[Federal Register Volume 85, Number 47 (Tuesday, March 10, 2020)]
[Proposed Rules]
[Pages 13982-14033]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-01537]



[[Page 13981]]

Vol. 85

Tuesday,

No. 47

March 10, 2020

Part II





 National Credit Union Administration





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12 CFR Parts 701, 702, 709, et al.





 Subordinated Debt; Proposed Rule

  Federal Register / Vol. 85 , No. 47 / Tuesday, March 10, 2020 / 
Proposed Rules  

[[Page 13982]]


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NATIONAL CREDIT UNION ADMINISTRATION

12 CFR Parts 701, 702, 709, and 741

RIN 3133-AF08


Subordinated Debt

AGENCY: National Credit Union Administration (NCUA).

ACTION: Proposed rule.

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SUMMARY: The NCUA Board (Board) is proposing to amend various parts of 
the NCUA's regulations to permit low-income designated credit unions 
(LICUs), Complex Credit Unions, and New Credit Unions to issue 
Subordinated Debt for purposes of regulatory capital treatment. 
Specifically, this proposed rule would create a new subpart in the 
NCUA's final risk-based capital rule (RBC Rule) that would address the 
requirements for and regulatory capital treatment of Subordinated Debt. 
This new subpart would, among other things, contain requirements 
related to applying for authority to issue Subordinated Debt, credit 
union eligibility to issue Subordinated Debt, prepayments, disclosures, 
securities laws, and the terms of a Subordinated Debt Note. This 
proposed rule also makes various additions and amendments to other 
parts and sections of the NCUA's regulations.

DATES: Comments must be received on or before July 8, 2020.

ADDRESSES: You may submit written comments, identified by RIN 3133-
AF08, by any of the following methods (Please send comments by one 
method only):
     Federal eRulemaking Portal: http://www.regulations.gov. 
Follow the instructions for submitting comments.
     Fax: (703) 518-6319. Include ``[Your Name]--Comments on 
Proposed Rule: Subordinated Debt'' in the transmittal.
     Mail: Address to Gerard Poliquin, Secretary of the Board, 
National Credit Union Administration, 1775 Duke Street, Alexandria, 
Virginia 22314-3428.
     Hand Delivery/Courier: Same as mail address.
    Public Inspection: You may view all public comments on the Federal 
eRulemaking Portal at http://www.regulations.gov, as submitted, except 
for those we cannot post for technical reasons. The NCUA will not edit 
or remove any identifying or contact information from the public 
comments submitted. You may inspect paper copies of comments in the 
NCUA's law library at 1775 Duke Street, Alexandria, Virginia 22314, by 
appointment weekdays between 9 a.m. and 3 p.m. To make an appointment, 
call (703) 518-6546 or email [email protected].

FOR FURTHER INFORMATION CONTACT: Tom Fay, Director of Capital Markets; 
or Justin M. Anderson, Senior Staff Attorney, Office of General 
Counsel, 1775 Duke Street, Alexandria, VA 22314-3428. Tom Fay can also 
be reached at (703) 518-1179, and Justin Anderson can be reached at 
(703) 518-6540.

SUPPLEMENTARY INFORMATION: 

Table of Contents

I. Background
    A. History
    B. Legal Authority
    C. Credit Union Data
    D. Summary of the Proposed Rule
    E. Securities Law Issues
II. Proposed Changes
    A. Part 701--Organization and Operations of Federal Credit 
Unions
    B. Part 702--Capital Adequacy
    C. Subpart D--Subordinated Debt, Grandfathered Secondary 
Capital, and Regulatory Capital
    D. Part 709--Involuntary Liquidation of Federal Credit Unions 
and Adjudication of Creditor Claims Involving Federally Insured 
Credit Unions in Liquidation
    E. Part 741--Requirements for Insurance
III. Regulatory Procedures
    A. Paperwork Reduction Act
    B. Executive Order 13132
    C. Assessment of Federal Regulations and Policies on Families
Part 701--Organization and Operations of Federal Credit Unions
    Sec.  701.25 Loans to Credit Unions
    Sec.  701.34 Designation of Low Income Status
    Sec.  701.38 Borrowed Funds
Part 702--Capital Adequacy
    Sec.  702.2 Definitions
    Sec.  702.104 Risk-Based Capital Ratio
    Sec.  702.109 Prompt Corrective Action for Critically 
Undercapitalized Credit Unions
    Sec.  702.205 Prompt Corrective Action for Uncapitalized New 
Credit Unions
    Sec.  702.206 Revised Business Plans (RBP) for New Credit Unions
    Sec.  702.207 Consideration of Subordinated Debt and 
Grandfathered Secondary Capital for New Credit Unions
Subpart D--Subordinated Debt, Grandfathered Secondary Capital, and 
Regulatory Capital
    Sec.  702.401 Purpose and Scope
    Sec.  702.402 Definitions
    Sec.  702.403 Eligibility
    Sec.  702.404 Requirements of the Subordinated Debt and 
Subordinated Debt Note
    Sec.  702.405 Disclosures
    Sec.  702.406 Requirements Related to the Offer, Sale, and 
Issuance of Subordinated Debt Notes
    Sec.  702.407 Discounting of Amount Treated as Regulatory 
Capital
    Sec.  702.408 Preapproval To Issue Subordinated Debt
    Sec.  702.409 Preapproval for Federally Insured, State-Chartered 
Credit Unions To Issue Subordinated Debt
    Sec.  702.410 Interest Payments on Subordinated Debt
    Sec.  702.411 Prior Written Approval To Prepay Subordinated Debt
    Sec.  702.412 Effect of a Merger or Dissolution on the Treatment 
of Subordinated Debt as Regulatory Capital
    Sec.  702.413 Repudiation Safe Harbor
    Sec.  702.414 Regulations Governing Grandfathered Secondary 
Capital
Part 709--Involuntary Liquidation of Federal Credit Unions and 
Adjudication of Creditor Claims Involving Federally Insured Credit 
Unions in Liquidation
    Sec.  709.5 Payout Priorities in Involuntary Liquidation
Part 741--Requirements of Insurance
    Sec.  741.204 Maximum Public Unit and Nonmember Accounts, and 
Low-Income Designation
    Sec.  741.226 Subordinated Debt
    Sec.  741.227 Loans to Credit Unions

I. Background

A. History

1. Secondary Capital for LICUs
    In 1996, the Board finalized Sec.  701.34 of the NCUA's regulations 
to permit LICUs to raise secondary capital from foundations and other 
philanthropic-minded non-natural person members and non-members.\1\ The 
Board issued the rule to provide an additional way for a LICU to build 
regulatory capital in order to serve two specific purposes: (1) Support 
greater lending and financial services in the communities served by the 
LICU; and (2) absorb losses to prevent the LICU from failing.
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    \1\ See 61 FR 50696 (Sept. 27, 1996) (final rule); see also 61 
FR 3788 (Feb. 2, 1996) (interim final rule); 12 CFR 701.34.
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    In 1998, as part of the Credit Union Membership Access Act 
(CUMAA),\2\ Congress amended the Federal Credit Union Act (the Act) to 
institute a system of prompt corrective action for federally insured 
credit unions based on a credit union's level of net worth. Relevant to 
this proposed rule, CUMAA specifically defined ``net worth,'' among 
other things, to include secondary capital issued by a LICU provided 
that the secondary capital be uninsured and subordinate to all other 
claims against the LICU, including the claims of creditors, 
shareholders, and the National Credit Union Share Insurance Fund 
(NCUSIF).\3\
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    \2\ Credit Union Membership Access Act of 1998, Public Law 105-
219, 301, 112 Stat. 913, 929 (codified at 12 U.S.C. 1790d(o)(2)(C) 
(1998)).
    \3\ Id.

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[[Page 13983]]

    In 2006, the Board further amended Sec.  701.34 to require 
regulatory approval of a LICU's secondary capital plan before the LICU 
could issue secondary capital.\4\ In the preamble to the final 2006 
rule, the Board noted that LICUs had sometimes used secondary capital 
to achieve goals different from those for which it was originally 
intended. It also highlighted a pattern of ``lenient practices'' by 
LICUs issuing secondary capital, which contributed to excessive net 
operating costs, high losses from loan defaults, and a shortfall in 
revenue.\5\ The Board stated:
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    \4\ 71 FR 4234 (Jan. 26, 2006).
    \5\ Id. at 4236. Before 2006, a LICU was required to submit a 
copy of its secondary capital plan to the NCUA, but it was not 
required to obtain preapproval.

    These practices include: (1) Poor due diligence and strategic 
planning in connection with establishing and expanding member 
service programs such as ATMs, share drafts and lending (e.g., 
member business loans (``MBLs'') real estate and subprime); (2) 
Failure to adequately perform a prospective cost/benefit analysis of 
these programs to assess such factors as market demand and economies 
of scale; (3) Premature and excessively ambitious concentrations of 
[Uninsured Secondary Capital] to support unproven or poorly 
performing programs; and (4) Failure to realistically assess and 
timely curtail programs that, in the face of mounting losses, are 
not meeting expectations. When they occur, these lenient practices 
contribute to excessive net operating costs, high losses from loan 
defaults, and a shortfall in revenues (due to non-performing loans 
and poorly performing programs)--all of which, in turn, produce 
lower than expected returns.\6\
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    \6\ Id. at 4236-37.

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    The Board also stated:

    Promoting diligent practices in place of lenient ones cannot 
help but improve the safety and soundness of LICUs. Requiring prior 
approval of [an Uninsured Secondary Capital] Plan will strengthen 
supervisory oversight and detection of lenient practices in several 
ways. First, it will prevent LICUs from accepting and using 
[Uninsured Secondary Capital] for purposes and in amounts that are 
improper or unsound. Second, the approval requirement will ensure 
that [Uninsured Secondary Capital] Plans are evaluated and critiqued 
by the Region before being implemented. Third, for both the NCUA and 
the LICU, an approved [Uninsured Secondary Capital] Plan will 
document parameters to guide the proper implementation of [Uninsured 
Secondary Capital], and to measure the LICU's progress and 
performance.\7\
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    \7\ Id. at 4237.

    The Current Secondary Capital Rule \8\ provides that secondary 
capital accounts must:
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    \8\ 12 CFR 701.34. The last substantive amendment to the NCUA's 
secondary capital rule were in 2010 with the addition of language 
regarding secondary capital received under the Community Development 
Capital Initiative of 2010. 75 FR 57843 (Sept. 23, 2010).
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     Be established as an uninsured secondary capital account 
or another form of non-share account;
     Have a minimum maturity of five years;
     Not be insured by the NCUSIF or any governmental or 
private entity;
     Be subordinate to all other claims against the LICU, 
including those of shareholders, creditors, and the NCUSIF;
     Be available to cover losses that exceed the LICU's net 
available reserves and, to the extent funds are so used, a LICU may not 
restore or replenish the account under any circumstances.\9\ Further, 
losses must be distributed pro rata among all secondary capital 
accounts held by the LICU at the time the loss is realized;
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    \9\ This generally means that when net operating losses exceed 
Retained Earnings, a LICU needs to first use the secondary capital 
funds to cover the excess amount.
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     Not be pledged or provided by the investor as security on 
a loan or other obligation with the LICU or any other party;
     Be evidenced by a contract agreement between the investor 
and the LICU that reflects the terms and conditions mandated by the 
Current Secondary Capital Rule and any other terms and conditions not 
inconsistent with that rule;
     Be accompanied by a disclosure and acknowledgment form as 
set forth in the appendix to the Current Secondary Capital Rule;
     Not be repaid, including any interest or dividends earned 
thereon, if the Board has prohibited repayment thereof under Sec. Sec.  
702.204(b)(11), 702.304(b), or 702.305(b) of the NCUA's regulations 
because the LICU is classified as ``Critically Undercapitalized''; or, 
if a LICU is a New Credit Union (as defined under Sec.  702.2 of the 
NCUA's regulations), as ``Moderately Capitalized,'' ``Marginally 
Capitalized,'' ``Minimally Capitalized,'' or ``Uncapitalized;''
     Be recorded on the LICU's balance sheet; \10\
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    \10\ While the Current Secondary Capital Rule requires a LICU to 
record secondary capital accounts on its balance sheet as ``equity 
accounts,'' generally accepted accounting principles in the United 
States require secondary capital accounts to generally be recorded 
as ``debt.'' See FASB (Financial Accounting Standards Board), ASC 
942-405-25-3 and 25-4. The instructions to the 5300 Call Report 
require all federally insured credit unions to report any secondary 
capital in the Liability section of the Statement of Financial 
Condition.
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     Be recognized as net worth in accordance with the schedule 
for recognizing net worth value in subsection (c)(2) of the Current 
Secondary Capital Rule;
     Be closed and paid out to the account investor in the 
event of a merger or other voluntary dissolution of a LICU, to the 
extent the secondary capital is not needed to cover losses at the time 
of the merger or dissolution (does not apply in the case where a LICU 
merges into another LICU); and
     Only be repaid at maturity,\11\ except that, with the 
prior approval of the NCUA and provided the terms of the account allow 
for early repayment, a LICU may repay any portion of secondary capital 
that is not recognized as net worth.\12\
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    \11\ A LICU may not issue a secondary capital account that 
amortizes over its stated term.
    \12\ See 12 CFR 701.34(d).
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    The Current Secondary Capital Rule also includes requirements 
related to secondary capital plan submissions and approvals, redemption 
of secondary capital, disclosures, and regulatory capital treatment.
    As noted above, since the passage of the CUMAA, a LICU that issues 
secondary capital is permitted to include the aggregate outstanding 
principal amount of that secondary capital in its Net Worth. Further, 
pursuant to the NCUA's currently effective risk-based net worth 
requirements, a LICU is also permitted to include such secondary 
capital in its risk-based net worth calculation. By contrast, a non-
LICU lacks the authority to issue secondary capital and, to the extent 
it issues any instruments analogous to secondary capital, to include 
any such instruments in either its Net Worth or its risk-based net 
worth calculation.
    In October 2015, the Board finalized a rule to replace the current 
risk-based net worth requirement with a risk-based capital (RBC) 
requirement.\13\ Under this revised standard, a LICU will be permitted 
to include secondary capital in its RBC calculations in the same 
fashion as it currently includes secondary capital in its risk-based 
net worth calculation. With this proposed rule, the Board now proposes 
to grant certain non-LICUs the authority to issue instruments in the 
form of subordinated debt and allow those instruments to be counted in 
their respective RBC calculations. This new authority,

[[Page 13984]]

however, would not permit non-LICUs to include subordinated debt in Net 
Worth.
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    \13\ 80 FR 66626 (Oct. 29, 2015). The Board has twice delayed 
the effective date for the final RBC Rule. First, in 2018, the 
effective date was delayed by one year, from January 1, 2019, to 
January 1, 2020. 83 FR 55467 (Nov. 6, 2018). Second, based on Board 
action at the December 2019 Board meeting, the effective date has 
been delayed for an additional two years from January 1, 2020 to 
January 1, 2022.
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    As discussed in more detail in the following subsections, under 
this proposed rule, certain non-LICUs would be permitted to issue 
Subordinated Debt and include such debt in their RBC calculation. In 
addition, under this proposed rule, all LICUs would be permitted to 
issue Subordinated Debt for Regulatory Capital treatment.\14\ Under 
this proposed rule, an Issuing Credit Union (defined in Sec.  702.402 
of the proposed rule) would be subject to the various requirements 
discussed in this preamble, including, but not limited to, securities 
laws, which are further discussed in section I. (E) of this preamble.
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    \14\ This proposal would not change the ability of a LICU to 
include Subordinated Debt in its Net Worth in the same manner in 
which it currently includes secondary capital in its net worth.
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2. Subordinated Debt for LICUs and Certain Non-LICUs
RBC
    In the proposed RBC rule issued in 2015,\15\ the Board requested 
stakeholder input on supplemental capital.\16\ Specifically, the Board 
posed the following six questions:
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    \15\ 80 FR 4340 (Jan. 27, 2015).
    \16\ Id. at 4384. The Board notes that when the agency began to 
consider authorizing non-LICU credit unions to issue instruments 
analogous to secondary capital instruments issued by LICUs, it used 
the term ``supplemental capital'' to refer to those instruments. In 
2017, when the Board issued an advance notice of proposed rulemaking 
on this topic, the NCUA used the umbrella term ``alternative 
capital'' to refer to both supplemental capital and secondary 
capital. In light of FCUs' authority only to issue debt instruments, 
however, the Board believes that it is more appropriate and accurate 
to use the umbrella term ``Subordinated Debt'' to refer to both 
secondary capital and what was once referred to as supplemental 
capital. It is important to note that, unless the context otherwise 
requires, the term ``Subordinated Debt'' refers to BOTH types of 
debt instruments.
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    (1) Should additional supplemental forms of capital be included in 
the RBC [ratio] numerator and how would including such capital protect 
the NCUSIF from losses?
    (2) If yes to be included in the RBC [ratio] numerator, what 
specific criteria should such additional forms of capital reasonably be 
required to meet to be consistent with [United States generally 
accepted accounting practices (U.S. GAAP)] and the [FCU] Act, and why?
    (3) If certain forms of certificates of indebtedness were included 
in the RBC ratio numerator, what specific criteria should such 
certificates reasonably be required to meet to be consistent with 
[U.S.] GAAP and the [FCU] Act, and why?
    (4) In addition to amending the NCUA's RBC regulations, what 
additional changes to the NCUA's regulations would be required to count 
additional supplemental forms of capital in the NCUA's RBC ratio 
numerator?
    (5) For [federally insured,] state-chartered credit unions, what 
specific examples of supplemental capital currently allowed under state 
law do commenters believe should be included in the RBC ratio 
numerator, and why should they be included?
    (6) What investor suitability, consumer protection, and disclosure 
requirements should be put in place related to additional forms of 
supplemental capital? \17\
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    \17\ Id.
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    In response to these questions, a majority of the commenters who 
addressed supplemental capital stated that it was imperative that the 
Board consider allowing credit unions to issue additional forms of 
capital. The commenters suggested this authority was particularly 
important because credit unions are at a disadvantage in the financial 
marketplace because most lack access to additional capital outside of 
Retained Earnings.
    While none of the commenters offered specific suggestions on how to 
implement supplemental capital, a few suggested that the Board 
promulgate broad, non-prescriptive rules to allow credit unions maximum 
flexibility in issuing supplemental capital.
2017 Advance Notice of Proposed Rulemaking (ANPR)
    On February 8, 2017, the Board published an ANPR to solicit 
comments on alternative forms of capital that credit unions could use 
in meeting capital standards required by statute and regulation.\18\ In 
response, the Board received 756 comments.
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    \18\ 82 FR 9691 (Feb. 8, 2017).
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    Of the 756 comments received, 688 appeared to be derived from one 
form letter.\19\ The form letter opposed the NCUA proceeding with a 
supplemental capital proposal, reasoning that allowing credit unions to 
issue supplemental capital would result in credit unions having an 
ownership structure similar to most tax-paying banks. It also 
maintained that credit unions have poorly managed existing secondary 
capital and suggested that, when combined with the necessary compliance 
with federal and state securities laws, this would result in widespread 
credit union failures and taxpayer bailouts. In addition, commenters 
that opposed a supplemental capital proposal generally stated that the 
FCU Act does not permit credit unions to issue supplemental capital.
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    \19\ While there were slight modifications to some letters, the 
substance of each letter was the same.
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    The Board disagrees with these assertions. First, most LICUs that 
have issued secondary capital generally have managed such capital well. 
Since the NCUA began requiring LICUs to obtain prior approval before 
issuing secondary capital, the Board is not aware of material losses to 
the NCUSIF resulting from the mismanagement of secondary capital. 
Further, the Board is proposing clear and robust requirements related 
to securities laws compliance, which will help ensure that Issuing 
Credit Unions are able to effectively navigate the complex framework of 
securities laws. Finally, as detailed more fully in section I. (B) of 
this preamble, section 1757(9) of the FCU Act grants a Federal Credit 
Union (FCU) the authority to issue debt instruments of the type 
contemplated by the ANPR and now by this proposed rule.\20\ The 
authority of a federally insured, state-chartered credit union (FISCU) 
to issue such instruments is derived from applicable state law.
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    \20\ 12 U.S.C. 1757(9).
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    In addition to the form comment letters, the Board received 68 
unique comments in response to the ANPR. Most of those comments 
supported proposing a rule to allow non-LICUs to issue an alternative 
form of capital. A majority of the commenters in favor of a proposal 
cited compliance with the NCUA's RBC Rule as the main reason for their 
support. Other reasons for support included credit union growth, 
protection from economic downturns, and providing services demanded by 
members.
    In general, the comments lacked specificity, and very few 
commenters addressed all or even most of the questions that the Board 
posed. Nevertheless, they covered a wide range of topics and offered 
varying levels of support for certain provisions. A discussion of more 
specific commenter feedback follows. The Board notes that, as 
demonstrated by the remainder of this preamble, it considered all 
comments to the ANPR in developing this proposed rule.
Permissible Investors
    Commenters opining on permissible investors typically addressed two 
distinct issues: Membership of investors and classification of 
investors. Eighteen commenters addressed the membership of investors. 
More than half of these commenters believed that both members

[[Page 13985]]

and non-members should be permitted to invest in supplemental capital, 
citing both market and flexibility advantages for Issuing Credit 
Unions. Five commenters believed that restricting investment to members 
would help preserve the mutual, member-owned structure of credit 
unions. One commenter argued that only non-members should be 
permissible investors.
    On the topic of investor classification, commenters were split 
almost evenly between providing maximum flexibility by permitting all 
persons to purchase supplemental capital and restricting investors to 
only non-natural persons or accredited investors. Commenters in favor 
of limiting the classes of potential investors stated that by only 
permitting more sophisticated investors, it would allow the NCUA's 
supplemental capital rule to be more flexible with respect to required 
disclosures.
    As discussed in more detail in section II. (C)(4) of this preamble, 
the Board is proposing to allow credit unions to issue Subordinated 
Debt to both members and non-members, provided the investor meets the 
definition of either ``Entity Accredited Investor'' or ``Natural Person 
Accredited Investor.'' These terms are further discussed in sections 
II. (C)(2) and (4) of this preamble.
Disclosures
    Twenty-seven commenters addressed the issue of disclosures. The 
majority of these commenters urged the NCUA to model any required 
disclosures after those established by the Office of the Comptroller of 
the Currency (OCC) or the Securities and Exchange Commission (SEC). 
These commenters maintained that these disclosures provide the highest 
level of investor and credit union protection and are the most familiar 
to investors. As discussed in greater detail in section II. (C)(5) of 
this preamble, the Board generally modeled the proposed disclosures in 
this rule after those required by the OCC and SEC.
Registration
    Nine commenters that addressed this issue advocated against 
requiring any form of registration with the NCUA before supplemental 
capital issuances. These commenters stated that the NCUA should require 
credit unions to follow SEC rules, which would likely exempt them from 
registration with the SEC. The commenters further cited flexibility and 
cost as reasons against registering with the NCUA. In addition, three 
commenters advocated for registration, citing safety and soundness 
concerns and comparability with the OCC's rules for national banks and 
federal savings associations.
    While the Board is not proposing a formal registration process 
similar to that employed by the SEC for securities issuances registered 
under the Securities Act of 1933, as amended (Securities Act), the 
proposed rule would require any credit union contemplating an offer or 
sale of Subordinated Debt Notes (as defined in Sec.  702.402 of the 
proposed rule) to obtain the NCUA's prior written approval before 
engaging in that activity. In addition, under this rule, every such 
offer and sale of Subordinated Debt Notes would require the preparation 
and delivery of certain offering materials to investors that conform to 
this rule's requirements and all applicable federal and state 
securities law (Offering Documents). Depending on whether a potential 
investor is an Entity Accredited Investor or a Natural Person 
Accredited Investor (each as defined in section II. (C)(2)), the 
Issuing Credit Union may need to obtain the NCUA's prior written 
approval before it uses such offering materials to offer and sell the 
Subordinated Debt Notes. See II. (C)(4) and (C)(6) of this preamble for 
detailed discussions about these requirements.
Permissible Instruments
    Thirty-four commenters addressed the topic of permissible 
instruments. Of these commenters, 22 favored a broad, principles-based 
approach to identifying permissible instruments, believing such an 
approach would allow credit unions to more easily meet the demands of 
investors and lower the cost of issuance. These commenters stated that 
the Board should provide a list of broad qualifications for a capital 
instrument and that any instrument fitting those qualifications should 
count as regulatory capital. While commenters did not clearly describe 
qualifications the Board should impose, some cited Basel III \21\ and 
the Current Secondary Capital Rule as possible models for the 
qualifications.
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    \21\ Basel Committee on Banking Supervision, Basel III: A global 
regulatory framework for more resilient banks and banking systems. 
(2011).
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    Conversely, the remaining 12 commenters addressing this topic 
stated that the Board should only permit debt instruments to count as 
regulatory capital, citing purchasers of debt lack of voting rights, 
ownership, and influence over credit unions. These commenters argued 
that limiting the type of instrument to debt was an additional 
protection against erosion of the mutual structure and potential loss 
of the credit union tax exemption. Please see the following section in 
this preamble for a detailed discussion of permissible instruments.

B. Legal Authority

1. Authority To Issue Subordinated Debt
    The borrowing authority granted to FCUs by the FCU Act, along with 
FCUs' statutory authority to enter into contracts and exercise 
incidental powers necessary or required to enable the FCUs to 
effectively carry on their business, supports the legal analysis that 
FCUs are authorized to incur indebtedness through the issuance of debt 
securities of the type contemplated by this proposed rule. Section 
1757(9) of the FCU Act authorizes FCUs:

to borrow, in accordance with such rules and regulations as may be 
prescribed by the Board, from any source, in an aggregate amount not 
exceeding, except as authorized by the Board in carrying out the 
provisions of subchapter III of this chapter, 50 per centum of its 
paid-in and unimpaired capital and surplus: Provided, That any 
Federal credit union may discount with or sell to any Federal 
intermediate credit bank any eligible obligations up to the amount 
of its paid-in and unimpaired capital.\22\
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    \22\ 12 U.S.C. 1757(9).

    Other than the provisions of Sec.  701.38 of the NCUA's 
regulations, which addresses borrowed funds from natural persons, the 
FCU Act does not provide any details as to the mechanisms that FCUs may 
employ to borrow.\23\ Further, section 201(b)(7) of the FCU Act 
implicitly allows credit unions to issue securities.\24\ Conversely, 
nothing in section 1757(9) or other provisions of the FCU Act appears 
to impose any specific restrictions or limitations on the mechanisms 
FCUs may employ to borrow, through the use of specific

[[Page 13986]]

limiting language, examples or illustrative transactions or situations, 
or otherwise. This stands in sharp contrast to many other subsections 
of section 1757 of the FCU Act which, for example, go into significant 
detail describing the types and terms of loans and extensions of credit 
that FCUs are permitted to make,\25\ and define the types of 
investments FCUs are permitted to make.\26\ In addition, the NCUA's 
regulations do not impose any specific restrictions or limitations on 
the mechanisms an FCU may employ to borrow, through the use of specific 
limiting language, examples, illustrative transactions, or situations.
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    \23\ In contrast, certain provisions of Title 12 of the United 
States Code relating to the regulation of other types of financial 
institutions expand on the institutions' basic authority to borrow 
money, including through the issuance of securities. For example, a 
Farm Credit System member is specifically authorized to:
    (a) Borrow money from or loan to any other institution of the 
System, borrow from any commercial bank or other lending 
institution, issue its notes or other evidence of debt on its own 
individual responsibility and full faith and credit, and invest its 
excess funds in such sums, at such times, and on such terms and 
conditions as it may determine.
    (b) Issue its own notes, bonds, debentures, or other similar 
obligations, fully collateralized as provided in section 2154(c) of 
this title by the notes, mortgages, and security instruments it 
holds in the performance of its functions under this chapter in such 
sums, maturities, rates of interest, and terms and conditions of 
each issue as it may determine with approval of the Farm Credit 
Administration.
    12 U.S.C.2153(a)(b).
    \24\ Id. section 1781(b)(7)
    \25\ Id. 1757(5).
    \26\ Id. 1757(7); (15).
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    Overall, the lack of specific restrictions or limitations on the 
mechanisms that may be employed and the specific authority granted in 
section 1757(9) to borrow ``from any source'' indicate that borrowings 
need not be limited to the types of arrangements typically entered into 
with banks, other credit unions, and other financial institutions--
namely, loans, lines of credit, and similar arrangements. Further, the 
specific authority provided in section 1757(1) of the FCU Act 
empowering FCUs to enter into contracts \27\ further supports the 
conclusion that FCUs have the power to enter into a variety of 
different arrangements with respect to borrowing.\28\ In addition, in 
the absence of specific restrictions and limitations, the ``incidental 
powers'' granted to FCUs in section 1757(17) of the FCU Act give 
significant discretion to FCUs with respect to how borrowings are 
effected.
---------------------------------------------------------------------------

    \27\ Id. 1757(1).
    \28\ Typical loan and line of credit arrangements entered into 
with banks, other credit unions and other financial institutions are 
clearly contractual in nature. Debt securities are also generally 
viewed as primarily contractual in nature, in large measure because 
of the terms of the securities themselves or the terms incorporated 
into the securities through an indenture, an issuing and paying 
agent agreement or similar agreement. This view of debt securities 
has been expressed in a wide variety of court cases. See, e.g., Katz 
v. Oak Industries, Inc., 508 A.2d 873, 878 (Del. Ch. 1986)) (``Under 
our law--and the law generally--the relationship between a 
corporation and the holders of its debt securities, even convertible 
debt securities, is contractual in nature.'').
---------------------------------------------------------------------------

    Further support for the position that FCUs have the authority to 
issue debt securities may be found in U.S. GAAP treatment of items that 
fall in the category of ``borrowings.'' Under U.S. GAAP, liabilities 
relating to borrowed money are presented as indebtedness on an entity's 
balance sheet, and the interest paid is presented as interest expense 
on its income statement, whether the borrowings are related to typical 
loan transactions, advances under lines of credit, or the issuance of 
debt securities. While the details of the different types of 
indebtedness for borrowed money are presented as separate line items in 
an entity's balance sheet and income statement, the treatment of 
``straight'' indebtedness (indebtedness that does not have equity/
residual ownership features, such as convertibility into shares) as 
liabilities, and interest paid thereon as interest expense, is 
essentially the same. In addition, while the details of the different 
types of indebtedness for borrowed money are presented as separate line 
items in the statement of cash flows, borrowings, whether in the form 
of loans from financial institutions or from the issuance of debt 
securities, are all presented in the ``cash flows from financing 
activities'' section of the statement.
    Throughout this proposed rule, the Board has included requirements 
to ensure that any Subordinated Debt issued by an Issuing Credit Union 
would be properly characterized as debt in accordance with U.S. GAAP. 
These requirements, as discussed in more detail in this preamble, 
include that the Subordinated Debt or the Subordinated Debt Note, as 
applicable, must:
     Be in the form of a written, unconditional promise to pay 
on a specified date a sum certain in money in return for adequate 
consideration in money;
     Have, at the time of issuance, a fixed stated maturity of 
at least five years and not more than 20 years from issuance. The 
stated maturity of the Subordinated Debt Note may not reset and may not 
contain an option to extend the maturity; and
     Be properly characterized as debt in accordance with U.S. 
GAAP.
    The Board notes that a FISCU's legal authority to issue 
Subordinated Debt derives from applicable state law and regulation. For 
the Subordinated Debt issued by a FISCU to qualify as regulatory 
capital under this proposed rule, however, the FISCU would be required 
to comply with all of the provisions of this rule, including the FISCU-
specific provisions that are detailed in section II. (C)(9) of this 
preamble.
2. The Board's Authority To Design RBC Standards
    In addition to credit unions' authority to issue Subordinated Debt, 
the FCU Act also provides the Board with broad discretion to design the 
risk-based net worth standards.\29\ Specifically, the FCU Act provides, 
in relevant part:
---------------------------------------------------------------------------

    \29\ As discussed above, the Board finalized a rule to replace 
the regulatory risk-based net worth requirement with an RBC 
requirement.

    The Board shall 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.\30\
---------------------------------------------------------------------------

    \30\ 12 U.S.C. 1790d(d).

    In designing such a risk-based net worth standard, Congress did not 
restrict the types of instruments the Board may include in its 
calculation of risk-based net worth, except that such calculation must 
take account of material risks that the Net Worth Ratio alone may not 
protect against. The Board, as discussed in this preamble, is proposing 
this rule to grant authority to LICUs, Complex Credit Unions, and New 
Credit Unions to issue Subordinated Debt that will count as regulatory 
capital. Based on the requirements in this proposed rule, the Board 
believes Subordinated Debt will be an additional tool that accounts for 
material risks faced by credit unions against which the Net Worth Ratio 
alone may not protect.
    While the Board has broad discretion to create the risk-based net 
worth standard, it does not have the authority to amend the statutory 
definition of net worth. Currently, the statutory definition of net 
worth includes secondary capital issued by a LICU that is uninsured and 
subordinate to all claims against the LICU. As such, the Board notes 
two points with respect to Subordinated Debt and Net Worth. First, 
Subordinated Debt issued by a non-LICU will not be included in that 
credit union's Net Worth or Net Worth Ratio. Second, Subordinated Date 
issued by a LICU after the effective date of a final Subordinated Debt 
rule will be included in that credit union's Net Worth and Net Worth 
Ratio.

C. Credit Union Data \31\
---------------------------------------------------------------------------

    \31\ Data from NCUA Call Report.
---------------------------------------------------------------------------

    As of June 30, 2019, there are 2,618 LICUs. Under this proposed 
rule, LICUs would continue to be eligible to issue Subordinated Debt. 
This proposed rule would newly authorize certain non-LICUs to be 
eligible to issue Subordinated Debt. Specifically, Complex Credit 
Unions and New Credit Unions would also be eligible to issue 
Subordinated Debt. The NCUA estimates that this proposed rule would 
allow an additional 285 non-LICUs, with total assets of $730 billion, 
to issue Subordinated Debt.

[[Page 13987]]



----------------------------------------------------------------------------------------------------------------
                                                                                                    Average net
               Proposed eligible                  # of credit         Total industry assets         worth ratio
                                                    unions                                              (%)
----------------------------------------------------------------------------------------------------------------
LICU..........................................           2,618  $628 billion....................              13
LICU--New Credit Union........................              10  $24 million.....................              23
Non-LICU Complex Credit Union.................             281  $730 billion....................              11
Non-LICU New Credit Union.....................               4  $12 million.....................              44
----------------------------------------------------------------------------------------------------------------
                                              Proposed Not Eligible
----------------------------------------------------------------------------------------------------------------
Non-LICU Non-Complex Credit Union.............           2,409  $162 billion....................              14
----------------------------------------------------------------------------------------------------------------
Total Assets and average Net Worth Ratios rounded. Only one of the 281 Non-LICU Complex Credit Unions had a Net
  Worth Ratio category of ``Undercapitalized.''

D. Summary of the Proposed Rule

    This proposed rule reflects not only the responses to the ANPR 
discussed above, but also research by NCUA staff, consultation with 
outside legal counsel, and a comprehensive review of the various 
current NCUA regulations, including the Current Secondary Capital Rule. 
The Board believes this proposal represents a balance between 
flexibility for credit unions and its responsibility to safeguard the 
NCUSIF and protect the safety and soundness of credit unions.
    This proposed rule would permit LICUs, Complex Credit Unions, and 
New Credit Unions to issue Subordinated Debt Notes for purposes of 
regulatory capital treatment.\32\ It contains a series of requirements 
with respect to the Subordinated Debt and Subordinated Debt Note, 
disclosures and offering materials, repayment (including prepayment), 
and regulatory capital treatment. It also includes an application 
procedure for both the issuance and repayment of Subordinated Debt 
Notes.
---------------------------------------------------------------------------

    \32\ Regulatory capital treatment is based on the type of credit 
union issuing Subordinated Debt. As discussed throughout this 
preamble, a LICU may include Subordinated Debt in its RBC ratio and 
its Net Worth; a Complex Credit Union that is not a LICU may include 
Subordinated Debt in its RBC ratio; and a New Credit Union that is 
not a LICU may use Subordinated Debt to avail itself of various 
Prompt Corrective Actions.
---------------------------------------------------------------------------

    In addition, the Board is proposing requirements related to the 
various securities law issues applicable to the offer, issuance, and 
sale of Subordinated Debt Notes. See sections I. (E) and II. (C)(6) and 
(8) in this preamble for a detailed discussion of these requirements.
    This proposed rule also makes various additions and amendments to 
other parts and sections of the NCUA's regulations. Specifically, this 
proposed rule would include: A new section addressing limits on loans 
to other credit unions; a grandfathering of any secondary capital 
issued before the effective date of a final Subordinated Debt rule 
(Grandfathered Secondary Capital); an expansion of the borrowing rule 
to clarify that FCUs can borrow from any source; revisions to the RBC 
Rule and the payout priorities in an involuntary liquidation rule to 
account for Subordinated Debt and Grandfathered Secondary Capital; and 
cohering changes to part 741 to account for the other changes proposed 
in this rule that apply to FISCUs.
    All secondary capital issued after the effective date of a final 
Subordinated Debt rule would be subject to the requirements for 
Subordinated Debt. This change would not impact a LICU's ability to 
include such instruments in its Net Worth.
    As noted above, secondary capital issued before the effective date 
of a final Subordinated Debt rule would be considered Grandfathered 
Secondary Capital. This proposal would also preserve the regulatory 
capital treatment of Grandfathered Secondary Capital for 20 years after 
the effective date of a final Subordinated Debt rule. Grandfathered 
Secondary Capital, under this proposal, would generally remain subject 
to the requirements in current Sec. Sec.  701.34(b) through (d) 
(Current Secondary Capital Rule). For ease of reference, the 
requirements in the Current Secondary Capital Rule would be moved from 
their current location to a section in the new proposed subpart.
    Finally, the Board has made cohering changes to various section of 
the NCUA's regulations. Specifically, this proposed rule includes:
     A new Sec.  701.25, which places limits on FCU loans to 
other credit unions;
     Recodification of Sec.  701.34 (b), (c), and (d) as Sec.  
702.414 to address Grandfathered Secondary Capital;
     An update to Sec.  701.38 that clarifies that FCUs can 
borrow from any source;
     Changes and additions to the final RBC Rule to account for 
Subordinated Debt issued by Complex Credit Unions and New Credit 
Unions;
     An update to the involuntary liquidation payout priorities 
in Sec.  709.5 to account for Subordinated Debt; and
     Changes to part 741 to account for FISCUs investing in or 
issuing Subordinated Debt and the treatment of Grandfathered Secondary 
Capital.
    These additional regulatory changes were necessary to ensure that 
this proposal represents a comprehensive review and revision of the 
NCUA's regulations to appropriately account for Subordinated Debt.

