions, which is 
generated from fees that are paid by investors, not by members.

Discussion

    The 250 percent risk weight factors in the relatively greater risks 
inherent in MSAs, and maintains comparability with the risk weight 
assigned to these assets by the Other Banking Agencies.\163\ As noted 
in the preamble to the Second Proposal, MSAs typically lose value when 
interest rates fall and borrowers refinance or prepay their mortgage 
loans, leading to earnings volatility and erosion of capital. 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.
---------------------------------------------------------------------------

    \163\ See, e.g., 12 CFR 324.32(l)(4)(i).
---------------------------------------------------------------------------

    While the Board agrees with commenters that MSAs may provide some 
hedge against falling rates under certain circumstances, 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, the commenters' argument is no 
longer directly applicable.
    NCUA does not agree with commenters who speculated that the 
proposed 250 percent risk weight assigned to this relatively small 
asset class would significantly dis-incentivize 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 stringent) risk weights 
for MSAs for some time and continue to sell loans and retain MSAs.
    The January 1, 2019 effective date for this final rule provides 
credit unions more than three years to adjust to these new requirements 
and provides credit unions with a phase-in period comparable to that 
given to banks following a similar change to the Other Banking 
Agencies' capital regulations.\164\
---------------------------------------------------------------------------

    \164\ See, e.g., 12 CFR 324.1(f).
---------------------------------------------------------------------------

Other On-Balance Sheet Assets

    The Second Proposal assigned specific risk weights to additional 
asset classes, which are discussed in more detail below. Under the 
proposal, all assets listed on the statement of financial condition not 
specifically assigned a risk weight under proposed Sec.  702.104 were 
assigned a 100 percent risk weight.\165\
---------------------------------------------------------------------------

    \165\ This is comparable to the Other Banking Agencies' capital 
rules, which maintained the 100 percent risk weight for assets not 
assigned to a risk weight category. See, e.g., 12 CFR 324.32; and 78 
FR 55339 (Sept. 10, 2013).
---------------------------------------------------------------------------

Public Comments on the Second Proposal

    The Board received several comments regarding the proposed risk 
weights for other on-balance sheet assets.
    Some commenters opposed the Second Proposal's risk weighting of 20 
percent for share-secured loan balances and member business 
(commercial) loans secured by compensating balances. By contrast, the 
commenters observed the comparable risk weight for community banks is 
zero percent if the cash is on deposit in the bank, which is 
appropriate given there is no risk. Thus, the commenters recommended 
that loan balances secured by shares or compensating balances on 
deposit at the originating credit union be reduced to a zero percent 
weighting, and loan balances secured by compensating balances on 
deposit at another financial institution be weighted at the proposed 20 
percent.
    One commenter agreed that the Board's efforts to align the risk-
based capital regulation more closely with the Other Banking Agencies' 
regulations were appropriate. The commenter suggested that, absent a 
compelling rationale for different treatment between the two systems, 
regulators should strive to maintain equal treatment for equal risks in 
all depository institutions. The commenter also recommended that 
principal-only STRIPS be risk-weighted based on the underlying 
guarantor or collateral.
    Some commenters suggested that imposing risk-based capital 
limitations on charitable donation accounts would contravene the appeal 
for credit unions to put money into these investments to fund 
charitable activities. Those commenters recommended that the Board 
amend the final rule to do one of the following: (1) Exempt CDAs from 
the risk-based capital regulation because the Board effectively 
balanced safety and soundness with effectuating credit unions' 
charitable intent when it passed the CDA regulation; (2) Assign a 100 
percent risk weight to any equity or corporate bond exposure in a CDA 
investment; (3) Apply a 100 percent risk weight to non-significant 
equity exposures because banks are permitted to apply a 100 percent 
risk weight to certain equity exposures deemed non-significant. Those 
commenters suggested that such treatment would support broader 
participation by credit unions with community development investments 
and enhance the goodwill and reputation of the credit union industry as 
it builds an investment resource to support charitable contributions.
    One commenter maintained that the Second Proposal would require a 
credit union to reduce its capital (in the numerator) by the amount of 
the underfunded portion of the pension plan, but was silent on how to 
reflect an overfunded pension asset. The commenter recommended that 
NCUA provide specific guidance on the treatment of an overfunded 
pension asset. Specifically, the commenter recommended the Board 
eliminate the inconsistent treatment by removing the overfunded pension 
asset from both the numerator and the denominator.
    A state supervisory authority commenter requested clarification on 
the risk weighting treatment of credit union deposits in the Bank of 
North Dakota. The commenter noted that the Bank is state-owned, and its 
deposits are neither federally nor privately insured, but are backed by 
a guarantee from the State of North Dakota. The commenter acknowledged 
it is a unique institution, and thus was unsure which risk weighting 
would apply to the deposits. The commenter suggested the deposits are 
low risk due to the guarantee by the state, and recommended it be 
afforded a 20 percent or lower weighting.
    At least one commenter recommend that the Board define auto and 
credit card servicing assets and assign them risk weights consistent 
with the risk weighting assigned to mortgage servicing assets.
    One commenter contended that the ``full look-through'' approach 
described under the Second Proposal failed to apply risk weights to 
mutual fund investments in a consistent manner to the holding of the 
same securities by

[[Page 66684]]

credit unions directly. The commenter explained that, for example, a 
credit union that holds ``U.S. Treasuries and Government Securities'' 
would assign a risk weight of zero percent to such holdings. By 
contrast, an investment fund, with similar U.S. Treasuries and 
Government Securities, would have a risk weight of 20 percent assigned 
to this asset. The commenter suggested this disparity in the treatment 
of the same asset when held by two different entities unnecessarily 
discriminates against a credit union's investments in mutual funds by 
penalizing the credit union for making the same investment indirectly 
that they could otherwise make directly. The commenter suggested 
further that the added layer of risk that the Second Proposal assumed 
will be present for indirect investments is not a factor with mutual 
funds, because they provide daily redemption at net asset value and 
generally provide sold share proceeds to the investor on the next 
business day. The commenter recommended that the Board revise the rule 
so that mutual fund risk weights are consistent with the risk weights 
on the underlying instruments. The commenter also recommended that the 
Board adopt a full look-through approach that is attuned to the 
distinctions between underlying assets that would allow low-risk mutual 
funds to carry risk ratios ranging between zero percent and 20 percent 
based upon the actual risk ratio of their holdings.
    One commenter suggested that the proposal was silent on how to risk 
weight loans held for sale, and recommended the Board assign a risk 
weight of 25 percent to loans held for sale.
    At least one commenter suggested that, under the Second Proposal, 
current non-federally insured student loans would be assigned a 100 
percent risk weight, despite other potential sources of insurance. The 
commenter asked whether there should be a distinction, at least for 
insured private student loans, and whether insured private student 
loans should be assigned a 50 percent risk weight and uninsured private 
student loans at 100 percent. The commenter suggested that, at some 
credit unions, private student loans are not only insured by an 
independent insurance company, but reinsured with three separate 
carriers. In such a situation, the commenter suggested that a 100 
percent risk weighting seemed excessive.

Discussion

    The Board generally agrees with the commenter who suggested that 
principal-only mortgage-backed-security STRIPS should be risk weighted 
based on the underlying collateral, which would more closely align 
NCUA's regulations with the Other Banking Agencies' rules. Principal-
only mortgage-backed-security STRIPS are purchased at a discount to 
par, and par is paid to the investor over the life of the bond. As with 
other mortgage-backed securities, the timing of the repayment of par is 
the primary risk when credit risk is not considered. Absent credit 
risk, the investor receives par. This is not the case with interest-
only mortgage-backed-security STRIPS, where an investor can receive 
less than the amount paid even without a credit event. Accordingly, 
this final rule assigns non-subordinated principal-only mortgage-
backed-security STRIPS a risk weight based on the underlying 
collateral.
    The Board also agrees with commenters who suggested the risk weight 
for certain accounts used for charitable purposes should be aligned 
with the 100 percent risk weight assigned to community development 
investments under the Other Banking Agencies' regulations. Charitable 
donation accounts are limited to 5 percent of net worth, which limits 
the risks of such accounts to the Share Insurance Fund. In addition, 
charitable donation accounts are required to be transparent segregated 
accounts, which enables NCUA to ensure that such accounts comply with 
applicable laws through supervision. As explained above and in more 
detail below, this final rule would permit credit unions to assign a 
100 percent risk weight to CDAs.
    The Board disagrees with the commenter who recommended removing 
overfunded pension assets from both the numerator and denominator. 
Under the Second Proposal, overfunded pension assets were not included 
in the risk-based capital ratio numerator or denominator, primarily 
because they are not disclosed on the financial statement as an asset, 
so there is no need to remove them from the calculation. Overfunded 
pension assets were excluded completely from the proposed risk-based 
capital calculation, and their inclusion in the final rule would add 
only needless complexity and could create volatility in the risk-based 
capital ratio.
    The Board disagrees with the commenter who suggested that any 
investment fund holding assets that are assigned a zero percent risk 
weight should receive a zero percent risk weight. As discussed in the 
Second Proposal, assets assigned a zero percent risk weight that are 
held in an investment fund are considered indirect obligations. The 
risk weight assigned to an investment fund that holds zero percent 
risk-weighted assets is 20 percent even though the underlying 
investments consist of zero risk-weighted assets due to the 
investment's structure as an investment fund. This is consistent with 
the Other Banking Agencies' regulations.
    The Board agrees with the commenter who suggested that the final 
rule should clarify the timing of holding reports used for the full 
look-through approach. As explained in more detail below, new appendix 
A to part 702 now clarifies which holding report should be used for the 
full look-through approach.
    The Board has decided to reduce the risk weight in the final rule 
for share-secured loans, where the shares securing the loan are on 
deposit at the credit union, to zero percent since the risk of loss is 
more a function of operational risk than credit risk. The Board 
maintained the 20 percent risk weight for share-secured loans where the 
collateral deposit is at another depository institution due to the 
added credit risk of the depository institution. The resulting risk 
weights for share-secured loans are more consistent with the Other 
Banking Agencies' related risk weights.
    Loan servicing assets associated with credit card loans or auto 
loans are different than loan servicing assets associated with 
mortgages because of the much shorter duration of the associated cash 
flows. Since shorter-term assets are individually assigned a risk 
weight, they default to the 100 percent risk weight assigned to all 
other assets, which is a reasonable risk weight based on the general 
credit quality associated with the underlying consumer loans. The 100 
percent risk weight is appropriate for this class of assets because 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 is 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

[[Page 66685]]

the Other Banking Agencies' capital regulations.\166\
---------------------------------------------------------------------------

    \166\ See, e.g., 12 CFR 324.32(l).
---------------------------------------------------------------------------

    This final rule 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. 
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. Accordingly, consistent with the Second 
Proposal, this final rule assigns loans held for sale a risk weight 
based on the loan's type.
    Non-federally guaranteed student loans are appropriately classified 
under current consumer loans due to the higher risks (default risk and 
extension risk) associated with this product.

104(c)(2)(i) Category 1--Zero Percent Risk Weight

    Proposed Sec.  702.104(c)(2)(i) provided 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.
    For the reasons explained above, the Board decided to remove the 
proposed language excluding directly and unconditionally guaranteed 
principal-only mortgage-backed-security STRIPS that were an obligation 
of the U.S. Government, its central bank, or a U.S. Government agency. 
The final rule also adds the word ``security'' after the word 
``mortgage-backed'' for clarity and consistently.
    In addition, the Board decided to lower the risk weight for share-
secured loans, where the shares securing the loan are on deposit with 
the credit union, to zero percent. Assigning a zero percent risk weight 
to share-secured loans under such circumstances is consistent with the 
risk weight assigned to such loans under the Other Banking Agencies.
    Accordingly, Sec.  702.104(c)(2)(i) of this final rule provides 
that a credit union must assign a zero percent risk weight to the 
following on-balance sheet assets:
     The balance of
    [cir] Cash, currency and coin, including vault, automatic teller 
machine, and teller cash.
    [cir] Share-secured loans, where the shares securing the loan are 
on deposit with the credit union.
     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 
interest-only mortgage-backed-security STRIPS.
    [cir] Federal Reserve Bank stock and Central Liquidity Facility 
stock.
     Insured balances due from FDIC-insured depositories or 
federally insured credit unions.

104(c)(2)(ii) Category 2--20 Percent Risk Weight

    Proposed Sec.  702.104(c)(2)(ii) provided 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.\167\
---------------------------------------------------------------------------

    \167\ This would include the NCUA Guaranteed Notes (NGNs), which 
are an obligation of the NCUA and are backed by the full faith and 
credit of the United States.
---------------------------------------------------------------------------

    [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.
    For the reasons explained above, the Board has decided to remove 
the proposed language excluding conditionally guaranteed principal-only 
mortgage-backed-security STRIPS that were an obligation of the U.S. 
Government, its central bank, or a U.S. Government agency. In addition, 
the Board decided to add the word ``security'' after the word 
``mortgage-backed'' for clarity and consistently. The Board also 
decided to revise the language regarding investment funds to clarify 
that the 20 percent risk weight includes only investment funds with 
portfolios permitted to hold only investments that are authorized under 
12 CFR 703.14(c).
    Accordingly, Sec.  702.104(c)(2)(ii) of this final rule provides 
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 interest-only mortgage-backed-security STRIPS.
    [cir] A non-subordinated obligation of a GSE other than an equity 
exposure or preferred stock, excluding interest only GSE mortgage-
backed-security STRIPS.
    [cir] Securities issued by PSEs that represent general obligation 
securities.
    [cir] Part 703 compliant investment funds that are restricted to 
holding only investments that qualify for a zero or 20 percent risk 
weight under Sec.  702.104.
    [cir] Federal Home Loan Bank stock.
     The balances due from Federal Home Loan Banks.
     The balance of share-secured loans, where the shares 
securing the loan are on deposit with another depository institution.
     The portions of outstanding loans with a government 
guarantee.
     The portions of commercial loans secured with contractual 
compensating balances.