E. Securities Law Issues

1. Subordinated Debt Notes Are Securities
    The NCUA continues to believe that any Subordinated Debt Note would 
be deemed to be a ``security'' for purposes of federal and state 
securities laws. Section 2(1) of the Securities Act broadly defines the 
term ``security'' to include, among other things, any:
     Stock;
     Note;
     Bond;
     Debenture;
     Evidence of indebtedness;
     Investment contract; or
     Interest or instrument commonly known as a security.\33\
---------------------------------------------------------------------------

    \33\ 15 U.S.C. 77b.
---------------------------------------------------------------------------

    The U.S. Supreme Court has repeatedly emphasized that the 
definition of ``security'' is quite broad. In a variety of cases 
analyzing the boundaries of the definition, the Supreme Court has 
stressed that the substantive characteristics of the instrument in 
question and the circumstances surrounding its issuance, rather than 
the mere name or title of the instrument, are of primary significance 
in determining whether the instrument, contract or arrangement in 
question will be deemed a ``security.'' While lower federal courts and 
some state courts have sometimes taken a more narrow view than the 
Supreme Court, common factors the courts generally consider in their 
analysis (particularly in the context of a debt instrument, contract or 
arrangement) include:
     The terms of the offer;

[[Page 13988]]

     In particular, the character of the economic inducement 
being offered to the potential counterparty, and whether the 
characteristics are consistent with a loan or typical extension of 
credit, or such that the counterparty would anticipate a potential 
return on investment in addition to repayment of the obligation and any 
stated interest;
     The plan of distribution;
     In particular, how the instrument is marketed and to whom 
it is marketed, and whether the potential counterparties are 
traditional lenders/providers of credit or investors who would 
anticipate a potential return on investment in addition to repayment of 
the obligation and any stated interest; and
     The ``family resemblance'' of the instrument to other 
instruments or arrangements that have been found to fall within the 
definition of a ``security,'' rather than having characteristics more 
akin to a loan or typical extension of credit.
    The NCUA's definition of a ``security'' is not as broad on its face 
as the Securities Act definition, but is generally consistent with the 
federal definition, relevant case law, and interpretations by the SEC. 
Section 703.2 of the NCUA's regulations defines the term to include a 
share, participation, or other interest in property or in an enterprise 
of the issuer or an obligation of the issuer that:
     Either is represented by an instrument issued in bearer or 
registered form or, if not represented by an instrument, is registered 
in books maintained to record transfers by or on behalf of the issuer;
     Is of a type commonly dealt in on securities exchanges or 
markets or, when represented by an instrument, is commonly recognized 
in any area in which it is issued or dealt in as a medium for 
investment; and
     Either is one of a class or series or by its terms is 
divisible into a class or series of shares, participations, interests, 
or obligations.\34\
---------------------------------------------------------------------------

    \34\ 12 CFR 703.2.
---------------------------------------------------------------------------

    For the foregoing reasons, the Board emphasizes that any issuance 
of a Subordinated Debt Note by an Issuing Credit Union must be done in 
accordance with applicable federal and state securities laws. Given the 
complexity of the securities law framework, any credit union 
contemplating an offer and sale of Subordinated Debt Notes needs to 
engage qualified legal counsel to ensure its compliance with securities 
laws before, during, and after any such offer and sale. The securities 
law information in this preamble does not constitute, and should not be 
construed or relied upon as, legal advice to any party.
2. Federal (SEC) Registration of Subordinated Debt Notes
    Section 5(a) of the Securities Act expresses a fundamental premise 
of the federal securities laws--that any offers and sales of securities 
must be registered with the SEC under the Securities Act, unless an 
exemption from registration is available.\35\ Sections 3 and 4 of the 
Securities Act outline a variety of exemptions from the registration 
requirements of Section 5(a).\36\ Based on either of two exemptions 
discussed below, Issuing Credit Unions will be able to offer and sell 
their Subordinated Debt Notes without registering the offering with the 
SEC under the Securities Act. Specifically, an Issuing Credit Union 
should be able to rely on either Section 3(a)(5) of the Securities Act 
or Rule 506 under Regulation D promulgated under Section 4(a)(2) of the 
Securities Act.
---------------------------------------------------------------------------

    \35\ 15 U.S.C. 77e.
    \36\ Id. 77c and 77d.
---------------------------------------------------------------------------

    Section 3(a) of the Securities Act provides a series of exemptions 
from Securities Act registration based on the character of the 
securities being offered, without regard to the nature of the offering 
or the nature of the purchasers in the offering. That is, the exemption 
applies to offerings:
     Conducted as public offerings or as private placements or 
a mix of the two;
     Made to investors that are institutions, individuals, or 
both; and
     Made to investors whether or not the investors meet one or 
more standards such as ``accredited investors'' or ``qualified 
institutional buyers,'' as each such term is defined in SEC 
regulations.
    Relevant to credit unions, section 3(a)(5) of the Securities Act, 
in relevant portion, exempts securities that are issued ``by a savings 
and loan association, building and loan association, cooperative bank, 
homestead association, or similar institution, which is supervised and 
examined by State or Federal authority having supervision over any such 
institution.'' The Board anticipates that nearly all Issuing Credit 
Unions would rely on this exemption from the registration requirements 
in the Securities Act.
    The Board notes that, in addition to the exemption in Section 
3(a)(5), Section 4(a) of the Securities Act provides certain exemptions 
based on the nature of the securities transaction and the persons 
involved in the transaction. In particular, Section 4(a)(2) provides 
certain exemptions (and authorizes the SEC to adopt related rules) 
based on the nature of the offering and the character of the offerees 
and purchasers of the securities, without regard to the character of 
the securities. That is, the exemptions apply to offerings of:
     Equity securities, including common and preferred stock 
and options, warrants, rights and other derivative securities;
     Debt securities, including bonds, notes and debentures; 
and
     Hybrid securities, including convertible securities.
    Rule 506 of Regulation D, which was adopted by the SEC under 
Section 4(a)(2) of the Securities Act, provides the specific 
requirements of one form of what is commonly referred to as the 
``private placement'' exemption. Under Regulation D, Rule 506, 
registration under the Securities Act is not required for offerings 
that are either (i) not made via any means of general solicitation or 
advertisement and where the number of purchasers who are not 
``accredited investors'' is limited to no more than 35, or (ii) made 
via general solicitation or advertisement but where all purchasers are 
``accredited investors''.
    Given the time and costs associated with offering and selling SEC-
registered securities, the Board recognizes that many Issuing Credit 
Unions may avail themselves of an exemption from the registration 
requirements of Section 5(a) of the Securities Act. Under this proposed 
rule, the Board would not mandate a specific exemption on which an 
Issuing Credit Union could or should rely. An Issuing Credit Union 
should consult with its securities counsel in determining the 
appropriate exemption upon which to rely.
    As discussed more fully in sections II. (C)(6) and (8) of this 
preamble, however, the Board is proposing to adopt a regulatory 
framework for the offer, issuance, and sale of Subordinated Debt Notes. 
This framework is independent of any available exemptions from the 
registration requirements of Section 5(a) of the Securities Act. It 
also generally aligns with certain disclosure requirements in the OCC's 
subordinated debt regulations. For example, the Board is proposing that 
every planned issuance of Subordinated Debt Notes would require an 
Issuing Credit Union to prepare and deliver an Offering Document to 
potential investors even though there are no SEC-mandated disclosure 
requirements for offerings of securities pursuant to the Section 
3(a)(5) exemption, and there generally are no SEC-mandated disclosure 
requirements

[[Page 13989]]

for offerings of securities pursuant to the Rule 506 private placement 
exemption as long as all purchasers in the offering are ``accredited 
investors.''
    The Board believes that adopting this regulatory framework would 
benefit both Issuing Credit Unions and investors, as the framework 
would provide potential investors information that is important to 
making a decision to invest in Subordinated Debt Notes and would 
clearly define the obligations of the related Issuing Credit Unions. 
These are important benefits that can reduce the possibility of 
investor confusion or misunderstandings and can assist an Issuing 
Credit Union in defending against claims by investors that they had a 
different understanding about the Issuing Credit Union, the terms of 
the offering, or the securities based on statements made by the Issuing 
Credit Union or its agents.
    Finally, the Board notes that the OCC also applies a regulatory 
framework to the offer, sale, and issuance of subordinated debt 
securities. The OCC's subordinated debt regulations require banks to 
comply with the OCC's registration requirements or otherwise qualify 
for an exemption under part 16 of those regulations. In particular, the 
OCC requires that any offers and sales of nonconvertible subordinated 
debt securities be made only to ``accredited investors'' and only after 
offering materials have been provided to potential investors.
3. State Registration of Subordinated Debt Notes
    Each state has its own securities laws and regulations and 
regulators charged with the duty of enforcing those laws and 
regulations. The states have general authority to regulate securities 
offerings and related matters occurring within or affecting their 
states. However, the federal securities laws include a number of 
provisions that substantially limit or completely preempt certain types 
of state regulation.
    Section 18 of the Securities Act \37\ provides that securities that 
meet the definition of ``covered securities'' are not subject to any 
form of substantive state securities regulation. States do retain 
authority to pursue fraud-based enforcement claims and the ability, 
under some circumstances, to require issuers to submit notice filings 
to the state, which allows the state to collect a filing fee.
---------------------------------------------------------------------------

    \37\ 15 U.S.C. 77r.
---------------------------------------------------------------------------

    Securities that fall within the Section 3(a)(5) exemption, as well 
as securities issued in an exempt offering under Regulation D, Rule 
506, both meet the definition of ``covered securities.'' As a result, 
in connection with any Subordinated Debt Notes offerings by Issuing 
Credit Unions that comply with the requirements of Section 3(a)(5) or 
Regulation D, Rule 506, state securities regulators will not be 
permitted to:
     Impose any registration, qualification or pre-clearance 
requirements on the issuer, the terms of the offering or the securities 
being offered;
     Assess the merits of the issuer, the terms of the offering 
or the securities being offered; or
     Require the delivery of any disclosure to potential 
purchasers of the securities in connection with the offering.
4. Disclosure Requirements and Anti-Fraud Provisions
    Although Section 3(a)(5) and Regulation D, Rule 506 provide 
exemptions from the registration requirements of the Securities Act, 
and reliance on those exemptions is not conditioned on the delivery of 
any required disclosure to potential investors (in the case of the 
traditional Rule 506 private placement under Rule 506(b), as long as 
all the investors are ``accredited''), the marketing and sale of the 
securities remain subject to the broad anti-fraud prohibitions of the 
Securities Exchange Act of 1934, as amended (Exchange Act).
    The Exchange Act's general anti-fraud prohibitions are embodied in 
Sec.  10(b), which generally prohibits the use of manipulative or 
deceptive devices or contrivances that violate SEC rules in connection 
with the purchase or sale of securities.\38\ Most of the litigation 
brought with respect to the rules promulgated under Sec.  10(b) has 
been brought under the general anti-fraud provision, Rule 10b-5, which 
provides as follows:
---------------------------------------------------------------------------

    \38\ 17 CFR 240.10b-5.

    It shall be unlawful for any person, directly or indirectly, by 
the use of any means or instrumentality of interstate commerce, or 
of the mails or of any facility of any national securities exchange,
    (a) to employ any device, scheme, or artifice to defraud,
    (b) to make any untrue statement of a material fact or to omit 
to state a material fact necessary in order to make the statements 
made, in the light of the circumstances under which they were made, 
not misleading, or
    (c) to engage in any act, practice, or course of business which 
operates or would operate as a fraud or deceit upon any person, in 
connection with the purchase or sale of any security.\39\
---------------------------------------------------------------------------

    \39\ Id.

    The primary intent of Rule 10b-5 (and, more broadly, the anti-fraud 
provisions of the Securities Act and the Exchange Act) is to prevent 
fraud, deceit, and incorrect or misleading statements or omissions in 
the offering, purchase and sale of securities. Given that intent, clear 
and complete disclosure is the critical factor in ensuring the anti-
fraud provisions of the Securities Act and Exchange Act are not 
breached in any offering of securities, regardless of whether the 
offering is registered with the SEC under the Securities Act or exempt 
from registration.
    In the absence of SEC-mandated disclosure delivery requirements, 
the practical concern for Issuing Credit Unions relying on either the 
Section 3(a)(5) or Regulation D, Rule 506 exemption is determining what 
type and amount of disclosure is appropriate to meet the anti-fraud 
standards. Relevant case law suggests that the type and amount of 
disclosure varies depending on a number of surrounding facts and 
circumstances, including:
     The nature of the potential investors (focusing on their 
level of sophistication);
     The nature of the security being offered (disclosure 
regarding the terms of debt instruments, preferred stock or more 
complex securities tends to be more detailed than disclosure regarding 
common stock);
     The nature of the business of the issuer and the industry 
in which the issuer operates (detailed disclosure may be more 
appropriate in the case of complex business structures and industries); 
and
     Market practices (focusing on the types of disclosure 
commonly provided by peer companies).
    There are a number of advantages in using a well-written disclosure 
document in connection with any offering of securities. First, using a 
disclosure document provides both the issuer and potential investors 
with a centralized resource clearly and consistently setting forth the 
terms of the offering and the securities being offered. Second, the 
disclosure document can be used as a reference to reduce the 
possibility of investor confusion or misunderstandings and can be used 
by the issuer as a defense against claims by investors that they had a 
different understanding about the issuer, the terms of the offering, or 
the securities based on statements made by the issuer or its agents. 
For these reasons, the Board is proposing that every planned issuance 
of Subordinated Debt Notes would require the preparation and delivery 
of a written

[[Page 13990]]

disclosure document, each of which must meet the standards of Rule 10b-
5.
    In brief, for any disclosure document to meet the standards of Rule 
10b-5, the disclosure included in the document (a) must not contain any 
untrue statement of a material fact and (b) must not omit to state a 
material fact the absence of which renders any disclosure already being 
made misleading. To accomplish those ends, the disclosure must be 
clear, accurate, and verifiable. In addition, the disclosure should 
cover topics that are typically important to investors in making an 
investment decision. Common topics in this category include:
     Material risks relating to the issuer and the industry in 
which the issuer operates;
     Material risks relating to the security being offered;
     The issuer's planned uses for the proceeds of the 
offering;
     Regulatory matters impacting the issuer and its 
operations;
     Tax issues associated with the security being offered; and
     How the securities are being offered and sold, including 
any conditions to be met in order to complete the offering.
    Sections 702.405, 702.406, and 702.408 of the proposed rule detail 
the Offering Document requirements for a planned issuance of 
Subordinated Debt Notes. These requirements are independent of and, in 
some cases, additive to any requirements imposed by applicable 
securities laws. The Board reiterates its expectation that credit 
unions contemplating an issuance of Subordinated Debt Notes retain 
professional advisors experienced in securities law disclosure matters 
to assist them in the preparation of related Offering Documents.
    Beyond the disclosure topics outlined above, a credit union 
considering issuing Subordinated Debt Notes may obtain guidance as to 
the type and amount of disclosure that is appropriate for its 
securities offerings from market participants. Sophisticated investors, 
rating agencies, underwriters, placement agents, and others often exert 
significant influence over disclosure practices in exempt securities 
offerings. In some settings, such as municipal bond offerings and 
offerings under Securities Act Rule 144A \40\ (made to highly 
sophisticated ``qualified institutional buyers''), it is not uncommon 
for disclosure documents to approach the level of detail that typically 
would be provided in a registration statement for an offering 
registered with the SEC under the Securities Act.
---------------------------------------------------------------------------

    \40\ 17 CFR 230.144A.
---------------------------------------------------------------------------

5. Ongoing Disclosure and Reporting to Investors; Investor Relations
    As discussed in this preamble, the SEC does not mandate any 
specific disclosure, either in form or substance, with respect to 
offers and sales of securities under the Section 3(a)(5) exemption or 
the Regulation D, Rule 506 exemption (if sales are made only to 
``accredited investors;'' sales to other investors do require the 
issuer to deliver specific types of disclosure). Similarly, SEC rules 
do not require companies that have relied on those exemptions to 
distribute or make available any disclosure after the offering has been 
completed or at any time in the future. As noted above, the preemptive 
effect of Section 18 of the Securities Act prohibits states from 
requiring any ongoing disclosure to investors following completion of 
an offering of ``covered securities.''
    It is often the case, however, that investors will require that the 
issuer provide some form of ongoing disclosure. Securities purchase 
agreements, or companion ``investor rights agreements,'' often specify 
the form and content of the ongoing disclosure and the frequency of 
delivery of the disclosure. Practice varies from a requirement to 
deliver quarterly and annual financial statements to disclosure in form 
and substance that mimics the disclosure an SEC-registered company 
would be required to provide to its investors. In addition, for 
issuances of debt securities under an indenture or an issuing and 
paying agent agreement, the terms of those documents commonly include 
requirements to provide certain information to the trustee or paying 
agent on an ongoing basis, and that information is either passed on 
directly to investors or is generally available to investors by request 
to the trustee or paying agent.
    Even in the absence of mandated or contractual requirements to 
provide disclosure, Issuing Credit Unions issuing Subordinated Debt 
Notes will likely face a variety of practical, disclosure-related 
issues. For example, investors frequently contact companies in which 
they hold an interest and ask for a variety of information about the 
company, its operations, its financial performance, and its prospects. 
While an Issuing Credit Union may prefer not to respond to those 
inquiries, from an investor relations standpoint, refusing to respond 
is not likely to be practical. Although this places certain burdens on 
an Issuing Credit Union's management, maintaining open lines of 
communication with investors can have significant practical benefits, 
including assessing possible interest in future offerings of 
Subordinated Debt Notes, negotiating possible buybacks of outstanding 
Subordinated Debt Notes, or negotiating amendments or modifications to 
obligations relating to any currently outstanding Subordinated Debt 
Notes.
    From a securities law standpoint, the type of information an 
Issuing Credit Union provides--and whether that information is provided 
only to the requesting investor, to all investors, or the marketplace--
generally raises a number of important issues. First, any information 
that is provided must be materially correct and complete, because the 
anti-fraud provisions of the securities laws could apply to those 
communications if an investor or potential investor relies on those 
communications in connection with the purchase or sale of a security. 
In addition, sharing material, non-public information with individual 
investors without making that information generally available to all 
investors could result in potential liability for the Issuing Credit 
Union.
    As a result, for securities law compliance and risk management 
purposes, under the proposed rule, Issuing Credit Unions issuing 
Subordinated Debt Notes must adopt policies and procedures covering 
matters such as:
     Who is responsible and authorized to speak on behalf of 
the Issuing Credit Union;
     What information will and will not be provided to 
requesting investors;
     Whether that information will be made available to other 
investors; and
     How that information will be made available to other 
investors.
    Although an Issuing Credit Union may not need to have full-time 
personnel dedicated to an investor relations function, some personnel 
will need to take on responsibility for investor relations, and will 
need to be prepared to accurately answer questions and respond to 
appropriate requests. In addition, the responsible personnel will need 
to be trained regarding appropriate boundaries for responses to and 
discussions with investors. As noted above, there are a variety of 
securities law issues relating to communications with investors. As a 
result, for securities law compliance and risk management purposes, 
Issuing Credit Unions issuing Subordinated Debt Notes will need to 
adopt certain policies and procedures covering interactions with 
investors.
    Finally, similar to commercial loans, lines of credit, and other 
types of debt financing, the debt security instrument

[[Page 13991]]

itself and/or the documents relating to debt securities issuances (for 
example, note purchase agreement, indenture, issuing and paying agent 
agreement) customarily require the issuer of debt securities to report 
its compliance (or non-compliance) with any covenants included in the 
terms of the debt securities. The frequency of reporting and the 
contents of the report can vary from situation to situation, based both 
on the demands of the investors and the term structure of the 
particular debt security. These obligations will make it necessary for 
the Issuing Credit Union to implement compliance and reporting controls 
and procedures to ensure compliance with the terms of the Subordinated 
Debt Notes generally, and for compliance with any applicable reporting 
requirements.
6. Potential Broker-Dealer Registration Issues
    Marketing activities by an Issuing Credit Union and its employees 
in connection with any offerings of Subordinated Debt Notes could 
require the employees to register as broker-dealers because the SEC 
interprets the definition of ``broker'' broadly to cover persons who 
play almost any active role in offers and sales of securities, 
including, under certain circumstances, employees of the issuer of the 
securities or its affiliates.
    There are exemptions available to both an Issuing Credit Union 
itself and its employees that can excuse them from the broker-dealer 
registration requirements. Credit unions that issue securities 
typically cannot be ``brokers'' of their own securities because they 
are not involved in the purchase or sale of securities for the account 
of other persons. Similarly, credit unions that issue securities 
typically cannot be ``dealers,'' because their normal business does not 
involve buying and selling their own securities for their own account. 
Credit union employees that participate in offering-related activities 
usually will be able to rely on the exemption provided by Rule 3a4-1 
under the Exchange Act.\41\ Conditions to relying on this exemption 
include the employee:
---------------------------------------------------------------------------

    \41\ 17 CFR 240.3a4-1.
---------------------------------------------------------------------------

     Not receiving commissions or other compensation relating 
to the offering;
     Not being disqualified under SEC rules due to past legal 
or regulatory issues;
     Not being associated with a broker or dealer during the 
offering; and
     Either limiting his or her offering-related activities, 
limiting the types of potential investors he or she interacts with, or 
limiting the number of offerings he or she participates in.
    As a result, for securities law compliance and risk management 
purposes, discussed further in section II(C)(8) of this preamble, 
Issuing Credit Unions must adopt certain policies and procedures 
covering compliance with broker-dealer requirements.
7. Director and Officer (``D&O'') Liability Insurance Coverage for 
Issuing Credit Unions
    Under the proposed rule, Issuing Credit Unions considering issuing 
Subordinated Debt Notes will need to evaluate the potential impact of 
those activities on their D&O coverage. The scope of D&O liability 
coverage, amount of premiums, and terms relating to retention 
(deductibles and self-insurance) are usually different for public 
companies versus private companies. While Issuing Credit Unions will 
not be ``public'' in the same way SEC-registered entities with 
securities traded on an exchange are, entities that begin issuing 
securities to more than a limited number of ``outside'' investors must 
often make adjustments to their existing D&O policies.
    For the reasons identified in subsections I. (E)(5), (6), and (7) 
above, the Board is proposing to require a credit union to include 
draft written policies on these issues as part of its application to 
issue Subordinated Debt Notes. See section II. (C)(8) of this preamble 
for a more detailed discussion of the application requirements.

II. Proposed Changes

    The following is a section-by-section analysis of the proposed 
changes. The Board invites comment on each proposed change and, where 
appropriate, has posed questions to solicit specific feedback on 
discrete aspects of the proposed rule. The Board notes that all 
references in this preamble to part 702 of the NCUA's regulations, 
including any subsection thereof, refer to the version of part 702 that 
gives effect to the final RBC Rule and which will become effective on 
January 1, 2022.

A. Part 701--Organization and Operations of Federal Credit Unions

1. Sec.  701.25 Loans to Credit Unions
    The Board proposes to add a new Sec.  701.25 for FCUs making loans 
to other credit unions. This section will only apply to natural person 
credit unions; corporate credit union lending is subject to Sec.  
704.7.\42\ While this section applies to FCUs, FISCUs will be subject 
to these requirements and limitation through the proposed Sec.  741.227 
as discussed in section II. (E)(3) of this preamble. Loans from FCUs to 
other credit unions are not currently addressed in the NCUA's 
regulations. The Board believes adding a new section for loans to 
credit unions will establish policy standards and limits to support 
safety and soundness and protect the NCUSIF.
---------------------------------------------------------------------------

    \42\ The NCUA is evaluating a potential proposed rule to clarify 
the extent to which corporate credit unions could purchase 
Subordinated Debt issued by natural person credit unions.
---------------------------------------------------------------------------

    The loans to other credit unions section includes the following FCU 
activities: \43\
---------------------------------------------------------------------------

    \43\ These requirements do not apply to natural person credit 
union investments in contributed capital of corporate credit unions, 
which is limited by 12 CFR 703.14(b).
---------------------------------------------------------------------------

     Loans not subordinate to the NCUSIF or to a private 
insurer (for privately insured credit unions);
     Subordinated Debt;
     Grandfathered Secondary Capital; and
     Loans or obligations subordinate to a private insurer (for 
privately insured credit unions).
    Specifically, the proposed Sec.  701.25 will establish:
     Limits on loans an FCU makes to other credit unions;
     Approval and policy standards for an FCU to make loans to 
other credit unions; and
     Requirements and limits on an FCU making investments in 
Subordinated Debt.
    The Board proposes Sec.  701.25(a) to establish aggregate and 
single borrower limits for loans, including investments in Subordinated 
Debt, an FCU can make to other credit unions. The proposed aggregate 
limit is the same as the limit in the FCU Act on an FCU's authority to 
invest its funds in loans to other credit unions.\44\ The single 
borrower limit is consistent with the single borrower limit in Sec.  
723.4(c) for commercial loans.
---------------------------------------------------------------------------

    \44\ 12 U.S.C. 1757(7)(C).
---------------------------------------------------------------------------

    The Board notes that the FCU Act imposes an aggregate limit on the 
amount of loans an FCU may make to other credit unions. Specifically, 
the FCU Act authorizes an FCU to make loans to other credit unions 
that, in the aggregate, cannot exceed 25 percent of the FCU's paid-in 
and unimpaired capital and surplus.\45\ Paid-in and unimpaired capital 
and surplus is defined in NCUA regulations as:
---------------------------------------------------------------------------

    \45\ Id.

    [S]hares plus post-closing, undivided earnings. This does not 
include regular reserves or special reserves required by law, 
regulation or special agreement between the

[[Page 13992]]

credit union and its regulator or share insurer.\46\
---------------------------------------------------------------------------

    \46\ 12 CFR part 700.

    The proposed aggregate limit in this section, therefore, is not a 
substantive change, but a regulatory codification of the limit imposed 
by the FCU Act. The Board believes the proposed rule would clarify loan 
limits in this section and minimize the need for readers to reference 
the FCU Act when determining aggregate limits for loans to credit 
unions.
    The Board is proposing a new single borrower limit for FCUs making 
loans to other credit unions that would be the greater of 15 percent of 
the FCU's Net Worth or $100,000, plus an additional 10 percent of the 
FCU's Net Worth if that amount is fully secured at all times with a 
perfected security interest by readily marketable collateral as defined 
in Sec.  723.2. There is no current single credit union borrower limit 
in the NCUA's regulations. The Board notes that the proposed single 
borrower limit is consistent with the single borrower limit in the 
NCUA's commercial lending and MBL rule.\47\ Because credit unions share 
many similarities with traditional corporate borrowers, the Board 
believes that basing the proposed single borrower limit in this rule on 
the commercial and MBL rule limit is appropriate. Furthermore, the 15 
percent of Net Worth single borrower limit for FCUs making loans to 
other credit unions would generally limit catastrophic losses to an FCU 
if the borrower defaults. The proposed 15 percent of Net Worth 
threshold is also consistent with the longstanding FDIC single-obligor 
limit.\48\ The Board would like to note that it is also considering a 
similar single obligor limit for uninsured deposits in future 
rulemakings.
---------------------------------------------------------------------------

    \47\ Id. 723.4(c).
    \48\ Id. 32.3(a).
---------------------------------------------------------------------------

    The Board proposes Sec.  701.25(b) to establish minimum approval 
and written policy standards for an FCU that is making loans to credit 
unions. The proposal would require that an FCU's board of directors 
approve all loans to other credit unions. The Board notes that the FCU 
Act already requires an FCU's board of directors to approve all loans 
to credit unions and, as such, this proposed requirement is not 
new.\49\
---------------------------------------------------------------------------

    \49\ 12 U.S.C. 1757(5)(C).
---------------------------------------------------------------------------

    The proposed rule also requires an FCU lending to another credit 
union to establish written policies that address how it would manage 
the risk of its loans to credit unions and the dollar limits, both 
aggregate and single borrower, on the amount of the loans. This would 
be a new requirement for FCUs making loans to other credit unions.
    The Board is proposing to add this requirement because it believes 
that making loans to credit unions should have similar policy 
requirements as other loans and investments. The Board also believes 
written policies can help ensure FCU lending to other credit unions 
will operate in a safe and sound manner. Policies create a framework 
for a credit union to consistently perform credit analysis and creates 
limits that are consistent with the credit union's risk tolerance and 
regulatory limits to help ensure the credit union is operating in a 
safe and sound manner.
    The Board believes that FCUs that make loans to other natural 
person credit unions may have traditionally included policies for this 
activity in their investment or loan policies. The Board believes 
including policies for loans to other credit unions in the investment 
policy or a loan policy is sufficient for compliance with this 
requirement, since the Board's concern is with the existence of 
sufficient policies, not where they reside.
    The Board is proposing Sec.  701.25(c) to establish minimum 
requirements and limits for an FCU that invests in Subordinated Debt, 
Grandfathered Secondary Capital or in loans and obligations issued by 
privately insured credit unions that are subordinate to a private 
insurer (PICU Subordinated Debt). The minimum requirements apply to 
both direct and indirect investments.
    A direct investment would have the issuer of the Subordinated Debt 
as the borrower on the investing credit union's balance sheet. For 
example, credit union A purchases Subordinated Debt from credit union 
B. This results in credit union A having risk exposure (credit risk) to 
credit union B through its holding of the Subordinated Debt note.
    An indirect investment is one in which the issuer of the 
Subordinated Debt is not identifiable on the investing credit union's 
balance sheet. An example of an indirect investment would be the 
purchase of shares in a mutual fund. For example, XYZ mutual fund 
purchases Subordinated Debt issued by credit union B. If credit union A 
purchases shares in this mutual fund, then credit union A would have an 
indirect investment in credit union B's Subordinated Debt, because only 
XYZ mutual fund would be recorded on credit union A's balance sheet.
    The Board is proposing that an FCU must meet three criteria to make 
direct or indirect investments in Subordinated Debt, Grandfathered 
Secondary Capital or PICU Subordinated Debt. Specifically, the 
investing FCU:
     Has, at the time of the investment, a capital 
classification of ``Well Capitalized;''
     Does not have any outstanding Subordinated Debt or 
Grandfathered Secondary Capital with respect to which it was the 
Issuing Credit Union; and
     Is not eligible to issue Subordinated Debt or 
Grandfathered Secondary Capital pursuant to an unexpired approval from 
the NCUA.
    The Board is proposing the ``Well Capitalized'' capital 
classification requirement because it believes that only ``Well 
Capitalized'' FCUs should invest in obligations of natural person 
credit unions that are subordinate to the NCUSIF or to a private 
insurer. Because any of the aforementioned subordinated obligations are 
in a first loss position, even before the NCUSIF or a private insurer, 
an involuntary liquidation of the related Issuing Credit Union or 
significant write-downs of the subordinated obligations would 
potentially mean large, and likely total, losses for the holders of 
those subordinated obligations. Therefore, the Board believes it would 
not be safe and sound to allow FCUs that are classified less than 
``Well Capitalized'' to invest in Subordinated Debt, Grandfathered 
Secondary Capital or PICU Subordinated Debt.
    Conversely, the Board believes that a ``Well Capitalized'' FCU 
generally has sufficient Net Worth to invest in Subordinated Debt, 
Grandfathered Secondary Capital or PICU Subordinated Debt, provided 
that the risk is limited as discussed further in this section of the 
preamble.
    The Board is also proposing that an FCU investing in Subordinated 
Debt, Grandfathered Secondary Capital, or PICU Subordinated Debt must 
not be an Issuing Credit Union of Subordinated Debt or Grandfathered 
Secondary Capital, or currently have approval from the NCUA to issue 
Subordinated Debt or Grandfathered Secondary Capital. The Board notes 
that an FCU would not be considered an Issuing Credit Union if it 
acquired Subordinated Debt or Grandfathered Secondary Capital issuance 
through a merger, as discussed further in section II. (C)(3) of this 
preamble. The Board believes that an Issuing Credit Union should not 
provide Regulatory Capital to other natural person credit unions. 
Furthermore, the potential to transmit losses between multiple Issuing 
Credit Unions that have both issued Subordinated Debt and invested in 
Subordinated Debt (loss transmission) could increase the risk of credit 
union failure and increase the

[[Page 13993]]

risk to the NCUSIF. For example, if an Issuing Credit Union both 
purchased and issued Subordinated Debt, losses from the Subordinated 
Debt purchased by the Issuing Credit Union could create losses on the 
Subordinated Debt issued by the Issuing Credit Union, thereby creating 
a potential loss transmission from the purchased Subordinated Debt to 
the issued Subordinated Debt. The Board is concerned that, if it does 
not restrict covered credit unions in this way, a loss incurred by an 
Issuing Credit Union would simultaneously transmit to an investing 
credit union (the credit union that is the purchaser of the issuer's 
Subordinated Debt Note). This inter credit union exposure results in an 
imprudent transmission of losses because a single loss can impact both 
institutions rather than the issuer alone. The Board believes that 
failing to prohibit inter credit union subordinated debt transactions 
will create an unsafe and unsound condition for the NCUSIF.
    Beyond loss transmission, if the Board were to allow Issuing Credit 
Unions to invest in Subordinated Debt, the level of Net Worth in the 
credit union system could appear to increase, while the actual loss-
absorbing capacity of the system would remain unchanged. For example, 
two LICUs each have $10 million in Net Worth, so the total Net Worth 
between the two credit unions is $20 million. If each credit union 
issued $1 million in Subordinated Debt and then sold it to the other, 
the Net Worth between the two credit unions would be $22 million. This 
would result in an artificial $2 million increase (ten percent) in Net 
Worth for the credit union system, and would increase potential loss 
transmission between the two credit unions as explained in the prior 
paragraph. The Board notes the increased total Net Worth in the system 
described above would also happen if only one credit union issued the 
Subordinated Debt and the other credit union purchased it, also 
artificially increasing the Net Worth in the system.
    The Board is proposing limits on the amount of investment an FCU 
can make in Subordinated Debt, Grandfathered Secondary Capital, or PICU 
Subordinated Debt. The proposed limit is only on an aggregate basis, 
because single borrower limits have been addressed in the proposed 
general single credit union borrower limit. The Board is proposing an 
aggregate limit of the lesser of 25 percent of Net Worth and any amount 
of Net Worth in excess of 7 percent of total assets.
    The Board believes a cap of 25 percent of Net Worth is appropriate 
given the higher relative risk of loss with Subordinated Debt, 
Grandfathered Secondary Capital, or PICU Subordinated Debt. This risk 
comes from the Subordinated Debt, Grandfathered Secondary Capital, or 
PICU Subordinated Debt being in a position to incur losses before the 
NCUSIF or a private insurer. In other words, the Subordinated Debt and 
Grandfathered Secondary Capital will take losses after retained 
earnings before the NCUSIF. The loss profile of Subordinated Debt and 
Grandfathered Secondary Capital would also apply to PICU Subordinated 
Debt.
    Past loss experience in credit union involuntary liquidations shows 
that it is not unusual for the NCUSIF to take losses in a liquidation. 
Any loss to the NCUSIF in a liquidation would result in a total loss of 
the Subordinated Debt and Grandfathered Secondary Capital. The risk for 
PICU Subordinated Debt would be similar to Subordinated Debt and 
Grandfathered Secondary Capital if a private insurer takes losses.
    The Board believes the severity of the potential loss warrants an 
aggregate limit on Subordinated Debt, Grandfathered Secondary Capital, 
and PICU Subordinated Debt of 25 percent of Net Worth. The Board also 
contemplated aggregate limits of 15 percent and 40 percent of Net 
Worth, but believes an aggregate limit of 25 percent of Net Worth 
strikes an appropriate balance between granting FCUs flexibility to 
invest, and the risks associated with Subordinated Debt, Grandfathered 
Secondary Capital, or PICU Subordinated Debt. The Board requests 
specific comment on whether the NCUA should consider a different 
aggregate limit, such as 15 percent of an FCU's Net Worth or 40 percent 
of Net Worth. The Board notes that this limit does not apply to natural 
person credit union investments in contributed capital of corporate 
credit unions, which is limited by Sec.  703.14(b).
    The Board is also proposing another measure of the aggregate limit, 
which could further restrict the amount of an FCU's investments in 
Subordinated Debt, Grandfathered Secondary Capital, and PICU 
Subordinated Debt. This limit is the amount of Net Worth in excess of 
seven percent of total assets. An FCU would calculate the amount of Net 
Worth in excess of 7 percent and would use this measure as the 
aggregate limit if it is an amount less than 25 percent of its Net 
Worth.
    The Board is proposing the aforementioned limit to ensure that 
total potential losses from Subordinated Debt, Grandfathered Secondary 
Capital, or PICU Subordinated Debt would not lower an FCU's Net Worth 
to below seven percent, which is ``Well Capitalized'' when measuring 
using the Net Worth Ratio. As mentioned earlier, the Board believes 
this is an important measure to promote safety and soundness when an 
FCU invests in Subordinated Debt, Grandfathered Secondary Capital, or 
PICU Subordinated Debt.
    Examples of the aggregate limit calculations are provided below.

     ABC FCU Has $100 Million in Net Worth and $1 Billion in Assets
------------------------------------------------------------------------
          Limit type               Limit calculation    Total  (million)
------------------------------------------------------------------------
Percent of Net Worth Limit....  25 percent of $100      $25.
                                 million (Net Worth).
Amount of Net Worth in excess   $100 million (Net       30.
 of 7%.                          Worth) minus [$1
                                 billion (current
                                 assets) times 7%].
Maximum amount of Subordinated  Lesser of the           25.
 Debt, Grandfathered Secondary   calculations.
 Capital, and PICU
 Subordinated Debt ABC FCU
 invest in.
------------------------------------------------------------------------

    In the above example, the percentage of Net Worth limit is the 
lesser of the measures and therefore is the binding constraint.

[[Page 13994]]



      LMN FCU Has $80 Million in Net Worth and $1 Billion in Assets
------------------------------------------------------------------------
          Limit type               Limit calculation    Total  (million)
------------------------------------------------------------------------
Percent of Net Worth Limit....  25 percent of $80       $20.
                                 million (Net Worth).
Amount of Net Worth in excess   $80 million (Net        10.
 of 7%.                          Worth) minus [$1
                                 billion (current
                                 assets) times 7%].
Maximum amount of Subordinated  Lesser of the           10.
 Debt, Grandfathered Secondary   calculations.
 Capital, and PICU
 Subordinated Debt ABC FCU
 invest in.
------------------------------------------------------------------------

    In the above example, the amount of Net Worth in excess of seven 
percent limit is the lesser of the measures and therefore is the 
binding constraint.
    The Board is proposing a paragraph that would prescribe how the 
components of the aggregate limit are calculated. The limit is based on 
an FCU's aggregate outstanding:
     Investment in Subordinated Debt;
     Investment in Grandfathered Secondary Capital;
     Investment in PICU Subordinated Debt; and
     Loans or portion of loans made by the credit union that 
are secured by any Subordinated Debt, Grandfathered Secondary Capital, 
or PICU Subordinated Debt.
    The Board is proposing this paragraph to ensure FCUs are more 
readily aware of the components that are subject to the aggregate limit 
in this section. In proposing to include loans, or portions of loans, 
secured by the first three components, the Board is including an 
exposure that could otherwise be unaccounted for by the lending credit 
union if the secured borrower defaults.
    The Board is proposing a paragraph for the calculation of an FCU's 
indirect investment in Subordinated Debt, Grandfathered Secondary 
Capital, or PICU Subordinated Debt. The Board is proposing this 
paragraph to ensure FCUs consistently measure indirect investment 
exposure. The credit union would be required to determine the 
percentage of a mutual fund's assets invested in such instruments and 
multiple that percentage by its own pro rata investment. This will 
ensure the credit union has an accurate evaluation of its indirect 
exposure to Subordinated Debt, Grandfathered Secondary Capital and PICU 
Subordinated Debt. In turn, this evaluation can be used to monitor 
compliance with the aggregate regulatory limit on such instruments. 
This calculation is similar to the full look-through approach for 
investment funds in Appendix A of the RBC Rule. An example of the 
calculation follows:
    ABC Fund is a $100 million fund and has $5 million of its holdings 
in Grandfathered Secondary Capital. XYZ FCU owns $10 million of ABC 
Fund.
     XYZ FCU's proportional ownership of the ABC Fund: $10 
million divided by $100 million equals ten percent of the fund.
     Indirect exposure: $5 million (Grandfathered Secondary 
Capital) in ABC Fund times ten percent equals $500,000.
    In the example above, XYZ FCU's indirect exposure, for aggregate 
limit calculation purposes, would be $500,000. This is the amount that 
would need to be included in the calculation of the aggregate limit.
2. Sec.  701.34 Designation of Low-Income Status
    The Current Secondary Capital Rule contains information on how a 
credit union can obtain a low-income designation and the procedures and 
regulations related to secondary capital. As discussed in section II. 
(C)(1) of this preamble, under this proposed rule, secondary capital 
and Subordinated Debt would be subject to nearly identical rules. As 
such, for ease of use, the Board is proposing to locate all regulations 
related to Subordinated Debt in proposed subpart D of part 702.
    To accomplish this, the Board is proposing to delete subsections 
(b) through (d) and the appendix to the Current Secondary Capital Rule. 
(Subsection (a) of the Current Secondary Capital Rule would remain in 
place.) As discussed below, the Board is proposing to relocate 
subsections (b)-(d) to Sec.  702.414 of proposed subpart D to part 702. 
The Board believes having one part that addresses capital and capital 
treatment will help users more easily review all related requirements, 
including Grandfathered Secondary Capital and Subordinated Debt 
provisions.
3. Sec.  701.38 Borrowed Funds
    The Board is proposing to revise an FCU's borrowing authority under 
Sec.  701.38 to permit borrowing from any source. This is a change from 
the current rule, which only addresses an FCU's borrowings from 
``natural persons.'' The Board is proposing to revise the current rule 
to clarify that an FCU may borrow from any source. This change is 
consistent with section 1757(9) of the FCU Act and, in the Board's 
view, supports an FCU's legal authority to issue Subordinated Debt 
Notes.\50\
---------------------------------------------------------------------------

    \50\ Id. 1757(9) (FCUs are subject to a maximum borrowing 
authority ``in an aggregate amount not exceeding, except as 
authorized by the Board in carrying out the provisions of subchapter 
III, 50 per centum of its paid-in and unimpaired capital and 
surplus: Provided, [t]hat any Federal credit union may discount with 
or sell to any Federal intermediate credit bank any eligible 
obligations up to the'').
---------------------------------------------------------------------------

    The Board also is proposing other clarifying revisions to Sec.  
701.38(a). Under the proposed rule, an FCU's borrowings would be 
evidenced by a ``written contract,'' as opposed to the more narrow 
language of current Sec.  701.38(a), which provides that a borrowing 
must be evidenced by ``a promissory note.'' The Board recognizes that, 
under current practice, borrowing contracts may take forms other than 
just a promissory note. The proposal still cites a promissory note as a 
primary example, but extends greater flexibility than current Sec.  
701.38(a) for what is an acceptable form of evidencing the borrowing.
    The Board is also proposing to revise Sec.  701.38(a)(2) to 
introduce the term ``funds'' to modify the description of a borrowing 
transaction to make it clearer to investors that such transactions are 
not shares of the Issuing Credit Union and, therefore, are not insured 
by the NCUA. The Board regards both of these changes as important 
clarifications that will benefit credit unions and investors.
    Lastly, the Board is proposing to revise Sec.  701.38(b) to 
reference the limitations on an FCU's maximum borrowing authority by 
citing section 1757(9) of the FCU Act and removing the current 
reference to Sec.  741.2 of the NCUA's regulations. However, under 
Sec.  741.2, a FISCU would be subject to the same borrowing limits as 
an FCU under Sec.  701.38. This technical refinement supports greater 
clarity in the regulation but does not change the amount of the 
limitation that currently applies to FCUs and FISCUs.