104(c)(2)(iii) Category 3--50 Percent Risk Weight

    Proposed Sec.  702.104(c)(2)(iii) provided 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

[[Page 66686]]

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.
    For the reasons explained above, the Board has decided to remove 
the proposed language excluding conditionally guaranteed principal-only 
mortgage-backed-security STRIPS that were non-subordinated, non-U.S. 
Government agency or non-GSE guaranteed residential mortgage-backed 
securities. In addition, the Board decided to add the word ``mortgage-
backed-security'' before the word ``STRIPS'' for clarity and 
consistently.
    Accordingly, Sec.  702.104(c)(2)(iii) of this final rule provides 
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 securities, excluding interest-
only mortgage-backed-security STRIPS.

104(c)(2)(iv) Category 4--75 Percent Risk Weight

    Proposed Sec.  702.104(c)(2)(iv) provided 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.
    For the reasons explained above, the Board has decided to retain 
this proposed section in the final rule without change.

104(c)(2)(v) Category 5--100 Percent Risk Weight

    Proposed Sec.  702.104(c)(2)(v) provided 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.
    For the reasons explained above, the Board has decided to remove 
the proposed language including principal-only mortgage-backed-security 
STRIPS in the 100 percent risk-weight category. The Board has also 
decided to include the exposure amount of non-subordinated tranches of 
any investments in the 100 percent risk-weight category. Credit unions 
also are given the option to use the gross-up approach as an 
alternative to the 100 percent risk-weight.
    Accordingly, Sec.  702.104(c)(2)(v) of this final rule provides 
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] Interest-only mortgage-backed-security STRIPS.
    [cir] Part 703 compliant investment funds, with the option to use 
the look-through approaches in Sec.  702.104(c)(3)(iii)(B) of this 
section.
    [cir] Corporate debentures and commercial paper.
    [cir] Nonperpetual capital at corporate credit unions.\168\
---------------------------------------------------------------------------

    \168\ Subject to non-significant equity exposure risk-weight 
under Sec.  702.104(c)(3)(i).
---------------------------------------------------------------------------

    [cir] General account permanent insurance.
    [cir] GSE equity exposure or preferred stock.
    [cir] Non-subordinated tranches of any investment, with the option 
to use the gross-up approach in paragraph (c)(3)(iii)(A) of this 
section.
     All other assets listed on the statement of financial 
condition not specifically assigned a different risk weight under this 
subpart.
    As discussed in more detail below, however, this final rule reduces 
the risk weight assigned to CUSO investments, corporate perpetual 
capital, and other equity investments to 100 percent for complex credit 
unions with non-significant equity exposures.\169\
---------------------------------------------------------------------------

    \169\ A credit union has ``non-significant equity exposures'' if 
the aggregate amount of its equity exposures does not exceed 10 
percent of the sum of the credit union's capital elements of the 
risk-based capital ratio numerator.
---------------------------------------------------------------------------

104(c)(2)(vi) Category 6--150 Percent Risk Weight

    Proposed Sec.  702.104(c)(2)(vi) provided 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.\170\
---------------------------------------------------------------------------

    \170\ Subject to the lower 100 percent non-significant equity 
exposure risk-weight under Sec.  702.104(c)(3)(i).
---------------------------------------------------------------------------

    [cir] Equity investments in CUSOs.\171\
---------------------------------------------------------------------------

    \171\ Subject to the lower 100 percent non-significant equity 
exposure risk-weight under Sec.  702.104(c)(3)(i).
---------------------------------------------------------------------------

    As discussed in more detail below, however, this final rule reduces 
the risk weight assigned to CUSO investments, and corporate perpetual 
capital, to 100 percent for complex credit unions with

[[Page 66687]]

non-significant equity exposures.\172\ For the reasons explained above, 
the Board has decided to retain this proposed section in the final rule 
without change.
---------------------------------------------------------------------------

    \172\ A credit union has ``non-significant equity exposures'' if 
the aggregate amount of its equity exposures does not exceed 10 
percent of the sum of the credit union's capital elements of the 
risk-based capital ratio numerator.
---------------------------------------------------------------------------

104(c)(2)(vii) Category 7--250 Percent Risk Weight

    Proposed Sec.  702.104(c)(2)(vii) provided that a credit union must 
assign a 250 percent risk weight to the carrying value of mortgage 
servicing assets (MSAs) held on-balance sheet.
    For the reasons explained above, the Board has decided to retain 
this proposed section in the final rule without change.

104(c)(2)(viii) Category 8--300 Percent Risk Weight

    Proposed Sec.  702.104(c)(2)(viii) provided 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).
    For the reasons explained above, the Board has decided to retain 
this proposed section in the final rule with only minor conforming 
changes.
    Accordingly, Sec.  702.104(c)(2)(viii) of this final rule provides 
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.\173\
---------------------------------------------------------------------------

    \173\ Subject to the lower 100 percent non-significant equity 
exposure risk-weight under Sec.  702.104(c)(3)(i).
---------------------------------------------------------------------------

     Investment funds that do not meet the requirements under 
12 CFR 703.14(c), with the option to use the look-through approaches in 
Sec.  702.104(c)(3)(iii)(B).
     Separate account insurance, with the option to use the 
look-through approaches in Sec.  702.104(c)(3)(iii)(B).

104(c)(2)(ix) Category 9--400 Percent Risk Weight

    Proposed Sec.  702.104(c)(2)(ix) provided 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.
    For the reasons discussed above, the Board has decided to retain 
this proposed section in the final rule without change.\174\
---------------------------------------------------------------------------

    \174\ Subject to lower 100 percent non-significant equity 
exposure risk-weight under Sec.  702.104(c)(3)(i).
---------------------------------------------------------------------------

104(c)(2)(x) Category 10--1,250 Percent Risk Weight

    Proposed Sec.  702.104(c)(2)(x) provided 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).\175\
---------------------------------------------------------------------------

    \175\ 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.
---------------------------------------------------------------------------

    For the reasons discussed above and in additional detail below, the 
Board has decided to retain this proposed section in the final rule 
with only minor conforming changes to the cross citations.

104(c)(3) Alternative Risk Weights for Certain On-Balance Sheet Assets

    Proposed Sec.  702.104(c)(3) provided 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. These alternative approaches provide a credit union with 
the ability to risk weight certain assets based on the underlying 
exposure of the subordinated tranche or investment fund without 
exposing the NCUSIF to additional risk.
    Other than the comments already discussed above, the Board received 
few comments on this section of the proposal and has decided to retain 
the proposed gross-up approach and look-through approaches in this 
final rule with only minor changes, which are discussed in more detail 
below. In addition, this final rule restructures proposed Sec.  
702.104(c)(3).
    As explained in more detail below, this final rule restructures the 
provisions in Sec.  702.104(c)(3) to renumber the gross-up and look-
through approaches and add in alternative risk-weighting methodologies 
for non-significant equity exposures and certain types of charitable 
donation accounts. These changes are in response to public comments 
received on the Second Proposal and, as explained below, would only 
lower the risk weights assigned to certain on-balance sheet assets 
under certain circumstances.

104(c)(3)(i) Non-Significant Equity Exposures

    Under the Other Banking Agencies' capital regulations, banks are 
permitted to assign a 100 percent risk weight to equity exposures when 
the aggregate amount of the exposures does not exceed 10 percent of the 
bank's total capital. The Board did not include a similar approach in 
the Second Proposal because it would have added significant complexity 
to the rule. As previously discussed, however, a significant number of 
commenters requested that NCUA's risk-based capital requirement include 
an alternative risk-weighting methodology, similar to that provided 
under the Other Banking Agencies' capital regulations, for non-
significant equity exposures at credit unions.
    Applying a 100 percent risk weight to an equity exposure, provided 
the exposure does not exceed 10 percent of the sum of the credit 
union's capital elements of the risk-based capital ratio numerator, 
will provide relief to certain credit unions holding limited amounts of 
higher-risk equity assets on their books. Such an approach is generally 
consistent with the Other Banking Agencies' regulations and will not 
increase risk weights for any equity exposures held by credit unions.
    Accordingly, this final rule adds the following provisions 
assigning alternative risk weights to non-significant equity exposures.

104(c)(3)(i)(A) General

    Section 702.104(c)(3)(i)(A) of this final rule provides that 
notwithstanding the risk weights assigned in Sec.  702.104(c)(2), a 
credit union must assign a 100 percent risk weight to non-significant 
equity exposures.

104(c)(3)(i)(B) Determination of Non-Significant Equity Exposures

    Section 702.104(c)(3)(i)(B) of this final rule provides that a 
credit union has non-significant equity exposures if the aggregate 
amount of its equity exposures does not exceed 10 percent of the sum of 
the credit union's capital elements of the risk-based capital ratio 
numerator (as defined under paragraph Sec.  702.104(b)(1)).

104(c)(3)(i)(C) Determination of the Aggregate Amount of Equity 
Exposures

    As discussed above, Sec.  702.104(c)(3)(i)(C) of this final rule 
provides that when determining the aggregate amount of its equity 
exposures, a credit union must include

[[Page 66688]]

the total amounts (as recorded on the statement of financial condition 
in accordance with GAAP) of the following:
     Equity investments in CUSOs,
     Perpetual contributed capital at corporate credit unions,
     Nonperpetual capital at corporate credit unions, and
     Equity investments subject to a risk weight in excess of 
100 percent.
    The Board determined that the assets identified above encompass the 
extent of funds invested in stock, equities, or debts associated with 
an ownership interest and are normally in a loss position subordinate 
to unsecured creditors. Non-perpetual capital at corporate credit 
unions, despite receiving a 100 percent risk-weight, is included in the 
calculation of equity exposure because its priority in liquidation is 
subordinate to shareholders and the NCUSIF. Limiting the sum of these 
higher credit risk accounts to 10 percent or less of the sum of a 
credit union's capital elements of the risk-based capital ratio 
numerator receiving a 100 percent risk weight ensures that the related 
loss exposure does not present a significant risk to the credit union 
or the NCUSIF.

104(c)(3)(ii) Charitable Donation Accounts

    Under the Other Banking Agencies' capital regulations, banks are 
permitted to apply a 100 percent risk weight to equity exposures that 
qualify as community development investments. The Board did not include 
a similar approach in the Second Proposal because credit unions do not 
hold community development investments in the same manner banks do. As 
previously discussed, however, a significant number of commenters 
requested that NCUA's risk-based capital requirement include an 
alternative risk-weighting methodology, similar to that provided under 
the Other Banking Agencies' capital regulations, for charitable 
donation accounts.
    The Board believes charitable donation accounts held at credit 
unions are similar enough in purpose to community development 
investments held at banks to warrant a 100 percent risk weight. Under 
this final rule, a credit union can choose whether to apply the 100 
percent risk weight because the account may be entitled to a lower risk 
weight based on the investments held in the account. As explained in 
the definitions part of the preamble, the 100 percent risk weight would 
apply only to accounts that meet the definition of a ``charitable 
donation account'' and the criteria provided therein. These limits are 
prudent and provide credit unions the option of applying the 100 
percent risk weight, if they choose.
    Accordingly, this final rule revises Sec.  702.104(c)(3)(ii) to 
provide that notwithstanding the risk weights assigned in Sec.  
702.104(c)(2), a credit union may assign a 100 percent risk weight to a 
charitable donation account.

104(c)(3)(iii) Alternative Approaches

    As discussed above, this final rule reorganizes Sec.  702.104(c)(3) 
and moves proposed Sec. Sec.  702.104(c)(3)(i) and (ii) under Sec.  
702.104(c)(3)(iii) with only non-substantive conforming changes. 
Instead of citing to FDIC's regulations, this final rule incorporates 
the text explaining how to apply the gross up approach \176\ and the 
look through approaches \177\ into appendix A to part 702 of NCUA's 
regulations. As discussed below, to incorporate the full text of 
Sec. Sec.  324.43(e) and 324.53 into NCUA's regulations, the Board made 
some minor conforming changes to the language and numbering used in the 
section. Other than the changes discussed above, no substantive changes 
are intended by these revisions.
---------------------------------------------------------------------------

    \176\ 12 CFR 324.43(e).
    \177\ 12 CFR 324.53.
---------------------------------------------------------------------------

    Accordingly, Sec.  702.104(c)(3)(iii) of this final rule provides 
that, notwithstanding the risk weights assigned in paragraph (c)(2) of 
this section, a credit union may determine the risk weight of 
investment funds, and non-subordinated or subordinated tranches of any 
investment as provided below.

104(c)(3)(iii)(A) Gross-Up Approach

    Proposed Sec.  702.104(c)(3)(i) provided 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. When calculating the risk weight for a subordinated tranche 
of any investment using the proposed gross-up approach, a credit union 
must have the following information:
     The exposure amount of the subordinated tranche;
     The current outstanding par value of the credit union's 
subordinated tranche;
     The current outstanding par value of the total amount of 
the entire tranche where the credit union has exposure;
     The current outstanding par value of the more senior 
positions in the securitization that are supported by the subordinate 
tranche the credit union owns; 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: \178\
---------------------------------------------------------------------------

    \178\ 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/                     40%
            value of the credit       $10,000,000.
            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.
C          Pro-rata share of the     40% times               $36,000,000
            more senior positions     $90,000,000.
            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 +           $40,000,000
            (D).                      $4,000,000.
F          The higher of the         50% primary risk                50%
            weighted average risk     weight for 1st
            weight applicable to      lien residential
            the assets underlying     real estate loan.
            the securitization or
            20%.