[[Page 13995]]

B. Part 702--Capital Adequacy

1. Sec.  702.2 Definitions
    The Board is proposing to add an introductory statement to the 
definitions section to indicate that all accounting terms not otherwise 
defined in the section will have the same meaning as in U.S. GAAP. The 
Board is adding this statement to clarify that, if an accounting term 
is not defined in the rule text, the reader should use any applicable 
definition provided under U.S. GAAP for that term. This clarifying 
statement supports the current practice of using U.S. GAAP definitions 
when an accounting term is undefined by the FCU Act or the NCUA's 
regulations.
    The Board is amending the definition of Net Worth. In the first 
sentence of the Net Worth definition, the Board is clarifying that the 
definition of Net Worth in this section is for natural person credit 
unions and is specifying the measurement of Net Worth is as of the date 
of determination. The definition in the current rule begins with ``Net 
worth means,'' and does not explicitly state that the Net Worth 
definition is for natural person credit unions. The Board is adding 
this phrasing to avoid the possibility of confusion that the definition 
of Net Worth could apply to corporate credit unions. The Board is also 
adding the new qualifier, ``as of any date of determination,'' to 
clarify that there is an ``as of'' date, which is addressed below.
    For clarification, the Board is proposing a technical, non-
substantive refinement to the definition of Net Worth in paragraph (1) 
of current Sec.  702.2 by adding ``most recent'' as a reference point 
for the date of determination. Current Sec.  702.2 does not explicitly 
state that Net Worth is measured as of the most recent quarter end, but 
the Board believes that this reflects the common understanding within 
the credit union industry.
    The Board is also proposing to change the wording regarding how 
U.S. GAAP is referenced when determining Net Worth from ``as determined 
under U.S. GAAP'' to ``as determined in accordance with U.S. GAAP.'' 
The Board believes that this non-substantive revision is more accurate 
than current Sec.  702.2.
    The Board is proposing to amend paragraph (2) in the Net Worth 
definition to include Subordinated Debt and to replace the term 
secondary capital accounts with Grandfathered Secondary Capital. It 
notes that these cohering changes are necessary based on other 
provisions of the proposed rule discussed throughout this preamble.
    The Board is also proposing an addition to paragraph (2) that 
clarifies the amounts of Subordinated Debt and Grandfathered Secondary 
Capital that count towards Regulatory Capital.\51\ In the current rule, 
the reader would need to know that secondary capital accounts have a 
schedule to reduce the recognition of Net Worth once they have a 
remaining maturity of five years or less. The Board believes that 
referencing the recognition of Net Worth in Sec. Sec.  702.407 and 
702.414 in the proposal would add clarity in calculating New Worth for 
LICUs that have issued Subordinated Debt or Grandfathered Secondary 
Capital. The Board is also proposing some formatting changes in 
paragraph (2) by adding two subparagraphs, (A) and (B), with text 
contained in a long paragraph in the current rule. The wording is 
unchanged except for ``National Credit Union Share Insurance Fund'' 
being spelled out. The Board is proposing this change to add ease for 
the reader.
---------------------------------------------------------------------------

    \51\ Regulatory Capital is capital, both Net Worth and/or the 
RBC numerator, as defined by NCUA. See section II(C)(2) of the 
preamble for more details.
---------------------------------------------------------------------------

    The Board is also adding new definitions for Grandfathered 
Secondary Capital and Subordinated Debt, as current Sec.  702.2 does 
not have these definitions. The definition of Grandfathered Secondary 
Capital is ``any subordinated debt issued in accordance with current 
Sec.  701.34 (recodified as Sec.  702.414 of subpart D of this part) 
or, in the case of a FISCU, with Sec.  741.204(c) before the effective 
date of a final Subordinated Debt regulation. The Board is proposing to 
add the definition of Grandfathered Secondary Capital as a way to refer 
to secondary capital issued under the current rule, as discussed in 
more detail in section II. (C)(14) of this preamble.
    Finally, the Board is also proposing to add a definition of 
Subordinated Debt, which will be the same as the meaning in the 
proposed subpart D. The definition of Subordinated Debt is ``an Issuing 
Credit Union's borrowing that meets the requirements of this subpart, 
including all obligations and contracts related to such borrowing.'' 
This definition is discussed in more detail in section II. (C)(2) of 
this preamble. The Board is adding a definition of Subordinated Debt so 
a reader of the proposed rule text outside of subpart D knows where to 
find the definition.
2. Sec.  702.104 Risk-Based Capital Ratio
    The Board is proposing to amend current Sec.  702.104(b)(1)(vii) to 
include both Subordinated Debt and Grandfathered Secondary Capital in 
the RBC Ratio.\52\ Current Sec.  702.104(b)(1)(vii) allows secondary 
capital accounts to be included in the RBC numerator. This change is 
necessary to properly give effect to Subordinated Debt and 
Grandfathered Secondary Capital in the RBC Ratio.
---------------------------------------------------------------------------

    \52\ The RBC Ratio is calculated using a numerator and a 
denominator. The numerator includes (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 U.S. 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) and deductions for (i) NCUSIF Capitalization Deposit; 
(ii) Goodwill; (iii) Other intangible assets; and (iv) Identified 
losses not reflected in the RBC Ratio numerator. The denominator 
includes risk-weighted assets.
---------------------------------------------------------------------------

    The Board is also clarifying that the amount of Subordinated Debt 
and Grandfathered Secondary Capital that is treated as Regulatory 
Capital, as discussed in section II. (C)(7) of this preamble, would be 
included as part of the RBC Ratio. Currently, the definition does not 
establish how secondary capital would be included in the RBC Ratio, but 
the Board intended that only the non-discounted portion of secondary 
capital would count in the RBC Ratio. Therefore, in this proposal, the 
Board is clarifying that only the portion of Grandfathered Secondary 
Capital and Subordinated Debt that counts as Regulatory Capital would 
be included in the RBC Ratio.
    Currently, the RBC Rule does not specifically include secondary 
capital or obligations issued by privately insured credit unions that 
are subordinate to a private insurer in any risk weighting category. As 
such, secondary capital and obligations issued by privately insured 
credit unions that are subordinate to a private insurer would be risk 
weighted at 100 percent under the ``(a)ll other assets listed on the 
statement of financial condition not specifically assigned a different 
risk weight under this subpart'' category.\53\
---------------------------------------------------------------------------

    \53\ 12 CFR 702.104(c)(2)(v)(C).
---------------------------------------------------------------------------

    The Board is proposing to add a new Sec.  702.104(c)(2)(v)(B)(9) 
that would assign a 100 percent risk weight to the exposure amount of 
natural person credit union Subordinated Debt, Grandfathered Secondary 
Capital, and loans or obligations issued by privately insured credit 
unions that are subordinate to a private insurer. The Board notes that 
this proposed change will not result in a different risk weighting than 
the RBC Rule requires. Given that Grandfathered Secondary Capital, 
Subordinated Debt, and obligations issued by privately insured credit 
unions that are subordinate to a

[[Page 13996]]

private insurer are similar instruments that share similar risks, the 
Board believes it is appropriate to include them in the same risk 
weighting category.
3. Sec.  702.109 Prompt Corrective Action for ``Critically 
Undercapitalized'' Credit Unions
    Section 216(a)(2) of the FCU Act directs the NCUA to take Prompt 
Corrective Action (PCA) to resolve the problems of credit unions.\54\ 
The FCU Act indexes various corrective actions to the following five 
net worth categories:
---------------------------------------------------------------------------

    \54\ 12 U.S.C. 1790d(a)(2).
---------------------------------------------------------------------------

     Well Capitalized;
     Adequately Capitalized;
     Undercapitalized;
     Significantly Undercapitalized; and
     Critically Undercapitalized.\55\
---------------------------------------------------------------------------

    \55\ Id. 1790d(c).
---------------------------------------------------------------------------

    Credit unions that fail to meet capital measures are subject to 
increasingly strict limits on their activities. The mandatory and 
discretionary supervisory actions included in the current RBC Rule aid 
in accomplishing PCA's purpose and provide a transparent guide of 
supervisory actions a credit union can expect as its capital declines.
    Section 702.109 of the RBC Rule provides for mandatory and 
discretionary PCA for ``Critically Undercapitalized'' credit unions. 
Among the discretionary actions in Sec.  702.109 is one related to 
secondary capital. Specifically, current Sec.  702.109(b) states that, 
beginning 60 days after the effective date of classification of a 
credit union as ``Critically Undercapitalized,'' the NCUA may 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.\56\
---------------------------------------------------------------------------

    \56\ 12 CFR 702.109(b)(11).
---------------------------------------------------------------------------

    The Board is proposing to retain the aforementioned discretionary 
action for Grandfathered Secondary Capital so as not to impact 
outstanding secondary capital agreements between LICUs and investors. 
The Board notes, however, that under this proposal the discretionary 
action, as discussed above, would be mandatory for Subordinated Debt. 
With this change, the Board intends to provide investors with 
certainty. As mentioned in section II. (C)(5) of this preamble, a 
credit union must disclose this mandatory action to all investors. The 
Board believes including this as a mandatory action will provide credit 
unions and investors with clear and transparent regulations regarding 
the agency's actions in a PCA context regarding Subordinated Debt. The 
Board notes that the mandatory treatment of this action is also 
consistent with the OCC's subordinated debt requirements.\57\
---------------------------------------------------------------------------

    \57\ Id. 5.47(d)(3)(ii)(B)(2).
---------------------------------------------------------------------------

4. Sec.  702.205 Prompt Corrective Action for Uncapitalized New Credit 
Unions
    The Board is proposing to make a technical correction to Sec.  
702.205 of the RBC Rule by changing the title of this section from 
``Mandatory liquidation of uncapitalized New Credit Union'' to 
``Discretionary liquidation of uncapitalized New Credit Union.'' The 
Board notes that the current text of this section states that the NCUA 
may place a New Credit Union into liquidation under section 
1787(a)(1)(A) of the FCU Act.\58\ Because the term ``may'' is 
discretionary, this proposed change will better align the title of this 
section with the accompanying text.
---------------------------------------------------------------------------

    \58\ 12 U.S.C. 1787(a)(1)(A).
---------------------------------------------------------------------------

5. Sec.  702.206 Revised Business Plans (RBP) for New Credit Unions
    The Board is proposing to delete paragraph (d) of Sec.  702.206 of 
the RBC Rule, which reads as follows:

    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.

    This section was intended as a placeholder for the eventual 
creation of a Subordinated Debt rule. As such, the Board is proposing 
to delete the text in this section and include a new Sec.  702.207 in 
the RBC Rule related to the consideration of Subordinated Debt for a 
New Credit Union. The Board addresses this new section in the following 
section of this preamble.
6. Sec.  702.207 Consideration of Subordinated Debt for New Credit 
Unions
    The Board is proposing a new section that would provide an 
exception from PCA for a New Credit Union that meets specific 
conditions related to Subordinated Debt. Specifically, under this 
section a New Credit Union would not be subject to mandatory and 
discretionary actions under PCA if the New Credit Union has outstanding 
Subordinated Debt that would be treated as Regulatory Capital if the 
credit union were a Complex Credit Union or a LICU. The Board notes 
that, to qualify for this proposed exception, a New Credit Union would 
have to have a Net Worth Ratio of at least one percent and issue 
Subordinated Debt in accordance with the requirements of proposed 
subpart D.
    As discussed in section II. (C)(3) of this preamble, a non-LICU New 
Credit Union may only issue Subordinated Debt if, at the time of 
issuance, it has retained earnings of at least one percent of total 
assets. Further, under this proposal, the NCUA would only consider, for 
purposes of this exception, the non-discounted portion of any issued 
Subordinated Debt. Finally, to qualify for this exception, the Board is 
proposing to require the ratio of the New Credit Union's Net Worth, 
plus its outstanding Subordinated Debt, to its total assets be at least 
seven percent.
    To avail itself of relief from PCA under this section, a New Credit 
Union would also be required to increase its Net Worth in a manner 
consistent with the New Credit Union's approved initial business plan 
or revised business plan. The Board believes the proposed rule allows a 
New Credit Union to use Subordinated Debt in a manner that allows the 
credit union to avoid PCA while maintaining a sufficient buffer between 
losses and the NCUSIF.
    Even if a New Credit Union meets the foregoing criteria, the 
proposed rule reserves the Board's authority to impose PCA on a New 
Credit Union in delineated circumstances. These circumstances include 
where a New Credit Union is operating in an unsafe or unsound manner or 
has not corrected a material unsafe and unsound condition that it was, 
or should have been, aware of. However, the Board would only impose PCA 
in these circumstances after providing a New Credit Union with written 
notice and opportunity for hearing pursuant to Sec.  747.2003 of the 
NCUA's regulations.
    For FISCUs, the Board is also proposing to include a requirement 
that the NCUA consult and seek to work cooperatively with the 
appropriate state supervisory authority (SSA) before invoking the 
reservation to impose PCA. The Board believes this reservation of 
rights will allow the NCUA to quickly and appropriately address unsafe 
or unsound conditions in a New Credit Union, regardless of whether the 
New Credit Union has issued Subordinated Debt.
    In addition, the Board is proposing to prohibit delegation of its 
authority to take PCA against a New Credit Union that would otherwise 
qualify for an

[[Page 13997]]

exemption from PCA because of its issuance of Subordinated Debt. The 
Board is proposing to retain such authority because such action could 
have a direct and material impact to the NCUSIF and the subject New 
Credit Union. This proposed non-delegation provision is similar to 
others related to PCA in the RBC Rule.
    The Board is also proposing to include in this section a statement 
that the NCUA will consider any outstanding Subordinated Debt issued by 
a New Credit Union in evaluating the credit union's revised business 
plan. Because Subordinated Debt acts as buffer between losses sustained 
by a credit union and the NCUSIF, the Board believes this change 
prudently allows New Credit Unions to avail themselves of the benefits 
of issuing Subordinated Debt while maintaining the safety and soundness 
of the NCUSIF.
    Finally, the Board is proposing to include a provision that allows 
the Board to liquidate a New Credit Union under section 1787(a)(3)(A) 
of the FCU Act, provided that a New Credit Union's Net Worth Ratio plus 
outstanding Subordinated Debt that has been issued by that New Credit 
Union and that counts as Regulatory Capital is, as of the applicable 
date of determination, below six percent and the New Credit Union has 
no reasonable prospect of becoming ``Adequately Capitalized.'' The 
Board believes it is prudent to include procedures whereby the Board 
can address a New Credit Union that does not have a reasonable prospect 
of being ``Adequately Capitalized.''
    The Board notes that, while Subordinated Debt can be a helpful tool 
for credit unions to meet their capital requirements, it believes that 
a credit union's business model should not rely too heavily on the 
issuance of Subordinated Debt. As such, this proposed provision 
supports the Board in fulfilling its statutory mandate of protecting 
the NCUSIF if a credit union has no reasonable prospect of becoming 
``Adequately Capitalized'' without giving effect to any Subordinated 
Debt issued by that credit union, and is failing to reach even marginal 
levels of capitalization with Subordinated Debt.

C. Subpart D--Subordinated Debt, Grandfathered Secondary Capital, and 
Regulatory Capital

1. Sec.  702.401 Purpose and Scope
    This proposed section sets out the general purpose of subpart D of 
part 702. As discussed in more detail below, this section of the 
proposal also addresses the authority for FISCUs to issue Subordinated 
Debt and the treatment of Grandfathered Secondary Capital.
    With respect to FISCUs, the Board proposes to clarify that the 
requirements of proposed subpart D of part 702 would apply to FISCUs, 
but only to the extent FISCUs are permitted by applicable state law or 
regulation to issue debt securities of the type contemplated by this 
rule. That is, under this proposal, a FISCU may only issue Subordinated 
Debt if such issuance is permissible under its applicable state law. To 
the extent that a FISCU's state law is more restrictive than this 
proposed rule, the FISCU would be required to follow that state law.
    With respect to secondary capital, the Board proposes to address in 
this section of the proposal both the treatment of outstanding 
Grandfathered Secondary Capital and the treatment of secondary capital 
issued in the form of Subordinated Debt after the effective date of a 
final Subordinated Debt rule.
    With respect to any Grandfathered Secondary Capital, the Board is 
proposing to allow such Grandfathered Secondary Capital to continue to 
be governed by the regulatory requirements under which it was issued. 
For ease of reference, the Board is proposing to relocate subsections 
(b)-(d) and Appendix A of the Current Secondary Capital Rule to a new 
Sec.  702.414. As discussed in section II. (C)(14) of this preamble, 
this new section would include all of the requirements in the Current 
Secondary Capital Rule, but would make clear that LICUs are not 
permitted to conduct new issuances under proposed Sec.  702.414.
    The Board is also proposing to prohibit Grandfathered Secondary 
Capital from receiving Regulatory Capital treatment as of 20 years from 
the effective date of a final Subordinated Debt rule. The Board notes 
that this proposed requirement would prevent Grandfathered Secondary 
Capital from perpetually receiving such grandfathered treatment. The 
Board believes 20 years would provide a LICU sufficient time to replace 
Grandfathered Secondary Capital with Subordinated Debt if such LICU 
seeks continued Regulatory Capital benefits of Subordinated Debt. The 
Board believes it is important to strike a balance between 
transitioning issuers of Grandfathered Secondary Capital to this 
proposed rule and ensuring that instruments do not indefinitely remain 
as Grandfathered Secondary Capital. The Board believes the structure of 
the proposed grandfather provision achieves this balance without 
unnecessarily disrupting the operations of LICUs, investors, and any 
outstanding secondary capital agreements.
    Finally, the Board is also clarifying that this proposed rule would 
treat as Subordinated Debt all secondary capital issued after the 
effective date of a final Subordinated Debt rule. As such, any post-
effective date application and/or issuance of secondary capital by a 
LICU would be subject to the requirements of this rule (except Sec.  
702.414, which, as noted above, only applies to Grandfathered Secondary 
Capital). As discussed above, this change would not alter the ability 
of a LICU to include Subordinated Debt in its Net Worth, the same way a 
LICU currently includes secondary capital in its Net Worth.
2. Sec.  702.402 Definitions
    This section contains proposed definitions to subpart D of 702. 
However, subpart D references some terms referenced elsewhere in the 
regulations. Therefore, for consistency purposes, the Board is 
proposing to cross-reference definitions of terms found elsewhere in 
the NCUA's regulations as follows:
---------------------------------------------------------------------------

    \59\ 83 FR 55467. (Nov. 6, 2018).
    \60\ 80 FR 66625. (Oct. 29, 2015).

------------------------------------------------------------------------
       Cross-referenced term                     Definition
------------------------------------------------------------------------
Complex Credit Union..............  The proposed rule defines the term
                                     as having the same meaning as in
                                     subpart A of part 702, as amended
                                     by the Board on November 6,
                                     2018.\59\
Grandfathered Secondary Capital...  The proposed rule defines the term
                                     as any subordinated debt issued in
                                     accordance with current Sec.
                                     701.34 before [EFFECTIVE DATE OF
                                     THE FINAL RULE].
Net Worth.........................  The proposed rule defines the term
                                     as having the same meaning as in
                                     Sec.   702.2.
Net Worth Ratio...................  The proposed rule defines the term
                                     as having the same meaning as in
                                     Sec.   702.2.
New Credit Union..................  The proposed rule defines the term
                                     as having the same meaning as in
                                     Sec.   702.201, as amended by the
                                     Board on October 29, 2015.\60\

[[Page 13998]]

 
Risk-based Capital (RBC) Ratio....  The proposed rule defines the term
                                     as having the same meaning as in
                                     Sec.   702.2 as amended by the
                                     Board on October 29, 2015.\61\
------------------------------------------------------------------------
\61\ Id.

    In addition to the cross-referenced terms, the Board is proposing 
to define the following terms:
    Accredited Investor. The proposed rule defines ``Accredited 
Investor'' as any Natural Person Accredited Investor or any Entity 
Accredited Investor, as applicable. The Board is aware that the SEC has 
recently published a proposed rule amending the definition of 
``accredited investor.'' The Board will evaluate any final rule issued 
by the SEC and make changes to a final Subordinated Debt rule 
accordingly. Such changes may include substituting specific cross 
references contained in the definitions of Entity Accredited Investor 
and Natural Person Accredited Investor with a more general cross 
reference. In addition, the Board may opt to include a reference to 
sample accredited investor forms, rather than include such form in the 
rule, as the Board is proposing to do so in Sec.  702.406 of this 
proposal.
    Appropriate Supervision Office. The proposed rule defines the term 
``Appropriate Supervision Office'' as, with respect to any credit 
union, the Regional Office or Office of National Examinations and 
Supervision that is responsible for supervision of that credit union. 
By doing so, it provides the Board flexibility in delegating the 
responsible office, which may change as a reflection of organization 
changes within the NCUA.
    Entity Accredited Investor. The proposed rule defines the term 
``Entity Accredited Investor'' as an entity that, at the time of 
offering and sale of Subordinated Debt to that entity, meets the 
requirements of 17 CFR 230.501(a)(1), (2), (3), (7), or (8), which 
generally are the requirements applicable to corporate or trust 
entities and not natural persons.
    Immediate Family Member. The proposed rule defines ``Immediate 
Family Member'' as a spouse, child, sibling, parent, grandparent, or 
grandchild (including stepparents, stepchildren, stepsiblings, and 
adoptive relationships). The proposed term is intended to be consistent 
with the definition found in the NCUA's regulations.\62\
---------------------------------------------------------------------------

    \62\ Appendix A to 12 CFR part 701, Article XVIII, Sec.  1.
---------------------------------------------------------------------------

    Issuing Credit Union. For the purposes of this subpart D of part 
702, the proposed rule defines ``Issuing Credit Union'' as a credit 
union that has issued, or is in the process of issuing, Subordinated 
Debt or Grandfathered Secondary Capital in accordance with the 
requirements of this proposed rule. The definition is consistent with 
the term used by OCC's regulations.\63\
---------------------------------------------------------------------------

    \63\ Office of the Comptroller of the Currency, Comptroller's 
Licensing Manual: Subordinated Debt (2017), available at https://www.occ.gov/publications-and-resources/publications/comptrollers-licensing-manual/files/licensing-booklet-subordinated-debt.html. Per 
the OCC's Comptroller's Licensing Manual for Subordinated Debt, the 
bank issuing subordinated debt is referred to as the ``issuing 
bank.''
---------------------------------------------------------------------------

    Low-Income Designated Credit Union (LICU). The proposed rule 
defines the term ``Low-Income Credit Union'' as a credit union 
designated as having low-income status in accordance with Sec.  701.34 
of this chapter. This definition is consistent with references to LICUs 
in the FCU Act as, ``a credit union that serves predominantly low-
income members.'' \64\
---------------------------------------------------------------------------

    \64\ 12 U.S.C. 1752(5); 1757a(b)(2)(A),); 1757a(c)(2)(B).
---------------------------------------------------------------------------

    Natural Person Accredited Investor. The proposed rule defines the 
term ``Natural Person Accredited Investor'' as a natural person who, at 
the time of offering and closing of the issuance and sale of 
Subordinated Debt to that person, meets the requirements of 17 CFR 
230.501(a)(5) or (6), which generally are the requirements applicable 
to natural persons and not corporate or trust entities; provided that, 
for purposes of purchasing or holding any Subordinated Debt Note, this 
term shall not include any board member or Senior Executive Officer, or 
any Immediate Family Member of any board member or Senior Executive 
Officer, of the Issuing Credit Union.
    Offering Document. The proposed rule defines the term ``Offering 
Document'' as the document(s) required by proposed Sec.  702.408, 
including any term sheet, offering memorandum, private placement 
memorandum, offering circular, or other similar document used to offer 
and sell Subordinated Debt Notes.
    Pro Forma Financial Statements means projected financial statements 
that show the effects of proposed transactions as if they actually 
occurred in a variety of plausible scenarios, including both optimistic 
and pessimistic assumptions, over measurement horizons that align with 
the credit union's expected activities. For consistency, this term as 
defined here is consistent with the Evaluating Secondary Capital Plans 
supervisory guidance issued by the Board on September 16, 2019.\65\
---------------------------------------------------------------------------

    \65\ Supervisory Letter No. 19-01, September (Sept. 16, 2019), 
available at https://www.ncua.gov/files/supervisory-letters/SL-19-01-evaluating-secondary-capital-plans.pdf.
---------------------------------------------------------------------------

    Qualified Counsel. The proposed rule defines the term ``qualified 
counsel'' as an attorney licensed to practice law in the relevant 
jurisdiction(s) who has expertise in the areas of federal and state 
securities laws and debt transactions of the type contemplated by the 
proposed rule. The Board believes that credit unions need to engage 
legal counsel that has the requisite experience and expertise to 
represent the credit union in all aspects of a Subordinated Debt 
transaction.
    Regulatory Capital. The proposed rule defines the term ``Regulatory 
Capital'' as (i) with respect to an Issuing Credit Union that is a LICU 
and not a Complex Credit Union, the aggregate outstanding principal 
amount of Subordinated Debt and, until [DATE 20 YEARS AFTER THE 
EFFECTIVE DATE OF THE FINAL RULE], Grandfathered Secondary Capital that 
is included in the credit union's Net Worth Ratio; (ii) with respect to 
an Issuing Credit Union that is a Complex Credit Union and not a LICU, 
the aggregate outstanding principal amount of Subordinated Debt that is 
included in the credit union's RBC Ratio; (iii) with respect to an 
Issuing Credit Union that is both a LICU and a Complex Credit Union, 
the aggregate outstanding principal amount of Subordinated Debt and, 
until [DATE 20 YEARS AFTER THE EFFECTIVE DATE OF THE FINAL RULE], 
Grandfathered Secondary Capital that is included in its Net Worth Ratio 
and in its RBC Ratio; and (iv) with respect to a New Credit Union, the 
aggregate outstanding principal amount of Subordinated Debt and, until 
[DATE 20 YEARS AFTER THE EFFECTIVE DATE OF THE FINAL RULE], 
Grandfathered Secondary Capital that is considered pursuant to proposed 
Sec.  702.207. This definition reflects the expanded eligibility of 
credit unions that may count Subordinated Debt as Regulatory Capital.

[[Page 13999]]

    Retained Earnings. The proposed rule defines the term ``Retained 
Earnings'' as in U.S. GAAP. The definition is consistent with the FCU 
Act, which defines Net Worth, in part, as a credit union's Retained 
Earnings balance under U.S. GAAP.\66\ Additionally, according to 
section 202 of the FCU Act, a credit union's statement of financial 
condition is generally to be reported consistent with U.S. GAAP.\67\
---------------------------------------------------------------------------

    \66\ 12 U.S.C. 1757a(c)(2)(A).
    \67\ Id. 1782(a)(6)(C)(i). This section of the FCU Act, provides 
a de minimus exception for following U.S. GAAP for credit unions 
with assets less than $10,000,000 unless prescribed by the Board or 
the appropriate SSA.
---------------------------------------------------------------------------

    Senior Executive Officer. The proposed rule defines the term 
``Senior Executive Officer'' as a credit union's chief executive 
officer (for example, president or treasurer/manager), any assistant 
chief executive officer (for example, any assistant president, any vice 
president or any assistant treasurer/manager) and the chief financial 
officer (controller). The term Senior Executive Officer also includes 
employees and contractors of an entity, such as a consulting firm, 
hired to perform the functions of positions covered by the term Senior 
Executive Officer. For consistency, this term as defined here is 
consistent with Sec.  701.14(b)(2) of the NCUA's regulations.
    Subordinated Debt.\68\ The proposed rule would define 
``Subordinated Debt'' as an Issuing Credit Union's borrowing that meets 
the requirements of this proposed rule, including all obligations and 
contracts related to such borrowing.
---------------------------------------------------------------------------

    \68\ Secondary capital issued by LICUs after [EFFECTIVE DATE OF 
THE FINAL RULE] would be considered Subordinated Debt.
---------------------------------------------------------------------------

3. Sec.  702.403 Eligibility
    Currently, Sec.  701.34 allows only LICUs to issue Secondary 
Capital. The proposed rule increases the current eligibility beyond 
LICUs in Sec.  701.34(b) to also include Non-LICU Complex Credit Unions 
and New Credit Unions. The Board is also proposing to grant eligibility 
to credit unions that anticipate being designated as a LICU or Non-LICU 
Complex Credit Union within 24 months following their planned issuance 
of the Subordinated Debt. The Board believes these proposed changes 
will allow additional credit unions to issue Subordinated Debt that 
would count as Regulatory Capital, which could aid these credit unions 
in complying with the PCA requirements in the FCU Act and the NCUA's 
regulations.
    Under this proposed rule, all eligible credit unions, regardless of 
designation type, are required to submit an initial application for 
preapproval under Sec.  702.408 of this section.
LICU Eligibility
    Consistent with the FCU Act and the Current Secondary Capital Rule, 
the Board is proposing to maintain a LICU's authority to seek the 
NCUA's approval to issue Subordinated Debt. As of June 30, 2019, credit 
unions with a LICU designation represented 49 percent of all federally 
insured credit unions with total assets of $628 billion or 41 percent 
of the total federally insured credit union assets.
Non-LICU Eligibility
    For the first time, the Board is proposing that the following 
categories of non-LICUs would generally be eligible to issue 
Subordinated Debt:

(1) Complex Credit Unions

    Under this proposed rule, a non-LICU Complex Credit Union must 
have a capital classification of at least ``Undercapitalized,'' as 
defined in the NCUA's capital standards,\69\ to be eligible to issue 
Subordinated Debt. The Board also notes that, under this proposed 
rule, the aggregate outstanding amount of Subordinated Debt issued 
by a non-LICU Complex Credit union may not exceed 100 percent of its 
Net Worth,\70\ as determined at the time of each issuance of 
Subordinated Debt. The Board is proposing this limit so that the 
non-LICU Complex Credit Union's regulatory capital is not primarily 
composed of Subordinated Debt, a lower quality form of capital. This 
approach is generally consistent with the Tier 1 and Tier 2 capital 
requirements for banks.
---------------------------------------------------------------------------

    \69\ See 12 CFR 702.102.
    \70\ See proposed 702.403(c) of the proposed rule.
---------------------------------------------------------------------------

(2) New Credit Unions

    The Board is proposing that all New Credit Unions, not just 
those that are a LICU, may be eligible to issue Subordinated Debt 
pending an NCUA-approved application as described in Sec. Sec.  
702.408 and 702.409. A ``New Credit Union'' means a federally 
insured credit union that has been both in operation for less than 
ten years and has $10 million or less in total assets.\71\ For 
purposes of this proposed rule, a New Credit Union may be a LICU or 
a non-LICU. The Board is proposing that a non-LICU New Credit Union 
have Retained Earnings equal to or greater than one percent of total 
assets to be eligible to issue Subordinated Debt. This provision is 
included to ensure the non-LICU New Credit Union has some level of 
loss-absorbing capacity before any deficit in Retained Earnings 
would be charged against the Subordinated Debt.
---------------------------------------------------------------------------

    \71\ 12 CFR 702.2.
---------------------------------------------------------------------------

(3) Credit unions that anticipate becoming a Complex Credit Union or 
LICU within 24 months of issuance

    In certain circumstances, the Board is proposing to extend 
eligibility for Subordinated Debt issuance to a credit union that does 
not meet the eligibility criteria currently, but has a reasonable 
likelihood of doing so in the near future. Under this proposal, an 
ineligible credit union that can demonstrate through an acceptable pro 
forma analysis that it is reasonably projected to become eligible 
within 24 months after issuance (that is, expects to become a non-LICU 
Complex Credit Union or a LICU within that timeframe) can obtain 
approval as well. Pro forma analysis should include projections of 
expected earnings and growth in a variety of plausible scenarios that, 
at a minimum include the required 24-month measurement horizon. 
Aspiring credit unions are also subject to the requirements of 
Sec. Sec.  702.408 and 702.409 for preapproval and must include in 
their applications documents to evidence how they will successfully 
become a LICU (see Sec.  701.34(a) requirements) or a Complex Credit 
Union within the 24-month period immediately following a planned 
issuance. The Board is providing this flexibility for aspiring credit 
unions that may consider Subordinated Debt as a potential source of 
funding within the required timeframe to support future growth while 
increasing Regulatory Capital.
FISCU Eligibility
    A FISCU's authority to issue Subordinated Debt, if any, is set 
forth in applicable state law and regulation. Such state laws may be 
narrower or broader than those for FCUs. However, to the extent a FISCU 
may issue Subordinated Debt under applicable state law and regulation, 
it would be bound by proposed Sec.  741.226.
Prohibition on Issuing and Investing in Subordinated Debt
    For the reasons discussed in sections II. (A)(1) and II. (B)(3) of 
this preamble, the Board is proposing to prohibit, except in limited 
circumstances, a credit union from both issuing and investing in 
Subordinated Debt.
    At the time of issuance of any Subordinated Debt, an Issuing Credit 
Union may not have any investments, direct or indirect, in Subordinated 
Debt or Grandfathered Secondary Capital (or any interest therein) of 
another credit union. If a credit union acquires Subordinated Debt or 
Grandfathered Secondary Capital in a merger or other consolidation, the 
Issuing Credit Union may still issue Subordinated Debt, but it may not 
invest (directly or indirectly) in the Subordinated Debt or 
Grandfathered Secondary Capital of any other credit union while any 
Subordinated Debt Notes issued by the Issuing Credit Union remain 
outstanding.

[[Page 14000]]

4. Sec.  702.404 Requirements of the Subordinated Debt and Subordinated 
Debt Notes
    The Current Secondary Capital Rule allows LICUs to issue secondary 
capital to ``non-natural person members and non-natural person 
nonmembers.'' \72\ Under the Current Secondary Capital Rule, a 
secondary capital account must:
---------------------------------------------------------------------------

    \72\ Id. 701.34(b).
---------------------------------------------------------------------------

     Be in the form of a written contract;
     Be an uninsured, non-share account;
     Have a minimum maturity of five years;
     Not be insured by the NCUSIF;
     Be subordinate to all other claims;
     Not be pledged or provided by the account investor as 
security on a loan or other obligation with the LICU or any other 
party;
     Be available to cover operating losses realized by the 
LICU that exceed its net available reserves, and to the extent funds 
are so used, the LICU must not restore or replenish the account under 
any circumstances. Losses must be distributed pro-rata among all 
Secondary Capital accounts held by the LICU at the time the losses are 
realized; and
     Be recorded as an equity account entitled uninsured 
Secondary Capital account.
Subordinated Debt Note Requirements
    The Board is proposing changes to the requirements of the Current 
Secondary Capital Rule. The proposed changes include additional 
requirements to help ensure the Subordinated Debt Notes are clearly 
issued as debt, rather than equity, pursuant to the authority in the 
FCU Act for an FCU to borrow from any source.\73\ Due to the 
cooperative structure of credit unions, and the members' rights to 
govern the affairs of them, FCUs do not have the authority to issue 
equity instruments. Therefore, it is essential for Subordinated Debt 
issued by FCUs to be considered debt rather than equity.
---------------------------------------------------------------------------

    \73\ 12 U.S.C. 1757(9).
---------------------------------------------------------------------------

    The Board notes that FISCUs may not be restricted under applicable 
state law and regulation to issuing only debt instruments. However, the 
Board is proposing that the debt requirement apply to both FCUs and 
FISCUs at this time. As insurer, the Board believes that the framework 
for the types of instruments that would qualify for Regulatory Capital 
should be consistent for all credit unions. The Board is requesting 
comments as to whether the NCUA should allow instruments other than 
debt instruments for FISCUs. If so, what specific instruments, 
including a detailed description, should be allowed? \74\
---------------------------------------------------------------------------

    \74\ Instruments to be considered must be permissible under 
applicable state law.
---------------------------------------------------------------------------

    As part of the Subordinated Debt Note requirements, the Board is 
proposing to require that a Subordinated Debt Note be in the form of a 
written debt agreement. This requirement aligns with requirements in 
debt transactions of the type contemplated by this rule, which 
typically require written debt agreements.
    Under the proposed rule, Subordinated Debt Notes must, at the time 
of issuance, have a fixed stated maturity of at least five years but no 
more than twenty years from issuance. The Current Secondary Capital 
Rule requires the Secondary Capital account to have a minimum maturity 
of five years, but does not have a maximum. A minimum maturity of five 
years is proposed, as it should create sufficient stability and 
longevity within a credit union's capital base to be available to cover 
losses. The Board is proposing the maximum maturity of 20 years to help 
ensure the Subordinated Debt is properly characterized as debt rather 
than equity. Generally, by its nature, debt has a stated maturity, 
whereas equity does not. The proposal is consistent with the OCC's 
subordinated debt regulation for a minimum maturity of five years, 
although that regulation does not have a maximum.\75\ Because U.S. 
national banks can issue equity, the distinction of a debt versus 
equity characterization for subordinated debt under the OCC's 
regulations is not as critical as it is for FCUs.
---------------------------------------------------------------------------

    \75\ 12 CFR 5.47(d)(1)(i).
---------------------------------------------------------------------------

    Under proposed Sec.  709.5(b), the Board is proposing that an 
Issuing Credit Union's Subordinated Debt be subordinate to all other 
claims in liquidation and have the same payout priority as all other 
Subordinated Debt, including Grandfathered Secondary Capital issued by 
the Issuing Credit Union. This proposed provision is substantially 
similar to the Current Secondary Capital Rule and the OCC's 
subordinated debt regulations. The FCU Act requires secondary capital 
accounts to be subordinate to all other claims against the Issuing 
Credit Union.\76\ Further, the Board is not proposing a separate class 
for Subordinated Debt issued by non-LICU Complex Credit Unions or non-
LICU New Credit Unions at this time.
---------------------------------------------------------------------------

    \76\ See 12 U.S.C. 1757a(c)(2)(B)(ii); 1790d(o)(2)(C)(ii).
---------------------------------------------------------------------------

    The Board is proposing that any Subordinated Debt Note must be 
unsecured. This provision is consistent with the OCC's subordinated 
debt regulations,\77\ and is not required in the Current Secondary 
Capital Rule. The Board is proposing this requirement because allowing 
arrangements that legally or economically secure Subordinated Debt 
would enhance the seniority of the Subordinated Debt in the event of 
liquidation of a credit union, which would be contrary to the proposed 
``subordinate to all other claims'' requirement and the FCU Act, as 
discussed above. Additionally, if the Subordinated Debt Notes were 
secured by an asset of the Issuing Credit Union, it may interfere with 
the Issuing Credit Union's operations as it forces the Issuing Credit 
Union to direct assets or resources to secure the Subordinated Debt 
Note.
---------------------------------------------------------------------------

    \77\ 12 CFR 5.47(d)(1)(iv).
---------------------------------------------------------------------------

    The proposed rule also prohibits two specific arrangements which, 
from an economic standpoint, would effectively act as a security 
arrangement for Subordinated Debt: (1) A sinking fund,\78\ and (2) a 
compensating balance or any other funds or assets subject to a legal 
right of offset, as defined by applicable state law.\79\ These 
arrangements, in essence, create a secured arrangement from an economic 
standpoint between the investor and Issuing Credit Union. In the event 
of the Issuing Credit Union's liquidation, these arrangements would 
function like collateral and be applied to the obligations of the 
Subordinated Debt. As a result, the Subordinated Debt Note could, in 
essence, become senior in right of payment to other credit obligations, 
thus limiting its ability to absorb losses and protect the NCUSIF.
---------------------------------------------------------------------------

    \78\ An example of a sinking fund arrangement is one that would 
require an FCU to periodically put aside money for the gradual 
repayment of the subordinated debt.
    \79\ An example of a compensating balance arrangement is where 
the investor would require an FCU to maintain a minimum balance in a 
bank account during the term of the debt.
---------------------------------------------------------------------------

    The Board is proposing that, at the end of each of its fiscal years 
(or more frequently as determined by the Issuing Credit Union), the 
Issuing Credit Union must apply its issued Subordinated Debt to cover 
any deficit in Retained Earnings on a pro rata basis among all holders 
of the Subordinated Debt and Grandfathered Secondary Capital of the 
Issuing Credit Union. While this is similar to the Current Secondary 
Capital Rule, it clarifies the frequency and timing of applying the 
Subordinated Debt to credit union losses, thus providing more 
transparency to investors of Subordinated Debt. The current rule is 
silent on the timing and

[[Page 14001]]

frequency of applying Secondary Capital to credit union losses.
    The Board is proposing that, except for approved prepayments 
discussed in sections II. (C)(11) and (12) of this preamble, the 
Subordinated Debt Note must be payable in full only at maturity. The 
Board is proposing this new provision to clarify that Subordinated Debt 
can only be prepaid with prior written approval from the NCUA as 
discussed in section II. (C)(11) of this preamble. While the Current 
Secondary Capital Rule does not include this provision, it does require 
the NCUA's approval to prepay secondary capital that no longer counts 
towards the credit union's Regulatory Capital.\80\ As such, this 
provision would not impose additional burden on credit unions.
---------------------------------------------------------------------------

    \80\ 12 CFR 701.34(d).
---------------------------------------------------------------------------

    The Board is proposing to require disclosure by the Issuing Credit 
Union of any prepayment penalties or restrictions on prepayment of a 
Subordinated Debt Note. While the Current Secondary Capital Rule does 
not contain this restriction, the Board believes this proposed 
requirement provides additional protection and transparency for 
Subordinated Debt Note investors.
    The Board is proposing changes to the permissible investors for 
Subordinated Debt. The proposed rule expands a credit union's current 
authority by allowing Subordinated Debt to be issued to Natural Person 
Accredited Investors and Entity Accredited Investors, except that no 
board member or Senior Executive Officer, and no Immediate Family 
Member of such board member or Senior Executive Officer, of the Issuing 
Credit Union may purchase or hold any Subordinated Debt Note issued by 
that Issuing Credit Union.
    Under the proposed rule, Accredited Investors would be required to 
attest to their accredited status using a form that is substantially 
similar to the form contained in proposed Sec.  702.406(c). This 
provision helps Issuing Credit Unions with their obligations to limit 
offers and sales of their Subordinated Debt Notes to qualified 
Accredited Investors.
Subordinated Debt Restrictions
    The restrictions section of the proposed rule adds provisions 
similar to those found in the OCC's subordinated debt rule,\81\ and 
also include provisions found in the Current Secondary Capital Rule. In 
general, these provisions are necessary to avoid undue restrictions on 
a credit union's authority or ability to manage itself in a safe and 
sound manner, ensure the Subordinated Debt is characterized as debt in 
accordance with U.S. GAAP, and prevent agreements that would interfere 
with the NCUA's supervision of credit unions.
---------------------------------------------------------------------------

    \81\ Id. 5.47.
---------------------------------------------------------------------------

    The Board is proposing a restriction that no Subordinated Debt or 
Subordinated Debt Note be insured by the NCUA. This provision is 
consistent with the Current Secondary Capital Rule, which requires 
secondary capital accounts to be uninsured per the FCU Act.\82\ 
Similarly, the OCC's subordinated debt regulations require that 
subordinated debt issued by national banks or federal savings 
associations not be insured by the FDIC.\83\ One benefit of 
Subordinated Debt that counts as Regulatory Capital is that it acts as 
a buffer to protect the depositors at a credit union as well as the 
NCUSIF. To allow Subordinated Debt to be insured by the NCUA would be 
contrary to this benefit and the payout priorities discussed previously 
in this section and in section II. (D)(1) of this preamble.
---------------------------------------------------------------------------

    \82\ 12 U.S.C. 1757a(c)(2)(B)(ii); 1790d(o)(2)(C)(ii).
    \83\ 12 CFR 5.47(d)(ii).
---------------------------------------------------------------------------

    The Board is proposing a restriction that the Subordinated Debt 
Note not include any express or implied terms that make it senior to 
any other Subordinated Debt or Grandfathered Secondary Capital. The 
Current Secondary Capital Rule contains a condition that Secondary 
Capital accounts are subordinate to all other claims. Similarly, the 
OCC's subordinated debt regulations require subordinated debt issued by 
national banks or federal savings associations to be subordinate to all 
depositors.\84\ The proposed restriction clarifies the Current 
Secondary Capital Rule's intent by not allowing any express or implied 
terms that may be contrary to the proposed requirement that 
Subordinated Debt be subordinate to all other claims as discussed 
earlier in this section.
---------------------------------------------------------------------------

    \84\ Id. 5.47(d)(1).
---------------------------------------------------------------------------

    The Board is proposing a restriction that the issuance of 
Subordinated Debt may not cause a credit union to exceed the borrowing 
limit in Sec.  701.38 for FCUs or, for a FISCU, any more restrictive 
state borrowing limit. While this restriction is not explicit in the 
Current Secondary Capital Rule, the borrowing limit is not a new 
regulation and the restriction currently applies to the issuance of 
secondary capital. The Board is proposing to include this provision to 
clarify that the borrowing limit does apply to Subordinated Debt 
issuances as they are considered borrowings for the Issuing Credit 
Union.
    The Board is proposing a new restriction not found in the Current 
Secondary Capital Rule that the Subordinated Debt Note not provide the 
investor with any management or voting rights in the Issuing Credit 
Union. To allow management or voting rights for Subordinated Debt 
investors would lead to some loss of control of the credit union by the 
credit union's board. Per the FCU Act, ``the management of a Federal 
credit union shall be by a board of directors, a supervisory committee, 
and where the bylaws so provide, a credit committee.'' \85\ Further, 
the FCU Act states the board of directors ``shall have the general 
direction and control of the affairs of the Federal credit union.'' 
\86\ Therefore, allowing Subordinated Debt investors to have some 
control of the Issuing Credit Union would be contrary to requirements 
of the FCU Act.
---------------------------------------------------------------------------

    \85\ 12 U.S.C. 1761(a).
    \86\ Id. 1761b.
---------------------------------------------------------------------------

    The Board is proposing that Subordinated Debt Notes not be eligible 
to be pledged or provided by the investor as security for a loan from 
or other obligation owing to the Issuing Credit Union. This provision 
is consistent with the Current Secondary Capital Rule \87\ and the 
OCC's subordinated debt regulations.\88\ Allowing such a transaction 
with the Subordinated Debt Note as collateral would result in the 
Issuing Credit Union loaning funds to the investor secured by debt owed 
by the Issuing Credit Union to the investor. As a result, such an 
arrangement does not provide a risk mitigation benefit to an Issuing 
Credit Union.
---------------------------------------------------------------------------

    \87\ 12 CFR 701.34(b)(8).
    \88\ Id. 5.47(d)(1)(v).
---------------------------------------------------------------------------

    The Board is proposing a restriction that the Subordinated Debt 
Note may not include any term or condition that would require a credit 
union to prepay or accelerate payment of principal or interest. This 
provision is not in the Current Secondary Capital Rule, but is 
consistent with the OCC's subordinated debt regulations.\89\ The 
Current Secondary Capital Rule and this proposal both require 
preapproval to pay Grandfathered Secondary Capital or Subordinated Debt 
prior to maturity as discussed in section II. (C)(11) of this preamble. 
Therefore, including such a term or condition in the Subordinated Debt 
Note may place a credit union in default should the NCUA not approve a 
request to prepay.
---------------------------------------------------------------------------

    \89\ Id. 5.47(d)(1)(vii).