[[Page 66689]]

 
G          Risk-weighted asset       $40,000,000 times       $20,000,000
            amount of the credit      50%.
            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 
million. Conversely, under the 1,250 percent risk weight approach, the 
credit union would be required to risk weight the subordinated tranche 
at $50 million (1,250 percent times $4 million). This example shows the 
benefit to credit unions of the proposed inclusion of the gross-up 
approach.
    In the case of master trust \179\ type structures and structured 
products,\180\ credits unions should calculate the pro-rata share of 
the more senior positions using the prospectus and current servicing/
reference pool reports.
---------------------------------------------------------------------------

    \179\ 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.
    \180\ 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.
---------------------------------------------------------------------------

    The Board received few comments objecting to allowing credit unions 
to use the gross-up approach, and has decided to retain the option of 
using the gross-up approach in this final rule. The final rule, 
however, incorporates the text of Sec.  324.43(e) into NCUA's 
regulations instead of simply citing to FDIC's regulations. As 
discussed above, this final rule also would permit credit unions to use 
the gross-up approach to risk-weight a non-subordinated tranche of any 
investment.
    Accordingly, Sec.  702.104(c)(3)(iii)(A) of this final rule 
provides that a credit union may use the gross-up approach under 
appendix A of this part to determine the risk weight of the carrying 
value of non-subordinated or subordinated tranches of any investment.

104(c)(3)(iii)(B) Look-Through Approaches

    Proposed Sec.  702.104(c)(3)(ii) provided 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. In 
particular, for purposes of applying risk weights to investment funds, 
the Board proposed giving 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 included these 
alternative approaches to make NCUA's risk-based capital requirement 
more comparable to the Other Banking Agencies' regulations and to grant 
credit unions additional flexibility.
    The first of the three full look-through approaches under 12 CFR 
324.53 required 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 required a credit union to use the 
information provided in the investment fund's prospectus. The minimum 
risk weight for any investment fund asset was 20 percent, regardless of 
which approach was used.
    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.\181\
---------------------------------------------------------------------------

    \181\ 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 proposed look-
through approaches:
    Full look-through approach. The full look-through approach allowed 
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 were required to use the most 
recently available holdings reports when utilizing the full look-
through approach.

[[Page 66690]]

    An example of the application of the full look-through approach is 
as follow:
---------------------------------------------------------------------------

    \182\ Fund holdings (percent of fund) multiplied by the credit 
union investment.
    \183\ Minimum 20 percent risk weight for assets in an investment 
fund, even if the individual risk weight is zero percent.
    \184\ Use 1,250 percent risk weight or gross-up calculation.
    \185\ 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 holding    Credit union
          Fund investment            (% of fund) %  exposure \182\      Risk weight %        Dollar risk weight
----------------------------------------------------------------------------------------------------------------
US Treasury Notes.................              50      $5,000,000  20 \183\.............  $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 \184\............             2.5         250,000  1,250................  3,125,000
                                   -----------------------------------------------------------------------------
    Totals........................  ..............      10,000,000  56 \185\.............  5,600,000 (Amount of
                                                                    (Weighted average       Risk Assets)
                                                                     Risk 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 allowed 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 follows:
---------------------------------------------------------------------------

    \186\ Minimum 20 percent risk weight for assets in an investment 
fund, even if the individual risk weight is zero percent.

                  Credit Union Investment: $10,000,000
------------------------------------------------------------------------
                                            Fund limits
         Permissible investments            (% of fund)     Risk weight
------------------------------------------------------------------------
US Treasury Notes.......................             100        \186\ 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     \187\ 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.
---------------------------------------------------------------------------

    \187\ 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 allowed 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:
---------------------------------------------------------------------------

    \188\ Minimum 20 percent risk weight for assets in an investment 
fund, even if the individual risk weight is zero percent.
    \189\ Use 1,250 percent risk weight unless the prospectus limits 
gross-up risk weights.
    \190\ 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).

                                      Credit Union Investment: $10,000,000
----------------------------------------------------------------------------------------------------------------
                                      Fund Limits
      Permissible investments         (% of fund)       Risk weight %        CU exposure     Dollar risk weight
----------------------------------------------------------------------------------------------------------------
US Treasury Notes.................             100  20 \188\.............              $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/Subordinated/IO/PO               30  50...................       3,000,000  1,500,000
 MBS.
Subordinated MBS..................              10  1,250 \189\..........       1,000,000  12,500,000
                                   -----------------------------------------------------------------------------
    Total.........................  ..............  158 \190\ (weighted        10,000,000  15,800,000 (Amount of
                                                     average risk weight).                  Risk Assets)
----------------------------------------------------------------------------------------------------------------


[[Page 66691]]

    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.

Public Comments on the Second Proposal

    The Board received a few comments relating to the proposed use of 
the look-through approaches. Most of these comments were addressed 
above. At least one commenter, however, suggested that the Board 
clarify that the timing of the most recent available holding reports 
are to be used by credit unions applying the full look-through 
approach.

Discussion

    The Board received no comments objecting to allowing credit unions 
to use the look-through approaches, and has decided to retain the 
option of using the gross-up approach in this final rule. The final 
rule incorporates the relevant text of Sec.  324.53 into NCUA's 
regulations instead of simply citing to FDIC's regulations and makes 
other minor conforming edits. In response to the comments received, the 
Board has also added language in paragraph (b)(2)(ii) of appendix A 
below to clarify which holding reports should be used when calculating 
a risk-weight using the full-look-through approach. The methodology for 
applying the look-through approaches is added to new appendix A to part 
702, which is discussed in more detail below.
    Accordingly, Sec.  702.104(c)(3)(iii)(B) provides that a credit 
union may use one of the look-through approaches under appendix A part 
702 to determine the risk weight of the exposure amount of any 
investment funds, the holdings of separate account insurance, or both.

104(c)(4) Risk Weights for Off-Balance-Sheet Activities

    Under the Second Proposal, Sec.  702.104(c)(4) provided 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.

Public Comments on the Second Proposal

    The Board received several comments regarding the proposed risk 
weights assigned to off-balance-sheet items. At least one commenter 
agreed with requiring capital for most off-balance-sheet activities. 
But the commenter suggested that credit unions should not be required 
to hold capital for off-balance-sheet exposures that are 
unconditionally cancellable (without cause), especially if the exposure 
is for less than one year. The commenter recommended that the Board 
adopt a more bank-like off-balance-sheet risk-based capital regime for 
such exposures. Another commenter stated that the proposal identifies 
the use of a 10 percent credit conversion factor for all noncommercial 
unused lines of credit, but noted that community banks utilize various 
credit conversion factors ranging from zero percent to 50 percent 
depending on whether the commitment is unconditionally cancellable 
(zero percent), conditionally cancellable within one year (20 percent), 
or conditionally cancellable beyond one year (50 percent). The 
commenter suggested that the design and inclusion of cancellation 
language in lending contracts is to mitigate the overall potential risk 
associated with unfunded amounts, and the type and extent of the 
specific language helps outline the extent and timeframe of the risk 
associated within each lending contract. As such, the commenter 
recommended that the credit conversion factors utilized by the 
community banks be adopted by NCUA to help ensure that the inherent 
risk embedded within specific cancellation language in lending 
contracts be accurately identified and risk weighted.
    At least one commenter recommended that the Board lower the credit 
conversion factor for unfunded consumer loans. Other commenters 
recommended unfunded, unconditionally cancellable commitments should be 
risk weighted at zero percent.
    Some commenters noted that under the proposal, the Board 
differentiates between partial recourse loans executed under the 
Federal Home Loan Banks' Mortgage Partnership Finance (MPF) Program and 
all other partial recourse lending programs. Commenters suggested that, 
although the MPF program loans enjoy a lower 20 percent credit 
conversion factor (CCF) compared to the 100 percent CCF applied to 
other partial recourse loans, credit unions that hold a contractual 
exposure amount that is less than 20 percent of the outstanding loan 
balance will have to hold more capital for MPF loans than for other 
partial recourse arrangements. For example, a $100,000 loan sold with a 
3 percent contractual exposure would have an off-balance-sheet value of 
$3,000 if it were a normal recourse loan and $20,000 if it were an MPF 
loan.\191\ Since MPF loans include a fixed contractual exposure amount, 
the commenter suggested there does not appear to be a strong 
justification for differentiating this loan program from other partial 
recourse loan arrangements. Even though this adjusted calculation may 
track historical losses in the MPF program more closely, commenters 
suggested that the Board consider whether it is appropriate to 
incorporate individualized risk weights for specific counterparties.
---------------------------------------------------------------------------

    \191\ The MPF program takes the outstanding loan balance 
multiplied by a 20 percent CCF (100,000 * .20 = 20,000), while other 
partial recourse loans take the maximum contractual exposure 
multiplied by a 100 percent CCF (3,000 * 1 = 3,000). Both loans 
would be subject to a 50 percent risk-weight as a first-lien 
residential real estate loan.
---------------------------------------------------------------------------

    One commenter suggested that the proposed treatment of the MPF 
Program does not address the complexity and risks associated with the 
program, and would prevent credit unions from selling loans in the 
secondary market that have no recourse at all and therefore pose no 
risk to the credit union. Under the Second Proposal, the capital 
requirement (after a credit

[[Page 66692]]

conversion factor) is derived from the total outstanding principal 
balance of all loans sold under the MPF Program. The commenter 
suggested it is important to note that the MPF Program is actually 
composed of several different types of loan purchase programs, some of 
which have a limited recourse component and some that do not. The 
commenter suggested further that each loan sold under an MPF program 
that includes a credit-risk sharing component undergoes an FHLB 
calculation that assigns a specific dollar amount for credit 
enhancement to that loan. And some loans with very low credit risk may 
have no credit enhancement assigned, while other loans with 
characteristics of higher credit risk are assigned a higher credit 
enhancement. According to the commenter, the total of these credit 
enhancement calculations, which is tracked by the FHLB and available 
online, is the maximum amount of risk for which a credit union is 
liable. The commenter suggested that in some cases, the results of the 
calculation for a particular loan may determine whether that loan is 
sold under the MPF Xtra Program (with no credit enhancement) or under a 
different MPF program that includes some form of credit enhancement. 
The commenter contended that, by lumping all MPF loans into one 
calculation, the proposal would significantly alter an institution's 
analysis of how to price and sell individual loans without any benefit 
to the institution or to NCUA in managing risk. As an alternative, the 
commenter suggested the credit conversion and risk weight be applied to 
the total credit enhancement under the MPF program for which a credit 
union is liable, instead of to the loan balances.

Discussion

    The small credit conversion factor for unused consumer lines of 
credit provides for the potential swift shift in credit risk that can 
occur when consumers access the lines. The other alternative credit 
conversion factors that include a determination of the term of the 
outstanding guarantee add additional complexity to the assignment of 
credit conversion factors and could result in a less consistent 
application of assigned risk weights even with expanded supervisory 
guidance.
    The definition of the (MPF) Program will provide for assignments of 
proper risk weights in transactions where credit unions receive fees 
for managing the credit risk of the loans. Under the MPF Program, 
credit unions retain recourse risk through a credit enhancement 
obligation to the FHLB for credit losses on certain loans. For loans 
sold to the FHLB that do not meet the definition of MPF loans, the risk 
weight is based on the maximum contractual amount of the credit union's 
exposure. In a loan sale transaction that creates no contractual 
exposure, the risk-weight would be zero. Supervisory guidance and Call 
Report instructions will be provided to ensure proper treatment of 
loans transferred under the FHLB programs and all other loans 
transferred with limited recourse.
    The proposed risk weights for off-balance-sheet activities will be 
retained, as they are clear and generally comparable to those assigned 
under the Other Banking Agencies' regulations.

104(c)(5) Derivatives

    Proposed Sec.  702.104(c)(5) would have provided that a complex 
credit union must assign a risk-weighted amount to any derivative 
contracts as determined under 12 CFR 702.105.
    For the reasons discussed below, the Board has decided to retain 
this proposed section in the final rule without change.

Current Sec.  702.105 Weighted-Average Life of Investments

    As discussed above, proposed new Sec.  702.105 would have replaced 
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 have been removed from 
part 702 altogether.
    The Board received no comments objecting to this change and has 
decided to retain this change in the final rule.

Section 702.105 Derivatives Contract

    Under the Second Proposal, Sec.  702.105 assigned risk weights to 
derivatives in a manner generally consistent with the approach adopted 
by FDIC in its interim final rule regarding regulatory capital.\192\ 
The NCUA Board proposed to focus only on interest-rate-related 
derivatives in the rule and referred credit unions to FDIC's rules for 
all non-interest-rate-related derivatives. The Board made this 
distinction because federal credit unions are restricted to interest-
rate-related contracts under NCUA's final derivatives rule, which was 
approved in January 2014. Federally insured state-chartered credit 
unions, however, may have broader authorization to use non-interest-
rate contracts if approved by the respective state supervisory 
authorities.
---------------------------------------------------------------------------

    \192\ See 78 FR 55339 (Sept. 10, 2013).
---------------------------------------------------------------------------

Public Comments on the Second Proposal

    The Board received a few general comments on proposed Sec.  
702.105. One commenter recommended that the Board, rather than just 
cross-citing to FDIC's regulations, incorporate the FDIC risk weights 
for non-interest-rate derivatives into NCUA regulations verbatim. The 
commenter suggested that although the vast majority of credit unions 
will probably not engage in this activity, its inclusion in NCUA's 
regulations would ease the regulatory burden for credit unions and 
examiners in finding and citing the appropriate authority. The 
commenter cautioned, however, that the Board should not create its own 
risk-weight system for non-interest-rate-related derivatives. The 
commenter suggested that, given the complex nature of derivatives, 
modifying the established regulatory framework could result in 
unintended consequences for credit unions engaged in that activity. In 
addition, state regulators have experience supervising derivative 
activity in state-chartered banks within the FDIC framework, which will 
help facilitate effective state supervision for credit unions with 
minimum confusion.
    Another commenter complained that the risk-weight calculations for 
derivatives were too complicated. The commenter suggested that 
derivatives, per GAAP, are fair valued daily, monthly, quarterly, and 
yearly, and reflected as an asset or a liability, while their impact 
runs through earnings or equity. Accordingly, the commenter recommended 
the Board apply a simpler formula to assess risk-based capital for 
derivatives, using a credit conversion factor to the notional amount 
and then applying a risk-weighted factor. Another commenter suggested 
that the Board simplify the calculation for derivatives based on the 
percentage of potential future exposure.

Discussion

    The Board has considered the comments suggesting the derivatives 
calculations be simplified. But given the number of variables to be 
considered for risk weighting--which include the type of derivative 
(interest rate or other), the legal agreement governing the 
transactions (qualified master netting agreement), the type of 
collateral to be used to satisfy margin movements, the method the 
credit union will use for collateral risk mitigation, and the 
counterparty approach (dealer or exchange)--it is impractical to 
simplify the calculation any further given the number of options that 
need to be

[[Page 66693]]

considered. Therefore the Board has maintained the proposed approach in 
this final rule.
    Consistent with NCUA's recently finalized derivatives rule,\193\ 
the Board is now adopting 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.\194\ Under FDIC's interim rule, derivatives transactions 
covered under clearing arrangements are treated differently than non-
cleared transactions. The Board addresses clearing separately below.
---------------------------------------------------------------------------

    \193\ See 78 FR 55339 (Sept. 10, 2013).
    \194\ See 78 FR 55339 (Sept. 10, 2013).
---------------------------------------------------------------------------

    The final rule focuses only on interest-rate-related derivatives 
and refers credit unions to FDIC's rules for all non-interest-rate-
related derivatives. The final rule makes 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 supervisory authorities. NCUA is not aware of any non-
interest-rate derivative contracts being used by federally insured, 
state-chartered credit unions (per Call Report data).

OTC Derivatives Transaction Risk Weight

    Under the Second Proposal, a credit union would have undertaken the 
following process to determine the risk weight for OTC derivative 
contracts. To determine the risk-weighted asset amount for a 
derivatives contract a credit union must first determine its exposure 
amount for the contract. The credit union must then recognize the 
credit mitigation of financial collateral, if qualified, and 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 proposal required 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) potential 
future exposure, 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.
    Under the proposal, the net CCE would have been 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 have been 
calculated as described in proposed Sec.  702.105(a)(2)(ii)(B).
    Under the 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.
    Under the proposal, if a derivatives contract were 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 (a)(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 proposal, which is discussed in more detail below.
    The Board received no comments objecting to this particular 
approach and has decided to retain the proposed process to determine 
the risk weight for OTC derivatives contracts in this final rule 
without change.

Cleared Derivatives Risk Weight

    Proposed Sec.  702.105 would have adopted an approach to assign 
risk weights to derivatives that is generally consistent with the 
approach adopted by the Other Banking Agencies.\195\ Under the Second 
Proposal, a credit union was required to calculate a trade exposure 
amount, determine the risk mitigation of any financial collateral, and 
multiply that amount by the applicable risk weight. Such an approach 
allowed 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, the 
proposed approach also accounted for the risk of loss associated with 
collateral posted by a credit union.
---------------------------------------------------------------------------

    \195\ See 78 FR 55339 (Sept. 10, 2013).
---------------------------------------------------------------------------

    The Board received no comments objecting to this particular 
approach and has decided to retain the proposed process to determine 
the risk weight for cleared derivatives in this final rule without 
change.

Trade Exposure Amount

    Under the Second Proposal, the trade exposure amount would have 
been equal to 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 took into account the 
exposure amount of the derivatives transaction and the exposure 
associated with any collateral posted by the credit union. This is the 
same approach employed by the Other Banking Agencies.\196\
---------------------------------------------------------------------------

    \196\ See, e.g., 12 CFR 324.35.
---------------------------------------------------------------------------

    The Board received no comments objecting to this particular 
approach and has decided to retain the proposed process to determine 
the trade exposure amount in this final rule without change.

Cleared Transaction Risk Weights

    Under the Second Proposal, after a credit union determines its 
trade exposure amount, it would have been 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 proposal 
required credit unions to apply a 2 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 have been required to 
conduct a sufficient legal review and determine that the agreement to 
prevent risk of loss is legal, valid, binding, and enforceable. If a 
credit union did not

[[Page 66694]]

meet either or both of these requirements, the credit union would have 
to apply a 4 percent risk weight to the transaction.
    The differing risk weights for cleared transactions took 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. This is the same approach employed by the 
Other Banking Agencies.\197\
---------------------------------------------------------------------------

    \197\ See, e.g., 12 CFR 324.35.
---------------------------------------------------------------------------

    The Board received no comments objecting to this particular 
approach and has decided to retain the proposed process to determine 
the risk weights for cleared transactions in this final rule without 
change.

Collateralized Transactions

    Under the Second Proposal, the Board 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 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.
    The Board received no comments objecting to this particular 
approach and, consistent with the proposal, has decided to permit a 
credit union to recognize risk-mitigating effects of financial 
collateral in OTC transactions in this final rule without change.

Risk Management Guidance for Recognizing Collateral

    Under the Second Proposal, before a credit union could recognize 
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 proposed 
including this concept in the rule so that credit unions could 
accurately recognize the risk mitigation benefit of collateral. This is 
the same approach taken by the Other Banking Agencies.
    The Board received no comments objecting to this particular 
approach and has decided to retain the proposed approach to risk 
management for recognizing collateral in this final rule without 
change.
    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 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.
    Lines 8 through 16 are calculations based on the approach and 
types of agreement, collateral, fair values and notional amounts of 
the credit union derivatives transactions.

[[Page 66695]]

[GRAPHIC] [TIFF OMITTED] TR29OC15.002

Federally Insured, State-Chartered Credit Unions' Derivative 
Transactions

    Under the Second Proposal, the Board included language that would 
require federally insured, state-chartered credit unions (FISCUs) to 
calculate risk weights in accordance with FDIC's rules for derivatives 
transactions that are not permissible under NCUA's derivatives rule. As 
noted above, one commenter requested that NCUA incorporate all of 
FDIC's language into the final RBC rule. FDIC's rules for derivatives 
are very detailed and lengthy. Incorporating these rules into this 
final rule would add unnecessary complexity. Further, as the options 
available to FISCUs are based on state laws, it would be a very time-
consuming and expensive process to monitor FDIC's rules to make future 
conforming changes in NCUA's risk-based capital regulations. For these 
reasons, the Board is retaining the cross-reference and is not 
incorporating the text of FDIC's derivatives regulations into this 
final rule.

Current Section 702.106 Standard Calculation of Risk-Based Net Worth 
Requirement

    The Second Proposal 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 Second Proposal, on the other 
hand, contained only a single measurement for calculating a credit 
union's risk-based capital ratio. Accordingly, current Sec.  702.106 
will no longer be necessary.
    The Board received no comments on this particular revision and has 
decided to eliminate current Sec.  702.106 from this final rule as 
proposed.

Current Section 702.107 Alternative Component for Standard Calculation

    The Second Proposal would eliminate current Sec.  702.107 regarding 
the use of alternative risk weight measures. The Board observed that 
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.
    The Board received no comments on this particular revision and has 
decided to eliminate current Sec.  702.107 from this final rule as 
proposed.

Current Section 702.108 Risk Mitigation Credit

    The Second Proposal would eliminate 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

[[Page 66696]]

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 received no comments on this particular revision and has 
decided to eliminate current Sec.  702.107 from this final rule as 
proposed.

Section 702.106 Prompt Corrective Action for Adequately Capitalized 
Credit Unions

    The Second Proposal renumbered current Sec.  702.201 as proposed 
Sec.  702.106, and would have made 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 also remove the requirement that adequately 
capitalized credit unions transfer the earnings retention amount from 
undivided earnings to their regular reserve account.
    The Board received no comments on this section and has decided to 
adopt the proposed amendments in this final rule without change.

Section 702.107 Prompt Corrective Action for Undercapitalized Credit 
Unions

    The Second Proposal renumbered current Sec.  702.202 as proposed 
Sec.  702.107, and made 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 also remove the requirement that undercapitalized 
credit unions transfer the earnings retention amount from undivided 
earnings to their regular reserve account.
    The Board received no comments on this section and has decided to 
adopt the proposed amendments in this final rule without change.

Section 702.108 Prompt Corrective Action for Significantly 
Undercapitalized Credit Unions

    The Second Proposal renumbered current Sec.  702.203 as proposed 
Sec.  702.108, and made 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 also remove the requirement that significantly 
undercapitalized credit unions transfer the earnings retention amount 
from undivided earnings to their regular reserve account.

Public Comments on the Second Proposal

    One state agency commenter noted that under the proposal, credit 
unions classified as significantly undercapitalized or worse would be 
required to restrict member business loans. The commenter acknowledged 
that it may be prudent to limit member business lending in some such 
cases, but felt there could be instances in which rational loan workout 
agreements require additional loans be granted to protect the cash flow 
or collateral position on loans already granted. The commenter 
suggested that forcing a restriction without some element of discretion 
on the part of the state examiner or federal examiner and corresponding 
state regulatory official and NCUA regional office may have the 
unintended consequence of artificially creating a liquidity problem for 
a borrower, and potentially jeopardizing the collection of existing 
credits. The commenter recommended that the decision to limit any type 
of lending be done on a case-by-case basis rather than a sweeping 
decision to be applied to all regardless of the circumstances.

Discussion

    The Board is bound by statute because section 216(g)(2) of the FCUA 
provides in relevant part:

[A]n insured credit union that is undercapitalized may not make any 
increase in the total amount of member business loans (as defined in 
section 107A(c) of this title) outstanding at that credit union at 
any one time, until such time as the credit union becomes adequately 
capitalized.

    The statutory language does not preclude a credit union from 
entering into loan workout agreements provided the total amount of 
member business loans outstanding, including unused commitments, does 
not increase. Accordingly, the Board has retained the language in 
proposed Sec.  702.108 in this final rule without change.

Section 702.109 Prompt Corrective Action for Critically 
Undercapitalized Credit Unions

    The Second Proposal renumbered current Sec.  702.204 as proposed 
Sec.  702.109, and made 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 also remove the requirement that critically 
undercapitalized credit unions transfer the earnings retention amount 
from undivided earnings to their regular reserve account.
    The Board received no comments on this section and has decided to 
adopt the proposed amendments in this final rule without change.

Section 702.110 Consultation With State Official on Proposed Prompt 
Corrective Action

    The Second Proposal renumbered current Sec.  702.205 as proposed 
Sec.  702.110, and made only minor conforming amendments to the text of 
the section.

Public Comments on the Second Proposal

    One state supervisory authority commenter pointed out that, under 
the proposal, authority to approve certain actions (such as net worth 
restoration plans, earnings retention waivers, etc.) must come from the 
NCUA Board, after consulting with the state regulator. The commenter 
recommended, however, that the authority to approve actions may be 
better placed with NCUA regional directors, after consulting with the 
state regulator. The commenter suggested that most states have a long 
and well established working relationship with regional offices, and 
regional directors should be in a better position to evaluate the 
reasonableness of this type of request.

Discussion

    The Board appreciates the commenter's suggestion, but declines to 
make the recommended change at this time. However, the Board may choose 
delegate its authority to approve actions under this section to 
regional directors without having to change NCUA's regulations. 
Accordingly, the Board has decided to retain proposed Sec.  702.110 in 
this final rule without change.

Section 702.111 Net Worth Restoration Plans (NWRPs)

    The Second Proposal renumbered current Sec.  702.206 as proposed 
Sec.  702.111, and made only minor conforming amendments to the text of 
most of the subsections, with a few exceptions discussed in more detail 
below.
    The Board reviewed the comments received on this section, which are 
discussed in more detail below, and has decided to adopt proposed Sec.  
702.111 in this final rule without change.

111(c) Contents of NWRP

    Under the Second Proposal, Sec.  702.111(c)(1)(i) provided 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

[[Page 66697]]

term of the NWRP, and will remain so for four consecutive calendar 
quarters.
    The Board received no comments on this section and has decided to 
adopt the proposed amendments in this final rule without change.

111(g)(4) Submission of Multiple Unapproved NWRPs

    Under the Second Proposal, Sec.  702.111(g)(4) provided 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.\198\ 
The proposed amendments were 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.
---------------------------------------------------------------------------

    \198\ 12 U.S.C. 1786; and 1790d.
---------------------------------------------------------------------------

Public Comments on the Second Proposal

    At least one commenter claimed that a number of credit unions are 
not aware of proposed new Sec.  702.111(g)(4) because NCUA led them to 
believe that the rule only applied to complex credit unions. The 
commenter suggested that NCUA has significant latitude to approve or 
deny net worth restoration plans, even if a credit union submits a plan 
that meets the stated requirements. The commenter opposed including the 
new provision in the final rule, and recommended the Board include 
safeguards to ensure that credit unions acting in good faith are able 
to successfully submit NWRPs. Another commenter contended that the 
Board presented no evidence that submitting multiple net worth 
restoration plans represents an unsafe and unsound condition.

Discussion

    The failure of a credit union to prepare an adequate net worth 
restoration plan places the credit union in violation of the FCUA 
requiring submission of an acceptable plan within the time allowed. The 
submission and rejection of multiple plans results in delays in 
resolving the problem of insured credit unions. Accordingly, to further 
ensure compliance with the FCUA, the Board has decided to adopt 
proposed Sec.  702.111(g)(4) in this final rule without change.
    The Board clarifies, however, that non-complex credit unions will 
not be expected to address risk-based capital in net worth restoration 
plans.