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

[[Page 14002]]

    The Board is proposing a restriction that a Subordinated Debt Note 
not include a term or condition that would trigger an event of default 
based on the credit union's default on other debts. This provision is 
not in the Current Secondary Capital Rule and the OCC's subordinated 
debt regulations do not specifically address this provision. However, 
the OCC's Comptroller's Licensing Manual for Subordinated Debt \90\ 
includes an example of a reasonable default trigger as one where the 
trigger is based on the bank having defaulted on other debts, but it 
includes a threshold for the amount of defaulted debt, such as a 
certain percent of capital. The Board is seeking comment on whether it 
should include a threshold trigger, rather than restrict all defaults 
based on a credit union's default on other debts (and, if so, what the 
threshold should be).
---------------------------------------------------------------------------

    \90\ Office of the Comptroller of the Currency, Comptroller's 
Licensing Manual: Subordinated Debt (2017), available at https://www.occ.gov/publications-and-resources/publications/comptrollers-licensing-manual/files/licensing-booklet-subordinated-debt.html.
---------------------------------------------------------------------------

    The Board is proposing that the terms of a Subordinated Debt Note 
may not require the credit union to make any form of payment other than 
in cash. A similar provision is not in the Current Secondary Capital 
Rule. However, the Board believes this provision is appropriate, as to 
allow other forms of payment that may not be liquid or may have price 
volatility (for example, foreign currency) results in an Issuing Credit 
Union taking on more risk.
Negative Covenant Provisions
    Similar to the section above, the Board has added a negative 
covenants \91\ section. This section includes requirements similar to 
the OCC's subordinated debt regulations.\92\ Should a credit union 
agree to such provisions, the NCUA would consider the practice unsafe 
and unsound, for the reasons discussed below. Further, these 
provisions, if agreed to, could potentially interfere with the NCUA's 
supervision of a credit union.
---------------------------------------------------------------------------

    \91\ A ``negative covenant'' is a clause found in loan 
agreements that prohibits a borrower from an activity.
    \92\ 12 CFR 5.47(d).
---------------------------------------------------------------------------

    The Board is proposing that a Subordinated Debt Note may not 
contain covenants that require an Issuing Credit Union to maintain a 
minimum amount of Retained Earnings or other financial performance 
provision. Although the Current Secondary Capital Rule does not contain 
this prohibition, this requirement is consistent with the OCC's 
subordinated debt regulations.\93\ To require a credit union to 
maintain a minimum amount of Retained Earnings or other financial 
performance provision could impede the operations of the credit or 
cause the credit union to take on excessive risk to maintain this 
requirement and avoid default.
---------------------------------------------------------------------------

    \93\ Id. 5.47(d)(2)(i).
---------------------------------------------------------------------------

    The Board proposes to prohibit covenants that unreasonably restrict 
an Issuing Credit Union's ability to raise capital through issuance of 
additional Subordinated Debt. This new provision is consistent with the 
OCC's Subordinated Debt regulations.\94\ The ability to issue 
Subordinated Debt provides eligible credit unions a long-term, stable 
source of funding for expansion and the coverage of losses. Therefore, 
such a covenant could impede operations and the financial well-being of 
the Issuing Credit Union and would be considered unsafe and unsound.
---------------------------------------------------------------------------

    \94\ Id. 5.47(d)(2)(ii).
---------------------------------------------------------------------------

    The Board is proposing prohibiting covenants that provide for 
default of Subordinated Debt as a result of an Issuing Credit Union's 
compliance with any law, regulation, or supervisory directive from the 
NCUA (or SSA, if applicable). The Board believes it is unsafe and 
unsound to allow such a covenant, as it would hamper the NCUA's or 
SSA's ability to effectively supervise the credit union or subject the 
credit union to escalated administrative actions for failure to follow 
a directive to avoid default on the Subordinated Debt. Further, it 
could potentially cause monetary fines against the credit union from 
failure to follow a law or regulation in order to avoid default.
    The Board is proposing a new provision which would prohibit 
covenants that provide for default of the Subordinated Debt as the 
result of a change in the ownership, management, or organizational 
structure, or charter of an Issuing Credit Union provided that the 
Issuing Credit Union or resulting institution, as applicable:
     Following such change, agrees to perform all obligations, 
terms, and conditions of the Subordinated Debt; and
     At the time of such change, is not in material default of 
any provision of the Subordinated Debt Note, after giving effect to the 
applicable cure period of not less than 30 calendar days.
    The proposed prohibition is substantially similar to the OCC's 
subordinated debt regulations.\95\ Change in management or 
organizational structure or charter of the Issuing Credit Union should 
have no impact on the Subordinated Debt as it would still be an 
obligation of the Issuing Credit Union under these circumstances. 
Further, to allow such a provision would provide a level of control to 
the investor over the affairs of the Issuing Credit Union. This would 
be contrary to the proposed Subordinated Debt restriction on allowing 
the investor with any management or voting rights in the Issuing Credit 
Union discussed earlier in this section.
---------------------------------------------------------------------------

    \95\ 12 CFR 5.47(d)(2)(iii).
---------------------------------------------------------------------------

    Additionally, in the case of a merger, as discussed in section II. 
(C)(12) of the preamble, the Board is proposing that Subordinated Debt 
can be assumed by the continuing credit union. However, whether the 
Subordinated Debt counts as Regulatory Capital would still be based on 
the continuing credit union's eligibility as discussed in section II. 
(C)(3) of this preamble.
    The Board is proposing a new provision that prohibits covenants 
that provide for default of the Subordinated Debt as the result of an 
act or omission of any third party. The Board believes that agreeing to 
such a provision would be unsafe and unsound for an Issuing Credit 
Union. While credit unions are expected to perform due diligence over 
third parties utilized, a credit union does not control the acts or 
omissions of the third parties. As such, it is not a reasonable 
expectation for the actions of a third party to trigger default or 
acceleration of payment of the Subordinated Debt.
Default Covenants
    The Board is proposing that Subordinated Debt Notes that include 
default covenants must provide the Issuing Credit Union with a 
reasonable cure period of not less than 30 calendar days. This new 
provision provides protection for Issuing Credit Unions by ensuring a 
reasonable cure period in the event of default. Further, this provision 
is consistent with the guidance issued by the OCC.\96\
---------------------------------------------------------------------------

    \96\ Office of the Comptroller of the Currency, Comptroller's 
Licensing Manual: Subordinated Debt, 19 (2017), available at https://www.occ.gov/publications-and-resources/publications/comptrollers-licensing-manual/files/licensing-booklet-subordinated-debt.html 
(stating that ``a bank should have a reasonable opportunity to cure 
the default.'').
---------------------------------------------------------------------------

Minimum Denominations
    In order to provide additional protections to purchasers of 
Subordinated Debt Notes who are Natural Person Accredited Investors, 
the Board is proposing that Subordinated Debt Notes sold or transferred 
to Natural Person Accredited Investors be made in

[[Page 14003]]

minimum denominations of $100,000. In addition, resales of Subordinated 
Debt Notes to Natural Person Accredited Investors could only be made in 
minimum denominations of $10,000. Requiring larger denomination notes, 
and preventing them from being broken into smaller denominations helps 
ensure that the purchasers of the Subordinated Debt Notes are 
sophisticated, high net worth individuals.
    The Board notes that an Issuing Credit Union may establish a larger 
minimum denomination for any issue of Subordinated Debt Notes sold to 
Natural Person Accredited Investors, as long as any such minimum 
denominations are adequately disclosed to potential investors and 
reflected in the related transaction documents. Under the proposed 
rule, there would be no minimum denomination requirements for 
Subordinated Debt Notes sold to Entity Accredited Investors because 
those purchasers are corporate entities who, in the Board's view, are 
sufficiently sophisticated in financial matters such that the 
additional protections afforded by large minimum denomination are not 
necessary.
    The Board notes that, since 1995, the OCC has imposed a $250,000 
minimum denomination requirement in sales of nonconvertible 
subordinated debt, which are limited to ``accredited investors.'' 
Further, in 1992, the OCC proposed a minimum denomination of $100,000 
for such sales, but increased it to $250,000 in the corresponding final 
rule.\97\ Recognizing the potential for overlap in market participants 
for Subordinated Debt Notes issued by Issuing Credit Unions and 
national bank nonconvertible debt instruments, the Board specifically 
requests comment on whether the NCUA's minimum denomination 
requirements should correspond with the OCC's requirements. In other 
words, (a) should the NCUA require minimum denominations of $250,000 in 
sales of Subordinated Debt Notes to Natural Person Accredited 
Investors, and (b) should the NCUA impose a minimum denomination 
requirement on sales of Subordinated Debt Notes to Entity Accredited 
Investors and, if so, should it be $10,000, $250,000, or a different 
threshold?
---------------------------------------------------------------------------

    \97\ 59 FR 54789, 54792 (Nov. 2, 1994).
---------------------------------------------------------------------------

5. Sec.  702.405 Disclosures
    As discussed in section I. (E)(2) of this preamble, the federal 
securities laws and related SEC rules do not require an issuer of 
securities to provide any particular level of disclosure to potential 
investors in securities that are offered, issued, and sold pursuant to 
most exemptions from the registration requirements of the Securities 
Act, nor do they mandate the content of any disclosure an issuer 
chooses to provide. Although the SEC makes it clear that its ``anti-
fraud'' rules apply to all offers and sales of securities, whether 
registered or exempt from registration, disclosure practices vary 
widely.\98\
---------------------------------------------------------------------------

    \98\ See 17 CFR 230.501(a) (``Users of Regulation D (230.500) 
should note the following: (a) Regulation D relates to transactions 
exempted from the registration requirements of section 5 of the 
Securities Act. . . Such transactions are not exempt from the anti-
fraud, civil liability, or other provisions of the federal 
securities laws.'').
---------------------------------------------------------------------------

    The Board believes that adopting a regulatory framework for the 
offer, issuance, and sale of Subordinated Debt Notes will benefit both 
Issuing Credit Unions and investors. Such a framework will provide 
potential investors information that is important to making a decision 
to invest in Subordinated Debt Notes of Issuing Credit Unions, and will 
clearly define the obligations of Issuing Credit Unions. The framework 
will also clarify various other investment considerations that an 
Issuing Credit Union should disclose to potential investors before 
their investment.
    The Board further believes this framework will help promote 
investor confidence, which is particularly important in view of credit 
unions' relative inexperience offering and selling securities. In 
addition, the Board believes that the proposed disclosure requirements 
will reduce the risk of investor claims against an Issuing Credit 
Union, which will provide at least two key benefits. Reducing investor 
claims may encourage credit unions concerned with the risks associated 
with the offer and sale of securities to take advantage of 
opportunities to raise capital through the sale of Subordinated Debt 
Notes. It also helps protect the interests of credit union members, as 
such claims could have an adverse effect on the safety and soundness of 
an Issuing Credit Union.
    The proposed rule requires an Issuing Credit Union to deliver an 
Offering Document to potential investors in Subordinated Debt Notes and 
prescribes certain specific disclosures to be made in the Offering 
Document and in the Subordinated Debt Note itself. Section 702.405 
covers the disclosure requirements for the Subordinated Debt Note, 
while the disclosure requirements for the Offering Document are 
addressed in Sec.  702.408.
    Section 702.405 requires that certain disclosure legends be 
prominently displayed on the face of the Subordinated Debt Note, and 
that certain additional disclosures be included elsewhere in the body 
of the Subordinated Debt Note.\99\ The Board's intention in proposing 
these requirements is to alert potential investors of a number of 
important matters regarding an investment in a Subordinated Debt Note. 
Because the required disclosures are required to be included in the 
Subordinated Debt Note itself, both initial investors (purchasers of 
the Subordinated Debt Note directly from the Issuing Credit Union) and 
persons who subsequently acquire the Subordinated Debt Note will have 
ready access to the information.
---------------------------------------------------------------------------

    \99\ A ``legend'' is a statement on a security, often noting 
restrictions on transfer or sale or other material limitations 
related to the security.
---------------------------------------------------------------------------

    Paragraph (a) of Sec.  702.405 requires that certain disclosure 
legends be prominently displayed on the face of the Subordinated Debt 
Note. Some of the required legends identify risks specific to an 
investment in any Subordinated Debt Notes of Issuing Credit Unions, 
including the:
     Prohibition on a holder of a Subordinated Debt Note from 
using the note as collateral for a loan from the Issuing Credit Union;
     Possibility that a portion of, or all of, the principal 
amount of a Subordinated Debt Note would be reduced to cover any 
deficit in retained earnings at the end of a credit union's fiscal year 
(or more frequently, as determined by the Issuing Credit Union), with 
the result that the amount equal to such reduction would no longer by 
payable on such Subordinated Debt Note; and
     Prohibition on redemption or prepayment of all or a 
portion of outstanding Subordinated Debt Notes prior to maturity, other 
than in limited circumstances involving advance approval of the NCUA or 
in connection with a voluntary liquidation of the Issuing Credit Union.
    Other required legends, such as the requirement to inform investors 
that the Subordinated Debt Notes are not shares in the Issuing Credit 
Union and are not insured by the NCUA, are similar to those that are 
required in offerings of securities by other types of regulated 
financial institutions. The required legend noting that the issuance 
and sale of the Subordinated Debt Note are not registered under the 
Securities Act is intended to alert potential investors that the 
Subordinated Debt Note does not benefit from all of the protections 
that are provided by Securities Act registration, and the disclosure 
legend language identifying the restrictions on

[[Page 14004]]

the sale or other transfer of Subordinated Debt Notes by holders 
informs holders of the notes that they are not freely tradeable, 
alerting them to the fact that the Subordinated Debt Notes may not be 
liquid investments supported by an active (or any) secondary trading 
market.
    This last legend combines elements of legends typically included in 
securities offered, issued and sold in offerings made pursuant to 
certain exemptions from the registration requirements of the Securities 
Act and elements that relate to other parts of the proposed rule that 
are unique to offers and sales of Subordinated Debt Notes, including 
the prohibition on sales or resales to members of the Issuing Credit 
Union's board, Senior Executive Officers and/or Immediate Family 
Members of board members or Senior Executive Officers.
    In paragraph (b) of Sec.  702.405, the Board proposes a requirement 
that an Issuing Credit Union include certain additional disclosures in 
the body of the Subordinated Debt Note. As is the case with the 
disclosure legends required by paragraph (a) of Sec.  702.405, the 
purpose of these disclosures is to inform potential investors of a 
number of important matters regarding an investment in the Subordinated 
Debt Note.
    The disclosures required under paragraph (b) in the proposed rule 
are intended to draw attention to certain potential repayment risks if 
an Issuing Credit Union is:
     Subject to an involuntary liquidation;
     ``Undercapitalized'' (for credit unions that are not New 
Credit Unions) or ``Moderately Capitalized'' (for credit unions that 
are New Credit Unions) and fails to submit or implement an acceptable 
restoration plan; or
     Classified as ``Critically Undercapitalized'' (for credit 
unions that are not New Credit Unions) or ``Uncapitalized'' (for credit 
unions that are New Credit Unions).
    The required disclosure regarding the consequences of an 
involuntary liquidation must describe the payout priority and level of 
subordination as provided in Sec.  709.5(b). The disclosure regarding 
``Undercapitalized'' or ``Moderately Capitalized'' status of an Issuing 
Credit Union must address the additional restrictions and requirements 
that would be imposed on the Issuing Credit Union if it fails to submit 
an acceptable net worth restoration plan, capital restoration plan, or 
revised business plan or if it materially fails to implement a plan 
that was approved by the NCUA (which restrictions and requirement are 
those applicable to a ``Significantly Undercapitalized'' credit union, 
for credit unions that are not New Credit Unions) or a ``Marginally 
Capitalized'' credit union (for credit unions that are New Credit 
Unions).
    The disclosure regarding an Issuing Credit Union that has been 
classified as ``Critically Undercapitalized'' or ``Uncapitalized'' must 
indicate that, beginning 60 days after the effective date of the 
``Critically Undercapitalized'' or ``Uncapitalized'' classification, 
the Issuing Credit Union is prohibited from paying principal of, or 
interest on, its Subordinated Debt Notes until it is reauthorized to do 
so by the NCUA, in writing (although unpaid interest may continue to 
accrue).
    Finally, paragraph (b) also requires an Issuing Credit Union to 
provide an overview of the risks associated with authority of the NCUA 
or any applicable SSA to conserve or liquidate a credit union under 
federal or state law. As noted in the discussion of Sec.  702.408, in 
addition to making these disclosures in the Subordinated Debt Note, 
substantially similar disclosures will also be required to be included 
in the Offering Document.
    Certain of the disclosures required by the proposed rule correspond 
to disclosure requirements set forth in the Current Secondary Capital 
Rule, including that Secondary Capital is not insured by the NCUA and 
that Secondary Capital is subordinate to all other claims on the assets 
of the Issuing Credit Union, including member shareholders, creditors, 
and the NCUSIF. The Board acknowledges, however, that the disclosure 
requirements for all Subordinated Debt Notes in Sec.  702.405 of the 
proposed rule exceed current disclosure requirements in the Current 
Secondary Capital Rule.
    As discussed earlier in this section, the Board believes that its 
proposed regulatory framework for the offer, issuance, and sale of 
Subordinated Debt Notes will benefit both Issuing Credit Unions and 
investors in a number of ways, including promoting investor confidence 
and reducing investor claims. Further, the requirements underlying this 
framework, including these proposed disclosures, have been in use in 
securities offerings for a number of years and are familiar to 
investors, market professionals, and legal advisors. Accordingly, the 
Board believes that the benefit from these proposed disclosure 
requirements far outweighs any associated burden associated in 
complying with them.
6. Sec.  702.406 Requirements Related to the Offer, Sale, and Issuance 
of Subordinated Debt Notes
    In addition to specifying the disclosures required to be provided 
to potential investors in Subordinated Debt Notes, the proposed rule 
addresses other key components of a regulatory framework for the offer, 
issuance, and sale of Subordinated Debt Notes. The provisions of Sec.  
702.406 cover a number of those key components, including:
     Delivery requirements of Offering Documents to potential 
investors;
     Limitations on the types of investors who may purchase and 
hold Subordinated Debt Notes (either in the initial sale of the 
Subordinated Debt Notes or in connection with any resales or other 
transfers of Subordinated Debt Notes);
     Qualification standards for trustees engaged by an Issuing 
Credit Union; and
     Policies and procedures to be followed by Issuing Credit 
Unions in connection with offers, issuances, and sales of their 
Subordinated Debt Notes.
    Paragraph (a) of Sec.  702.406 obligates an Issuing Credit Union to 
deliver an Offering Document that satisfies the requirements of Sec.  
702.408(e) to each purchaser of its Subordinated Debt Notes. While 
Sec.  702.408(e) specifies certain disclosure topics that must be 
addressed in every Offering Document, paragraph (a) of Sec.  702.406 
reminds Issuing Credit Unions that those are the minimum required 
disclosures and, depending on the surrounding facts and circumstances, 
additional disclosure may be necessary to provide potential investors 
with material information relevant to an investment decision.
    The proposed rule's obligation to provide such further material 
information as may be necessary to make the required disclosures, in 
the light of the circumstances under which those disclosures have been 
made, not misleading, is consistent with the anti-fraud concepts 
embodied in the federal securities laws. These include Rule 10b-5 under 
the Exchange Act.\100\ As noted earlier, the anti-fraud rules apply to 
all offers and sales of securities, whether or not such offers and 
sales are registered under the Securities Act.
---------------------------------------------------------------------------

    \100\ 17 CFR 240.10b-5. In pertinent part, the rule provides:
    It shall be unlawful for any person, directly or indirectly, by 
the use of any means or instrumentality of interstate commerce, or 
of the mails or of any facility of any national securities exchange 
. . . (b) To make any untrue statement of a material fact or to omit 
to state a material fact necessary in order to make the statements 
made, in the light of the circumstances under which they were made, 
not misleading . . . in connection with the purchase or sale of any 
security.

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[[Page 14005]]

    Paragraph (a) also addresses the timing of delivery of the Offering 
Document by an Issuing Credit Union, requiring that the document be 
delivered in a reasonable time before any issuance and sale. The 
``reasonable time'' requirement is consistent with a number of SEC 
rules relating to securities offerings exempt from Securities Act 
registration.\101\ While the Board believes an Issuing Credit Union 
should determine what constitutes a reasonable time, the intent of the 
requirement is to ensure that potential investors receive the Offering 
Document sufficiently in advance of making a purchase decision so to 
provide them with a meaningful opportunity to review the document and, 
if desired, consult with financial and/or legal advisors.
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    \101\ See, e.g., 17 CFR 230.506(b).
---------------------------------------------------------------------------

    Paragraphs (b) and (c) of Sec.  702.406 impose limitations on who 
may invest in Subordinated Debt Notes, and cover both initial 
purchasers of Subordinated Debt Notes (purchasers buying Subordinated 
Debt Notes in the initial issuance from an Issuing Credit Union) and 
subsequent purchasers or transferees of Subordinated Debt Notes who 
acquire the securities from an existing holder of a note.
    Paragraph (b) prohibits issuances and sales of Subordinated Debt 
Notes outside of the United States (any one of the states thereof, 
including the District of Columbia, its territories, and its 
possessions). The Board determined not to allow non-US investors from 
purchasing or holding any Subordinated Debt Notes because the risks and 
complexities associated with offshore offerings of securities 
outweighed the potential benefits to credit unions, especially given 
that credit unions generally are not significantly involved in foreign 
transactions. The Board specifically is requesting comment as to 
whether this restriction unduly limits the marketability and 
functionality of Subordinated Debt Notes issuances.
    Paragraph (c) prohibits issuances and sales of Subordinated Debt 
Notes to persons other than Accredited Investors. The definition of 
``Accredited Investor'' in Sec.  702.402 includes two types of 
Accredited Investors; the definitions of ``Entity Accredited 
Investors'' and ``Natural Person Accredited Investors'' tie to the 
categories included in the definition of ``Accredited Investor'' in 
Rule 501(a) of Regulation D under the Securities Act, with one 
important exception.\102\ The definition of ``Accredited Investor'' 
omits certain persons affiliated with an Issuing Credit Union--board 
members and senior executive officers of an Issuing Credit Union are 
not ``Accredited Investors'' for purposes of the proposed rule, nor are 
Immediate Family Members of any such board member or senior executive 
officer. As a result, board members and senior executive officers of 
the Issuing Credit Union and their Immediate Family Members are 
prohibited from purchasing or holding Subordinated Debt Notes of that 
Issuing Credit Union.
---------------------------------------------------------------------------

    \102\ 17 CFR 230.501(a).
---------------------------------------------------------------------------

    The Board believes that limiting the potential pool of investors is 
appropriate given the risks involved in investing in securities that 
share the characteristics of Subordinated Debt Notes. It also believes 
that investors should possess a level of sophistication that permits 
them to understand the terms of Subordinated Debt Notes and adequately 
assess the risks involved in an investment in this type of security and 
in the Issuing Credit Union. The Board notes that the OCC restricts 
sales of national banks' nonconvertible Subordinated Debt to Accredited 
Investors, but does not impose this restriction on other sales of 
Subordinated Debt instruments.\103\ The Board specifically is 
requesting comment on whether restricting sales of Subordinated Debt 
Notes to Accredited Investors unduly limits the marketability and 
functionality of Subordinated Debt Notes issuances.
---------------------------------------------------------------------------

    \103\ 12 CFR part 5.
---------------------------------------------------------------------------

    As noted above, the proposed rule also distinguishes between 
Natural Person Accredited Investors and Entity Accredited Investors. 
While this distinction matters in important ways for offers and sales 
of Subordinated Debt Notes, including minimum denomination 
requirements, Offering Document approval processes, and resale 
provisions, it does not alter the Board's belief that every investor in 
Subordinated Debt Notes must be sophisticated and able to assess the 
risks inherent in this type of investment. Rather, the Board believes 
that Entity Accredited Investors are likely to be even more 
sophisticated investors than Natural Person Accredited Investors and, 
therefore, some of the restrictions that the proposed rule places on 
Natural Person Accredited Investors are not necessary for the 
protection of Entity Accredited Investors. The Board recognizes that 
the OCC does not distinguish between categories of Accredited Investors 
in this same way. Therefore, the Board specifically requests comment on 
whether this distinction between Entity Accredited Investors and 
Natural Person Accredited Investors unduly limits the marketability and 
functionality of Subordinated Debt Notes issuances.
    The Board also believes it is inappropriate to permit an Issuing 
Credit Union's board members, Senior Executive Officers, or their 
Immediate Family Members to purchase or hold Subordinated Debt Notes 
due to conflict of interest and anti-fraud concerns that certain of 
those such individuals exercise control over the Issuing Credit Union 
and have, or could gain, access to material non-public information in 
respect of the Issuing Credit Union and/or the Subordinated Debt Notes. 
The Board specifically is requesting comment as to whether this 
restriction unduly limits the marketability and functionality of 
Subordinated Debt Notes issuances.
    For the same reasons as there are restrictions on initial 
purchasers of Subordinated Debt Notes, paragraph (c), paragraph (g), 
and Sec.  702.404(a)(10) operate together to prohibit the reissuance or 
resale of Subordinated Debt Notes to persons other than Accredited 
Investors. They also prohibit the reissuance, resale, or other transfer 
of Subordinated Debt Notes to an Issuing Credit Union's board members, 
senior executive officers, or their Immediate Family Members.
    Further, the ability to reissue or resell Subordinated Debt Notes 
after their initial issuance depends on the nature of the initial 
purchaser of the securities. Subordinated Debt Notes initially 
purchased by an Entity Accredited Investor may be reissued or resold 
only to another Entity Accredited Investor, while Subordinated Debt 
Notes initially purchased by a Natural Person Accredited Investor may 
be reissued or resold to an Entity Accredited Investor or a Natural 
Person Accredited Investor.
    Paragraph (c) of Sec.  702.406 also requires an Issuing Credit 
Union to take certain steps to verify the Accredited Investor status of 
potential purchasers. Issuing Credit Unions will be required to obtain 
a Certificate of Accredited Investor Status from each potential 
purchaser and take additional steps to verify a potential investor's 
status by reviewing specific financial information from tax returns, 
brokerage statements and similar documentation, or by receiving a 
certification of a potential investor's status as an Accredited 
Investor from a broker-dealer, registered investment adviser, attorney, 
or certified public accountant. These verification requirements and 
methods are substantially similar to the requirements and methods 
provided in Rule 506(c) of Regulation D under the Securities

[[Page 14006]]

Act.\104\ The Board believes that following practices that have been in 
use in securities offerings for a number of years and which are 
familiar to investors, market professionals, and legal advisors will 
allow Issuing Credit Unions to more easily implement investor 
verification protocols that meet the requirements of the proposed rule.
---------------------------------------------------------------------------

    \104\ See 17 CFR 230.506(c).
---------------------------------------------------------------------------

    Paragraph (d) of Sec.  702.406 sets qualification standards for 
trustees engaged by Issuing Credit Unions in connection with issuances 
and sales of Subordinated Debt Notes. Under the proposed rule, an 
Issuing Credit Union is not required to engage a trustee.\105\ However, 
if an Issuing Credit Union chooses to engage a trustee, the trustee 
must meet the qualification requirements of the Trust Indenture Act of 
1939, as amended (TIA), related TIA rules, and any applicable state law 
qualification requirements.
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    \105\ With certain exceptions, trustees generally are required 
only in connection with offerings of debt securities registered 
under the Securities Act.
---------------------------------------------------------------------------

    Because of the significance of the trustee's role in issuances of 
debt securities, the Board believes it is appropriate to impose these 
standards to ensure the competence, independence, and financial 
soundness of the trustee, and that employing the market-accepted 
qualification standards set forth in the TIA sufficiently addresses 
those matters. Even if an offering of debt securities has a qualified 
trustee, however, the indenture administered by that qualified trustee 
does not need to meet all of the requirements of the TIA applicable to 
the form and content of indentures.\106\
---------------------------------------------------------------------------

    \106\ 15 U.S.C. 77aaa-77bbbb.
---------------------------------------------------------------------------

    Paragraph (e) of Sec.  702.406 covers sales practices of an Issuing 
Credit Union relating to offers, issuances, and sales of Subordinated 
Debt Notes, including at any office of the Issuing Credit Union. In 
this context, an ``office'' means any premises used by the Issuing 
Credit Union that is identified to the public through advertising or 
signage using the Issuing Credit Union's name, trade name, or logo.
    The proposed rule permits sales activities by an Issuing Credit 
Union of its own Subordinated Debt Notes if the Issuing Credit Union 
completes a written application and receives approval from its 
Appropriate Supervision Office. The application requires, in 
significant part, that the Issuing Credit Union provide a written 
description of its plan to comply with the sales practices requirements 
delineated in paragraph (e).
    The substantive requirements of paragraph (e) are intended to 
prescribe acceptable sales practices that are consistent with general 
industry norms for sales of securities, while discouraging sales 
practices the Board believes are inappropriate for credit unions and 
will help reduce the possibility that an Issuing Credit Union, 
affiliated credit union service organization (CUSO), or their 
respective employees violate applicable securities laws.
    In particular, the proposed rule prohibits the payment of direct or 
indirect compensation in the form of commissions, bonuses, or similar 
payments to any employee of the Issuing Credit Union or a CUSO who 
assists in the marketing and sale of the Issuing Credit Union's 
Subordinated Debt Notes. The prohibition does not apply to payments 
made to securities personnel of registered broker-dealers or payments 
otherwise permitted by applicable law, provided that such payments are 
consistent with industry norms.
    Paragraph (e) also places limits on the Issuing Credit Union and/or 
CUSO personnel who may engage in the marketing and sales efforts. Under 
the proposed rule, marketing activities and sales may only be 
undertaken by regular, full-time employees of the Issuing Credit Union 
and/or securities personnel who are subject to supervision by a 
registered broker-dealer (who may be employees of the Issuing Credit 
Union's affiliated CUSO that is assisting in the marketing and sale of 
the Issuing Credit Union's Subordinated Debt Notes).
    All sales, including resales, of securities must comply with 
applicable securities laws. Paragraph (g) of Sec.  702.406 prescribes 
the ways in which Subordinated Debt Notes may be resold following their 
initial sale by an Issuing Credit Union. Subordinated Debt Notes sold 
by an Issuing Credit Union pursuant to an exemption from registration 
under the Securities Act may only be resold pursuant to the same or 
another exemption from registration under the Securities Act. This 
resale exemption may be the same one on which an Issuing Credit Union 
relied in connection with the initial sale of the Subordinated Debt 
Notes or it may be another available exemption.
7. Sec.  702.407 Discounting of Amount Treated as Regulatory Capital
    The Board is proposing to adopt the current Sec.  701.34 
requirements for discounting the Subordinated Debt amount for 
Regulatory Capital purposes with a technical refinement on the 
calculation of the amount.
    The Current Secondary Capital Rule requires a credit union to use 
the lesser of the remaining balance of the accounts after any 
redemption and losses; or the original amount of secondary capital 
reduced by 20 percent annually starting once the remaining maturity of 
the Secondary Capital is less than five years. This treatment is 
consistent with the treatment of subordinated debt by the FDIC and the 
OCC.
    The Board is proposing to simplify how a credit union would base 
its discounting calculation on the net amount outstanding at the time 
the credit union conducts its calculation. This means that, if a credit 
union prepays any of its Subordinated Debt, the amount that would be 
discounted would be the net amount that remains after the prepayment. 
By doing this, the Board is making the proposed rule more consistent 
with the FDIC and OCC treatment of subordinated debt that counts 
towards Tier 2 capital.\107\
---------------------------------------------------------------------------

    \107\ 12 CFR 3.20(d)(iv); 12 CFR 324.20(d)(iv).
---------------------------------------------------------------------------

    For example, if ABC FCU originally issued a $20 million 
Subordinated Debt Note and prepays $10 million of the original note, 
the balance treated as Regulatory Capital would be calculated using the 
remaining outstanding amount ($10 million), not the original 
Subordinated Debt Note ($20 million).
    The following chart shows the outstanding balance of the 
Subordinated Debt, on a percentage basis that counts as Regulatory 
Capital:

------------------------------------------------------------------------
                                        Balance treated as Regulatory
        Remaining maturity                    Capital (percent)
------------------------------------------------------------------------
Four to less than five years......  80
Three to less than four years.....  60
Two to less than three years......  40
One to less than two years........  20
Less than one year................  0
------------------------------------------------------------------------

    The proposed rule would require an Issuing Credit Union to apply 
the percentage of the outstanding Subordinated Debt that counts as 
Regulatory Capital included in the Net Worth and/or the RBC Ratio to 
each quarter-end Call Report cycle, because Net Worth and the RBC 
Ratios are required to be calculated at quarter-end. For example, if 
ABC FCU has $10 million in outstanding Subordinated Debt, the full 
amount would count towards Regulatory Capital if it matures in five 
years or more. Once the

[[Page 14007]]

remaining maturity of the Subordinated Debt is less than five years, 
the amount of outstanding Subordinated Debt that counts towards 
Regulatory Capital will reduce by 20 percent annually. This means that 
the amount that would count towards Regulatory Capital would be:
     $10 million if the remaining maturity is at least five 
years;
     $8 million if the remaining maturity is at least four 
years and less than five years;
     $6 million if the remaining maturity is at least three 
years and less than four years;
     $4 million if the remaining maturity is at least two years 
and less than three years;
     $2 million if the remaining maturity is at least one year 
and less than two years; and
     No amount would count towards Regulatory Capital if the 
maturity is less than one year.
    As discussed in section II. (C)(11) of this preamble, the proposal 
would create a new authority to allow FCUs to prepay Subordinated Debt 
if the prepayment option is clearly disclosed in the Subordinated Debt 
Note and approval is granted by the Appropriate Supervision Office, in 
writing. As discussed above, if an FCU does prepay a portion of the 
Subordinated Debt, only the remaining outstanding balance of the 
Subordinated Debt would be used to calculate the balance treated as 
Regulatory Capital.
8. Sec.  702.408 Preapproval To Issue Subordinated Debt
    The Board is proposing that eligible credit unions be required to 
submit an application and receive written preapproval from the NCUA 
before issuing Subordinated Debt. Currently, under the Current 
Secondary Capital Rule, a federally chartered LICU must receive 
approval of its secondary capital plan by the NCUA before it may offer 
secondary capital accounts. A federally insured, state-chartered LICU 
must receive approval of its secondary capital plan by the applicable 
SSA, with the NCUA's concurrence, before it may offer secondary 
capital.
    The Board remains dedicated to a requirement for an eligible credit 
union to obtain written preapproval before issuing Subordinated Debt as 
it views this step as an important prudential safeguard. The Board 
believes a preapproval process is part of a credit union's sound 
management plan, and helps the NCUA ensure that planned debt securities 
are structured in such a manner as to appropriately protect the NCUSIF.
    As discussed below, the Board proposes to require a credit union to 
include information on 15 specific topics in its initial application to 
issue Subordinated Debt. The Board recognizes the many potential 
benefits that an issuance of Subordinated Debt Notes may confer on an 
Issuing Credit Union, but it also appreciates the concomitant 
complexities and risks. The decision to offer and sell securities such 
as Subordinated Debt Notes should be made only after careful 
consideration, preparation, and diligence by the Issuing Credit Union, 
including with professional advisors as warranted. For this reason, the 
Board is proposing to continue to require all credit unions 
contemplating an offer, issuance, and sale of Subordinated Debt Notes 
to receive the NCUA's prior written approval before engaging in such 
activity.
Background
    In 2006,\108\ the Board amended Sec.  701.34 to add a requirement 
for regulatory approval of a LICU's secondary capital plan before it 
could issue such accounts. The Board highlighted, by requiring prior 
approval of a secondary capital plan, that it was strengthening 
supervisory oversight and detection of lenient practices in several 
ways. First, it will prevent LICUs from accepting and using secondary 
capital for purposes and in amounts that are improper or unsound. 
Second, the approval requirement will ensure that secondary capital 
plans are evaluated and critiqued by the NCUA Regional Director before 
being implemented. Third, for both the NCUA and LICUs, an approved 
secondary capital plan will document parameters to guide the proper 
implementation of secondary capital, and to measure the LICU's progress 
and performance.\109\
---------------------------------------------------------------------------

    \108\ 71 FR 4234 (Jan. 26, 2006). The last substantive 
amendments to the NCUA's secondary capital regulations took place in 
2010 with the addition of language regarding secondary capital 
received under the Community Development Capital Initiative of 2010. 
75 FR 57843 (Sept. 23, 2010).
    \109\ 71 FR 4234, 4237 (Jan. 26, 2006).
---------------------------------------------------------------------------

    In September 2019, the NCUA issued a Letter to Credit Unions,\110\ 
``Evaluating Secondary Capital Plans,'' which included a Supervisory 
Letter to NCUA staff. The Supervisory Letter provided information about 
the authority of LICUs to offer secondary capital accounts and 
specified a consistent framework for the analysis and approval or 
denial of secondary capital plans submitted to the NCUA for approval.
---------------------------------------------------------------------------

    \110\ Supervisory Letter No. 19-01, (Sept. 16, 2019), available 
at https://www.ncua.gov/files/supervisory-letters/SL-19-01-evaluating-secondary-capital-plans.pdf.
---------------------------------------------------------------------------

    As part of this proposed rule, the Board is looking to enhance and 
clarify much of the existing secondary capital account plan 
requirements in paragraphs (b), (c), and (d) of the Current Secondary 
Capital Rule by adding similar provisions to the proposed Sec.  702.408 
of the proposed rule to govern the issuance of Subordinated Debt. All 
of the current secondary capital plan requirements are incorporated 
into these proposed rule requirements with additional provisions aimed 
at greater clarification of the NCUA's expectations for diligence and 
supporting analysis. The proposed review and analysis of a credit 
union's Subordinated Debt documents by the NCUA is intended to make the 
preapproval process more efficient while ensuring that credit union 
applicants comply with applicable laws and regulations and that the 
issuance of Subordinated Debt represents a safe and sound endeavor.
    The NCUA's analysis of applications will be fact-specific to each 
credit union's situation at the time a credit union submits its 
Subordinated Debt application documents for approval. It is important 
to note that these proposed preapproval requirements specifically state 
that the requirements represent the minimum information an eligible 
credit union must include in the application.
Preapproval for FISCUs To Issue Subordinated Debt
    Under this proposed rule, a FISCU would be subject to the 
preapproval requirements in Sec.  702.408. Under this proposal, FISCUs 
would also be subject to the requirements of Sec.  702.409, which, as 
discussed in section II. (C)(9) of this preamble, would contain 
additional preapproval requirements for FISCUs.
Preapproval Requirements and Steps
    The Board is proposing the following preapproval requirements as 
part of an initial application process. Questions from the NCUA arising 
during the proposed preapproval process could result in the need for a 
credit union to submit additional documents. In addition, certain 
credit unions will need preapproval of the Offering Documents depending 
on whether the investor is a Natural Person Accredited Investor or an 
Entity Accredited Investor as outlined in Sec.  702.408(d).

[[Page 14008]]



------------------------------------------------------------------------
      Preapproval and reporting steps           Proposed rule section
------------------------------------------------------------------------
Initial Application and NCUA Approval        Sec.   702.408(b) and (c).
 Process.
Offering Documents and NCUA Approval         Sec.   702.408(d) through
 Process, Submission of Offering Documents    (g).
 after use.
Submission of All Documents after Issuance.  Sec.   702.408(i).
------------------------------------------------------------------------

Initial Application To Issue Subordinated Debt
    The Board is proposing that all eligible \111\ credit unions be 
required to submit an initial application (Sec.  702.408(b)) to the 
Appropriate Supervision Office that, at a minimum, includes the 
following 15 items:
---------------------------------------------------------------------------

    \111\ Proposed 702.403.
---------------------------------------------------------------------------

    (1) A statement indicating how the credit union qualifies to issue 
Subordinated Debt given the eligibility requirements of Sec.  702.403 
with additional supporting analysis if anticipating to meet the 
requirements of a LICU or Complex Credit Union within 24 months after 
issuance of the Subordinated Debt. The Board is proposing to grant 
credit unions that do not yet meet the eligibility requirements the 
opportunity to obtain preapproval if they can reasonably demonstrate 
they will become an eligible LICU or Complex Credit Union within the 
24-month timeframe. A credit union's supporting analysis must indicate 
which of the eligibility criteria it anticipates meeting.
    For an eligible credit union, the Board does not believe this 
proposed requirement will add any significant burden. For a credit 
union that is not yet eligible, this proposed requirement will allow 
the Board to determine if such credit union may reasonably become 
eligible within the required time period;
    (2) The maximum aggregate principal amount of Subordinated Debt 
Notes and the maximum number of discrete issuances of Subordinated Debt 
Notes that the credit union is proposing to issue within the period 
allowed under subsection (k) of this section, which is one year from 
the approval of the initial application or Offering Document, depending 
on whether the investor is a Natural Person Accredited Investor or an 
Entity Accredited Investor. The Board is adopting the requirement from 
the paragraph (b)(1)(i) of the Current Secondary Capital Rule for the 
maximum aggregate amount and expanding this to include multiple 
issuances. The Board recognizes the potential efficiency gains for both 
the NCUA and the credit union in providing a preapproval decision 
authorizing a number of discrete issuances within the period allowed as 
doing so could be more convenient in meeting the credit union's goals 
while eliminating the prospect of multiple application reviews by the 
NCUA. If an initial application contemplates more than one issuance in 
the period allowed,\112\ the credit union should include details of 
each of the planned issuance amounts including, but not limited to; the 
dollar amounts for each issuance, the estimated issuance dates and 
maturities, and any other contractual terms of the individual 
Subordinated Debt Notes. The credit union must ensure its aggregate 
principal amount of Subordinated Debt issuance does not exceed the 
maximum borrowing limit set forth in Sec.  741.2 of the NCUA's 
regulations or cause a credit union to be in violation of any other 
applicable regulatory limits or requirements, or any written agreement 
or other approved plan with the NCUA.
---------------------------------------------------------------------------

    \112\ Proposed 702.408(k).
---------------------------------------------------------------------------

    As part of this requirement, the Board is requesting an analysis to 
support that a credit union has considered all other borrowing needs, 
as well as contingent liquidity needs, over the life of the planned 
Subordinated Debt issuance and has measured the aggregate amount of all 
borrowing activities. If a credit union's proposed Subordinated Debt 
issuance would increase the overall borrowing amounts to an unsafe 
level at any time over the life of the Subordinated Debt, the NCUA will 
deem this exposure to be unsafe and unsound.
    (3) The estimated number of investors and the status of such 
investors (Natural Person Accredited Investors and/or Entity Accredited 
Investors) to whom the credit union intends to offer and sell the 
Subordinated Debt Notes. Paragraph (b) of the Current Secondary Capital 
Rule limits eligible investors in secondary capital to member or 
nonmember non-natural person investors.\113\ The Current Secondary 
Capital Rule's limitation prevents the sale of secondary capital to 
consumers who could lack the ability to understand the risks associated 
with an uninsured secondary capital account.
---------------------------------------------------------------------------

    \113\ 12 CFR 701.34(b).
---------------------------------------------------------------------------

    The Board is proposing to revise the investor requirement from non-
natural person investors to Accredited Investors in accordance with the 
provisions of Regulation D of the Securities Act.
    The specific identification and certification of an Accredited 
Investor is a requirement of the proposed Sec.  702.406(c). The 
certification requires a credit union receive an unambiguous, signed, 
one-page certification from any potential investor of a Subordinated 
Debt Note. Depending on whether the Subordinated Debt Notes are sold 
exclusively to Entity Accredited Investors or whether the potential 
investors include at least one Natural Person Accredited Investor 
determines if a credit union would need to have its Offering Documents 
approved for use by the NCUA.
    The Board is proposing to require a credit union to specify the 
number of investors because this information will be used in the NCUA's 
evaluation of a credit union's analysis of the use of Subordinated Debt 
and its safe and sound management. Further, the Board is proposing to 
require credit unions to identify the classification of potential 
investors, because such classification will impact additional review 
steps in the proposed preapproval process.
    (4) A statement identifying any outstanding Subordinated Debt and 
Grandfathered Secondary Capital previously issued by the credit union. 
The Board does not see this as a significant burden for credit unions 
because they have an incumbent risk management responsibility to track 
and manage their issuance. The Board is proposing to require this 
information because it will assist the NCUA in verifying if a credit 
union has prior experience with Subordinated Debt;
    (5) A copy of the credit union's strategic plan, business plan, and 
budget, and an explanation of how the credit union intends to use the 
Subordinated Debt in conformity with those plans. The Board is 
clarifying the expectation that a credit union demonstrate how a 
planned issuance complies with each of its strategic, business, and 
budgeting plans consistent with its board's approved intentions. The 
NCUA issued a Supervisory Letter in September 2019 providing guidance 
to field staff regarding the authority of LICUs to offer Secondary 
Capital accounts.\114\ The Supervisory Letter clarifies the framework 
the NCUA uses to analyze

[[Page 14009]]

and approve or deny Secondary Capital plans.
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    \114\ Supervisory Letter No. 19-01, (Sept. 16, 2019), available 
at https://www.ncua.gov/files/supervisory-letters/SL-19-01-evaluating-secondary-capital-plans.pdf.
---------------------------------------------------------------------------

    With the proposed rule, the Board's expectation is that a credit 
union have a clear business objective for offering Subordinated Debt as 
envisioned and must explain how the additional costs and risks are 
acceptable and consistent with the credit union's business model. The 
plan must explain why the Subordinated Debt plan is consistent with a 
credit union's mission, budget, and strategic goals.
    An eligible credit union must also explain how (when necessary) its 
strategic plan, business plan, and budget will need to be updated if 
the initial application to issue Subordinated Debt is approved.\115\ As 
part of this endeavor, a credit union will need to make clear in its 
application that it has the expertise to safely and soundly manage the 
planned use(s) of Subordinated Debt or has budgeted to obtain the 
necessary expertise and will secure it before deploying an approved 
Subordinated Debt issuance. The Board believes this requirement will 
demonstrate a credit union's due diligence in developing a plan to 
issue Subordinated Debt or Grandfathered Secondary Capital.
---------------------------------------------------------------------------

    \115\ An eligible credit union does not need to explicitly 
incorporate the secondary capital plan into its board-approved 
strategic plan, business plan, and budget until the plan is approved 
by the NCUA, and then only to the extent it is necessary and 
material enough to warrant a change to the credit union's approved 
plans and budget.
---------------------------------------------------------------------------

    (6) An analysis of how the credit union will provide for liquidity 
to repay the Subordinated Debt upon maturity of the Subordinated Debt. 
The Board sees this as a critical requirement of the initial 
application and notes that this is a requirement in the Current 
Secondary Capital Rule. Generally, Subordinated Debt plans involve a 
combination of new services and balance sheet activities, which 
introduce the potential to increase risk to earnings and capital if 
they are not adequately identified, measured, monitored, and 
controlled.
    A credit union should also guard against future threats to its 
liquidity; this is of particular importance to the final determination 
about whether an application is a safe and sound endeavor. A credit 
union's ability to demonstrate it can reliably estimate liquidity needs 
and changes in its liquidity positions that result from Subordinated 
Debt over a multi-year horizon is necessary for both a credit union and 
the NCUA to understand the potential future threats.
    A credit union that uses a leveraged growth strategy that 
significantly increases its credit, interest rate, and liquidity risks 
may find it has potentially excessive liquidity risk under some adverse 
scenarios. Excessive liquidity risk can arise from large increases in 
nonperforming loans and/or significant unrealized losses on 
investments. The credit union should understand how these risks arise, 
what drives such risks (for example, unmet growth targets, rising 
unemployment, recession, rapid changes in interest rates, etc.), and 
understand whether the risks could pose a threat when a Subordinated 
Debt obligation comes due.
    A credit union's reliance on Subordinated Debt can be destabilizing 
if the credit union fails to replace the Subordinated Debt with net 
worth (typically by building its retained earnings) over time. If the 
Subordinated Debt matures during a time when it is experiencing 
financial distress and is in a weakened capital position, a credit 
union may not be able to replace Subordinated Debt with a new issuance. 
A market for such a credit union to issue new Subordinated Debt could 
disappear, leaving the credit union with an abrupt decline in loss-
absorbing capital when it is most needed. These factors, and 
availability of investors at the time of potential reissuance, 
underscore why a credit union needs to have a reasonable and 
supportable projection of its future liquidity positions and earnings 
under a variety of plausible scenarios, including both optimistic and 
pessimistic assumptions, over measurement horizons that align with the 
credit union's expected activities.
    The analysis must include an explanation of how Subordinated Debt 
is to be repaid and how the credit union's liquidity planning is 
utilizing a range of possible economic conditions or its initial 
application may be found deficient for safety and soundness reasons. 
The analysis should also incorporate the credit union's reliance on 
other funding alternatives.
    (7) Pro Forma Financial Statements (balance sheet, income 
statement, and statement of cash flows), including any off-balance 
sheet items, covering at least five years. Analytical support for key 
assumptions and key assumption changes must be included in the 
application. Key assumptions include, but are not limited to, interest 
rate, liquidity, and credit loss scenarios. The Board notes that 
current Sec.  701.34 requires a LICU to submit a minimum of two years 
of Pro Forma Financial Statements.\116\ As discussed below, the Board 
is proposing to expand and clarify this requirement to ensure credit 
unions evaluate risks associated with issuing Subordinated Debt. 
Analytical support for key assumptions and the respective changes must 
be included in the application. Key assumptions include, but are not 
limited to, interest rate, liquidity, and credit loss scenarios.
---------------------------------------------------------------------------

    \116\ 12 CFR 701.34(b)(1)(v).
---------------------------------------------------------------------------

    The Board is proposing to extend the time horizon of the pro forma 
financial statements to five years compared to the Current Secondary 
Capital Rule of two years.\117\ Given the minimum maturity requirement 
of five years \118\ and the full amount available for Regulatory 
Capital treatment with a remaining maturity in excess of five years, 
the Board is proposing that the analysis supporting the pro forma 
financials be extended to the same five years. The Board is interested 
in receiving comments on this change.
---------------------------------------------------------------------------

    \117\ Id.
    \118\ This is a requirement of both the current rule (12 CFR 
701.34(b)(4)) and the proposed rule (proposed 702.404(a)(2)).
---------------------------------------------------------------------------

    The pro forma financial statements are a critical part of the 
credit union's analysis to show the effects of proposed transactions as 
if they actually occurred. Pro forma financial statements are a 
routine, yet essential, tool for documenting and testing the soundness 
of the assumptions a credit union relies on to project future 
performance. Subordinated Debt can have a significant impact on a 
credit union's revenues and expenses. Such borrowings are interest 
bearing and can have a higher cost than most forms of borrowing because 
they are uninsured and subordinate to all other claims. There are also 
other potential costs associated with a credit union's safe and sound 
oversight of Subordinated Debt (for example, staffing needs, expanded 
credit union systems, third-party assistance, and other costs 
associated with expanding services).
    When developing pro forma financial statements, an eligible credit 
union should include projections of expected earnings in a variety of 
plausible scenarios, including both optimistic and pessimistic 
assumptions, over measurement horizons that align with the credit 
union's expected activities. In addition, analyses should address the 
sensitivity of any key underlying assumptions to reasonable changes in 
their amount/degree. Forecasting earnings and Regulatory Capital under 
different market risk factors is a sound practice for credit unions. To 
properly identify and measure the range of potential outcomes, a credit 
union needs to conduct scenario analysis to see how different key 
assumptions affect

[[Page 14010]]

earnings and net worth for a variety of plausible scenarios.
    A credit union needs to determine if the aggregate amount of 
Subordinated Debt, coupled with other planned uses identified in its 
plan is appropriate given the institution's risk-management processes 
and staff experience. Both the people and the processes should be 
prepared to handle the use of Subordinated Debt. A credit union's board 
of directors should ensure that the credit union can manage the volume 
and/or complexity of planned activities, especially in cases where such 
activities represent a material increase above what has been managed 
historically.
    The NCUA expects a credit union to use sound practices when 
producing pro forma financial statements. When evaluating pro forma 
financials, the NCUA will consider, in particular, whether a credit 
union:
     Performed a cost/benefit analysis (including impact on 
balance sheet and operations) for any new products or services;
     Developed pro forma financials that take into account a 
range of plausible assumptions (optimistic and pessimistic) for both 
growth and portfolio performance metrics;
     Used reasonable and supportable underlying assumptions to 
generate scenario analyses;
     Used underlying assumptions and treatment of assets and 
liabilities consistently across the various supporting analyses. For 
example, a credit union should be consistent, where appropriate, across 
the various risk assessments and forecasts, such as projected activity 
levels, interest rates on assets and liabilities, measures of on-
balance-sheet liquidity, and underlying assumptions about growth and 
performance of assets and liabilities (defaults, prepayments, 
maturities, replacement of maturities, etc.).
     Addressed its ability, under pessimistic scenarios, to 
respond to adverse event risks under its contingency funding plan 
strategies (for example, credit deterioration in a recessionary 
environment, unmet growth objectives, adverse rate environments, etc.).
     Modeled the risk characteristics of increased borrowings 
and/or adding higher risk loans and investments to portfolios (if 
relied on in the Secondary Capital plan) adequately for credit, 
liquidity, and interest rate risk purposes.
    (8) A statement indicating how the credit union will use the 
proceeds from the issuance and sale of the Subordinated Debt. The Board 
has proposed to retain this requirement from the Current Secondary 
Capital Rule,\119\ as a credit union must identify the purpose of 
issuing Subordinated Debt with specific reason(s), or strategy, behind 
the planned use of Subordinated Debt. The intended reason or strategy 
for using Subordinated Debt should be the primary basis for the maximum 
aggregate amount an eligible credit union states in its plan.
---------------------------------------------------------------------------

    \119\ 12 CFR 701.34(b)(1)(ii).
---------------------------------------------------------------------------

    The complexity of Subordinated Debt strategies ranges from 
straightforward plans (for example, those that call for a one-for-one 
redeployment of proceeds into cash, loans, and/or investments of the 
same aggregate amount) to more complex plans that reflect a combination 
of additional borrowings and asset redeployments, increasing risk and/
or the size of a credit union's balance sheet.
    The Board recognizes various ways a credit union may use 
Subordinated Debt to its benefit, which include, but are not limited 
to:
     Restoring Regulatory Capital to a minimum desired level 
due to unexpected losses or strong and sustained asset growth that 
outpaced its ability to build Regulatory Capital through Retained 
Earnings;
     Increasing Regulatory Capital to a desired level relative 
to the level of risk inherent in its operations;
     Increasing Regulatory Capital to a desired level to 
support future growth or other member service initiatives; and
     Enhancing earnings by increasing the level of lending or 
investing a credit union could otherwise achieve.
    The potential incremental increase in risk taken by issuing 
Subordinated Debt can be significant, and the NCUA generally views 
growth strategies that involve a high degree of leverage as higher 
risk.\120\ When adopting such a strategy, a credit union should 
carefully assess its plan to identify any material risks to earnings 
and net worth, and properly identify and measure the degree of risk 
posed by the strategy;
---------------------------------------------------------------------------

    \120\ For the purposes of this letter, ``leverage'' refers to 
funding activity outside a credit union's customary deposit base.
---------------------------------------------------------------------------

    (9) A statement identifying the governing law specified in the 
Subordinated Debt Notes and the documents pursuant to which the 
Subordinated Debt Notes will be issued. The Board is requesting the 
credit union to identify the governing law in respect of the 
Subordinated Debt Notes and the documents pursuant to which the 
Subordinated Debt Notes will be issued. The intent of this requirement 
is to ensure that an Issuing Credit Union has engaged with legal 
counsel qualified to render legal advice in that jurisdiction and has 
considered the venues where controversies, should they arise, could be 
litigated.
    (10) A draft written policy governing the offer, and issuance, and 
sale of the Subordinated Debt, developed in consultation with Qualified 
Counsel. For this requirement, an Issuing Credit Union must include a 
draft written policy that governs the offer, issuance, and sale of the 
Subordinated Debt with its initial application.
    The proposed rule would require an Issuing Credit Union to develop 
the policy in consultation with qualified legal counsel. Given the 
complexities and risks inherent in any securities offering, the Board 
believes it is important for an Issuing Credit Union to consult with 
legal advisors with expertise in securities offerings of the type 
contemplated by the proposed rule and the application of the related 
federal and state securities laws.
    The draft policy required by paragraph (10) of the proposed rule 
specifies the minimum topics an Issuing Credit Union must assess and 
address for securities law compliance and risk management purposes, 
including its investor relations and communications plans. An Issuing 
Credit Union can, and should, include any other topic it determines is 
appropriate and/or necessary for a complete securities program in the 
draft policy. See section I. (E)(5) of this preamble for more 
information about considerations an Issuing Credit Union should address 
in its investor relations plans.
    (11) A schedule that provides an itemized statement of all expenses 
incurred or expected to be incurred by the credit union in connection 
with the offer, issuance, and sale of the Subordinated Debt Notes to 
which the initial application relates, other than underwriting 
discounts and commissions or similar compensation payable to broker-
dealers acting as placement agents. The schedule must include, as 
applicable, fees and expenses of counsel, auditors, any trustee or 
issuing and paying agent or any transfer agent, and printing and 
engraving expenses. If the amounts of any items are not known at the 
time of filing of the initial application, the credit union must 
provide estimates, clearly identified as such. Such a schedule must 
include, as applicable, fees and expenses of counsel, auditors, any 
trustee or issuing and paying agent or any transfer agent, and printing 
and engraving expenses. If the amounts of any items are not known at 
the time of filing of the initial application, a credit

[[Page 14011]]

union must provide estimates, clearly identified as such.
    The Board is proposing this requirement to ensure an Issuing Credit 
Union takes into account the other potential costs to it associated 
with overseeing Subordinated Debt in a safe and sound manner (for 
example, staffing needs, expanded credit union systems, third-party 
assistance, and other costs associated with expanding services). This 
initial application requirement can be submitted as part of a budgeting 
plan in the initial application requirement number four, but must have 
the itemized statement of all expenses related to the issuance of 
Subordinated Debt.
    (12) In the case of a New Credit Union, a statement that it is 
subject to either an approved initial business plan or revised business 
plan, as required by this part, and how the proposed Subordinated Debt 
would conform with the approved plan. Unless the New Credit Union has a 
LICU designation pursuant to Sec.  701.34, it must also include a plan 
for replacing the Subordinated Debt with Retained Earnings before the 
credit union ceases to meet the definition of New Credit Union in Sec.  
702.2 of this part. The Board believes this will add minimal burden to 
a New Credit Union that is applying for Subordinated Debt authority, 
while also increasing the efficiency of the NCUA's review.
    Unless a New Credit Union has a LICU designation pursuant to Sec.  
701.34(a), it must also include a plan for replacing the Subordinated 
Debt with Retained Earnings before the credit union ceases to meet the 
definition of New Credit Union in Sec.  702.2. The Board is proposing 
this requirement to ensure that, when a New Credit Union no longer 
meets the definition of New Credit Union as defined in Sec.  702.2, the 
credit union is either eligible to continue receiving Regulatory 
Capital treatment for its Subordinated Debt, or the credit union has a 
plan to replace the Subordinated Debt with Retained Earnings. Such a 
plan would ensure that, when a New Credit Union ceases to meet the 
definition of New Credit Union, it would remain safe and sound.
    The Board notes that, without such a plan, when a New Credit 
Union's Subordinated Debt ceases to be counted as Regulatory Capital, 
it would immediately be subject to PCA.
    (13) A statement describing any investments the credit union has in 
the Subordinated Debt of any other credit union, and the manner in 
which the credit union acquired such Subordinated Debt, including 
through a merger or other consolidation. Eligibility details can be 
seen in proposed Sec.  702.403. The Board believes such a requirement 
will impose minimal burden on an applicant credit union, while aiding 
the NCUA in determining a credit union's compliance with Sec.  
702.403(b) of this proposed rule;
    (14) A signature page signed by the credit union's principal 
executive officer, principal financial officer or principal accounting 
officer, and a majority of the members of its board of directors. 
Amendments to an initial application must be signed and filed with the 
NCUA in the same manner as the initial application. The Board is 
proposing this requirement to ensure that both a credit union's senior 
management and board are aware of and have approved the credit union's 
plan for issuing Subordinated Debt; and
    (15) Any additional information requested in writing by the 
Appropriate Supervision Office. The Board is proposing this requirement 
to ensure the NCUA has adequate information to assess an applicant 
credit union's suitability to issue Subordinated Debt in a manner the 
agency determines to be safe and sound. The Board notes that this is 
not a new requirement; current Sec.  701.34 states that the information 
required to be provided by a credit union is the minimum information 
necessary for the NCUA to review a secondary capital plan.\121\
---------------------------------------------------------------------------

    \121\ 12 CFR 701.34(b)(1).
---------------------------------------------------------------------------

Decision on Initial Application
    The NCUA's review of an initial application to issue Subordinated 
Debt is intended to evaluate an eligible credit union's compliance with 
applicable laws and regulations and determine whether its application 
and documents represent a safe and sound endeavor for the credit union. 
The NCUA's analysis will be fact-specific to each credit union's 
situation at the time a credit union submits its initial application 
for approval.
    With this proposed rule, the Board is increasing the review time of 
the initial application to 60 days from the Current Secondary Capital 
Rule's period of 45 days.\122\ The Board is also proposing to remove 
the automatic approval provision in circumstances in which an applicant 
is not notified by the NCUA within the 60-day review period. The 
Appropriate Supervision Office may also extend the deadline for the 
review of the initial application in cases where it has requested 
additional documents or has determined that the application is 
incomplete. The Board believes the expanded requirements for initial 
applications are broader than the current rule requirements and that 
the enhanced description of diligence expectations will require a more 
thorough review by the Appropriate Supervision Office.
---------------------------------------------------------------------------

    \122\ Id. 701.34(b)(2)).
---------------------------------------------------------------------------

    The Board is also proposing a conditional approval by which the 
Appropriate Supervision Office may approve the initial application with 
certain conditions. For example, the Appropriate Supervision Office may 
approve an aggregate principal amount less than the original request 
given the overall risk to the credit union. The NCUA may allow other 
conditional approvals such as maintaining a minimum level of net worth 
during the term of the Subordinated Debt, limiting the uses as 
prescribed in the initial application of the Subordinated Debt 
proceeds, or other limitations or conditions the NCUA deems necessary 
to protect the NCUSIF. The Appropriate Supervision Office will state 
the reasons to support the partial or conditional approval as part of 
the written determination. The Board notes that this is current agency 
practice with respect to secondary capital applications, and allows the 
Appropriate Supervision Office to adequately address concerns it may 
have with an application without unduly restricting a credit union's 
ability to issue Subordinated Debt.
    Upon receiving an initial application, the Appropriate Supervision 
Office will evaluate a credit union's:
     Compliance with the proposed initial application 
requirements and all other NCUA regulations;
     Ability to manage and safely offer, issue, and sell the 
proposed Subordinated Debt; and
     Financial condition, operational condition, risk 
management practices and board oversight.
    In addition, the Appropriate Supervision Office will evaluate the 
safety and soundness of the proposed use of the Subordinated Debt, and 
any other factors the Appropriate Supervision Office determines are 
relevant. This reflects the minimum of the information the Appropriate 
Supervision Office will evaluate.
Financial Condition
    In evaluating a credit union's request to issue Subordinated Debt, 
the NCUA will evaluate a credit union's current and prospective 
financial condition. If a credit union is already experiencing serious 
financial difficulties, it may not have the financial or operational 
capacity to handle any additional challenges associated with 
Subordinated Debt, especially riskier endeavors. In particular, the 
NCUA will

[[Page 14012]]

evaluate a Subordinated Debt application to determine whether:
     Planned activities potentially result in a concentration 
of high-risk characteristics (credit, liquidity, or interest rate risk) 
that can pose an undue threat to the credit union's earnings or 
Regulatory Capital;
     Planned activities potentially worsen factors and trends 
that are contributing to existing safety and soundness concerns that 
have not yet been resolved; and
     A credit union has a reasonable exit strategy if its 
actual growth and financial performance were to fall short of necessary 
breakeven levels.
Operational Condition
    In evaluating a credit union's initial application, the NCUA will 
also consider its existing knowledge of the credit union's current 
operational condition, its track record in managing new programs 
successfully, and prior experience (if any) with Subordinated Debt. A 
key consideration is whether a credit union has the resident knowledge, 
experience, expertise, and resources necessary to handle any higher 
levels of risk. This includes having personnel in the right positions, 
as well as having staff with adequate experience and knowledge.
    The NCUA will also evaluate whether management and the board have 
demonstrated the ability to promptly and successfully address existing 
and potential problems and risks, and the potential need to recruit 
additional staff or outsource specific activities to a third party.
    As part of its assessment of an initial application, the NCUA will 
determine if a credit union is venturing into new or higher-risk 
programs and activities that appear to be outside the institution's 
prior experience. A credit union should also assess this and explain 
how it intends to address any material gaps in the adequacy of 
technical staff and managerial oversight, and any lack of experience 
with the proposed strategies and activities in the application 
documents.
    If a credit union is contemplating an increase in risk limits (and 
exposure) above its historical tolerance levels, it is critical that 
the board of directors has been adequately informed. The credit union 
board may also need to authorize changes in other board-approved 
policies. A credit union's application should clearly and conspicuously 
acknowledge the risk implications and reflect a commitment from the 
board that any necessary changes to policies, procedures, and personnel 
(or third-party support) will be approved.
    The Appropriate Supervision Office will appraise the quality, 
capability, and leadership expertise of the individuals who guide and 
supervise a credit union. Credit unions should address the following as 
part of the initial application requirements, including (but not 
limited to):
     Does the credit union operate in compliance with laws and 
regulations?
     Does the credit union perform satisfactorily in key areas, 
such as its capital level, asset quality, earnings, liquidity, and 
interest rate risk management?
     Does the board of directors appropriately govern the 
credit union's operations, including the establishment of its 
strategies and the approval of budgets?
     Does the board understand the key risks facing the credit 
union?
     Are management decisions consistent with the direction set 
by the board of directors?
     Does management respond quickly to address shortcomings 
resulting from failed internal control processes, audits, and 
examinations?
     Does management implement policies and a culture that 
promotes the safe and effective operation of the credit union?
     Does management inform the board of its progress in 
executing strategies and performance against budget?
    These questions speak to the capability of a credit union's 
leadership team, which are reflected in the Management (M) component of 
a credit union's CAMEL rating. The Appropriate Supervision Office uses 
this information when considering a request for approval of an initial 
application because a credit union's leadership is crucial in 
overseeing risk management for planned activities.
Risk-Management Processes and Credit Union Board Oversight
    A credit union's board of directors is responsible for establishing 
an adequate risk management framework through its policies, procedures, 
and risk limits. Policies and practices need to be consistent with the 
credit union's business strategies and reflect the board's risk 
tolerance, taking into account the credit union's financial condition. 
In reviewing a credit union's application documents, the Appropriate 
Supervision Office needs to determine whether the credit union has or 
will take appropriate steps to address:
     Existing policies and procedures that will need to be 
updated, and/or new policies and procedures that will need to be 
adopted,
     The necessary staff expertise and qualifications to handle 
new activities are in place or will be retained, and
     The impact of any planned borrowing and increased balance 
sheet leverage will be integrated properly into the credit union's risk 
reporting and contingency funding plan.
    While a credit union's board of directors is ultimately responsible 
for the credit union's strategic direction and policies, it is expected 
that they generally delegate the responsibility for executing and 
maintaining an appropriate risk management framework to senior 
management. Senior management then becomes responsible for both an 
initial assessment and the subsequent governance of Subordinated Debt 
activities.
    Board members should ensure that the types and levels of risk 
inherent in any Subordinated Debt issuance are within their approved 
tolerances, and direct senior management to revise a plan when 
appropriate. Ultimately, the board should approve the initial 
application for submission to the NCUA. The board ensures that the 
credit union is staffed appropriately to handle the planned activities, 
and should understand the associated risks. They should remain informed 
by being briefed periodically by responsible staff. This is consistent 
with the NCUA's expectations for governance over any major risk 
activity.
    The NCUA will also assess the extent of credit union management's 
involvement in the development of the application and whether a credit 
union relied on third-party vendors in supporting its analysis. The 
NCUA assesses the use of third parties when reviewing an application 
from a credit union that has engaged the services of a vendor to 
evaluate due diligence to determine whether any third-party agreements 
adequately preserve the credit union's legal and business interests.
Offering Document
    Once an Issuing Credit Union has completed the application and 
approval process specified in paragraphs (a) through (c) of Sec.  
702.408, it may proceed with an offer, sale, and issuance of 
Subordinated Debt Notes, but only if it meets certain additional 
requirements regarding the form and content of the Offering Document it 
intends to use in connection with its planned offering. Paragraphs (d) 
through (g) of Sec.  702.408 address the required use of Offering 
Documents, disclosure requirements specifying the minimum scope and 
coverage of disclosures to be included in Offering Documents, and the 
NCUA's

[[Page 14013]]

review process for Offering Documents intended to be used in offerings 
where the potential investors include one or more Natural Person 
Accredited Investors.
    Consistent with the requirements of Sec.  702.406(a), paragraph (d) 
of Sec.  702.408 proposes that an Issuing Credit Union that has 
received initial approval of its application must prepare an Offering 
Document for each planned issuance of Subordinated Debt Notes. If 
potential investors in a planned offering of Subordinated Debt Notes 
include one or more Natural Person Accredited Investors, the Issuing 
Credit Union may only distribute an Offering Document to any potential 
investor after the Offering Document has been declared ``approved for 
use'' by the NCUA. Paragraph (d) also reiterates the requirement set 
forth in Sec.  702.406(a) that an Offering Document be provided to each 
potential investor a reasonable time prior to any issuance and sale of 
Subordinated Debt Notes. The intent of the requirement is to ensure 
that potential investors receive the Offering Document with sufficient 
time to review the Offering Document before making a purchase decision 
and, if desired, consult with financial and/or legal advisors.
Requirements for All Offering Documents
    Paragraph (e) of Sec.  702.408 specifies the minimum scope and 
coverage of disclosures a credit union must include in its Offering 
Documents. The required disclosures include basic information about the 
Issuing Credit Union, the Subordinated Debt Notes, and any 
underwriter(s) or placement agent(s) engaged by the Issuing Credit 
Union to assist it in connection with the offering. The Offering 
Document must also include a discussion of risk factors that describes 
the material risks associated with the purchase of the Subordinated 
Debt Notes. The Board recognizes that these risks may vary from one 
Issuing Credit Union to another, so an Issuing Credit Union should 
tailor the required disclosures and discussion of material risk factors 
to address any special or distinctive characteristics of its business, 
field of membership, or geographic location that are reasonably likely 
to have a material impact on the Issuing Credit Union's future 
financial performance.
    Paragraph (e) also requires that the Offering Document contain 
disclosures that cover the same items addressed in paragraphs (a) and 
(b) of Sec.  702.405, which requires certain disclosure legends to 
appear on the face of the Subordinated Debt Note itself and certain 
additional disclosures to be included in the body of the Subordinated 
Debt Note. Those requirements are discussed in detail in ``--Sec.  
702.405 Disclosures.'' Consistent with the requirements of Sec.  
702.405, paragraph (e) also states that Issuing Credit Unions are 
obligated to provide such further material information as may be 
necessary to make the required disclosures, in the light of the 
circumstances under which those disclosures have been made, not 
misleading. This obligation is consistent with the anti-fraud concepts 
embodied in the federal securities laws, including Rule 10b-5 under the 
Exchange Act, which apply to all offers and sales of securities.
    Further, paragraph (e) of Sec.  702.408 requires an Issuing Credit 
Union to provide details regarding the material terms of the 
Subordinated Debt Notes being offered. Because the terms of the 
Subordinated Debt Notes are likely to vary from one offering to 
another, the Board believes it is important that Issuing Credit Unions 
provide details regarding specific terms and provisions of the 
particular Subordinated Debt Notes being offered and sold in each 
instance. To that end, the disclosure is required to address the 
following, at a minimum:
    (1) Principal amount, interest rate, payment terms, maturity date, 
and any provisions relating to prepayment of the Subordinated Debt 
Notes;
    (2) All material covenants, both affirmative and negative, that 
govern the Subordinated Debt Notes, including the covenants required to 
be included pursuant to the proposed rule;
    (3) Any legends required by applicable state law (which legends are 
in addition to any legends required to be included on the face of the 
Subordinated Debt Notes by the NCUA's regulations or any applicable 
state law);
    (4) An additional legend in the form prescribed by the proposed 
rule that informs potential investors that securities regulators, 
including the SEC, and the NCUA have not passed on the merits of or 
approved the offering, or any of the terms of the Subordinated Debt 
Notes or the disclosures provided to potential investors by the Issuing 
Credit Union in the Offering Document; and
    (5) That the offer and sale of the Subordinated Debt Notes have not 
been registered with the SEC under the Securities Act and the 
securities will be issued pursuant to exemptions from those 
registration requirements.
    The Board notes that these types of legends are routinely included 
in securities Offering Documents, including those used by other types 
of financial institutions. Such legends serve to inform potential 
investors that the NCUA and other regulators do not assess the merits 
of any investment offering and, further, that the Issuing Credit Union 
is responsible for the disclosure in the Offering Document, whether or 
not the NCUA or any other regulator has reviewed the document.
    Paragraphs (f) and (g) of Sec.  702.408 outline certain important 
differences in the offering process for Subordinated Debt Notes that 
will be offered to any Natural Person Accredited Investors (whether the 
offering is directed only to Natural Person Accredited Investors or to 
both Natural Person Accredited Investors and Entity Accredited 
Investors) versus the offering process for sales that will be made 
solely to Entity Accredited Investors. The Board believes that Natural 
Person Accredited Investors, while sophisticated and able to assess the 
risks inherent in investing in Subordinated Debt Notes, can benefit 
from receiving an Offering Document that has been subject to review by 
the NCUA. On the other hand, the Board believes that Entity Accredited 
Investors are likely to be even more sophisticated investors than 
Natural Person Accredited Investors and, therefore, more capable of 
assessing the disclosures provided in the Offering Document, even one 
that has not been subject to the NCUA's review.
    For offerings that will include Natural Person Accredited Investors 
as potential purchasers (no matter how many), an Issuing Credit Union 
must submit a draft of its Offering Document to the NCUA for review, 
complete the review process, and have the draft declared ``approved for 
use'' by the NCUA before its first use.\123\ The purpose of the review 
process is to permit the NCUA to assess an Issuing Credit Union's 
compliance with the proposed rule's disclosure requirements and provide 
the Issuing Credit Union the opportunity to address the NCUA's 
questions and comments. Through this process, the Issuing Credit Union 
will provide any additional information requested by the NCUA and file 
any amendment(s) to its Offering Documents in response to the Agency's 
questions, comments, and concerns so as to allow the NCUA to reach a 
conclusion either to declare an Offering Document ``approved for use'' 
or to disapprove the Offering Document as inadequate.
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    \123\ The NCUA expects that this review process will be an 
iterative one between NCUA staff and the Issuing Credit Union, 
similar to that between the OCC and national banks or between the 
SEC and parties seeking to have their registration statements 
declared effective by the SEC.