111(j) Termination of NWRP

    Under the Second Proposal, Sec.  702.111(j) provided that, for 
purposes of part 702, an NWRP terminates once the credit union has been 
classified as adequately capitalized or well capitalized for four 
consecutive quarters. The proposed paragraph also provided, 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 was intended to provide 
clarification for credit unions on the timing of an NWRP's termination.
    The Board received no comments on this section and has decided to 
adopt the proposed amendments in this final rule without change.

Section 702.112 Reserves

    The Second Proposal renumbered current Sec.  702.401 as proposed 
Sec.  702.112. Consistent with the text of current Sec.  702.401(a), 
the proposal also would require that each 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.
    The Board received no comments on this section and has decided to 
adopt the proposed amendments in this final rule without change.

Regular Reserve Account

    As mentioned above, the 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.
    The Board received no comments on the elimination of current Sec.  
702.401(b) and has decided to adopt the proposed revision in this final 
rule without change.

Section 702.113 Full and Fair Disclosure of Financial Condition

    The Second Proposal renumbered current Sec.  702.402 as proposed 
Sec.  702.113, and made only minor conforming amendments to the text of 
the section with the exception of the changes to proposed Sec.  
702.113(d) that are discussed in more detail below.
    The Board received no comments on this section and has decided to 
adopt the proposed amendments in this final rule without change.

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 current Sec.  702.402(d)(4), 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 current Sec.  
702.402(d)(4), which provides that adjustments to the valuation ALLL 
will be recorded in the expense account ``Provision for Loan and Lease 
Losses.'' This change is intended to clarify that the ALLL is to be 
maintained in accordance with GAAP, as discussed above.
    The Board received no comments on these proposed revisions and has 
decided to adopt the proposed amendments in this final rule without 
change.

(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 italicized words ``and 
lease'' and ``timely and'' would be added 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, these 
changes are intended 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.
    The Board received no comments on this section and has decided to 
adopt the proposed amendments in this final rule without change.

(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 change 
is intended to provide full

[[Page 66698]]

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.
    The Board received no comments on this section and has decided to 
adopt the proposed amendments in this final rule without change.

(d)(3)

    Proposed Sec.  702.113(d)(3) retained the language in current Sec.  
702.401(d)(5) with no changes.
    The Board received no comments on this section and has decided to 
adopt the proposed amendments in this final rule without change.

Section 702.114 Payment of Dividends

    The Second Proposal renumbered current Sec.  702.402 as proposed 
Sec.  702.114 and made amendments to the text of paragraphs (a) and 
(b).
    The Board received no comments on this section and has decided to 
adopt the proposed amendments in this final rule without change.

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 proposed 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. Because of the removal of the regular 
reserve account, and to conform to GAAP, the proposal would amend the 
language to 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.
    The Board received no comments on this section and has decided to 
adopt the proposed amendments in this final rule without change.

114(b) Payment of Dividends and Interest Refunds

    The Second Proposal would eliminate the language in current Sec.  
702.403(b) and replace it with a new provision. Proposed new 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). Proposed paragraph (b) would have 
provided further that the request for written approval must include the 
plan for eliminating any negative retained earnings balance.
    The Board received no comments on this section and has decided to 
adopt the proposed amendments in this final rule without change.

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

    Consistent with the Second Proposal, this final rule adds new 
subpart B, which contains most of the capital adequacy rules that apply 
to ``new'' credit unions. The current net worth measures, net worth 
classification, and text of the PCA requirements applicable to new 
credit unions are renumbered. They remain mostly unchanged from the 
current 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 exceeded 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 
an unsafe and unsound condition.
    (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

    The Board received no comments on this section. Accordingly, 
consistent with the Second Proposal, this final rule renumbers current 
Sec.  702.301 as Sec.  702.201. The final rule also clarifies that a 
credit union may not regain a designation of ``new'' after reporting 
total assets in excess of $10 million.

Section 702.202 Net Worth Categories for New Credit Unions

    The Board received no comments on this section. Accordingly, 
consistent with the Second Proposal, this final rule renumbers current 
Sec.  702.302 as Sec.  702.202, and makes 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

    The Board received no comments on this section. Accordingly, 
consistent with the Second Proposal, this final rule renumbers current 
Sec.  702.303 as Sec.  702.203, and makes 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), this final rule also removes 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

    The Board received no comments on this section. Accordingly, 
consistent with the Second Proposal, this final rule renumbers current 
Sec.  702.304 as Sec.  702.204, and makes 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), this final rule removes 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

    The Board received no comments on this section. Accordingly, 
consistent with the Second Proposal, this final rule renumbers current 
Sec.  702.305 as proposed Sec.  702.205, and makes only minor 
conforming amendments to the text of the section.

Section 702.206 Revised Business Plans (RBPs) for New Credit Unions

    The Board received no comments on this section. Accordingly, 
consistent with the Second Proposal, this final rule renumbers current 
Sec.  702.306 as Sec.  702.206, makes mostly minor conforming 
amendments to the text of the section, and adds new Sec.  
702.206(g)(3). Consistent with the proposed elimination of the regular 
reserve requirement in current Sec.  702.401(b), this final rule also 
removes the requirement that new credit unions transfer the earnings 
retention amount from undivided earnings to their regular reserve 
account.

[[Page 66699]]

206(g)(3) Submission of Multiple Unapproved Revised Business Plans

    The Board received no comments on this section. Accordingly, 
consistent with the Second Proposal, Sec.  702.206(g)(3) of this final 
rule provides 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.\199\ As explained in the preamble to the Second 
Proposal, 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. This amendment is intended clarify that 
submitting multiple RBPs that are rejected by NCUA, or a 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.
---------------------------------------------------------------------------

    \199\ 12 U.S.C. 1786 and 1790d.
---------------------------------------------------------------------------

Section 702.207 Incentives for New Credit Unions

    The Board received no comments on this section. Accordingly, 
consistent with the Second Proposal, this final rule renumbers current 
Sec.  702.307 as proposed Sec.  702.207, and makes only minor 
conforming amendments to the text of the section.

Section 702.208 Reserves

    The Board received no comments on this section. Accordingly, 
consistent with the Second Proposal, this final rule adds new Sec.  
702.208 regarding reserves for new credit unions. Also, consistent with 
the text of the current reserve requirement in Sec.  702.401(a), this 
final rule requires 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 the part of the preamble associated with Sec.  
702.112 above, this final rule eliminates 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 will be eliminated upon the effective 
date of this final rule. Upon the effective date of this final rule, a 
federal credit union should close out its regular reserve balance into 
undivided earnings. A federally insured state-chartered credit union, 
however, may still maintain a regular reserve account if required under 
state law or by its state supervisory authority.

Section 702.209 Full and Fair Disclosure of Financial Condition

    The Board received no comments on this section. Accordingly, 
consistent with the Second Proposal, this final rule renumbers current 
Sec.  702.402 as Sec.  702.209 and makes 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

    The Board received no comments on this section. Accordingly, 
consistent with the proposed elimination of the regular reserve 
requirement, Sec.  702.209(d) of this final rule removes the language 
in current Sec.  702.402(d)(4), 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 final rule removes current Sec.  
702.402(d)(3), which provides that adjustments to the valuation ALLL 
will be recorded in the expense account ``Provision for Loan and Lease 
Losses.'' As discussed in the part of the preamble associated with 
Sec.  702.113, the changes to this section emphasize the need to record 
the ALLL in accordance with GAAP.

(d)(1)

    The Board received no comments on this section. Accordingly, 
consistent with the Second Proposal, current Sec.  702.401(d)(1) is 
renumbered as Sec.  702.209(d)(1) and amended to provide that charges 
for loan and lease losses shall be made timely and in accordance with 
GAAP. This final rule adds 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 is 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)

    The Board received no comments on this section. Accordingly, 
consistent with the Second Proposal, current Sec.  702.401(d)(2) is 
renumbered as Sec.  702.209(d)(2) and is amended to provide that the 
ALLL must be maintained in accordance with GAAP. This change is 
intended to provide full and fair disclosure to credit union members, 
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)

    The Board received no comments on this section. Accordingly, 
consistent with the Second Proposal, current Sec.  702.401(d)(5) is 
renumbered as Sec.  702.209(d)(3) and retains the language with no 
changes.

Section 702.210 Payment of Dividends

    The Board received no comments on this section. Accordingly, 
consistent with the Second Proposal, the language in current Sec.  
702.403 is incorporated into new Sec.  702.210 of this final rule.

210(a) Restriction on Dividends

    The Board received no comments on this section. Accordingly, 
consistent with the Second Proposal, Sec.  702.210(a) provides that, 
for new 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

    The Board received no comments on this section. Accordingly, 
consistent with the Second Proposal, Sec.  702.210 provides 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 B of part 702 unless the 
appropriate regional director and, if state-chartered, the appropriate 
state official, has given prior written approval (in an RBP or 
otherwise). Paragraph (b) provides further that the request for written 
approval must include the plan for eliminating any negative retained 
earnings balance.

C. Appendix A to Part 702--Alternative Risk Weights for Certain On-
Balance Sheet Assets

    As discussed in the part of the preamble that discusses Sec.  
702.104(c)(3) of this final rule, the Board is adding new appendix A to 
part 702 of NCUA's regulations. As previously stated, this final rule 
allows credit unions to

[[Page 66700]]

determine the risk weight of certain investment funds, and the risk 
weight of a subordinated tranche of any investment instead of using the 
risk weights assigned in Sec.  702.104(c)(2). This final rule 
incorporates the relevant portions of Sec. Sec.  324.43(e) and 324.53 
of FDIC's regulations, which were incorporated only by reference in the 
Second Proposal, into new appendix A of part 702 of NCUA's regulations. 
To incorporate the text of FDIC's regulations into NCUA's regulations, 
the Board had to make some minor conforming changes to the proposed 
language incorporated into appendix A. No substantive changes to the 
proposed methodology for calculating the gross-up and look-through 
approaches are intended.
    Accordingly, Appendix A to part 702 of this final rule provides 
that instead of using the risk weights assigned in Sec.  702.104(c)(2), 
a credit union may determine the risk weight of certain investment 
funds, and the risk weight of non-subordinated or subordinated tranches 
of any investment as provided below.

(a) Gross Up-Approach

(a)(1) Applicability

    Paragraph (a)(1) of appendix A provides that: Section 
702.104(c)(3)(iii)(A) of part 702 provides that, a credit union may use 
the gross-up approach in this appendix to determine the risk weight of 
the carrying value of non-subordinated or subordinated tranches of any 
investment.

(a)(2) Calculation

    Paragraph (a)(2) of appendix A provides, to use the gross-up 
approach, a credit union must calculate the following four inputs:
     Pro rata share, which is the par value of the credit 
union's exposure as a percent of the par value of the tranche in which 
the securitization exposure resides;
     Enhanced amount, which is the par value of tranches that 
are more senior to the tranche in which the credit union's 
securitization resides;
     Exposure amount, which is the amortized cost for 
investments classified as held-to-maturity and available-for-sale, and 
the fair value for trading securities; and
     Risk weight, which is the weighted-average risk weight of 
underlying exposures of the securitization as calculated under this 
appendix.

(a)(3) Credit Equivalent Amount

    Paragraph (a)(3) of appendix A provides that the ``credit 
equivalent amount'' of a securitization exposure under this part equals 
the sum of:
     The exposure amount of the credit union's exposure; and
     The pro rata share multiplied by the enhanced amount, each 
calculated in accordance with paragraph (a)(2) of appendix A to part 
702.

(a)(4) Risk-Weighted Assets

    Paragraph (a)(4) of appendix A provides, to calculate risk-weighted 
assets for a securitization exposure under the gross-up approach, a 
credit union must apply the risk weight required under paragraph (a)(2) 
of appendix A to part 702 to the credit equivalent amount calculated in 
paragraph (a)(3) of appendix A to part 702.

(a)(5) Securitization Exposure Defined

    Paragraph (a)(5) of appendix A provides, for purposes of paragraph 
(a) of appendix A to part 702, ``securitization exposure'' means:
     A credit exposure that arises from a securitization; or
     An exposure that directly or indirectly references a 
securitization exposure described in first element of this definition.

(a)(6) Securitization Defined

    Paragraph (a)(6) of appendix A provides, for purposes of paragraph 
(a) of appendix A to part 702, ``securitization'' means a transaction 
in which:
     The credit risk associated with the underlying exposures 
has been separated into at least two tranches reflecting different 
levels of seniority;
     Performance of the securitization exposures depends upon 
the performance of the underlying exposures; and
     All or substantially all of the underlying exposures are 
financial exposures (such as loans, receivables, asset-backed 
securities, mortgage-backed securities, or other debt securities).

(b) Look-Through Approaches

(b)(1) Applicability

    Paragraph (b)(1) of appendix A provides: Section 
702.104(c)(3)(iii)(B) provides that, a credit union may use one of the 
look-through approaches in appendix A to part 702 to determine the risk 
weight of the exposure amount of any investment fund, or the holding of 
separate account insurance.

(b)(2) Full Look-Through Approach

(b)(2)(i) General

    Paragraph (b)(2)(i) of appendix A provides, a credit union that is 
able to calculate a risk-weighted asset amount for its proportional 
ownership share of each exposure held by the investment fund may set 
the risk-weighted asset amount of the credit union's exposure to the 
fund equal to the product of:
     The aggregate risk-weighted asset amounts of the exposures 
held by the fund as if they were held directly by the credit union; and
     The credit union's proportional ownership share of the 
fund.

(b)(2)(ii) Holding Report

    Paragraph (b)(2)(ii) of appendix A provides, to calculate the risk-
weighted amount under paragraph (b)(2)(i) of appendix A, a credit union 
should:
     Use the most recently issued investment fund holding 
report; and
     Use an investment fund holding report that reflects 
holdings that are not older than six months from the quarter-end 
effective date (as defined in Sec.  702.101(c)(1) of part 702).