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[[Page 14014]]

    An Issuing Credit Union that issues Subordinated Debt Notes that 
will be offered exclusively to Entity Accredited Investors will not be 
required to submit a draft of its Offering Document to the NCUA for 
review and declaration as ``approved for use.'' Once the Issuing Credit 
Union has received the approval of its application under paragraph (c) 
of Sec.  702.408 and has completed the drafting of an Offering Document 
that it affirms meets all the disclosure requirements included in the 
proposed rule, the Issuing Credit Union may use that Offering Document 
immediately, without the need to receive any ``approved for use'' 
declaration or other clearance from the NCUA.
    In all instances, the proposed rule will require an Issuing Credit 
Union to file a copy of each Offering Document with the NCUA within two 
business days of its first use. This requirement ensures that the NCUA 
has contemporaneous notice of activity in the credit union Subordinated 
Debt market, and it generally aligns with filing requirements imposed 
by other federal regulators on issuances of securities.
Material Changes to Initial Application or Offering Documents
    In the event that an Issuing Credit Union's circumstances 
materially change after the NCUA has approved an initial application, 
but before the closing of the relevant offer and sale of Subordinated 
Debt Notes, paragraph (h) requires an Issuing Credit Union to submit an 
amended application before it continues its Subordinated Debt Notes 
offering. In the amended application, the Issuing Credit Union must 
describe the event or change and receive approval from the NCUA before 
it may complete the offer and sale of the related Subordinated Debt 
Notes. This amended application filing and approval requirement applies 
to any offering--whether an offering made solely to Entity Accredited 
Investors or an offering that includes Natural Person Accredited 
Investors. An Issuing Credit Union must determine what constitutes a 
``material change'' in its circumstances and whether that change 
warrants the submission of an amended application. The Board encourages 
credit unions to consult with legal and other professional advisors in 
making that determination, and further recognizes that credit unions 
may be guided by concepts of materiality found in the securities laws.
    Similarly, if, after an Offering Document has been ``approved for 
use'' but before the closing of the relevant offer and sale of 
Subordinated Debt Notes, a material event arises or a material change 
in fact occurs that, individually or in the aggregate, results in an 
``approved for use'' Offering Document containing any untrue statement 
of material fact, or omitting to state a material fact necessary in 
order to make statements made in the Offering Document not misleading 
in light of the circumstances under which they were made, paragraph (h) 
requires the Issuing Credit Union (and any person acting on its behalf) 
to discontinue any offers or sales of the Subordinated Debt Notes.
    The proposed rule requires an Issuing Credit Union to revise the 
Offering Document and to submit any such amended Offering Document to 
the NCUA to be ``approved for use'' before the credit union resumes any 
offers or sales of Subordinated Debt Notes. If there is a material 
change in circumstances after an Issuing Credit Union has first used an 
Offering Document in an offer and sale of Subordinated Debt Notes made 
exclusively to Entity Accredited Investors, the proposed rule requires 
an Issuing Credit Union to determine, in accordance with applicable 
securities laws, whether such change warrants delivery of a revised 
Offering Document to potential investors. However, the Board reminds 
all Issuing Credit Unions of the continuing applicability of the anti-
fraud provisions of the federal securities laws to in-progress 
offerings and the importance of considering whether continued use of an 
Offering Document that has not been amended to reflect material events 
or changes could be inconsistent with those provisions. An Issuing 
Credit Union must file any revised Offering Document with the NCUA 
within two business days of its first use.
    The failure of an Issuing Credit Union to comply with the 
application amendment and/or Offering Document amendment requirements 
could result in the NCUA imposing administrative remedies available 
under the FCU Act, including prohibiting the Issuing Credit Union from 
issuing any additional Subordinated Debt for a specified period and/or 
determining not to treat the Subordinated Debt as Regulatory Capital.
Notification of Subordinated Debt Issuance
    Paragraph (i) of Sec.  702.408 proposes a notice and recordkeeping 
provision that would require an Issuing Credit Union to notify its 
Appropriate Supervision Office no later than ten business days after 
the closing of a Subordinated Debt Note issuance and sale and, as part 
of the notice filing, to submit documents relating to the issuance and 
sale to the NCUA, including, but not limited to:
     A copy of the executed Subordinated Debt Note;
     Any purchase agreement used;
     Any indenture or other transaction document used to issue 
the Subordinated Debt Notes;
     Copies of signed Accredited Investor Certificates from all 
investors;
     Documents (other than Offering Documents previously filed 
with the NCUA) provided to investors related to the offer and sale of 
the Subordinated Debt Note; and
     Any other material documents governing the issuance, sale 
or administration of the Subordinated Debt Notes.
Resubmissions
    Paragraph (j) of Sec.  702.408 provides that, if the NCUA provides 
a written adverse determination in respect of any application to offer 
and sell Subordinated Debt Notes and/or any Offering Document (if the 
offer and sale will be made to any Natural Person Accredited 
Investors), an Issuing Credit Union may amend such application or 
Offering Document to cure the deficiencies noted in the written 
determination and re-file such application or Offering Document with 
the NCUA in accordance with the rule's provisions. The Board notes that 
both the application and Offering Document approval processes may be 
iterative, at times requiring multiple submissions by an Issuing Credit 
Union before the NCUA provides its approval.
    The Board notes, however, there could be instances when an Issuing 
Credit Union's application and/or Offering Document will not be 
approved by the NCUA. In such instances, the NCUA will provide a 
written determination specifying the reasons for the disapproval. 
Paragraph (j) also provides that an Issuing Credit Union may appeal the 
NCUA's decision in respect of any application and/or Offering Document 
under subpart A of part 746 of the NCUA's regulations.\124\
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    \124\ 12 CFR part 746, subpart A.
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    The Board proposes to expire an Issuing Credit Union's authority to 
issue Subordinated Debt Notes one year from the later of the date the 
Issuing Credit Union received NCUA approval of its initial application, 
if the proposed offering is to be made solely to Entity Accredited 
Investors, or the ``approved for use'' date of the applicable Offering 
Document if the proposed offering will include any Natural Person 
Accredited Investors. The Board specifically is requesting comment as 
to whether this

[[Page 14015]]

one-year limit, which is intended in part to ensure that an Issuing 
Credit Union does not offer and sell Subordinated Debt Notes following 
a material change in the information on which the NCUA relied in 
approving the offer and sale of that Issuing Credit Union's 
Subordinated Debt Notes, unduly limits the marketability and 
functionality of Subordinated Debt Notes issuances.
    The proposed rule provides the right for an Issuing Credit Union to 
file a written request for one or more extensions of the one-year limit 
with the Appropriate Supervision Office, provided any such request is 
filed at least 30 calendar days before the expiration of the applicable 
period noted above. A credit union's extension request must demonstrate 
good cause for an extension(s) and address whether such an extension 
will pose any material securities law implications.
Filing Requirements
    Paragraph (l) of Sec.  702.408 specifies the mechanics of filing 
required disclosure and transactional documents with the NCUA, while 
paragraph (m) notes that the NCUA may require filing fees to accompany 
certain filings. The Board notes that other federal regulators assess, 
or have reserved the right to assess, filing fees in connection with 
securities offerings under their jurisdiction.
    The Board is requesting comment as to whether the imposition of 
filing fees would unduly limit the marketability and functionality of 
Subordinated Debt Notes issuances. Specifically, if the NCUA were to 
assess any such filing fees, on what should the NCUA base the fee 
structure and why? For example, should the NCUA follow the filing fee 
structures of other federal regulators and, if so, which regulators? 
Should LICUs and/or New Credit Unions be exempt from any filing fee 
requirements, or should they have a reduced fee structure?
9. Sec.  702.409 Preapproval for FISCUs To Issue Subordinated Debt
    The Board is proposing to include a section that details the 
application procedures specific to FISCUs. Under the Current Secondary 
Capital Rule, a FISCU must submit its secondary capital plan to both 
the NCUA and its SSA. The SSA is responsible for rendering a decision 
on such plan with the concurrence of the NCUA. The Board notes that 
this requirement has proved problematic in some instances. 
Specifically, some states do not have regulations that address the 
evaluation of secondary capital plans. In some cases, this has resulted 
in a conflict between the requirements of the Current Secondary Capital 
Rule and the applicable state laws of some SSAs.
    Based on lessons learned from the Current Secondary Capital Rule 
and the fact Subordinated Debt stands in front of the NCUSIF as loss 
absorbing capital, the Board is proposing to change the approval 
process for FISCUs seeking to issue Subordinated Debt. Under this 
proposed rule, a FISCU must still submit the information required under 
Sec.  702.408 to both the NCUA and its SSA. However, the Board is 
proposing to shift the responsibility for rendering a decision from the 
states to the NCUA. As such, the proposed rule states that the NCUA 
will render all decisions on FISCU Subordinated Debt applications, but 
will only approve a Subordinated Debt application after obtaining the 
concurrence of the credit union's SSA. The Board believes this 
maintains the supervisory authority of the SSA while shifting the 
responsibility for rendering decisions to the NCUA. The Board notes 
that while it is changing the process for FISCU application approvals, 
it is not changing the current process for approvals of FISCU 
applications to prepay Subordinated Debt. As discussed in section II. 
(C)(11) of this preamble, a FISCU seeking approval to prepay 
Subordinated Debt must still seek approval from its SSA before 
submitting an application to prepay to the NCUA.
    In addition, the Board is considering adding a requirement in a 
final Subordinated Debt rule that would require a FISCU to submit with 
its application an attestation that it has consulted with its SSA and 
the Subordinated Debt it is proposing to issue is permissible under 
state law. The Board believes this requirement may be useful to and 
efficient for both the NCUA and a FISCU. Such a requirement would 
ensure a FISCU is permitted to issue Subordinated Debt under state law 
before the credit union and the NCUA expend resources on the credit 
union's application. The Board invites feedback on this requirement.
    This section of the proposed rule also states that the NCUA will 
notify a FISCU's SSA before issuing a decision to ``approve for use'' a 
FISCU's Offering Document and any amendments thereto, under proposed 
Sec.  702.408. Because rendering a decision to ``approve for use'' an 
Offering Document is an iterative process, the Board is not proposing 
to seek the SSA's concurrence on this decision. The Board believes that 
obtaining such concurrence may delay the review process and negatively 
impact credit unions, while providing little utility to the supervision 
by an SSA. The Board believes that concurrence in the decision to 
approve a FISCU's application and notice of a decision to ``approve for 
use'' a FISCU's Offering Document strikes a balance between involvement 
by the appropriate SSA and the NCUA's role as insurer.
    The Board is also proposing to include in this section a 
requirement stating that if the Appropriate Supervision Office has 
reason to believe that a Subordinated Debt issuance by a FISCU could 
subject that FISCU to federal income taxation, the Appropriate 
Supervision Office may require the FISCU to provide:
    (1) A written legal opinion, satisfactory to the NCUA, from 
nationally recognized tax counsel or letter from the Internal Revenue 
Service indicating whether the proposed Subordinated Debt would be 
classified as capital stock for federal income tax purposes and, if so, 
describing any material impact of federal income taxes on the FISCU's 
financial condition; or
    (2) A Pro Forma Financial Statement (balance sheet, income 
statement, and statement of cash flows), covering a minimum of five 
years, that shows the impact of the FISCU being subject to federal 
income tax.
    This proposed section further provides that, should such 
information be required, a FISCU may determine in its sole discretion 
whether the information it provides is in the form articulated in 
either (1) or (2) above.
    The Board notes that FISCUs are exempt from federal income taxation 
under Sec.  501(c)(14) of the Internal Revenue Code.\125\ Conversely, 
FCUs are exempt from federal income taxation under the FCU Act.\126\ 
Section 501(c)(14) of the Internal Revenue Code exempts state-chartered 
credit unions that are operating on a not-for-profit basis, organized 
without capital stock, and operating for mutual purposes. While FCUs 
may only permissibly issue Subordinated Debt under their borrowing 
authority, it is possible that a FISCU, under state law, could issue an 
instrument that otherwise meets that requirements of subpart D of part 
702, but may have a structure akin to capital stock. The Board is 
therefore proposing a backstop provision to protect the safety and 
soundness of FISCUs that may propose to issue an instrument that an 
Appropriate Supervision Office has reason to believe could be treated 
as capital stock.
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    \125\ IRC 501(c)(14).
    \126\ 12 U.S.C. 1768.
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    In such limited situations, the Board is proposing to require a 
FISCU to demonstrate that the instrument will

[[Page 14016]]

either not be treated by the Internal Revenue Service as capital stock 
or that, if an instrument is treated as capital stock (thereby 
subjecting the FISCU to federal income taxation), the associated costs 
can be safely absorbed by the FISCU. While the Board expects there to 
be few instances in which this provision is invoked, if any, its 
inclusion in the proposed rule protects against all possible 
circumstances to ensure the ongoing safety and soundness of FISCUs that 
issue Subordinated Debt. The Board believes this proposed provision 
would ensure that a FISCU conducts thorough due diligence on the 
ramifications of issuing an instrument that could subject it to federal 
income taxation, and demonstrate that either such instrument will not 
subject the credit union to taxation or that it has the financial 
capabilities to remain in a safe and sound condition with the added 
expense of federal income taxation.
10. Sec.  702.410 Interest Payments on Subordinated Debt
    In purchasing Subordinated Debt from credit unions, investors face 
certain regulatory uncertainties. For example, the FCU Act and the 
NCUA's regulations provide authority to prohibit dividend or interest 
payments in specified scenarios. In its PCA regulations, the Board 
specifically lists restrictions on the payment of interest on secondary 
capital as an option for ``Critically Undercapitalized'' credit 
unions.\127\ Even for a credit union with a more favorable net worth 
classification, PCA authorities allow the Board to ``restrict or 
require such other action as [it] determines will carry out the purpose 
of [the PCA provisions] better than'' the specifically listed 
authorities.\128\ These discretionary authorities may make it difficult 
for investors to gauge risks related to Subordinated Debt purchases, 
resulting in more extensive disclosure requirements and higher costs 
for Issuing Credit Unions.
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    \127\ As discussed in section II. (B)(3) of this preamble, the 
Board is proposing to make cohering changes to this section of the 
PCA regulations to address Grandfathered Secondary Capital and 
Subordinated Debt.
    \128\ 12 CFR 702.107; 702.108.
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    To address this investor uncertainty, the Board is considering 
multiple approaches. First, the Board is proposing provisions that 
would prohibit interest payments on Subordinated Debt for any 
``Critically Undercapitalized'' credit union. The proposed rule would 
make this mandatory for Subordinated Debt (it is currently a specified 
discretionary authority under the NCUA's regulations).\129\ This 
approach aligns with banking law,\130\ which prohibits interest on 
subordinated debt for ``Critically Undercapitalized'' banks, except 
where the institution requests and receives regulatory approval. 
Standardizing this preclusion is consistent with what the market is 
accustomed to for subordinated debt of national banks. The Board has 
included proposed disclosures that would be required to address this 
risk of PCA requirements (see section II. (C)(5) of this preamble).
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    \129\ Id. 702.109(b)(11).
    \130\ 12 U.S.C. 1831o(h)(2).
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    Second, the Board is proposing a safe harbor for interest payments 
on Subordinated Debt for any credit union in a net worth category more 
favorable than ``Critically Undercapitalized.'' Under this safe harbor, 
the NCUA would not prohibit interest payments on Subordinated Debt for 
such credit unions, provided that a list of criteria are satisfied (see 
proposed Sec.  702.410(c)). These qualifying criteria provide that a 
credit union must have issued the Subordinated Debt in an arms-length 
transaction, in the ordinary course of business, with no evidence of 
intent to hinder or defraud the Issuing Credit Union or its creditors. 
In addition, the Subordinated Debt must comply with the proposed 
issuance requirements. The proposed rule also clarifies that the safe 
harbor neither waives nor affects other authorities the NCUA may 
exercise in any of its regulatory, conservatorship, or liquidating 
agent capacities.
    The Board invites comment on whether it should retain the proposed 
interest safe harbor or eliminate it. While the safe harbor could make 
debt pricing more favorable for Issuing Credit Unions, such an impact 
remains to be seen. Conversely, such a safe harbor could cost the 
NCUSIF, as the Board may be unable to limit interest payments for 
Issuing Credit Unions subject to PCA.
    In considering the interest safe harbor, the Board notes that 
neither the FDIC nor the OCC provide similar relief in connection with 
the subordinated debt of their regulated banking institutions. While 
the scope of this safe harbor would be unique in the subordinated debt 
market, the Board believes it could make Subordinated Debt issued by 
Issuing Credit Unions a more viable product at a lower cost. In hopes 
of increasing viability, the Board is willing to consider this interest 
safe harbor and welcomes comment on this issue.
11. Sec.  702.411 Prior Written Approval To Prepay Subordinated Debt
    Consistent with the Current Secondary Capital Rule, the proposed 
rule requires a credit union to receive prior written approval from the 
Appropriate Supervision Office to prepay Subordinated Debt. However, 
the Board is proposing to expand a credit union's authority to prepay 
any portion of the Subordinated Debt. Under the Current Secondary 
Capital Rule, only the portion of the secondary capital that no longer 
counts as Regulatory Capital may be approved for prepayment. The Board 
believes this proposed change will provide credit unions additional 
flexibility to effectively manage issued Subordinated Debt.
    In addition, the Board notes that if the terms of the Subordinated 
Debt Note allow prepayment (call option), the prepayment option and the 
requirements of this proposed section of the regulation must clearly be 
disclosed in the Subordinated Debt Note. The Board is adding this 
requirement to ensure investors receive adequate disclosure of a credit 
union's option to prepay the issued Subordinated Debt and the 
regulatory requirements related to such prepayment.
    To obtain approval to prepay, the proposed rule requires a credit 
union to submit an application to the Appropriate Supervision Office. 
To provide regulatory relief, the proposed requirements of the 
application are less prescriptive than the Current Secondary Capital 
Rule, and more comparable to the OCC's subordinated debt 
regulations.\131\ To request early redemption of secondary capital, the 
Current Secondary Capital Rule requires a LICU to demonstrate to the 
NCUA that the: \132\
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    \131\ 12 CFR 5.47(f)(2)); (g)(1)(ii).
    \132\ Id. 7022.34(d)(1).
---------------------------------------------------------------------------

     LICU will have a post-redemption net worth classification 
of ``Adequately Capitalized'' per part 702 of this chapter;
     Discounted secondary capital has been on deposit for at 
least two years;
     Discounted secondary capital will not be needed to cover 
losses prior to maturity;
     LICU's books and records are current and reconciled;
     Proposed redemption will not jeopardize other current 
sources of funding; and
     LICU's board of directors authorized the request to 
redeem.
    Under this proposal, a credit union must provide an application for

[[Page 14017]]

prepayment to the Appropriate Supervision Office. However, the required 
items are a change from the Current Secondary Capital Rule. The Board 
believes that normally, the proposed required items for prepayment 
should provide the Appropriate Supervision Office with the appropriate 
information to make a sound decision on prepayment. A credit union must 
provide, at a minimum, a copy of the Subordinated Debt Note (including 
any agreements reflecting the terms and conditions of the Subordinated 
Debt) and an explanation of why the credit union believes it still 
would hold an amount of capital commensurate with its risk post 
redemption. The Board believes this information will allow the 
Appropriate Supervision Office to adequately determine the safety and 
soundness of prepaying Subordinated Debt.
    The Board notes, however, that this proposed rule clarifies that 
the information discussed above is the minimum information required in 
an application for approval to prepay Subordinated Debt, and that an 
Appropriate Supervision Office may request additional information if 
needed. The OCC's subordinated debt regulations have similar 
flexibility. Allowing a request for additional information ensures the 
Appropriate Supervision Office has all the relevant information to make 
an appropriate decision regarding the prepayment.
FISCU Application To Prepay Subordinated Debt
    Before submitting an application seeking prepayment authority to 
the NCUA, a FISCU must obtain written approval from its SSA. This 
process differs from the proposed original issuance approval process 
under Sec.  702.409 as discussed in section II. (C)(9) of this 
preamble, which would allow for simultaneous submission to the NCUA and 
SSA. The proposed requirement of prior approval by the SSA before a 
credit union applies to the NCUA for prepayment approval provides the 
SSA the first review and opportunity to render a decision on a FISCU's 
application to prepay, and acknowledges the SSA's role with safety and 
soundness relative to FISCUs. The NCUA's role as final approver 
reflects the nature of Subordinated Debt as protection for the NCUSIF.
NCUA Decision on Application To Prepay Subordinated Debt
    The Board is proposing to retain a 45-day timeline to review and 
respond to a prepayment request. However, the proposed rule would make 
one change to the approval process. Currently, if an Issuing Credit 
Union does not receive a response from the Appropriate Supervision 
Office within 45 days, the request to prepay is deemed approved. Under 
the proposed rule, automatic approvals no longer occur. This change is 
consistent with the removal of automatic approvals for the proposed 
original issuance approval process as discussed in section II. (C)(8).
12. Sec.  702.412 Effect of a Merger or Dissolution on the Treatment of 
Subordinated Debt as Regulatory Capital
    Paragraph (b)(9) of the Current Secondary Capital Rule states that 
``. . . in the event of merger or other voluntary dissolution of a 
LICU, other than merger into another LICU, the secondary capital 
accounts will be closed and paid out to the account investor to the 
extent they are not needed to cover losses at the time of merger or 
dissolution.'' \133\ The Board is proposing to retain the general 
framework in current paragraph (b)(9), but to make several adjustments 
to account for the additional types of credit unions that may issue 
Subordinated Debt and provide additional flexibility to a resulting 
credit union in a merger.
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    \133\ Id. 34(b)(9).
---------------------------------------------------------------------------

    Specifically, the Board is proposing to permit the acquisition of 
Subordinated Debt in a merger or assumption transaction regardless of 
the classification of the resulting credit union. Currently, this is 
only permissible if both the resulting and merging credit unions are 
LICUs. The Board believes this change will provide additional 
flexibility to credit unions, while, as discussed in the next 
paragraph, maintaining controls on the Regulatory Capital treatment of 
Subordinated Debt. The Board also notes that this provision could be a 
benefit to investors, as the Subordinated Debt could remain outstanding 
and earning interest versus being repaid.
    Under this proposed rule, the Regulatory Capital treatment of any 
acquired Subordinated Debt would be contingent on several factors. 
First, if the resulting credit union is a LICU, Complex Credit Union, 
or New Credit Union, it may acquire the Subordinated Debt of the 
merging credit union, and the non-discounted portion of such 
Subordinated Debt will continue to be treated as Regulatory Capital. 
Irrespective of the foregoing, if the resulting credit union is not a 
LICU, the acquired Subordinated Debt will not count toward that credit 
union's Net Worth. Acquired Subordinated Debt will only count toward a 
resulting credit union's Net Worth if such credit union is a LICU.
    If the resulting credit union is not a LICU, Complex Credit Union, 
or New Credit Union, the Board is proposing to provide two options for 
addressing the assumed Subordinated Debt. First, if permitted by the 
terms of the Subordinated Debt Note, the resulting credit union can 
apply to the NCUA for approval to prepay the Subordinated Debt. If the 
NCUA grants such approval, the Subordinated Debt may be repaid in 
accordance with the requirements related to prepayment, discussed in 
section II. (C)(11) of this preamble.
    Second, the resulting credit union may continue to hold the 
acquired Subordinated Debt, but such Subordinated Debt will not be 
treated as Regulatory Capital unless the resulting credit union becomes 
a LICU, Complex Credit Union, or New Credit Union. In the event the 
resulting credit union becomes one of the aforementioned types of 
credit unions, the Board is proposing to allow any non-discounted 
portion of acquired Subordinated Debt to immediately be treated as 
Regulatory Capital upon the resulting credit union being designated as 
a LICU, Complex Credit Union, or New Credit Union. If the resulting 
credit union never becomes a credit union eligible to receive 
Regulatory Capital treatment of the acquired Subordinated Debt, such 
Subordinated Debt may continue to be held by the resulting credit union 
or prepaid, in accordance with the prepayment section of this proposed 
rule, but, in either case, such Subordinated Debt will never receive 
Regulatory Capital treatment. Further, acquisition of Subordinated Debt 
in a merger does not permit an ineligible credit union to issue its own 
Subordinated Debt. This proposed rule only allows an ineligible credit 
union to hold acquired Subordinated Debt until maturity.
    The Board believes the proposed treatment of acquired Subordinated 
Debt is consistent with the safety and soundness goals of this proposed 
rule and provides resulting credit unions with flexibility to exercise 
business judgment in determining how to proceed with acquired 
Subordinated Debt.
    The Board is also proposing to address voluntary liquidations in 
this section of the rule. Specifically, the Board is proposing to 
permit a credit union to prepay Subordinated Debt as part of a 
voluntary liquidation. Any such prepayment must, however, be conducted 
in accordance with the prepayment requirements of the proposed rule 
(see Sec.  702.411). The

[[Page 14018]]

Board believes it is appropriate to require a credit union to apply for 
approval to prepay Subordinated Debt in a voluntary liquidation, as it 
is incumbent upon the NCUA to determine if the Subordinated Debt will 
or could be needed to cover any losses that a credit union may incur 
during liquidation.
13. Sec.  702.413 Repudiation Safe Harbor
    The FCU Act provides multiple authorities to the Board as 
conservator or liquidating agent that could affect Subordinated Debt. 
For example, in both conservatorships and liquidations the FCU Act 
provides the Board the authority to repudiate contracts.\134\ The Board 
can also enforce contracts that might otherwise have provided for 
default, acceleration, or the exercise of other rights upon insolvency 
or appointment of a conservator or liquidating agent. Any of these 
authorities could affect a potential investor's evaluation of an 
Issuing Credit Union's Subordinated Debt.
---------------------------------------------------------------------------

    \134\ 12 U.S.C. 1787(c).
---------------------------------------------------------------------------

    With respect to repudiation, the Board, including its lawfully 
appointed designee, has the authority to repudiate any contract within 
a reasonable period following appointment as conservator or liquidating 
agent for an insured credit union. This authority is subject only to a 
conservator's or liquidating agent's discretionary decision that the 
contract is both burdensome and that repudiation will promote orderly 
administration of a credit union's affairs. Repudiation generally 
limits recourse by introducing limits on both time and type of 
recourse. The time for determination of damages is the date of 
appointment of the conservator or liquidating agent and the type of 
recourse is limited to ``actual direct compensatory'' damages. Punitive 
or exemplary damages, damages for lost profit or opportunity, and 
damages for pain and suffering are excluded from the scope of actual 
direct compensatory damages, and case law further defines the 
boundaries of permitted damages. Permissible damages elements that are 
approved as a claim (after proceeding through the administrative claims 
process) become eligible for payment at their related priority under 12 
CFR 709.5(b), subject to availability of funds.
    Thus, a conservator's or liquidating agent's repudiation authority 
is broad and could affect a Subordinated Debt investor's rights to 
payment. While the extent of impact could vary substantially based on 
individual circumstances, the Board believes the exercise of this power 
in connection with Subordinated Debt would have the least consequence 
in involuntary liquidation scenarios. In such a scenario, a credit 
union will generally be insolvent (or at least ``Critically 
Undercapitalized''), and only in unusual cases will funds be available 
to fully pay approved claims beyond those of the NCUSIF and uninsured 
shareholders.\135\ In many cases Subordinated Debt may have been 
entirely extinguished to cover deficits before a liquidation occurs. 
Therefore, the Board believes the issue of repudiating Subordinated 
Debt contracts in liquidation contexts is unlikely to make a 
measureable difference to any Subordinated Debt purchaser.
---------------------------------------------------------------------------

    \135\ 12 CFR 709.5(b)(6).
---------------------------------------------------------------------------

    On the other hand, the conditions under which the Board may invoke 
its conservatorship authorities are broader than those that apply to 
liquidations. They include a credit union's consent, violation of an 
order to cease and desist, or concealment of books and records, among 
others. In the case of conservatorships, a conservator has the power to 
repudiate Subordinated Debt contracts in situations where a credit 
union remains solvent. Such repudiation, if exercised, could 
substantially affect the timing of a holder's receipt of principal, 
along with interest payments that may have otherwise continued. While 
conservatorships are rare, the possibility of such action creates 
additional uncertainty regarding a purchaser's ability to value the 
Subordinated Debt at the time of purchase. This additional uncertainty 
could, in turn, affect the cost and marketability of Subordinated Debt 
issued under the proposed rule.
    To address this uncertainty, the Board has included a safe harbor 
in the proposed rule by which it would prevent the conservator's 
exercise of repudiation authority when a conserved credit union is 
solvent. Like the proposed safe harbor related to interest payments, 
the proposed rule establishes a list of criteria that, if satisfied, 
would qualify a Subordinated Debt instrument for the repudiation safe 
harbor. To qualify, a credit union must have issued the Subordinated 
Debt in an arms-length transaction, in the ordinary course of business, 
with no evidence of intent to hinder or defraud the Issuing Credit 
Union or its creditors. In addition, the Subordinated Debt must comply 
with all of the proposed requirements of the proposed rule. The safe 
harbor described in the proposed rule also clarifies that it neither 
waives nor affects other authorities the NCUA may exercise in any of 
its regulatory, conservatorship, or liquidating capacities.\136\ In 
liquidation contexts, the safe harbor would not apply, for the reasons 
stated above.
---------------------------------------------------------------------------

    \136\ These criteria are similar to those that apply to assets 
transferred in connection with a securitization or participation, as 
set forth in 12 CFR 709.9. In the securitization and participation 
context, the NCUA's safe harbor in 12 CFR 709.9 does not extend to 
repudiation itself, but is limited to the reclamation of related 
collateral when the Board exercises the repudiation power. Unlike 
the safe harbor for securitization and participations, the proposed 
safe harbor would prohibit repudiation altogether in the 
circumstances described.
---------------------------------------------------------------------------

    The Board invites comment on whether it should retain the proposed 
repudiation safe harbor or eliminate it. While the safe harbor could 
make Subordinated Debt pricing more favorable for credit unions, such 
an impact remains to be seen. Conversely, the safe harbor could cost 
the NCUSIF, as the Board may be unable to repudiate Subordinated Debt 
contracts that a conserved credit union is unable to service, creating 
or increasing financial distress.
14. Sec.  702.414 Regulations Governing Grandfathered Secondary Capital
    As discussed in section II. (C)(1) of this preamble, the Board is 
proposing to grandfather secondary capital issued by LICUs before the 
effective date of any final Subordinated Debt rule. For clarity and 
ease of use, therefore, the Board is proposing to include the Current 
Secondary Capital Rule in subpart D as Sec.  702.414, with minor 
modifications. The Board believes this proposed change would aid LICUs 
in quickly finding the rules applicable to Grandfathered Secondary 
Capital, while maintaining the Board's objective to house all capital 
related rules for natural person credit union in one part. The Board is 
also proposing to delete the Current Secondary Capital Rule to avoid 
having two nearly identical rules on secondary capital.
    The Board notes that, under this proposed rule, there would be some 
technical differences between the Current Secondary Capital Rule and 
proposed Sec.  702.414. Such differences serve to clarify that a LICU 
may only follow the rules in this section for Grandfathered Secondary 
Capital, and that the proposed rule does not permit a LICU to continue 
offering secondary capital under the Current Secondary Capital Rule.
    In addition, proposed Sec.  702.414(a)(2) would include a statement 
indicating that any issuances of secondary capital not completed by the 
effective date of a final Subordinated Debt rule are, as of such 
effective date, would be subject to the requirements applicable to

[[Page 14019]]

Subordinated Debt discussed elsewhere in this preamble. The Board is 
proposing this requirement to ensure all issuances of secondary capital 
not yet completed would be subject to the requirements of this proposed 
rule. The Board is, however, requesting specific comment on what it 
should set as the implementation date for such provision. While the 
Board wants to ensure future issuances of secondary capital are subject 
to the requirements of this rule, it is not intending to negatively 
impact LICUs that are close to issuing secondary capital under a 
secondary capital plan that was approved before the effective date of a 
final Subordinated Debt rule. The Board encourages commenters to 
identify what would be a reasonable amount of time to allow LICUs to 
conduct such issuances.
    This proposed section also makes a minor technical correction in 
proposed Sec.  702.414(b)(1), which instructs a LICU how to properly 
account for secondary capital on its balance sheet. The Current 
Secondary Capital Rule requires a LICU to record secondary capital as 
equity. This is, however, inaccurate, as U.S. GAAP requires such 
instrument to be accounted for as debt rather than equity. As such, 
this proposed change merely reflects the proper accounting treatment of 
secondary capital, and is not a substantive change.

D. Part 709--Involuntary Liquidation of Federal Credit Unions and 
Adjudication of Creditor Claims Involving Federally Insured Credit 
Unions in Liquidation

1. Sec.  709.5 Payout Priorities in Involuntary Liquidation
    The Board is proposing to make conforming changes to the section of 
part 709 that addresses payout priorities in involuntary liquidations. 
Currently, Sec.  709.5(b) lists secondary capital as the last priority 
for payout when a LICU is liquidated. In accordance with the FCU Act, 
secondary capital must be subordinate to all other claims against a 
LICU, including claims of other creditors, the NCUSIF, and 
shareholders.\137\ Because this is a statutory provision, the Board is 
required to maintain Subordinated Debt issued by LICUs as the last in 
the list of payout priorities.
---------------------------------------------------------------------------

    \137\ 12 U.S.C. 1757a(c)(2)(B)(ii); 1790d(o)(2)(C)(ii).
---------------------------------------------------------------------------

    Under the proposed rule, Subordinated Debt for LICUs, Complex 
Credit Unions, and New Credit Unions will be the same instrument and 
subject to the same regulation. Secondary capital and proposed 
Subordinated Debt also both function as capital that is subordinate to 
all claims, including those by the NCUSIF, general creditors, and 
shareholders. As such, the Board believes it is appropriate to include 
Subordinated Debt in the last payout priority when a natural person, 
federally insured credit union is liquidated. Further, to address 
Grandfathered Secondary Capital, discussed in section II. (C)(1) of 
this preamble, the last payout priority will clarify that such 
Grandfathered Secondary Capital continues to remain the last payout 
priority position.

E. Part 741--Requirements for Insurance

    The Board is proposing to make several changes to part 741 to 
ensure consistency with the other proposed changes in this rule. 
Specifically, the Board is proposing to amend Sec.  741.204 and add new 
Sec. Sec.  741.226, and 741.227.
1. Sec.  741.204 Maximum Public Unit and Nonmember Accounts, and Low-
Income Designation
    Currently, Sec.  741.204 includes the rules and requirements for 
low-income FISCUs. Among these requirements is a discussion of how a 
low-income FISCU can apply for authority to issue secondary capital. 
Because secondary capital will, under the proposed rule, be included as 
part of Subordinated Debt and will no longer be included in Sec.  
701.34, the Board is proposing to make clarifying amendments to this 
section.
    Specifically, the Board is proposing to change the cross reference 
in this section to proposed Sec.  702.414 and clarify that this section 
only applies to secondary capital issued before the effective date of 
any final Subordinated Debt regulation. As discussed in the next 
section of this preamble, the Board is proposing to add a section to 
part 741 to address the requirements that apply to a FISCU seeking 
approval to issue Subordinated Debt after the effective date of a final 
Subordinated Date rule.
2. Sec.  741.226 Subordinated Debt
    The Board is proposing to add a new section in subpart B of part 
741 to instruct a FISCU to comply with the requirements of subpart D of 
part 702 before it may issue Subordinated Debt. The new proposed 
section also clarifies that a FISCU may only issue Subordinated Debt in 
accordance with subpart D of part 702 if such issuance complies with 
applicable state law and regulation. As discussed in section II. (C)(9) 
of this preamble, subpart D to part 702 includes application procedures 
specific to FISCUs. This proposed new section is clarifying in nature 
and does not result in a substantive change for FISCUs.
3. Sec.  741.227 Loans to Other Credit Unions
    The Board is proposing to include a new section in part 741 that 
would make the limitation on loans to credit unions included in 
proposed new Sec.  701.25 applicable to all federally insured credit 
unions. As discussed in section II. (A)(1) of this preamble, the Board 
is proposing a new Sec.  701.25 to address safety and soundness 
concerns with loans between credit unions. Because the concerns 
discussed in relation to Sec.  701.25 are not unique to FCUs, the Board 
believes it is prudent to extend the requirements of that section to 
all credit unions.

III. Regulatory Procedures

A. Paperwork Reduction Act

    The Paperwork Reduction Act of 1995 (PRA) applies to rulemakings in 
which an agency by rule creates a new paperwork burden on regulated 
entities or modifies an existing burden (44 U.S.C. 3507(d)). For 
purposes of the PRA, a paperwork burden may take the form of a 
reporting, recordkeeping, or a third-party disclosure requirement, 
referred to as an information collection.
    NCUA is seeking comments on the information collection requirement 
of a proposed new subsection to part 702 that addresses requirements 
and regulatory capital treatment of subordinate debt. A request for a 
new OMB control number has been submitted to the Office of Management 
and Budget (OMB) for review and approval. The request contains 
information collection requirements associated with applying for 
authority to issue subordinated debt, credit union eligibility to issue 
subordinate debt, prepayments and disclosures. These information 
collection requirements apply to low-income credit unions (LICUs), 
complex and new credit unions.
    The initial application requirement to issue subordinated debt can 
be found in Sec.  702.408(b) and is estimated to impact 25 credit 
unions annually and is estimated to take 100 hours per respondent. 
Following approval of the initial application, an issuing credit union 
must prepare and submit for each issuance of subordinated debt, an 
offering document for NCUA approval. This offering document is 
estimated to take each of the 25 issuing credit unions 40 hours to 
prepare. Additional reporting requirements covered under Sec. Sec.  
702.406, 702.408, 702.409, 702.411, and 702.414 involve requests for 
additional information, extensions, and prepayments. An issuing credit 
union must provide a copy of the approved

[[Page 14020]]

offering document to each investor (Sec.  701.408(d)), and a FISCU must 
also provide a copy to its state supervisory authority (Sec.  
702.409(a)); averaging an hour per respondent. Recordkeeping 
requirements to maintain records prescribed by this proposed rule is 
estimated to average 15 minutes per record. Proposed new Sec.  
701.25(b) requires federally insured credit unions to establish a 
written policies for making loans to other credit unions. This 
recordkeeping requirement to retain this policy update is estimated to 
average 30 minutes and would impact 3,300 credit union.
    Information collection requirement reported under Sec.  702.414 are 
currently cleared under OMB control number 3133-0140, Secondary Capital 
for Low-Income Designated Credit Unions. This burden will be 
consolidated under this request for a new OMB control number and 3133-
0140 will be discontinued upon prolongation of this rule.
    OMB Control Number: 3133-NEW.
    Title of information collection: Subordinated Debt.
    Estimated number of respondents: 3,300.
    Estimated number of responses per respondent: 1.12.
    Estimated total annual responses: 3,703.
    Estimated burden per response: 1.53.
    Estimated total annual burden: 5,662.
    The NCUA invites comments on: (a) Whether the proposed collection 
of information is necessary for the proper performance of the functions 
of the agency, including whether the information will have practical 
utility; (b) the accuracy of the agency's estimate of the burden of the 
proposed collection of information, including the validity of the 
methodology and assumptions used; (c) ways to enhance the quality, 
utility and clarity of the information to be collected; and (d) ways to 
minimize the burden of the collection of information on those who are 
to respond, including through the use of appropriate automated, 
electronic, mechanical, or other technological collection techniques or 
other forms of information technology.
    All comments are a matter of public records. Comments submitted in 
response to this document will be summarized and included in the 
request for OMB approval. Comments regarding the information collection 
requirements of this rule should be sent to (1) Dawn Wolfgang, NCUA PRA 
Clearance Officer, 1775 Duke Street, Alexandria, VA 22314, Suite 6032, 
or email at [email protected] and the (1) Office of Information and 
Regulatory Affairs, Office of Management and Budget, Attention: Desk 
Officer for NCUA, New Executive Office Building, Room 10235, 
Washington, DC 20503, or email at [email protected].

B. Executive Order 13132

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

C. Assessment of Federal Regulations and Policies on Families

    The NCUA has determined that this rule will not affect family well-
being within the meaning of 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 701

    Advertising, Aged, Civil rights, Credit, Credit unions, Fair 
housing, Individuals with disabilities, Insurance, Marital status 
discrimination, Mortgages, Religious discrimination, Reporting and 
recordkeeping requirements, Sex discrimination, Signs and symbols, 
Surety bonds.

12 CFR Part 702

    Credit unions, Reporting and recordkeeping requirements.

12 CFR Part 709

    Claims, Credit unions.

12 CFR Part 741

    Bank deposit insurance, Credit unions, Reporting and recordkeeping 
requirements.

    By the NCUA Board on January 23, 2020.
Gerard Poliquin,
Secretary of the Board.

    For the reasons discussed above, the NCUA is proposing to amend 12 
CFR parts 701, 702, 709, and 741 as follows:

PART 701--ORGANIZATION AND OPERATION OF FEDERAL CREDIT UNIONS

0
1. 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, 1785, 1786, 1787, 1788, 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.

0
2. Add Sec.  701.25 to read as follows:


Sec.  701.25   Loans to credit unions.

    (a) Limits. A federal credit union may make loans, including 
investments in Subordinated Debt, to other credit unions, including 
corporate credit unions and privately insured credit unions, subject to 
the following limits:
    (1) Aggregate limit. The aggregate principal amount of loans to 
other credit unions may not exceed 25 percent of the federal credit 
union's paid-in and unimpaired capital and surplus.
    (2) Single borrower limit. The aggregate principal amount of loans 
made to any one credit union may not exceed the greater of 15 percent 
of the federal credit union's Net Worth, as defined in part 702 of this 
chapter, at the time of the closing of the loan or $100,000, plus an 
additional 10 percent of the federal credit union's Net Worth if the 
amount that exceeds the federal credit union's 15 percent general limit 
is fully secured at all times with a perfected security interest by 
readily marketable collateral as defined in Sec.  723.2 of this 
chapter.
    (b) Approval and policies. A federal credit union's board of 
directors must approve all loans to other credit unions and establish 
written policies for making such loans. The written policies must, at a 
minimum, include the following:
    (1) How the federal credit union will manage the credit risk of 
loans to other credit unions; and
    (2) The limits on the aggregate principal amount of loans the 
federal credit union can make to other credit unions. The policies must 
specify the limits on the aggregate principal amount of loans the 
federal credit union can make to all other credit unions and the 
aggregate principal amount of loans the federal credit union can make 
to any single credit union; provided that any limits included in such 
policies do not exceed the limits in this section.
    (c) Investment in Subordinated Debt--(1) Eligibility. A federal 
credit union may only invest, directly or indirectly, in the 
Subordinated Debt of federally

[[Page 14021]]

insured, natural person credit unions, or in loans or obligations 
issued by a privately insured credit union that are subordinate to the 
private insurer; provided that the investing federal credit union:
    (i) Has at the time of the investment, a capital classification of 
``Well Capitalized,'' as defined in part 702 of this chapter;
    (ii) Does not have any outstanding Subordinated Debt or 
Grandfathered Secondary Capital, in each case with respect to which it 
was the Issuing Credit Union (as defined in part 702 of this chapter); 
and
    (iii) Is not eligible to issue Subordinated Debt or Grandfathered 
Secondary Capital pursuant to an unexpired approval from the NCUA under 
subpart D of part 702 of this chapter.
    (2) Aggregate limit--(i) Aggregate limit. A federal credit union's 
aggregate investment (direct or indirect) in the Subordinated Debt and 
Grandfathered Secondary Capital of any federally insured, natural 
person credit union, and in loans or obligations issued by a privately 
insured credit union that are subordinate to the private insurer, may 
not cause such aggregate investment to exceed, at the time of the 
investment, the lesser of:
    (A) 25 percent of the investing federal credit union's Net Worth at 
the time of the investment; and
    (B) Any amount of Net Worth in excess of seven percent (7%) of 
total assets.
    (ii) Calculation of aggregate limit. The amount subject to the 
limit in subsection (A) of this section is calculated at the time of 
investment, and is based on a federal credit union's aggregate 
outstanding:
    (A) Investment in Subordinated Debt;
    (B) Investment in Grandfathered Secondary Capital;
    (C) Investment in loans or obligations issued by a privately 
insured credit union that are subordinate to the private insurer; and
    (D) Loans or portion of loans made by the credit union that is 
secured by any Subordinated Debt, Grandfathered Secondary Capital, or 
loans or obligations issued by a privately insured credit union that 
are subordinate to the private insurer.
    (3) Indirect investment. A federal credit union must determine its 
indirect exposure by calculating its proportional ownership share of 
each exposure held in a fund, or similar indirect investment. The 
federal credit union's exposure to the fund is equal to the exposure 
held by the fund as if they were held directly by the federal credit 
union, multiplied by the federal credit union's proportional ownership 
share of the fund.
0
3. In Sec.  701.34,
0
a. Revise the section heading;
0
b. Remove and reserve paragraph (b); and
0
c. Remove paragraphs (c) and (d) and Appendix to Sec.  701.34.
    The revision reads as follows:


Sec.  701.34   Designation of low income status.