(b)(3) Simple Modified Look-Through Approach

    Paragraph (b)(3) of appendix A provides that under the simple 
modified look-through approach, the risk-weighted asset amount for a 
credit union's exposure to an investment fund equals the exposure 
amount multiplied by the highest risk weight that applies to any 
exposure the fund is permitted to hold under the prospectus, 
partnership agreement, or similar agreement that defines the fund's 
permissible investments (excluding derivative contracts that are used 
for hedging rather than speculative purposes and that do not constitute 
a material portion of the fund's exposures).

(b)(4) Alternative Modified Look-Through Approach

    Paragraph (b)(4) of appendix A provides that under the alternative 
modified look-through approach, a credit union may assign the credit 
union's exposure amount to an investment fund on a pro rata basis to 
different risk weight categories under subpart A of part 702 based on 
the investment limits in the fund's prospectus, partnership agreement, 
or similar contract that defines the fund's permissible investments. 
The paragraph provides further that the risk-weighted asset amount for 
the credit union's exposure to the investment fund equals the sum of 
each portion of the exposure amount assigned to an exposure type 
multiplied by the applicable risk weight under subpart A of this part. 
The paragraph also notes that if the sum of the investment limits for 
all exposure types within the fund exceeds 100

[[Page 66701]]

percent, the credit union must assume that the fund invests to the 
maximum extent permitted under its investment limits in the exposure 
type with the highest applicable risk weight under subpart A of this 
part and continues to make investments in order of the exposure type 
with the next highest applicable risk weight under subpart A of this 
part until the maximum total investment level is reached. The paragraph 
also provides that if more than one exposure type applies to an 
exposure, the credit union must use the highest applicable risk weight. 
Finally, the paragraph provides that a credit union may exclude 
derivative contracts held by the fund that are used for hedging rather 
than for speculative purposes and do not constitute a material portion 
of the fund's exposures.

D. Other Conforming Changes to the Regulations

    The Board received only one comment on this section. The commenter 
expressed concern that the references to the risk weightings for member 
business loans under Sec.  723.1(d) and (e) were confusing and should 
be eliminated because of the proposed rule's use of the term 
``commercial loan,'' instead of member business loans, in assigning 
risk weights. The Board generally agrees with the commenter's concerns 
and has revised Sec.  723.1(d) and (e) to remove the words referring to 
the risk-weighting standards for member business loans. Accordingly, 
consistent with the Second Proposal, this final rule makes minor 
conforming amendments to Sec. Sec.  700.2, 701.21, 701.23, 701.34, 
703.14, 713.6, 723.1, 723.7, 747.2001, 747.2002, and 747.2003.

V. Effective Date

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

    In the preamble to the Second Proposal, the Board proposed an 
effective date of January 1, 2019 to provide credit unions and NCUA a 
lengthy implementation period 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.

Public Comments on the Second Proposal

    The Board received many comments regarding the proposed effective 
date of the final rule. Several commenters suggested that given the 
significant operational implications for both credit unions and the 
NCUA, a 2019 effective date is appropriate. Those commenters suggested 
the proposed effective date would allow credit unions to adjust their 
balance sheets and strategic plans to achieve a well-capitalized 
standard under the rule without disrupting member products and 
services. Commenters also noted that the proposed effective date aligns 
with the implementation timeframe of the Other Banking Agencies and, 
thus, would avoid creating a competitive disadvantage across competing 
financial services entities.
    A substantial number of other commenters, however, requested that 
the effective date be delayed until 2021 to coincide with refunds the 
commenters expect to receive from the Corporate Stabilization Fund. The 
commenters suggested the refunds will be important to those credit 
unions that will need to increase capital levels in order to comply 
with the new regulation.
    Other commenters argued that the proposed timeframe was 
insufficient given the significance of the impact of the proposed 
requirements and the length of time it would take credit unions to 
adjust their business strategies, portfolios and capital to best 
position themselves relative to the rule. Commenters complained the 
task would be burdensome for credit unions given their limited options 
for raising capital when compared to banks, which were afforded seven 
years to fully implement BASEL III. Accordingly, those commenters 
recommended various extended implementation periods ranging from five 
years to seven years, or phase-in periods over a similar timeframe.
    One commenter speculated that extending the implementation until 
2019 would create a dual standard for credit unions near threshold 
levels. The commenter asked: What measure should be the plan for the 
coming 2-3 years? The commenter acknowledged that for some credit 
unions, the change will result in better risk-based capital levels than 
under the current rule. But the commenter argued that fixing the 
current capital levels under rules being phased out could cause real 
harm to memberships and credit union health.
    Several commenters noted that the Financial Accounting Standards 
Board (FASB) plans to replace the current credit impairment model with 
a current expected credit loss model. Commenters suggested further that 
any final rule issued by FASB will require NCUA and FASB harmonization 
with respect to forecasting models utilized by credit unions to reduce 
conflicts between examination guidance. Accordingly, commenters 
recommended that the NCUA Board delay implementation of any final risk-
based capital rule until the final FASB rule has been fully implemented 
by credit unions.
    One commenter recommended that if IRR, access to additional 
supplemental forms of capital, and risk-based share insurance premium 
changes are likely in the near future, the Board should delay 
finalization and implementation of the proposed rule until a 
comprehensive analysis can be conducted to ensure an integrated, 
aligned approach to risk-based capital. The commenter contended that 
addressing interest rate risk, supplemental capital, risk-based share 
insurance premiums and risk-based capital in silos will not create the 
most efficient and effective solution.

Discussion

    The proposed January 1, 2019 effective date provides credit unions 
with more than three years to ramp up implementation, which should be 
more than sufficient time to make the necessary adjustments to systems 
and operations before the effective date of this final rule. In 
addition, as noted above, the effective date generally coincides with 
the full phase-in of FDIC's capital regulations. In response to 
commenters who asked the Board to phase in the implementation, the 
Board found that phasing in the new capital rules for credit unions 
would add additional complexity with minimal benefit.
    Further, it would be inappropriate to delay implementation due to 
potential changes in accounting that may be forthcoming, and the 
elimination of the cap on the amount of the ALLL will reduce the impact 
of the announced change in maintaining the ALLL.
    Accordingly, this final rule will become effective on January 1, 
2019.

VI. Impact of This Final Rule

    This final rule will apply to credit unions with $100 million or 
greater in total assets. As of December 31, 2014, there were 1,489 
credit unions (23.7 percent of all credit unions) with assets of $100 
million or greater. As a result, approximately 76 percent of all credit 
unions will be exempt from the risk-based capital requirement.\200\ A 
net of 16 complex credit unions with total assets of $9.8 billion would 
have a

[[Page 66702]]

lower capital classification as a result this rule with a capital 
shortfall of approximately $67 million.\201\ Approximately 98.5 percent 
of all complex credit unions will remain well capitalized.\202\ The 
aggregate and average RBC ratios for complex credit unions are 17.9 and 
19.2 percent respectively.\203\ As shown in the table below most 
complex credit unions will have a risk-based capital ratio well in 
excess of the 10 percent needed to be well capitalized.
---------------------------------------------------------------------------

    \200\ The proposed risk-based capital requirements applied 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. 
There were 1,872 FDIC-insured banks with assets less than $100 
million as of December 2014.
    \201\ In the second proposal using data as of December 31, 2013, 
NCUA estimated less than 20 credit unions would experience a decline 
in their capital classification with a capital shortfall of $53.6 
million.
    \202\ Of the 1,489 impacted credit unions, only 23, or 1.54 
percent, would have less than the 10 percent risk-based capital 
requirement to be well capitalized. Of these, seven have net worth 
ratios less than 7 percent and therefore are already categorized as 
less than well capitalized.
    \203\ In the second proposal, based on December 2013 Call Report 
data, NCUA estimated the aggregate average risk-based capital ratio 
would be 18.2 percent with an average risk-based capital ratio of 
19.3 percent.

                                           Distribution of Net Worth Ratio and Final Risk-Based Capital Ratio
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                            Less than well    Well capitalized   Well capitalized   Well capitalized   Greater than well
                      Number of CUs                          capitalized        to well +2%        +2% to +3.5%       +3.5% to +5%      capitalized +5%
Net Worth Ratio                                                         <7%              7%-9%           9%-10.5%          10.5%-12%                >12%
RBC Ratio                                                              <10%            10%-12%          12%-13.5%          13.5%-15%                >15%
--------------------------------------------------------------------------------------------------------------------------------------------------------
Net Worth Ratio.........................................                 14                297                449                334                 395
Final RBC Ratio.........................................                 23                107                140                194               1,025
--------------------------------------------------------------------------------------------------------------------------------------------------------

Public Comments on the Second Proposal

    The Board received a substantial number of comments regarding 
NCUA's estimates of the impacts of the Second Proposal. Most commenters 
who mentioned the impacts of the proposal suggested the rule would have 
negative impacts on the credit union industry. Numerous commenters 
speculated that the proposal would unjustifiably slow credit union 
growth in the future, and that the funds used to meet the newly 
proposed requirements could otherwise be used to make loans to 
consumers or small businesses, or be used in other productive ways. 
Commenters also speculated that the requirements in the proposal would 
restrict credit union lending to consumers by forcing credit unions to 
maintain capital on their books rather than lending to their members. 
At least one commenter recommended that the Board more thoughtfully 
consider the actual market effect on the credit union industry and 
produce more reasonably calibrated risk weights based on the 
cooperative nature of credit unions. The commenter recommended that the 
Board also reconsider the value of concentration escalators and provide 
empirical data that reflect what actual additional risk is created 
based on concentration of certain asset categories. Other commenters 
claimed the higher capital levels that would be required under the 
proposal would reduce the amount of support, both monetary and 
operational, that larger credit unions have historically provided to 
their smaller counterparts, which would put additional strain on the 
finances and operations of many smaller credit unions.
    One credit union trade association commenter speculated that under 
the proposal, the number of credit unions downgraded would more than 
double during a downturn in the business cycle. Under the commenter's 
analysis, 45 credit unions would have been downgraded during the most 
2007-2009 financial crisis if this proposal had been in place in 2009. 
According to the commenter, of those 45 credit unions, 41 would be well 
capitalized today. The commenter suggested that to have avoided a 
downgrade, those credit unions would have had to increase their capital 
by $145 million, or an average of $3.2 million per credit union. The 
commenter stated that almost all of the credit unions that would have 
been downgraded (95 percent) are well capitalized or adequately 
capitalized today. The commenter claimed this empirically proves that 
the proposal is unnecessary and unduly burdensome, as it would further 
strain the credit union system during a financial downturn. The 
commenter estimated that, in order to satisfy the proposal's well 
capitalized threshold, credit unions would need to hold at least an 
additional $729 million. The commenter estimated further that, to 
satisfy the proposal's adequately capitalized threshold, credit unions 
would need to hold at least an additional $260 million.
    Another commenter argued that the Board's cost estimates failed to 
include the one-time costs that would be incurred by the entire credit 
union industry in system changes, additional reports, potential 
additional segregation and segmentation of the balance sheet, etc. in 
order to fill out the new Call Report forms. The commenter speculated 
that such costs will far outweigh the costs that the Board has 
identified in the proposal.
    Yet another commenter maintained that, according to the proposal, 
most complex credit unions are currently well capitalized under both 
the net worth ratio and the proposed risk-based capital ratio. The 
commenter calculated that as of September 30, 2014, complex credit 
unions had an average net worth ratio of 10.7 percent and a risk-based 
capital ratio of 19.3 percent, both well in excess of guidelines 
identifying well capitalized status. The commenter suggested that only 
19 complex credit unions would fall from well capitalized status under 
the proposal. Thus, the commenter concluded that the costs associated 
with the proposal seemed excessive given how extremely well capitalized 
the credit union industry is today under current guidelines.
    One credit union commenter suggested that for the risk-based 
capital requirement to be effective, it would have to be more complex. 
The commenter explained that this would mean requiring more information 
on the Call Report and adding new categories of loans in the final 
rule. Another credit union commenter supported making the risk-based 
capital framework as complicated as it needs to be to more accurately 
reflect the unique needs and structure of the credit union industry.
    Several commenters noted that in March 2015, FASB announced 
expectations to finalize the standard for timely financial reporting of 
credit losses in the third quarter of 2015. Commenters recommended the 
Board consider the possible effects of the FASB proposal in relation to 
NCUA's risk-based capital regulations and remove any duplicative 
regulatory burdens that may be created.

[[Page 66703]]

    A significant number of commenters requested that the Board 
minimize the burden on credit unions of expanding the Call Report. 
Several commenters suggested the Board consider an approach where 
credit unions would have the option of providing the additional, 
detailed information required under the proposal. One commenter 
suggested such an approach could be accomplished by including 
additional optional data fields within the Call Report, similar to the 
approach used by FDIC. The commenter suggested further that any changes 
required of a credit union require the expenditure of resources, and in 
a time when many credit unions are struggling to comply with existing 
rules from NCUA and other regulators, the Board should consider any 
alternatives that will reduce the burden of this rule on credit unions. 
Another commenter contended that NCUA's current estimate of the public 
burden of collecting information for the Call Report grossly 
understates the actual amount of time required. The commenter suggested 
that the variety of data needed to generate a quarterly Call Report 
takes employees from some credit unions 66 hours (10 times NCUA's 
current 6.6 hour estimate). The commenter recommended the Board 
consider the time and resources dedicated to producing the additional 
Call Report data required by the proposal and focus on minimizing that 
burden and impact to credit unions. At least one commenter recommended 
that any Call Report updates required by this rulemaking be made 
available to credit unions at least six months before the effective 
date of the final rule.

Discussion

    The Board has considered the comments received and recognizes that 
unduly high minimum regulatory capital requirements and unnecessary 
burdens could lead to less-than-optimal outcomes. Thus, as discussed 
throughout this preamble and in the Paperwork Reduction Act section to 
follow, the Board has made appropriate efforts to target the impacts 
and reduce the burdens of this final rule. This final rule only targets 
outlier credit unions with insufficient capital relative to their risk. 
The final rule meets Congress' express purpose of prompt corrective 
action ``. . . to resolve the problems of insured credit unions at the 
least possible long-term cost to the Fund,'' \204\ by establishing a 
risk-based capital requirement which will reduce the likelihood that a 
credit union will become undercapitalized and eventually fail at a cost 
to the Fund.
---------------------------------------------------------------------------

    \204\ 12 U.S.C. 1790d(a)(1).
---------------------------------------------------------------------------

    The Board's elimination of the 1.25 percent of risk-assets cap on 
the amount of ALLL in the risk-based capital ratio numerator will 
reduce the impact of the risk-based capital ratio during economic 
downturns when credit unions are more likely to be funding higher 
levels of loan losses. Removal of the ALLL cap will also mitigate 
concerns with FASB's proposed related changes to GAAP.\205\ A reduction 
in capital ratios during economic downturns is a normal result for both 
the risk-based capital ratio and the net worth ratio. The capital 
adequacy requirement will enhance a credit union's ability to measure 
and plan for economic downturns.
---------------------------------------------------------------------------

    \205\ See Financial Standards Accounting Board, Proposed 
Accounting Standards Update, Financial Instruments--Credit Losses, 
Subtopic 825-15 (Dec. 20, 2012).
---------------------------------------------------------------------------

    Sound capital levels are vital to the long-term health of all 
financial institutions. Credit unions are already expected to 
incorporate into their business models and strategic plans provisions 
for maintaining prudent levels of capital. This final rule ensures 
minimum regulatory capital levels for complex credit unions will be 
more accurately correlated to risk. The final rule achieves a 
reasonable balance between requiring credit unions posing an elevated 
risk to hold more capital, while not overburdening lower-risk credit 
unions.
    As indicated in the table below, according to the impact measure 
used in the Second Proposal, 72 complex credit unions would have had 
higher capital requirements due to the risk-based capital ratio 
requirement based on December 31, 2014 data.\206\
---------------------------------------------------------------------------

    \206\ The method used in the Second Proposal was calculated by 
taking 10 percent of estimated risk assets divided by total assets 
with results exceeding 7.5 percent indicating the risk-based capital 
requirement is the higher minimum-capital requirement.
    \207\ This computation calculates the amount of capital required 
by multiplying the estimated 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 \207\
--------------------------------------------------------------------------------------------------------------------------------------------------------
  RBC ratio--leverage equivalent         <6%             6-7.5%          7.5-8.5%         8.5-9.5%         9.5-11%            >11%           Average
--------------------------------------------------------------------------------------------------------------------------------------------------------
Number of CUs....................             816              601               57               11                4                0            5.90%
--------------------------------------------------------------------------------------------------------------------------------------------------------

    Using another more conservative measure developed based on 
suggestions received from commenters, NCUA identified 308 credit 
unions, or 20 percent of all complex credit unions, that are likely to 
have a higher minimum capital requirement under the risk-based capital 
ratio requirement being adopted under this final rule.\208\ While up to 
20 percent of credit unions are likely to have the risk-based capital 
ratio as the binding constraint, only 20 of those credit unions have an 
estimated risk-based capital ratio below 10 percent.\209\
---------------------------------------------------------------------------

    \208\ Calculated based on a positive result to the following 
formula: ((risk-weighted assets times 10 percent) - allowance for 
loan losses - equity acquired in merger - total adjusted retained 
earnings acquired through business combinations + NCUA share 
insurance capitalization deposit + goodwill + identifiable 
intangible assets) - (total assets times 7 percent).
    \209\ Also, given the new treatment of non-significant equity 
exposures, which could not be estimated due to existing data 
limitations, this impact may be further reduced.
---------------------------------------------------------------------------

    NCUA's latest analysis concludes it is reasonable for the risk-
based capital ratio requirement to be the primary determiner of the 
capital requirement for about 20 percent of complex credit unions 
because these 308 credit unions have an average risk-weighted assets to 
total assets ratio of 72 percent--which is significantly higher than 
the 59 percent average ratio for all complex credit unions.
    As noted earlier, concentration risk is a material risk addressed 
in this final rule. Based on December 31, 2014 Call Report data, if 
this final rule were effective today, NCUA estimates that the 
additional capital required for concentration risk would have the 
following impact:

[[Page 66704]]



------------------------------------------------------------------------
                                  Number of credit   Percentage of 1,489
                                 unions with total    credit unions with
    Concentration threshold     assets greater than      total assets
                                 $100 million as of   greater than $100
                                     12/31/2014            million
------------------------------------------------------------------------
First-Lien Residential Real                     135                  9.1
 Estate (>35% of Total Assets)
Junior-Lien Residential Real                     57                  3.8
 Estate (>20% of Total Assets)
Commercial Loans (using MBLs                     12                  0.8
 as a proxy) \210\ (>50% of
 Total Assets)................
------------------------------------------------------------------------

    The Board considered the impact of the individual data items 
necessary to compute the risk-based capital ratio. Many commenters' 
requests for further stratification of risk weights were determined to 
create a data burden in excess of the benefits. All revisions to the 
Call Report will be subject to the publication and opportunity for 
comment process in accordance with the requirements of the Paperwork 
Reduction Act of 1994 to obtain a valid control number from the U.S. 
Office of Management and Budget (OMB). Interested parties are invited 
to submit written comments to each notice of information collection 
that NCUA will submit to OMB for review.
---------------------------------------------------------------------------

    \210\ Using MBL data as the current Call Report does not capture 
``commercial loan'' data as defined in this final rule.
---------------------------------------------------------------------------

VII. Regulatory Procedures

Regulatory Flexibility Act

    The Regulatory Flexibility Act (RFA) generally requires that, in 
connection with a final rulemaking, an agency prepare and make 
available a final regulatory flexibility analysis that describes the 
impact of the final 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 \211\) and publishes 
its certification and a short, explanatory statement in the Federal 
Register together with the rule.
---------------------------------------------------------------------------

    \211\ On September 24, 2015, the Board published Interpretative 
Ruling and Policy Statement 15-1, which amends the definition of 
small credit unions for purposes of the RFA to credit unions with 
assets of less than $100 million. 80 FR 57512 (Sept. 24, 2015). This 
change, however, does not take effect until November 23, 2015, which 
is after the date this rule is scheduled to be voted on by the 
Board.
---------------------------------------------------------------------------

Public Comments on the Second Proposal

    A small credit union commenter suggested that while credit unions 
with less than $100 million in assets are not subject to the 
requirements of this proposal, there is great apprehension among small 
credit unions that NCUA examiners will require them to meet the basic 
requirements in the risk-based capital rule.
    Several commenters contended that NCUA's current estimate of the 
public burden of collecting information for the Call Report grossly 
understates the actual amount of time required. At least one commenter 
suggested that the variety of data needed to generate a quarterly Call 
Report takes employees from some credit unions 66 hours (10 times 
NCUA's estimate of 6.6 hours).

Discussion

    The amendments this final rule makes to part 702 primarily affect 
complex credit unions, which are those with $100 million or more in 
assets. The revised risk-based capital requirement and capital adequacy 
plan under this final rule do not apply to small credit unions.
    NCUA recognizes that because many commenters suggested NCUA collect 
more granular data for credit union Call Reports, small credit unions 
with assets less than $50 million could be affected if they are asked 
to assemble and report additional data. NCUA, however, will make every 
reasonable effort to redesign the Call Report system so that all credit 
unions with $100 million or less in assets are not unnecessarily 
burdened by the data requirements that apply to complex credit unions. 
NCUA plans to propose information collection changes to reflect the new 
requirements of this final rule in the future, and publish the 
regulatory reporting requirements separately--including the steps NCUA 
has taken to minimize the impact of the reporting burden on small 
credit unions--for comment.
    In addition, this final rule makes a number of minor changes to 
current part 702 of NCUA's regulations including:
     Part 702--Reorganizing and renumbering part 702, including 
sections of the part applicable to small credit unions.
     Section 702.2--Making minor amendments to certain 
definitions applicable to all credit unions under part 702.
     Section 702.111(g)(4) & 702.206(g)(3)--Making minor 
clarifications regarding the submission of multiple unapproved NWRPs or 
RBPs.
     Sections 702.112 & 702.208--Eliminating the regular 
reserve account requirement for all credit unions.
     Sections 702.113(d) & 702.209(d)--Making minor amendments 
to the treatment of loan and lease losses.
     Section 702.114 & 702.210--Making minor amendments to part 
702 regarding the payments of dividends for all credit unions.
     Section 702.201--Making minor revisions to the definition 
of ``new credit union.''
    NCUA believes the one time burden associated with the policy review 
and revisions related to these amended provisions will be one hour for 
small credit unions. Accordingly, the effects of this final rule on 
small credit unions are minor.
    Based on the above assessment, the Board certifies that this final 
rule 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.\212\ 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 changes made to part 702 by this final rule will impose 
new information collection requirements.
---------------------------------------------------------------------------

    \212\ 44 U.S.C. 3507(d); 5 CFR part 1320.
---------------------------------------------------------------------------

    NCUA determined that the proposed changes to part 702 would 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 in the Second Proposal estimated 
that all 6,554 credit unions would have to amend their procedures and 
systems for preparing Call Reports. NCUA proposed addressing the costs 
and providing notice of the particular changes that would be made in 
other collections, such as the NCUA Call Report and Profile as part of 
its regular amendments separate from this proposed rule.

[[Page 66705]]

    NCUA also estimated that approximately 21.5 percent, or 1,455 
credit unions, would be defined as ``complex'' under the proposed rule 
and would have additional data collection requirements related to the 
new risk-based capital requirements.
    NCUA's Total Estimated One-Time Costs of the Second Proposal:
    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 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.

Public Comments on the Second Proposal

    A significant number of commenters maintained that the proposal did 
not incorporate the estimated burden for establishing a comprehensive 
written strategy for maintaining an appropriate level of capital and 
other changes to a complex credit union's operations other than data 
collection. Commenters suggested the effects of the proposal would be a 
greater burden for complex credit unions upon the implementation year 
and for ongoing years. Commenters noted that NCUA's final rule on 
Capital Planning and Stress Testing estimated 750 hours of paperwork 
burden in the initial year and 250 hours in subsequent years, and 
suggested it was unclear how the requirements of the Second Proposal 
would differ from the final rule on Capital Planning and Stress Testing 
in terms of burden. Using the cost estimate previously utilized by NCUA 
for the final rule on Capital Planning and Stress Testing, one 
commenter suggested a more reasonable estimate for this proposal would 
be $23,926 per credit union or $34.8 million to the industry for the 
initial year of the final RBC rule. The commenter also suggested there 
would be an ongoing annual cost of $7,975 per credit union or $11.6 
million to the industry, which, over a five-year period, would have a 
cumulative cost to the industry of approximately $81.2 million.
    In addition, several commenters contended that NCUA's current 
estimate of the public burden of collecting information for the Call 
Report grossly understates the actual amount of time required. At least 
one commenter suggested that the variety of data needed to generate a 
quarterly Call Report takes employees from some credit unions 66 hours 
(10 times NCUA's estimate 6.6 hours).

Discussion

    The final changes will result in some costs for complex credit 
unions associated with updating internal policies, including a 
comprehensive strategy for maintaining an appropriate level of capital, 
the cost estimates for which are discussed in more detail below. 
Further, there will be marginal costs associated with updating data 
collection and reporting systems for the NCUA Call Reports. The changes 
to the Call Reporting requirements, however, will be handled as part of 
NCUA's regular Call Report updates separately from this proposed rule. 
The information collection requirements for the Call Report are 
approved by OMB under Control No. 3133-004.
    In response to commenters who believe all complex credit unions 
will need substantial time to establish and maintain a comprehensive 
written capital strategy, NCUA field staff report that many well-
managed complex credit unions already have comprehensive strategies for 
maintaining appropriate levels of capital. Further, commenters compared 
the burden of the Capital Planning and Stress Testing hours; however, 
for the vast majority of complex credit unions, the written capital 
strategy will not necessarily approach the complexity and more rigorous 
requirements associated with stress testing.
    NCUA has updated its PRA analysis based on December 2014 Call 
Report data. Again, NCUA will make every effort to redesign the Call 
Report system so that small credit unions are not unnecessarily 
burdened by the data requirements that apply to complex credit unions.
    The final rule contains minor changes to Sec. Sec.  702.2, 
702.111(g)(4), 702.206(g)(3), 702.112, 702.208, 702.113(d), 702.209(d), 
702.114, 702.210, and 702.201 for which all credit union's should be 
aware. The information collection requirements contained in 
702.111(g)(4) and 702.206(g)(3) are generally related to information 
collected under OMB Control No. 3133-0154.
    NCUA estimates that 1,489 credit unions defined as ``complex'' will 
have additional data collection requirements related to the new risk-
based capital requirements. This slight increase from 1,455 credit 
unions in the Second Proposal occurred as some credit unions that had 
assets of less than $100 million grew in size and now meet the 
definition of ``complex.''
    As a result, NCUA's Total Estimated One-Time Costs based on the 
December 2014 Call Report data have changed slightly:
    One-time burden for policy review and revision:
     40 hours times 1,489 complex credit unions. The total one-
time cost for complex credit unions totals 59,560 hours or $1,898,174, 
an average of $1,275 per credit union.
     1 hour times 4,784 non-complex credit unions. The total 
one-time cost for credit unions with $100 million or less in assets 
totals 4,784 hours, for a total estimated cost of $152,562.