* * * * *
0
4. Revise Sec.  701.38 to read as follows:


Sec.  701.38   Borrowed funds.

    (a) Federal credit unions may borrow funds from any source; 
provided that:
    (1) The borrowing is evidenced by a written contract, such as a 
signed promissory note, that sets forth the terms and conditions 
including, at a minimum, maturity, prepayment, interest rate, method of 
computation of interest, and method of payment;
    (2) The written contract and any solicitation with respect to such 
borrowing contain clear and conspicuous language indicating that:
    (i) The funds represent money borrowed by the federal credit union; 
and
    (ii) The funds do not represent shares and, therefore, are not 
insured by the National Credit Union Administration.
    (b) A federal credit union is subject to the maximum borrowing 
authority of an aggregate amount not exceeding 50 percent of its paid-
in and unimpaired capital and surplus. Provided that any federal credit 
union may discount with or sell to any federal intermediate credit bank 
any eligible obligations up to the amount of its paid-in and unimpaired 
capital (12 U.S.C. 1757(9)).

PART 702--CAPITAL ADEQUACY

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

    Authority: 12 U.S.C. 1766(a), 1790d.

0
6. In Sec.  702.2:
0
a. Add a sentence after the first sentence of the introductory text;
0
b. Add a definition for ``Grandfathered Secondary Capital'' in 
alphabetical order;
0
c. Amend the definition of ``Net Worth'' by revising the introductory 
text and paragraphs (1) and (2); and
0
d. Add a definition for ``Subordinated Debt'' in alphabetical order.
    The additions and revision read as follows:


Sec.  702.2   Definitions.

    * * * All accounting terms not otherwise defined herein have the 
meanings assigned to them in accordance with United States generally 
accepted accounting principles (U.S. GAAP). * * *
* * * * *
    Grandfathered Secondary Capital means any subordinated debt issued 
in accordance with Sec.  701.34 of this chapter (recodified as Sec.  
702.414) or, in the case of a federally insured, state-chartered credit 
union, with Sec.  741.204(c) of this chapter before [EFFECTIVE DATE OF 
THE FINAL RULE].
* * * * *
    Net Worth means, with respect to any federally insured, natural 
person credit union, as of any date of determination:
    (1) The retained earnings balance of the credit union at the most 
recent quarter end, as determined in accordance with U.S. GAAP, subject 
to paragraph (3) of this definition.
    (2) With respect to a low-income designated credit union, the 
outstanding principal amount of Subordinated Debt treated as Regulatory 
Capital in accordance with Sec.  702.407, and the outstanding principal 
amount of Grandfathered Secondary Capital treated as Regulatory Capital 
in accordance with Sec.  702.414, in each case that is:
    (i) Uninsured; and
    (ii) Subordinate to all other claims against the credit union, 
including claims of creditors, shareholders, and the National Credit 
Union Share Insurance Fund.
* * * * *
    Subordinated Debt has the meaning as provided in subpart D of this 
part.
* * * * *
0
7. In Sec.  702.104, revise paragraph (b)(1)(vii) and add paragraph 
(c)(2)(v)(B)(9) to read as follows:


Sec.  702.104   Risk-based capital ratio.

* * * * *
    (b) * * *
    (1) * * *
    (vii) The outstanding principal amount of Subordinated Debt treated 
as Regulatory Capital in accordance with Sec.  702.407 and the 
outstanding principal amount of Grandfathered Secondary Capital treated 
as Regulatory Capital in accordance with Sec.  702.414; and
* * * * *
    (c) * * *
    (2) * * *
    (v) * * *
    (B) * * *
    (9) Natural person credit union Subordinated Debt, Grandfathered 
Secondary Capital, and loans or obligations issued by a privately 
insured credit union that are subordinate to the private insurer.
* * * * *

[[Page 14022]]

0
8. Amend Sec.  702.109 by:
0
a. Redesignating paragraphs (a)(3) and (4) as paragraphs (a)(4) and 
(5), respectively;
0
b. Adding new paragraph (a)(3); and
0
c. Revising paragraph (b)(11).
    The addition and revision read as follows:


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

    (a) * * *
    (3) Restrictions on payments on Subordinated Debt. Beginning 60 
days after the effective date of a federally insured, natural person 
credit union being classified by the NCUA as ``Critically 
Undercapitalized'', that credit union shall not pay principal of or 
interest on its Subordinated Debt, except that unpaid interest shall 
continue to accrue under the terms of the related Subordinated Debt 
Note (as defined in subpart D of this part), to the extent permitted by 
law;
* * * * *
    (b) * * *
    (11) Restrictions on payments on Grandfathered 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 Grandfathered 
Secondary Capital (as defined in subpart D of this part), except that 
unpaid dividends or interest shall continue to accrue under the terms 
of the account to the extent permitted by law;
* * * * *
0
10. Revise Sec.  702.205(d) to read as follows:


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

* * * * *
    (d) Discretionary liquidation of an uncapitalized new credit union. 
In lieu of paragraph (c) of this section, an uncapitalized new credit 
union may be placed into liquidation on grounds of insolvency pursuant 
to 12 U.S.C. 1787(a)(1)(A).


Sec.  702.206   [Amended]

0
11. Amend Sec.  702.206 by removing paragraph (d), and redesignating 
paragraphs (e) through (h) as (d) through (g), respectively.
0
12. Redesignate Sec. Sec.  702.207 through 702.210 as Sec. Sec.  
702.208 through 702.211, respectively, and add new Sec.  702.207 to 
read as follows:


Sec.  702.207   Consideration of Subordinated Debt and Grandfathered 
Secondary Capital for new credit unions.

    (a) Exception from prompt corrective action for new credit unions. 
The requirements of Sec. Sec.  702.204 and 702.205 do not apply to a 
new credit union if, as of the applicable date of determination, each 
of the following conditions is satisfied:
    (1) The new credit union has outstanding Subordinated Debt or 
Grandfathered Secondary Capital;
    (2) The Subordinated Debt or Grandfathered Secondary Capital would 
be treated as Regulatory Capital under subpart D of this part if the 
new credit union were a Complex Credit Union or a low income-designated 
credit union;
    (3) The ratio of the new credit union's Net Worth (including the 
amount of its Subordinated Debt and Grandfathered Secondary Capital 
treated as Regulatory Capital (as defined in subpart D of this part)) 
to its total assets is at least seven percent (7%); and
    (4) The new credit union's Net Worth is increasing in a manner 
consistent with the new credit union's approved initial business plan 
or RBP.
    (b) Consideration of Subordinated Debt and Grandfathered Secondary 
Capital in evaluating an RBP. The NCUA shall, in evaluating an RBP 
under this subpart B, consider a new credit union's aggregate 
outstanding principal amount of Subordinated Debt and Grandfathered 
Secondary Capital.
    (c) Prompt corrective action based on other supervisory criteria--
(1) Application of prompt corrective action to an exempt new credit 
union. The NCUA Board may apply prompt corrective action to a new 
credit union that is otherwise exempt under paragraph (a) of this 
section in the following circumstances:
    (i) Unsafe or unsound condition. The NCUA Board has determined, 
after providing the new credit union with written notice and 
opportunity for hearing pursuant to Sec.  747.2003 of this chapter, 
that the new credit union is in an unsafe or unsound condition; or
    (ii) Unsafe or unsound practice. The NCUA Board has determined, 
after providing the new credit union with written notice and 
opportunity for hearing pursuant to Sec.  747.2003 of this chapter, 
that the new credit union has not corrected a material unsafe or 
unsound practice of which it was, or should have been, aware.
    (2) Non-delegation. The NCUA Board may not delegate its authority 
under paragraph (c) of this section.
    (3) Consultation with state officials. The NCUA Board shall consult 
and seek to work cooperatively with the appropriate state official 
before taking action under paragraph (c) of this section and shall 
promptly notify the appropriate state official of its decision to take 
action under paragraph (c) of this section.
    (d) Discretionary liquidation. Notwithstanding paragraph (a) of 
this section, the NCUA may place a new credit union into liquidation 
pursuant to 12 U.S.C. 1787(a)(3)(A), provided that the new credit 
union's ratio under paragraph (a)(3) of this section is, as of the 
applicable date of determination, below six percent (6%) and the new 
credit union has no reasonable prospect of becoming ``Adequately 
Capitalized'' under Sec.  702.202.
    (e) Restrictions on payments on Subordinated Debt. Beginning 60 
days after the effective date of a new credit union being classified by 
the NCUA as ``Uncapitalized'', the new credit union shall not pay 
principal of or interest on its Subordinated Debt, except that unpaid 
interest shall continue to accrue under the terms of the related 
Subordinated Debt Note, to the extent permitted by law.
0
13. Redesignate subparts D and E as subparts E and F, respectively, and 
add new subpart D to read as follows:
Subpart D--Subordinated Debt, Grandfathered Secondary Capital, and 
Regulatory Capital
Sec.
702.401 Purpose and scope.
702.402 Definitions.
702.403 Eligibility.
702.404 Requirements of the Subordinated Debt and Subordinated Debt 
Note.
702.405 Disclosures.
702.406 Requirements related to the offer, sale, and issuance of 
Subordinated Debt Notes.
702.407 Discounting of amount treated as Regulatory Capital.
702.408 Preapproval to issue Subordinated Debt.
702.409 Preapproval for federally insured, state-chartered credit 
unions to issue Subordinated Debt.
702.410 Interest payments on Subordinated Debt.
702.411 Prior written approval to prepay Subordinated Debt.
702.412 Effect of a merger or dissolution on the treatment of 
Subordinated Debt as Regulatory Capital.
702.413 Repudiation safe harbor.
702.414 Regulations governing Grandfathered Secondary Capital.
Appendix A to Subpart D of Part 702--Disclosure and Acknowledgement 
Form

Subpart D--Subordinated Debt, Grandfathered Secondary Capital, and 
Regulatory Capital


Sec.  702.401   Purpose and scope.

    (a) Subordinated Debt. This subpart sets forth the requirements 
applicable to all Subordinated Debt issued by a federally insured, 
natural person credit union, including the NCUA's review

[[Page 14023]]

and approval of that credit union's application to issue or prepay 
Subordinated Debt. This subpart shall apply to a federally insured, 
state-chartered credit union only to the extent that such federally 
insured, state-chartered credit union is permitted by applicable state 
law to issue debt instruments of the type described in this subpart. To 
the extent that such state law is more restrictive than this subpart 
with respect to the issuance of such debt instruments, that state law 
shall apply. Any secondary capital, as that term is used in the Federal 
Credit Union Act, issued after [EFFECTIVE DATE OF THE FINAL RULE] is 
Subordinated Debt and subject to the requirements of this subpart.
    (b) Grandfathered Secondary Capital. Any secondary capital issued 
under Sec.  701.34 of this chapter before [EFFECTIVE DATE OF THE FINAL 
RULE] is governed by Sec.  702.414. Grandfathered Secondary Capital 
will no longer be treated as Regulatory Capital as of [DATE 20 YEARS 
AFTER THE EFFECTIVE DATE OF THE FINAL RULE].


Sec.  702.402   Definitions.

    To the extent they differ, the definitions in this section apply 
only to Subordinated Debt and not to Grandfathered Secondary Capital. 
(Definitions applicable to Grandfathered Secondary Capital are in Sec.  
702.414.) All other terms in this subpart and not expressly defined 
herein have the meanings assigned to them elsewhere in this part. For 
ease of use, certain key terms are included below using cross citations 
to other sections of this part where those terms are defined.
    Accredited Investor means a Natural Person Accredited Investor or 
an Entity Accredited Investor, as applicable.
    Appropriate Supervision Office means, with respect to any credit 
union, the Regional Office or Office of National Examinations and 
Supervision that is responsible for supervision of that credit union.
    Complex Credit Union has the same meaning as in subpart A of this 
part.
    Entity Accredited Investor means an entity that, at the time of 
offering and closing of the issuance and sale of Subordinated Debt to 
that entity, meets the requirements of 17 CFR 230.501(a)(1), (2), (3), 
(7), or (8).
    Grandfathered Secondary Capital means any subordinated debt issued 
in accordance with Sec.  701.34 of this chapter (recodified as Sec.  
702.414 of subpart D of this part) or, in the case of a federally 
insured, state-chartered credit union, with Sec.  741.204(c) of this 
chapter, before [EFFECTIVE DATE OF THE FINAL RULE].
    Immediate Family Member means spouse, child, sibling, parent, 
grandparent, or grandchild (including stepparents, stepchildren, 
stepsiblings, and adoptive relationships).
    Issuing Credit Union means, for purposes of this subpart, a credit 
union that has issued, or is in the process of issuing, Subordinated 
Debt or Grandfathered Secondary Capital in accordance with the 
requirements of this subpart.
    Low-Income designated Credit Union (LICU) is a credit union 
designated as having low-income status in accordance with Sec.  701.34 
of this chapter.
    Natural Person Accredited Investor means a natural person who, at 
the time of offering and closing of the issuance and sale of 
Subordinated Debt to that person, meets the requirements of 17 CFR 
230.501(a)(5) or (6); provided that, for purposes of purchasing or 
holding any Subordinated Debt Note, this term shall not include any 
board member or Senior Executive Officer of the Issuing Credit Union or 
any Immediate Family Member of any board member or Senior Executive 
Officer of the Issuing Credit Union.
    Net Worth has the same meaning as in Sec.  702.2.
    Net Worth Ratio has the same meaning as in Sec.  702.2.
    New Credit Union has the same meaning as in Sec.  702.201.
    Offering Document means the document(s) required by Sec.  702.408, 
including any term sheet, offering memorandum, private placement 
memorandum, offering circular, or other similar document used to offer 
and sell Subordinated Debt Notes.
    Pro Forma Financial Statements means projected financial statements 
that show the effects of proposed transactions as if they actually 
occurred in a variety of plausible scenarios, including both optimistic 
and pessimistic assumptions, over measurement horizons that align with 
the credit union's expected activities.
    Qualified Counsel means an attorney licensed to practice law in the 
relevant jurisdiction(s) who has expertise in the areas of federal and 
state securities laws and debt transactions similar to those described 
in this subpart.
    Regulatory Capital means:
    (1) With respect to an Issuing Credit Union that is a LICU and not 
a Complex Credit Union, the aggregate outstanding principal amount of 
Subordinated Debt and, until [DATE 20 YEARS AFTER THE EFFECTIVE DATE OF 
THE FINAL RULE], Grandfathered Secondary Capital that is included in 
the credit union's Net Worth Ratio;
    (2) With respect to an Issuing Credit Union that is a Complex 
Credit Union and not a LICU, the aggregate outstanding principal amount 
of Subordinated Debt that is included in the credit union's RBC Ratio;
    (3) With respect to an Issuing Credit Union that is both a LICU and 
a Complex Credit Union, the aggregate outstanding principal amount of 
Subordinated Debt and, until [DATE 20 YEARS AFTER THE EFFECTIVE DATE OF 
THE FINAL RULE], Grandfathered Secondary Capital that is included in 
its Net Worth Ratio and in its RBC Ratio; and
    (4) With respect to a New Credit Union, the aggregate outstanding 
principal amount of Subordinated Debt and, until [DATE 20 YEARS AFTER 
THE EFFECTIVE DATE OF THE FINAL RULE], Grandfathered Secondary Capital 
that is considered pursuant to Sec.  702.207.
    Retained Earnings has the same meaning as in United States GAAP.
    RBC Ratio has the same meaning as in Sec.  702.2.
    Senior Executive Officer means a credit union's chief executive 
officer (for example, president or treasurer/manager), any assistant 
chief executive officer (e.g., any assistant president, any vice 
president or any assistant treasurer/manager) and the chief financial 
officer (controller). The term ``Senior Executive Officer'' also 
includes employees and contractors of an entity, such as a consulting 
firm, hired to perform the functions of positions covered by the term 
Senior Executive Officer.
    Subordinated Debt means an Issuing Credit Union's borrowing that 
meets the requirements of this subpart, including all obligations and 
contracts related to such borrowing.
    Subordinated Debt Note means the written contract(s) evidencing the 
Subordinated Debt.


Sec.  702.403   Eligibility.

    (a) Subject to receiving approval under Sec.  702.408 or 702.409, a 
credit union may issue Subordinated Debt only if, at the time of such 
issuance, the credit union is:
    (1) A Complex Credit Union with a capital classification of at 
least ``Undercapitalized,'' as defined in Sec.  702.102;
    (2) A LICU;
    (3) Able to demonstrate to the satisfaction of the NCUA that it 
reasonably anticipates becoming either a Complex Credit Union meeting 
the requirements of paragraph (a)(1) of this section or a LICU within 
24 months

[[Page 14024]]

after issuance of the Subordinated Debt Notes; or
    (4) A new credit union with Retained Earnings equal to or greater 
than one percent (1%) of assets.
    (b) At the time of issuance of any Subordinated Debt, an Issuing 
Credit Union may not have any investments, direct or indirect, in 
Subordinated Debt or Grandfathered Secondary Capital (or any interest 
therein) of another credit union. If a credit union acquires 
Subordinated Debt or Grandfathered Secondary Capital in a merger or 
other consolidation, the Issuing Credit Union may still issue 
Subordinated Debt, but it may not invest (directly or indirectly) in 
the Subordinated Debt or Grandfathered Secondary Capital of any other 
credit union while any Subordinated Debt Notes issued by the Issuing 
Credit Union remain outstanding.
    (c) If the Issuing Credit Union is a Complex Credit Union that is 
not also a LICU, the aggregate outstanding principal amount of all 
Subordinated Debt issued by that Issuing Credit Union may not exceed 
100 percent of its Net Worth, as determined at the time of each 
issuance of Subordinated Debt.


Sec.  702.404   Requirements of the Subordinated Debt and Subordinated 
Debt Note.

    (a) Requirements. At a minimum, the Subordinated Debt or the 
Subordinated Debt Note, as applicable, must:
    (1) Be in the form of a written, unconditional promise to pay on a 
specified date a sum certain in money in return for adequate 
consideration in money;
    (2) Have, at the time of issuance, a fixed stated maturity of at 
least five years and not more than 20 years from issuance. The stated 
maturity of the Subordinated Debt Note may not reset and may not 
contain an option to extend the maturity;
    (3) Be subordinate to all other claims in liquidation under Sec.  
709.5(b) of this chapter, and have the same payout priority as all 
other outstanding Subordinated Debt and Grandfathered Secondary 
Capital;
    (4) Be properly characterized as debt in accordance with U.S. GAAP;
    (5) Be unsecured, including, without limitation, prohibiting the 
establishment of any legally enforceable claim against funds earmarked 
for payment of the Subordinated Debt through:
    (i) A compensating balance or any other funds or assets subject to 
a legal right of offset, as defined by applicable state law; or
    (ii) A sinking fund, such as a fund formed by periodically setting 
aside money for the gradual repayment of the Subordinated Debt.
    (6) Be applied by the Issuing Credit Union at the end of each of 
its fiscal years (or more frequently as determined by the Issuing 
Credit Union) in which the Subordinated Debt remains outstanding to 
cover any deficit in Retained Earnings on a pro rata basis among all 
holders of the Subordinated Debt and Grandfathered Secondary Capital of 
the Issuing Credit Union; it being understood that any amounts applied 
to cover a deficit in Retained Earnings shall no longer be considered 
due and payable to the holder(s) of the Subordinated Debt or 
Grandfathered Secondary Capital;
    (7) Except as provided in Sec. Sec.  702.411 and 702.412(c), be 
payable in full by the Issuing Credit Union or its successor or 
assignee only at maturity;
    (8) Disclose any prepayment penalties or restrictions on 
prepayment;
    (9) Be offered, issued, and sold only to Entity Accredited 
Investors or Natural Person Accredited Investors, in accordance Sec.  
702.406; and
    (10) Be re-offered, reissued, and resold only to an Entity 
Accredited Investor (if the initial offering, issuance, and sale was 
solely made to Entity Accredited Investors) or any Accredited Investor 
(if the initial offering, issuance, and sale involved one or more 
Natural Person Accredited Investors).
    (b) Restrictions. The Subordinated Debt or the Subordinated Debt 
Note, as applicable, must not:
    (1) Be structured or identified as a share, share account, or any 
other instrument in the Issuing Credit Union that is insured by the 
National Credit Union Administration;
    (2) Include any express or implied terms that make it senior to any 
other Subordinated Debt issued under this subpart or Grandfathered 
Secondary Capital;
    (3) Cause the Issuing Credit Union to exceed the borrowing limit in 
Sec.  741.2 of this chapter or, for federally insured, state-chartered 
credit unions, any more restrictive state borrowing limit;
    (4) Provide the holder thereof with any management or voting rights 
in the Issuing Credit Union;
    (5) Be eligible to be pledged or provided by the investor as 
security for a loan from, or other obligation owing to, the Issuing 
Credit Union;
    (6) Include any express or implied term, condition, or agreement 
that would require the Issuing Credit Union to prepay or accelerate 
payment of principal of or interest on the Subordinated Debt prior to 
maturity, including investor put options;
    (7) Include an express or implied term, condition, or agreement 
that would trigger an event of default based on the Issuing Credit 
Union's default on other debts;
    (8) Include any condition, restriction, or requirement based on the 
Issuing Credit Union's credit quality or other credit-sensitive 
feature; or
    (9) Require the Issuing Credit Union to make any form of payment 
other than in cash.
    (c) Negative covenants. A Subordinated Debt Note must not include 
any provision or covenant that unduly restricts or otherwise acts to 
unduly limit the authority of the Issuing Credit Union or interferes 
with the NCUA's supervision of the Issuing Credit Union. This includes, 
but is not limited to, a provision or covenant that:
    (1) Requires the Issuing Credit Union to maintain a minimum amount 
of Retained Earnings or other metric, such as a minimum Net Worth Ratio 
or minimum asset, liquidity, or loan ratios;
    (2) Unreasonably restricts the Issuing Credit Union's ability to 
raise capital through the issuance of additional Subordinated Debt;
    (3) Provides for default of the Subordinated Debt as a result of 
the Issuing Credit Union's compliance with any law, regulation, or 
supervisory directive from the NCUA or, if applicable, the state 
supervisory authority;
    (4) Provides for default of the Subordinated Debt as the result of 
a change in the ownership, management, or organizational structure or 
charter of the Issuing Credit Union; provided that, following such 
change, the Issuing Credit Union or the resulting institution, as 
applicable:
    (i) Agrees to perform all of the obligations, terms, and conditions 
of the Subordinated Debt; and
    (ii) At the time of such change, is not in material default of any 
provision of the Subordinated Debt Note, after giving effect to the 
applicable cure period described in paragraph (d) of this section.
    (5) Provides for default of the Subordinated Debt as the result of 
an act or omission of any third party, including but not limited to a 
credit union service organization, as defined in Sec.  712.1(d) of this 
chapter.
    (d) Default covenants. A Subordinated Debt Note that includes 
default covenants must provide the Issuing Credit Union with a 
reasonable cure period of not less than 30 calendar days.
    (e) Minimum denominations of issuances to Natural Person Accredited 
Investors. An Issuing Credit Union may only issue Subordinated Debt 
Notes to Natural Person Accredited Investors in minimum denominations 
of $100,000, and cannot exchange any such

[[Page 14025]]

Subordinated Debt Notes after the initial issuance or any subsequent 
resale for Subordinated Debt Notes of the Issuing Credit Union in 
denominations less than $10,000. Each such Subordinated Debt Note, if 
issued in certificate form, must include a legend disclosing that it 
cannot be exchanged for Subordinated Debt Notes of the Issuing Credit 
Union in denominations less than $100,000, and Subordinated Debt Notes 
issued in book-entry or other uncertificated form shall include 
appropriate instructions prohibiting the exchange of such Subordinated 
Debt Notes for Subordinated Debt Notes of the Issuing Credit Union in 
denominations that would violate the foregoing restrictions.


Sec.  702.405   Disclosures.

    (a) An Issuing Credit Union must disclose the following language 
clearly, in all capital letters, on the face of a Subordinated Debt 
Note:

     THIS OBLIGATION IS NOT A SHARE IN THE ISSUING CREDIT 
UNION AND IS NOT INSURED BY THE NATIONAL CREDIT UNION 
ADMINISTRATION.
     THIS OBLIGATION IS UNSECURED AND SUBORDINATE TO ALL 
CLAIMS AGAINST THE ISSUING CREDIT UNION AND IS INELIGIBLE AS 
COLLATERAL FOR A LOAN BY THE ISSUING CREDIT UNION.
     AMOUNTS OTHERWISE PAYABLE HEREUNDER MAY BE REDUCED IN 
ORDER TO COVER ANY DEFICIT IN RETAINED EARNINGS OF THE ISSUING 
CREDIT UNION. AMOUNTS APPLIED TO COVER ANY SUCH DEFICIT WILL RESULT 
IN A CORRESPONDING REDUCTION OF THE PRINCIPAL AMOUNT OF ALL 
OUTSTANDING SUBORDINATED DEBT ISSUED BY THE ISSUING CREDIT UNION, 
AND WILL NO LONGER BE DUE AND PAYABLE TO THE HOLDERS OF SUCH 
SUBORDINATED DEBT. AMOUNTS APPLIED TO COVER ANY SUCH DEFICIT MUST BE 
APPLIED AMONG ALL HOLDERS OF SUCH SUBORDINATED DEBT PRO RATA BASED 
ON THE AGGREGATE AMOUNT OF SUBORDINATED DEBT OWED BY THE ISSUING 
CREDIT UNION TO EACH SUCH HOLDER AT THE TIME OF APPLICATION.
     THIS OBLIGATION CAN ONLY BE REPAID AT MATURITY OR IN 
ACCORDANCE WITH 12 CFR 702.411. THIS OBLIGATION MAY ALSO BE REPAID 
IN ACCORDANCE WTH 12 CFR PART 710 IF THE ISSUING CREDIT UNION 
VOLUNTARILY LIQUIDATES.
     THE NOTE EVIDENCING THIS OBLIGATION HAS NOT BEEN AND 
WILL NOT BE REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED 
(THE ``SECURITIES ACT''), OR THE SECURITIES LAWS OF ANY STATE OF THE 
UNITED STATES OR ANY OTHER JURISDICTION, AND MAY BE ISSUED, SOLD, 
PLEDGED, OR OTHERWISE TRANSFERRED ONLY (A) AS PERMITTED IN THE NOTE 
AND TO A PERSON WHOM THE ISSUER OR SELLER REASONABLY BELIEVES IS [AN 
``ACCREDITED INVESTOR'' (AS DEFINED IN 12 CFR 702.402)] [AN ``ENTITY 
ACCREDITED INVESTOR'' (AS DEFINED IN 12 CFR 702.402)] (THAT IS NOT A 
MEMBER OF THE ISSUING CREDIT UNION'S BOARD, A SENIOR EXECUTIVE 
OFFICER OF THE ISSUING CREDIT UNION (AS THAT TERM IS DEFINED IN 12 
CFR 702.402), OR ANY IMMEDIATE FAMILY MEMBER OF ANY SUCH BOARD 
MEMBER OR SENIOR EXECUTIVE OFFICER), PURCHASING FOR ITS OWN ACCOUNT, 
(1) TO WHOM NOTICE IS GIVEN THAT THE SALE, PLEDGE, OR OTHER TRANSFER 
IS BEING MADE IN RELIANCE ON THE EXEMPTION FROM SECURITIES ACT 
REGISTRATION PROVIDED BY SECTION 3(a)(5) OF THE SECURITIES ACT, OR 
(2) IN ACCORDANCE WITH ANOTHER EXEMPTION FROM THE REGISTRATION 
REQUIREMENTS OF THE SECURITIES ACT (SUBJECT TO THE DELIVERY OF SUCH 
CERTIFICATIONS, LEGAL OPINIONS, OR OTHER INFORMATION AS THE ISSUING 
CREDIT UNION MAY REASONABLY REQUIRE TO CONFIRM THAT SUCH SALE, 
PLEDGE, OR TRANSFER IS BEING MADE PURSUANT TO AN EXEMPTION FROM, OR 
IN A TRANSACTION NOT SUBJECT TO, THE REGISTRATION REQUIREMENTS OF 
THE SECURITIES ACT), (B) IN COMPLIANCE WITH THE CERTIFICATION AND 
OTHER REQUIREMENTS SPECIFIED IN THE [INDENTURE OR OTHER DOCUMENT 
PURSUANT TO WHICH THE SUBORDINATED DEBT NOTE IS ISSUED] REFERRED TO 
HEREIN, AND (C) IN ACCORDANCE WITH ANY APPLICABLE SECURITIES LAWS OF 
ANY STATE OF THE UNITED STATES AND ANY OTHER APPLICATION 
JURISDICTION.

    (b) An Issuing Credit Union must also clearly and accurately 
disclose in the Subordinated Debt Note:
    (1) The payout priority and level of subordination, as described in 
Sec.  709.5(b) of this chapter, that would apply in the event of the 
involuntary liquidation of the Issuing Credit Union;
    (2) A general description of the NCUA's regulatory authority that 
includes, at a minimum:
    (i) If the Issuing Credit Union is ``Undercapitalized'' or, if the 
Issuing Credit Union is a New Credit Union, ``Moderately Capitalized'' 
(each as defined in this part), and fails to submit an acceptable Net 
Worth restoration plan, capital restoration plan, or revised business 
plan, as applicable, or materially fails to implement such a plan that 
was approved by the NCUA, the Issuing Credit Union may be subject to 
all of the additional restrictions and requirements applicable to a 
``Significantly Undercapitalized'' credit union or, if the Issuing 
Credit Union is a New Credit Union, a ``Marginally Capitalized'' New 
Credit Union;
    (ii) Beginning 60 days after the effective date of an Issuing 
Credit Union being classified as ``Critically Undercapitalized'' or, in 
the case of a New Credit Union, ``Uncapitalized,'' the Issuing Credit 
Union shall not pay principal of or interest on its Subordinated Debt, 
until reauthorized to do so by the NCUA; provided, however, that unpaid 
interest shall continue to accrue under the terms of the Subordinated 
Debt Note, to the extent permitted by law.
    (3) The risk factors associated with the NCUA's or, if applicable, 
the state supervisory authority's, authority to conserve or liquidate a 
credit union under the Federal Credit Union Act (FCU Act) or applicable 
state law.


Sec.  702.406   Requirements related to the offer, sale, and issuance 
of Subordinated Debt Notes.

    (a) Offering Document. An Issuing Credit Union or person acting on 
behalf of or at the direction of any Issuing Credit Union may only 
issue and sell Subordinated Debt Notes if, a reasonable time prior to 
the issuance and sale of any Subordinated Debt Notes, each purchaser of 
a Subordinated Debt Note receives an Offering Document that meets the 
requirements of Sec.  702.408(e) and such further material information, 
if any, as may be necessary to make the required disclosures in that 
Offering Document, in the light of the circumstances under which they 
are made, not misleading.
    (b) Territorial limitations. An Issuing Credit Union may only 
offer, issue, and sell Subordinated Debt Notes in the United States of 
America (including any one of the states thereof and the District of 
Columbia), its territories, and its possessions.
    (c) Accredited Investors. An Issuing Credit Union may only offer, 
issue, and sell Subordinated Debt to Accredited Investors, and the 
terms of any Subordinated Debt Note must include the restrictions in 
Sec.  702.404(a)(10); provided that no Subordinated Debt Note may be 
issued, sold, resold, pledged, or otherwise transferred to a member of 
the board of the Issuing Credit Union, any Senior Executive Officer of 
the Issuing Credit Union, or any Immediate Family Member of any such 
board member or Senior Executive Officer. Prior to the offer of any 
Subordinated Debt Note, the Issuing Credit Union must receive a signed, 
one-page, unambiguous certification from any potential investor of a 
Subordinated Debt Note. The certification must be in substantially the 
following form:


[[Page 14026]]



CERTIFICATE OF ACCREDITED INVESTOR STATUS

    Except as may be indicated by the undersigned below, the 
undersigned is an accredited investor, as that term is defined in 
Regulation D under the Securities Act of 1933, as amended (the 
``Act''). In order to demonstrate the basis on which it is 
representing its status as an accredited investor, the undersigned 
has checked one of the boxes below indicating that the undersigned 
is:
    [ ] A bank as defined in Section 3(a)(2) of the Act, or any 
savings and loan association or other institution as defined in 
Section 3(a)(5)(A) of the Act whether acting in its individual or 
fiduciary capacity; a broker or dealer registered pursuant to 
Section 15 of the Securities Exchange Act of 1934; an insurance 
company as defined in Section 2(a)(13) of the Act; an investment 
company registered under the Investment Company Act of 1940 or a 
business development company as defined in Section 2(a)(48) of that 
act; a small business investment company licensed by the U.S. Small 
Business Administration under Section 301(c) or (d) of the Small 
Business Investment Act of 1958; a plan established and maintained 
by a state, its political subdivisions, or any agency or 
instrumentality of a state or its political subdivisions, for the 
benefit of its employees, if such plan has total assets in excess of 
$5,000,000; an employee benefit plan within the meaning of the 
Employee Retirement Income Security Act of 1974, if the investment 
decision is made by a plan fiduciary, as defined in Section 3(21) of 
such act, which is either a bank, savings and loan association, 
insurance company, or registered investment adviser, or if the 
employee benefit plan has total assets in excess of $5,000,000 or, 
if a self-directed plan, with investment decisions made solely by 
persons that are accredited investors;
    [ ] A private business development company as defined in Section 
202(a)(22) of the Investment Advisers Act of 1940;
    [ ] An organization described in Section 501(c)(3) of the 
Internal Revenue Code; a corporation; a Massachusetts or similar 
business trust; or a partnership, not formed for the specific 
purpose of acquiring the securities offered, with total assets in 
excess of $5,000,000;
    [ ] A natural person whose individual net worth, or joint net 
worth with the undersigned's spouse, at the time of this purchase 
exceeds $1,000,000 (excluding the value of the person's primary 
residence);
    [ ] A natural person who had individual income in excess of 
$200,000 in each of the two most recent years or joint income with 
the undersigned's spouse in excess of $300,000 in each of those 
years and has a reasonable expectation of reaching the same income 
level in the current year;
    [ ] A trust with total assets in excess of $5,000,000, not 
formed for the specific purpose of acquiring the securities offered, 
whose purchase is directed by a person who has such knowledge and 
experience in financial and business matters that he or she is 
capable of evaluating the merits and risks of the prospective 
investment; or
    [ ] An entity in which all of the equity holders are accredited 
investors by virtue of their meeting one or more of the above 
standards.
    The undersigned understands that [NAME OF ISSUING CREDIT UNION] 
(the ``Credit Union'') is required to verify the undersigned's 
accredited investor status AND ELECTS TO DO ONE OF THE FOLLOWING:
    [ ] Allow the Credit Union's representative to review the 
undersigned's tax returns for the two most recently completed years 
and provide a written representation of the undersigned's reasonable 
expectation of reaching the income level necessary to qualify as an 
accredited investor during the current year;
    [ ] Allow the Credit Union's representative to: (1) Obtain a 
written representation from the undersigned that states that all 
liabilities necessary to make a determination of net worth have been 
disclosed; and (2) review one or more of the following types of 
documentation dated within the past three months: bank statements, 
brokerage statements, tax assessments, appraisal reports as to 
assets, or a consumer report from a nationwide consumer reporting 
agency;
    [ ] Provide the Credit Union with a written confirmation from 
one of the following persons or entities that such person or entity 
has taken reasonable steps to verify that the undersigned is an 
accredited investor within the prior three months and has determined 
that the undersigned is an accredited investor:
     A registered broker-dealer;
     An investment adviser registered with the Securities 
Exchange Commission;
     A licensed attorney who is in good standing under the 
laws of the jurisdictions in which such attorney is admitted to 
practice law; or
     A certified public accountant who is duly registered 
and in good standing under the laws of the place of such 
accountant's residence or principal office.
    In Witness Whereof, the undersigned has executed this 
Certificate of Accredited Investor Status effective as of ___, 20_.

Name of Investor

[Name of Authorized Representative

Title of Authorized Representative]

Signature

Address

Address

Phone Number

Email Address

    (d) Use of trustees. If using a trustee in connection with the 
offer, issuance, and sale of Subordinated Debt Notes, the trustee must 
meet the requirements set forth in the Trust Indenture Act of 1939, as 
amended, and any rules promulgated thereunder, including requirements 
for qualification set forth in section 310 thereof, and any applicable 
state law.
    (e) Offers, issuances, and sales of Subordinated Debt Notes. Offers 
issuances, and sales of Subordinated Debt Notes are required to be made 
in accordance with the following requirements:
    (1) Application to offer, issue, and sell at offices of Issuing 
Credit Union. If the Issuing Credit Union intends to offer and sell 
Subordinated Debt Notes at one or more of its offices, the Issuing 
Credit Union must first apply in writing to the Appropriate Supervision 
Office indicating that it intends to offer, issue, and sell 
Subordinated Debt Notes at one or more of its offices. The application 
must include, at a minimum, the physical locations of such offices and 
a description of how the Issuing Credit Union will comply with the 
requirements of this subsection;
    (2) Decision on application. Within 60 calendar days (which may be 
extended by the Appropriate Supervision Office) after the date of 
receipt of a complete application described in paragraph (e)(1) of this 
section, the Appropriate Supervision Office will provide the Issuing 
Credit Union with a written determination on its application to conduct 
offering and sales activity from its office(s). Any denial of an 
Issuing Credit Union's application under this section will include the 
reasons for such denial;
    (3) Commissions, bonuses, or comparable payments. In connection 
with any offering and sale of Subordinated Debt Notes (whether or not 
conducted at offices of the Issuing Credit Union), an Issuing Credit 
Union shall not pay, directly or indirectly, any commissions, bonuses, 
or comparable payments to any employee of the Issuing Credit Union or 
any affiliated Credit Union Service Organizations (CUSOs) assisting 
with the offer, issuance, and sale of such Subordinated Debt Notes, or 
to any other person in connection with the offer, issuance, and sale of 
Subordinated Debt Notes; except that compensation and commissions 
consistent with industry norms may be paid to securities personnel of 
registered broker-dealers as otherwise permitted by applicable law;
    (4) Issuances by tellers. No offers or sales may be made by tellers 
at the teller counter of any Issuing Credit Union, or by comparable 
persons at comparable locations;
    (5) Permissible issuing personnel. In connection with an offering 
or sale of Subordinated Debt Notes (whether or not conducted at offices 
of the Issuing Credit Union), such activity may be conducted only by 
regular, full-time employees of the Issuing Credit Union or by 
securities personnel who are subject to supervision by a registered 
broker-dealer, which securities personnel may be employees of the 
Issuing Credit Union's affiliated CUSO that is assisting the Issuing 
Credit Union

[[Page 14027]]

with the offer, issuance, and sale of the Subordinated Debt Notes;
    (6) Issuance practices, advertisements, and other literature used 
in connection with the offer and sale of Subordinated Debt Notes. In 
connection with an offering or sale of Subordinated Debt Notes (whether 
or not conducted at offices of the Issuing Credit Union), issuance 
practices, advertisements, and other issuance literature used in 
connection with offers and issuances of Subordinated Debt Notes by 
Issuing Credit Unions or any affiliated CUSOs assisting with the offer 
and issuance of such Subordinated Debt Notes shall be subject to the 
requirements of this subpart; and
    (7) Office of an Issuing Credit Union. For purposes of this 
subsection, an ``office'' of an Issuing Credit Union means any premises 
used by the Issuing Credit Union that is identified to the public 
through advertising or signage using the Issuing Credit Union's name, 
trade name, or logo.
    (f) Securities laws. An Issuing Credit Union must comply with all 
applicable federal and state securities laws.
    (g) Resales. All resales of Subordinated Debt Notes issued by an 
Issuing Credit Union by holders of such Subordinated Debt Notes must be 
made pursuant to Rule 144 under the Securities Act of 1933, as amended 
(17 CFR 230.144) (other than paragraphs (c), (e), (f), (g) and (h) of 
such Rule), Rule 144A under the Securities Act of 1933, as amended (17 
CFR 230.144A), or another exemption from registration under the 
Securities Act of 1933, as amended. Subordinated Debt Notes must 
include the restrictions on resales in Sec.  702.404(a)(10).


Sec.  702.407   Discounting of amount treated as Regulatory Capital.