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 final 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 final rule.

Assessment of Federal Regulations and Policies on Families

    NCUA has determined that this final 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.

[[Page 66706]]

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 October 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) 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
6. 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''.
0
c. 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. Sec.  702.101, 702.202, and subparts A and B to read as 
follows:

Sec.
702.1 Authority, purpose, scope, and other supervisory authority.
702.2 Definitions.
Subpart A--Prompt Corrective Action
702.101 Capital measures, capital adequacy, effective date of 
classification, and notice to NCUA.
702.102 Capital classification.
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 undercapialized 
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 B--Alternative Prompt Corrective Action for New Credit Unions
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 A--Prompt Corrective Action


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 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

[[Page 66707]]

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.


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 that chartered the affected 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 the value of the asset or liability 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.
    Charitable donation account means an account that satisfies all of 
the conditions in Sec.  721.3(b)(2)(i), (b)(2)(ii), and (b)(2)(v) of 
this chapter.
    Commercial loan means any loan, line of credit, or letter of credit 
(including any unfunded commitments) 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, purchase or sell assets, enter into a 
borrowing agreement, or enter into a financial transaction.
    Consumer loan means a loan for household, family, or other personal 
expenditures, including any loans that, at origination, are wholly or 
substantially 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 one or more vehicles to be part of a fleet of 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 or five business days.
    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 enter into derivative transactions.
    Excluded goodwill means the outstanding balance, maintained in 
accordance with GAAP, of any goodwill originating from a supervisory 
merger or combination that was completed on or before December 28, 
2015. This term and definition expire on January 1, 2029.
    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 on or before December 28, 2015. This term and 
definition expire on January 1, 2029.
    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.

[[Page 66708]]

    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 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.
    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.
    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 
depository institution receives fees for managing the credit risk of 
the loans. The credit risk must be shared between the depository 
institution 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

[[Page 66709]]

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 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.
    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.
    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.
    Part 703 compliant investment fund means an investment fund that is 
restricted to holding only investments that are permissible under Sec.  
703.14(c) of this chapter.
    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.
    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

[[Page 66710]]

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, 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. An investment that does not 
have a junior claim to other investments in the same issuance on the 
underlying collateral or assets is non-subordinated. A Security that is 
junior only to money market eligible securities in the same issuance is 
also non-subordinated.
    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. U.S. Government agency includes NCUA.

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 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.

[[Page 66711]]

    (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 following
     classification is . . .          Net worth ratio                applicable if         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.
    (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:
    (1) Cash, currency and coin, including vault, automatic teller 
machine, and teller cash.
    (2) share-secured loans, where the shares securing the loan are on 
deposit with the credit union.

[[Page 66712]]

    (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 
interest-only mortgage-backed-security 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 interest-only mortgage-backed-security STRIPS.
    (2) A non-subordinated obligation of a GSE other than an equity 
exposure or preferred stock, excluding interest-only GSE mortgage-
backed-security STRIPS.
    (3) Securities issued by PSEs that represent general obligation 
securities.
    (4) Part 703 compliant investment funds that are restricted to 
holding only investments that qualify for a zero or 20 percent risk-
weight under this section.
    (5) Federal Home Loan Bank stock.
    (C) The balances due from Federal Home Loan Banks.
    (D) The balance of share-secured loans, where the shares securing 
the loan are on deposit with another depository institution.
    (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 interest-
only mortgage-backed security 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) Interest-only mortgage-backed security STRIPS.
    (3) Part 703 compliant investment funds, with the option to use the 
look-through approaches in paragraph (c)(3)(iii)(B) 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.
    (8) Non-subordinated tranches of any investment, with the option to 
use the gross-up approach in paragraph (c)(3)(iii)(A) of this section.
    (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 investments, other than a CUSO 
investment.
    (B) Investment funds that do not meet the requirements under Sec.  
703.14(c) of this chapter, with the option to use the look-through 
approaches in paragraph (c)(3)(iii)(B) of this section.
    (C) Separate account insurance, with the option to use the look-
through approaches in paragraph (c)(3)(iii)(B) 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)(iii)(A) of this section.
    (3) Alternative risk weights for certain on-balance sheet assets--
(i) Non-significant equity exposures.-- (A) General. Notwithstanding 
the risk weights assigned in paragraph (c)(2) of this section, a credit 
union must assign a 100 percent risk weight to non-significant equity 
exposures.
    (B) Determination of non-significant equity exposures. A credit 
union has non-significant equity exposures if the aggregate amount of 
its equity exposures does not exceed 10 percent of the sum of the 
credit union's capital elements of the risk-based capital ratio 
numerator (as defined under paragraph (b)(1) of this section).
    (C) Determination of the aggregate amount of equity exposures. When 
determining the aggregate amount of its equity exposures, a credit 
union must include the total amounts (as recorded on the statement of 
financial condition in accordance with GAAP) of the following:
    (1) Equity investments in CUSOs,
    (2) Perpetual contributed capital at corporate credit unions,
    (3) Nonperpetual capital at corporate credit unions, and
    (4) Equity investments subject to a risk weight in excess of 100 
percent.
    (ii) Charitable donation accounts. Notwithstanding the risk weights

[[Page 66713]]

assigned in paragraph (c)(2) of this section, a credit union may assign 
a 100 percent risk weight to a charitable donation account.
    (iii) Alternative approaches. Notwithstanding the risk weights 
assigned in paragraph (c)(2) of this section, a credit union may 
determine the risk weight of investment funds, and non-subordinated or 
subordinated tranches of any investment as follows:
    (A) Gross-up approach. A credit union may use the gross-up approach 
under appendix A of this part to determine the risk weight of the 
carrying value of non-subordinated or subordinated tranches of any 
investment.
    (B) Look-through approaches. A credit union may use one of the 
look-through approaches under appendix A of this part to determine the 
risk weight of the exposure amount of any investment funds, the 
holdings of separate account insurance, or both.
    (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.


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.

  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 years.        0.005
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.
---------------------------------------------------------------------------

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

    (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.
    (2) 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 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

[[Page 66714]]

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 a 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 this section.

 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 equal to 5           2.0        3.0
 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 12 CFR 
part 324, when assigning risk weights to exposure amounts for 
derivatives contracts not addressed in paragraphs (a) or (b) of this 
section.

[[Page 66715]]

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 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,

[[Page 66716]]

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;
    (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);

[[Page 66717]]

    (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;
    (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

[[Page 66718]]

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, 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

[[Page 66719]]

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.

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 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

[[Page 66720]]

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).
    (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

[[Page 66721]]

as provided under paragraphs (a)(1) or (a)(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 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 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.

[[Page 66722]]

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.

Subparts C and D--[Removed]

0
9. Remove subparts C and D.

Subpart E--[Redesignated as Subpart C]

0
10. Redesignate subpart E, consisting of Sec. Sec.  702.501-702.506, as 
subpart C, consisting of Sec. Sec.  702.301-702.306.


Sec.  702.504  [Amended]

0
11. Amend newly redesignated Sec.  702.504(b)(4) by removing the 
citation ``Sec.  702.506(c)'' and adding in its place ``Sec.  
702.306(c)''.


Sec.  702.505  [Amended]

0
12. Amend newly redesignated Sec.  702.505(b)(4) by removing the 
citation ``Sec.  702.504'' and adding in its place ``Sec.  702.304''.

0
13. Appendix A to part 702 is added to read as follows:

Appendix A to Part 702--Gross-Up Approach, and Look-Through Approaches

    Instead of using the risk weights assigned in Sec.  
702.104(c)(2) a credit union may determine the risk weight of 
certain investment funds, and the risk weight of a non-subordinated 
or subordinated tranche of any investment as follows:
    (a) Gross-up approach--(1) Applicability. Section 
702.104(c)(3)(iii)(A) of this part provides that, a credit union may 
use the gross-up approach in this appendix to determine the risk 
weight of the carrying value of non-subordinated or subordinated 
tranches of any investment.
    (2) Calculation. To use the gross-up approach, a credit union 
must calculate the following four inputs:
    (i) Pro rata share, which is the par value of the credit union's 
exposure as a percent of the par value of the tranche in which the 
securitization exposure resides;
    (ii) Enhanced amount, which is the par value of tranches that 
are more senior to the tranche in which the credit union's 
securitization resides;
    (iii) Exposure amount, which is the amortized cost for 
investments classified as held-to-maturity and available-for-sale, 
and the fair value for trading securities; and
    (iv) Risk weight, which is the weighted-average risk weight of 
underlying exposures of the securitization as calculated under this 
appendix.
    (3) Credit equivalent amount. The ``credit equivalent amount'' 
of a securitization exposure under this part equals the sum of:
    (i) The exposure amount of the credit union's exposure; and
    (ii) The pro rata share multiplied by the enhanced amount, each 
calculated in accordance with paragraph (a)(2) of this appendix.
    (4) Risk-weighted assets. To calculate risk-weighted assets for 
a securitization exposure under the gross-up approach, a credit 
union must apply the risk weight required under paragraph (a)(2) of 
this appendix to the credit equivalent amount calculated in 
paragraph (a)(3) of this appendix.
    (5) Securitization exposure defined. For purposes of this this 
paragraph (a), ``securitization exposure'' means:
    (i) A credit exposure that arises from a securitization; or
    (ii) An exposure that directly or indirectly references a 
securitization exposure described in paragraph (a)(5)(i) of this 
appendix.
    (6) Securitization defined. For purposes of this paragraph (a), 
``securitization'' means a transaction in which:
    (i) The credit risk associated with the underlying exposures has 
been separated into at least two tranches reflecting different 
levels of seniority;
    (ii) Performance of the securitization exposures depends upon 
the performance of the underlying exposures; and
    (iii) All or substantially all of the underlying exposures are 
financial exposures (such as loans, receivables, asset-backed 
securities, mortgage-backed securities, or other debt securities).
    (b) Look-through approaches.--(1) Applicability. Section 
702.104(c)(3)(iii)(B) provides that, a credit union may use one of 
the look-through approaches in this appendix to determine the risk 
weight of the exposure amount of any investment fund, or the holding 
of separate account insurance.
    (2) Full look-through approach. (i) General. A credit union that 
is able to calculate a risk-weighted asset amount for its 
proportional ownership share of each exposure held by the investment 
fund may set the risk-weighted asset amount of the credit union's 
exposure to the fund equal to the product of:
    (A) The aggregate risk-weighted asset amounts of the exposures 
held by the fund as if they were held directly by the credit union; 
and
    (B) The credit union's proportional ownership share of the fund.
    (ii) Holding report. To calculate the risk-weighted amount under 
paragraph (b)(2)(i) of this appendix, a credit union should:
    (A) Use the most recently issued investment fund holding report; 
and
    (B) Use an investment fund holding report that reflects holding 
that are not older than 6-months from the quarter-end effective date 
(as defined in Sec.  702.101(c)(1).
    (3) Simple modified look-through approach. Under the simple 
modified look-through approach, the risk-weighted asset amount for a 
credit union's exposure to an investment fund equals the exposure 
amount multiplied by the highest risk weight that applies to any 
exposure the fund is permitted to hold under the prospectus, 
partnership agreement, or similar agreement that defines the fund's 
permissible investments (excluding derivative contracts that are 
used for hedging rather than speculative purposes and that do not 
constitute a material portion of the fund's exposures).
    (4) Alternative modified look-through approach. Under the 
alternative modified look-through approach, a credit union may 
assign the credit union's exposure amount to an investment fund on a 
pro rata basis to different risk weight categories under subpart A 
of this part based on the investment limits in the fund's 
prospectus, partnership agreement, or similar contract that defines 
the fund's permissible investments. The risk-weighted asset amount 
for the credit union's exposure to the investment fund equals the 
sum of each portion of the exposure amount assigned to an exposure 
type multiplied by the applicable risk weight under subpart A of 
this part. If the sum of the investment limits for all exposure 
types within the fund exceeds 100 percent, the credit union must 
assume that the fund invests to the maximum extent permitted under 
its investment limits in the exposure type with the highest 
applicable risk weight under subpart A of this part and continues to 
make investments in order of the exposure type with the next highest 
applicable risk weight under subpart A of this part until the 
maximum total investment level is reached. If more than one exposure 
type applies to an exposure, the credit union must use the highest 
applicable risk weight. A credit union may exclude derivative 
contracts held by the fund that are used for hedging rather than for 
speculative purposes and do not constitute a material portion of the 
fund's exposures.

PART 703--INVESTMENT AND DEPOSIT ACTIVITIES

0
14. 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
15. 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

[[Page 66723]]

(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
16. 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
17. 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,''.


Sec.  713.6  What is the permissible deductible?

    (a)(1) * * *

------------------------------------------------------------------------
                  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
18. The authority citation for part 723 continues to read as follows:

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


Sec.  723.1  [Amended]

0
19. Amend Sec.  723.1 as follows:
0
a. In paragraph (d) remove the words ``and the risk weighting standards 
of part 702 of this chapter''; and
0
b. In paragraph (e) remove the words ``and the risk weighting standards 
under part 702 of this chapter''.


Sec.  723.7  [Amended]

0
20. Amend Sec.  723.7(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
21. 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
22. Amend Sec.  747.2001(a) by removing the citation ``702.302(d)'' and 
adding in its place the citation ``702.202(d)''.


Sec.  747.2002  [Amended]

0
23. Amend Sec.  747.2002(a) 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.  702.304(b) or Sec.  702.305(b)'' and adding 
in their place the words ``Sec.  702.204(b) or Sec.  702.205(b)''.


Sec.  747.2003  [Amended]

0
24. Amend Sec.  747.2003(a) by removing the citation ``702.302(d)'' and 
adding in its place the citation ``702.202(d)''.

[FR Doc. 2015-26790 Filed 10-28-15; 8:45 am]
 BILLING CODE 7535-01-P