    The amount of outstanding Subordinated Debt that may be treated as 
Regulatory Capital shall reduce by 20 percent per annum of the initial 
aggregate principal amount of the applicable Subordinated Debt (as 
reduced by prepayments or amounts extinguished to cover a deficit under 
Sec.  702.404(a)(6)), as required by the following schedule:

------------------------------------------------------------------------
                                                               Balance
                                                              treated as
                     Remaining maturity                       Regulatory
                                                               Capital
                                                              (percent)
------------------------------------------------------------------------
Four to less than five years...............................           80
Three to less than four years..............................           60
Two to less than three years...............................           40
One to less than two years.................................           20
Less than one year.........................................            0
------------------------------------------------------------------------

Sec.  702.408  Preapproval to issue Subordinated Debt.

    (a) Scope. This section requires all credit unions to receive 
written preapproval from the NCUA before issuing Subordinated Debt. 
Procedures related specifically to applications from federally insured, 
state-chartered credit unions are contained in Sec.  702.409. A credit 
union seeking approval to offer and sell Subordinated Debt at one or 
more of its offices must also follow the application procedures in 
Sec.  702.406(e). All approvals under this section are subject to the 
expiration limits specified in paragraph (k) of this section.
    (b) Initial application to issue Subordinated Debt. A credit union 
requesting approval to issue Subordinated Debt must first submit an 
application to the Appropriate Supervision Office that, at a minimum, 
includes:
    (1) A statement indicating how the credit union qualifies to issue 
Subordinated Debt given the eligibility requirements of Sec.  702.403 
with additional supporting analysis if anticipating to meet the 
requirements of a LICU or Complex Credit Union within 24 months after 
issuance of the Subordinated Debt;
    (2) The maximum aggregate principal amount of Subordinated Debt 
Notes and the maximum number of discrete issuances of Subordinated Debt 
Notes that the credit union is proposing to issue within the period 
allowed under paragraph (k) of this section;
    (3) The estimated number of investors and the status of such 
investors (Natural Person Accredited Investors and/or Entity Accredited 
Investors) to whom the credit union intends to offer and sell the 
Subordinated Debt Notes;
    (4) A statement identifying any outstanding Subordinated Debt or 
Grandfathered Secondary Capital previously issued by the credit union;
    (5) A copy of the credit union's strategic plan, business plan, and 
budget, and an explanation of how the credit union intends to use the 
Subordinated Debt in conformity with those plans;
    (6) An analysis of how the credit union will provide for liquidity 
to repay the Subordinated Debt upon maturity of the Subordinated Debt;
    (7) Pro Forma Financial Statements (balance sheet, income 
statement, and statement of cash flows), including any off-balance 
sheet items, covering at least five years. Analytical support for key 
assumptions and key assumption changes must be included in the 
application. Key assumptions include, but are not limited to, interest 
rate, liquidity, and credit loss scenarios;
    (8) A statement indicating how the credit union will use the 
proceeds from the issuance and sale of the Subordinated Debt;
    (9) A statement identifying the governing law specified in the 
Subordinated Debt Notes and the documents pursuant to which the 
Subordinated Debt Notes will be issued;
    (10) A draft written policy governing the offer, and issuance, and 
sale of the Subordinated Debt, developed in consultation with Qualified 
Counsel, which, at a minimum, addresses:
    (i) Compliance with all applicable federal and state securities 
laws and regulations;
    (ii) Compliance with applicable securities laws related to 
communications with investors and potential investors, including, but 
not limited to: Who may communicate with investors and potential 
investors; what information may be provided to investors and potential 
investors; ongoing disclosures to investors; who will review and ensure 
the accuracy of the information provided to investors and potential 
investors; and to whom information will be provided;
    (iii) Compliance with any laws that may require registration of 
credit union employees as broker-dealers; and
    (iv) Any use of outside agents, including broker-dealers, to assist 
in the marketing and issuance of Subordinated Debt, and any limitations 
on such use.
    (11) A schedule that provides an itemized statement of all expenses 
incurred or expected to be incurred by the credit union in connection 
with the offer, issuance, and sale of the Subordinated Debt Notes to 
which the initial application relates, other than underwriting 
discounts and commissions or similar compensation payable to broker-
dealers acting as placement agents. The schedule must include, as 
applicable, fees and expenses of counsel, auditors, any trustee or 
issuing and paying agent or any transfer agent, and printing and 
engraving expenses. If the amounts of any items are not known at the 
time of filing of the initial application, the credit union must 
provide estimates, clearly identified as such;
    (12) In the case of a New Credit Union, a statement that it is 
subject to either an approved initial business plan or revised business 
plan, as required by this part, and how the proposed Subordinated Debt 
would conform with the approved plan. Unless the New Credit Union has a 
LICU designation pursuant to Sec.  701.34 of this chapter, it must also 
include a plan for replacing the Subordinated Debt with Retained 
Earnings before the credit union ceases

[[Page 14028]]

to meet the definition of New Credit Union in Sec.  702.2;
    (13) A statement describing any investments the credit union has in 
the Subordinated Debt of any other credit union, and the manner in 
which the credit union acquired such Subordinated Debt, including 
through a merger or other consolidation;
    (14) A signature page signed by the credit union's principal 
executive officer, principal financial officer or principal accounting 
officer, and a majority `of the members of its board of directors. 
Amendments to an initial application must be signed and filed with the 
NCUA in the same manner as the initial application; and
    (15) Any additional information requested in writing by the 
Appropriate Supervision Office.
    (c) Decision on initial application. Upon receiving an initial 
application submitted under this subsection and any additional 
information requested in writing by the Appropriate Supervision Office, 
the Appropriate Supervision Office will evaluate, at a minimum, the 
credit union's compliance with this subpart and all other NCUA 
regulations, the credit union's ability to manage and safely offer, 
issue, and sell the proposed Subordinated Debt, the safety and 
soundness of the proposed use of the Subordinated Debt, the overall 
condition of the credit union, and any other factors the Appropriate 
Supervision Office determines are relevant.
    (1) Written determination. Within 60 calendar days (which may be 
extended by the Appropriate Supervision Office) after the date of 
receipt of a complete application, the Appropriate Supervision Office 
will provide the credit union with a written determination on its 
application. In the case of a full or partial denial, or conditional 
approval under paragraph (c)(2) of this section, the written decision 
will state the reasons for the denial or conditional approval.
    (2) Conditions of approval. Any approval granted by an Appropriate 
Supervision Office under this section may include one or more of the 
following conditions:
    (i) Approval of an aggregate principal amount of Subordinated Debt 
that is lower than what the credit union requested;
    (ii) Any applicable minimum level of Net Worth that the credit 
union must maintain while the Subordinated Debt Notes are outstanding;
    (iii) Approved uses of the Subordinated Debt; and
    (iv) Any other limitations or conditions the Appropriate 
Supervision Office deems necessary to protect the NCUSIF.
    (d) Offering Document. Following receipt of written approval of its 
initial application, an Issuing Credit Union must prepare an Offering 
Document for each issuance of Subordinated Debt Notes. In addition, as 
required in paragraph (f) of this section, an Issuing Credit Union that 
intends to offer Subordinated Debt Notes to any Natural Person 
Accredited Investors must have the related Offering Document declared 
``approved for use'' by the NCUA before its first use. At a reasonable 
time prior to any issuance and sale of Subordinated Debt Notes, the 
Issuing Credit Union must provide each investor with an Offering 
Document as described in this section. All Offering Documents must be 
filed with the NCUA within two business days after their respective 
first use.
    (e) Requirements for all Offering Documents. (1) Minimum 
information required in an Offering Document. An Offering Document 
must, at a minimum, include the following information:
    (i) The name of the Issuing Credit Union and the address of its 
principal executive office;
    (ii) The initial principal amount of the Subordinated Debt being 
issued;
    (iii) The name(s) of any underwriter(s) or placement agents being 
used for the issuance;
    (iv) A description of the material risk factors associated with the 
purchase of the Subordinated Debt Notes, including any special or 
distinctive characteristics of the Issuing Credit Union's business, 
field of membership, or geographic location that are reasonably likely 
to have a material impact on the Issuing Credit Union's future 
financial performance;
    (v) The disclosures described in Sec.  702.405 and such additional 
material information, if any, as may be necessary to make the required 
disclosures, in the light of the circumstances under which they are 
made, not misleading;
    (vi) Provisions related to the interest, principal, payment, 
maturity, and prepayment of the Subordinated Debt Notes;
    (vii) All material affirmative and negative covenants that may or 
will be included in the Subordinated Debt Note, including, but not 
limited to, the covenants discussed in this subpart;
    (viii) Any legends required by applicable state law; and
    (ix) The following legend, displayed on the cover page in prominent 
type or in another manner:

    None of the Securities and Exchange Commission (the ``SEC''), 
any state securities commission or the National Credit Union 
Administration has passed upon the merits of, or given its approval 
of, the purchase of any Subordinated Debt Notes offered or the terms 
of the offering, or passed on the accuracy or completeness of any 
Offering Document or other materials used in connection with the 
offer, issuance, and sale of the Subordinated Debt Notes. Any 
representation to the contrary is unlawful. These Subordinated Debt 
Notes have not been registered under the Securities Act of 1933, as 
amended (the ``Act'') and are being offered and sold to [an Entity 
Accredited Investor][an Accredited Investor] (as defined in 12 CFR 
702.402) pursuant to an exemption from registration under the Act; 
however, neither the SEC nor the NCUA has made an independent 
determination that the offer and issuance of the Subordinated Debt 
Notes are exempt from registration.

    (2) Legibility requirements. An Issuing Credit Union's Offering 
Document must comply with the following legibility requirements:
    (i) Information in the Offering Document must be presented in a 
clear, concise, and understandable manner, incorporating plain English 
principles. The body of all printed Offering Documents shall be in type 
at least as large and as legible as 10-point type. To the extent 
necessary for convenient presentation, however, financial statements 
and other tabular data, including tabular data in notes, may be in type 
at least as large and as legible as 8-point type. Repetition of 
information should be avoided. Cross-referencing of information within 
the document is permitted; and
    (ii) Where an Offering Document is distributed through an 
electronic medium, the Issuing Credit Union may satisfy legibility 
requirements applicable to printed documents, such as paper size, type 
size and font, bold-face type, italics and red ink, by presenting all 
required information in a format readily communicated to offerees and, 
where indicated, in a manner reasonably calculated to draw the 
attention of offerees to specific information.
    (f) Offering Documents approved for use in offerings of 
Subordinated Debt to any Natural Person Accredited Investors--(1) 
Filing of a Draft Offering Document. An Issuing Credit Union that 
intends to offer Subordinated Debt Notes to any Natural Person 
Accredited Investors must file a draft Offering Document with the NCUA 
and have such draft Offering Document declared ``approved for use'' by 
the NCUA before its first use.
    (i) Request for additional information, clarifications, or 
amendments. Prior to declaring any Offering Document ``approved for 
use,'' the NCUA may ask

[[Page 14029]]

questions, request clarifications, or direct the Issuing Credit Union 
to amend certain sections of the draft Offering Document. The NCUA will 
make any such requests in writing.
    (ii) Written determination. Within 60 calendar days (which may be 
extended by the NCUA) after the date of receipt of each of the initial 
filing and each filing of additional information, clarifications, or 
amendments requested by the NCUA under paragraph (f)(1)(i) of this 
section, the NCUA will provide the Issuing Credit Union with a written 
determination on the applicable filing. The written determination will 
include any requests for additional information, clarifications, or 
amendments, or a statement that the Offering Document is ``approved for 
use.''
    (2) Filing of a final Offering Document. At such time as the NCUA 
declares an Offering Document ``approved for use'' in accordance with 
paragraph (f)(1)(ii) of this section, the Issuing Credit Union may then 
use that Offering Document in the offer and sale of the Subordinated 
Debt Notes. The Issuing Credit Union must file a copy of each of its 
Offering Documents with the NCUA within two business days after their 
respective first use.
    (g) Filing of an Offering Document for offerings of Subordinated 
Debt exclusively to Entity Accredited Investors. An Issuing Credit 
Union that is offering Subordinated Debt exclusively to Entity 
Accredited Investors is not required to have its Offering Document 
``approved for use'' by the NCUA under paragraph (f) of this section 
before using it to offer and sell the Subordinated Debt Notes. As 
described in this section, however, the Issuing Credit Union must file 
a copy of each of its Offering Documents with the NCUA within two 
business days after their respective first use.
    (h) Material changes to any initial application or Offering 
Document--(1) Reapproval of initial application. If any material event 
arises or material change in fact occurs after the approval of the 
initial application by the NCUA, but prior to the completion of the 
offer and sale of the related Subordinated Debt Notes, then no person 
shall offer or sell Subordinated Debt Notes to any other person until 
an amendment to the Offering Document reflecting the event or change 
has been filed with and approved by the NCUA.
    (2) Reapproval of Offering Document. If an Offering Document must 
be approved for use under paragraph (f) of this section, and any event 
arises or change in fact occurs after the approval for use of any 
Offering Document, and that event or change in fact, individually or in 
the aggregate, results in the Offering Document containing any untrue 
statement of material fact, or omitting to state a material fact 
necessary in order to make statements made in the Offering Document not 
misleading in light of the circumstances under which they were made, 
then no person shall offer or sell Subordinated Debt Notes to any other 
person until an amendment reflecting the event or change has been filed 
with and ``approved for use'' by the NCUA.
    (3) Failure to request reapproval. If an Issuing Credit Union fails 
to comply with paragraph (h)(1) or (2) of this section, the NCUA may, 
at its discretion, exercise the full range of administrative remedies 
available under the FCU Act, including:
    (i) Prohibiting the Issuing Credit Union from issuing any 
additional Subordinated Debt for a specified period; and/or
    (ii) Determining not to treat the Subordinated Debt as Regulatory 
Capital.
    (i) Notification. Not later than 10 business days after the closing 
of a Subordinated Debt Note issuance and sale, the Issuing Credit Union 
must submit to the Appropriate Supervision Office:
    (1) A copy of each executed Subordinated Debt Note;
    (2) A copy of each executed purchase agreement, if any;
    (3) Any indenture or other transaction document used to issue the 
Subordinated Debt Notes;
    (4) Copies of signed certificates of Accredited Investor status, in 
a form similar to that in Sec.  702.406(c), from all investors;
    (5) All documentation provided to investors related to the offer 
and sale of the Subordinated Debt Note (other than any Offering 
Document that was previously filed with the NCUA); and
    (6) Any other material documents governing the issuance, sale or 
administration of the Subordinated Debt Notes.
    (j) Resubmissions. An Issuing Credit Union that receives any 
adverse written determination from the Appropriate Supervision Office 
with respect to the approval of its initial application or any 
amendment thereto or, if applicable, the approval for use of an 
Offering Document or any amendment thereto, may cure any reasons noted 
in the written determination and refile under the requirements of this 
section. This subsection does not prohibit an Issuing Credit Union from 
appealing an Appropriate Supervision Office's decision under subpart A 
of part 746 of this chapter.
    (k) Expiration of authority to issue Subordinated Debt. (1) Any 
approvals to issue Subordinated Debt Notes under this section expire 
one year from the later of the date the Issuing Credit Union receives:
    (i) Approval of its initial application, if the Issuing Credit 
Union is offering Subordinated Notes exclusively to Entity Accredited 
Investors; or
    (ii) The initial approval for use of its Offering Document, if the 
Issuing Credit Union is offering Subordinated Debt Notes to any Natural 
Person Accredited Investors.
    (2) Failure to issue all or part of the maximum aggregate principal 
amount of Subordinated Debt Notes approved in the initial application 
process within the applicable period specified in paragraph (k) of this 
section will result in the expiration of the NCUA's approval. An 
Issuing Credit Union may file a written extension request with the 
Appropriate Supervision Office. The Issuing Credit Union must 
demonstrate good cause for any extension(s), and must file the request 
at least 30 calendar days before the expiration of the applicable 
period specified in paragraph (k) of this section or any extensions 
granted under paragraph (k) of this section. In any such written 
application, the Issuing Credit Union must address whether any such 
extension poses any material securities law implications.
    (l) Filing requirements and inspection of documents. (1) Except as 
otherwise provided in this section, all initial applications, Offering 
Documents, amendments, notices, or other documents must be filed with 
the NCUA electronically at http://www.NCUA.gov. Documents may be signed 
electronically using the signature provision in Rule 402 under the 
Securities Act of 1933, as amended (17 CFR 230.402).
    (2) Provided the Issuing Credit Union filing the document has 
complied with all requirements regarding the filing, the date of filing 
of the document is the date the NCUA receives the filing. An electronic 
filing that is submitted on a business day by direct transmission 
commencing on or before 5:30 p.m. Eastern Standard or Daylight Savings 
Time, whichever is then currently in effect, would be deemed received 
by the NCUA on the same business day. An electronic filing that is 
submitted by direct transmission commencing after 5:30 p.m. Eastern 
Standard or Daylight Savings Time, whichever is then currently in 
effect, or on a Saturday, Sunday, or Federal holiday, would be deemed 
received by the NCUA on the next business day. If an electronic filer 
in good faith attempts to file a document

[[Page 14030]]

with the NCUA in a timely manner, but the filing is delayed due to 
technical difficulties beyond the electronic filer's control, the 
electronic filer may request that the NCUA adjust the filing date of 
such document. The NCUA may grant the request if it appears that such 
adjustment is appropriate and consistent with the public interest and 
the protection of investors.
    (3) If an Issuing Credit Union experiences unanticipated technical 
difficulties preventing the timely preparation and submission of an 
electronic filing, the Issuing Credit Union may, upon notice to the 
Appropriate Supervision Office, file the subject filing in paper format 
no later than one business day after the date on which the filing was 
to be made.
    (4) Any filing of amendments or supplements to an Offering Document 
must include two copies, one of which must be marked to indicate 
clearly and precisely, by underlining or in some other conspicuous 
manner, the changes made from the previously filed Offering Document.
    (m) Filing fees. (1) The NCUA may require filing fees to accompany 
certain filings made under this subpart before it will accept those 
filings. The NCUA provides an applicable fee schedule on its website at 
www.NCUA.gov.
    (2) Filing fees must be paid to the NCUA by electronic transfer.


Sec.  702.409   Preapproval for federally insured, state-chartered 
credit unions to issue Subordinated Debt.

    (a) A federally insured, state-chartered credit union is required 
to submit the information required under Sec.  702.408 and, if 
applicable, paragraph (b) of this section to both the Appropriate 
Supervision Office and its state supervisory authority. The Appropriate 
Supervision Office will issue decisions approving a federally insured, 
state-chartered credit union's application only after obtaining the 
concurrence of the federally insured, state-chartered credit union's 
state supervisory authority. The NCUA will notify a federally insured, 
state-chartered credit union's state supervisory authority before 
issuing a decision to ``approve for use'' a federally insured, state-
chartered credit union's Offering Document and any amendments thereto, 
under Sec.  702.408, if applicable.
    (b) If the Appropriate Supervision Office has reason to believe 
that an issuance by a federally insured, state-chartered credit union 
under this subpart could subject that federally insured, state-
chartered credit union to federal income taxation, the Appropriate 
Supervision Office may require the federally insured, state-chartered 
credit union to provide:
    (1) A written legal opinion, satisfactory to the NCUA, from 
nationally recognized tax counsel or letter from the Internal Revenue 
Service indicating whether the proposed Subordinated Debt would be 
classified as capital stock for federal income tax purposes and, if so, 
describing any material impact of federal income taxes on the federally 
insured, state-chartered credit union's financial condition; or
    (2) A Pro Forma Financial Statement (balance sheet, income 
statement, and statement of cash flows), covering a minimum of five 
years, that shows the impact of the federally insured, state-chartered 
credit union being subject to federal income tax.
    (c) If the Appropriate Supervision Office requires additional 
information from a federally insured, state-chartered credit union 
under paragraph (b) of this section, the federally insured, state-
chartered credit union may determine, in its sole discretion, whether 
the information it provides is in the form described in paragraph 
(b)(1) or (2) of this section.


Sec.  702.410   Interest payments on Subordinated Debt.

    (a) Requirements for interest payments. An Issuing Credit Union is 
prohibited from paying interest on Subordinated Debt in accordance with 
Sec.  702.109.
    (b) Accrual of interest. Notwithstanding nonpayment pursuant to 
paragraph (a) of this section, interest on the Subordinated Debt may 
continue to accrue according to terms provided for in the Subordinated 
Debt Note and as otherwise permitted in this subpart.
    (c) Interest safe harbor. Except as otherwise provided in this 
section, the NCUA shall not impose a discretionary supervisory action 
that requires the Issuing Credit Union to suspend interest with respect 
to the Subordinated Debt if:
    (1) The issuance and sale of the Subordinated Debt complies with 
all requirements of this subpart;
    (2) The Subordinated Debt is issued and sold in an arms-length, 
bona fide transaction;
    (3) The Subordinated Debt was issued and sold in the ordinary 
course of business, with no intent to hinder, delay or defraud the 
Issuing Credit Union or its creditors; and
    (4) The Subordinated Debt was issued and sold for adequate 
consideration in U.S. dollars.
    (d) Authority, rights, and powers of the NCUA and the NCUA Board. 
This section does not waive, limit, or otherwise affect the authority, 
rights, or powers of the NCUA or the NCUA Board in any capacity, 
including the NCUA Board as conservator or liquidating agent, to take 
any action or to exercise any power not specifically mentioned, 
including but not limited to any rights, powers or remedies of the NCUA 
Board as conservator or liquidating agent regarding transfers or other 
conveyances taken in contemplation of the Issuing Credit Union's 
insolvency or with the intent to hinder, delay or defraud the Issuing 
Credit Union or the creditors of such Issuing Credit Union, or that is 
fraudulent under applicable law.


Sec.  702.411   Prior written approval to prepay Subordinated Debt.

    (a) Prepayment option. An Issuing Credit Union may include in the 
terms of its Subordinated Debt an option that allows the Issuing Credit 
Union to prepay the Subordinated Debt in whole or in part prior to 
maturity, provided, however, that the Issuing Credit Union is required 
to:
    (1) Clearly disclose the requirements of this section in the 
Subordinated Debt Note; and
    (2) Obtain approval under paragraph (b) of this section before 
exercising a prepayment option.
    (b) Prepayment application. Before an Issuing Credit Union can, in 
whole or in part, prepay Subordinated Debt prior to maturity, the 
Issuing Credit Union must first submit to the Appropriate Supervision 
Office an application that must include, at a minimum, the information 
required in paragraph (d) of this section.
    (c) Federally insured, state-chartered credit union prepayment 
applications. Before a federally insured, state-chartered credit union 
may submit an application for prepayment to the Appropriate Supervision 
Office, it must obtain written approval from its state supervisory 
authority to prepay the Subordinated Debt it is proposing to prepay. A 
federally insured, state-chartered credit union must provide evidence 
of such approval as part of its application to the Appropriate 
Supervision Office.
    (d) Application contents. An Issuing Credit Union's application to 
prepay Subordinated Debt must include, at a minimum, the following:
    (1) A copy of the Subordinated Debt Note and any agreement(s) 
reflecting the terms and conditions of the Subordinated Debt the 
Issuing Credit Union is proposing to prepay;
    (2) An explanation why the Issuing Credit Union believes it still 
would hold an amount of capital commensurate with its risk exposure 
notwithstanding

[[Page 14031]]

the proposed prepayment or a description of the replacement 
Subordinated Debt, including the amount of such instrument, and the 
time frame for issuance, the Issuing Credit Union is proposing to use 
to replace the prepaid Subordinated Debt; and
    (3) Any additional information the Appropriate Supervision Office 
requests.
    (e) Decision on application to prepay. (1) Within 45 calendar days 
(which may be extended by the Appropriate Supervision Office) after the 
date of receipt of a complete application, the Appropriate Supervision 
Office will provide the Issuing Credit Union with a written 
determination on its application. In the case of a full or partial 
denial, including a conditional approval under paragraph (e)(2) of this 
section, the written decision will state the reasons for the denial or 
conditional approval.
    (2) The written determination from the Appropriate Supervision 
Office may approve the Issuing Credit Union's request, approve the 
Issuing Credit Union's request with conditions, or deny the Issuing 
Credit Union's request. In the case of a denial or conditional 
approval, the Appropriate Supervision Office will provide the Issuing 
Credit Union with a description of why it denied the Issuing Credit 
Union's request or imposed conditions on the approval of such request.
    (3) If the Issuing Credit Union proposes or the NCUA requires the 
Issuing Credit Union to replace the Subordinated Debt, the Issuing 
Credit Union must receive affirmative approval under this subpart and 
must issue and sell the replacement instrument prior to or concurrently 
with prepaying the Subordinated Debt.
    (f) Resubmissions. An Issuing Credit Union that receives an adverse 
written determination on its application to prepay, in whole or in 
part, may cure any deficiencies noted in the Appropriate Supervision 
Office's written determination and reapply under the requirements of 
this section. This subsection does not prohibit an Issuing Credit Union 
from appealing the Appropriate Supervision Office's adverse decision 
under subpart A of part 746 of this chapter.


Sec.  702.412   Effect of a merger or dissolution on the treatment of 
Subordinated Debt as Regulatory Capital.

    (a) In the event of a merger of an Issuing Credit Union into or the 
assumption of its Subordinated Debt by another federally insured credit 
union, the Subordinated Debt will be treated as Regulatory Capital only 
to the extent that the resulting credit union is either a LICU, a 
Complex Credit Union, and/or a New Credit Union.
    (b) In the event the resulting credit union is not a LICU, a 
Complex Credit Union, or a New Credit Union, the Subordinated Debt of 
the merging credit union can either be:
    (1) If permitted by the terms of the Subordinated Debt Note, repaid 
by the resulting credit union upon approval by the NCUA under Sec.  
702.411; or
    (2) Continue to be held by the resulting credit union as 
Subordinated Debt, but will not be classified as Regulatory Capital 
under this subpart, unless the resulting credit union meets the 
eligibility requirements of Sec.  702.403.
    (c) Voluntary liquidation. In the event of a voluntary dissolution 
of an Issuing Credit Union that has outstanding Subordinated Debt, the 
Subordinated Debt may be repaid in full according to 12 CFR part 710, 
subject to the requirements in Sec.  702.411.


Sec.  702.413   Repudiation safe harbor.

    (a) The NCUA Board as conservator for a federally insured credit 
union, or its lawfully appointed designee, shall not exercise its 
repudiation authorities under 12 U.S.C. 1787(c) with respect to 
Subordinated Debt if:
    (1) The issuance and sale of the Subordinated Debt complies with 
all requirements of this subpart;
    (2) The Subordinated Debt was issued and sold in an arms-length, 
bona fide transaction;
    (3) The Subordinated Debt was issued and sold in the ordinary 
course of business, with no intent to hinder, delay or defraud the 
Issuing Credit Union or its creditors; and
    (4) The Subordinated Debt was issued and sold for adequate 
consideration in U.S. dollars.
    (b) This section does not authorize the attachment of any 
involuntary lien upon the property of either the NCUA Board as 
conservator or liquidating agent or its lawfully appointed designee. 
Nor does this section waive, limit, or otherwise affect the authority, 
rights, or powers of the NCUA or the NCUA Board in any capacity to take 
any action or to exercise any power not specifically mentioned, 
including but not limited to any rights, powers or remedies of the NCUA 
Board as conservator or liquidating agent (or its lawfully appointed 
designee) regarding transfers or other conveyances taken in 
contemplation of the Issuing Credit Union's insolvency or with the 
intent to hinder, delay or defraud the Issuing Credit Union or the 
creditors of such Issuing Credit Union, or that is fraudulent under 
applicable law.


Sec.  702.414   Regulations governing Grandfathered Secondary Capital.

    This section codifies the requirements of Sec. Sec.  701.34(b), 
(c), and (d) of this chapter in subpart D, with minor modifications, in 
effect before [EFFECTIVE DATE OF THE FINAL RULE]. The terminology used 
in this section is specific to this section. All secondary capital 
issued before the effective date of this rule that was issued in 
accordance with Sec. Sec.  701.34(b), (c), and (d) of this chapter in 
subpart D or, in the case of a federally insured, state-chartered 
credit union, Sec.  741.204(c) of this chapter, that is referred to 
elsewhere in this subpart as ``Grandfathered Secondary Capital,'' is 
subject to the requirements set forth in this section.
    (a) Secondary capital is subject to the following conditions:
    (1) Secondary capital plan. A credit union that has Grandfathered 
Secondary Capital under this section must have a written, NCUA-approved 
``Secondary Capital Plan'' that, at a minimum:
    (i) States the maximum aggregate amount of uninsured secondary 
capital the LICU plans to accept;
    (ii) Identifies the purpose for which the aggregate secondary 
capital will be used, and how it will be repaid;
    (iii) Explains how the LICU will provide for liquidity to repay 
secondary capital upon maturity of the accounts;
    (iv) Demonstrates that the planned uses of secondary capital 
conform to the LICU's strategic plan, business plan and budget; and
    (v) Includes supporting pro forma financial statements, including 
any off-balance sheet items, covering a minimum of the next two years.
    (2) Issuances not completed before [EFFECTIVE DATE OF THE FINAL 
RULE]. Any issuances of secondary capital not completed by the 
effective date of this subpart are, as of the effective date of this 
subpart, subject to the requirements applicable to Subordinated Debt 
discussed elsewhere in this subpart.
    (3) Nonshare account. The secondary capital account is established 
as an uninsured secondary capital account or other form of non-share 
account.
    (4) Minimum maturity. The maturity of the secondary capital account 
is a minimum of five years.
    (5) Uninsured account. The secondary capital account is not insured 
by the National Credit Union Share Insurance Fund or any governmental 
or private entity.
    (6) Subordination of claim. The secondary capital account 
investor's claim against the LICU is subordinate to all other claims 
including those of

[[Page 14032]]

shareholders, creditors and the National Credit Union Share Insurance 
Fund.
    (7) Availability to cover losses. Funds deposited into a secondary 
capital account, including interest accrued and paid into the secondary 
capital account, are available to cover operating losses realized by 
the LICU that exceed its net available reserves (exclusive of secondary 
capital and allowance accounts for loan and lease losses), and to the 
extent funds are so used, the LICU must not restore or replenish the 
account under any circumstances. The LICU may, in lieu of paying 
interest into the secondary capital account, pay accrued interest 
directly to the investor or into a separate account from which the 
secondary capital investor may make withdrawals. Losses must be 
distributed pro-rata among all secondary capital accounts held by the 
LICU at the time the losses are realized. In instances where a LICU 
accepted secondary capital from the United States Government or any of 
its subdivisions under the Community Development Capital Initiative of 
2010 (``CDCI secondary capital'') and matching funds were required 
under the Initiative and are on deposit in the form of secondary 
capital at the time a loss is realized, a LICU must apply either of the 
following pro-rata loss distribution procedures to its secondary 
capital accounts with respect to the loss:
    (i) If not inconsistent with any agreements governing other 
secondary capital on deposit at the time a loss is realized, the CDCI 
secondary capital may be excluded from the calculation of the pro-rata 
loss distribution until all of its matching secondary capital has been 
depleted, thereby causing the CDCI secondary capital to be held as 
senior to all other secondary capital until its matching secondary 
capital is exhausted. The CDCI secondary capital should be included in 
the calculation of the pro-rata loss distribution and is available to 
cover the loss only after all of its matching secondary capital has 
been depleted.
    (ii) Regardless of any agreements applicable to other secondary 
capital, the CDCI secondary capital and its matching secondary capital 
may be considered a single account for purposes of determining a pro-
rata share of the loss and the amount determined as the pro-rata share 
for the combined account must first be applied to the matching 
secondary capital account, thereby causing the CDCI secondary capital 
to be held as senior to its matching secondary capital. The CDCI 
secondary capital is available to cover the loss only after all of its 
matching secondary capital has been depleted.
    (8) Security. The secondary capital account may not be pledged or 
provided by the account investor as security on a loan or other 
obligation with the LICU or any other party.
    (9) Merger or dissolution. In the event of merger or other 
voluntary dissolution of the LICU, other than merger into another LICU, 
the secondary capital accounts will be closed and paid out to the 
account investor to the extent they are not needed to cover losses at 
the time of merger or dissolution.
    (10) Contract agreement. A secondary capital account contract 
agreement must have been executed by an authorized representative of 
the account investor and of the LICU reflecting the terms and 
conditions mandated by this section and any other terms and conditions 
not inconsistent with this section.
    (11) Disclosure and acknowledgement. An authorized representative 
of the LICU and of the secondary capital account investor each must 
have executed a ``Disclosure and Acknowledgment'' as set forth in the 
appendix to this section at the time of entering into the account 
agreement. The LICU must retain an original of the account agreement 
and the ``Disclosure and Acknowledgment'' for the term of the 
agreement, and a copy must be provided to the account investor.
    (12) Prompt corrective action. As provided in this part, the NCUA 
may prohibit a LICU as classified ``critically undercapitalized'' or, 
if ``new,'' as ``moderately capitalized'', ``marginally capitalized'', 
``minimally capitalized'' or ``uncapitalized,'' as the case may be, 
from paying principal, dividends or interest on its uninsured secondary 
capital accounts established after August 7, 2000, `except that unpaid 
dividends or interest will continue to accrue under the terms of the 
account to the extent permitted by law.
    (b) Accounting treatment; Recognition of net worth value of 
accounts--(1) Debt. A LICU that issued secondary capital accounts 
pursuant to paragraph (a) of this section must record the funds on its 
balance sheet as a debt titled ``uninsured secondary capital account.''
    (2) Schedule for recognizing net worth value. The LICU's reflection 
of the net worth value of the accounts in its financial statement may 
never exceed the full balance of the secondary capital on deposit after 
any early redemptions and losses. For accounts with remaining 
maturities of less than five years, the LICU must reflect the net worth 
value of the accounts in its financial statement in accordance with the 
lesser of:
    (i) The remaining balance of the accounts after any redemptions and 
losses; or
    (ii) The amounts calculated based on the following schedule:

------------------------------------------------------------------------
                                                              Net worth
                                                               value of
                     Remaining maturity                        original
                                                               balance
                                                              (percent)
------------------------------------------------------------------------
Four to less than five years...............................           80
Three to less than four years..............................           60
Two to less than three years...............................           40
One to less than two years.................................           20
Less than one year.........................................            0
------------------------------------------------------------------------

    (3) Financial statement. The LICU must reflect the full amount of 
the secondary capital on deposit in a footnote to its financial 
statement.
    (c) Redemption of secondary capital. With the written approval of 
NCUA, secondary capital that is not recognized as net worth under 
paragraph (b)(2) of this section (``discounted secondary capital'' re-
categorized as Subordinated Debt) may be redeemed according to the 
remaining maturity schedule in paragraph (c)(3) of this section.
    (1) Request to redeem secondary capital. A request for approval to 
redeem discounted secondary capital may be submitted in writing at any 
time, must specify the increment(s) to be redeemed and the schedule for 
redeeming all or any part of each eligible increment, and must 
demonstrate to the satisfaction of NCUA that:
    (i) The LICU will have a post-redemption net worth classification 
of at least ``adequately capitalized'' under this part;
    (ii) The discounted secondary capital has been on deposit at least 
two years;
    (iii) The discounted secondary capital will not be needed to cover 
losses prior to final maturity of the account;
    (iv) The LICU's books and records are current and reconciled;
    (v) The proposed redemption will not jeopardize other current 
sources of funding, if any, to the LICU; and
    (vi) The request to redeem is authorized by resolution of the 
LICU's board of directors.
    (2) Decision on request. A request to redeem discounted secondary 
capital may be granted in whole or in part. If a LICU is not notified 
within 45 days of receipt of a request for approval to redeem secondary 
capital that its request is either granted or denied, the LICU may 
proceed to redeem secondary capital accounts as proposed.
    (3) Schedule for redeeming secondary capital.

[[Page 14033]]



------------------------------------------------------------------------
                                                              Redemption
                                                               limit as
                     Remaining maturity                       percent of
                                                               original
                                                               balance
------------------------------------------------------------------------
Four to less than five years...............................           20
Three to less than four years..............................           40
Two to less than three years...............................           60
One to less than two years.................................           80
------------------------------------------------------------------------

    (4) Early redemption exception. Subject to the written approval of 
NCUA obtained pursuant to the requirements of paragraphs (c)(1) and (2) 
of this section, a LICU can redeem all or part of secondary capital 
accepted from the United States Government or any of its subdivisions 
at any time after the secondary capital has been on deposit for two 
years. If the secondary capital was accepted under conditions that 
required matching secondary capital from a source other than the 
Federal Government, the matching secondary capital may also be redeemed 
in the manner set forth in the preceding sentence. For purposes of 
obtaining NCUA's approval, all secondary capital a LICU accepts from 
the United States Government or any of its subdivisions, as well as its 
matching secondary capital, if any, is eligible for early redemption 
regardless of whether any part of the secondary capital has been 
discounted pursuant to paragraph (b)(2) of this section.

Appendix A to Subpart D of Part 702--Disclosure and Acknowledgement 
Form

    A LICU that is authorized to accept uninsured secondary capital 
accounts and each investor in such an account must have executed and 
dated the following ``Disclosure and Acknowledgment'' form, a signed 
original of which must be retained by the credit union:

Disclosure and Acknowledgment

    [Name of CU] and [Name of investor] hereby acknowledge and agree 
that [Name of investor] has committed [amount of funds] to a 
secondary capital account with [name of credit union] under the 
following terms and conditions:
    1. Term. The funds committed to the secondary capital account 
are committed for a period of _ years.
    2. Redemption prior to maturity. Subject to the conditions set 
forth in 12 CFR 702.414, the funds committed to the secondary 
capital account are redeemable prior to maturity only at the option 
of the LICU and only with the prior written approval of NCUA.
    3. Uninsured, non-share account. The secondary capital account 
is not a share account and the funds committed to the secondary 
capital account are not insured by the National Credit Union Share 
Insurance Fund or any other governmental or private entity.
    4. Prepayment risk. Redemption of U.S.C. prior to the account's 
original maturity date may expose the account investor to the risk 
of being unable to reinvest the repaid funds at the same rate of 
interest for the balance of the period remaining until the original 
maturity date. The investor acknowledges that it understands and 
assumes responsibility for prepayment risk associated with the [name 
of credit union]'s redemption of the investor's U.S.C. account prior 
to the original maturity date.
    5. Availability to cover losses. The funds committed to the 
secondary capital account and any interest paid into the account may 
be used by [name of credit union] to cover any and all operating 
losses that exceed the credit union's net worth exclusive of 
allowance accounts for loan losses, and in the event the funds are 
so used, (name of credit union) will under no circumstances restore 
or replenish those funds to [name of institutional investor]. 
Dividends are not considered operating losses and are not eligible 
to be paid out of secondary capital.
    6. Accrued interest. By initialing below, [name of credit union] 
and [name of institutional investor] agree that accrued interest 
will be:

__Paid into and become part of the secondary capital account;
__Paid directly to the investor;
__Paid into a separate account from which the investor may make 
withdrawals; or
__Any combination of the above provided the details are specified 
and agreed to in writing.
    7. Subordination of claims. In the event of liquidation of [name 
of credit union], the funds committed to the secondary capital 
account will be subordinate to all other claims on the assets of the 
credit union, including claims of member shareholders, creditors and 
the National Credit Union Share Insurance Fund.
    8. Prompt Corrective Action. Under certain net worth 
classifications (see 12 CFR 702.204(b)(11), 702.304(b) and 
702.305(b), as the case may be), the NCUA may prohibit [name of 
credit union] from paying principal, dividends or interest on its 
uninsured secondary capital accounts established after August 7, 
2000, except that unpaid dividends or interest will continue to 
accrue under the terms of the account to the extent permitted by 
law.

ACKNOWLEDGED AND AGREED TO this _day of [month and year] by:
-----------------------------------------------------------------------

[name of investor's official]
[title of official]
[name of investor]
[address and phone number of investor]
[investor's tax identification number]

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

[name of credit union official]
[title of official]

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

0
14. The authority citation for part 709 continues to read as follows:

    Authority: 12 U.S.C. 1757, 1766, 1767, 1786(h), 1786(t), and 
1787(b)(4), 1788, 1789, 1789a.

0
15. Amend Sec.  709.5 by revising paragraph (b)(8) to read as follows:


Sec.  709.5   Payout priorities in involuntary liquidation.

* * * * *
    (b) * * *
    (8) Outstanding Subordinated Debt (as defined in part 702 of this 
chapter) or outstanding Grandfathered Secondary Capital (as defined in 
part 702 of this chapter); and
* * * * *

PART 741--REQUIREMENTS OF INSURANCE

0
16. The authority citation for part 741 continues to read as follows:

    Authority:  12 U.S.C. 1757, 1766(a), 1781-1790, and 1790d; 31 
U.S.C. 3717.

0
17. Amend Sec.  741.204 by revising paragraph (c) and removing 
paragraph (d) to read as follows:


Sec.  741.204   Maximum public unit and nonmember accounts, and low-
income designation.

* * * * *
    (c) Follow the requirements of Sec.  702.414 for any Grandfathered 
Secondary Capital (as defined in part 702 of this chapter) issued 
before [EFFECTIVE DATE OF THE FINAL REGULATION].
0
18. Add Sec. Sec.  741.226 and 741.227 to read as follows:


Sec.  741.226   Subordinated Debt.

    Any credit union that is insured, or that makes application for 
insurance, pursuant to title II of the Act must follow the requirements 
of subpart D of part 702 of this chapter before it may issue 
Subordinated Debt, as that term is defined in Sec.  702.402 of this 
chapter, and to the extent not inconsistent with applicable state law 
and regulation; and


Sec.  741.227   Loans to credit unions.

    Any credit union that is insured pursuant to Title II of the Act 
must adhere to the requirements in Sec.  701.25 of this chapter.

[FR Doc. 2020-01537 Filed 3-9-20; 8:45 am]
 BILLING CODE 7535-01-P